Sunday, September 30, 2012

Dark Clouds Over Euro.

Beginning 2012 Euro was already sliding down from 1.4750 of 2011 and had reached 1.27 by Jan 2012. Greece was at the front and centre of all news and it was looking as if Euro is going to break up any-time  And I was writing that we should keep an eye on the commercial position in the COT report. Commercials were increasing their long position throughout the year and even when Euro reached 1.20 in June/August of 2012, the long position of the commercials were at record high. In June 2012, the Euro long position in COT was at record level of 329K long vs. 70K short. In other word, when the Euro was reaching its low for the year, commercials were holding almost 5 long for 1 short. 

Now when Euro has touched 1.32, we see that the commercials are reducing their long drastically. From the last week COT report, there are only 120K long vs. 60K short. Looking at other way, while there has not been major change in the short position, the long position has reduced by 64% over this period and most of these reductions have come in the last two weeks.

Regular readers know I had written in the past that demise of Euro is premature. But now it seems that the cows are coming home.  Spain is going to ask for almost $ 300 billion by October end and after that Italy.  There is not enough money in Europe to bail out 11 of the 17 members. And everyone expects Germany to pay up. I don’t think it is going to happen and my prediction of two years back that we might have two tired Euro, one for Northern Europe and one for Southern Euro, may well come true in 2013/2014.

The monthly chart of Euro is also very interesting;

It has made three attempts at 1.20 levels since 2008-9 and is now hanging just above there. If it breaks that level, there is only air below till 0.90 where it started its life.

Tom McClellan of McClellan Publication shows some interesting chart about Euro Dollar COT Position and according to him, the stocks somehow follows it with a 12 months lag. That indicator is reaching the top around November 2012 and dives 30000 ft down in 2013/14.

Seeing how the commercials operate on a very long term time scale, I do not think there is imminent danger and we will most likely get the final pop by November / December of 2012 but I would expect to take position on the defensive side thereafter.  

On a shorter term time scale, coming week, it is very likely that we will see a test of SPX 1420. If we see SPX testing 1410-20 level and bouncing from there, I would most likely start taking long position. While going long, I would select sectors like Bio-technology (XBI), pharmaceuticals (SGEN), precious metals (CDE, AGQ, DGP) and TBT. Deutsche Bank and JPM both have buy recommendation on CDE and it has a beta of 1.5. However, PM sector is due for a pull back and most likely we will get the pull back this week.  And since we are not day traders and want to take the correct position while avoid whipsaws, we better be patient before taking any position.

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Peter Thiel and Reid Hoffman talk Silicon Valley, hits and misses


High profile Valley startup founders Peter Thiel and Reid Hoffman (of Paypal/Facebook and LinkedIn, respectively) discuss innovation in Silicon Valley, the coming mobile economy, and their greatest hits and misses in this Forbes video interview.

Related posts:

1. Elon Musk and Peter Thiel on entrepreneurship and creativity.

2. Mark Cuban: How to Get Rich + Success and Motivation

3. Steve Jobs: Billion Dollar Hippy (BBC documentary).

And Our Cities?

The public is presumably aware that virtually all western economies are drowning in sovereign debt -- a problem that grows worse as the clock ticks.  Nothing going on in Europe or the US (count Japan in there too, though they are not thought of as 'western') changes the dynamic of spiraling out-of-control debt and sluggish, if not collapsing, economies.

States within the US have their own problems.  There is no way for California or Illinois to avoid bankruptcy and several other states are right behind them.

But, in all of this, we have forgotten about our cities.  Almost without exception, American cities are headed down the road to bankruptcy.  Their problems are similar to the problems of the states -- public pension and health care promises that have never been properly funded.  We are already seeing policemen and teachers being laid off so that comfortable public employees can retire at twice the national average income or more.  Expect more of that until the the schools and public safety concerns shift the debate.

Eventually, these lopsided obligations will drown city financing.  The cities will look to the states. The states will look to the federal government.   The federal government will look to the Federal Reserve.  The Federal Reserve is busy printing money to bail out our national deficit.  Soon, the Fed will be asked to print far more money to bail out our states and cities.

Why are we in this situation?  Because politicians of both parties have mislead the public about the true cost of the public pension funds and health care programs enacted by state and local government.  At the national level, politicians have consistently lied about the funding status of social security and medicare.  So, where does this end?

The unwillingness to tell the truth about the funding status of the various entitlements that exist at all levels of government paves the road to Greece.  The future can be observed daily on the streets of Athens and Madrid.

Saturday, September 29, 2012

Weekend Report.

We all can see the writing on the wall but can we read it? The Chicago PMI, another cooked up data by the Govt. went negative, despite all efforts by the powers that be, for the 1st time since 2009. The following chart is from Reuters:

Now we know the reason for the “Hail Mary pass”. Bernanke knows something which we don’t. But the virus has developed resistance for the medicine and now the medicine is causing more sickness. Borrowed money, money printed out of thin air cannot create prosperity. I wish you would see the following presentation in full:

So do we go short here?

Heck no! Not till after election. Let me quote from Stock Trader’s Almanac:

Psychological: Intoxicated. Despite weak fundamental data, Europe’s debt crisis, escalating geopolitical tensions, the pending fiscal cliff, etc. the market continues to drift higher with only an occasional pause. Central banks, the world-round, have either pledged to or have already begun to refill the punch bowl. At some point it time it may run dry again, but for now the market seems to care little about anything else.

Fundamental: Weak. Global growth is slowing and it was confirmed by warnings from Caterpillar and FedEx. Many Q3 corporate earnings forecasts are actually expecting year-over-year declines. Unemployment is still above 8% and the recent decline in the headline rate was actually due to the labor force shrinking, not because of new hirings. Today’s sharply lower than expected final Q2 GDP showing just 1.3% annual growth and the abysmal durable goods orders report only further underscores why the Fed took action.

Technical: Consolidating. After breaking out to new recovery highs, the market yielded to typical end-of-September weakness while digesting the Fed’s latest action. Provided the geopolitical environment and economic data do not deteriorate in any meaningful manner in coming weeks, the market is likely to resume its drift higher, at least until after the election when Congress returns to session. 

My short term cycles are down for some more time and I think we will see lots of chop. I was hoping that PM sector will sell off and offer a good entry point but so far it has not obliged. SPX 50DMA is around 1410 and unless it is broken convincingly, there is no reason to go short given that the last push up is about due. ( Does not apply to day traders). I see that the sentiments have turned bearish in the last two weeks and everyone is expecting the top or some sell off.

When everyone agrees it is time to be contrarian. The market inflicts maximum pain to maximum number of people and I think it is laying a bear trap. In the coming week, we might see little more selling just to keep the bears excited and entice them with more shorts and then zoom up. Where and how far it will go up, I do not have any idea. However, it can test the all time high of 1526 before the fat lady sing again.

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Feeding the Beast -- Who Are The Victims?

Higher education claims a higher and higher percentage of the nation's resources.  No longer the land of the underpaid, it is routine for administrators to make high six figure incomes and many university presidents make well over seven figures.  Sounds like Wall Street, only better.  The work hours typically include six months vacation every year.  Not a bad deal.

But not good enough, apparently, as colleges and universities demand more and more with higher tuitions and higher expenditures from government at all levels.

One of the more insidious parts of this disgraceful situation is the expansion of student loans by the Obama Administration.  The main thrust of this is to increase the tuition levels at all schools to take advantage of this new source of funding.  Knowing that students can borrow, schools have created internal departments that are designed to educate and encourage students to take on debt so that the schools can further boost their own tuition charges.  Keep increasing the availability of student loans and the colleges and universities will continue to escalate tuition.

The results of all of this government largesse is the creation of a huge underclass in America -- young people strangled by student loan debt that they are increasingly unable to pay.  Check out the Wall Street Journal story today on the rising default levels by young people on their student debt.  This problem will soon rival the mortgage crisis.

This is the ultimate squeeze play.  Strangle the economy so that job opportunities for young people disappear and jack up tuition to absurd levels and force students to take on debt that they have no real chance of paying off.  This is the compassion of modern politics.

No one asks:  why are college costs rising faster than any other cost in the economy.  Are colleges doing something that involves increasing costs?  If so, what?  The colleges and universities have very successfully kept this question under wraps while they demand more and more resources to fund an elite group of employees who have huge incomes and net wealth and work less and less.

Not only are our youth saddled with massive debts to cover current recipients of social security and medicare, but now, as if that weren't enough, we are pushing them into massive indebtedness and an economy that provides no way out for them. 

These kind of cruel policies often are cloaked by phrases like: "investing in education" or "investing in the future."  But, what is really going on is a transfer of resources from our young people to elite, protected, typically tenured people who see themselves as entitled to massive income, benefits, and an ever-declining work load.

Friday, September 28, 2012

Assume That We Have A Can Opener

There is an old joke about the doctor, lawyer and the economist, all three, stranded on a desert island with nothing to eat.  They stumble upon a tin can of vegetables.  How do you open the tin can?  The doctor proposes to give it aspirin, the lawyer says 'file a brief.'  The economist?  The economist says: "assume that we have a can opener."

Economists have a well deserved reputation for assuming away difficulties.  Simon Johnson's article in today's NY Times is a good example.  Johnson correctly points to the US National debt as very serious problem that needs a solution and needs it now.  His article suggests that there is an easy solution.  In Johnson's own words:

"And American politicians could find other ways to restore federal government revenue to where it was in the late 1990s while also bringing health care spending under control."

Sure, just bring me that can opener.  How does one "bring health care under control."  Johnson doesn't tell us how to do that and that, sports fans, is the biggest single problem that the US faces in getting its national debt under control.  Maybe, Obamacare's unelected panel that determines who lives and who dies in the brave new world of the future can accomplish that task.  A simple law providing euthanasia for all citizens over 50 years of age might be the Obama secret plan to reign in health care.  Why knows?  Simon doesn't tell us.

As for restoring federal government revenue to where it was in the late 1990s, one assumes that a tech bubble, similar to that of the late 1990s, will be available to fuel the tax revenues necessary to temporarily produce that result. How does one do that with no economic growth?  Ah, the Obama dilemma.  Killing off the economy, which the Obama Administration has managed to do so well, conflicts with their other agenda -- maximizing tax revenues.  You can't have it both ways.

The Johnson article gives a window into the answer to the question:  why aren't economists facing the real economic issues of our time -- out of control national debt and economies mired in stagnation.  Why aren't economists interested in these issues?  So, what are they interested in? 

Read Uwe Reinhardt's absurd article in today's NY Times and you will see what topics occupy the time of our federally-subsized economists these days.  Redistribution.  Ah, there's a real topic of interest.  How do we slice up the declining pie?  Guess what he concludes? Give more money to higher education!  That sounds like an objective solution.  I wonder why a Princeton academic thinks that the number one issue of our times is how to increase the salaries of Ivy League professors.  Does this guy have a conflict of interest?

Economists are no different than other people.  They are self-seeking folks trying to line their own pocket.  Since their employer is the government, they speak up for expanding the interests of their employer, which translates into the interests of themselves.

So, don't expect economists to shed any serious light on the major economic issues of our times.  They aren't interested.

Thursday, September 27, 2012

On Script So Far.

Few days back I wrote that I expect lots of head fake and whipsaws. Yesterday I said that it is not yet real deal. And here we are today; another 1% gain day when GDP estimate was below 2% (nearing recession) and Europe is burning. All because China is expected to pump and save the world? One reader complained that there is no action with me but I would like to point out that it unless we have a definite trend it makes sense to wait in the sideline and not chase the bus in either direction, unless of course you are a day trader. Money not lost in trading is money earned.

So far SPX has tested 1470+ and is now moving between 1430 to 1460. Unless it clears 1460 with authority or breaks down below its 50 DMA which is around 1410 now, we are in the chop zone and taking a position in the chop zone is injurious to health.

The signals are all conflicting, both technically as well as fundamentally.  The world economy is possibly on its death bed and the doctors (central bankers) are keeping it alive with huge doses of steroid (read liquidity). It is not going to make it better, but will definitely keep it alive for a while longer while prolonging the agony.  
Looking at a very long term chart (monthly), I get a feeling that we still have another 100 point or so to run.

We got the bounce we were looking for and from here, either we test /ES 1455-60 again tomorrow and sell off or we break it and start the final phase of the journey. Seasonality and cycles say that we will take a breather; I think we will see a high in the morning and sell off in the afternoon. But that is just a guess and don’t catch my neck if it turns out some other way. It does not really matter because all I am interested to see is a failed test of the high before deciding the next course of action.

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Wednesday, September 26, 2012

No Cigar Yet.

I am amazed to see how quickly the sentiment changes from euphoria to doomsday. Was it last week, there were talks of SPX 1500 or higher? And now the coming doom! Part of the reason being the Fed has taken out the surprise factor. For last three months the Pavlovian dogs have been drooling about the coming QE and now that it is here, they are caught in the headlight.  And so far we just had about 2% correction.

Few days back I wrote that we should expect a correction of about 5% or so and that would be a good buying opportunity. I cannot say for sure how deep the correction will be but so far it appears that it is not a real deal. So long SPX does not break down below 50 DMA, there is no reason to take it seriously.

I think we will test SPX 1410 on Friday and if we bounce from there, which would be an opportunity to long. Again, timing is everything and if that bounce fails to clear the high of September 14, then and only then we can say that we have a good shorting opportunity.  Of course this is a text book situation and the real thing may unfold differently, but it’s all about probability. Nobody except GS and JPM can beat the market everyday of the quarter.

Nothing has been fixed, Europe is as broken today as it was day before, China is still a fantasy land of infinite growth, Japan with its 240% debt to GDP ratio is now ready to fight China and drag USA with it, Israel and Iran can’t wait to bomb each other. But hey, what does it matter, USA can still print money and prosper.

We know how it is going to end but if your central bank is giving you free money, it would be very un-patriotic to refuse that offer. After all, it is the land of the free and brave. I am not so brave but I still want the free money. So I am waiting for a pull back of gold and silver to their 50 DMA and take an entry which should be good for at least the 2ndquarter of 2013. The fly in the ointment in the theory is a possible war somewhere in the world which will cause huge recession worldwide. But that is something we do not have  much control and if I can read the evil plan of the Banksters, we are OK till May of 2013.

Tomorrow we may see a bounce but the selling is not over yet. We need to test the 50 DMA in SPX which is around 1410 and see if that holds. I am ready to wait till Friday to decide if there is a trade worth taking.

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Civil Disorder and Chaos on the Rise in Greece and Spain

Riots are now turning violent in Greece and Spain.  Police surrounding the parliament building in Madrid last night were seen on videos beating demonstrators.  The Merkel-Sarcozy-Hollande-Geithner-Bernanke-Draghi policy is bearing fruit.  Civil society is breaking down in Greece and Spain.  The NY Times has a lengthy, front-page story yesterday about formerly middle class Spaniards foraging for food from garbage trucks.  That this is becoming a common scene in Spain was the thrust of the article.

This will only get worse.  Unemployment and starvation is the ultimate outcome of the modern welfare state and it is now on display in the Eurozone with more yet to come.  Spain is still dithering about whether to alter 'early retirements' under their social security schemes.  This would be funny, if it weren't tragic.  Who is going to fund those who are already retired?  One might ask a similar question in Greece.  Are American and German taxpayers going to provide the money?  Obama suggests that this is a lively possibility.  Long run, even the US and Germany do not have the resources to bail out these countries.  The US and Germany suffer from the same disease that has lead to the current turmoil in Spain and Greece.  They are just at a different place on the timeline.  The ultimate destination is the same.

You can't solve debt problems by increasing the amount of the debt.  That obvious truism is responsible for the current debacle, which will only get worse.

Tuesday, September 25, 2012

Have We Seen The Top?

However much I want to believe that it is a top and the road is down, I am not jumping the gun yet. Yes it is topping but even with this 1% drop (wow!) (how come Ben?) we do not have the sell signal yet. Remember that chart of Presidential Election Cycle from Bespoke? Here it is for your ready reference:

So it is just about time for a correction.  Whether it will be 3% -5% correction or 10% + correction, we will have to wait and see. As of now it is a warning shot. The line in the sand /ES 1445 has been broken. The indexes opened high, reached higher and closed in red, which means that more correction ahead. It need not be tomorrow though because SPX has 4 red days in a row and a bounce is due.

Yesterday I wrote that we will see a test of the high today and a top is near. We did see SPX reach 1462.80 before selling off. So it is on script.

In the morning I tweeted that all the asset classes are selling in sync. But when the indexes dropped hard in the last two hours, oil, gold and silver did not budge much. May be gold and silver will sell off in the Asian session , so I am willing to wait a while longer to decide if the sell-off is real or it’s a head fake. In all probabilities, we will see a bounce in the next few days.

I want to share a chart from Lance Roberts:

Lance thinks that any correction here is a buying opportunity and I somewhat agree with him, at least till election. I would love the indexes do a dead cat bounce, re-test the high in the next few days or so and roll over 100 SPX points, but that’s just wish full thinking.

Euro is hanging around 1.29 levels and it has already made three attempts to break below and have bounced from there. Will 3rdtime be the charm?  If it breaks from here the next level is 1.2750 and it will take equities along with it.

The Euro position in the latest COT report shows that commercials are still net long Euro by almost 3 times.

However, the long for the last week has come down to 140 k from 230 k. which is almost 40% drop in the long position in one week and that indicates that the commercials may be winding down their long position. We will keep an eye on this one. If you remember, in the past I had repeatedly mentioned that commercials are long Euro and all talks of Euro disintegration is just talk, at least for now.

Bonds gave a buy signal and their bounce seems to be more serious kind of bounce.  From $132 in end of July, TLT came down to $118 on 14th Sept. It has now bounced back to $ 123. I think it will re test the high one more time before the boom is over.

Thanks for sharing my thoughts. Join me in twitter for the real time market action and to avoid head fakes (@BBFinanceblog). By the way, the blog now has a “ Donate” button and your contributions will be my stimulus package.

Monday, September 24, 2012

Wait and Watch.

As I said yesterday, I was not convinced that we had a trend change and we are more likely to see a test of the high. So when the market opened lower, I sent out tweets that /ES 1445 is the line in the sand. The line held and the market erased most of the morning loss. Just to repeat myself, today was officially the  1stday of QE3.

It has been a long time; we have not checked the sentiment indicator chart below:

In the battle between fear and greed, greed definitely has an upper hand right now.  Yesterday I asked, can the equities prices fall when there is a QE in play? The answer is: depends. In short term, the risk asset prices rise as we have seen in QE 1 and QE 2. But when there is QE infinity like they have in Japan, the asset prices go down over a longer time horizon. It has happened in Japan where Nikkei is down to 9000 from 38000 in 20 odd years.

I quote the following from Peter Tchir:

The Fed first cut the target rate from 5.25% to 4.75% on September 18, 2007.  Remember when 50 bps was a big cut and not twice the target rate?  The S&P 500 was 1,477 the day before the cut.  It popped 43 points that day to close at 1,520.  It got as high as 1,565 in October and has never been above there since.  So in a 5 year period where the Fed has been more aggressive than any other central bank known to mankind, the Fed is still losing.  Before going further, think about what the Fed has done since that first rate cut and where stocks are now.
I am not looking to go toe to toe with the Fed for 10 rounds of a bare knuckle brawl, but “don’t fight the fed” as an effective investment strategy has a lot of flaws.
Also contrary to the universally accepted wisdom that QE ensures good stock performance, we show QE isn't a cure all for stocks and then many other things, including powerful earnings growth (which we neglected to mention) helped power stocks.  On an even more basic level, the initial QE1, didn’t turn stocks around immediately, and stocks in fact sold off for months and hit record lows after QE was announced.

Therefore, while liquidity will trump in short term, fundamentals will catch up in long term and one should play accordingly.

What is the short term play now? The market is in consolidation mode and the mantra is BTFD. I am waiting for the market to break this consolidation range in either way. A correction is due but with all the free money around, it is hard to come by. So the only sensible thing to do is to wait. The cycles are showing a top in a day or two, therefore I expect a test of high by tomorrow or soon thereafter.  If it makes a new high, all bets are off. If it fails to make a new high, the minor expected correction may follow through. As of now, there is no sell signal yet.  October is going to show which candidate will win the race.

Precious metal sector is showing some signs of weakness. Silver appears to be weaker than gold.
In conclusion, its wait and watch time and cash is king.

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Merkel is a Failed Leader

Angela Merkel says the right things and does the wrong things.  As a conservative leader, she and her conservative sidekick Nicolas Sarcozy, led the Eurozone down the bailout track while loudly proclaiming that responsibility for foolish behavior would not be rewarded.  But rewards were soon forthcoming from Merkel and Sarcozy.  Merkel still strikes the pose of frugal leader while steamrolling Germany toward the largest bailout in world history.

Merkel talks about saving the Euro.  The issues in the Eurozone have little or nothing to do with saving the Euro.  The Euro is doing fine.  What is not doing fine is the fiscal situation of the Euro member states.  They are all going bankrupt, including Germany.  What currency is in place is of little importance if you cannot pay your debts and the Eurozone cannot pay their debts.  What they have is a temporary reprieve and a lot of conversation.  The endgame in this is all too obvious.  But, it won't include Chancellor Merkel.  She will be long gone by the time we get to the endgame.  She will join her pal Sarcozy in the losers bracket.

Meanwhile, the left takes the podium -- Francois Hollande of France.  His absurd policies will simply hasten the economic collapse of France.  Somehow, all of the Eurozone seems obsessed with the idea that rhetoric is a substitute for policy.  The conversation continues as the Eurozone slides into economic collapse.  What once was a shining example of the fruits of capitalism has now become a monument to socialism and poor policy.  All socialist experiments end in the same economic junk pile.

The cconomic end to all of this is obvious -- the collapse of the economies in the Eurozone.  What will not happen is that Germany will emerge a strong economy while Greek collapses.  Germany will be swept along with Greece.  Germany's economic policies differ only in degree from the policies that are currently driving Greece into the economic ditch -- there is no difference in kind.

The more interesting question is:  will democracy survive in the Eurozone?  Based upon history, it is unlikely that democracy will survive.  Demagogues thrive when democracy fails to deliver economic prosperity.  Polls show that extremist political groups are benefitting from the chaos in the Eurozone.  The first country to fall to the extremists will be Greece, but they won't be the last.  The ultimate end to the welfare state is economic collapse and political chaos.  We are at the earliest stages of that process.

Merkel and Sarcozy won election in their respective countries running as conservatives.  Their policies are a tribute to the fact that conservatives are just as likely to support the welfare state as liberals.  While there may be minor and insignificant differences between Merkel and Sarcozy and their liberal opponents, their policies are essentially the same -- extend and pretend.  Misleading the public about the cost of the welfare state is common practice for all the major political parties in the western world, including the US.

Sunday, September 23, 2012

Bearish Reversal?

Friday we had a bearish reversal day when the market opened higher closed lower / red.  In a normal world I would have considered it as the signal for a top and trend reversal. But in this day and age of new normal, I am asking myself, was it a failed tests of the high and I am not convinced that it was so.  The price actions of other risk asset classes were not in sync with a sell off yet. Therefore, my take is, even if we see little weakness in the next day or day, we are unlikely to close below 1450 in SPX. If however it does close below 1450, that will be the 1stwarning shot. On the other hand does it mean we are going higher to the moon? Not yet.  I expect there will be lots of head fake and whipsaws in the next few days.  Let us not forget that QE3 or QEInfinity officially starts from Monday.

Question is, can the market go down when QE is on? The following chart is from Dshort.

Which shows that equities have gone up during the earlier QEs.  This was precisely the reason the US stock market is sitting at multi year high when everything ran up on the anticipation of QE.  But it does not tell the whole story. The law of diminishing return in coming in play and the balloon seems rather fully inflated. The next is an asset bubble burst of epic proportion. Also if you carefully analyze the chart, you will see that immediately after every QE the market has actually gone down and then up.

I think we are coming close to a short term top of some kind but it is not the ultimate top. For that we will have to wait till after election when the sh*t fits the fan. It now seems that whole world want ”O” to be re-elected and EU leaders have expressed their dislike for the Republican candidate and the party in many shapes and forms. Europeans and even the Russians think that they are better off with the known devil in an uncertain world and they will not rock the boat too much till November. Even the two mad men of Middle East will wait till the election in USA to start the war game, if at all. In some sense, discussing politics is a waste of time because the politicians have already sold themselves many times over to the highest bidders and irrespective of whom so ever wins, we will be screwed. Guaranteed!

Bottom line, a 5-7% correction now will be a good buying opportunity. In any event, precious metals will be a safe play long run because everyone is printing and inflation will pick up sooner rather than later. You may ask if inflation is a concern how come bond yields are going down. One of the reasons is that the Fed is monetizing the debt and now holds almost 30% of all outstanding treasuries. But soon the Fed is going to lose control and interest rates will rise poking a giant hole in the bond bubble. It’s just bit early for the balloon to burst but burst it will. The Fed is actively seeking inflation and it will get it. The problem with inflation is, once the genie is out, it is difficult to put it back in the bottle. It is a question of when not if.

Elsewhere in the world, Spain is fighting with its autonomous regions who are asking for fiscal independence.  It is like playing a game of bluff within bluff. Catalonia is bluffing Spain and Spain is bluffing EU. Who will blink first? And here is an article about another region of Spain which is without medicine as well as empty construction projects.
And we thought only China has ghost towns. It seems the story of boom and bust is same everywhere.

All in all, it is going to be an interesting week or two going forward. So remember to fasten your seat belt and trade safe.

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The Joy of Giving Other People's Money Away

We've all heard about the joy of giving, but what if the money that we are giving away is someone else's money?  Wow! What a thrill.  That's the attitude of the Charlottesville City Council as they parcel out taxpayer money with little or no thought.  After all, they reason, these are only small amounts of money.  There is, of course, no concern by the City Council that the money that they are giving away so blithely is not their money, but taxpayer money.  Here is the URL for this amazing story:

The attitude expressed by City Council members in Charlottesville is typical of liberal attitudes everywhere towards taxpayer money.  Dole it out to your friends with reckless abandon.  Just multiply all the numbers in the article by 10 million and you have the US government, the government of California, Illinois, Greece, Spain, Italy, etc.  It is easy to be charitable and caring when you are spending other people's money.  It is far less easy to be charitable when spending your own.  That is why Romney's tax return shows that he gives four times as much of his money to charity as do the Obamas.  Charity to Obama is spending the hard earned dollars of people who don't agree with him.  Romney's idea of charity is to give his own money, not the money of others.

Herein is the great divide in America:  Does charity begin at home or is charity the looting of your neighbor's pocket to give money to those that you favor?

Saturday, September 22, 2012

Europe's payroll taxes

The Wall Street Journal made this nice graph on Saturday.

Forget "who bears," it's the totals here that are mind-boggling. In most countries, if you add up the "employer" and "employee" contributions, you get between 30 and 40%. So, if a worker produces 100 euros worth of output, 30-40 euros immediately go to the government. And there is an additional 20%+  VAT when the worker goes to buy something. So, right out of the gate, we have a 50-60% wedge between working and the fruits of labor. Income taxes, corporate taxes and property, excise, and other taxes are all on top of that! It's a wonder anyone in Europe bothers to work at all.

(I haven't looked in to the numbers, but I presume the European numbers include financing of their health systems, and the US number does not. Don't feel so cheeky.) 

The story was about a proposal to shift "employer contribution" to "employee contribution" in Portugal, as "the title" who bears the burden" suggests.

Economists will quickly tell you that who pays the tax doesn't matter. Gas stations pay the gas tax, but everyone can see that it is all passed on as higher gas prices; we're not "socking it to the rich oil companies" with gas taxes.

But if wages are "sticky," especially if fixed by union contract or law forbidding cuts, then this argument fails, and the Portugese transfer is an interesting way to lower wages without devaluing the currency, changing the overall tax wedge, or repealing laws forbidding wage cuts. 

Apparently the protesters in the streets figured that one out. If they figure out that nominal wage increases offset the whole thing, then we're back to the standard theorem.


Casey Mulligan and one commenter noticed that I oversimplified.
It's not huge but not rounding error either: you cannot just add the employer and employee rates in order to quantify the combined distortion, unless wages are held fixed, because the employer contribution is omitted from the payroll tax base. The formula typically used by tax economists is:


Eg a 100% employer tax is very different, and much less damaging, than a 100 percent employee tax. Your error is largest when the employer rate is far from zero, which it is in Europe.
Good point, and in retrospect it's better to use the right formula than simplify too much, even here. However, for everyone else, keep in mind that this is not a serious attempt to measure the overall total marginal disincentive in tax and transfer systems. The point is that this rather large social insurance wedge is at the beginning; we add income taxes, means-tested transfers, phaseouts, wealth taxes, etc to this rather large base. We keep talking about income taxes as if they existed in a vacum.

On the quesiton whether it's a tax because you get benefits: What counts is the margin. A forced savings plan has very little disincentive. If you have to save 10% of income, you get the results eventually. The wedge is only how much you'd really rather have the income today. US social security has a bit of you get more if you pay more, but not that much. And my impression is that european social insurance systems give much less marginal benefit for marginal contributions. (Commenters, I'm curious to hear facts on that)

The Media and the Issues

You would think that the US economy was booming and all was right in the world if you are a regular listener to the major TV and radio outlets in America.  Recently, I was in Eastern Europe and was pleasantly surprised to read in foreign newspapers the issues that Americans face in the upcoming election -- the economy, foreign policy, the deficit, etc.  Back home, these issues don't seem to be of any interest to the media.  Such issues are of interest to voters, but they rarely see them discussed on NBC, ABC, public TV and the like.

The big issues, according to US media, is whether or not a presidential candidate is willing to release their tax returns from decades ago or sidebar comments the candidates may have made before they were candidates that have absolutely nothing to do with any of the important issues.  The media is in the "gotcha" business.  It isn't just that they favor one party or another, it is more that the media doesn't really seem interested in mundane things like unemployment, the deficit, burning embassies, dying ambassadors, war between Isreal and Iran.  Instead it is more important, according to the media stars to worry about cosmetic issues.  "Does Romney connect with the average guy?"  "Is Obama no longer cool?"  These kinds of nonsensical discussions dominate the news coverage of the American presidential election.

No wonder the public knows so little about the issues of our day.  Anyone who spends their time watching the major news media or 'public television' or listening to 'public radio' is likely to become an expert on what dress size Michele Obama wears but is likely to have no idea what goes on in the Middle East or how the American economy is faring, since the latter topics are rarely if ever discussed in the major media.  There are, fortunately, media outlets that do address the major issues of the day.  The "City Journal," for example, published by the Manhattan Institute is a serious publication that addresses issues faced by the American citizenry in a thoughtful, serious way.  They are not the only good source of information.  One issue of City Journal will provide the thoughtful American with more real news and information than a decade of the NY Times and Washington Post.

An uninformed electorate is likely to make some serious mistakes.  That seems to be what the media is counting on.

Friday, September 21, 2012


Jerry Brown's $ 28 billionbudget gap in California turns out to be a mirage.  Brown considered the $ 28 billion number a crisis for California, when he strode into the Governor's mansion.  A blue ribbon committee founded by Democrat and Obama advisor Paul Volcker has studied the budget gap in California and come up with a different number, or should I say, a range.  The outcome of that study is discussed in today's New York Times in an article by Mary Williams Walsh.  The actual California budget gap, according to the Volcker committee is somewhere between $ 167 billion and $ 335 billion.  Ooops!

Even this is a dramatic understatement of California's plight since the combined unfunded liability of CALPERS, CALSTERS, and the nine largest county pension funds in California is well in excess of $ 1 Trillion, which is a multiple of the assumption being used by California's state government in assessing the budget gap.  So, the committee is trying to be California-friendly.  But, heck.  A trillion here, a trillion there.  After a while, you're talking about real money.

Meanwhile, Brown and the California legislature have tacked on many new job-killing legislative initiatives that keep California in the economic doldrums.  California is currently in a race with New York to see who can lose the most wealthy citizens, fleeing exhorbitant tax rates.

So, what is the future for California?  How's Greece doing these days?

Thursday, September 20, 2012


Well, the market action was kind of a teaser. It raised hopes for the bears with SPX down 10 points by 10AM. But I sent out four tweets suggesting caution and to avoid taking short bets. Thankfully, it worked out as planned and the indexes were almost unchanged. We should be testing the highs of last Friday and that may well happen tomorrow or next Monday.

Therefore, nothing much to blah blah today. I think we are approaching a topping zone but given all the liquidity around, it is risky to be short without adequate confirmation. Next week has a possibility to be interesting.

Tomorrow is triple witching and regular folks should stay home, away from computers, least we do something stupid and take a trade.

Hope my nagging is able to keep you from harm's way. That's all I have for tonight. Thanks for reading World of Finance. Join me in twitter (@BBFinanceblog) and share it with your friends.

Two views of debt and stagnation

Two new papers on economic stagnation in periods of high government debt (i.e. now) are making a splash: 

Public Debt Overhangs by Carmen  Reinhart,Vincent Reinhart and Ken Rogoff
The Output Effect of Fiscal Consolidations by Alberto Alesina, Carlo Favero and Francesco Giavazzi

This review is mostly about the former, with a little mention of the latter (maybe I'll get back to that later)

The Reinharts and Rogoff look at episodes in which government debt crossed 90% of GDP. They have two big conclusions: the episodes lasted  a long time, "...among the 26 episodes we identify, 20 lasted more than a decade," and those episodes are associated with slow growth: "the vast majority of high debt episodes—23 of the 26— coincide with substantially slower growth."

They want very much to conclude that high debt causes the slow growth, referring to "growth-reducing effects of high public debt." But as always in economics, correlation is not causation, which they recognize:
But obvious concerns arise here about cause and effect. Is the public debt overhang causing the slower growth? Or is an exogenous shock that causes slower growth either helping to generate the public debt overhang or else prolonging the escape from that debt overhang?
Evidence? Well, the debt episodes last a long time
The long length of typical public debt overhang episodes suggests that even if such episodes are originally caused by a traumatic event such as a war or financial crisis, they can take on a self-propelling character...
 The long duration belies the view that the correlation [high debt with low growth] is caused mainly by debt buildups during business cycle recessions. ...
No, alas. This makes a pretty good first-year exam question: write down a model in which income is completely exogenous (unrelated to debt levels) yet once a country crosses 90% debt/GDP it takes decades to repay, and growth is slower conditional on high debt. (Hint: Use the permanent income model. Countries get in debt when they have bad income shocks. Debt has a unit root in that model, so debt excursions are never expected to revert.  It does take "growth fluctuations" that are beyond "cyclical," but those do exist, even without high debt.)

Ok, well,
This endogeneity conundrum has not been fully resolved. However, a number of recent studies have tackled the problem. .... [they] have concluded that the relationship cannot be entirely from low growth to high debt, and that very high debt likely does weigh on growth.
Oh, great. "Studies." Yet, as I read the review of the "studies," they are the usual sort of growth regressions or instruments, hardly decisive of causality.

I shouldn't be too hard, because I agree with the conclusion (high debt is likely to cause low growth). I'm just picky about the logic. But for a reason.

What's missing? A mechanism. To discuss cause and effect sensibly we have think about the plausible mechanism is. Regressions can too easily conclude that since rich guys drive BMWs, all you need to do is drive a BMW and you'll get rich.

And clearly, debt by itself doesn't matter -- it's how debt leads to other economic events that matters.

This is to me a frustrating feature of Reinhart and Rogoff's earlier work. Recessions after financial crises are typically longer (usually misquoted as "always.") Ok, but why? Because governments follow policies after financial crises that screw up economies for a long time (distorting taxes, wealth transfers, propping up zombie financial institutions)? Because of "private debt overhang" that would be cured by a massive transfer from savers to borrowers? (Not my favorite theory, but popular around the lunchroom so I'll mention it.)  Because the destruction of property rights in bailouts freezes new investment?  Their work is quoted as a mysterious fact of nature about which nothing can be done.

Here, Reinharts and Rogoff do mention some mechanisms
The first channel operates through a quantity effect on private sector investment and savings. When public debt is very high, it will tend to soak up the available investment funds and thus to crowd out private investment. If the government at the same time is imposing policies that attempt to reduce its debt burden with higher taxes, a burst of unexpected inflation, or various types of financial repression, then investment may well be discouraged further.
The first mechanism seems to me to confuse debt with deficits. The second one rings true: high debts correspond to high taxes (really high tax rates), wealth expropriation, and other big drags on investment. Financial repression is an under-reported issue:
In addition, governments in the second half of the twentieth century often used policies of “financial repression” to reduce the cost of the public debt, by limiting capital flows and regulating financial institutions in such a way that alternative investments were blocked and financing for government debt would flow more cheaply.
See Banks, comma, European. And given the detailed control that Dodd-Frank gives to US regulators, I can see "gee, we didn't see you at the Treasury Auction. Should we send some inspectors down to look at the books?" coming to a bank near you soon.
The second channel involves a rising risk premium on the interest rates for government debt. Sufficiently high levels of public debt call into question whether the debt will be repaid in full, and can thus lead to a higher risk premia and its associated higher long-term real interest rates, which in turn has negative implications for investment as well as for consumption of durables and other interest-sensitive sectors, such as housing. 
This makes less sense by itself. Why should a risk premium on government debt matter to private investment?  Well, because we can all see that an indebted government is going to tax away private businesses... but we already talked about that.

A mechanism could let us sort out cause and effect. We can see distorting taxation, financial repression, property rights destruction in defaults, inflation, and see which paths following high debt make growth better or worse.  (Many PhD theses here!)

And, more importantly, the correlation is really pretty useless until we figure out which mechanism is at work.

RRR's Conclusions:
This paper should not be interpreted as a manifesto for rapid public debt deleveraging
exclusively via fiscal austerity in an environment of high unemployment.
OK, but I find this annoyingly misleading. Why sign on to the deliberately obfuscation induced by current political use of the word "austerity"? Cutting spending is a lot different from raising marginal tax rates. "Unemployment" sounds like an endorsement of short-term Keynesian stimulus, which must be the one thing that clearly doesn't work in their data once debt gets to 90% of GDP.

Alesina and company make this clear:
Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions. 
Here we have in a nutshell my frustration with the Reinhart-Rogoff paper. There is a causal mechanism staring us in the face -- high taxes, prospective wealth confiscation (and financial repression) kill growth. Yet, they want to make "debt" the culprit, not really looking at the causal mechanisms in any detail. Why are they not just a big data set for Alesina and co's conclusions?  Back to RRR:
Our review of historical experience also highlights that, apart from outcomes of full or selective default on public debt, there are other strategies to address public debt overhang including debt restructuring and a plethora of debt conversions (voluntary and otherwise). 
Now you get the agenda and weak discussion of causal mechanisms. If "debt" is the problem, the answer is obvious: default or inflate it away. "Restructuring" and "conversions" are nice words for default.

But the case for default is not, in fact, made anywhere in the "review of historical experience" in this paper. Serial defaulters in their data do not have higher growth rates. Paying it back worked out OK for Alexander Hamilton. The Soviet Union was inaugurated the opposite way with a big default. If washing your hands of debts is such a good idea, it's interesting that so many governments go to such lengths to avoid it.

Where is the option, liberalize your economy, and grow out of it? They dismiss the one great data point that goes against the trend, the UK paying off Napoleonic war debt, thus,
there were substantial transfers from the colonies to finance debts and facilitate debt reduction...With the exception of the United Kingdom at the height of its colonial powers in the nineteenth century,

So forget  free markets, industrial revolution, railroads and all that -- England just taxed colonies like ancient Rome?

Speaking of the 19th century
In those days before fiat currency, inflation was not as prevalent as it would later become. Thus, the “liquidation” of government debt via a steady stream of negative real interest rates was not as easily accomplished in the days of the gold standard and relatively free international capital mobility as in the decades after World War II.
This sounds like a bad thing!

Yeah, default sounds great ex-post. But it is the precommitment against default ex-post that lets you borrow ex-ante. To say nothing of the chaos a large-scale sovereign default or inflation in the US and Europe would cause. Not so easy.

I don't mean to sound one-sided on this. I've been advocating Greek default for a while, at least while the original bond holders still held some of the debt. (Too late now). I'd still rather see us all  liberalize, grow, and pay it off. I'd rather see governments cut spending, as I see that paying it off by confiscatory wealth taxes will lead to a big no growth data point. Default is only a little better than that option. But let's face up to the costs of default, not just how nice it will be to wipe out the debt.
However, the evidence, as we read it, casts doubt on the view that soaring government debt does not matter when markets (and official players, notably central banks) seem willing to absorb it at low interest rates—as is the case for now.

I'm glad to end on a note of total agreement. "As is the case for now" only applies to some countries -- ask a Greek friend!

BofA Shrinks; Goldman Sheds New Hires

Wherever you look, the American financial service sector is retreating.  The decline of US pre-eminence in world finance began with the regulatory overkill of Sarbanes-Oxley legislation in 2002, but the real death blow was the Dodd-Frank Act of 2009.  The future will be in Hong Kong, Shanghai, Singapore.  London may survive this, but that remains to be seen, but New York is definitely fading.  Basically, American financial strength is being legislated into weakness.

You wonder why?  Have stocks done poorly.  On April 24th,1995, a scant 17 years ago, the Dow Jones Industrial Average closed at 4,303.  Yesterday, the DJIA closed at 13,577, about 3 1/2 times as high as the 1995 level.  (This result includes the 2008 financial crash).  Is that bad?  Has the average investor been screwed?  Is this why pension funds are in trouble?  The market hasn't delivered enough?  How much is enough?

Why this rush to destroy American financial pre-eminence?   You wonder how folks will like the slow growth and tepid stock returns of the future thanks to the regulatory overkill that is strangling our financial sector.

Chicago Teachers Pension Plan is Broke

Like almost every public pension plan in America, the Chicago teachers' public pension plan is not going to survive.  Mary Williams Walsh's article in today's New York Times lays out the numbers.  With just over $ 10 billion in assets the fund is paying out more than $ 1 billion more than they take in every year.  The end is clear.

Why is this the case?  Because it is very easy for politicians to make promises of things that they will do in the future, while providing benefits right now.  Social Security operates on this premise.  Give the benefits now, pay for them later.  But, of course, they never pay later.  That part is simply kicked down the road.

We have already witnessed pension funds cutting the benefit payments for folks that have already retired.  We are about to see a wave of such actions.  The Chicago teachers fund is in much better shape than the Illinois state employee fund.  So, guess where that one is headed.

The crime is that politicians pretend that nothing is wrong.  They castigate those, like Paul Ryan, who propose ways of providing funding for programs that everyone already knows will go broke if nothing is done.  So, the programs go broke. 

This means the future for the elderly of the future is bleak.  Medicare and social security will not be there for people who, today, are in their middle working years.  They will have almost nothing when they reach retirement age.  The situation is worse than that for public employees in many states where even folks in their fifties will have no retirement income in another decade.

Those who are currently retired are at risk as well, but their situation is not nearly so dire as those in the generation to follow.

Instead of pretending that these systems will be available in the future, the public should be made aware now that their retirement dreams are dreams that will not be fulfilled.  Then these folks can begin saving for their old age.  Pretending that what is clearly not going to be there is going to be there is a cruel policy that will produce untold misery for the future elderly when they realize, too late, that what was promised is not going to be delivered.

Wednesday, September 19, 2012

Qfinity and Insanity.

Well, we did see a green close, as I said yesterday and we still have two more days to see the test of the high. In this day and age of Qfinity anything is possible and team O&B may not like to see the market red for too many days. It is now illegal to have red close for more than two days in a row.  However if we do not see the test of the high by Friday and we see continued weakness, I would advise caution if you are planning to go short. The cycles are up till around 25th-27thSeptember. After all, the test of high is only about 10-15 points away and unless we have seen a failed test of the high, it is too risky to short.

That Bernanke put is reflected in the following chart.
Investors Intelligence Sentiment Chart

The bullish sentiment is now reaching the danger zone but not everything is extreme yet.

Today both bonds and equities were up. Gold and silver spent the day hurrying up and going nowhere. But Crude gave sell signal. However, given the geo political madness in Middle East, I do not want to take a short trade on Oil. Thanks but no thanks.

I would like to share few videos from Bloomberg:
That pretty much explains QFinity.
Forbes also talks about gold:

If you remember, I had written before that I expect gold to reach around $2500 in near future and I am waiting to get long gold again, now that every central bank has started printing money and inflation will come before they realize it. I am waiting for a good entry in PM.

Things may seem quite but it is churning inside and it is highly unlikely that a triple witching week will be quite. It is time for portfolio adjustments. So better be careful.

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Humans vs. algos: Mike Bellafiore on the future of trading

Mike Bellafiore of SMB Capital talks with MSN about humans vs. algos and the future of trading

A few notable quotes and points from Bella's interview: 

1. Bella and his traders don't look at the current environment as "man vs. machine". 

Instead, they trade around the computers. Most of the advantage that "black box" programs or algorithms have are based on micro-scalping, trading for sub-penny moves. SMB Capital traders have changed their methods, extended their trading time frames, and are adapting to the current market structure.

2. Play your own game. As Mike says, "Do your own thing, let the computers do their thing. Don't play that [computer's] game. Play a game that trades on a longer time frame. Find the trades that work for you."

3. On the large percentage of daily trading volume on US markets that is high-frequency trading (HFT) or machine-based: 

"We used to have market makers and they don't exist anymore. The HFTs became the market makers, but they're trying to make a penny or two cents. You're not trying to do that as a retail investor, you're trying to buy a stock because you have a thesis on it [holding for a directional trade or investment while managing your risk]".

4. Finally, Bella acknowledges the coming wave of exchange consolidations and technologies that will open up new opportunities in electronic trading. 

Increased access to new, international markets will increase our opportunities as traders, since patterns and underlying psychology will repeat themselves in other markets. 

Additionally, traders will learn to create their own automated programs to take advantage of new market opportunities. The future of speculation will be one in which traders apply techniques in their home markets to equity markets abroad, while also reaching into new products and asset classes.

Enjoy the interview, and ask yourself how you might prepare for the changes and opportunities ahead in a "smaller, and more connected" trading world. 

Related posts

1. Interview with Michael Bigger, trader and author

2. Mark Minervini interview: define and refine your approach.

A Glimpse into the Future

Liz Alderman's article in the New York Times today, "Euro or No, Economics of Everyday Greek Life is Eroding" provides a glimpse into the future of the western economies.  Economic and civil order has broken down in Greece.  The rising popularity of the neo-nazi party (now at 18 percent of the electorate) is gathering in the fruits of the collapse of the Greek welfare state.  In time, democratic government will collapse in Greece to be replaced by one of the extremes.  The so-called centrist governments cannot deliver and will not survive.

Greeks expect the promises of past governments to be honored.  That is an expectation that has no hope of reality.  Their frustrations are spilling over into everyday economic and political life.  The beginnings of a similar breakdown are evident in Spain, Portugal and Italy.  No government can survive by imposing a program of austerity.  Their citizenry still believes the lies that they have been told for generations.  It is too late to convince them that all of these benefits they have come to expect cannot be afforded.

Gradually, this collapse will extend across the plains of Europe and eventually engulf even France and Germany.   The UK, not a member of the Eurozone, is not immune.  Their fiscal path is a road to disaster as well.  As for the US, the opening bell of the slide to disaster will be heard soon from California and Illinois.

The truth is that no society can survive as an entitlement society except at virtual poverty levels -- the old Soviet Union, modern day Cuba.  The prosperity in the US and Europe that was built on free markets, self reliance, and limited government is being sabatogued by a growing state control of all aspects of economic life and a sense of entitlement by the bulk of their populations.  This is the path to Greece.

Printing dollars and printing Euros -- the current policy of the Fed and ECB -- will only provide a brief breathing space as the western economies weaken.  Fortunately, Asia is not marching down this path and the future is bright for Asia.  But the lights are dimming in the West.  Alderman's article today in the NY Times is one of many recent articles chronicling the slow slide of Greece into anarchy.

Tuesday, September 18, 2012

Backing and Filling.

Today it was all about backing and filling, like I said yesterday. In the morning I Tweeted that it is not the time to short yet. And the market was not in a hurry to go anywhere. I think we are going to see green close tomorrow and a test of SPX 1470 by Friday.

Only exciting thing was the selloff of Nat. Gas which lost over 3% and Crude closed below $ 96. But again, no sell signal yet.

The interesting development going forward is going to be how Spain goes with the begging bowl to ECB. Remember how they removed Bunga Berlusconi? The Italian bond yield spiked up and the greatest womanizer of Italy was forced to step down despite having a majority in parliament.  Now the same routine will be played on Rajoy.  Spanish bond yield have started to flirt with 7% and the much promised unlimited yet sterilized bond buying program of ECB is not anywhere near. The markets are going to test the resolve of the ECB and the European politicians very soon.

Let me quote from Peter Tchir:
I am growing more concerned that Europe is slipping back into crisis mode.  We have had a window where the ECB stepped up, Germany backed down, and there is enough “wiggle room” to get something done.  Spain needs to ask and they need to ask soon, because all Europe has is “wiggle room”.  There is not true deep support for the ECB’s new policy.  Heck, the IMF has admitted how difficult it is to structure programs for EU nations.  The German court upheld ESM, but will other countries raise their own challenges?  Will disgruntled Germans (and those in other countries) find alternative ways to try and block plans for more widespread ECB intervention?
I don’t know the answers to those questions, but it would be foolish to think that someone isn’t working on those plans of attack.  Draghi is desperately trying to get pregnant.  He knows there is no such thing as being “a little pregnant” and once the OMT is turned on for Spain, and then Italy, there will be almost no turning back.  Either the programs will work right away – doubtful, or every 6 months or so, Europe will be faced with the alternative of taking losses on existing programs and stopping them, or upping the ante – likely.  So the likely scenario is every so often (3 to 9 months), Europe will face the same old decision, admit you were wrong, take losses, and move on to proper restructuring, or paper it over and pretend it will get better (which eventually it may).  We all know what Europe will decide.  Politicians and Central Bankers don’t lose money, not if they can help it.  So Draghi needs to get on that slippery slope of aggressive buying before he gets stopped out.

 That scenario very much plays along with the expected sell off in the equities by the last week of September, early October and eventually, the mess in Europe, Fiscal Cliff in America and geopolitical volcano in Middle East will all come together to create the perfect storm in 2013-2014.

I feel bad that the best days of investing are behind us all. The period from 1985 till 2000 was golden when SPX travelled from less than 200 to 1500 in 15 years without any hiccups. And we are still struggling to go near 1500 after another 12 years. More likely we will see SPX below 500 again because of the stupid policies of the central bankers and politicians. It is no fun investing in a bear market.  Just ask Japan and I am afraid, so is Bernanke that USA is becoming another Japan. To avoid that deflation he is ready to embrace inflation but when you ride a tiger, you cannot get down without getting killed. Ben knows that as well but he hopes it will not be his problem as his term will expire soon. He has already shown his hand and there is no other trick up his sleeve.

But I am just wasting time with all these silly talks. It’s all markets fault. There is nothing happening and please don’t do anything silly out of boredom. Two good opportunities are around the corner and we just have to be patient. You know my favourite quote” Forget about the fear of missing out”.

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Why you borrow matters

Borrowing for investment may be a good idea.  Debt is not a bad thing.  It can be a good thing.  It depends upon what you are borrowing for.

Borrowing to finance a new business or to expand an old one is a good idea.  Borrowing for investment purposes is generally a good idea.

Borrowing is generally a bad idea if you simply borrow to finance consumption that you cannot otherwise afford.  Eventually 'consumption borrowing' will lead to disaster since nothing is taking place that can pay off the debt that is being created.  This is the type of borrowing that is taking place in western economies today.

As much as politicians talk about 'investing in our future,' what they invariably mean in practice is financing consumption for a favored part of the electorate.  Rarely if ever is modern government spending intended to finance investment of any kind.  Paying more money to your favorite public employee, including teachers, is not a form of investment -- it is a form of consumption for your favorite public employee unless they choose to save some part of it.  Transferring wealth from rich to poor and supplementing that with more debt is simply an expansion of debt and consumption.

Borrowing to consume at the expense of private and public investment activity is a ticket to disaster.  We see that disaster unfolding in the western economies today.  In short order, the current euphoria in the US and in Europe over the virtues of printing money as a substitute for capitalism will turn to despair as their economies are crushed with the weight of too much debt. and too little economic activity.

You can only live off false promises for a limited period of time.  Sooner or later, crushing the private economy, expanding the government sector, letting sovereign debt increase without limit only results in disaster.

Monday, September 17, 2012

Quo Vadis?

The 1st meaningful economic data after Helicopter Ben announced QEinfinity  was the empire manufacturing  index and it was a disaster.  It was at its lowest level since 2009, dropping to a minus 10.4 reading. No wonder Ben sees something which we don’t and he is very afraid. At the same time, it is like a mad professor unwilling to accept that what he is doing is not working. In his mind, QE must work even if by work he means risk assets going up along with commodities. And I think the 4th qtr. GDP reading will come at 1% or below.  ECRI is defending its call that USA is already in recession.

From Early last week, ECRI notified clients that the U.S. economy is indeed tipping into a new recession. And there's nothing that policy makers can do to head it off.

ECRI's recession call isn't based on just one or two leading indexes, but on dozens of specialized leading indexes, including the U.S. Long Leading Index, which was the first to turn down — before the Arab Spring and Japanese earthquake — to be followed by downturns in the Weekly Leading Index and other shorter-leading indexes. In fact, the most reliable forward-looking indicators are now collectively behaving as they did on the cusp of full-blown recessions, not "soft landings

And yet we expect the stock market to reach somewhere near 1600 in SPX. It’s so eerily similar to 2007-2008. On one hand I see the market price action following the Presidential cycle pattern. The following chart is from Bespoke:

On the other hand I see that OEXA200R is at the top of the range and historically there is not much room to run higher.

And then there is so much liquidity in the market, at least $85 billion a month from here till Nov.

So which way folks? We know economy is tanking but we also know that liquidity trumps at least in short term.

In situations like this I turn to my cycles and crystal ball for direction and they are saying that we most likely will follow the Presidential cycle. Which means we will possibly find a correction by end of September and a final push to new highs by the election?  2013-2014 will definitely be nasty unless the Fiscal Cliff thing has been worked out by then. But given the deep political divide between the two parties, any compromise looks very unlikely. Just look at the following secret video of Romney.
May be he is telling the truth but telling truth is never a strong quality of a politician. That’s why Obama was so successful in the 1stplace. His occupational training had prepared him to avoid truth in any kind or form. But what do I know of politics and my ill advised head butting in politics is of no use in finding what the stock market will do.  

We had a little bit of a correction today some of which was somewhat covered in the last few minutes. I think this week we will see the markets going back and forth and a test of the high by Friday, the triple witching day. If the market fails to make a new high by then, most likely we will see a 5%-7% correction which will be a buying opportunity.

Lets see how things work out.

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Sunday, September 16, 2012

Sargent and interest-rate options

By now, you've probably seen Tom Sargent's great Ally Bank TV spot.

But, were I to needle Tom just a bit, I might ask, "Tom, the Ally Bank CD allows you the option of raising your CD rate once over its two-year life. Can you explain when to optimally exercise that option?''  Or (second beer), "Tom, to what portfolio optimization question is the answer, combine a two-year CD with an American option to raise the rate once?  You must have some great robust-control result here about parameter uncertainty in dynamic interest-rate models."

Hail Mary Pass.

We now have an open ended money pumping mechanism in USA. Is that a good news or bad? This program was initiated in the name of job creation, but will it? Remember that Democratic hack Chuck Schumer, who is in bed with TBTF banks telling Bernanke in one of the Senate hearing that the fed is the only game in the town? I think everyone knows and understands that the Fed QE has nothing got to do with job creation. It is all about the 1stand 3rd mandate of the Fed, i.e. to give free money to its member banks and to blow another wealth bubble to create an illusion of wealth and implement the trickledown theory.

So from now till Nov. US markets will have about $ 85 billion per month of flow and now they will target the MBS not treasuries. Did any of the reporters attending JH or any of Ben’s press conferences ask him what happened to the $2 trillion that he had already dumped in the market since 2009? Why it did not create any jobs to reduce the unemployment?  The fact is jobs are not created by Central Bankers. Yes they can help. If the interest rate is too high, the central bank can help reduce the rate of interest. When there is liquidity crisis, they can pump liquidity and help the small business get loans. But today in America, the interest rate is near zero and banks are sitting on huge reserves. Banks have no interest in giving loans to the small business which creates the jobs. Simply because, the banks can get free money from the Fed, purchase the US treasuries which give them risk free 3% and use the same treasuries as collateral for further loan. The giant Ponzi scheme and debt monetization that I wrote few months back. So the only way this more free money will be used in speculation and derivatives trading by the TBTF banks. It might push up the equities prices but won’t achieve anything else. And now they have given themselves a mandate to go on printing and pumping till infinity. It is un precedent for any central bank to take this step unless there is desperation and their back is on the wall. There is nothing else they can do, if this also fails, which it will.

So what is the unintended consequence? While the massive deleveraging is on with no growth whatsoever anywhere and the geopolitical situation is so bad that there is talks of possible war between Israel and Iran, or is it China and Japan or some other countries in far east, how long before inflation takes hold in USA?

As and when it does, what it will do to the wealth effect that Bernanke is desperately trying to create.

The long bond yield has started to rise and inflation expectation and it very much matches with my view that the 30 year period of the bull market in bonds is coming to an end. I think one can safely bet for the rise in the interest rates in USA. The bond market is many times bigger than equities market. When the bond market bubble burst there would be no place to hide. Don’t expect the money to flow in equities because the S&P earnings ratios are already high and the companies are not going to be able to generate any higher income going forward. There is only so much IPads you can sell or dump so many new cars on dealers and book sell, or build so much empty homes. Don’t expect China to bail out the world because there is trouble in heaven. For e.g. the low cost manufacturers of Christmas decoration manufacturers in Yiwu province are seeing their order dropped 20% to 40% for this year. They are the bell weather for Chinese exports sector.

So I am wondering where the job growths are going to come from? If US companies are unable to sell abroad because the BRICs have no money, if Chinese companies cannot export because Europe has no money, if Middle East is going to blow up anytime, what will happen to all those freshly minted dollars? The worst nightmare situation that can happen is: Dollar goes up, interest rates go up and asset prices go down. Along with it comes the social unrest. What we are seeing in MENA region, in southern Europe and Greece, reaches USA. By the way, while there is no demand for the business to hire more people, another reason is the huge bureaucracy that makes the life of small businessmen hell. Few years back one of our business tried to expand it the US market. We used to think that doing business in Canada is tough. But what we saw in the state of New York, with their labour laws and 1000s of forms and regulations, made us realize that Canada is much more business friendly than USA. They talk of NAFTA making business easier between US and Canada but that’s absolutely incorrect. You can import poisonous toothpaste from China and sell it in USA with much less hassle than importing a container of maple chocolate truffle. The FDA would make life living hell and yet businessmen make an effort. Hats off to those who continue to do business in this hostile environment. But what else you can expect when your president says that the businessmen did not develop their own business. The alternative on the other side is not any better either.

Yesterday John Mauldin sent his news letter “Thoughts from Frontline” and he makes a top ten list of most important issues facing America. They are:
1.       Deficit.
2.       Deficit
3.       Deficit
4.       Deficit
5.       Deficit
6-10.Everything else.
And I could not agree with him more. With a deficit of well past $16 trillion and the printing press at full speed, the future does not look very promising. How we will use this knowledge in our investment world is another story.

That’s it for this sunny Sunday. Enjoy the weekend and please join me in Twitter( @ BBFinanceblog) and share with your friends.