StockTouch Blog

Case Shiller and the “post-bubble work out”

May 31, 2012 by Peter

Case Shiller, the leading index when it comes to home prices has released some new data on housing prices in the US. The housing price index shows more of the same from US real estate, stagnancy, or in english, nothings moving on the market.  The national index fell 2% in the first quarter of 2012 and was off 1.9% year over year.   Residential real estate, to many analysts, is becoming a sort of boring dead money asset.  The likelihood of huge declines is low and the more likely scenario is your standard post-bubble “work out” period where steadying demand will slowly chew into the still high supply over time resulting in a flattish market.

David M. Blitzer, Chairman of the Index Committee at S&P Indices elaborated on today’s CS report:

“While there has been improvement in some regions, housing prices have not turned. This month’s report saw all three composites and five cities hit new lows. However, with last month’s report nine cities hit new lows. Further, about half as many cities, seven, experienced falling prices this month compared to 16 last time.

The National Composite fell by 2.0% in the first quarter alone, and is down 35.1% from its 2nd quarter 2006 peak, in addition to recording a new record low. The 10- and 20-City Composite mimic these results; also down about 35% from their relative peaks and hit new lows.”

Looking at the graph, you could guess that this is the optimistic scenario. True bubbles go back to where they started, that would be around 80 in this case, or another 50% drop. And if you do that using CPI Rent, CS went from 50 to 100 during the boom and is now moving below 60, at the levels before the 2001 recession. So while it looks like housing prices may have stabilized they could in-fact just be “stagnant”, and potentially could drop a bit more still. Scary.

A change in hedge fund holdings

by Peter

Hedge funds have long been known as mysterious investment vehicles of the rich, with little visibility into their actual holdings and strategies its always interesting to get a look behind the curtain. Hedge funders are known to move stock prices, sometimes dramatically raising volatility of specific shares, like every time David Einhorn gets on a conference call. So when Goldman released its latest report on the two latest trends in hedge funds’ equity holdings that may have some impact on equity volatility going forward we figured we should report.

1.     “Investment allocation in small-, mid-, and large-cap stocks for an average fund is about a third for each of these categories. So one would think that by taking the full hedge fund universe, it would be equally weighted across the three capitalization groups. But that is far from reality. Small hedge funds like small-cap stocks and large ones prefer large-cap stocks. It means that as the large funds become even bigger, the overall percentage of large cap stocks within the hedge fund universe should rise (simply because large hedge funds control a bigger portion of the total hedge fund assets). That has indeed been the case, with small caps representing only 17% of the overall hedge fund equity AUM.”

2. “Hedge funds run highly concentrated portfolios. The latest numbers from Goldman indicate that top 10 positions make up some 64% of hedge fund equity portfolios. That compares to 34% for large-cap mutual funds. Such concentrations indicate that hedge fund overall performance is driven by just a few stocks.”

Combining 1 and 2 above tells us that certain large-cap stocks could experience dramatic moves, as hedge funds change positions in these names. Large concentrations and significant holdings could result in some outsize volatility. This is something every investor should be aware of as it could have a drastic impact on your holdings.

 

Are the Greeks about to play hardball with the Germans?

May 25, 2012 by Peter

CNBC reported last week that the likely new Greek leader is willing to gamble with the Euro to get what Greece needs:

“The head of Greece’s Radical Left Coalition, Alexi Tsipras, told CNBC Thursday that he will “go as far as I can” to keep Greece in the euro zone despite declaring earlier this week that the Greek bailout agreement is “null and void” and should be abandoned.”

 Now this may not seem like big news, but it’s the first we’ve seen of Greece pushing back on German demands in the Eurozone.  While it may seem like this is a crazy move, as Germany is clearly in the drivers seat when it comes to financial positions in Europe, that may not be the case, why you ask?  It’s simple.  According to Cullen Roche at Pragcap:

“They’re all involved in a single currency.  So there’s no floating exchange rates to balance trade.  There’s also no currency sovereignty so each of the nations are susceptible to solvency crisis.  So what happened was the trade deficit nations inevitably had to borrow from the trade surplus nations to fund their continued spending.  Who was doing most of this lending?  Germany’s banking sector of course.  So, the two are inextricably linked.  If Italy, for instance, defaults, it will kill the German banks.  Additionally, because Germany is the primary trade surplus nation in the region they are enjoying the benefits of the single currency system.  If Italy were to bring back the Lira in this environment the Euro would soar against the Lira making Germany less competitive with Italy.  So, Germany has A LOT to lose here.  In fact, I’d argue that it’s the periphery holding all the cards here.”

In many trade economists opinions this type of negotiation should have happened years ago.  Then the ball’s in Germany’s court.  Maybe they leave the Euro?  Maybe they succumb to the pressure and move towards something resembling a fiscal union?  Maybe they give in on E-bonds?  Who knows?  But someone needs to push back because the current construct isn’t working and isn’t going to work.

So Japan just finished deleveraging….

May 20, 2012 by Peter

So with many economists, analyst and pundits claiming America or Europe or really any somewhat financially troubled money printing, deleveraging country is headed towards the same fate as Japan. Its really good news to hear that Japan’s deleveraging cycle might be ending. According to Credit Suisse who recently published a nice note on the balance sheet recession and Japan’s de-leveraging cycle.  Japan has undergone one of the most crushing de-leveraging cycles in history due to simultaneous asset bubbles in equities and real estate and an extremely misguided policy response. The result has been a 20 year malaise that has knocked the Japanese economy down to the world’s fourth largest. If your’re a follower of the StockTouch blog you’ll notice we have made claims to similar economic woes in Europe. The good news according to Credit Suisse is that the balance sheet recession in Japan is finally ending:

“Unlike the US, UK or Eurozone, Japan’s corporate sector over the last 20 years faced a daunting prospect of having to de-leverage against the backdrop of deflation and flat nominal GDP. In our view, the Japanese corporates have performed a near “miracle” of reducing US$6 tn of debt without help from growing economy and despite the reluctance of BoJ to embrace a more aggressive monetary policy. It seems there is growing evidence that after 20 years, the Japanese corporate sector is finally “healing”. We focus on three signs: (1) the corporate sector is no longer reducing debts or increasing cash; (2) private investment is no longer declining; and (3) ROE and ROIC are gradually recovering (though from depressed levels). At the same time, Japan’s labour productivity growth rates continue to offset the poor demographics, while competitiveness, innovation and complexity indices remain strong. It seems likely that the corporate sector could surprise on the upside.”

Buffet vs Gold, who wins?

May 13, 2012 by Peter

Americans favorite senior citizen Warren Buffet has yet again ruffled some feathers with his comments on Gold not being as solid an investment as stocks or bond.  Among many broad generalizations that Mr. Buffett has made this one seems to be somewhat wonky. We wont condemn one of the most prolific investors in history, we’ll leave that to Bespoke Investments who point out, that Berkshire has far underperformed gold since the turn of the century and not by a small margin:

“Buffett certainly has a point.  An ounce of gold 12 years ago is still an ounce of gold today.  But isn’t the same thing true of stock in Berkshire Hathaway (BRK/A)?  Given the fact that BRK/A does not pay a dividend, no matter how much a holder ‘fondles’ or looks at their holdings, one share of BRK/A stock purchased twelve years ago is still one share today.  Sure, you can sell it for more now than you bought it then, but the same is true of gold.  In fact, your gain on gold is considerably more than your gain would be on BRK/A.  Looking at the performance of the two assets since the start of 2000 shows that the value of gold has increased considerably more than the value of Berkshire Hathaway.  In fact, with a gain of 466% since the start of 2000, gold’s gain has been nearly four times the return of BKR/A (466% vs 120%).

Granted, there’s a mean case of cherry picking going on here, but I see the arguments from both sides….Gold is in fact money and can serve an important role in one’s portfolio.  But it should NEVER be the centerpiece of someone’s portfolio.

Sell in May and Go AWAY

May 3, 2012 by Peter

So you may have heard the traders colloquialism “sell in may, and go away” but is there any rhyme or reason as to why. Well to find out i picked up the Stock Trader’s Almanac to figure out exactly what goes on in May and if these traders superstitions actually had any merit. They cite the month of May as the beginning of the
“disaster area” for equities:

◆ “May/June disaster area” between 1965 and 1984 with S&P down 15 out of 20 Mays

◆ Between 1985 and 1997 May was the best month, with 13 straight gains, gaining 3.3% per year on average, up 7, down 5 since

◆ Worst six months of the year begin with May

◆ A $10,000 investment compounded to $527,388 for November to April in 60 years compared to a $474 loss for May to October

◆ Dow Memorial Day week record: up 12 years in a row (1984-1995), down seven of the last 14 years

◆ Since 1951 pre-presidential election year Mays rank poorly, #10 Dow & S&P and #8 NASDAQ

Knowing what the data says, and that traders are some of the most superstitious people out there its actually rather scary to look at the above data. So perhaps this one time we can go against our statistics teachers better judgment and assume correlation might really be the causes here.

Why Robert Shiller isnt so optimistic on housing

April 28, 2012 by Peter

You may have heard of The Standard & Poor’s Case–Shiller Home Price Indices, which if your not familiar is a National Home Price Index composite of single-family home prices for the nine U.S. Census division. Robert Shiller, who represents the “Shiller” half of the aforementioned index is a economist at Yale, and is one of the few economists with a good long-term track record calling house prices. Shiller recently sat down with the Wall Street Journal to discuss the latest house price data.  Although we’ve been seeing a few signs of stability in recent data Shiller is not terribly optimistic about the long-term outlook.  The key points from his comments:

    • The trend looks steady down.
    • Prices are back to their 2002 levels.
    • Bubbles tend to overshoot on the downside.
    • He doesn’t think home prices are likely to climb any time soon.
    • Without a change in consumer sentiment home prices will remain in a funk.

See the full interview here

 

Does Europe have a Currency Crisis or what?

April 25, 2012 by Peter

Almost every economist, journalist or analyst has laid claim to having identified the banking crisis before it happened. They all pointed to post from early 08 about how they had predicted, “something was wrong”, although obviously no one had all the answers or knew how it was going to unfold. Though some did have a perceived better understanding than other, for instance back in 2008 one of the writes over at Pragcap seemed to get the cause down:

“We have a major capital problem at the U.S. banking level.  What Ben Bernanke and Hank Paulson are essentially proposing is an asset swap.  The Fed will take on the toxic assets of the banks and they will receive reserves in exchange.  This is important because it will alleviate the strains in the credit markets.  That’s a good first step, however, it is not a solution to the problem at the household level and THAT is where the real economic weakness is.  By introducing this asset swap idea Ben Bernanke is simply altering bank balance sheets.  He is not fixing the economy.

So, the government has a partially correct solution. Not the BEST solution, but it gets to the core of the credit issues. They will essentially trade the bad paper for good paper and it will alleviate many of the pressures on the banks. As I have written here many times the banks are the lifeblood of the system.  I like to think of the banks as the oil in the engine.  If you run out oil the system begins to break down and eventually the engine stops running.  You can’t have a healthy functioning economy if the banks aren’t lending.  Unfortunately, because this won’t fix any problems at the household level it won’t induce any borrowing.  So, it’s a clever way to resolve the banking crisis, however, it doesn’t fix the root of the problem which is at the household level.”

While not complete in understanding as to how things would unfold (ie. QE and what was pulverizing the US economy at the time,) Cullen understood one big macro point, where the disease started.  Back in 2008 and 2009 we heard endless chatter about the “banking crisis”.   But the banking crisis was a symptom of the household debt crisis.  So it led policymakers to obsess over ways to fix the banks.  This of course, didn’t cure the real problem, the households.  

And now a sad thing is occurring in Europe.  We see increasing chatter about a “balance sheet recession” in Europe, debt crisis or even a potential banking crisis, which seems to be the main consensus. Thankful The Economist came around and said this is merely a symptom of what’s really ravaging Europe.  The article in summary states that Europe has a currency crisis, and the Euro is unworkable as is.  The debt crisis is nothing but a symptom of this much bigger problem. 

So if the currency is the problem shouldn’t it be collapsing?

FT Alphaville has posted some good comments by JP Morgan analysts on some of the big macro questions regarding Europe, and this exact question:

“Why has the euro not collapsed, yet, given a recession and EMU break-up risk? The EMU periphery cannot devalue against the core, but would greatly benefit from a drop in the euro. The answer is likely that currencies are relative prices, and the fiscal situation in the US, UK, and Japan is as bad as in the Euro area, even as the latter has problems with internal funding. Each of these four currencies has fallen dramatically against the smaller G10 countries that are in better shape (CAD, CHF, AUD, NOK). The Euro area also has no external deficit, and funding problems may have led to capital repatriation, supporting the euro.”

What this means is Europe would be doing worse if it weren’t for the fact that the US, UK and Japan weren’t laggards too. So when those other countries pick up and start growing again (if ever) Europe will still be in a rough spot. So how do you fix that?  French President Nicolas Sarkozy called for a “Refounding and rethinking the organization of Europe.” Or in English a way to make these nations autonomous in the Euro or some other currency, perhaps their own.

So whats the deal with corporate profits

April 18, 2012 by Peter

new report from Grantham Mayo van Otterloo (GMO) entertains a startling conclusion. The report is on the level of corporate profit margins in today’s economy and seeks an explanation to their height. Profit margins for corporations are at an all time high in a data set that extends back to the nineteen fifties. ValueWalk analyzed this issue recently, based on similar research from Oppenheimer.

The report, though complex in its analysis, is simple in its conclusion. The report suggests that the height of profit margins at this time will be balanced out in the future by much lower returns. That conclusion may seem overly simplistic but the economic model behind it is stringent.

James Montier at the GMO takes the Kalecki profit equation and breaks down the recent drivers into segments.  He shows that the budget deficit has been the primary driver of corporate profits in recent years:

“With this brief tour of the drivers of macro profits complete, we are now in a position to see how the various sources have interacted to generate the profits we have actually witnessed. This decomposition is shown graphically in Exhibit 5. Even a cursory glance at the exhibit reveals that net investment has generally been the biggest driver of corporate profitability over time. However, the stand-out engine of corporate profits of late has been the fiscal deficit.”

“To further highlight this dependence of profits upon the fiscal deficit, Exhibit 6 shows the breakdown of profits during 2011. The massive impact that the fiscal deficit has had becomes immediately clear. Government savings have a negative effect on profits; a fiscal deficit is just negative government savings, hence the double minus sign in the table below”

And his conclusion:

“The government deficit may stay high this year, due largely to it being an election year. However, it is almost unthinkable that it will remain at current levels over the course of the next few years. As such, unless households start to re-leverage or the current account improves significantly, and assuming that the government moves toward some form of deficit reduction plan, corporate profits are likely to struggle. From this perspective, a structural break in profit margins looks to be difficult to support. So, for the time being we will continue to base our forecasts on the mean reversion of profit margins.”

That’s quite the sharp analysis.  In summary the risk GMO is predicting is that the budget deficit are likely to decline and we’re likely to see stagnant economic growth and declining corporate profits.  We’re all clear for 2012, but the risks are plentiful moving forward and if there’s one thing that equity markets hate it’s declining profit margins and profits…

Is Greece getting kicked out of the IMFs basement?

by Peter

So as the other PIGS countries continue to economically slide further and further away from prosperity, it begs the question what are the world’s financial governing/advising bodies to-do? Especially with Greece who seems to be the worst off, how should the world’s financial big brother the IMF deal with these types of situations? Can they just keep borrowing? Or is there a point when you let them “grow up”.

The International Monetary Fund appears to be scaling back its contributions and exposure to Greece, Bloomberg reports. Aka kicking Greece out of the preverbal mother’s basement.

While the Fund did put up 27 percent, or €30 billion ($39 billion) to the first bailout, it only ponied up for 14 percent, €18.2 billion ($23.8 billion) of the aid contributed for Greece the second time around.

This development comes just as Greece completes a debt restructuring with its private creditors. This constituted the first default of an advanced economy in more than 60 years.

The IMF not contributing more funds to the Greece rescue is a big sign that it sees the likelihood of a second Greek debt restructuring in the future. While increasing it is still loaning Greece needed money (as it should, it’s the IMFs only job), it is nonetheless doing so cautiously.

While we wont know if the IMF ever had plans of contributing more, it is nonetheless indicative of the fund’s reserve in taking on more exposure to Greece as opposed to, say, the rest of the euro area where they continue to lend freely. And when the organization that is supposed to let troubled countries borrow from their coffers doesn’t want to let someone borrow anymore, you have to start thinking.

It also indicates that the fund’s contributors, the largest of which is the United States, are tiring with Europe’s resistance to bearing more of the burden for its sovereign debt crisis. Economist Nouriel Roubini wrote that the official sector would have to take almost the entirety of the hit in the case of a second Greek default. The stronger financial burden EU leaders have to bear, the more likely they will take quicker action to address Europe’s problems, aka lack of growth, trade imbalances, and absence of fiscal integration.

Meanwhile, newly issued Greek bonds are already trading at distressed levels, 18.1 percent for 11-year bonds and 13.4 percent for 30-year bonds. The FT points out that this indicates persistent investor fear that Greece will see another debt restructuring before long.

What went on last week: An economic data summary

April 14, 2012 by Peter

This past week was thin for U.S. economic data. The trade deficit was smaller than expected, suggesting some upward revisions to Q1 GDP forecasts (the advance report for Q1 GDP will be released in two weeks on April 27th).

Other data disappointed a little. Initial weekly unemployment claims increased to 380,000, consumer sentiment dipped, and the NFIB small business survey declined slightly. After several months of stronger-than-expected data, the data flow is now coming in mostly at or below expectations.

In other news, recent Fed comments suggest QE3 is likely only if the economy falters as stated by our previous posts And overseas, the yield on Spanish bonds increased sharply with the 10 year almost up to 6%. So we might be in for another round of Euro worries.

There will be several housing reports released next week (builder confidence, housing starts and existing home sales), and we will see if there is any pickup in activity

• Trade Deficit declined in February to $46 Billion
The Department of Commerce reported:
“Total February exports of $181.2 billion and imports of $227.2 billion resulted in a goods and services deficit of $46.0 billion, down from $52.5 billion in January, revised. February exports were $0.2 billion more than January exports of $180.9 billion. February imports were $6.3 billion less than January imports of $233.4 billion”. 

The trade deficit was well below the consensus forecast of $51.7 billion.

Oil averaged $103.63 per barrel in February, down slightly from January. The decline in imports was a combination of less petroleum imports and less imports from China.

Exports to the European Union were $22.5 billion in February, up from $20.0 billion in February 2011.

• Key Measures of Inflation in March
On a year-over-year basis, the median CPI rose 2.4%, the trimmed-mean CPI rose 2.4%, and core CPI rose 2.3%. Core PCE is for February and increased 1.9% year-over-year.

These measures show inflation on a year-over-year basis is mostly still above the Fed’s 2% target. So this is good news for those hoping to hold off more QE, and bad news for those in the bond market hoping for alil more stimulus.

• Weekly Initial Unemployment Claims increased to 380,000
The four-week average of weekly unemployment claims increased to 368,500.

The 4-week moving average has been moving sideways at this level for about two months.
• BLS: Job Openings increased slightly in February

Jobs openings increased slightly in February, and the number of job openings has generally been trending up, and are up about 16% year-over-year compared to February 2011.

Quits increased in February, and quits are now up about 9% year-over-year and quits are now at the highest level since 2008. These are voluntary separations and more quits might indicate some improvement in the labor market.

• NFIB: Small Business Optimism Index declined in March

The index declined to 92.5 in March from 94.3 in February. This is slightly above the 91.9 reported in March 2011.

This index remains low – probably due to a combination of sluggish growth, and the high concentration of real estate related companies in the index. And the single most important problem remains “poor sales”.

• Consumer Sentiment declines slightly in April to 75.7

The preliminary Reuter University of Michigan consumer sentiment index for April declined slightly to 75.7, down from the final March reading of 76.2.

This was below the consensus forecast of 76.2. Overall sentiment is still fairly weak – probably due to a combination of the high unemployment rate, high gasoline prices and sluggish economy – however sentiment has rebounded from the decline last summer and is up from 69.8 in April 2011.

What is Deleveraging, and how should it impact your investment decisions?

April 13, 2012 by Peter

We are squarely in the deleveraging phase for the global economy. A quote I lifted from Forbes, but could have easily been from any news outlet available. Its quick, succinct and unless you’ve been working in the research room at a hedge fund lately you like have a very faint idea of what that sentence means or how it might effect your investments.

 So what is “deleveraging?” In a macro-economic sense it refers to the simultaneous reduction of leverage in multiple private and public sectors, lowering the total debt to nominal GDP ratio of the economy. Essentially by “deleveraging” you’re getting rid of your debt, by either paying it down, or by defaulting on it.  Thus how an economy de-leverages (payment or default, and in what proportion) affects the future performance of that economy in that it effects both lenders’ propensity to lend, and borrowers’ willingness to borrow

 So as you might have heard the global economy is/has been/was/will be “deleveraging”, so what does this mean for investing.

 In their latest Scorecard Nomura is wondering if the corporate deleveraging implies a new golden age for credit given that credit has outperformed equities over the last decade:

 

Credit returns are leveraged to have the same volatility as respective equities over this horizon – Nomura

They make the following interesting points in their note:

“-Corporates around the world have been deleveraging for longer than most people realize, starting around the time of the tech bubble in 2000.
-Deleveraging is generally bad for equities, but good for credit assets.
-In the US, Europe and Japan, credit has outperformed equities by any reasonable measure (e.g. volatility, drawdowns, absolute).
-As credit is far less volatile than equities, some leverage is sensible. Even leveraged credit can be less risky than unleveraged equities.”

Point number 1: Corporations in the US, Europe and Japan have been de-leveraging for some time

“Events since 2008 have highlighted the excessive leverage of households, banks and various governments‟ balance sheets in US and Europe. However, less well recognized is the fact that corporate leverage (ex-financials) in these countries has been on a steady decline since 2000 (Graph 2).

Point number 2: Deleveraging is generally bad for equities, but good for credit assets

“Given a certain return on assets, a company can raise its returns on equity by increasing the ratio of debt in its capital structure. This is good for equity holders, but harms debt holders by lowering the threshold for default (when the value of assets is lower than the value of debt). This was the case in US and Europe in the 1990s. Though, notably in Japan, where deleveraging had already started, equity returns were negative in the 1990s. However, when companies turn conservative and start reducing debt, credit holders benefit and equity holders lose out. While good quality credit data did not exist for Japan in the 1990s, if we consider the performance of credit vs. equities in G3 since 1999 (Graph 1 above), we can see evidence of this. Credit in G3 (US, EU, Japan) has had higher risk-adjusted returns than equities since 2002.”

So to decode all this financial mumbo jumbo, as the volatility of credit is much lower than equities, investors could have taken a suitable amount of leverage on credit to convert this into high absolute returns. 

For more than just a basic assessment of credit vs equities investments during  period of deleveraging, check out the below posts on capital structure arbitrage and how hedge funds utilize these strategies.

Distressed Debt Investing – Capital Structure Arbitrage Part 1.

How hedge funds exploit Eurozone anomalies


Whats the deal with gas prices?

April 10, 2012 by Peter

As you and your wallets have likely known for sometime this year gas and oil prices have been rather high, and as you might have guessed that’s not so great for the economy either. So far – as Professor Hamilton noted late last month: Oil prices and the U.S. economy– prices haven’t been too “disruptive”. Meaning, the high prices have yet to impact consumer and business decisions on travel.

From Ronald White at the LA Times: Gasoline prices may have finally peaked for now

The uncertainty over whether prices have peaked comes from the fact that 15 of the 23 states with the most expensive gasoline are still higher than they were at this time last week. Still, there was some guarded optimism among analysts.

Gasoline prices in the hardest-hit areas have finally shown signs of relief with prices falling now in Chicago as they have for a few weeks in California,” said Patrick DeHaan, senior petroleum analyst for GasBuddy.com. “We may see an earlier peak than we have in prior years.”

From the Chicago Sun-Times: Gasoline prices in Chicago area fall double digits from record highs

“In the Chicago area, the average price of unleaded regular gas Monday was $4.34 a gallon, down 17 cents from the record high of $4.506 reached March 27 and down 11 cents from April 2, according to AAA, Wright Express and the Oil Price Information Service.

In the city of Chicago, the average price was down 8 cents from a week earlier at $4.57 a gallon and down 11 cents from the record high of $4.678, also reached on March 27.”

With some of the biggest travel holidays creeping up on the American public (Memorial day) it may still be too soon to call a peak in prices, but it looks like there maybe some relief or at least stabilization ahead. So go ahead and pack the car or head to the beach, because at least for now it looks like prices at the pump should remain stable, for at least a few days.

Now you see it, now you dont.

April 9, 2012 by Peter

It seems like only yesterday, or last week, that the “recovery” was self-sustaining or strong according to economists.  You’d be hard pressed to find many economists or TV talking heads who had anything bad to say about the economic data coming out or the economic trends they saw. All it seems to take is an average payrolls report and everyone thinks the recovery is treading on thin ice, and likely will need more government aide aka QE3. Even though as we covered in our last post, the Fed isn’t exactly chomping at the bit to unleash another round of stimulus.  So here’s a sampling of responses from this weeks research reports, mostly from WSJ:

Paul Krugman:

“Meanwhile, just a quick note on the jobs report; not good, of course. You don’t want to overreact to one month — but this shows the utter folly of all the talk about how it’s time to move from stimulus to tightening, time for the Fed to worry about inflation instead of jobs, and all that. We’re still very much in the Lesser Depression, and all our focus should be on getting out.”

Mark Thoma:

“This is just one month’s worth of data, and monthly data can be noisy so it’s not time to panic yet. The recovery could pick up steam again next month. But the possibility that it won’t pick up, e.g. because unseasonably good weather distorted the numbers for the last few months, has to be taken seriously by policymakers. Those in charge of monetary and fiscal policy must realize that forecasts have both upside and downside risks, and that doing too little if economic growth turns out to be slower than expected is far more costly than doing too much because economic growth exceeds projections.”

Brad Delong:

“Unemployment rate declines that spring from falls in the employment to population ratio are really unwelcome…”

Neil Dutta, Bank of America Merrill Lynch:

“The March employment report was decidedly downbeat and offsets some but not all of the positive tone we’ve seen in recent labor market indicators. All you have to do is check off the boxes. Softer payroll growth? Check. Shorter work week? Check. Soft earnings? Check. ”

Dan Greenhaus, BTIG LLC:

“The decline in [the employment to population ratio] has been instrumental in keeping the unemployment rate lower than it might otherwise be, something that Ben Bernanke is keenly aware of. While the labor force has surged of late, taking it back to, roughly speaking, peak levels, it remains below the level at which it would have been had previous growth rates been realized. Again, Ben Bernanke knows this and when discussing the role of monetary policy, QE3, in the current environment, the discussion is not only about asset prices or inflation. The debate about whether monetary policy can help fix what some believe is wrong with the labor market and right now, despite what some are saying, Ben Bernanke believes the answer is “yes.”’

What’s surprising here is the short memories of these economists regarding QE2. .  Did we all forget that QE2 did approximately nothing for the US economy?  Now, QE in Europe has worked, but only because it’s essentially helped fund member states.  That’s entirely different from the way QE works in the USA where it simply swaps assets.  What we’ve seen in Europe in recent months is totally different and has been supportive.  But QE3 if implemented in the same manner as QE2 is unlikely to do much aside from cause asset prices to once again deviate from fundamentals.  Then again, maybe that’s all anyone cares about anymore….If we can keep asset prices up then everyone wins, right? (check out last blog post on what PIMCO is up to).

Don’t just take our word for it. Alan Greenspan former Fed Chief said, “the $2 trillion in quantative easing over the past two years had done little to loosen credit and boost the economy.” He continued“There is no evidence that huge inflow of money into the system basically worked.”

Even further Nomura did some great investigation into the jobs report and its impact on the economy in general saying: “At this stage of the cycle, a decline in claims becomes a less useful signal of labor market strength as a pick-up in hiring, as opposed to a drop in layoffs, takes on a greater importance.” Essentially making the claim that labor markets are just normalizing and this is really nothing to worry about.

So the big question these days is does this change the outlook for QE3? Likely no. None of these economists work at the Fed first off. Second the Fed has been crystal clear as to where they stand on QE3. They’re not implementing further QE with the core inflation rate over 2%.  The report this week doesn’t change anything.  Now, if this weakness becomes a trend then maybe the QE argument begins to pick up steam and the Fed might revisit the subject.

Whats the deal with QE3?

April 5, 2012 by Peter

“They will, “why wont they”, “They have to” and “they shouldn’t” are the default first words out of any analysts, economists, or columnists mouth/blogs recently regarding the Fed and how they should handle “QE3”. So Earlier this week when the Fed released its FOMC minutes and stated:

“The Committee also stated that it is prepared to adjust the size and composition of its securities holdings as appropriate to promote a stronger economic recovery in a context of price stability. A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate consistent rate of 2 percent over the medium run.”

It seemed they might have silenced the critics and provided a clear answer about QE3 for the short term (as with any Fed action): So as long as core inflation is above 2% the Fed is on hold.  So as the core sits at 2.2% and unlikely to drop down well below 2% in the coming months we can likely conclude that means no QE3 any time soon….right?

Well Bill Gross at PIMCO seemed to disagree, taking to twitter to say “Central banks are where bad bonds go to die. Without QE, the financial markets and then the economy will falter.” Now lets not forget Gross runs PIMCO who make money via fixed income products aka bonds, and have been openly betting heavily on more QE. So Gross may be out for his own interest here. To further state that point on Tuesday, Gross’s PIMCO Total Return Fund fell 0.45% on hints that more QE would not be in the offing.

Gross isn’t alone, Goldman’s Jan Hatzius has provided the three reasons why he believes QE3 is still on the table.  He says:

“1. The improvement might not last: With real GDP growth tracking just 2% in the first quarter and signs that at least some of the recent strength is false.

2. Even if the improvement does last, faster growth would be desirable to push down the unemployment rate more quickly: Fed officials believe that the level of economic activity and employment is still far below potential.…This creates an incentive to find policies that speed up the return to full employment.

3. Not easing might be equivalent to tightening: At a minimum, the bond market currently discounts some probability of QE3.”

So essentially Hatzius thinks that the growth we’ve experienced is an anomaly, even if it continues we’ll need help, and that investors have already priced in QE3, so not doing it would cause a correction.

On the contrary Dallas Fed President Fisher stated that he is “personally perplexed by the markets’ continued preoccupation” with “so-called QE3”. Fisher’s view is that large asset purchase programs “injected money into the system,” but that “most of that money has accumulated on the sidelines” in the form of excess reserves with the Fed.

The negative view of QE3 is in agreement with other more hawkish FOMC members who don’t believe such a program’s benefits justify the potential risks. The chart below is a good example of how relatively ineffective QE has been in increasing the broad money supply. M3 was already recovering when QE2 began, and it’s unclear just how much of an impact asset purchases had on broader liquidity.

Fisher also referred to the FOMC forecast for exceptionally low rates through 2014 as “not to be used externally, but also harmful if swallowed” (a quote from the 1966 FOMC forecast).

Ultimately the decision is up to the Fed, and for now it looks like they’re staying put despite the case painted by Gross and his fixed income buddies. The worrying question here is if investors really understand the purpose of QE and its effects on the market. The general purpose of QE is to create a wealth effect, by reducing interest earned on investment grade bonds so investors pile into more risky assets and pump up the economy. While some believe it increases the money supply the reality is that the private sector gives away one asset and gets another. So there’s no change in net financial assets. For a deeper look, the guys over at FT have done a great pro’s and cons list on the Feds options.

 

 

 

 

 

Are financial Acronyms hiding weakness?

March 29, 2012 by Peter

The media in it’s endless creativity loves making acronyms. To be fair they help average investors/news readers easily in one quick breathe describe how certain countries are doing, economically in this case. Some recent favorites, PIGS or Portugal, Italy, Greece, Spain, and sometimes Ireland (PIIGS), denote certain European economies that aren’t doing so hot/may be in crisis depending on who you ask, and THE BRICS, or Brazil, Russia, India and China being the economies that are awesome.

Now there’s been a lot of hoopla and media attention on both the PIGS and BRICS, but what happens when someone no longer fits the mold of the acronym? Well it seems the media ignores it, perhaps to avoid changing those acronyms they spent soo much time thinking up.

For sometime India in particular has been on the decline, yet ignored. In 2011 India’s stock market; The Bombay Stock Exchange was one of the worst performing. The BSE 30-share index was off 18.06% for 2011, worse than the stock markets of other BRIC economies.

India isn’t fairing well with their ratings either, Moody’s recently cut India’s banking sector outlook to negative, from stable:

“India’s economic momentum is slowing because of high inflation, monetary tightening, and rapidly rising interest rates. At the same time, concerns have emerged over the sustainability of the recovery in the US and Europe, and the rise in the borrowing program of the Indian government, which could drain funds away from the private credit market.

…”With asset quality, given the tightening environment, we anticipate that it will deteriorate over the next 12-18 months, thereby causing an increase in provisioning needs for the banks in FY2012 and FY2013.”

Secondly, capital flight has emerged as a huge problem for India’s economy as they rely heavily on foreign investors to keep its current account gap in check. So as investors look to cut risk, and avoid emerging and deteriorating markets for more stable one,  investors have only $530 million in Indian equities so far this year, compared with $28.9 billion a year ago, according to the Securities and Exchange Board of India (SEBI).

So things don’t look that solid in India, so perhaps calling them a “BRIC” economy is ironic now. According to Jefferies analysts Nilesh Jasani and Piyush Nahar, “India’s economic slowdown has been driven by a collapse in the investment cycle that are far from being played out.”

Jasani and Nahar write that India suffers from having a risk-averse investor class, and local companies seem to prefer investing in Africa and Europe over India.

The problem then with India is that lackluster real economic prospects are causing risk averse investors to hold onto their cash, and this lack of investment continues to hurt GDP growth, worsen supply-side shortages, drive up inflation, and hurt job creations

It might be a bit premature to start grouping India with the rest of the world’s lackluster economies in the “PIGS” section of the news, Though according to some it might be time to reconsider their “BRIC” status, even if BRC doesn’t have as good a ring to it.

 

Was Bernanke right about the gold standard?

March 27, 2012 by Peter

Last week Federal Reserve Chairman Ben Bernanke went back to his familiar stomping grounds “the classroom” to educate some youngsters atGeorge Washington University about the history and role of central banks and the Federal Reserve. The talk was part of a series he plans to giveentitled “The Federal Reserve and Its Role in Today’s Economy.”

What many in the mainstram media interpreted this talk as was Bernanke attacking the Gold standard. Many have even begun proclaiming that Bernanke has officially killed the Gold Standard. Joe Weisenthal over at Business Insider claims Ben Bernanke Just Murdered The Gold Standard, as well his colleague Simone Foxman, writes Ben Bernanke Explains Why The World Will Never See Another Gold Standard. So is the Gold standard as a theory really dead?

Both BI writers cite Bernanke, “Gold standards are far from perfect,” and “They are a waste of resources.”  In summary citing several problems associate with a gold standard: That Gold creates a lack of price stability (inflation), There are speculative attacked on gold backed economies, and the inability to open up credit when needed.

While its true that gold standards aren’t perfect, one could cite that argument against pretty much anything. So I’ll just ignore that and jump on Bernanake’s first point that on price volatility. Simone Foxman summarizes Bernanke up nicely, while advocates of the gold standard are right that prices remain stable in the long-term, on a year to year basis, that’s not true. Limited supplies of gold—or changes to the supply of gold—cause prices of goods to be volatile in the short-term, regardless of long-term price stability.”

Now this is pretty interesting. Simone/Bernanke admits that prices under a gold standard remain stable in the long term but she, like Bernanke is worried about the short-term. There are two key errors or omissions here. The first is that prices under a gold standard are not necessarily stable in and of themselves (short or long-term). Rather prices are relatively stable under a gold standard if and only if banks do not lend out more gold than there is.

History has shown that alleged problems of the “gold standard” are primarily a problem of central bank interest rate manipulations in conjunction with fractional reserve lending that allows banks to lend out more money than there is gold backing it up. The John Law Mississippi Bubble is a classic example. If we are to continue pointing fingers, when it comes to short-term price stability, the Fed does not have a leg to stand on. There was the housing bubble; the Tech bubble and their subsequent collapses should be proof enough.

On the Inability to Open Up Credit Foxman says, “[Bernanke] pointed to a substantial tome of economic research finding that the gold standard aggravated the Great Depression, saying “the gold standard was one of the main reasons the Great Depression was so bad and so long.” The inability of the Federal Reserve to control monetary policy—open up credit, address unemployment, and drive business demand—left it with much less power to avert or mitigate the decade-long crisis. Bernanke added that countries not tied to the gold standard also had a much easier time getting out of the Depression. In the modern world, he said, “we’ve seen that problem with various kinds of fixed exchange rates.”

Another opinion on the same topic from John Kenneth Galbraith, who was considered an expert on the great depression and an economic adviser to several US presidents on Economics, says In A Short History of Financial Euphoria  “The great depression was the enormous run-up in credit and money the preceded it.” With that in mind, it is beyond silliness to propose more credit and more money is the cure for a problem caused by too much money and too much credit.

In the end all of the problems allegedly caused by the gold standard are in fact properly attributed to one of the following four things according to our economist friends we’ve cited:

1.     Central banks and their central planning

2.     Fractional reserve lending

3.     Fed manipulation of interest rates

4.     Government sponsored monetary printing

So perhaps the Gold Standard isnt dead. Some would have you believe it’s merely Bernanke’s interpretation of economic conditions, and desire to protect his power that are limiting the Gold standard as a viable option.

Are we underestimating Eurozone problems?

March 26, 2012 by Peter

Recently the news would have you believe things have been getting better in the Eurozone, with bailouts being approved, new regulations being put in place, and a general lack of pessimism, Europe might be back on track. But has anything really changed, are we glossing over whats really going on, in favor of a happier story? Even recently the Spanish and Italian economies have not been looking all that hot, even when compared to several months back. Yet there are growing concerns over fiscal slippage in Spain and weak economic readings from Asia and Europe which are weighing on demand for lower rated euro-zone government bonds.

From the Wall Sreet Journal” Spanish bonds extended a slide that was triggered earlier this month after the country was chided by euro-zone authorities over the government’s unilateral decision to revise up its budget deficit target for this year. With concerns over Greece abating after a crucial debt exchange went through, Spain is increasingly being seen as the next flashpoint in the euro zone.

The economy is stuttering, unemployment is rampant, and the market is losing confidence in the government’s ability to mend its finances. If the sell-off in Spanish bonds were to accelerate, Italy might not be left unscathed either.”

All of a sudden economists and analysts (such as this CS forecast) are realizing they’ve underestimated the level of the periphery recession. Its scary to think about the forecasting mistakes coming through recently, the latest being in the Eurozone manufacturing PMI (seen in graph below). It seems analysts and economists had underestimated just how bad things were.

With all that is going on in Europe lately It’s hard to think of anything but a depression-style economy in Spain for example, when nearly a quarter of the population is out of work (22.85%).

And only now is the global news media catching onto the dire situation.

Businessweek: Europe’s economy may struggle to regain strength after shrinking 0.3 percent in the fourth quarter as governments toughen budget cuts, rising oil prices erode consumers’ purchasing power and global demand weakens.”

 

Whats going on with Jobless claims

March 23, 2012 by Peter

The Labor Department reported today that “seasonally-adjusted initial jobless claims fell to a four-year low of 348,000 for the week ending 348,000, the lowest level since early March 2008”.

Its great to see claims falling, but there are problems comparing weekly jobless claims over time. This is because  they are not adjusted for the increasing size of the economy, population, or labor force over long periods.  To better understand this point lets take a trip back in time, following the 1981-1982 recession, jobless claims fell below 350,000 for the first time in January 1984 since before the recession. But keep in mind civilian employment then was only about 103 million, compared to 142 million today.  Adjusted for the employment level, 350,000 initial claims in 1984 was about 0.34% of employed workers, while today it’s only about 0.25% of employment.

For those who dont speak “economist”: So adjusted jobless claims for the past few months are at about the exact same levels we previously saw during the last two post-recession expansions in 1992-1993 and 2002-2003, and are below comparable post-recession periods in the 1970s and 1980s.  Conditions in today’s labor market are actually better than the unadjusted claims would suggest, this is one of the many data points economists are using to predict the start of the recovery.

Resolutionary indeed!

March 17, 2012 by Jennifer

We are excited to be supporting the retina display of the new iPad. At 2048 x 1356 and with a whopping 3,145,728 pixels at 264 pixels per inch (PPI), the new iPad delivers an uncannily crisp, vivid viewing experience. If you have a new iPad, please update StockTouch to get the sharpest, most beautiful version of the app yet.

Why hasnt the US Govt refinanced their debt to take advantage of low rates?

March 14, 2012 by Peter

A few days ago on CNBC, Jim Cramer asked why Tim Geithner hasn’t yet refinanced America’s debt, as we’re seeing super-cheap long-term rates. To get some perspective on this, here’s a long-term look at the yield on 30-year US Treasuries.

As expected, rates are super-low.

So Cramer’s thought seem logical, as he put it: “Let’s lock in these super-low rates, and take the possibility of a bond-vigilante-inspired, Greece crisis off the table.”

That sounds like a great idea right? Who wouldn’t want a lower rate on their debt? Well, let’s explain real quick why this is never going to happen.

These reasons are in no particular order.

  •   The US is nothing like Greece. The US has its own currency, which it can print. Greece doesn’t. So the US will never “run out of dollars” such as how Greece ran out of Euros.
  • The Treasury can’t just refinance its debt like a homeowner can refinance their mortgage. To actually pull off a refinancing event, the Treasury would have to simultaneously issue tons of long-term debt, and then buy back the short-term debt, otherwise this would just blow us past the statutory debt ceiling. What’s more, it’s not clear that the Treasury would have the authority to start buying back debt since that’s not budgeted for.
  • This could end up being costly. Imagine if we’re Japan, and long-term yields fell for another decade, and here we were with $1 trillion in debt that we arbitrarily took out at high yields, thinking rates couldn’t possibly go lower.

Most importantly, this would be bad for the economy.

Right now, the policy overt goal of the Fed is to lower long-term rates to help people refinance debt, and theoretically to force holders of US Treasuries into riskier assets.

Thus refinancing activities would accomplish the opposite. Selling $1 trillion extra 30-year Treasuries would suck tons of liquidity out of the market; increase long-term rates, while making it easier for people to stay in non-productive risk-free assets.

Basically, there’s no point for Geithner to do this, he can’t do it, and it would hurt the economy.

Apple Love

March 7, 2012 by Jennifer

Today Apple announced the new retina display iPad. We couldn’t be more excited. We were also pleasantly surprised to see Tim Cook talk about “groundbreaking apps” and to cite and show StockTouch as one of them. Check out the video below (embedded from CNN) as well as a still from Apple’s event rebroadcast (we are at approximately the 20 minute mark).

The Greek bond swaps

by Peter

So while we’re all still waiting on hand and foot till Thursday to get a final number on how many of Greece’s private creditors will participate in a bond swap deal requisite for EU leaders to give the struggling country its bailout, a bunch of headlines today suggest that there’s trouble afoot.

The biggest and scariest question is still whether Greece can get sufficient investor participation to go through with the deal at all.

Today, Greece’s finance ministry said it is planning to activate collective action clauses on Greek-law bonds which would force investors to participate in the bond swap so long as enough of them agreed to the deal voluntarily if it can. In contrast to the plans it had previously released, this would permit the Greek government to trigger these collective action clauses on bonds issued under Greek law with a quorum of 50 percent of bondholders and just 66.6 percent approval.

Such bonds make up €177.3 billion ($232.4 billion) of Greece’s debt issuances. Bondholders would take a 55.3 percent haircut on these bonds, and so the restructuring would reduce Greece’s immediate debt burden by nearly €100 billion.

(These aren’t the only bonds at issue, however. About €18 billion issued under foreign (notably, UK) laws, on the other hand, require 75 percent of all noteholders to agree to the CAC during meetings that will be held later in the month.

Banking news.gr also reported earlier today that Greek Finance Minister Evangelos Venizelos had called an extraordinary meeting between Greek bankers and government officials, in order to convince the latter that going through the deal is a necessity.

Later in the day, Reuters reported that at least four Greek pension funds amounting to at least €2 billion have refused to go ahead with the bond swap. These holdouts join hedge funds who bought issues of distressed Greek debt speculatively, who will not participate in order to reap the payouts of credit default swaps insurance contracts they bought on Greek debt.

While analysts, on the whole, still expect Greece to get sufficient participation to be able to activate the CACs (regardless of the fact that these would probably provoke a credit event), the fact that the country is having difficulty in soliciting participation is nonetheless troublesome. Investors will be watching carefully for signs that Greece will or will not be able to go ahead with the deal.

What happens to Greek markets if they leave the Euro?

March 5, 2012 by Peter

So with all that’s been going on in Euro zone, especially Greece many are calling for Greece to leave, or considering leaving the Euro. The more important question as investors though is, what are the prospects for the Greek stock market if Greece leaves the Euro.

SocGen’s Patrick Legland and Daniel Fermon have produced this clever chart.

It compares the Athens market to the Argtine market, during its crisis.

Basically, Argentina was essentially in the same situation as Greece, except the Argentina peso was pegged to the dollar.

When Argentina de-pegged, its equity market surged when priced in pesos, and fell when priced in dollars.

If Greece “de-pegs” expect the market to rally when priced in drachmas, and tank when priced in Euros.

 

More LTRO to come for Europe?

March 2, 2012 by Peter

The Europeans Central Bank’s Three-yearlong term refinancing operation or LTRO, is now widely believed to have been the reason Europe was able to Avert a full-scale banking crisis.

Before we throw a party let’s put this in perspective. While European banks’ purchases of sovereign debt as a result of the LTRO may have funded some countries through the end of the year, the banks themselves have a long way to go before they’ll be secure about their own funding next year.

In fact, according to this chart (via @ZeroHedge) banks would need a full four more LTROs before they would be sure to meet funding requirements by the end of next year. The €489 billion ($657 billion) they scooped up in the last LTRO is still paltry in comparison to banks’ €2.4 trillion in funding needs by the end of next year.

Obviously, the banks are going to attempt to raise more capital through other outlets, as they should. At minimum, however, what this chart is highlighting is that it’s still difficult to be certain that a credit crunch wouldn’t take down Europe’s banking system (where banks would be unable secure more capital and would fold).

This weeks LTRO is expected to produce the same take-up as December’s. We could very well see renewed pressures on the banking system if this allotment falls short.