The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor--Jesse Livermore
Attention owners of US government bonds! The Government Accountability Office was unable to render an opinion on the 2010 consolidated financial statements of the US government because of "widespread material internal control weaknesses, significant uncertainties, and other limitations." Not that this is anything new; the GAO has not signed off US government financial records for the last 14 years, indicating that even US auditors are unwilling to expose themselves to potential jail time for assisting the US in the largest financial fraud in history. Quick question: If you heard that a publicly traded corporation was unable to get their auditors to sign off on their financial statements, what is your first thought? If you are like me, you would be racing to the computer to short as much stock as my margin account will allow. After all, the first indication of fraud is when even the auditors refuse to sign off on financial statements. Is this perhaps why we have seen US bond yields surge recently as the smart money begins to move out of US government debt? We shall see.
According to the GAO the major accounting problems included:
1) serious financial management problems at the Department of Defense (DOD) that made its financial statements unauditable, (2) the federal government’s inability to adequately account for and reconcile intragovernmental activity and balances between federal agencies, and (3) the federal government’s ineffective process for preparing the consolidated financial statements.
I was not particularly surprised that the DOD was the worst offender considering their new slogan "What some call fraud, others call good business." The military-industrial complex has been stealing trillions through illegal bid rigging, kickbacks, and procurement fraud for years. The GAO goes on to say that an estimated $125.4 billion in improper payments, information security across government, and tax collection activities were detected. This is generally accounting-speak for massive fraud with nobody really knowing where the money really went.
Another interesting tidbit from the report, which should not come as a surprise to anyone, was that the GAO was not able to sign off on the 2010 statement on Social Security. The obvious reason is that Social Security is nothing more than a bookkeeping entry with no trust fund. Not even Enron's auditor Aurthur Anderson would have the balls to attest to the accuracy of the mythical Social Security trust fund. But I love it how politicians herd the sheep to the financial slaughterhouse by insisting Social Security is solvent and a promise to future generations. The only promise, of course, is that you will likely starve to death relying on Social Security to provide you with any retirement.
The only question left to ask is how long will it take for US bond holders to see that that they have lent money to a fraudulent reporting entity, engaged in a massive shell game of debt and money printing? That is probably a question for the Chinese to be asking themselves right now. Got gold?
You don't need a crystal ball or Svengali to see that 2011 will be a trubulent year for the ecoomy and the markets. Here are some prognostications for 2011:
1. Housing Surprises To the Down Side--Yes, everyone with a pulse already knows the housing market is depressed, but I think the market is generally underestimating the impact of further price declines (call it the Bernanke Put perhaps). We have already seen confirmation from key housing indices like Case-Shiller, CoreLogic, and Altos 20 City Composite of a dramatic deterioration in home prices. This is surprising, given the fact the Fed is printing trillions of dollars to prop up asset prices. It goes to show how egregiously overvalued US home prices are. The only question is: How much worse does it get? I think we could easily see 10% across the board declines, which would mean new lows for home prices, putting more pressure on the banks as they continue to hide losses (with government approval).
2. Stocks Decline When Priced In Gold--I do not waste any more time trying to predict stock market movements. After all, I am not a HFT bot and do not understand their algorithms very well. On top of that, the Federal Reserve has openly announced they are manipulating the market higher to increase the "wealth effect." To put it plainly--THERE IS NO MARKET ANYMORE---just government intervention. Under the circumstances, it is foolhardy to guess if the market will rise or decline in 2011. What I can bet is that when compared to gold, stocks will continue their multi-year decline as dollar debasement takes it toll (thanks Zimbabwe Ben).
3. EU Debt Crisis Worsens---Again, most market participants already know the problems facing the PIIGS, but they continue to downplay the potential consequences. You can't blame them really; the Fed, ECB, etc have showed they will always bail out irresponsible gamblers even if it means destroying the value of the national currency. So I think it is reasonable to conclude that Spain and Portugal will receive a EU bailout financed, of course, by ECB monopoly money. I do not think Italy or Belgium will receive a bailout in 2011--that is what will happen in 2012. Right now, the markets remain completely ambivalent to the problems down the road in Europe. It is like the whole "sub-prime is contained" slogan in 2007 which the bulls used to propel stocks higher. Everybody with a brain knew it was a problem, but they ignored it at their peril.
4. Debt Deflation In Europe---The combination of ECB monetary policy along with recent austerity measures in the PIIGS region will all but ensure numerous countries in Europe enter a new recession. This keeps the ECB on hold throughout the entire year. Can you imagine what would happen to Spain, Ireland, etc if the ECB starts a rate hike cycle? Depression! That is why I am shocked when analysts predict an ECB rate hike in 2011. The market is expecting 50 bps by the end of 2011 which still seems too aggressive. The bifurcated economic growth in Europe is finally putting strains on the ECB. For example, the German economy needs higher rates as it is growing quite well, thanks to strong exports. But the PIIGS need low rates forever just to limp along and skirt a full blown depression. Because the EU and therefore ECB are politically oriented, they will side with easy monetary policy to preserve this misguided monetary union at all costs.
5. The Fed Keeps Interest Rates at 0%---As they continue with their policy of bleeding the middle class and honest savers to funnel money directly to their overlord bankster owners. This will complete 3 consecutive years of the almost 0% rate earned on money. To recoup their lost income, millions of Americans will be forced to gamble their money away in the ponzi-scheme we refer to as the stock market. All part of Zimbabwe Ben's attempt to create new and more powerful bubbles to "rescue" the economy. Commodities will continue to be favored by investors as real assets increase in popularity as they cannot be printed out of thin air. The only problem for the Dear Chairman at the Fed is what to do when oil surpasses $100 and starts to really depress consumer spending and increase input costs for companies, thereby putting pressure on margins? I can hear the term "margin contraction" becoming a popular buzz word on CNBC in 2011. The surgically enhanced stock fluffer at CNBC, Maria Bartiromo, may at first have trouble saying the term correctly, but after a few speech lessons, she will master it. But to conceal her depression at having to announce earnings misses, she may have to load up on some BOTOX extra strength to get through the year intact.
Well, there you have it, my outlook for 2011 for what it is worth. Happy trading!
According to the latest AAII sentiment survey, the retail crowd has evidently had one too many drinks from Zimbabwe Ben's limitless punchbowl (now with extra alcohol). Does this mean the market is near a top or simply vulnerable to a market correction to sober up some overly optimistic bulls?
Let's take a look at the current AAII reading and compare it to other movements of unwarranted bullish sentiment. Right now, 63.3% of retail traders are bullish and expect higher prices. Only 16.4% are bearish and no doubt are regretting every minute of it, indicating widespread complacency within the markets.
How does this compare historically for the AAII sentiment survey? The average sentiment is 39% bullish with occasional readings above 50% with a few occasions of 65% or better. The all time high for bullish sentiment was back in early 2000 (1-6-00 to be precise) at the height of the dot com mania, where every housewife was making a fortune day trading Internet stocks. Just the kind of days our criminal Chairman of the Fed is trying to bring back. It was at this time that bullish sentiment hit 75%, indicating the entire market was positioned for perpetually high stock prices. We, of course, know what followed as we entered a secular bear market in stocks.
I have looked back over the last 10 years see what has happened 3 weeks and then again 3 months after a bullish sentiment reading of 63% or more and bearish sentiment below 20%. Here are the results:
Since Jan. 2000, the condition (that is, a bullish sentiment of 63%) has only occurred 14 times making it very rare.
3 weeks later the market was up 50% of the time, which does not help very much and is akin to tossing a coin
3 months later market was down 57% of the time, which does not exactly make you comfortable betting the farm either way
There was a strong cluster of these signals in late 2003-early 2004, which as we know now meant higher stock prices ultimately.
So what can we conclude from the current AAII sentiment reading? It is obvious that while helpful, the AAII sentiment indicator is far from perfect and should never be relied upon in isolation. It also shows that the market can stay irrational longer than you can remain short. While most people obsess about the AAII bullish sentiment, I think the bearish sentiment is a better indicator to watch. It is currently very low and suggests to me a correction rather than a top in the market. This will no doubt disappoint the bears who have been praying for a market top for quite some time. I was in the game in 2009, but gradually I saw that money printing equates to higher stock prices, regardless of economic fundamentals. The Fed does not care anymore about the appearance of monetary prudence. If the market starts to fall as it did in May-August period, the Fed will simply print more money! It is tragedy that the market is a mere reflection not of the economy, but only government interventions and manipulations. Trade accordingly!
Now here are the charts.
click charts for larger image
Here is a shorter term chart of AAII sentiment
Here is a longer term chart which compares AAII bullish sentiment to the SP 500
Here is a longer term chart of AAII bearish sentiment compared to the SP 500
I had thought this would prove to be a simple and quite vacation---I was wrong.
1. Departing flight to France (connected through Amsterdam) was delayed over 5 hours. This would not have been a problem if I had not been trapped in the plan the entire time! The last thing you want when you are facing a 10 1/2 flight is to be packed in a cattle car for an additional 5 hours. Thanks KLM you miserable pieces of trash. What was the great problem which prevented us from taking off? Communications difficulty between the flight cabin and flight crew. Big F-ing deal in my opinion. If it had been a engine problem I would have not be complaining. As a little gift for confining me in a cattle car for 15 hours, KLM gave everybody a $100 travel voucher. Thanks, but no thanks.
2. After flying for what seemed like an eternity and not being able to sleep in a packed flight with little leg room, I got to the hotel and was not able to sleep. Jet lag had screwed up my whole circadian clock and I had insomnia for 4 consecutive nights. That's right, I only got around 6 hours of sleep for the first 4 nights. By the 5th day I was on the verge of complete collapse due to sheer exhaustion and the relentless pace of a guided trip through southern France (almost all of it was walking). Luckily, on the 5th night and with the help of copious amounts of alcohol, melatonin, and aspirin I finally got some much needed sleep. I do not recommend this combination to anybody, but at a certain point you have to get to sleep no matter what the risk. It was a god-send because the next step was hospitalization where they shoot you up with sedatives.
3. The next problem facing the trip was constantly poor weather in southern France. I mean cold, rainy weather with strong wind and the occasional amount of snow. The most bizarre part was that everyone I meet told me that the weather was usually nice and pleasant in southern France. As it turns out the weather had only taken a turn for the worse when I showed up! The most frustrating aspect was that it seemed to follow me across France from Toulouse, Albi, Carcassone, Avignon, and finally back to Toulouse. It was only the last two days in Toulouse when the weather moderated and I had some fun.
4. The issue of security at airports was one another problem of the trip and proved burdensome and unnecessary. Ironically, my departing flight was not too bad (after all, I have been conditioned living in LA to have low expectations). It took 2 1/12 hours to get through check in and airport security. I was not groped by TSA and did not have to go through any naked body scanners. The same was not true for my trip coming home to police state USA. I took a flight from Toulouse to Amsterdam on the way back. Went through the metal detectors and usual security. Got busted trying to bring a bottle of wine back (apparently that is prohibited), but that was not a major issue. Then I got to Amsterdam where I had to go through security again, along with a passport check. It took over 1 hour of waiting in line to get through some new passport control area. This is a bullshit security measure considering I already had my passport checked in Toulouse (and don't terrorists always have valid passports?). But it gets worse. Right before I boarded the flight to LAX from Amsterdam, I had to got through another layer of security. This time with a mandatory naked body scanner and another check of my personal belongings. I said that I did not want to go through the naked body scanner and was told "too bad, you are in the EU and have no choice.. You either miss your flight or you go through the naked body scanner." It is times like these when you hope the EU collapses very soon, instead of a prolonged and drawn out affair. I wanted to get home so I went through the machine. But I did notice that children under 13 were allowed to go through only a metal detector. No doubt this is because the machines violate child pornography laws and the airline would face lawsuits.
After flying for another 15 hours I finally got to LAX. Had to go through customs, which took over an hour. Some first generation immigrant gave me a hard time during customs when they ask you questions. They asked me how long I was going to stay in the US. I replied "for a long time I live here." The supercilious customs agent did not like the answer and we went back and forth, with him asking me the same goddamn question over and over. Next I got to wait in line for another customs check where some fat, slothful, old guy asks you what you did when you were abroad. I joked that I went there for some hot sex with lots of French women! He started laughing and I finally got through US customs. Oh and by the way do not even think about trying to sneak marijuana through US customs from Amsterdam--they have the dogs out and waiting for you.---and no I did not have anytime for that kind of thing in Amsterdam.
5. French food is terribly repetitive and boring which was a shocker to me. Generally, French cuisine is thought of very highly internationally, with unique sauces and flavors. But the truth is that during my 2 weeks in France, the best two meals were not French, but Italian and Middle Eastern. In fact some of the members of group actually went to McDonald's (much better than the slop you get in the US)
Overall, I think I would have enjoyed the trip more if the weather had been more accommodating. I am a big history buff and love medieval castles and cities and that kind of thing. But the problems of the weather and an overly rigid travel schedule made it hard to enjoy the surroundings. However, I met someone on the trip so all was not in vain.
I will be back to posting regularly on Monday. Have alot to cover including something on the dire state of Spain and its eventual economic collapse.
Going to Toulouse, France, and nearby Albi, Carcassonne, Avignon and Montpellier, so posting will be light until I return on the Dec 23rd. The best part is that I have a stop over in Amsterdam and you know what that means!
The one negative is the new security measures at LAX. I am certainly not going in to the naked body scanners to be radiated. However, the enhanced pat-downs, which resemble sexual groping, are not a pleasant alternative either. Hopefully, I do not have to make the choice and only go through the metal detector. If I have to make a choice, I will probably choose the groping. When some TSA thug is feeling me up, I will quip " I hope you are enjoying this as much as I am!"
Every week the National Association of Active Investment Managers asks professional money managers to report their total equity exposure. This week the average equity exposure increased slightly to 63.11%, up from 62.47 previously. This shows that the pros are not completely buying the recent market rally. Even though the market has surpassed the highs reached back in April, average total equity exposure is much lower. Because this is a contrary indicator, market corrections generally coincide with a number close to 80% or more. So far, we have not yet reached this level, indicating the market could continue higher in the short-term.
The National Association of Independent Investors released its weekly sentiment survey. Bullish sentiment rose 3.4 points to 53%, while bearish sentiment fell 3.6 points to 22.6%. Neutral investors were largely unchanged at 24.4%.
The retailers continue their bullish posturing and quite frankly they have been 100% correct over the last 3 months. Call it the money printing effect I guess. The retail crowd believe they have little to fear because if stocks ever start to fall, Zimbabwe Ben will simply print more money and debase the dollar further. This Bernanke Put is much more valuable then the old Greenspan put which only meant lower interest rates.
Generally, when retail sentiment is this high, you do not make money initiating new stock positions. It is usually best to let the market have a correction, which then scares the retailers back into cash before buying more stock. However, the AAII sentiment survey is not full proof as we have seen over the last few months, but the odds are on your side that the market should at least pause before another leg higher. One last thing we should consider is the seasonality of December, which has always been quite favorable for stocks. You rarely see steep sell-offs in December as the major institutions and hedge funds start closing their books to lock in returns.
Overall, I would say caution is warranted, especially when you hear people like Marc Faber say they expect a market correction in the short term.
Here is a short term chart of AAII sentiment
click charts for larger image
Next up is a chart which compares AAII bullish sentiment to the SP 500
Finally, here is a chart which compares AAII bearish sentiment to the SP 500.
JP Morgan has a very helpful chart which shows the pace of hiring among state and local governments. You can see that for the first time in the last 60 years, the public sector is shedding jobs, putting pressure on the unemployment rate and the labor market. Expect more of this to continue as state and local governments work to solve massive budget deficits. This dynamic should keep unemployment high because of the large contribution the public sector makes to the jobs market. Just the excuse the Fed needs to keep printing money to "save the economy."
It is no secret that the Federal Reserve relies primarily on two data points when deciding monetary policy: output gap and unemployment. The output gap is the difference been potential GDP and actual GDP. Despite the fact no one really knows what potential GDP is, central banks rely upon the metric to predict inflation/deflation, unemployment, and slack in aggregate demand. Right now the US output gap is estimated at around $890 billion, down from 1.1 trillion back in 2009. To the members of the Fed this amount of slack in the economy indicates that deflation is the greatest threat to the economy. It also gives the Fed the impression that printing money and low interest rates are needed to stimulate the economy.
Please note that I do NOT agree with any of this, but this is accepted to wisdom of Zimbabwe Ben and his co-conspirators at the Federal Reserve.
The purpose of this exercise is to try to understand what the members of the FOMC are thinking and how it relates to their interest rate decisions. We are trying to guess when the Fed might raise rates from zero percent to a more normal rate. It is obvious that zero interest rate policy (ZIRP) has been used as tool to illegally transfer wealth from honest savers to globalist banks. In fact, it is the hidden bailout for the banks as they rake in the cash by collecting deposits at 0.25% and reinvesting the proceeds in 10-year government treasuries yielding 3%. Leverage it a few times, and you get a really nice return, courtesy of starving seniors who cannot afford to live off their savings. Rinse.Wash. Repeat. This may be one of the largest transfers of wealth in US history all done surreptitiously by unelected officials at the Fed.
When asked to defend their criminally insane policies, Fed officials naturally turn to the output gap and unemployment as justifications for ZIRP. They say that it is necessary until the output gap closes, and when the unemployment rate returns to more normal levels (assumed to be 5-6%). So lets see some estimates of when this might occur. Below is a chart from Scotia which shows the output gap under different growth rates for the economy. To people who rely on savings for retirement, this is a very depressing chart. It shows that the US will not be closing the output gap anytime soon. Actually, under the most optimistic of scenarios (4.5% growth), it would still take until 2013 to close the output gap. If you use the more realistic case (2.5% growth), the output gap will not be closed before 2020.
click chart for larger image
Now that we have seen the bleak outlook for the output gap, let's take a look at unemployment. The unemployment rate in the US is 9.8% and has been above 9.0% for the last 19 months, despite the recession officially ending in June 2009. As we have discussed before, the US economy needs to create 100,000 jobs per month just to keep the unemployment rate steady (assuming 1% population growth). The US is currently adding between 30-60K per month which means the unemployment rate is likely to tick higher in 2011. The chart below from the Minneapolis Fed shows the lackluster pace of job creation during economic recoveries. The first thing that you will see is the uncanny resemblance to the 2003-2004 recovery which featured very slow job growth coming out of a recession, often referred to as a jobless recovery (a misnomer if there ever was one)
If we assume a recovery similar to the 2003-2004 period, it will take a very long time to reduce unemployment to acceptable levels. The question is: How long? The answer, of course, depends on your assumptions, but I think it is safe to say the pace of the so-called recovery has been very weak from a historical perspective. The optimistic scenario is 4-5 years according to Bernanke in his 60 Minutes interview. The Fed has indicated that it will most likely increase rates before it ever starts to sell its bond portfolio. Under this best case scenario, the Fed will keep rates very low (under 1%), at least through 2013. Of course, for the best case scenario to occur, the economy would really have to pick up, and job creation would have to total between 150,000-200,000 per month. To me, this seems too optimistic so let's assume a more realistic case where it takes 7-10 years for unemployment to return to normal levels. Under this scenario, the economy does not have a double dip but remains at about the same pace it is on currently (with a slight pick up in the second half of 2011 and into 2012. If this scenario occurs we could see rates near zero through 2015 if not longer, which would pretty much ruin the retirements for millions of Americans. Indeed, bond guru extraordinaire Bill Gross of PIMCO has stated interest rates are likely to remain low for "several years." Regardless of where interest rates go, the bottom line is that the Fed is going to keep real interest rates negative for an extended period of time.
The realization that interest rates will likely stay low for years to come makes saving and planning for the future much more difficult. Normally, when economic conditions are uncertain, the best thing to do is hold your assets in cash and wait for more clarity. However, money currently has a negative real value as real inflation exceeds what you can get in a money market fund or bank deposit. This makes cash a bad investment, especially if you hold on to it for the next few years as the Fed debases the dollar. You won't lose in nominal terms but will suffer in real inflation adjusted terms. So cash is out.
The obvious alternative is equities as every investment advisor will say stocks are a hedge against inflation. Unfortunately, history shows that equities have a poor record when it comes to high inflation and hyperinflation. For example, between 1968-1982 period known as stagflation, stocks lost about 80% of their value in real inflation adjusted terms. Hardly a hedge against inflation! It is true that that stocks do well in a low inflation environment (2-3%),but with the Fed literally printing money, inflation is working its way through the system, and it is only a matter of time before it appears in consumer prices (within 2-5 years). Early indications of this process are evident through the surge in commodity prices across the board. This is not to say that all stocks are bad, but as an asset class they will likely continue to lose value adjusted for inflation (as they have since 2000).
Normally, owning hard assets like gold and silver do well when real interest rates are negative. We have written before why this is a good option for people who do not need income. But for people who live of their savings, this is not a viable option. The only real alternative is oil and natural gas royalty trusts and Master Limited Partnerships. These investments are primarily energy related (transmission, pipelines, storage, etc) and pay 5-8% per year and the amount should gradually increase as the company grows. The problem with these type of investments is the volatility, not just for income, but for capital as well. During the 2007-2010 period, we have seen dramatic swings in commodities with oil rising from $70 to $147 and then back to $40, only to rise again back to $90. This erratic behavior destroyed many royalty trusts with many cutting their dividends by up to 90%. You also saw large capital losses.
Master Limited Partnerships did not fare much better because they rely heavily on debt to finance operations. When the credit crunch occurred in late 2008, many of these companies faced serious liquidity and solvency issues as they could not refinance debt or tap bank credit. The more prudently managed companies quickly rebounded after the 2008 crash and have largely recovered their losses from 2008. This is why I generally favor MLPs as a method of income in this zero interest rate world. MLPs have the luxury right now of being able to borrow very cheaply, which reduces their interest payments, leaving more money available for dividends and capital expenditures (for future growth). MLPs also have favorable tax advantages thing to keep in mind when considering MLPs is their business model. For safety of income, you want a MLP which has modest debt, strong cash flow, and a stable business. The most important thing is whether the company any commodity price risk. Many pipeline companies make their money by simply charging a toll on volume passed through their pipelines. This is the business model you want because it ensures stable cash flow. However, some companies role the dice and tie part of their revenue to commodity prices. While this works great during rising commodity prices, it can be quite disastrous when prices fall dramatically, like they did in 2008. This downward pressure caused reduced cash flow, leading to violations of debt covenants and increasing the risk of bankruptcy. So you really want to avoid these type companies as you are effectively gambling on commodity prices.
Well, there you have it-- some ways to generate stable and growing income in a ZIRP world. I deliberately chose not to include bonds because with likely inflation in the future, you do not want to own fixed income investments. Another reason for not discussing bonds is because they are egregiously overvalued (especially government bonds) as everyone races to generate more income compared to zero percent in cash. This is most evident in the junk bond market as high yields attract unsuspecting investors who are taking extraordinary risk to generate 6-9% per year. The ZIRP of the Fed is a criminal act which is going to harm millions of people all in an attempt to bailout insolvent banks.
Bernanke's appearance on CBS' 60 minutes was classic Bernanke--supremely confident, dismissive of criticism, and full of hubris. The most incredible part was when the interviewer asked him how confident the Fed was in controlling inflation. The answer from Bernanke was 100% confident. To me, this seemed like deja vu all over again. The last time Bernanke was 100% confident of anything was regarding subprime and how this small part of the mortgage market was "contained." Before that, Bernanke was 100% confident that there was no such thing as a bubble in the housing market. When asked by Maria Bartiromo (AKA Money Honey) if he was concerned that home prices could fall, Bernanke responded that he did not "agree with the premise of the question" because home prices had never fallen nationwide in the post-war period. After his horrible record of forecasting, I get chills down my spine whenever Zimbabwe Ben says he is confident in anything.
Also, Bernanke seemed to indicate that more money printing is definitely on the way if unemployment stays high and core inflation (i.e. everything you need to live like food and energy) remains low. Since the general forecast is exactly this by June of 2011, when QE 2 expires, it is almost a lock we will be seeing QE 3.
Here is the video.
Below is an excerpt of the transcript released by CBS.
Q: The major banks are racking up profits in the billions. Wall Street bonuses are climbing back up to where they were. And yet, lending to small businesses actually declined in the third quarter. Why is that?
A: A lot of small businesses are not seeking credit, because, you know, because their business is not doing well, because the economy is slow. Others are not qualifying for credit, maybe because the value of their property has gone down. But some also can’t meet the terms and conditions that banks are setting.
Q: Is this a case of banks that were eager to take risks that ruin the economy being now unwilling to take risks to support the recovery?
A: We want them to take risks, but not excessive risks. we want to go for a happy medium. And I think banks are back in the business of lending. But they have not yet come back to the level of confidence that –or overconfidence –that they had prior to the crisis. We want to have an appropriate balance.
Q: What did you see that caused you to pull the trigger on the $600 billion, at this point?
A: It has to do with two aspects. the first is unemployment The other concern I should mention is that inflation is very, very low, which you think is a good thing and normally is a good thing. But we’re getting awfully close to the range where prices would actually start falling.
Q: Falling prices lead to falling wages. It lets the steam out of the economy. And you start spiraling downward. … How great a danger is that now?
A: I would say, at this point, because the Fed is acting, I would say the risk is pretty low. But if the Fed did not act, then given how much inflation has come down since the beginning of the recession, I think it would be a more serious concern.
Q: Some people think the $600 billion is a terrible idea.
A: Well. I know some people think that but what they are doing is they’re looking at some of the risks and uncertainties with doing this policy action but what I think they’re not doing is looking at the risk of not acting.
Q: Many people believe that could be highly inflationary. That it’s a dangerous thing to try
A: Well, this fear of inflation, I think is way overstated. we’ve looked at it very, very carefully. We’ve analyzed it every which way. One myth that’s out there is that what we’re doing is printing money. We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying treasury securities. And by lowering interest rates, we hope to stimulate the economy to grow faster. So, the trick is to find the appropriate moment when to begin to unwind this policy. And that’s what we’re going to do.
Q: Is keeping inflation in check less of a priority for the Federal Reserve now?
A: No, absolutely not. What we’re trying to do is achieve a balance. We’ve been very, very clear that we will not allow inflation to rise above two percent or less.
Q: Can you act quickly enough to prevent inflation from getting out of control?
A: We could raise interest rates in 15 minutes if we have to. So, there really is no problem with raising rates, tightening monetary policy, slowing the economy, reducing inflation, at the appropriate time. Now, that time is not now.
Q: You have what degree of confidence in your ability to control this?
A: One hundred percent.
Q: Do you anticipate a scenario in which you would commit to more than 600 billion?
A: Oh, it’s certainly possible. And again, it depends on the efficacy of the program. It depends, on inflation. And finally it depends on how the economy looks.
Q: How would you rate the likelihood of dipping into recession again?
A: It doesn’t seem likely that we’ll have a double dip recession. And that’s because, among other things, some of the most cyclical parts of the economy, like housing, for example, are already very weak. And they can’t get much weaker. And so another decline is relatively unlikely. Now, that being said, I think a very high unemployment rate for a protracted period of time, which makes consumers, households less confident, more worried about the future, I think that’s the primary source of risk that we might have another slowdown in the economy.
Q: You seem to be saying that the recovery that we’re experiencing now is not self-sustaining.
A: It may not be. It’s very close to the border. — it takes about two and a half percent growth just to keep unemployment stable. And that’s about what we’re getting. We’re not very far from the level where the economy is not self-sustaining.
Q: [On calls to cut the deficit]
A: We need to play close attention to the fact that we are recovering now. We don’t want to take actions this year that will affect this year’s spending and this year’s taxes in a way that will hurt the recovery. That’s important. But that doesn’t stop us from thinking now about the long term structural budget deficit. We’re looking at ten, 15, 20 years from now, a situation where almost the entire federal budget will be spent on Medicare, Medicaid, Social Security, and interest on the debt. There won’t be any money left for the military or for any other services the government provides. We can only address those issues if we think about them now.
Q: How concerned are you about the calls that you’re beginning to hear on Capitol Hill that would curb the Fed’s independence?
A: Well, the Fed’s independence is critical. The central bank needs to be able to make policy without short term political concerns. In order to do what’s best for the economy. We do all of our analysis, we do all of our policy decisions based on what we think the economy needs. Not based on when the election is or what political conditions are.
Q: Is there anything that you wish you’d done differently over these last two and a half years or so?
A: Well, I wish I’d been omniscient and seen the crisis coming, the way you asked me about, I didn’t, But it was a very, very difficult situation. And– the Federal Reserve responded very aggressively, very proactively
Q: How did the Fed miss the looming financial crisis?
A: there were large portions of the financial system that were not adequately covered by the regulatory oversight. So, for example, AIG was not overseen by the Fed. … The insurance company that required the bailout, was not overseen by the Fed. It didn’t really have any real oversight at that time. Neither did Lehman Brothers the company that failed Now, I’m not saying the Fed should not have seen some of these things. One of things that I most regret is that we weren’t strong enough in in putting in consumer protections to try to cut down on the subprime lending problem. That was an area where I think we could have done more.
Q: The gap between rich and poor in this country has never been greater. In fact, we have the biggest income disparity gap of any industrialized country in the world. And I wonder where you think that’s taking America.
A: Well, it’s a very bad development. It’s creating two societies. And it’s based very much, I think, on– on educational differences The unemployment rate we’ve been talking about. If you’re a college graduate, unemployment is five percent. If you’re a high school graduate, it’s ten percent or more. It’s a very big difference. It leads to an unequal society and a society– which doesn’t have the cohesion that– that we’d like to see.
Q: We have talked about how the next several years are going be tough years in this country. But I wonder what you think about the ten year time horizon. Fifteen years. How do things look to you long term?
A: Long term, I have a lot of confidence in the United States. We have an excellent record in terms of innovation. We have great universities that are involved in technological change and progress. We have an entrepreneurial culture, much more than almost any other country. So, I think that in the longer term the United States will retain its leading position in the world. But again, we gotta get there. And we have some very difficult challenges over the next few years.
CBS is reporting that Fed Chairman Bernanke will say in a TV interview which airs on Dec 5 that QE 2 is not limited to $600 billion, indicating that Zimbabwe Ben is prepared to print more money. This should not come as a shock to readers of this blog. We have said that QE is nothing more than debt monetization with a fancy name. The criminals at the Fed use the guise of "increasing employment" and "boosting the economy" to carry out their money printing. If you disagree, the Fed's paid pumpers (Steve Leisman,etc) will say you hate poor people and want them to remain unemployed. I love how the Fed and the media have turned illegal dollar debasement into some benevolent act to help the average person. Of course, this is to be expected in a police state. The only thing that matters is the party line, and all dissents will be punished. I wonder how the average person is better off with oil at $90, which equates to $3.35 per gallon in Los Angeles. The higher commodity prices rise (as a result of dollar debasement), the less money the American cattle..err..I mean consumer has to spend on such necessities as ipods and iPads (Oh, yes, and food). This means at some time in 2011 consumer spending will have to weaken. When it does, the economy will roll over and guess what--the Fed will print more money! It is a truly virtuous cycle, which works until the day the dollar collapses. Get ready for Zimbabwe style inflation if this continues!
The interview on CBS will be a must-watch event. No doubt the equity markets will love it as it means more dollar debasement, which leads to a higher stock market (only in nominal terms, remember).
Just when you think the labor market may be turning the corner, you get more disappointment. Today the BLS reported non-farm payrolls increased by only 39,000 versus expectations of around 155,000. The unemployment rate ticked higher to 9.8% showing that the labor market has a long way to go before it ever recovers from the recession. We have discussed before how hard it is for the unemployment rate to drop considering economic conditions but it merits repeating. The following is from a SF Fed study which asked the question: How many jobs need to be created each month to reduce the unemployment rate to 8% by 2012? Here are the results
1. To keep the unemployment rate steady at 9.8%, the US economy needs to create 100,000 jobs per month. This assumes average population growth of 1% and a flat labor force participation rate.
2. According to the Congressional Budget Office, the US economy needs to create 227,000 jobs per month. This assumption is based upon a projected uptick in the labor force participation rate to 64.8%. If the CBO is off by only 0.1%, the number jumps 10,000 to 237,000 jobs per month required.
3. The Social Security Administration expects the labor force participation rate to fall to 64.6% in 2012. This means that starting September 2010, the US has to create 208,000 jobs per month to reach the 8% unemployment rate goal.
4. The Bureau of Labor Statistics is predicting a labor force participation rate of 65.5% in 2012. Under this assumption, the US economy has to create a whopping 294,000 jobs per month.
5. In November 2010 the US created 39,000 jobs, far below the rate necessary to reduce the unemployment rate. During the last "jobless recovery," when economic conditions were much more favorable job creation averaged 140,000 jobs per month.
The Federal Reserve's own forecasts regarding unemployment are far too optimistic. The current assumption is 9.0% in 2011 and about 8.0% in 2012. Unless the US economy starts creating creating at least 100,000 private sector jobs, the unemployment rate will increase into 2011! Bank of America has correctly called for this for a while. This would be a major set back for the economy and increase the chances of more QE. You notice how gold increased $15 immediately after the payroll announcement.
One thing I would keep an eye on through 2011 is how companies respond to higher raw material prices and other input costs. So far, they have not been able to completely pass them on to consumers because of weak final demand. At a certain point, this puts incredible stress on margins and hence corporate earnings. What do corporations do at this point? If history is any guide, they will start to cut jobs again to improve productivity. I know most people will say that corporations have already cut as much as they can during the recession, so they will not be firing workers. My reply is that with new technological advancement, you can always replace more people with machines, which do not require fair wages, health care, or other benefits (except perhaps some WD-40).
The only thing that could prevent this scenario from playing out would be some miraculous surge in aggregate demand. I don't see this happening anytime soon, especially with the deleveraging process working its way through the economy. It is not just corporations (many financials), but consumers as well who are paying down debt and using debit cards rather than credit cards for spending. This deleveraging dynamic will permanently reduce aggregate demand for the foreseeable future.
click charts for larger image
I don't know about you, but this looks like structural unemployment to me.
The National Association of Active Investment Managers released its weekly sentiment survey of money managers. This week total equity exposure among respondents declined a bit to 62.47%, from 66.67% previously. The NAAIM survey is a contrary indicator and market tops usually coincide with a reading around 80% and bottoms near 20%.
I like to compare and contrast what the retail crowd is doing according to the AAII sentiment survey and the NAAIM which surveys the professionals. We see that even though the market has been strong, investment professionals are not increasing their equity exposure. They are still long equities but not to such an extreme that would signal a correction in the market, indicating the rally may continue. Meanwhile, the AAII sentiment is showing that the retailers are very bullish and expect higher prices.
The American Association of Independent Investors released its weekly sentiment survey. Bullish sentiment increased 2.3 points to 49.7%, while bearish sentiment rose 1.5% points to 26.2%, up from 24.7% previously. Investors who described themselves as neutral declined to 24.1%.
Well, the retailers are certainly back to their euphoric ways as bullish sentiment nears 50%. Usually this is a signal for caution as the retailers are almost always wrong. However, if you look at the charts below, bullish sentiment has been very high for the past 3 months, thanks to the Fed openly announcing they will not let the stock market fall. This sort of government intervention has distorted the market and rendered some indicators (including this one) useless as trading indicators. Historically, retail sentiment has been a good (though not perfect) contrary indicator as one sells when the retailers are bullish and buys when they are bearish. If you have followed this strategy over the last 3 months, it has not worked very well. That said, I still follow this indicator to look for extremes in sentiment that may be helpful in the future. One more thing to keep in mind Just because this indicator has remained extremely bullish for a prolonged period of time, it does not mean the market is near a top. There have been cases over the last 15 years, during a bull market, when bullish retail sentiment actually led to more gains for the general market.
Here is a short term chart of AAII sentiment
click charts for larger image
Here is a longer term chart which compares AAII bullish sentiment to the SP 500.
Finally, here is a chart which compares AAII bearish sentiment to the SP 500.
A fascinating research report has been released by Fitch Ratings which ran a simulation and asked: What would happen to the world economy if Chinese GDP growth fell from the current 9.6% pace to a more moderate 4.7% in 2011? This is a pertinent question considering the risks to Chinese growth, including monetary tightening to deal with rapid food inflation and the prospects of a housing bubble. It is no secret that China has surpassed the US as the world's growth engine and has been the dominant factor in commodity prices. Back in 1980 China accounted for 2% of world GDP, but today represents 12%. A slowing China would have profound and wide reaching impact across the global economy.
The Hypothetical Scenario
1. Some shock occurs in the Chinese economy starting in late 2010 that reduces 2011 GDP growth to 4.7%. The underlying cause could be anything from property bubble bust to Chinese banking crisis.
2. The slowdown in China would only be temporary as GDP growth rebounds to 7.2% in 2012 and 9.8% in 2013.
3. Chinese property prices fall 15% from recent peak in 2010 and recover in late 2012.
4. Property price declines cause major problems for Chinese banks, requiring the central government to recapitalize the banking system.
5. Shanghai stock market falls 50% during first half of 2011.
The Impact of a Chinese Slowdown
In this scenario, world GDP growth in 2011 would decline from 0.5% to 2.7%, with emerging Asian countries the most hard hit. Fitch predicted that growth in emerging Asia would slow to 4.7% down from the base estimate of 7.3%. The US would fare a little better with a reduction of 0.4% along with the EU region which would see growth lowered by 0.2%. Latin America GDP growth would be slowed by 0.3% to 3.9%.
Commodities
While world GDP growth only moderates under the scenario, commodities will be vulnerable to large price declines. Fitch estimates that commodities could fall 20% across the board with industrial commodities being hit the hardest.
Who Benefits
While almost every aspect of the world economy would be affected by a slowdown in China, there are a few beneficiaries. Industries like retail, consumer products, overseas power generation, and certain companies in the steel industry which have no upstream integration do well. Retail and consumer products benefit because of lower wholesale prices due to reduced labour and manufacturing costs in China (the US consumers will love this). Overseas power generators will do well as lower fuel costs increase profit margins, but they could be impacted by slightly lower demand. Fitch also seems to think certain steel companies will benefit from lower iron ore and coaking coal prices help to protect margins in the face of lower demand (I am not sure Fitch is correct on this one).
Multinationals
Global multinationals that have manufacturing subsidiaries in China will be negatively impacted. Sectors most impacted will be in the automotive, heavy machinery, chemicals and commodities sectors. Fitch estimates that large US industrial companies derive 10-20% of their revenue from Asia. Determining how much exposure to China is difficult because most companies do not break down revenues by country. But Fitch thinks the industries most impacted would include global automotive sector would be hit the hardest, putting pressure on companies such as Volkswagen, GM, Toyota, and Honda.
Another sector impacted by a Chinese slowdown is the US restaurant chain sector, which is heavily dependent on Chinese operations for growth. For example, Yum Brands relies on its Chinese operations for 34% of total revenues and 35% of the group’s operating profits in 2009.
Contagion Risk
The slowdown in China would also impact global markets as the risk trade is abandoned by the major trading desks and hedge funds. Fitch estimates that Asian stock markets would fall 25% in sympathy with the sell-off in China. US and European markets would also fall but not by as much as emerging markets. The large decline in equities would precipitate a widening of emerging market sovereign credit spreads, causing them to widen by 100 bps. Asian banks would also be negatively impacted, especially in Hong Kong, Taiwan, Japan, Korea and Australia due to the deterioration in asset quality.
For purposes of this simulation, Fitch assumes contagion risk is relatively low and does not consider an Asian Financial Crisis scenario.
Countries at Most Risk to a Chinese Slowdown
The countries that are at most risk to a slowdown of China are heavily dependent on commodity exports. Fitch took a look at which countries rely most on commodities as a percentage of their current account balance. These countries would be impacted the most.
1. Chile
2. Peru
3. Kuwait
4. Russia
5. Australia
6. Argentina
7. Indonesia
8. Columbia
9. Brazil
10.Malaysia
My Thoughts
I have a few problems with Fitch's assumptions, especially regarding the temporary slowdown for China in 2011, but then a swift recovery into 2012-2013. Do you really think the Chinese economy could recover so quickly from a banking crisis that required the government to recapitalize the entire banking system? Somehow, I do not think it is that easy. Historical evidence says countries recover much more slowly from banking/financial crises (5-10 years) than general business led recessions.
Furthermore, the assumption that commodity prices only decline 20% seems too optimistic in my view. If the Chinese economy suffered a banking crisis and the country were subjected to a prolonged period of low growth, commodities would fall much more as the whole reason for owning commodities is Chinese growth.
Overall, I was surprised that Fitch would commission this report because rating agencies are not known for their keen sense of foresight. They are notorious for constantly downplaying major risks and favoring positive outcomes. Maybe they have learned something from the whole financial crisis!
