Tuesday, July 31, 2012

Crunch Time.

A quick post is in order. Tomorrow is the day the BTFD crowed has been waiting for. Tomorrow is the day when Ben and co. will save the world like Mario saved Europe. But I think it is still early days for QE in USA but who can say for sure. The danger for the bears will come not from Bernanke, but from the other side of the pond. Like it did in last December. Mario started LTRO and most of us under estimated the liquidity effect it could have on the US stock market. If ECB converts that ESF or “whateverthatshitthingsis” as bank which could then guarantee and convert 1 trillion euro to 7 trillion euro , just by magic. It will not solve anything but will definitely buy time.

More I think about it, more I am convinced that the Fed will open a swap line to ECB or do some other shenanigan and provide them liquidity indirectly and ask ECB to ease instead of staring direct bond buying program.  That will be politically correct as well.

It is really risky to be a bear at this time and yet I do not have the courage to BTFD yet. I still think a major correction is due but ECB has been able to buy good deal of time just by talking. Either way, we are in a range and unless I see a break of the range with conviction, it is not good to let our conviction dictate the trade or investment. Return of capital is more important than return on capital. At least that is what I think. If we must take a trade because we are bored, that would be the dumbest thing to do. Also let us not forget that this is the Presidential Election year cycle.

Bottom line, although I am tempted to short, I am holding on. I may miss an opportunity by being cautious, but I do not mind missing that opportunity just to have surety. Because if the market falls, we can be sure of QE and the subsequent up. That will be easy money.

So trade accordingly. I would advice not to front run. It is better to give up some points at the beginning of a move just to avoid whipsaw and mental agony.

I am out of market action till 8th of August and by that time lots of issues would be clear. I think one more push up is still due before a major correction. I am looking at AUD to top out around 1.07.

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Just how bad is the economy?

The second-quarter GDP numbers came out. The newspapers and Republicans pounced on low growth and anemic job growth. The Democrats rebut growth is growth and tell us of the steady job gains. How bad is the economy?

Economists know that levels matter, and that long-run growth matters more than anything else. I made a few graphs to emphasize these points.

Start with the level (in logs) of real GDP. (This is an update of a graph I saw on John Taylor's blog.)

Looking at levels you see the current awfulness better than by looking at growth rates. GDP declined almost 5% in the recession, but then started growing at a glacial pace, averaging 2.4% since the trough.  We seem stuck in this slow growth trap.

If you distrust trend lines, you are wise. But this one reflects a solid historical pattern. Here is real GDP and the 1965-2007 trend through postwar history.

You can see that the economy has quite reliably returned to the trend line after recessions.The 1950s had a steeper trend, but there too the small recessions were followed by catchup growth.

Here is what the recovery is supposed to look like (Again, idea stolen from John Taylor, except I'm using trends rather than "potential GDP'' which I distrust.) 

To be fair, I fit the trend through 1980, so I would not use ex-post information. You see that after the severe 1980 recession at the even more severe 1982 recession, the economy recovered to trend, by posting a few years of 6% growth.

The tragedy is poorly expressed in growth rates. By 1987, the economy was back on the prior trend line. We are now 14.5% below the trendline, and each year that goes by like this we lose another half a percent. The average person in the economy is producing 14.5% less, and earning 14.5% less, than if we had followed the path following the 1982 recession.

That's a lot -- and a lot more than the litany of quarterly growth rates suggest.

I used trends, rather than the CBO potential output. If you read how they make it, you're likely to do that too. But here is the same graph contrasting my trend and the CBO's potential

This is tragic. The CBO is giving up on us. The CBO potential, which goes towards a 2.35% long run growth rate, says that what we are seeing now is the new normal. All we can hope for is a modest recovery, and then anemic, sclerotic growth forever after that. The difference between 2.3% and 3.0% adds up fast as the years go by. (And the CBO has been bending the trend line down steadily as the recession goes on. Back in 2005, it's "potential" looked like my "trend." They didn't see a permanent downward shift in level or reduction in growth rates. Look for "potential" to keep declining.)

Well, perhaps the CBO is doing its job as forecasters, saying "here is what will happen if you continue down the present policy path," not "here is where the economy would be if you adopted growth-oriented policies."

What about employment? I find employment more significant than unemployment. Unemployment means job search. It means people answer a survey saying they don't have a job, and are actively searching for a job. It does not count all the people who gave up, or went on disability (effectively ending their careers), early retirement, or are just living in Mom's basement and playing video games. (I don't mean to make light of it. That may be the most tragic, as the chance to accumulate skills is lost.)

Here's a good summary measure, the ratio of employed people to the population

This is really tragic. Employment declined by about 7 million people, from 63% of the population to about 58%. And it has stayed there ever since. The "job gains" you hear about in the news are just barely keeping up with population. As we are about 14% below trend and slowly losing ground, we are 7 million jobs short and sitting there too.

The link between employment and output is productivity. To keep the numbers simple here, I made plots of output per worker. Output per hour, and corrections for demographics and capital use are better, but this is simpler and works about as well. Here is a graph of productivity.

I crammed a lot of information in this graph. The first thing to notice is the behavior in the recession and now. There was a dip in productivity -- output fell more than the number of workers fell. But it has since recovered.

In the short run, capital doesn't change much, so as a rough guide you make more output when you hire more workers (or increase hours) and vice versa. So, GDP = Productivity x workers. To get more workers, we need to make a lot more GDP. The lackluster GDP growth is the other side of the terrible employment coin.

There's more in the graph. In the long run, rising productivity is behind everything good in the economy. It's what gives more income per capita. Rising productivity is the only hope for paying for entitlements and getting out of our deficit trap. It's the main hope for long-run GDP growth, after the empolyment-population ratio reverts to where it should be. Rising productivity comes from new ideas, new companies, new ways of doing business. It isn't all pleasant. Lots of incumbents lose out. Rising productivity is the core of a "growth" agenda as economists understand the word. 

You see in the graph that something terrible happened in the 1970s. Productivity, which was behind the large postwar boom, slowed down to a glacial 1% per year. 1982 marked a break in that as well. Productivity  started growing 1.69% per year, producing the boom of the late 1980s and 1990s, and incidentally producing large Federal surpluses.

OK, but the far right of the graph doesn't look so good does it. Here it is, blown up, with a 2003-today trend marked in as well.

This is an economists' horror movie. Yes, productivity did rebound. But it seems to be growing slowly as well.

The trends are an economists' horror movie. Real GDP seems not to be recovering at all -- no period of swift growth to go back to a trend. We seem stuck at 2.4% growth forever. The CBO is giving up on us too. Employment will not recover as a fraction of population until the economy recovers. We seem stuck at low employment forever. And now we seem headed to a 1970s productivity slowdown as well.

I don't view this as contentious, outside of Presidential politics. Paul Krugman thinks the economy is pretty awful too.

What to do? If only it were so simple as to have the Fed print up another two trillion dollars, or have the Treasury borrow another $5 trillion and blow it on stimulus boondoggles. We're stuck in sclerotic growth, and to everyone but a few die-hard extremists, that means growth-oriented policies are the only way out. 

Disclaimer. Yes, I know there are better ways to measure all this, especially productivity. This is an attempt to paint the basic picture using the simplest numbers. The message is, look at the levels and look at the trends. If you do that with better data, you will have gotten the message.

Data are from the St. Louis Fed's wonderful Fred database, series GDPC96, GDPPOT,  EMRATIO.

Folly in Massachusetts

Health care costs have gone through the roof since Massachusetts adopted its own version of Obamacare during the reign of Governor Mitt Romney.  The original legislation was bi-partisan.  Now, a bi-partisan majority of the Massachusetts legislature is poised to 'fix' the cost problem.  Pay heed, because this is where the national Obamacare is headed.

The legislature will vote today to remove $ 200 billion in costs over the next 15 years.  How will they do this?  By simply telling hospital and doctors that they are now going to pay less for health care services.  Seems so simple doesn't it.  Why don't we do that with everything?  Heck why not just make health care free in Massachusetts by telling hospitals and doctors that we just won't pay anything at all.  That way, Massachusetts' version of Obamacare won't cost anyone anything.

Monday, July 30, 2012

ECB May Be Preparing to Cross the Rubicon

This week, the European Central Bank (ECB) is going to announce policy measures to bolster the Euro and the bond markets in Spain and Italy (among others).  All of the available measures "Europeanize" the problems of Spain and Italy.  The real significance of this will be a disaster for Germany.  This won't be apparent in the immediate aftermath of the ECB policy announcements.  The instant reaction will be joy in Euroland and rallies in world markets. 

That happiness will gradually give way to the realization that nothing has changed in Europe.  The problems in Greece, Spain, Italy, and Portugal will continue to get worse, though, briefly, yields on their sovereign debt will be lower.   The idea that simply bringing in one more guarantor will solve the problems of Europe is almost laughable.  The media and the world's economists should be ashamed of themselves for believing that there is anything that ECB can do by itself to solve Europe's problems.  This is the same absurdity as believing that the Fed can offset the damage to the US economy being done daily by the Obama Administration.

Europe's problems stem from overwhelming levels of sovereign debt, absurd entitlement programs, and stultifying regulation of business and employment.  Nothing the ECB is mulling have anything to do with these problems.  All Draghi and the ECB are proposing is a temporary liquidity fix that effectively takes reform off the table.  This has been the strategy from the beginning -- find a way to increase the amount of sovereign debt without addressing the root cause of the problems of the Eurozone.  The ECB is leading Europe down the road to economic and political disaster.  One has to wonder if the US will take the same path.

Sunday, July 29, 2012

Doctor Shortage -- Wonder Why?

The NY Times has an article by Annie Lowrey and Robert Pear today on the growing shortage of doctors in the United States.  Now, logically, if you had a shortage of something what would you think is causing it?  This article seems to have no clue.

Let me offer some suggestions.  Try medicare and medicaid for starters.  Whenever the government gets involved, people tend to head for the exit.  Basically medicare and medicaid funding is based upon the premise that doctors would prefer to lower their own standard of living in the future and take on more patients.  These programs assume that doctors would much prefer to deal with patients who cannot afford to pay them and have little or no incentive to take preventative health care seriously.

Why is there less interest in becoming a doctor?  The combination of a future dealing with folks that cannot and will not pay, a government that is supposed to pay but is broke, a job that is overburdened with government red tape and a lifetime of defending yourself in court against frivolous lawsuits, is enough to convince smart and talented people to opt into some other profession.

The future of American medical care can be seen in modern Greece.   Hospitals are corroding, patients cannot get care of any kind at any price, and basic medicines are sold mainly on the black market.  That's where government health care takes you.

Obama said during the election:  "Why is America the only county in the developed world who cannot afford health care for all of its citizens?"  Interesting question.  The answer:  UK, Canada, France, Germany, Italy, Spain, Greece, among others can't afford health care for all of its citizens either, unless there are enough bondholders out there to provide the funding.  But that only works until bondholders wise up, as they are now doing in Europe.

European countries cannot afford government health care.   No one can.

Only free markets can deliver quality health care.  Everything else is simply fraud and will in time produce the result that we see playing out today in modern Greece.

Saturday, July 28, 2012

Fear Of Missing Out!

It was a wild week for the market and a grueling one for me.  Let us start by reviewing from the last post:

“Readers know that I am leaning bearish. As a bear, when I see that everyone around is agreeing with me, it scares the day light out of me. If everyone agrees and everyone is right, it would be so easy to make money in stock market. Alas, it is never that easy. “
“Today I closed my short position because I would not be able to monitor it regularly, may be a little too early and left some profits on the table, but hey, no regrets.  The big game is still on and I will be there. For now I think a bounce is brewing, which will kill few bears and trap few more bulls.”
However, for now when everyone has jumped on to the bear side, I would like to step back and wait for a while. I do not trust these bots and dark pools. Moreover, FX has not dropped along with Apple. Euro is still above 1.2062 and AUD has not broken 1.02 yet. They will break down very soon, but for now, the slide has halted.  Short term, the indexes are over sold. This week 173 firms representing 37% of S&P will have their ER. So caution is warranted. “

Now you be the judge.

How do I read this market? I am just amazed that they are able to manipulate the market so easily. As if just by mere wishing. And there are suckers every time ECB or The Fed or their pets mention QE or some sort of bond buying program. Or just simply says, “believe me”. We definitely are walking on quick sand and people still fall for the same BS over and over again.

How do I invest or trade in this market? I do not invest in this market and have been largely in cash for well over two months now. I kept writing that preservation of capital is most important in this environment. I believe that the fundamentals do not justify the stock market going up and requires at least a 20% correction before we can see value again. The sovereigns are struggling and on the verge of bankruptcy or default. The Powers That Be are out of tools and are applying band aid after band aid and are praying each day that passes. The markets are behaving like a terminally ill patient in ICU, who is given blood transfusion and steroids just to keep it alive. When given the shot, it stirs and sits up but the effects of these transfusions are getting shorter and the patient falls back in coma shortly thereafter. At some point, the patient will die.

Understanding that fundamental concept and knowing that manipulators with the active backing of a corrupt governmental system are playing havoc, will help us remain safe. But there are still people out there ( I know, I get comments and emails!) who have faith in the system, who thinks that the market is bigger than the ability of the TBTF banks to manipulate and those who think technical analysis alone will help them make money in this quagmire. Even God cannot save you, guys.

You may ask, very well, now that we know that it is doomed, why are we not short with everything or as Prechter says, short will leverage? Let me explain that with an analogy. Its rainy season and rain is expected. The weather man said at night that tomorrow there will be sun shine. You get up in the morning and see that it is not raining but the sky is over cast. What do you do? I would still take an umbrella while going out but not open it. The situation is somewhat similar here. The dark clouds are hovering over us. The weathermen ( B and D) are telling us that it is not going to rain and everything will be fine. So we remain prepared for the worst but do not open the umbrella either.  I have said repeatedly in the past, never under-estimate the power of these crooks. They can and will distort the market in the short term. TA is powerless in the face of these master puppeteers.  But I take my cue to get out of any short position from TA. Please don’t ask for any particular indicator because there is none. It is a combination of many indicators and judgment call. At the end of the day, we make the call and hope to be lucky. When I got out of the short position on 24th July, I was thinking maybe I got out too quickly. But I was sure of the coming squeeze and I sent out many tweets to that effect.

So what’s next? I think the risk remains to the downside. Against everything negative, low revenue growth,  earnings call misses, global slowdown, looming sovereign default of Eurozone countries and massive , unsustainable debt by USA, only thing holding up the market, is the hope that Bernanke will bring QE on August 1st. By front running QE it is making Bernanke’s job that much difficult. When DOW is 13000, what justification can he have to pump more money? Isn’t the QE been already priced in? Even if QE comes on 1stAugust, which I doubt, how far will it push the market up when the economy is on stall speed at 30000 ft above the ground.  Personally, I do not think we will have the QE this time. Because it will be politically suicidal for Ben when “Audit The Fed” bill has passed congress and the Democratic hack Chuck Schumer is openly urging him for action. Everyone knows that Ben’s is the only game in town and Republicans will tear into him. But It will be there before election. If what I am thinking works out correctly, can you imagine how disappointed the market will be on August 1st? But we cannot be certain.  It is a bad idea to gamble with the retirement savings. If we must play, then take a calculated risk of losing a very small portion of the portfolio and try out to see what happens. But I would advice strong risk management.  Even if we miss this down opportunity, we can be sure of the easy money opportunity coming next because then there will be QE and we can catch the ride up risk free. 

I want to emphasis that this is not the last opportunity and if we have the power dry, (Cash) we can shoot when the ducks are in line. Right now, they are scattered all over. If we allow our conviction and greed to override caution, we will get hurt.

So let the markets go up for the next two days. Some indicators are over bought, some are not. But over bought can remain over bought for a long time and if you want to short just looking at RSI, that would be a mistake. Wait for the short squeeze to end and momentum to fade. Above all, just remove that “fear of missing out” from your head. If no QE 3 on August 1st, then the road is clear for the bears.

Thanks for all the wonderful comments and emails. The coming week is also going to be tough for me but I will tweet as soon as I get an opportunity. So join me in Twitter (@ BBFinanceblog). But the most important thing for today is to enjoy your weekend with your loved ones. Crooks and their manipulated markets can wait.

Friday, July 27, 2012

Myths and Facts About the Gold Standard

This is a July 28 2012  Wall Street Journal OpEd with a few of their cuts restored.

While many people believe the United States should adopt a gold standard to guard against inflation or deflation, and stabilize the economy, there are several reasons why this reform would not work. However, there is a modern adaptation of the gold standard that could achieve a stable price level and avoid the many disruptions brought upon the economy by monetary instability.

Let's start by clearing up some common misconceptions. Congressman Ron Paul's attraction to gold, and Federal Reserve Chairman Ben Bernanke's biggest criticism, is that a gold standard implies an end to monetary policy and the Federal Reserve. It does not.

Under a gold standard, the U.S. Treasury could exchange dollars for gold at a price of, say, $1,000 per ounce. In practice, that means banks would freely exchange their dollar accounts at the Fed for electronic claims to gold.

Nevertheless, the Fed could still buy government debt or other securities in exchange for newly created reserves, lend its reserves to banks, and set interest rates on its loans to banks. A gold standard would not stop the Fed from being the lender of last resort, bank regulator and financial crisis firehouse. For better or for worse.

This isn't theory. It's history. The Bank of England operated an active monetary policy under a gold standard for two and a half centuries. And the U.S. Federal Reserve was founded under the gold standard in 1914.

Moreover, the history of the gold standard is not just happy centuries of price-level stability. It is also a long history of crises, devaluations, suspensions of convertibility, and defaults on sovereign debt.

Debauching the currency—the great bugaboo of gold-standard champions—will always remain a temptation: If the government promises $1,000 per ounce and a recession comes along, it can say "we need to stimulate. Now it's $1,100 per ounce." In fact, such devaluation would be a much more effective way of deliberately causing inflation than today's zero interest rates, twists, and QEs. The left should be advocating a gold standard so they can devalue it! The success of a gold standard in achieving stable prices depends heavily on its rules and commitments against devaluation—rules honored in the past, until they weren't.

A gold standard also does not eliminate debt crises or debt-induced inflation. No monetary system can absolve a nation of its fiscal sins.

Imagine a government with $15 trillion of debt, $2 trillion of money outstanding, and $2 trillion of gold reserves. Then its debt comes due. If the government can't raise tax revenues, cut spending, or persuade investors to lend against credible future budget surpluses, it must print $15 trillion of cash not backed by gold, devalue the currency, or default on the debt. Worse, if people see that outcome looming, they will run to change their money for gold ahead of time, causing a crisis as the government's gold stocks run out.

A successful gold standard needs a clear way to deal with such crises. Here is one plan: Instead of printing unbacked cash, the government lowers the coupon payments on its bonds and notes—similar to the way corporations can cut dividend payments. Of course, this is effectively a gentle "default" in times of stress. But at least a fiscal impasse would not lead to a devaluation of the currency. Other plans are possible. Some clear expectations of how sovereign fiscal stress will be resolved is vital. Europe is now paying the price for its absence.

Yet if you don't expect magic, you are not disappointed by its absence. With these warnings, a modern version of the gold standard is attractive.

Why not the old version? Most of all because the value of gold is poorly linked to other prices in the economy, which is what we want to stabilize. Fixing the price of gold today would do little to control the general price level. There are two big reasons for the disconnection between gold and other prices.

First, in the past, inventory demand for gold coins linked the value of gold to other goods. If prices rose, people needed to hold more gold coins to make transactions. They would spend less on other goods and services, which brought prices down again. But that channel is absent in a modern economy. Since people could buy and transfer gold deposits with a click of a mouse, nobody would have to hold substantial inventories. And we are not going back to a 19th-century payments system based on lugging around gold coins.

Second, features that made gold such good money in the past—it is hard to produce and has few other uses—make its price especially badly connected to other prices. The relative price of gold has skyrocketed, yet few of us abandon our jobs to go mine gold, and few of us substitute buying gold to buy other things. These economic pressures to realign gold and other prices are nearly absent.

The solution is pretty simple. A gold standard is ultimately a commitment to exchange each dollar for something real. An inflation-indexed bond also has a constant, real value. If the Consumer Price Index (CPI) rises to 120 from 100, the bond pays 20% more, so your real purchasing power is protected. CPI futures work in much the same way. In place of gold, the Fed or the Treasury could freely buy and sell such inflation-linked securities at fixed prices. This policy would protect against deflation as well as inflation, automatically providing more money when there is a true demand for it, as in the financial crisis.

The Fed currently interprets "price stability" to mean 2% inflation forever. A CPI standard could enforce 2% inflation. But why not establish a price-level target instead? The CPI could be the same 30 years from now as it is today, and long-term contracts could carry no inflation risk. That is the real spirit of the Gold standard.

The Fed's main objection to a price-level target has been that 2% inflation gives it more stimulating power. With 2% inflation, setting a nominal interest rate of zero allows the Fed to achieve a negative 2% real interest rate, which may encourage people to borrow even more than at a zero real rate. Whether such interest-rate stimulation is needed, wise, successful on average, and worth its cost of perpetual inflation is the key question. I think not.

More deeply, the history of discretionary, shoot-from-the-hip monetary policy is one misstep after another, and of turbulence induced by guessing what the Fed will do. Since the demise of the gold standard, thoughtful economists have been searching for a replacement rule—Milton Friedman's money-growth rule, for example, John Taylor's interest-rate rule, and inflation or nominal GDP targets. Rules advocates understand that the economy works better overall with stable units, rather than the government manipulating units to trick us into buying more or less. A price-level standard is a firm rule.

In sum, a rule like the CPI standard could achieve the price-level stability that motivates the longing for a return to gold, avoiding the limitations of an actual gold standard in the modern financial system.

Mr. Cochrane is a professor of finance at the University of Chicago Booth School of Business, an adjunct scholar at the Cato Institution, and a senior fellow at Stanford University's Hoover Institution.

Update: A few comments, such as John Tamny in Forbes interpreted
Nevertheless, the Fed could still buy government debt or other securities in exchange for newly created reserves, lend its reserves to banks, and set interest rates on its loans to banks. A gold standard would not stop the Fed from being the lender of last resort, bank regulator and financial crisis firehouse. For better or for worse.
to be a full-throated endorsement that we need a Fed to do all these things. Alas, the WSJ cut the "for better or for worse," which clarified that. But even without, I'm just saying gold won't stop the Fed, not that that the Fed must fulfill these functions. Actually, I'm quite a skeptic of the idea that the Fed must fulfill all these functions -- the first draft said "Gargantuan financial regulator" too, the Fed's main new function about which I'm really skeptical.  Words are at a premium in opeds, alas.

The big point here, though, is that the question of monetary standard is 99% distinct from these other activities of the Fed. Both are worth discussing. But they are separate issues.

Sandy Weill is Wrong

Sandy Weill is wrong.  Separating commercial from investment banking is not a good idea.  Glass-Steagall was always foolish and the 1999 law that overturned it was an intelligent move.  The financial crisis was not related to the abolition of Glass-Steagall.

I agree that taxpayers should not backstop proprietary trading.  I agree 100 percent with that and yet I think the Volcker Rule is ridiculous.  How do you reconcile those views?  Simple, get the taxpayer out of the way.  It is one thing to guarantee $ 10,000 checking accounts, but the Fed guarantees, effectively, all the creditors of our banking system.  No creditor, including unsecured bond holders, has ever lost a penny when an FDIC guaranteed bank failed.  They bail out everyone, even though there is absolutely nothing in the law governing the FDIC guarantees that sanctions such activity.  The FDIC puts the taxpayer at risk -- after the fact -- with no legal authority whatsoever.  That's what Sheila Bair's FDIC does, in reality.  They extend the law to give themselves powers that the law never granted them.

What should be done is to roll back the FDIC guarantees to $ 10,000 per individual (not per account) and get the taxpayer out of the way.  Secondly, let investment banks, like JP Morgan, Citi, Goldman Sachs, whatever, fail when they can't make it.  Get the taxpayer out of the way.  Nothing justified the foolish TARP bailout.  It was bad policy then and would be bad policy now. (Whether or not it made money or not is irrelevant.  It created a moral hazard problem that will not go away easily).

By providing all these taxpayer guarantees, you rationalize the absurd regulatory regime that Dodd-Frank is ushering in.  It  might be simpler to just pass a law that says average Americans can no longer borrow money legally and if the average American wants a credit card, forget it.  That would be a lot cheaper and accomplish pretty much the same thing as Dodd-Frank.

Providing taxpayer guarantees where they are completely unnecessary and then regulating the financial service industry into morbidity simply sucks the life out of a free enterprise economy.  The result is what you see today in the American economy.  We have turned our banking system into a state run banking system modeled after the system that the Chinese are now trying to discard.  Good for them; our bad.

Thursday, July 26, 2012

The Fed and The ECB

It's amazing what people will believe.

With the US economy sledgehammered by an unfriendly legal, tax and regulatory environment, the Fed is going to be able to do something about it?  What?  Lower interest rates?  Buy bonds and expand the nation's indebtedness?  Are our debts too low that they need expanding by the Fed?  How do you convince a businessman to hire someone in this environment?  Have the Fed buy Treasury bonds?  Is this a serious discussion?

How about Europe?  Mario Draghi announces that the ECB will do everything in its power to keep the Euro from falling apart.  Really?  By lending countries more money?  Is that the ticket?

No macroeconomic solutions will solve the problems in the western economies.  The microeconomic situation is not favorable for hiring.  Employees are, relatively, far too expensive compared to other factors of production and compared to countries in Asia where labor is not loaded up with government goodies that makes them toxic to employers.  So, western labor is doomed.  It's that simple. 

The only macro policy available is to make drastic cuts in entitlement programs, something no one is even considering doing.  Absent cuts in entitlements, no western nation can survive bankruptcy.  It is simply a matter of time.

So what role do these central banks play?  In reality, they have about as much to do with the real economy as astrologers (who are much more entertaining).  Central banks can impact the money supply and that's about it.  Increases in liquidity don't help economies that are mired in sovereign debt problems, though it may buy some time until everyone figures out the total irrelevancy of the central banks.

There is nothing the ECB can do about the sovereign bankruptcies that are in Europe's future, except perhaps hasten Germany's inclusion in the list of those who will ultimately default.  The real reasons for the current problems are: 1) over-regulated and over-taxed economies; 2) entitlement programs for retirement and health care.  No one is discussing fixing either 1 or 2.  Since those are the main drivers of the current problems, it is easy to see where this is headed and the central bank conversations are beside the point.

Krugman, Delong and Inflation

Quite a few commenters and correspondents have asked me what I think of the latest blast, "What Chicago Doesn't Know" from Krugman and the obliquely-titled "The need for a higher rate of increase in prices" from Brad DeLong.

Yes, I've been worried for some time that our current debt could lead to inflation. And yes, that inflation has so far not happened, and US government interest rates remain low.

Well, they made fun of Friedman when he said in 1968 that inflation was coming. They made fun of Greenspan when he said in 1996 that stocks seemed awfully high, and stocks went up for a few more years. They made fun of Shiller when he said in 2005 that house prices looked awfully high, and they went up for a few more years. Greek interest rates were really low in 2007.

Krugman asks whether I have realized I have the "wrong model." My model is arithmetic.

The Federal Government has about $15 trillion of formal Federal debt outstanding. It has uncountable trillions more unfunded promises and credit guarantees. Right now it takes in about $1.5 trillion and spends about $3 trillion a year.

We must, by arithmetic, either pay off this debt, default on it, or inflate it away. Which will we do?

I hope we pay it off. The only hope for paying it off is to return promptly to strong long-run growth, and to reform entitlements. Doubling Federal revenues by raising income tax rates on "the rich," or by cutting discretionary spending by more than $1.5 trillion per year, forever, seem unlikely.  That's arithmetic too.

But I'm not optimistic. Growth economics is unanimous: You get such growth only from higher productivity, and from letting new innovative competitors dethrone established interests. That's not where our economy is going. Keynesian stimulus doesn't give 10 or 20 years of sustained growth, even in Krugman's "model." 

Defaulting on the debt means financial catastrophe.* And it doesn't solve the entitlement problem. Bad as our past debts are, our projected deficits are worse. 

I happen to dislike inflation. Krugman and DeLong are all for it. They must have been smoking better weed in the 1970s.  But I notice that lots of people seem to agree with them. So, it seems to me that inflate it away, and print money to pay the bills,  remains a decent possibility. 

That's arithmetic. I wonder which part of arithmetic Krugman would have me abandon.

What Chicago does "know" is scholarship. DeLong cites a transcription from discussion at a long ago conference. Krugman doesn't even bother to have an RA dig up a direct link so he can pretend he's reading anything but DeLong. At Chicago, we take a little time to research what people actually have to say before calling them "numbskulls" on the New York Times' website (Krugman) or less than "half-intelligent" (DeLong).  You know what I think of that. Why you continue to read these guys is a mystery to me.

For those of you  infected with that old-fashioned spirit who want to  read what I really wrote on the subject, let me suggest Inflation and Debt in National Affairs, Understanding Policy in the Great Recession in the European Economic Review, or even an accessible  Wall Street Journal OpEd as a good starting place.

All these sources make it quite clear that I view inflation is a danger, not a forecast. The popping of "bubbles" is hard to predict. We're sitting on an earthquake fault. When or if it goes is anyone's guess.

I also pointed out that inflation can come quickly, as it surprised the Keyensians of the 1970s, and as its quick disappearance surprised them again in the 1980s when the US returned to growth-oriented policies.

You can't repeal arithmetic. That which is unsustainable cannot last.

Update 2: A correspondent reminded me that I forgot the obvious zinger, from Alex Tabarrok.
Paul Krugman (March 11, 2003): …I’m terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits. …we’re looking at a fiscal crisis that will drive interest rates sky-high….But what’s really scary — what makes a fixed-rate mortgage seem like such a good idea — is the looming threat to the federal government’s solvency. …How will the train wreck play itself out? ….my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt...
See Alex's post for more, including the Krugman response. I'll promise to hammer away at Romney's budgets just as hard, if his promises do not materialize. 

*Update: I was trying to keep it short (for once), and focused on the Krugman/DeLong affair, but a few commenters pointed out that in my own writing I equate inflation and default, that I've argued that Greece should default, and I've argued for forms of debt that make it easier for the US to default. So.. what's this calamity with default?

At issue here is really what our leaders will choose to do. When they have not chosen to grow, so it's down to default or inflation, will they choose default or inflation? Now, though I've been arguing for a Greek default for almost 3 years now, European leaders clearly consider that a "catastrophe." Yesterday's announcement that the ECB will do anything to "save the euro" -- swallowing the trope that sovereign default means the end of the euro -- is essentially an announcement they'll choose inflation over even Greek default. Let alone France. Or Germany. 

Evean a Greek default will not be painless. A large (we need tens of trillions) and unexpected US default will be financially much more chaotic. All those too big to fail banks holding treasuries go under.  The US loses all its "reserve currency" status. It's a big deal.  The Fed is talking about printing money again to buy mortgages because it doesn't like the current once in a century deal on mortgage rates (for those who can get them). Will the Fed really refuse to monetize in a rollover crisis and force the US to default? In my view, not a chance. 

Finally, as I did point out briefly, a default might help Greece, but our big fiscal problem is the looming entitlements not (just) paying off our stock of existing debt. Defaulting on all the debt doesn't solve that problem. And after  a default, the US will have a lot of trouble borrowing, so it will have to pay for entitlements by just printing more money. So the default won't even stop inflation.

All this is a long way down the road, remember. And a return to growth means none of it has to happen.

To Mr. Krugman, we are sailing in smooth waters, nobody has seen an iceberg yet, so it must be safe, so stoke the boilers.  All I am saying is, there are icebergs out there in the middle of the night. Let's distinguish forecasts from risk management.

Wednesday, July 25, 2012

A good Greek story

Matt Jacobs sent along a link to a great story from Greece on Reuters,  "Lessons in a shrimp farm's travails." The whole article is worth reading, but here are a few tidbits:
Just over a decade ago, Napoleon Tsanis set out from Sydney with 11 million euros and a dream to build a shrimp farm in his ancestral homeland... What he got was years of wrestling Greek bureaucracy and a court battle with a civil servant...

it's the civil servants that are throwing you into this labyrinth on purpose," Tsanis, 44, said. "The law gives them the latitude to delay you or punish you."

...A process that would take just two or three months to complete in Australia got stuck in a maze of official opinions and permits across several ministries. Greek politicians assured him that the paperwork would be done in 18 months, but that date came and went with no progress.

... then, though, another law change that sought to keep aquaculture projects small meant Tsanis had to break up his farm into sections to go ahead.

...One of the main obstacles to more investment is the legal jumble that dictates how Greek businesses work. Even government officials admit the lack of clear laws and the endless requests for opinions, studies and permits are there to give work to unionized specialists.

"There are whole businesses and technical offices employing engineers and experts specifically for the purpose of licensing," said Tsakanikas at the IOBE think tank.

Red tape often leads to corruption.

Tsanis said he steadfastly refused to bribe anyone. In one incident, in 2005, he appealed to a minister in Athens to get a permit unstuck. "The minister called in the public servant who was refusing to give us the permit and ordered him to issue it the next morning," he said, declining to specify the minister or ministry involved. "When we went back to get it, the civil servant told me: 'Australian, that guy is a politician and he'll be gone tomorrow, but I'll be here waiting for you.

The only European Union country not to have a fully functioning land registry - despite collecting EU funds to set it up and then paying penalties when it failed to do so - Greece still lacks a comprehensive zoning law and building rules.

"Several interests prefer a fuzzy system they can manipulate," Papaconstantinou said. "We must simplify building permits, which are a hub of corruption."

After his shrimp farm opened, Tsanis had hoped to build a 120 million euro golf resort. But when the local authorities decided they didn't want it, he opted not to fight.

This story rings with several of the themes on this blog, and I can't resist hitting you over the head a bit.

The nature of "regulation." In the popular discussion "regulation" means a wise system of rules that keep order in markets. Here is regulation in action.

There are different kinds of regulation. This is "regulation" by a deliberately vague forest of laws and rules, which give great discretionary power to the functionaries who administer those regulations. And clearly, they and their cronies like to keep it that way.

This is not "regulation" by clear rules, which you can quickly appeal in court if they are misapplied. The lack of title, zoning, and property rights falls in the same bucket.

Let us not feel superior, fellow Americans. This is the system of regulation to which we are crashing. Dodd Frank and Obamacare look a lot like Greek zoning laws, as far as the power of appointed officials vs. the rule of law are concerned.

Currency. Many of my macroeconomics colleagues think the main problem with the Greek economy is an "overvalued" exchange rate and thus too high wages. Rather than see high unemployment drive down wages that are "sticky" by some magic mechanism (even Paul Krugman admits he doesn't really know why wages are "sticky"), they would like to see Greece have a Drachma to devalue, or what the heck, devalue the whole euorozone, as even Anil Kashyap and Martin Feldstein have recently argued, along with Austan Goolsbee and more reliable liberals.

How much of Mr. Tsanis' troubles does this analysis describe? Not zero, in fact. The article says
He survived, he said, thanks to the 30 percent appreciation of the Australian dollar versus the euro in recent years
He doesn't even mention wages. I guess you have to open a factory before you have to start paying people.

You assign a percentage. Add up whether, faced with this story, the first thing you want to do is devalue the currency, or maybe if as economists we should be writing opeds about "shock liberalization" instead. Decide if this economy will liberalize on its own, given time, and "breathing space" by more German subsidies.

Micro vs. macro. In Greece's slump, as in ours, how much is this, "microeconomic" problems solveable only by micro liberalization, and how much is "macroeconomic," solveable by central banks, "stimulus" programs and the like?

Mandated Loan Forgiveness

The Obama Administration policy of forcing loan foregiveness on private market lenders began in the mortgage market and is now being extended into the student loan market. Such loan foregivess essentially rips up legitimate contracts and replaces them with the arbitrary whims of government, deciding who should pay up and who needn't bother.

 Lenders aren't stupid and they have memories. It is incredibly difficult now for middle America to get mortgages thanks to Obama Administration loan foregiveness policies. Why? Because lenders know that politicians can, at their pleasure, rip up the contracts and deny the lenders the payments they are entitled to.

So, why lend to the class of Americans that the Obama Administration seems to want to provide loan foregiveness for? No reason I can think of. The next group that will find themselves out of luck when seeking loans will be students, especially the demographic now escaping their obligations thanks to the President.

Tuesday, July 24, 2012

Is The Dream Over?

Is the dream over? The Apple of the eye missed! The world must be coming to an end! So what next?
At this point of writing, ES futures are down about 6-7 handles. Not that bad considering almost all the hedge funds are loaded with Apple to the gill. QQQ fell below $ 62 and is trying to recover. But Apple is down 5% after hours.  It will now fall for much of August and below $ 500 is not unimaginable. I had this discussion with one of our dear reader in the not so distant past when I wrote that Apple is looking ripe for a fall. You can possibly find it in comment section in one of the older posts.

Readers know that I am leaning bearish. As a bear, when I see that everyone around is agreeing with me, it scares the day light out of me. If everyone agrees and everyone is right, it would be so easy to make money in stock market. Alas, it is never that easy.

Today I closed my short position because I would not be able to monitor it regularly, may be a little too early and left some profits on the table, but hey, no regrets.  The big game is still on and I will be there. For now I think a bounce is brewing, which will kill few bears and trap few more bulls.

The day started like I wrote yesterday. Tested the lows of yesterday and broke below. But when the BTFD crown came, they found that the drinking bowl is missing today. Just like I said yesterday but I did not expect it to happen so soon.  I was expecting a bounce and WSJ hack did float the rumour before the close. Only Apple spoiled the party. But we may still get a bounce just to squeeze the shorts. Need to wait few days before loading on the short side again. As my regular readers know, my target is 1200-1220 in SPX.  I remember someone asking me couple of days back whether I still believe in my target! Someone (Anonymous) also called me crazy because I had taken position in FAZ and TZA and other leveraged shorts. There you go.

However, for now when everyone has jumped on to the bear side, I would like to step back and wait for a while. I do not trust these bots and dark pools. Moreover, FX has not dropped along with Apple. Euro is still above 1.2062 and AUD has not broken 1.02 yet. They will break down very soon, but for now, the slide has halted.  Short term, the indexes are over sold. This week 173 firms representing 37% of S&P will have their ER. So caution is warranted.

By the way, I read somewhere that GS is calling for a bottom of the housing market. You know the drill. It is now confirmed that housing has much more to fall.

Last thought for the day, I sent out tweet yesterday that bad things are going to happen. If you have missed it, here is the link again. Hendry: ‘Bad Things are Going to Happen’ - US Business News - CNBC

From tomorrow I may not be able to do regular post for couple of weeks. But I will definitely try to scribble few lines if something interesting happens. Thanks for reading http://bbfinance.blogspot.com/. Please join me in Twitter (@BBFinanceblog) and do re-tweet, post it on wall and share with your friends and circle.

Six policies from NPR

"Six policies economists love (and politicians hate)" From NPRs Planet Money

The Planet Money team got together a group of economists from widely differing political backgrounds, and came up with this very nice list of policies the economists all agreed on--which are all regarded as hopeless in the standard political debate.
  1. Eliminate the mortgage tax deduction.
  2. End the tax deduction companies get for providing health-care to employees.
  3. Eliminate the corporate income tax. Completely.
  4. Eliminate all income and payroll taxes. ... Instead, impose a consumption tax.
  5. Tax carbon emissions. 
  6. Legalize marijuana.
It is often perceived that economists don't agree on anything, or that economists are pretty much just like everyone else in the spectrum of their policy views -- that economics training really has no clarifying effect on one's worldview. This list is a nice counterexample. We could probably safely add eliminating all agricultural subsidies and free trade.

(I quoted the proposals as above. In fact, the health tax exemption applies to individuals, and it's for employer-provided group health insurance, not care.  Hat tip, I found the NPR story in a nice post on econlog)

Monday, July 23, 2012

Powell Post

Jim Powell has a very nice article at Forbes,with his trademark combination of thoughtful comment and detailed facts.

I love his litany of ways that the government subsidizes and taxes the same activity. Hmm, I wonder what maximizes the need of all sides to come ask for favors. It's a great list for those of you who think that regulation in practice achieves much of anything coherent:
Government is actually a big bureaucracy run amuck, a vast tangle of contradictions that often have harmful consequences.  For instance:
  • Politicians scold citizens for consuming too much sugar, but the government provides subsidies for producing high fructose corn syrup that’s widely used in sodas, cookies and other sweets.
  • Taxes are higher because government subsidizes some farmers to grow crops and subsidizes other farmers not to grow crops.
  • Government subsidizes home ownership and restricts the number of homes that can be built.
  • Politicians criticize business executives who take on too much debt, but government encourages debt by providing tax deductions for interest (no deductions for equity capital), and of course the government itself is deeper in debt than anybody else.
  • Politicians complain that companies invest so much money overseas, but the government imposes a 35 percent tax on earnings brought back to the United States.
  • Politicians bemoan our dependence on foreign oil, while restricting oil drilling on public lands and offshore.
  • Businesses can be prosecuted for (1) “predatory price cutting” if they charge too little, (2) “price gouging” if they charge too much or (3) “price fixing” if they charge the same as their competitors.
  • By providing billions of dollars of federal aid for attending college, government subsidizes demand, which has had the effect of making college more expensive and more difficult to pay for than it otherwise would be for everybody who doesn’t get federal aid.
  • Politicians promote the virtues of small, high-mileage cars, and they enforce laws that make it hard to produce such cars profitably in the United States.
  • There are laws that make it harder for employers to hire people and laws that provide income for the unemployed.
  • The government shuts off water in California, intensifying a drought and leading to higher unemployment, all to save small fish, while proposing thousands of square miles of windmills that kill birds.
  • Politicians encourage more couples to get married, but there have been higher taxes on married people than on single people, providing incentives not to get married.
  • Politicians say they want more doctors, while enforcing laws that limit the number of students who can enter medical schools.
  • Government promotes health care inflation by channeling hundreds of billions of dollars a year into the health care sector, enabling people to bid up health care prices – and then the government tries to limit health care price increases with health care rationing, such as excluding more treatments from coverage.
  • Government provides subsidies for growing tobacco and enforces prohibitions on smoking
Jim goes on to some great stories of mind-numbing paperwork -- echoed in today's Wall Street Journal article on how the mind-numbing complexity of the tax code affects small businesses, and gives another subsidy to big ones.  And he adds some sobering reminders of how well federal "infrastructure" projects work out. (The Big Dig, Bart, Denver's airport, and so on.)

My only complaint is that Jim tied the article to President Obama's unfortunate "you didn't build it" gaffe. I find that whole business sad, and sad that his opponents can't seem to find a better way to express their serious disagreements with the administration's  policies. We complain about politicians who stick to teleprompters, but when the slightest little misstep will be taken out of context and flung around for weeks, well, you know why the candidates largely stick to a boring script of 5-second soundbites. I also don't find our quadrennial habit of personalizing profound policy disagreements that useful. It's pointless to blame Obama for policies -- like the above -- that three quarters of the Democratic party and at least half the Republicans endorse.

Bait and Switch.

That is the sound we are going to hear soon from the BTFD crowd.

So far in 2012 we have been conditioned to BTFD. Our brain has been wired to the safety net named Bernanke. That if the stock market ever falls 20 points, he will be there. In fact so much is the disconnect between the US equity market and the rest of the assets class all over the world, that it is not even funny.  But one of these days the sheeples will find that the punch bowl has been removed without so much as a “sorry”. And I think that day of reckoning is damn close.

Was it only last Thursday that we were talking about SPX 1400? I wonder what the next 10-15 days will do the market sentiment.  Most of the damage was done overnight in the futures. As soon as the cash market opened, SPX was down 20 points. So what chance retail had to position itself? After that they were lured to buy the dip throughout the day except the last 5 minutes again. What chance in hell do they have?  Now the futures are going down again. Possibly another gap down tomorrow.

I would like to show you a nice graph from Lance Roberts of XFactor.

So we have to be very careful for the next 10-15 days as anything can happen. I have been writing for many days now that any rip is an opportunity to sell. Unless Ben comes and shows us the colour of the money, there is no reason to be long.

How do I read the tea leave in this backing and filling market? Tomorrow I expect the market to go down and test today’s low at the open. Then a bounce in the afternoon, similar to what we had today, building up the anticipation for Apple ER. We know that Apple ER is both an art and a science and they will definitely blow away all the projection etc. There will be a general bounce and QQQ will possibly reach 64.50+. And then I think the punch bowl will be gone.  This is just a wild guess and please don’t shoot me if the market has some other plan for tomorrow. I am just reading the tea leave and the entrails of the dead bull.

The BTFD crowd is last to get the news but commodities had a real bad day. Silver broke $ 27 level and Crude lost almost 3%. Peter Brandt has some very interesting charts which match with my calls to the T. You may want to check it out. http://peterlbrandt.com/factor-update-july-22-2012/

I somewhat agree with his calls because I think Bonds will spike along with the coming correction of the equities. I also think there will be a flight to safety and margin calls, when folks will be forced to sell everything, including their position in gold and silver. That should take silver down to $ 20. Soft commodities like wheat, corn and sugar will also give back much of its gain. So if you have some profit in the current surge of corn and wheat, you may want to take off some profit and re-enter at a lower level.

Thanks for reading http://bbfinance.blogspot.com/. Please join me in Twitter (@BBFinanceblog) and do re-tweet, post it on wall and share with your friends and circle.

Sunday, July 22, 2012

Who is for growth?

This weekend, a prominent columnist delivered some brilliant advice to a presidential candidate:
...make America the launching pad where everyone everywhere should want to come to launch their own moon shot, their own start-up, their own social movement. We can’t stimulate or tax-cut our way to growth. We have to invent our way there....
...we should aspire to be the world’s best launching pad because our work force is so productive; our markets the freest and most trusted; our infrastructure and Internet bandwidth the most advanced; our openness to foreign talent second to none; our funding for basic research the most generous; our rule of law, patent protection and investment-friendly tax code the envy of the world; our education system unrivaled; our currency and interest rates the most stable; our environment the most pristine; our health care system the most efficient; and our energy supplies the most secure, clean and cost-effective.

No, we are not all those things today...
Ok, quiz time. Is this
  1. Some zany free-marketer pushing the Romney campaign to give some teeth to its "pro-growth" rhetoric?
  2.  Advice to Ron Paul on a speech to rouse the Republican convention?
  3. Thomas Friedman, New York Times columnist extraordinaire, in its Sunday pages advising the Obama campaign?
 Amazingly, C. The preamble was
Is there an integrated set of policies, and a narrative, that could animate, inspire and tie together an Obama second term? I think there is.... Obama should aspire to make America the launching pad..
Which gives me hope. Friedman is obviously much better connected than I. If he thinks there is even a ghost of a chance that the Obama campaign would adopt such a strategy, or that the administration would follow anything vaguely like this policy, that is tremendously good news. I thought these sorts of positions, while  middle-of-the-road growth economics, were, in the political sphere, too wildly free-market to hope for from the Romney campaign.

Think of what they mean.
  • "We can’t stimulate our way to growth" is a remarkable admission for anyone in the New York Times orbit. Ok, it included "or tax cut," but an "investment-friendly tax code" has to mean low marginal rates on investment, which means low marginal rates on investment income. No way around it, lower marginal rates, broaden the base.
  • "Our currency and interest rates the most stable" means likewise abandoning hope that endless rounds of Fed "stimulus" or devaluation as the key to success. Both statements are a repudiation of discretionary shoot-from-the-hip macroeconomic policy.
  • A "productive" work force is not composed of protected unions and government workers, on federal boondoggle contracts.  
  • "Openness to foreign talent" means we have to let people in. 
  • "Rule of law" means that health, energy and financial regulation cannot be run by powerful regulators and their crony-capitalist protected industries.
  • All of Friedman's startups succeed by undercutting and putting out of business old ossified but politically well connected companies, yes creating net new jobs but destroying a lot of old ones in the process. 
  • If you've been reading this blog at all, you know  the likelihood that the current health care law and expansion of medicare will deliver anything like "efficiency."
These are radical views indeed. Congratulations to Friedman for stating them, and I hope his friends at the campaign are listening. A Nixon-to-China moment would certainly be refreshing.

(OK, but the moon shot analogy is just weird. What does spending about 3 percent of GDP to send two guys to the moon have to do with unleashing the innovation of thousands of new entrepreneurs? )

Friday, July 20, 2012

Things That Make You Go "Hmmmm".

This headline is not original but I could not find anything more appropriate.

About 10 days back I shared a US $ chart by Chris Kimble. Today he has an update:

Now let us see how far the Dollar goes.  This is consistent with my call for major correction in the equities in the coming days.

Today SPX dived down out of the gate but someone was trying very hard to hold the line as you can see.

Will it hold on Monday?

The last chart of the day is from dshort.com which is self explanatory.

Normally the treasury yield and equities market have moved in tandem but since the beginning of 2012, they have diverged. Is this a temporary phenomenon? If not who will catch up? The red line will come up to blue? With $ 16 trillion debt, can America afford to pay more interest?  If not then the blue line has to come down to the red. The thought itself is so fascinating!

The yield today is lower than it was at the height of the financial crisis. Does the bond market know something which the equities are not aware of?  We will soon find out.

Thanks for reading http://bbfinance.blogspot.com/. I need some stimulus from you guys and as Tim says, please click on to the Ads.  Have fun and enjoy the weekend.

The Stock Market -- Where Now?

There is an old saying: "Don't fight the tape!"  -- meaning, of course, sometimes the stock market just wants to go up regardless.  That seems to be what we have been witnessing the past few weeks as the stock market has almost regained its high for the year.

Why and where next?  First, the economy.  The economy has weakened over the past few months and seems to have stalled.  GDP growth may be zero at this point.  There are some bright spots:  the energy sector is the brightest, housing has started to look better in most sections of the country. But, the trends are down everywhere else.   A slide into negative growth territory is probably ahead in the second half of the year.

What about Europe?  The steady slide into economic and political chaos continues across the Eurozone.  The only thing new is the strong possibility that Germany may join its sister states into the slide into disaster.  None of this has much to do with the Euro at this point.  The real issue is that debt market buyers seem poised to walk away from several sectors of the European sovereign debt market.  As that happens, Europe may descend into a new dark age.  Watch Greece and Spain for a preview of the future for much of Europe.  Thus far, there has been no reform and no austerity.  There have been government layoffs in Greece and Spain, but mostly because there is simply no money left to pay them.

What about the US business community?  This sector of the economy has not been this dispirited since the 1930s.  Large swaths of the American public no longer seem to believe in free markets.  That Obama still polls as high as he does is a clear indication that capitalism is in a fight for survival.  With half of all Americans now on some form of government support, the trend is ominous.  Given this atmosphere, the business community is frightened out of its wits and unlikely to provide the normal impetus to economic recovery that has appeared in every recession since the 1930s, except, of course, this one.

Without a recommittment to free markets, it is hard to see how the US situation gets any better.  The "tax the rich" themes of the Obama campaign, where "rich" is defined as someone making income of $ 200,000 per year, is hauntingly similar to Francois Hollande's call for 75 % tax rates in France.  Unemployment in France is now in double digits and rising and growth has turned negative.  Investors are looking for ways to hide income and assets, as opposed to looking for ways to deploy their assets in new businesses and ventures. 

Congressional Democrats believe that more food stamps and more unemployment compensation is the way to promote economic growth.  You wonder if they are kidding about this.  The President thinks business can grow and prosper without entrepreneurs.  He seems to believe that people should risk their capital without any hope of economic reward.  Receiving rewards for risking capital seems to be viewed as a criminal activity by the current occupant of the White House.

With this backdrop, stocks seem fully priced even though earnings reports are favorable.  Unless and until government policy becomes more tolerant of free markets, it is hard to see anything but trouble ahead for both the stock market and the American economy.  I would continue to avoid the stock market in this unfriendly environment.

Thursday, July 19, 2012

Bungee Jumping.

My clan, the accountants, must be in high demand with the Fortune 500 companies who report  their earnings every quarter. Because despite a weak economy and bad quarter, companies after companies are beating the projected EPS. Even when the top line is down or costs are high or demands are slow, they will miraculously meet or exceed the EPS even if by a penny. If this is not creative accounting, what else is it? It’s a shame that an accountant never gets nor will ever get a Nobel Prize in creative imagination. They get prize for writing stories, why not a prize for the best accountant creating profit when it is not there. How did they manage to show profit in JPM after over $ 4 billion loss? If the banks had such a great quarter how come most of them are planning layoffs? Of course US Govt. gives very generous helping hand by tweaking the FASB rules or even allowing the Banks to mark securities to books or by not following IFRS.  But manipulation is now accepted fact of life and you cannot wake up who is already awake but is pretending to be asleep.

For two days in a row, while SPX has gone up, XLF , the ETF for financials has closed in red.  Normally financials lead the market. The weakness of the financials do not bode well for the market as a whole. If these TBTF guys can’t beat the market in their own game, what hope the momo chasing investor has in picking up the nickel before the steamroller? At some point of time, things go out of hand. Now it seems is the time for LIBOR to catch up. The reserve for legal trouble will not be enough but they have the Fed to bail them out.

I remember last year, around the same time, asking the same question, how low VIX can go. Here is a graph to explain what I am talking about.

(Hat Tip: NJB Deflator)
I am not so much worried about how the market will play out tomorrow or day after. The hope driven rally is showing signs of topping but the earning season is keeping it going. But very soon the ugly head of realty will rear its head. Do I think that we are coming to an all time top? Yes and no. No because there will be another attempt by the central bankers to re-inflate the balloon. When that happens will we cross the all time of high of 2007 is the question. I expect that test to happen by November. Before that a test of the fall is around the corner. To those who think that SPX will cross 1400, I have one question. Assuming that SPX does reach 1400, that is around 25 points away. After that what? But we will cross the bridge when we come to it.

Thanks for reading http://bbfinance.blogspot.com/. Please join me in Twitter (@BBFinanceblog) and do re-tweet, post it on wall and share with your friends and circle.

More weird behavior in high frequency markets

Today's Coke and IBM markets are jumping every hour on the hour.  Does anyone know what the heck is going on? One guess received: another case of algorithms gone wild. But whose, and on the hour, exactly? And are there no humans left to counter this sort of thing? Looking at the google finance plot (source here) this started exactly at the open today and seems to have petered out. (Thanks Giovanni Puma for sending me the pictures.)

Update (Friday AM). Bloomberg article on it. They have no idea either, beyond suspecting an algorithm has a bug in it. But why can one trader move a large market so much?

Update 2 (Friday 10 am) Better coverage and better graphs in the Wall Street Journal, suspecting " a computer algorithm known as a time-weighted algorithmic program, or a TWAP. These programs are designed to parse trades out over a set period of time, helping explain the clockwork-like consistency of the trading. “I think some large institutional buyer is using a new algorithm,” mused Eric Hunsader, chief executive of market data service Nanex.

Translation, I think: this is a "fundamental buyer" (known as "liquidity trader" or "mark") trying to parcel a big position out by spreading the trade out through the day, using an algorithm to do so, and not really watching the results. Still... a puzzle to me why people use such algorithms. Randomizing is the only way not to get front run. And a bigger puzzle that markets for coke and IBM are effectively so illiquid in the middle of the day that even big mistakes can move prices. Stay tuned....

Common sense from France

Today's WSJ has a lovely editorial from Pascal Salin, professor emeritus of economics at the Université Paris-Dauphine. It echoes many of the things I've said about the euro crisis, but with deeper political insight....and it's from France.

A few tidbits with comment
Contrary to what is claimed daily in the media by politicians and many economists, there is no "euro crisis." The single currency doesn't have to be "saved" or else explode.
The present crisis is not a European monetary problem at all, but rather a debt problem in some countries—Greece, Spain and some others—that happen to be members of the euro zone. ... there is no logical link between these countries' fiscal situations and the functioning of the euro system.
A currency union can work just fine without fiscal union.
..the deficits now plaguing these countries were, in large part, justified only a few years ago as necessary to initiate so-called "recovery policies."  But it is always an illusion to believe that governments could increase total demand and thereby induce producers to produce more....The present state of affairs in countries that engaged in stimulus blowouts in 2008 and 2009 should serve as proof of the failure of the Keynesian model.
A letter from Europe that rejects the confusion between common currency and sovereign default, and  sees the abject failure of stimulus? There is still hope. 

I found Prof. Salin's view of the political situation most interesting:
The "euro crisis" is a pure political construction without any economic content. It could even be said that the crisis is a splendid opportunity for many politicians to impose some of their longstanding goals on everyone else. For instance, before the introduction of the euro, many politicians who called themselves Europeans considered monetary union a stepping stone to political union....
So, in Prof. Salin's view, the Euro worthies are deliberately linking sovereign default to breaking up the euro zone in a deliberate effort to scare wary voters into accepting fiscal union. 
This process has begun and continues to develop. Politicians now argue that "saving the euro" will require not only propping up Europe's irresponsible governments, but also reinforcing and centralizing decision-making. This is now the dominant opinion of politicians in Europe, France in particular.
It's really the "centralizing decision-making" that is the problem not "political union." The US at least historically had a political union without requiring the rules on provenance of prosciutto to be written by bureacrats in Brussels.
There are a few reasons why politicians in Paris might take that view. They might see themselves as being in a similar situation as Greece in the near future, so all the schemes to "save the euro" could also be helpful to them shortly....
Yeah, but the Germans may not have any money left by then!

What to do instead? Someone else likes "shock liberalization:"
The real solutions to Europe's debt problems lie in tax cuts and deregulation, and it's here that national politicians should turn their attention. Pan-European cooperation won't deliver any government from its fiscal or economic crises. Only national governments, each working independently to implement the best possible policies, can hope to achieve that.
What a breath of fresh air.

I can't wait to read Prof. Salin's next letter on France's 75% tax -- especially in the face of the UK's disastrous and quickly repealed experience with a 50% tax.  (16 billion pounds forecast revenue turned in to two.) 

Wednesday, July 18, 2012

Patience Is Not A Virtue, It Is A Necessity.

Well, the C of the A-B-C in SPX did make a higher high today, although marginally higher. Obviously, everyone is now convinced of the trend change and no longer need any QE or punch bowl. It seems equities have now reached escape velocity and ready to fly to far away galaxies. It does not matter that the world around is not feeling so good. GDP estimates by the Govt. is below 2% in USA and non-existent in Europe. But who cares. At least if you take a look at VIX, you would think that there are no worries in the world and the sky is as blue as it can get. For the 3rd day running, I am showing the weekly chart of VIX and now it is at the same level as it was in 2008 before the crash.

Europe is now out of the memory and many expert chart masters are now giving all clear signal. We cannot even imagine that there can be a massive and sudden correction. Last August SPX dropped 80 points in one day. Because when we are coming down, gravity makes it that much faster. I do not think now is the time to be cute or smart. Even though the cycle top has been reached and my model is calling for an immediate correction, I am willing to wait little more, because the higher it goes, the harder it falls. And it is going up on hot air.
Gold is not responding to the enthusiasm of equities. So let us see how far the shenanigan carries the market. Let me close the post by sharing a chart from Ed Matts.
Either way the end is not very far. I personally prefer the Bearish and Bearish count which fits with my calculations. So let us have some more patience and see how it all unfolds.

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Tax What You Wish to Discourage

Taxing activities means you wish to discourage or perhaps even eliminate them.  Cigarette and liquor taxes are a good examples.  Is their purpose revenue or to discourage undesirable activity?  So, why does Obama want higher taxes on the rich?  To discourage?  To eliminate?

One clear reason not to tax the rich is that you want the economy to improve or you want to lower the national debt.  Taxing the rich will actually have the exact opposite effect.

So, the Obama argument is that we should extend the Bush tax cuts for the middle class only if we can guarantee a weaker economy than we have now and offset the middle class tax cuts with lower revenues (though higher rates) from the rich that will increase the national debt.

And half of the nation wants to vote for this.

Tuesday, July 17, 2012

Good quotes about losers (and losing)

Great collection of quotes on losing from Jeff Watson's blog. 

You'll see that many of these observations apply to trading and business. Here are a few of my favorites:
"A loser doesn’t know what he’ll do if he loses, but talks about what he’ll do if he wins, and a winner doesn’t talk about what he’ll do if he wins, but knows what he’ll do if he loses."
“One of the first businesses of a sensible man is to know when he is beaten, and to leave off fighting at once.” -  Samuel Butler
"There may be as much nobility in being last as in being first, because the two positions are equally necessary in the world, the one to complement the other." - Jose Ortega y Gasset
"Wise men never sit and wail their loss, but cheerily seek how to redress their harms." - Shakespeare
"When wealth is lost, nothing is lost; when health is lost, something is lost; when character is lost, all is lost." - Motto 
Head on over to Jeff's blog to see the full (bookmark-worthy) list.

*Photo credit: The Frustrated Gambler, via Christies.com