Thursday, May 08, 2014 - Monetary Policy Is Not A Panacea

Monetary Policy Is Not A Panacea

by Sinclair Noe

DOW + 32 = 16550
SPX – 2 = 1875
NAS– 16 = 4051
10 YR YLD + .01 = 2.60
OIL – 01 = 100.24
GOLD - .10 = 1290.80
SILV - .15 = 19.25

Stocks were mostly lower today. The closing numbers looked quiet but it was a roller coaster ride with the Dow Industrials up about 150 points. The Nasdaq also squandered early gains to finish in negative territory. The Nasdaq ended lower for a third straight session, its longest losing streak since early April. A late selloff in utilities and energy, among the best performing sectors recently, dragged the S&P 500 lower. Of 445 companies in the S&P 500 that have reported earnings, 68.2% beat expectations, above the 66% beat rate for the past four quarters. Profits are expected to rise 5.3% this quarter.

The number of people who applied for new unemployment benefits last week fell to the lowest level in a month. Initial jobless claims dropped by 26,000 to a seasonally adjusted 319,000.

The federal government had a budget surplus of $114 billion in April. That is $1 billion more than a year ago and would be the biggest April surplus since 2008. For the fiscal year to date, CBO estimates the deficit to be $301 billion, down $187 billion compared to the same period in 2013.

Retailers posted modestly higher sales in April. Results from March and April are generally viewed together because of the shifting nature of Easter, which fell about three weeks later this year and moved into April from March last year. For the two-month period, retailers reported 3.4% growth, down from 3.5% a year earlier.

Consumer credit balances increased by $17.5 billion in March to a total of $3.141 trillion. The gain was a bigger increase than the $15.5 billion expected by economists. This was the biggest month-over-month growth rate since February 2013. Nonrevolving debt like college and auto loans grew by $16.4 billion. Revolving debt like credit cards increased by $1.1 billion.

At 4.21%, the 30-year fixed-rate mortgage is at its lowest since the week of November 7, 2013, so says Freddie Mac in their new weekly report on national mortgage rates. Last week, it averaged 4.29%. A year ago, it was 3.42%. Since the housing market crashed, the Federal Reserve has used extraordinarily easy monetary policy to keep interest rates like mortgage rates low in its effort to bolster the housing market and stimulate the economy.  Lately, various housing-market metrics such as existing-home sales, new-home sales, and mortgage applications have all been flagging. Last week, we learned that the US homeownership rate was at a 19-year low, and some experts think it'll never come back.

Yesterday, Fed Chair Janet Yellen said, "One cautionary note, though, is that readings on housing activity—a sector that has been recovering since 2011—have remained disappointing so far this year and will bear watching. The recent flattening out in housing activity could prove more protracted than currently expected rather than resuming its earlier pace of recovery." That was the big takeaway from Yellen’s Congressional testimony yesterday.

Fed Chair Janet Yellen was back on Capitol Hill today for a second day of testimony. She appeared before the Senate Budget Committee.  Yellen’s favorite new line is, “Monetary policy is not a panacea.” That pretty much says it all.

There are a couple of trends that concern Yellen; long term unemployment; there are about 3.5 million workers who haven’t found a job for at least 6 months. Also, income inequality is pulling down spending and slowing the economy. Yellen would like to do something about these disturbing trends, but you know, “Monetary policy is not a panacea.”

Meanwhile, the European Central Bank was meeting to determine monetary policy for the Euroland; they decided to leave interest rates unchanged at 0.25%. ECB President Mario Draghi’s favorite line is “whatever it takes” and he’s been saying it for a couple of years. Euroland is slogging along with persistently low inflation and high unemployment. Draghi says something should be done, but he did not say what; and the ECB might address stimulus of some sort or another next month or so.

Perhaps Draghi is waiting to see how the situation in Ukraine plays out; right now the picture is smoky and very gray. Rebels in eastern Ukraine say they will proceed with a referendum this weekend seeking autonomy even though Russian President Putin appeared to withdraw his support for the vote. Putin yesterday presided over nationwide army drills, a day after he softened his tone by promising to withdraw troops from the border. The government in Kiev says a referendum would be illegal. Putin also indicated he would pull Russian troops from the Ukrainian border, but satellite images show that probably isn’t happening. The situation involving the tug of war between the West and Russia regarding Ukraine has steadily worsened over time and now involves outright economic warfare; sanctions on one side and the threat of energy shortages on the other.

Even former Treasury Secretary Tim Geithner is coming out of exile to hawk a new book. Geithner says there had been talk about nationalizing banks back in the crisis days. On the legacy of the bailouts, Geithner rejects criticism that the Troubled Asset Relief Program benefited the rich rather than ordinary Americans. And yet he acknowledges that the too big to fail banks are bigger and more dangerous than ever.

Have you ever seen a boxer knocked out? The devastating blow is the one you don’t see coming. Mark Carney, governor of the Bank of England and head of the Financial Stability Board, an international watchdog set up to guard against future financial crises, was recently asked to identify the greatest danger to the world economy. He answered shadow banking. It is huge and growing fast, and little understood, and even less transparent. We don’t even know exactly what counts as shadow banking; basically, it refers to lending by non-bank institutions and it involves more than $70 trillion in assets, up from about $25 trillion ten years ago.

A broader definition, however, would include any bank-like activity undertaken by a firm not regulated as a bank: it could be bond trading platforms set up by technology firms, or payment systems offered by Paypal or financing offered by a retailer such as Sears, or peer-to-peer lending, or money market funds, or who knows what. At the core is the concept of credit and lending. Shadow banking fills a void left by traditional banks, which have become miserly with lending.

Yet shadow banking is poorly or non-regulated. Think of the structured investment vehicles, a legal entity created by banks to sell loans repackaged as bonds. These were notionally independent, but when they got into trouble they pulled in the banks that had set them up. Or money market funds, which seemed like a nice safe place to park cash as a stop-gap measure; they seemed conservative, nearly risk free, until they suffered a run.

Banks must now incorporate structured investment vehicles on their balance-sheets. Money-market funds must hold more liquid assets, to guard against runs. Limits on leverage have been imposed or are being considered for many forms of shadow banks. American regulators are still allowing some money-market funds to create the impression that an investor can never lose money in them. The problem for banks is that they are involved in shadow banking, either in the form of loans to shadow banks, or because the banks buy the products created by shadow banks.

One of the biggest paces for concern is China. Banks there are banned from expanding lending to certain industries, and from luring deposits by offering high returns. So they do both of these things indirectly, through shadow banks of various sorts. Some firms are setting themselves up as pseudo-banks. It is hard to imagine that all the shadowy loans to unprofitable steel mills and overextended property developers will pay off. At which point the Chinese government will likely step in a take control, but there will be a cost.

Nouriel Roubini, the New York University professor and chairman of Roubini Global Economics is known as something of an economic pessimist, and now he thinks we’re on the verge of a bubble, but not a collapse. Roubini says the Federal Reserve will keep its key lending rate low even after it lifts off from near zero, where it has rested for the few years. That slow process of normalization will keep the spigot of borrowing flowing, helping support the economy. But it will also lead to risky lending practices. Hence, a bubble is inflating that could eventually pop.

Roubini cited the return of some of the key characters associated with the period before the last financial collapse: Lots of low quality bond sales, debt without strong protections for bondholders. Roubini says: “All the risky things that were happening back in ’06 and ‘07 are back again to the same level, if not more. So we are in the beginning of a credit bubble, but just the beginning.”

Nonetheless, Roubini doesn’t see the reversal happening immediately, citing money that continues to rush into the market. For now, credit investors appear to be stuck in an uneasy equilibrium.

He’s by no means the first person to make this claim: the question of financial stability is one of the key criticisms of the Fed’s accommodative policies. Roubini didn’t criticize the central bank, so much as say that the Fed is damned-if-you-do, damned-if-you don’t.

Yeah, well, we’ve all learned that monetary policy is not a panacea.

Tuesday, April 15, 2014 - Yellen in the Lions' Den

Yellen in the Lions' Den
by Sinclair Noe

DOW + 89 = 16,262
SPX + 12 = 1842
NAS + 11 = 4034
10 YR YLD - .01 = 2.62%
OIL - .22 = 103.83
GOLD – 24.20 = 1303.40
SILV - .41 = 19.66

Stocks were all over the place today. We started with triple digit gains for the Dow Industrials, dipped to triple digit losses, then back into positive territory for the close with the major indices closing just below their morning highs. This kind of volatility does not engender confidence; it does warrant caution.

The utilities sector gained 1.3% and finished ahead of the other groups, extending its YTD gain to 11.8%; the biotech ETF added 1%, while the broader healthcare sector advanced 1.1%.Tech stocks have been beaten up quite a bit over the past couple of weeks. The Nasdaq 100 Tech Index (NDXT) is down 7% since April 1st. The Nasdaq Composite has exhibited weakness, but not to the point of meeting the definition of a correction; it would take a slide to 3,922 to mark a 10% fall from the March 5 closing high at 4,357; a 10% pullback from the March 6 intraday high of 4,371 would be achieved at 3,934.

The Labor Department’s Consumer Price Index, or CPI, increased 0.2% in March after posting a 0.1% increase in February. Excluding volatile food and energy prices, core prices ticked up 0.2%.Prices rose 1.5% for the 12 months ending in March. That is up from February’s year-over-year reading of 1.1%. Core prices moved up 1.7% over the 12 months, up from 1.6% in February.

A major factor in both headline and core CPI in March was a 0.3% increase in shelter costs. On an annual basis, housing costs were up 2.7%, the fastest pace in six years. The indexes for medical care, used cars and airline fares also increased in March. Apparel prices rose for the first time this year. Household furnishings and recreation prices dipped in the month. Real or inflation-adjusted hourly wages, meanwhile, fell 0.3% in March to $10.31. Real wages have risen 0.5% over the past 12 months. So, we’re not seeing wage-push inflation.

The big difference has been housing; shelter costs account for a full third of the basket of goods and services tracked in the consumer price index. In the past year, consumer prices excluding shelter have risen just 1%, an indication that inflation pressures are subdued outside of housing.

The old rule of thumb was that rents and utilities combined should not take up more than 30% of household income. A new study by Zillow finds 90 cities where the median rent, not including utilities, was more than 30 percent of the median gross income. A study by Harvard finds that nationally, half of all renters are now spending more than 30% of their income on housing, up from 38% of renters in 2000. Part of the reason for the squeeze on renters is simple demand; between 2007 and 2013 the United States added, on net, about 6.2 million tenants, compared with 208,000 homeowners.

For many middle and lower income people, high rents choke spending on other goods and services, impeding the economic recovery. Low-income families that spend more than half their income on housing spend about a third less on food, 50% less on clothing, and 80% less on medical care compared with low-income families with affordable rents.

Federal Reserve Chairwoman Janet Yellen is scheduled to go to the lion’s den tomorrow, making a speech before the Economic Club in New York. Today, Yellen took the show on the road, speaking to a banking conference in Atlanta, she said current rules on how much capital banks must hold to protect against losses don't address all threats. She said the Fed's staff is considering what further measures might be needed, and such measures would likely apply to only the largest and most complex banks. Yellen said the Fed would review the likely effects of imposing stricter rules on banks. That probably plays better in Atlanta than Manhattan.

At some point Yellen must press the case of the Fed as regulator and in control of the banks rather than vice versa. Now, any threat or hint of threat at tighter control is only likely to result in the big banks moving risky behavior into less regulated areas of the financial system. These areas are often called the shadow banking system.

One area of concern for Yellen and her Fed colleagues is the short-term debt markets. So, Yellen would like to see the banks hold more capital; the idea being that it would make them less susceptible to a run. Now, when you hear that the Fed Chair is concerned about a bank run, this is not the old fashioned bank run, with customers lined up at the door of Bedford Savings and Loan and Jimmy Stewart trying to persuade his neighbors that their long-term loans will provide sufficient liquidity to short-term needs.

The problem goes to an area of regulation overlooked, or perhaps neglected by Congress and the various regulators; specifically derivatives; and after the collapse in 2008 what the regulators did was to concentrate the risk of the derivatives among four major Wall Street banks; the big banks just got bigger.

If you’ve ever stood in a teller’s line at the bank, you may have noticed the FDIC sticker, which reads, “Backed by the full faith and credit of the United States Government.” Effectively, that means, if the assessments the FDIC charges the banks to meet the needs of the Deposit Insurance Fund run short, the taxpayer must prop up the fund to make insured depositors whole. On top of that promise, the National Depositor Preference statute came into being in the US in 1993, making all deposit liabilities at insured depository banks preferred over the claims of other creditors.

The serious wrinkle in the plan is that if one of the four largest banks in terms of derivative exposure was put into receivership by the FDIC, its derivative counterparties have the legal right to assert a super-priority claim on the liquid assets of the bank, jumping in front of depositors. Typically, the counterparties start grabbing their collateral before the public is even aware of the problem.

The Deposit Insurance Fund probably has about $40 billion in assets. With the Dodd-Frank prohibition against further taxpayer bailouts of banks, where would the FDIC turn to stem a run on one of the largest banks?

Under the Federal Deposit Insurance Act, the FDIC, acting as a conservator or receiver for an insured depository institution, has the right to “disaffirm or repudiate any contract or lease.” But here again, Wall Street has the FDIC between a rock and a hard place. Let’s say there was a reenactment of 2008 and Citigroup was sliding toward insolvency. If the FDIC repudiated Citigroup’s derivative contracts, it would set off a panic and contagion at the other three largest banks holding trillions in derivatives, creating an even larger financial tab for the Deposit Insurance Fund to meet. Banks taking deposits of public funds are required to pledge collateral against any funds exceeding the deposit insurance limit of $250,000. But derivative claims are also secured with collateral, and they have super-priority over all other claimants, including other secured creditors. The money is gone before you get to the teller’s window.

But before you lose any sleep over the prospects of another, potentially far worse global financial meltdown, take solace that the economy is recovering. There are a few more jobs, and consumers are spending, and the housing market is improving, and the Fed has been pumping money into the economy to foster this growth of credit. Right?

Well, one of the lessons we’ve learned in the recovery is that there is a difference between credit growth and economic growth. And absent real and sustainable economic growth a gap eventually forms as credit growth expands. The more one spends on a place of shelter the less one has to spend on other things, and overall demand is reduced. Bank lending finances the purchase of existing assets, particularly with reference to real estate. Such existing asset finance does not directly stimulate investment or consumption, but it drives up asset prices, and that leads lenders and borrowers to believe that even more credit is both safe and desirable. The expansion is like a rubber band that can only stretch so far.

So, it seems the greatest danger to the current economy are the very mechanisms that are still used to “fix” the last financial crisis: money-printing and asset-purchases by major central banks around the world that unleashed a global flood of liquidity for over five years. Most of this massively huge pile of cash has landed in the laps of banks, institutional investors, hedge funds, private equity firms, and other speculators has not been used to boost lending to the private, and thus has not contributed to the recovery of the real economy. Instead, it has been poured into financial assets and has artificially goosed their valuations.

This money sloshing through the system and the persistence of zero-interest-rate policies have driven desperate investors ever further out into “all risky asset classes,” including emerging assets, junk-rated corporate credit, Eurozone peripheral debt, and equities. That buying pressure has inflated their valuations even further. And in the emerging markets, it led to an appreciation of exchange rates.

And when the rubber band breaks, there will be a derivatives bet on it. When the derivatives default, the counterparties, operating in an unregulated shadow banking world of their own design, do not have sufficient capital to pay off the derivatives bet, and so the first thing they’ll do is raid the bank vaults, and when that dries up, the short-term credit markets freeze, because none of the counterparties have faith that the other party has any more in capital reserves than they have.

Thursday, March 20, 2014 - Stress Tests and Such

Stress Tests and Such
by Sinclair Noe

DOW + 108 = 16331
SPX + 11 = 1872
NAS + 11 = 4319
10 YR YLD un = 2.77%
OIL - .27 = 98.63
GOLD – 2.10 = 1329.50
SILV - .34 = 20.37

More sanctions for and from Russia; President Obama today expanded sanctions against Putin’s inner circle, now banning visas and freezing assets of 20; the blacklist now includes a commodity broker with a brokerage based in Switzerland, plus Bank Rossiya with about $10 billion in assets.

In response, the Russian Duma, the lower house of parliament ratified the annexation of Crimea, and Putin announced sanctions against US oligarchs, including Senators John McCain and Harry Reid, and House Speaker John Boehner. McCain said he would have to cancel his plans for Spring break in Siberia.

There is an EU summit underway, and it remains to be seen if European leaders will get tough with sanctions. German Chancellor Angela Merkel has been talking tough but the Euro-economy is still fragile, and it is doubtful sanctions will serve as a strong deterrent. This is not to say that sanctions won’t have an effect. Some of Russia's largest companies are registered abroad where they may benefit from lower tax rates.

You might not have caught this next bit of news, after all there was a lot going on today with the Russian sanctions and the breaking news on the missing plane and the basketball brackets and such; anyway, in Florida today, after talking about sanctions, President Obama called for legislation requiring equal pay for equal work.

Obama said: “Women with college degrees may earn hundreds of thousands of dollars less over the course of her career than a man at the same educational level, and that’s wrong. This isn’t 1958 -- it’s 2014.”

This is clearly a blatant attempt to draw in more female voters in the mid-term elections; still it’s true.

California is facing wildfires "outside of any normal bounds" as a historic drought turns drying brush and trees into a perfect tinderbox. Fire officals say the state recorded 665 wildfires from the start of the year through March 8, about three times the average of 225 for this time of year. Cal Fire officials warn that each day without heavy rain deepened the risks of a catastrophic fire season and made it hard to deal with more wildfires if and when they broke out. And the fires are bigger.

Even before this year's drought, forest officials were reporting a longer fire season, and more catastrophic mega-fires, in California and other western states. Half of the worst fires in recorded Californian history have occurred since 2002. This is usually the time of year when much of the state is greening up. We haven't even got into the months that historically are the worst in California – late August, September and October – so that's a big red flag right there.

The number of Americans filing for jobless benefits hovered near three-month lows last week. Initial claims for state unemployment aid increased 5,000 to a seasonally adjusted 320,000 last week.

In a separate report, the Philadelphia Federal Reserve Bank said its business activity index rebounded to 9.0 in March from -6.3 in February. Any reading above zero indicates expansion in the region's manufacturing. There was a rebound in new and unfilled orders at factories in the region. Shipments also bounced back, but inventories fell. Employers opted to increase hours for existing workers rather than expand payrolls.

The National Association of Realtors said existing home sales slipped 0.4% to an annual rate of 4.60 million units. That was the lowest level since July 2012. Inventory levels are low, while prices have been moving higher. The median price for a previously owned home rose 9.1% in February from a year earlier.

The Conference Board's leading economic index rose 0.5% in February, after a 0.1% rise in January and a 0.1% decline in December.

The Federal Reserve submitted the stress test results on the 30 biggest US banks; 29 passed, one failed. Zions Bank does not have enough capital reserves; this is not a surprise; Zions is resubmitting its capital plan after taking a charge on bank trust preferred securities which Zions tried to claim as Tier 1 capital, but the Fed did not accept that.

Anyway, the Fed figures that if the economy falls off another cliff, the banks would lose $501 billion, but they would be able to survive. The Fed defines falling off a cliff as a bad recession where unemployment spikes to 11.25%, the stock market drops 50%, and home prices drop 25%. Most sane people would call that a depression.

Previous stress tests were used to reassure investors that the big banks were not a hot mess and were financially strong, even in tough times. The problem is that the tests aren’t very realistic. Unfortunately, the Fed’s approach ignores a lot of the horrible things that actually happen in nasty downturns. For example, banks’ borrowing costs tend to rise, killing profits that could offset their losses; trouble at one bank can spread as investors wonder which others will be affected; credit freezes can force financial institutions to sell assets at a loss, setting in motion downward spirals in which falling prices and banks’ woes reinforce each other. If you start thinking about all those things, we’d be lucky if one bank could pass the test. Of course, that wouldn’t inspire much confidence, and so…

Remember not so long ago when the markets were upset about emerging markets and a slowdown in China? Just in case you forgot, Morgan Stanley has just issued a report on China. Here are some of the key points:

Morgan Stanley analysts…, “believe China’s twin excesses (excessive investment funded by excessive debt) will inevitably unwind, causing a substantial slowdown in China’s economy, significantly below market expectations. In recent weeks, a trip to the region and further research into China’s shadow banking system have convinced Morgan Stanley analysts  that China is approaching its “Minsky Moment,” which increases the chances of a disorderly unwind of China’s excesses. (that reference to “Minsky moment” refers to an economist named Hyman Minsky, from the 1930, who basically claims that the more you prop up an economy, the more likely it will eventually become unstable) The efficiency with which credit generates economic activity is already deteriorating, as more investments are made in non-productive projects and more debt is being used to repay old debts.

Based on the Morgan Stanley analysis, their baseline case is that China may slow from the current level of 7.7% Gross Domestic Product (GDP) growth to 5.0% over the next two years. A disorderly unwind could take Chinese growth down to 4% in a shorter time frame with potentially disastrous consequences for levered Chinese assets (banks, property) and the entire commodity supply chain (commodity stocks, equipment stocks, commodity-sensitive countries and their currencies).

The consensus is more optimistic and expects China’s economy to grow by 7.4% in 2014 and 7.2% in 2015. Most market participants have concluded that the Chinese economy, despite its excesses, will slow only moderately as the government successfully manages to “soft-land” the credit and investment boom and that, as a result, the impact on global GDP growth could be moderate and is not likely to derail the global developed-market-led expansion. However, one of the more controversial conclusions of their analysis is that global economic growth could be impacted severely enough to cause a global earnings recession.

They suspect China’s economy has arrived at that unstable state where speculative and Ponzi finance appear to dominate. From a macroeconomic perspective, very few economies have ever created as much debt as China has in the past five years. China’s private sector debt has increased from 115% of GDP in 2007 to 193% at the end of 2013. That 80% increase over five years compares to the U.S.’s 26% in 2000-2005. In recent years, only Spain and Ireland have achieved debt growth greater than China’s. Every year, China is now adding $2.5 trillion of private sector debt to a $9.7 trillion GDP.

There is evidence that this debt growth has become excessive and non-productive. It now takes 4 renminbi (RMB) of debt to create 1 renminbi of GDP growth from a nearly 1:1 ratio in the early and mid-2000s. After the massive stimulus and more than doubling of new bank loans in 2009, the government attempted to stabilize credit growth, but the growth of the shadow banking system exploded instead. Shadow banking now accounts for more than a fifth of total credit in China—or about 40% of GDP from a base of 12% just five years ago. The shadow banking system funnels credit to borrowers who can no longer get loans from the formal banking sector.

Defaults or near-defaults have begun to occur with regularity over the past three months and are likely to pick up in quantity significantly over the next year. As it is becoming more clear that investors may not get all of their money back, interest rates on trust products, wealth management products (WMPs), corporate bonds, and bank loans have risen by roughly 200 basis points in the last year.

The unwind of this credit boom is likely in progress, and they expect it to pick up speed over the coming months and quarters. It will likely involve a steady drip of defaults and near-defaults as insolvent borrowers finally become illiquid. Market rates for all assets except central government bonds and central bank bills will likely continue to rise, reflecting increasing market fears of default by shaky borrowers. Asset values will likely begin to deteriorate as stressed borrowers attempt to sell assets to stay afloat. As a result, banks and other financial entities could begin to increase provisioning for bad debts and to reduce credit availability by gradually tightening credit standards. This could lead to a credit crunch where credit to the economy is choked off for all but the safest borrowers. Most other analyses concludes that China could slow more than currently expected by the consensus, but that the global economy is well-positioned to withstand such a slowdown. And the Morgan Stanley report concludes that they are  a bit more pessimistic.

Wednesday, February 12, 2014 - Which Way the Wind Blows

Which Way the Wind Blows

by Sinclair Noe

DOW – 30 = 15,963
SPX – 0.49 = 1819
NAS + 10 = 4201
10 YR YLD + .04 = 2.76%
OIL + .33 = 100.27
GOLD + .90 = 1292.80
SILV unch = 20.34

After a four day rally, the stock market came back to a dose of reality.

Just a reminder that the Fed has started gradually reducing the amount of money it pumps into the economy. The move could hardly have been a surprise, because the Fed announced as early as last spring that it would begin doing so by the end of 2013. Now, it’s happening, and likely won’t change, and Janet Yellen said the rest of the world needs to adjust because the Fed has set its course. That has made for shaky markets around the world.

Remember that about a month ago, we started worrying about emerging markets. China said their economy was slowing down; that in turn will hurt the exports of commodity producers, weakening their trade balances. The big question now is how much further growth in China will slow. A serious cutback in China’s demand would not just harm emerging markets’ shipments directly to China, it would also cause further erosion in the already falling world prices for emerging markets’ coal, copper, palm oil and other commodities. China is also dealing with a shadow banking system ripe with potential defaults. But that isn’t the only problem in the world.

Many of those emerging markets also have unique economic and political problems that seemed to boil over at about the same time.  So, the hot money has been exiting emerging markets. This is the same hot money that flooded into emerging markets when the Fed had the printing press cranked up to QE3. This has happened before. It happens all the time. Back in the late 90’s the Asian economies vowed to avoid a repeat by building up trade surpluses and saving with a vengeance. They held back on investment and consumption; they hoarded foreign reserves, such as US Treasury bonds, which in turn lead to a speculative bubble in American subprime mortgages. Just to remind us all that we are not alone in this global economy.

The Federal Reserve says recent efforts by emerging markets such as Brazil, India and Turkey to stem investor flight from their economies are just “stopgap measures” that need to be followed by heftier policy actions. The Fed issued a report saying continued progress implementing monetary, fiscal and structural reforms will be needed in some emerging market economies to help remedy fundamental vulnerabilities, put them on a firmer footing, and make them more resilient to a range of economic shocks.

The Fed said in its report that many emerging markets learned from the financial crises in Asia and Latin America in the late 1990s and early 2000s and moved to flexible currencies, building cash reserves and cutting their dependence on foreign lending. Now, the response in the emerging markets seems to be slamming on the brakes by raising interest rates as they emerge, potentially sacrificing investment and jobs along the way. This is probably an imperfect reaction. I don’t know what was learned from the crises of the past, but those problems haven’t disappeared with a four day rally on Wall Street.

The Fed’s comments are likely to fuel debate at the upcoming meeting of finance officials and central bankers from the world’s 20 largest economies late next week in Sydney, Australia. The whole mess might even result in strategic shift from China to other developing Asian countries as the preferred locale for making export goods. And if the developing countries don’t step up, it raises the question of whether the EU or the US could fill the void.

I ran across an interesting article from Vanguard. It says financial data is notoriously easy to manipulate. You probably knew that, but the article says a difference of only one year can have a major effect on the five-year annual performance returns of U.S. stocks. If your starting point is 2013, this number is an impressive 18.7%, because it omits the big drop in 2008. But if you ran the numbers just one year earlier, from December 31, 2012, the five-year average return number dropped to 2.04%. Vanguard correctly concluded that basing investment decisions on "data-dependent snapshots" could be a big mistake.

Let’s talk about the weather. Not the Ice storm in the Southeast; you know about that; hundreds of thousands of people without electricity because the ice on the lines or on trees that fall into the lines; more than 3,000 canceled flights. Atlanta looks like some frozen wasteland in an apocalyptic science fiction movie. Soon, the storm will pass and meander up the seaboard and dump a foot or so of snow on New York City. Yesterday, Fed Chair Janet Yellen said the wild winter storms probably had an impact on the December and January jobs reports; probably knocked a smidge off the GDP as well. It’s important, but that’s not the weather I want to talk about today.

Today, I’d like to talk about the drought in California. Of course, last week a weather pattern known as the pineapple express dropped some rain on the state, and all it seems to take is one decent rainstorm to wash away all awareness of a drought. But it would take three months of nearly solid rain to get out of the current drought and that isn’t going to happen. Here’s what will happen.

Food and electricity and water will all cost more. And then there will be additional costs to build up water systems because if we don’t then things will get really dicey. The scientists have been warning us for decades that droughts will become more common. Predicting any single season’s rainfall is tough but forecasters think this year may be the driest year in the last 500 years. Most of the state is experiencing “extreme drought”. About 10 percent of the state is experiencing "exceptional drought," the highest possible level. Several smaller communities are in danger of running out of water, soon and despite the rain last week.

Most of the computer modeling seems to predict that over the next 3 to 5 decades, the changing current patterns caused by melting sea ice will increase average annual precipitation in the Northwest by about 40%, and average precipitation in the Southwest will decrease by 30%, maybe faster. Those are big changes, but before we get there, we’ll get smaller previews of the future.

Let’s start with agriculture. California produces a good chunk of the nation's food: half of all our fruits and vegetables, along with a significant amount of dairy and wine. Many farmers who plant annual crops have already made plans to cut back on planting to conserve water.

Farmers who tend crops that grow on trees and vines are in a tougher position, because their plants have to be maintained year-round. The good news is that it usually takes more than one year of drought to kill a tree, the bad news is that one year of drought can wreak havoc with production, and the worse news is that we’re in the third year of drought.  An almond tree after one year of drought will lose 50% of production, and even if we get normal water levels next year, the production will continue to drop by 90% before returning to normal. So, this year will be bad and next year will be worse. The most vulnerable crops are probably stone fruits like plums, cherries, peaches, and apricots, which are adapted to wetter climates.

For California rancher’s the drought means less grass for beef and dairy cows to graze, and that means many ranchers are selling now. If you enjoy a barbecue, enjoy it now before you have to take out a loan for a steak.

Expect shortages and possible price increases for lettuce, broccoli, melons, citrus, and rice. Yes California is a major rice producer. Of course, rice is an international food stuff, but in China there has been a major drought as well. Citrus also comes from different parts of the world, but remember the southeast has had a crazy cold winter that has already caused damage to citrus crops.

Expect to spend more on electricity. Hydroelectric energy makes up about 14 percent of the state's power supply. With less water running through turbines, the grid may need to use more natural gas, which is more expensive. And the state is also running low on natural gas, in part because of the extra demand generated by Eastern states. Southern California has become increasingly dependent on natural gas-fired plants since the decision last year to shutter the troubled San Onofre nuclear power plant. When it was operating, the twin-reactor San Onofre plant produced enough power for 1.4 million homes. And there will be extra costs to clean up the San Onofre site, which will be passed on to you. And just last week there was a “flex-alert”, where state officials called for people to turn off the lights and anything else that was sucking power. A flex alert in the winter is strange indeed.

And don’t forget the fires. In Southern California, fire season really never ended. Seasonal firefighters in Southern California, usually employed only during summer and fall months, have stayed on staff all year long. And already this year, this winter, wildfires have been igniting all up and down the state. Cal Fire is considering expanding inspections to check compliance with "defensible space" rules, which require that residents have 100 feet of space free of flammable materials, like brush or other vegetation, around their houses.

And finally, water will cost more. Conservation will be increasingly important but it can be costly. One solution is desalination plants, but those use lots of energy and are very expensive. Transporting water is a possible option, again very expensive.  Major water projects can’t be constructed in 2 or 3 months. Planning and infrastructure involve a lot of lead time. There really isn’t much choice. It has to be done.

Thursday, January 23, 2014 - They Must Think We’re All Morons

They Must Think We’re All Morons

by Sinclair Noe

DOW – 175 = 16,197
SPX – 16 = 1828
NAS – 24 = 4218
10 YR YLD - .09 = 2.77%
OIL + .47 = 97.20
GOLD + 26.30 = 1264.10
SILV + .22 = 20.11

We have economic reports to cover, some interesting news out of China; lots to talk about today. But what is the top story on most major news outlets? Justin Beiber was arrested in Miami for DUI and drag racing his Lamborghini from strip club to strip club. Seriously. We could spend the whole hour talking about it…, if we were brain dead. That is the biggest story in the country, because they must think we’re all morons.

This has been a very quiet week for economic data but today we got a few economic reports.

Initial jobless claims held steady last week at a nearly 2-month low as 326,000 people filed for first time unemployment benefits.

The Markit Flash US Manufacturing Purchasing Managers' Index (PMI) fell to 53.7 for January, its slowest growth in three months. A reading of 53.7 still indicates growth in manufacturing, and the researchers say we shouldn’t read too much into the report because cold weather has to play into the results. According to the economist from Markit: "After allowing for companies that saw production and sales disrupted by the cold weather, the rate of growth of output and orders remained as strong, if not stronger, than seen late last year.”

In another consequence of the weather, natural gas prices jumped more than 5% during yesterday's session, pushing prices to levels not seen since late 2011. This morning, it's close to cracking $5. The government cut its gas inventory forecasts. Also, gas delivery to consumers in New York and Boston set records yesterday as the most recent snowstorm buried the Northeast. Nat gas is a common way to heat homes, especially in the Northeast, and we’ve had some serious storms this winter.

If you’re looking for ways to trade the move, there are funds and ETFs; among the best known is UNG, which is not to be confused with a trade on the oil sector in general. There is a tendency to chase anything that moves fast. I don’t know where the price of nat gas will go from here; I do know the storms will pass.

The Federal Housing Finance Agency reported home prices ticked up 0.1% in November, and were up 7.6% from the year-earlier period. The National Association of Realtors reports sales of previously owned homes rose in December for the first time in 5 months, and capping the best year since 2006. A total of 5.09 million U.S. previously owned houses were sold in 2013 compared with 4.66 million the prior year.

The index of US leading indicators rose in December. The Conference Board’s gauge of the outlook for the next three to six months climbed 0.1 percent after a revised 1 percent gain the prior month that was larger than previously estimated. The report noted progress in the labor market, rising equity prices, rising home values, continued strength in consumer spending, and rising orders to manufacturers. Five of the 10 indicators in the leading index contributed to the increase.

The biggest economic report today came from China. Activity in China's factory sector contracted in January for the first time in six months. Weighed down by weaker domestic and export demand, the flash Markit/HSBC Purchasing Managers' Index (PM) fell to 49.6 in January from December's final reading of 50.5, dropping below the 50 line which separates expansion of activity from contraction. The reading points to a further slowdown in manufacturing and the entire Chinese economy, which then has implications for the US economy. Chinese leaders have pledged to push reforms to unleash new growth drivers as the world's second-largest economy loses steam, burdened by industrial overcapacity, piles of debt and soaring house prices.

And this has been another area of concern about China. China’s growth model appears to be built on a mix of investments and exports and debt; the dependence on debt has been producing diminishing returns. Lending has in recent years been the driver of growth, but each yuan of new borrowing now produces 1/4 the amount of GDP increase that it did five years ago, and now there are concerns about an imminent default in its shadow banking system, or investments made off balance sheet.

The Chinese cabinet is seeking to increase government oversight of lending by companies that currently face little or no supervision. The shadow system has grown in recent years because the Chinese government has too tightly controlled traditional banking. It keeps the interest rates that conventional banks pay to depositors extremely low and gives out cheap loans to state-owned enterprises and favored companies that might not be able to repay the money.

And now it looks like one of those companies might not be able to repay. The China Credit Trust Company has told investors that it may not make a January 31 repayment on what would amount to the equivalent of about $500 million; that’s a big chunk of money but not a scary number, in itself. The problem is that nay significant defaults could shatter the widespread assumption that off-balance-sheet investments carry an implicit guarantee from state banks and their partner institutions. Regulators have warned that investors must assume the risks from high-yielding investments and not expect protection from losses unless such guarantees are explicit. Local governments have largely ignored these injunctions and have stepped in repeatedly in recent years with bailouts for local firms facing default on corporate bonds and trust loans.

The low rates, of course, have led savers to invest money in speculative real estate projects or dubious investments known as wealth management products offered by banks and finance companies that promise higher rates of return. Much of that money is then lent to private businesses and local governments, which cannot get conventional bank loans because regulated banks are required to give preferences to state-owned companies.

If there is a credit crunch, it would be very different from the Lehman contagion we experienced 5 years ago, and so we probably won’t see any Western style back crashes because the financial system is still an arm of the Chinese government. So, it will likely end in an entirely different way, and we’re not sure what that is.

Next week, the Federal Reserve FOMC meeting will take center stage. It will be Ben Bernanke’s final FOMC meeting. And although we see signs of an improving economy, (or as the Fed said: “cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions.")  We have also seen a wobbly start to the trading year on Wall Street; and this came on the heels of the December FOMC meeting in which the Fed announced the first stage of tapering, curtailing asset purchases by $10 billion per month to just $75 billion per month. There is consensus that the Fed will take the next step in tapering next week; announcing an additional $10 billion a month in asset purchases.

The thinking has been that if things get bad, the Fed will simply ride to the rescue by postponing the taper and resuming or increasing asset purchases. We have to start by looking at what it means by “bad”. Economically speaking, it would be bad if unemployment were to spike; another credit collapse such as we saw in 2008 would be  bad; an economic  meltdown of any sort, domestic or international (think China, at least for today) – that would be bad. How about a 10% correction on Wall Street?

Stock market corrections are common, and we are overdue for some sort of correction, just based on past performance. The Fed’s taper announcement may very well serve as a catalyst or just an excuse for a correction. So, will the Fed jump in to clean up?

Not likely. The Fed has set a new course, and they will most likely have to stay the course, at least for the foreseeable future. There has been a concerted effort to emphasize forward guidance as the primary policy tool. Backtracking now would undermine the Fed's credibility. The Fed might like to talk about the importance of its independence and any reversal of taper would be seen as political. And any backtracking would be a serious blow to the Fed’s economic forecasting abilities and the Fed’s credibility.

And then there is the idea that the Fed’s balance sheet has grown too large, too fast. Increasing asset purchases would be seen as increasing the risks of future imbalances given the surge in stock prices that coincided with prior QE programs. In other words, there is the concern that QE could lead to bubbles, especially QE without an exit date would surely end badly. And a final reason, backtracking on taper and jumping back into the markets might not work this time. Each round of QE has resulted in slightly diminished returns. What if the Fed announced new stimulus and it failed to stimulate?

If the Fed is compelled to go back to the QE well, though, the cyclical sectors would be at heightened risk of underperforming as optimistic expectations get wrung out of stock prices. But this would only happen if things get bad (a subjective term) and we would likely see that coming.

The economic data have remained supportive of the Fed's tapering announcement in December. The December jobs report was weak, but it will be revised. Investor expectations are that the economy is stronger; not really strong but certainly not as weak as it was. So the Fed will likely continue with the taper, slowly and surely. And if the economy falters or something melts down, well they still have some other tools in the tool belt.

  

It’s still earnings reporting season and the big report today came after the close of trade as Microsoft posted net income of $6.5 billion, or 78 cents a share, compared with $6.3 billion, or 76 cents a share, in the year-ago quarter.  Revenue rose 14% to $24.5 billion, partly reflecting the release in November of a new Xbox videogame console and a fresh version of Microsoft’s Surface tablet computer ahead of the holidays. The results topped analysts’ guesses. No word on a replacement for CEO Steve Ballmer, who has announced his retirement.

Treasury prices rallied today. In part it was a safe haven move, with the weak data out of China; maybe some rebalancing or even an old fashioned short squeeze. Mortgage rates fell, decreasing borrowing costs for homebuyers. The average rate for a 30-year fixed mortgage was 4.39 percent this week, down from 4.41 percent and the lowest since November. The average 15-year rate slipped to 3.44 percent from 3.45 percent.

I mentioned earlier that we had a couple of reports on housing today. The Federal Housing Finance Agency reported home prices ticked up 0.1% in November, and were up 7.6% from the year-earlier period. The National Association of Realtors reports sales of previously owned homes rose in December for the first time in 5 months, and capping the best year since 2006.

Another report shows that the housing recovery has reached a level where it is increasingly unaffordable. You guessed it, California topped the list. The salary you have to earn to  be able to buy the median home in San Francisco is just over $125,000 as of November, and the median cost of a home in San Francisco is somewhere between $705,000 and $813,000, depending on what data source you look at; best guess is that home prices in San Francisco are up 24% over the past year. San Francisco tops the list of the most unaffordable cities. Next are San Diego and Los Angeles – the California trifecta – then New York City, where a mere $71,245 in income suffices to buy the median home. Households earning the median income of $51,000, well, forget it.

The reason San Francisco tops  the list is fairly simple, the tech bubble has attracted billions in fresh money, and one reason it has gravitated to San Francisco is past history and also tax incentives handed out to tech companies.

San Francisco may be extreme, but housing bubbles are now re-cropping up across the nation – and so are the very factors that helped inflate the prior housing bubble and then magnified the ferociousness of its implosion.

Helocs, or home equity loans, were up 30.8% in the first nine months of 2013 from prior year and are expected to reach $60 billion for the year, the highest level since 2009 when the market was in collapse mode. But it’s still a far cry from 2006, when such loans hit an all-time crazy record of $430 billion. Using the home as an ATM cranks up consumer spending. If the money is plowed back into the house, such as remodeling a bathroom, it adds some value to the house and lowers the risk of the loan. If it is used to buy gadgets, cars, or vacations, it still cranks up the economy in the US and other countries. But when home prices decline, homeowners and banks get slaughtered.

Also, the housing boom has seen the return of creative financing. Interest only home loans are back and they’re especially popular for jumbo loans. In a number of high-cost counties, including San Francisco, these are loans over $625,500 that banks can’t sell to Fannie Mae and Freddie Mac but have to keep on their balance sheets. Bank of America said that 36% of its fourth-quarter mortgages were jumbo loans, up from 23% in the first quarter. And adjustable rate mortgages, or ARMs made up 22% of all purchase loans in December, up from 11% in December 2012, the highest ratio since July 2008.

The result of higher prices has been slowing sales. In December sales volume was down 17.7% in San Francisco and 12.7% in the Bay Area from a year earlier. In California, volume dropped 12.1% to 34,949 sales, the worst December since 2007 – and 19.7% below the average for all Decembers since 1988.

In Palo Alto, at the center of the techie induced price hikes, home prices are now 40% above the prior bubble peak. But don’t call it a bubble, it’s a housing recovery, at least until it pops.

Friday, September 20, 2013 - The Real Reason for No Taper

The Real Reason for No Taper

by Sinclair Noe

DOW – 185 = 15,451
SPX - 12 = 1709
NAS – 14 = 3774
10 YR YLD - .02 = 2.73%
OIL – 1.72 = 104.67
GOLD – 39.50 = 1326.60
SILV – 1.29 = 21.90

The big news for investors over the next couple of weeks will be whether Congress can shoot itself in the foot. This past week's big news for investors was no news from the Fed; no taper; although today St. Louis Fed President James Bullard said taper could begin as early as October.

What does the no taper decision really mean? Since the major beneficiary of QE is the banks, it would seem logical that the main reason not to taper is because the banks are not as healthy as we are led to believe, or they're involved in more risky business.

Ellen Brown wrote Web of Debt and a new book called the Public Bank Solution. I've talked with Ellen on multiple occasions and she recently posted an article on her blog. Ellen did a great job of explaining the risks of the shadow banking system. Please click here to read her article.

Wednesday, July 17, 2013 - Good Markets, Bad Economy

Good Markets, Bad Economy

by Sinclair Noe

DOW + 18 = 15,470
SPX + 4 = 1680
NAS + 11 = 3610
10 YR YLD - .04 = 2.49%
OIL + .59 = 106.59
GOLD – 16.90 = 1275.60
SILV - .72 = 19.29

Let's start today with a quick rundown of a few earnings reports.

Intel reported second quarter net income of $2 billion, down from $2.8 billion a year ago. Revenue was $12.8 billion, and they expect third quarter revenue around $13.5 billion, both revenue numbers and guidance were below current estimates.

IBM posted earnings of $4.3 billion on revenue of $24.9 billion. Earnings were up slightly from a year ago, while revenue was down slightly.

Bank of America reports net income rose 63 percent, to $4 billion from $2.5 billion in the period a year earlier, while revenue increased to $22.7 billion from $22 billion. The bank benefited from higher revenue from equities sales and trading and a reduction in expenses, but its mortgage unit continued to struggle.

This seems to be a recurring trend for the big banks; more profits from the Wall Street business side, less revenue from the old fashioned loan business, less money set aside for reserves. The concerns are that trading performance tends to be uneven over time, and cutting costs can only go so far, it doesn't increase revenue.

June housing starts fell 9.9% to an annualized rate of 836,000—the lowest level since August 2012. The drop in housing starts was led by a decline in multifamily construction, which fell 26.2% versus 0.8% for single-family houses.

The Federal Reserve released its Beige Book survey today, and it indicates “modest to moderate” growth. Housing construction and home prices improved, while consumer spending increased in most districts, fueled by rising car and truck sales. The housing recovery is also driving more production of lumber, materials and construction equipment.

The report says hiring held steady or increased in most districts. But employers in some districts were reluctant to hire permanent or full-time workers. Employers have added an average of 202,000 jobs a month this year, up from about 180,000 a month in the previous six months. Still, growth has been weak.

Fed Chairman Ben Bernanke went before the House of Representatives today to deliver his semi-annual testimony, which was also pretty beige. Bernanke said: “We’re going to be responding to the data. If the data are stronger than we expect, we’ll move more quickly” to reduce bond purchases. If data “don’t meet the kinds of expectations we have about where the economy’s going, then we would delay that process or potentially increase purchases for a time.”

The Fed chairman described labor markets as “far from satisfactory, as the unemployment rate remains well above its longer-run normal level, and rates of underemployment and long-term unemployment are still much too high.”

And then we have to realize that the Fed's economic forecasting is usually a bit more rosy than realistic. Each year for the past 3 years they've been forced to revise lower. Already this year, economic growth has dropped below expectations. The Fed's prediction of stronger growth in the second half will almost certainly be cut from the current level of 2.5%. The recent spike in inflationary pressures, which is almost entirely due to the surge in energy costs, also negatively impacts the economy. The spike in inflationary pressures in 2011 coincided with the peak in economic activity. And increases in energy prices are highly correlated to recessions, as we discussed yesterday.

So, Bernanke's testimony today confirmed the Fed isn't going to exit QE or taper off from purchases any time soon. They can't reduce liquidity without risking the markets tanking, taking down consumer confidence and negatively impacting the economy. Or, the other way to look at it is that the Fed is the only thing holding up the markets as the economy continues to slowly grind along, or more likely, erode.

The Fed is constantly communicating its intentions regarding rates and it just tends to artificially prop up the markets, resulting in an imbalance, or some think a possible bubble. The Fed has controlled the markets in part starting with the Greenspan Put, then the historically low interest rates, and then the nearly constant infusions of fresh cash for primary dealers by way of massive government bond purchases. By pegging money market rates, the Fed has created fertile ground for carry trades; and the carry trades create an artificially bigger and bigger bid for risk assets. In this kind of environment, it seems prices can only go up.

After all, the Fed is providing what amounts to insurance against downside risk. The super cheap money and the idea that Too Big to Fail won't be allowed to fail, then attracts even more money flowing into even more speculative long positions. The Fed sets near zero interest rate policy well out into the future, and that eliminates any surprises in the yield curve. That, in turn, allows the traders in the money markets to hypothecate and rehypothecate securities without worries.

The monetary policy of the Fed serves to prop up risk assets but it doesn't do much to drive economic growth. There may be some trickle down effect but not enough to lift economic growth. The old fashioned ideas of credit creation aren't working. We've seen this failure as the big banks have been reporting earnings. The big banks have been reporting remarkable profits, but it comes from their trading desks; gambling in high risk assets; and it comes from setting aside fewer reserves. They just aren't making traditional loans.

Traditional loans used to get money circulating through the economy. A bank made a loan to a consumer or a business. The consumer or the business then spends the money and that adds to GDP which then increases corporate sales and profits. The money circulates and economic activity increases. But money velocity has dropped, even as the Fed has been shoveling trillions of dollars into the banks; that money hasn't found its way into the broader economy, it's been swallowed up by offshore trading in the highly profitable and incredibly dangerous and unregulated international derivatives markets; or what is sometimes called shadow banking, which has now grown to about $70 trillion.

The shadow banking system has grown to such incredible size without providing any real benefit to the broader economy, and represents a far bigger risk than benefit for GDP growth. The Fed's QE policy, and the reason Wall Street gets it's panties in a wad at the thought that QE might end, is nothing more than a way for the Fed to raise the reserve levels of banks; which means the banks don't have to set aside reserves from their own profits. The money remains on the Fed's books as a credit to the bank, unless the bank chooses to re-invest in some sort of asset purchase; which they typically do; which drives up asset prices, but does nothing for the economy.

So, the economy is not improving, or at the best it is slowly improving, but not enough to reach escape velocity. We've seen some job growth but not enough and the quality of jobs is weak; many of the jobs are part-time or temporary, and wages are shrinking; which means disposable income is shrinking; which mean demand is weak and top line sales are slipping; which means that the way corporations keep profits up is by cost cutting, but we're coming to the end of the rope when it comes to cost cutting. The major market indices are at record highs but the economy is still grinding along in a trough.

So, we've got a multi-trillion dollar shadow banking system propped up by credit creation in the form of QE and leveraged for optimal results; and indeed, the banks have been returning optimal results. But remember that leverage is a two-way street. It works great when the trade goes your way, but it can double your losses when the trade turns against you. What happens when the asset you have leveraged into suddenly begins to move in the wrong direction exposing you to substantial loss - not increased profits? More importantly what happens if the sheer size of your positions are so significant relative to market volume that liquidity disappears and you can't exit the trade without significantly moving the market in the wrong direction? The answer of course is that you are stuck. We've seen this before with Lehman Brothers, with LTCM, and more recently with the London Whale. We will see it again.

Bernanke talked today about the necessary economic conditions that would warrant a change in QE policy. Maybe the Fed could exit QE if there was some fiscal policy that actually had the potential to increase GDP and provide jobs and spur demand. We don't have that. We have a weak economy and highly speculative asset bubbles and all it takes is a blip in liquidity and the whole show could freeze over in a heartbeat.

So for now the market makers will back stop sell offs. Investors will continue to play along because they have no place else to go. And the Federal Reserve will continue with its accommodative policy; they don't really have a choice in the matter.