Tuesday, August 21, 2012 - A Crash? Your Guess is as Good as the Economists, Maybe Better

A Crash? Your Guess is as Good as the Economists, Maybe Better 
-by Sinclair Noe

DOW – 68 = 13,203
SPX – 4 = 1413
NAS – 8 = 3067
10 YR YLD -.01 = 1.80%
OIL -.30 = 98.16
GOLD + 17.40 = 1639.60
SILV + .52 = 29.43
PLAT + 25.00 = 1516.00

Normally, these are the slow,  sultry, dog days of summer; that's what we've seen lately. Volume has been so light that you wondered if everyone had gone to sleep. And then this morning, people started trading, or maybe the computers started trading. Who can say which? Volume jumped to the highest in 3 weeks and prices flopped. 

David Kostin, Goldman Sachs chief US equity strategist, has sent a note to clients advising them to get out of stocks; Kostin is forecasting a 12 percent drop ahead, down to about 1250, believing that Congress will fail to address the fiscal cliff before the election, and maybe even before the end of the year. Kostin says: "Political realities and last year's precedent suggest the potential that Congress fails to reach agreement in addressing the fiscal cliff is greater than what most investors seem to believe based on our client conversations.”

According to Goldman Sachs economists, the worst case scenario this year is that a lame duck Congress does absolutely nothing after the election - not even kick the can down the road by voting in a short extension of the tax breaks and spending plans. Under that scenario, 2013 GDP would actually contract.

Now normally I would hear a report like this and dismiss it, or because it came from Goldman Sachs, I might take a contrarian stance because we know that Goldman has a history of misleading the investing public. Also, because we know Goldman Sachs is two-faced. Goldman senior investment strategist Abby Joseph Cohen just this morning said she expects equities to outperform bonds for the remainder of the year. So, it appears there is a little bi-polar disorder among Goldman economists. 

Then we see a research report from Nomura strategist Bob Janjuah and he expects the S&P to fall by 20-to-25-percent over the next three months.  Janjuah expects the dollar to be a big beneficiary if the S&P 500 does fall as sharply as he predicts.

He says the  coming major risk-off phase will be dollar bullish and bullish for core government bonds; which means 10-year bonds in the US, Germany and the UK could hit just one percent. He predicts the Federal Reserve will not provide more quantitative easing until December. Those hoping for a big bazooka from the Fed or the European Central Bank before December will be disappointed.

Janjuah says he expects “Mr Bernanke to disappoint markets at Jackson Hole next week, and also because we are confident that markets will soon discover that neither the ECB nor Eurozone politicians will actually be able to deliver on their promises. For now we are happy to risk 30 S&P points against us, in order to potentially pick up 300 S&P points in our favor.”

Sure enough, the Euro-zone seems to be in disarray. The ECB is discouraging  speculation that it might act far more aggressively to contain borrowing costs for countries like Spain. The ECB dismissed a report in Der Spiegel that they would buy up bonds in whatever quantity was necessary. Today, The Daily Telegraph, a British newspaper, supported that Der Spiegel report that the ECB planned to put a hard cap on Spanish and Italian bond yields. So, the European markets are now trading on rumors and speculation that the ECB will make a big bond buying commitment. 

Yields at a Spanish short-term debt auction fell, while Europe's  volatility index  hit a one-month low, signaling a steady rise in investors' appetite for risk. Spanish 10-year bond yields fell 10 basis points to 6.24 percent, with shorter-dated yields down as much 16 basis points. Italian bond yields also dropped.  Portuguese 10-year yields fell 30 basis points on the day to 9.40 percent, the lowest level since April 20. 

Euro financial markets have been running on hopes that the new urgency in Europe will overcome the crisis. Greek Prime Minister Antonis Samaras will meet German Chancellor Angela Merkel, French President Francois Hollande and Eurogroup chief Jean-Claude Juncker in the coming days to try to secure more help from the European Union, International Monetary Fund and ECB, even though Greece has fallen behind on its debt-cut targets. Samaras is hoping the Troika will cut some slack, it probably won't happen but if Greece can hold out hope, then there is hope for the rest of the continent.

The euro climbed 1 percent to $1.24, and the dollar index slipped to 81.92; for now the chart of the US Dollar looks to be rolling over to the downside.  This sparked a bit of a commodity wide rally today as speculators ran to hard assets. Precious metals moved higher. Corn and soybeans posted new record high closes. 

The ECB still refuses to confirm the newspaper reports but it is clear that the ECB damn well better step up big, or there will be massive problems, and the time-line is about  3 weeks. 

Central banks around the world have maintained near-zero short-term interest rates for many years now, trying to save the world. The Federal Reserve has bought up billions of dollars worth of government and mortgage bonds and they hold them on its on balance sheet, in order to hold down long term interest rates.  You can argue the Fed has helped but these actions are not without negative side effects. Central bank intervention can give investors headaches and it also  causes markets to behave in strange ways.

And lately, there has been some strange behavior in the junk bond market. Junk bonds are issued by companies that either have relatively risky business plans, or that already carry a large amount of debt, or they are just generally considered a credit risk. And because of the relative riskiness of loaning money to them, these companies typically have to pay 3% or 4% more in interest than the US government does to borrow for the same amount of time.

With interest rates so low for so long, investors have been increasingly willing to risk their money on junk bonds in order to get that extra yield. And as new money starts pouring into high-yield bonds, some are starting to worry that the junk bond market has reached bubble-like levels. Maybe investors piling into junk bonds for the attractive yields should worry about the fact that the default rate has been creeping up lately. 
High yields are tempting, especially compared to what government bonds are paying, but the yields are supposed to compensate for risk. Investors who are only paying attention to the spread aren’t accounting for the fact that the junk bonds are paying 0.5% less interest than they were five years ago. And, of course, the world hasn’t gotten any less risky over the past 5 years. 

So is this possible junk-bond bubble a threat to the broader economy? Probably not. The bubble might not pop, but it is another indication of the unintended consequences of having the Fed run monetary policy, inducing investors to take bigger than normal risks; maybe the Fed can control any fall-out or maybe when any bubble pops it makes a mess; a mess for junk bond investors, a mess for companies looking for capital. 

Wikileaks and Free Speech NY Times
I don't know where Julian Assange came from; I know he's an Australian citizen, but he seemed to appear on the international scene out of nowhere. His name generates more hits on search engines than the British Prime Minister. The news media in the Untied States does a poor job of informing Americans. Wikileaks, the website created by Assange, has created a unique approach to journalism. The site disseminates raw data, without interpretation or editorial opinion, just raw data in the form of cables, memos, dispatches, videos, and such. Sometimes some information has been redacted to protect people in dangerous situations; the idea was not to expose a US spy or undercover agent; still the data released has proven quite embarrassing for some people in positions of power. 

Julian Assange has been granted asylum by Ecuador and he is now living in the Ecuadorean Embassy in London. Ecuador has acted in accordance with important principles of international human rights. Indeed, nothing could demonstrate the appropriateness of Ecuador's action more than the British government's threat to violate a sacrosanct principle of diplomatic relations and invade the embassy to arrest Mr. Assange.

Since WikiLeaks' founding, it has revealed the "Collateral Murder" video footage that shows the seemingly indiscriminate killing of Baghdad civilians by a US Apache attack helicopter; United States collusion with Yemen's dictatorship to conceal our responsibility for bombing strikes there; the Obama administration's pressure on other nations not to prosecute Bush-era officials for torture; and much more.

Predictably, the response from those who would prefer that Americans remain in the dark has been ferocious. Top elected leaders from both parties have called Mr. Assange a "high-tech terrorist." And thre are demands that he be prosecuted under the Espionage Act. Most Americans, Britons and Swedes are unaware that Sweden has not formally charged Mr. Assange with any crime. Rather, it has issued a warrant for his arrest to question him about allegations of sexual assault in 2010.

All such allegations must be thoroughly investigated before Assange moves to a country that might put him beyond the reach of the Swedish justice system. And if Assange is guilty he deserves no quarter.  But it is the British and Swedish governments that stand in the way of an investigation, not Assange.

Swedish authorities have traveled to other countries to conduct interrogations when needed, and the WikiLeaks founder has made clear his willingness to be questioned in London. The Ecuadorean government made a direct offer to Sweden to allow Assange to be interviewed within Ecuador's embassy. In both instances, Sweden refused.

Mr. Assange has also committed to traveling to Sweden immediately if the Swedish government pledges that it will not extradite him to the United States. Swedish officials have rejected this proposal; so did the Brits.  So, it is obvious that the real agenda is to get Assange to Sweden, where certain treaties would make it easy to extradite him to the US. Mr. Assange has every reason to fear such an outcome. WikiLeaks itself has published e-mails from Stratfor, a private intelligence corporation, which state that a grand jury has already returned a sealed indictment of Mr. Assange. The charge would likely be espionage, a capital offense.

If Mr. Assange is extradited to the United States, the consequences will reverberate for years around the world. Mr. Assange is not an American citizen, and none of his actions have taken place on American soil. If the United States can prosecute a journalist in these circumstances, the governments of Russia or China could, by the same logic, demand that foreign reporters anywhere on earth be extradited for violating their laws. The setting of such a precedent should deeply concern everyone, admirers of WikiLeaks or not. On Sunday, Assange took to a microphone from a balcony of the Ecuadoran embassy and proclaimed the US risks  “dragging us all into a dark, repressive world in which journalists live under fear of prosecution,” 



There is an interesting aside, Wikileaks published more than 250,000 US Embassy cables that highlighted embarrassing back room dealings. Some of this information might have resulted in the Arab Spring, but Wikileaks really ran into trouble when Assange threatened to release hundreds of thousands of documents that he said would expose major banks wrongdoing, and would almost certainly result in the ruin of more than one major US bank. Shortly thereafter, all sources of funding for Wikileaks were shut down, and Assange was arrested. We still haven't seen the bank document dump from Wikileaks.