Tuesday, April 30, 2013 - Relax, 20 Years Pass in the Click of a Mouse

Relax, 20 Years Pass in the Click of a Mouse

by Sinclair Noe

DOW + 21 = 14,839
SPX + 3 = 1597
NAS + 21 = 3328
10 YR YLD + .01 = 1.67%
OIL – 1.46 = 93.04
GOLD + .70 = 1478.20
SILV - .24 = 24.45

The Dow Industrial Average did not hit a record high close. The old record close is 14,865. The S&P 500 did hit a new record high close. What next? Sell.

Tomorrow is May 1^st. Sell. Sell everything, or at least all stocks. We've been over this before. The theory is “Sell in May and Stay Away”. This is the best six months, worst six months theory of investing. It basically says you sell stocks in May and you buy back in November. The six months from May to November are bad; the six months from November through April are good. This works on broader stock averages and it can also apply to individual stocks, but the results on individual stocks are not as predictable. So if you have a S&P 500 Index Fund, or a Dow Industrials ETF, or something like that, sell.

The S&P 500's gains between November - April have trounced May - October returns for more than 60 years. Annualized gains from November - April have averaged 13.8%, while May - October gains have averaged only 1.4%. Numerous academic studies of the market going back many decades have confirmed that even though there is not a correction every year, an investor who simply bought the Dow or S&P 500 via an index mutual fund or ETF on November 1 each year, and moved to cash on May 1 outperformed the market over the long-term by a significant amount.

Had you adhered to the old adage "sell in May and go away" for the past three years, you would have not only avoided a lot pain, but you would have likely outperformed the benchmarks, as well. This as the springs of 2010, 2011 and 2012 each marked the starting point for sell-offs that would shave anywhere from 9% to 19% off of the S&P 500 in just a matter of months.

Does that mean it outperforms the market in every individual year? No. But then there is no strategy that does. Money managers hate it because it is so simple that anybody can do it and especially when the majority of mutual funds and professional money-managers fail to match the market’s return.

It really is simple; it is a strictly mechanical trade. One of its most important attributes is that it avoids the problems that most often harms performance: the emotions of fear or greed.

Wait a minute. We're at record highs. If you sell right now, you could be missing out on a big gain. That's greed talking. Stocks have churned higher in a broad trend channel for more than four years. Since the market dropped sharply in late 2011, this uptrend has found a steeper slope--tightening toward the new highs. The market has dodged some bullets over the past several months. But the underlying trend has proven so far that it is stronger than the soft economic data. Unless price says it's time to pound sand, there's no reason to get out of the way. Again, that's greed talking.

And if you are like most investors, you will listen to that greedy voice inside your head. So, I have a way to help you.

Yale Hirsch, the publisher of the Stock Traders Almanac came up with the Sell In May strategy in the 1970s; he updated the idea in 1999. Hirsch back-tested 51 years of data and found a very simple way to double the performance while eliminating 61% of the market risk. Ready?

Put a MACD indicator on the chart and use that to time you exit and entry. MACD stands for Moving Average Convergence Divergence. So you pull up a chart of the S&P 500, click on the MACD technical indicator, and if it turns negative any time around May 1, you get out. And if it turns positive any time around November 1, you get back in. Over the last 15 years this simple but effective improvement resulted in entries as early as October 16 and as late as November 28, and exits as early as April 20 and as late as May 16. The Sell in May strategy beats the overall market, and the MACD addition beats the Sell in May, by about a double.

The MACD indicator uses three exponential moving averages: a short or fast average, a long or slow average, and an exponential average of the difference between the short and long moving averages, which is used as a signal line. MACD reveals overbought and oversold conditions for securities and market indexes, and generates signals that predict trend reversals with significant accuracy. Gerald Appel is the guy who came up with MACD and he recommends an 8-17-9 MACD to generate buy signals and a 12-25-9 MACD to confirm a sell signal for a stock, which has had a strong bullish move. MACD turns bullish when it moves above its signal line or into positive territory, whichever comes first. MACD turns bearish when it moves below its signal line or into negative territory.

Buy Signal Recap:

1. Buy on October 16th if MACD is bullish.

2. Wait for bullish MACD signal if MACD is not bullish on October 16th.

Sell Signal Recap:

1. Sell on April 20th if MACD is bearish

2. Wait for a bearish MACD signal if MACD is not bearish on April 20th.

The six month cycle is not infallible. While adding MACD improves the historical results, it does not mean every signal will work.

And then if you do sell in May, where do you go? Just take a vacation; go to cash. Relax.

Chicago PMI came in weaker-than-expected at 49, showing a contraction in Midwest manufacturing activity in April.

Consumer confidence rebounded in April as Americans felt better about the economy's short-term prospects and their own incomes. The Consumer Confidence Index rose to 68.1 this month after dropping to 61.9 in March. The percentage of respondents who expected business conditions to improve over the next six months increased to 16.9% from 15% in March. In addition, the percentage of consumers who expected increased income rose to 16.8% from 14.6%.

Home prices in the nation’s largest American cities continued their strong gains in February. The Standard & Poor’s/Case-Shiller home price index of 20 American cities rose 0.3% over the prior month and was up 9.3% over February 2012. All of the cities covered by the index have risen year-over-year for two consecutive months. Phoenix posted particularly strong gains, up 23% over the year. California metro areas also gained over the year. The San Diego area was up 10.2%, San Francisco 18.9% and Los Angeles 14.1%.

The homeownership rate declined to 65% in the first quarter, down from 65.4% during the same period in the prior year. The homeownership rate represents the number of households that are occupied by owners divided by the total number of occupied households. The rate has declined fairly steadily for years, and is down from a peak of 69.2% in 2004, when the housing market bubble was ramping up.

The US Treasury said it now expects to pay off $35 billion of debt in the April-to-June quarter, compared to an earlier projection, given in February, that it would have to borrow $103 billion. This will be the first quarter that Treasury has paid off debt since April-to-June period 2007. Current CBO projections have the deficit dropping as low as 2.4 percent of GDP by 2014, under its 30-year average.

The two parties are miles apart on how to cut the deficit and national debt: Republicans want to slash spending even more. Democrats want to raise revenue.

And then there are the people who reject the entire premise of the current high-stakes fiscal fight. There’s no short-term deficit problem, they say, and there isn’t even an urgent debt crisis that requires immediate attention. Aided by a pile of recent data suggesting the deficit is already shrinking significantly and current spending cuts are slowing the economy, elements from the left and right are coming around to the point of view that fiscal austerity, in all its forms, is more the problem than the solution.

Even Goldman Sachs issued a report this week arguing that the drop in the deficit and relatively stable longer-term debt outlook should ease demand in Washington for more tightening. The Goldman analysts said even the current budget cuts would knock down growth by 2 percent, a number that would put the US back close to economic contraction.

Perhaps the story that might resolve the question is Japan; which for the past twenty years has been the story of flat-line growth and heavy debt. That changed recently with a new PM, Abe, and a new head of the Bank of Japan, Kuroda, and a new monetary recipe: double Japan's money supply in two years, and promise to ignite 2 percent inflation in two years, reversing nearly two decades of falling prices.  Kuroda's central idea is a more determined version of the Federal Reserve's "quantitative easing," which involved pumping vast amounts of money into the American financial system. His plan calls for the BOJ to roughly double annual purchases of Japanese government bonds to a half-trillion dollars and double its purchase of riskier assets in two years.

The aim is to push down long-term interest rates, encourage companies and individuals to borrow, and induce investors to seek higher returns, in the equity markets for instance.The BOJ's decision to deluge financial markets with cash sent the benchmark Nikkei Stock Average to a near five-year high. The yen went to a four-year low to around 100 to the dollar. The 10-year bond yield hit a record low 0.315 percent before rebounding.

Twenty years ago today a British computer scientist launched a website which was pretty basic, just text instructions for using the World Wide Web. It is worth noting because it was the first website and it opened the web to all, and now we're addicted to it. Twenty years, that's all.

Monday, April 29, 2013 - A Busy Week Heading in the Same Direction

A Busy Week Heading in the Same Direction

by Sinclair Noe

DOW + 106 = 14,818
SPX + 11 = 1593
NAS + 27 = 3307
10 YR YLD + .01 = 1.67%
OIL + .58 = 93.58
GOLD + 13.60 = 1477.50
SILV + .55 = 24.69

 The S&P 500 index ended at an all-time high. We have a celebration when the Dow Industrial Average closes at an all time high; no party for the S&P 500. I wish I could give you a valid reason for this but it defies logic. There is no law that says you can't enjoy milk and cookies anyway.

This week offers a packed economic calendar,with ISM manufacturing data Wednesday, and PMI manufacturing reports for the euro zone and China on Thursday. The week ends with Friday's U.S. employment report, expected to show 150,000 new nonfarm payrolls in April; and the backdrop to all the information is last Friday's initial report on first quarter GDP, which came in at 2.5%, short of the consensus forecast of 3%. 

Also, we'll compare and contrast this week's news with last week's reports out of Europe showing economic weakness in Germany as well really bad weakness in the peripheral countires where unemployment is rising from one awful record to another. In Spain, for example, the rate increased to 27.2%, with an even more stunning 57.2% rate among the young. In Greece, the unemployment rate tops 27% and the government is cutting thousands more jobs to qualify for more ECB bailout money.

The European Central Bank will face increasing pressure to cut its interest rate, currently at 0.75%, and to loosen monetary conditions, and to cut back on draconian austerity requirements. Italian Prime Minister Enrico Letta urged a focus on growth policies and away from austerity measures in his inaugural speech. Money market traders are evenly split on whether the ECB will cut rates at its meeting.

The ECB may well disappoint next week, since several influential decision makers oppose a rate cut. Even if the ECB does act, a quarter-point cut will do nothing for growth. And most importantly, such a tiny rate cut, if it happens, will simply underline the ECB’s refusal to follow the Federal Reserve, the Bank of Japan, the Bank of England and the Swiss National Bank in expanding the money supply or taking other “unconventional” measures that could potentially have a much greater financial impact than any marginal fiddling with interest rates. 

The Bank of Japan has already pulled out the big bazookas to loosen monetary policy and to jump into the bond markets. The result has been a roaring bull market in Japan.

In the US, corporate earnings show companies are still able to counter a worrisome revenue situation by cutting costs. Just 38 percent of the 271 S&P 500 companies that had reported through Friday topped revenue estimates, with the aggregate figure actually showing a sales decline of 1.45 percent. Weak corporate top-line growth is likely to spell an equally troubled bottom line for the 11.7 million unemployed. 

 And even as we continue to hit record highs in the stock markets; unfortunately, the broader economy hasn't joined in the party. The vast majority of US households face declining incomes and lower savings rates. This morning, the Commerce Department reported household purchases rose just 0.2%. Ultimately, it is households that provide demand for what companies make and sell. Cost cutting benefits are finite.

Last week, a Pew Research study showed that the top 7% of the population got richer during the past 5 years, while the remaining 93% lost. An Allstate/National Journal Heartland Monitor poll released Thursday found that while most Americans (56 percent) hold out hope that they‘ll be in a higher class at some point, even more Americans (59 percent) are worried about falling out of their current class over the next few years. In fact, more than eight in 10 Americans believe that more people have fallen out of the middle class than moved into it in the past few years.

Even more arresting was the extent to which things that used to be the unquestioned trappings of middle-class life have come to be seen as upper-class luxuries. Nearly half – 46 percent – of the respondents who described themselves as middle class said that being able to pay for children’s college education was possible only for the upper class. Forty-three percent thought that only the upper class had enough savings to deal with a job loss, and 40 percent believed only the upper class could save enough to retire comfortably.

For the land of opportunity, this is a seismic shift. America was created as a country where the middle class could prosper - Thomas Jefferson crowed that America had no paupers and few who were rich enough to live without labor.

This was supposed to be the place where, as Bill Clinton liked to put it, if you worked hard and played by the rules, you could get ahead. And Americans gloried in the fact that the world’s huddled masses regularly demonstrated their belief in the American dream by voting with their feet.

The respondents to the Heartland poll know the world has changed. Nearly two-thirds of those who described themselves as middle class said their generation had less job and financial security than their parents. More than half said they had less opportunity to advance.

The middle class is dying. Chart after chart, story after story, poll after poll, all show that the claim that we are a middle class nation are hollow fiction. People know things are bad, they know they are screwed, and they are coming to the realization that the problem is the giant corporations and their rapacious executives. A majority of people polled, 54%, believe that the actions of corporate CEOs have made things worse for the middle class. 

And so, that is the backdrop as the Federal Reserve FOMC starts two days of meetings tomorrow. Expect the FOMC to signal that the central bank is ready to step up to the plate – no backing down from accommodative monetary policy. In recent meetings the FOMC has indicated that it would like to taper off its $85 billion in monthly purchases of market securities, or at least they would like to know where the exit is located. Of course, the more the Fed looks for exits, the more the market players start eying exits. 

So, the Fed needs to come out and say QE will stick around for a while. This week, look for the Fed to offer reassurances of ongoing support, in large part because Congress is so dysfunctional that the Fed is the only way to support economic activity. And also because inflation is not a problem; the recent measures of inflation were running about 1.2% in the first quarter, well below target and even further from the limits. And last month's jobs report was sluggish at best.

Unfortunately, aggressive monetary policy is probably not enough to lift the economy; not enough for sustainable strong growth; and it can't last forever. At some point, high market valuations will either be validated by improving fundamentals or, if the fundamentals don't improve, they will eventually drag down the high valuations. Right now, valuations are high because the Fed is artificially pumping up the markets; it can't last forever but there is no reason for the Fed to stop the party right now. We hit a record high close on the S&P 500 today. A trend in place is more likely to remain in place than it is to reverse, until it reverses. Downside potential remains real; it could just be a tweet away.

It took only about five minutes for the market to tank and rebound after a group hacked the Associated Press’ Twitter feed to put out bogus information — and now the feds are taking a longer look to find out who got rich during the chaos.

The Securities and Exchange Commission and the Commodity Futures Trading Commission have each opened investigations into the hack that falsely reported “explosions in the White House and Barack Obama is injured” and briefly wiped away $136 billion in market value. Sources in and out of government say investigators will sort through the big financial winners and not just conduct a standard review of a market swing.

In addition to the SEC and the CFTC, the FBI is investigating the attack. Security and financial experts predicted the National Security Agency and the State Department, along with the Department of Homeland Security, would open their own inquiries.

The secretive NSA didn’t confirm any role, saying that Homeland Security “has the lead to secure civilian information and communications systems for the executive branch.”

A group called the Syrian Electronic Army immediately took credit for the attack last week, although terror experts note the Syrians don’t have the most sophisticated cyber-warriors.

One line of particular interest for investigators is that of lightning-fast “cheetah” traders who conduct deals with high-speed computers and who were trading in the market when the attack occurred.

Just a tweet away.

Friday, April 26, 2013 - The Fix is In

The Fix is In

by Sinclair Noe

DOW + 11= 14,712
SPX – 2 = 1582
NAS – 10 = 3279
10 YR YLD - .05 = 1.66%
OIL - .86 = 92.78
GOLD – 5.30 = 1463.90
SILV - .36 = 24.14

The initial guesstimate of first quarter gross domestic product shows the economy growing at a 2.5% pace. Consumer spending increased by 3.2%, the strongest increase in consumer spending in 2 years. Defense spending fell at an annual rate of 11.5 percent in the first quarter, on the heels of a 22.1 percent decline in the last three months of 2012.

This is the initial report on GDP and it is subject to revisions. The initial fourth quarter GDP number came in at a negative 0.1% and was revised up to 0.4%; the first quarter estimate of 2.5% is well below expectations, and it certainly isn't showing enough strength to indicate a solid recovery.

Personal disposable income, today’s report shows, actually fell by $140 billion in total from the fourth quarter. Reversion of the payroll tax to its normal rates at the beginning of 2013 will continue to drag on the disposable income of middle-class consumers throughout the year. Business investment in productive equipment and IT — a driver of productivity, innovation, and employment — slowed markedly to 3% growth in the first quarter, relative to nearly 12% in the prior quarter. Residential investment maintained strong growth, however, expanding 13% as housing markets in many areas of the country seem to be turning up. exports grew 2.9% in the first quarter. Imports grew even faster at 5.4%, much of that due to an increase in oil prices.

The quick and easy is that cuts in government spending is acting as a drag on economic growth. Government spending fell at an annual rate of 8.4 percent, after a decrease of 14.8 percent in the fourth quarter of 2012 — with both declines happening before the March start of the sequester. Fiscal policy is not enough to get the economy to cruising speed, and monetary policy has only been effective at delivering below-target inflation.

The sequester cuts haven't yet hit the economy, at least it wasn't reflected in the first quarter GDP numbers; the sequester has hit; maybe you haven't felt it yet, unless you were in an airport the past week. Washington politicians are frequent fliers; they are feeling the sequester.

The original theory was that the specter of sequestration would be so threatening that Republicans and Democrats would agree to a budget deal rather than permit it to happen. That theory was wrong. The follow-up theory was that the actual pain caused by sequestration would be so great that it would, in a matter of months, push the two sides to agree to a deal. That theory was wrong. The reality is that the pain of the sequester doesn't matter if it hits the general public, but if it inconveniences politicians; then they will change the parts they don't like.

Today, the Congress decided that the part of the sequester that resulted in furloughs for air traffic controllers, which resulted in delays at airports; they decided that was just too painful, so they are coming up with the money to prevent the air traffic controller furloughs.

Former Labor Secretary Robert Reich correctly observed that most of the pain of the sequester is invisible.

Brandeis University in Waltham, Massachusetts, for example, is bracing for a cut of about $51m in its $685m of annual federal research grants and contracts. The public schools of Syracuse, New York, will lose over $1m. The Housing Authority of Joliet, Illinois, will take a hit of nearly $900,000. Northrop Grumman Information Systems just issued layoff notices to 26 employees at its plant in Lawton, Oklahoma. Unemployment benefits are being cut in Pennsylvania and Utah.

Taken together, these cuts are significant. But they're so localized, they don't feel as if they're the result of a change in national policy.

A second reason the consequences of the sequester haven't been obvious to most Americans is that a large percentage of the cuts are in programs directed at the poor – and America's poor are often invisible.

The Salt Lake Community Action Program, for example, recently closed a food pantry in Murray, Utah, serving more than 1,000 needy people every month. The Southeast Alaska Regional Health Consortium is closing a center that gives alcohol and drug treatment to Native Alaskans. Some 1,700 poor families in and around Sacramento, California are likely to lose housing vouchers that pay part of their rents. More than 180 students are likely to be dropped from a Head Start program run by the Cincinnati-Hamilton County (Ohio) Community Action Agency.

All across America, food pantries and community centers catering to the poor are laying off staff, reducing services, or closing. But most Americans don't know anything about this because the poor live in different places than the middle class. Poverty has become ever more concentrated geographically in America.

A final reason much of the sequester is invisible is that many employees are being "furloughed" rather than fired. "Furlough" is a euphemism for working shorter workweeks and taking pay cuts.

Two thousand civilian employees at the Army Research Lab in Maryland, for example, are being subject to one-day-per-week furloughs starting this week, resulting in a 20% drop in pay. The Hancock Field Air National Guard Base is furloughing 280 workers. Many federal courts are now closed on Fridays.

Furloughs arguably spread the pain. Mass layoffs would be far harder to swallow.

For all these reasons, the sequester hasn't been particularly visible.

But the politicians couldn't deal with flight delays. Sequestration will continue because there is no more pain to push for overturning the whole policy. Well, there's no more pain for the politicians; there's going to be plenty of problems for people who don't have political clout. Air travelers get bailed out; cancer patients; food pantries, schools – all that other stuff is still grounded.

The jobless rate in Spain is now 27.2% for the first quarter; the highest since they have been recording unemployment there going back to the 1970's. In France, more than 3.2 million are unemployed, the highest jobless rate since 1997.

So, things are kind of lousy but there is a little bit of growth in the US economy, thank goodness we're not in Spain, or Greece, or Cyprus, or heaven forbid – Syria; it's okay, we'll just kind of slog along.

It would be great if we lived in a world where there were enough air traffic controllers for all the planes in the sky, and money for cancer research, and money for food pantries, and enough economic growth to create jobs for all the people who want to work. That would be great, but that's not the world we live in. The reason is not because we can't live in prosperity and abundance; the reason is because the banksters are skimming; they are siphoning off profits, at the expense of well, everybody else.

Now, let's move our attention to a story that has been building slowly and received almost no attention in the mainstream media. I'll provide a couple of links. (go to Eatthebankers.com) and click here (Matt Taibbi) and here (Bloomberg Businessweek)

First, let's get in the way back machine. Remember the Libor rate rigging scandal? Libor is the London Interbank Offered Rate, it's where 18 of the big banks get together each day and submit interest rates that the banks would be charged if borrowing from other banks. They take the numbers and average them together, and Libor is then used as the benchmark interest rate for almost everything that uses an interest rate. The Libor is used to calculate how much interest you pay on a credit card, a mortgage, a car loan, financial products, bonds, and derivatives; all together, about $500 trillion dollars worth of financial instruments. And the whole thing was rigged.

The banksters were submitting false numbers to try to look better during the financial crisis and they were also front-running trades based upon the rates, and sometimes they were getting the people who submitted the numbers to submit fake numbers to manipulate trades based on the Libor interest rate.

Taibbi:

Yet despite so many instances of at least attempted manipulation, the banks mostly skated. Barclays got off with a relatively minor fine in the $450 million range, UBS was stuck with $1.5 billion in penalties, and RBS was forced to give up $615 million. Apart from a few low-level flunkies overseas, no individual involved in this scam that impacted nearly everyone in the industrialized world was even threatened with criminal prosecution.

Two of America's top law-enforcement officials, Attorney General Eric Holder and former Justice Department Criminal Division chief Lanny Breuer, confessed that it's dangerous to prosecute offending banks because they are simply too big. Making arrests, they say, might lead to "collateral consequences" in the economy.

The relatively small sums of money extracted in these settlements did not go toward reparations for the cities, towns and other victims who lost money due to Libor manipulation. Instead, it flowed mindlessly into government coffers.

So, the government won't prosecute, but some private investors did, and in March a case went before federal judge Naomi Buchwald in the Southern District of New York and the judge basically said there was no collusion by the banks because the banks weren't competing against one another. So the judge dismissed most of the claim against the banks.

But the case did open up another investigation because if the banks were rigging $500 trillion in interest rates, maybe they were rigging other markets as well.  So, regulators have subpoenaed as many as 15 banks and about a dozen current and former brokers at ICAP, a London based brokerage, with trading desks in New Jersey. ICAP is short for Intercapital. ICAP's website says they are the world’s leading voice and electronic interdealer broker and provider of post trade risk and information services. Among other things, the company collects the data submitted by 13 banks to set ISDAfix prices. ISDA is the International Swaps and Derivatives Association; and the ISDAfix is the benchmark for interest rate swaps, which is about a $379 trillion dollar market.

In their simplest form, swaps are used by investors to exchange a fixed interest rate for a floating one, or vice versa. They affect everything from pension annuities to commercial real estate investments, to more complex derivatives.

And now regulators, including the Commodity Futures Trading Commission, are trying to determine if they’re colluding to manipulate quotes.

The ISDAfix works the same way as the Libor did. Banks submit rates and an average is compiled every day. About 15 banks and about a dozen brokers set the rates on a $379 trillion dollar market. An April16 report by the International Organization of Securities Commissions found that benchmark setting is a process with “opportunities for abusive conduct,” through submission of “false and misleading data” or attempts to buy off the people who physically enter submissions.

In other words, the ICAP brokers may have been gathering the information and then holding on, delaying publication of the rates to allow the banksters to slip in a trade ahead of the public.

It's not like these guys would have to cheat in really big and obvious ways; just a tiny fraction of a percent of a $379 trillion dollar market is enough to pay, one-one hundredth of one percent would be enough to pay for air-traffic controllers, cancer centers, Head Start, food pantries – you know – everything in the sequester.

But wait, there's more.

Given what we have seen in Libor, we’d be foolish to assume that other benchmarks aren’t venues that deserve review, and that means more than just Libor and ISDAfix. So, what other markets carry the same potential for manipulation?

In all the over-the-counter markets, you don't really have pricing except by a bunch of guys getting together and setting prices.

That includes the markets for gold, where prices are set by five banks in London every morning and afternoon (it's called the AM and PM fix); and silver, whose price is set by just three banks; as well as benchmark rates in numerous other commodities – jet fuel, diesel, electric power, coal, you name it.

The problem in each of these markets is the same: We all have to rely upon the honesty of companies like Barclays (already caught and fined $453 million for rigging Libor) or JPMorgan Chase (paid a $228 million settlement for rigging municipal-bond auctions) or UBS (fined a collective $1.66 billion for both muni-bond rigging and Libor manipulation) to faithfully report the real prices of things like interest rates, swaps, currencies and commodities.

All of these benchmarks based on voluntary reporting are now being looked at by regulators around the world. And after they're done investigating, they will be too afraid to do anything because the banks are to big to jail. And so the banksters will continue to skim off the top of everything, and that means that the rest of us will just kind of slog along.

Thursday, April 25, 2013 - Austerians v. Keynesians

Austerians v. Keynesians

by Sinclair Noe

DOW + 24 = 14,700
SPX + 6 = 1585
NAS + 20 = 3289
10 YR YLD + .01 = 1.71%
OIL + 1.79 = 93.22
GOLD + 36.70 = 1469.20
SILV + 1.24 = 24.50

Five years ago the banking system nearly imploded and almost resulted in a meltdown of the global financial system. Three years ago Congress passed the Dodd-Frank financial reforms, aimed at correcting some of the problems of 2008. Dodd-Frank may have included some good ideas, but you had to wade through 2,000 pages to find anything worthwhile. Much of the legislation has still not been implemented, and on the issue of averting another banking system implosion, it really didn't do much; it basically called on regulators to do a better job of catching problems and nipping them in the bud. We all know that's not going to happen.

And so, the biggest banks have been getting bigger than before the financial crisis and it's widely believed that if a big bank were to fail, they would be bailed out.., again. The government considers these banks to be Systemically Important Financial Institutions, which means they are Too Big to Fail. That implied backing has given firms a green light to engage in risky activities that pose a threat to the financial system.

Yesterday, Senators David Vitter and Sherrod Brown introduced legislation that aims to end the implicit guarantee of a government bailout. Brown and Vitter are calling for big banks with more than $500 billion in assets to have capital equal to 15 percent of their assets. Banks with at least $50 billion would have to set aside 8 percent. Community banks, those below the $50 billion threshold, would be exempt because they typically have large reserves.

There are global capital requirements for big banks; known as the Basel III requirements, but that is a risk-weighted measure; the banks can still count very risky assets, although less-risky assets get a higher ranking.

The legislation presents Wall Street megabanks with a clear choice: either have enough of your own capital to cover your own losses or downsize until you are no longer a risk to taxpayers. The banks are opposed to the idea. Shocking, right? The banks claim that if they have to hold enough capital to cover their losses, that means they would have to cut back on lending. This would probably be a better argument if the banks were actively expanding their lending as opposed to actively expanding their proprietary trading.

This is proposed legislation at this time. And even though it has strong populist support, it probably has a snowballs chance in Blythe, in July. However, it should prove a valuable fundraising tool for the politicians willing to oppose it. Brown and Vitter may have honorable intentions, but this is how Congress really makes its pocket and re-election money.

So, five years down the road; no solutions.

For the past five years there has also been a debate about how to lift the economy out of the hole left by the near financial meltdown. One one side were the Keynesians and on the other side, the austerians. The Keynesians, following the ideas of the British economist John Maynard Keynes, wanted to increase government spending to offset weakness in the private sector. The idea is that this stimulus spending would reduce unemployment, create demand, and prop up economic growth. The austerity crowd wanted to cut spending to reduce deficits and restore confidence. The austerians were following the ideas of economists Kenneth Rogoff and Carmen Reinhart, among others, who claimed that if  governments did not cut spending, countries would soon cross a deadly 90% debt-to-GDP threshold, after which growth would be permanently impaired.

This was more than just an academic debate. Japan embraced austerity and its economy stagnated for two decades. Europe embraced austerity and its economy has been battling rolling waves of recessions, and in some countries, economic depression. The most recent numbers out of the Euro-zone show new highs in unemployment for Greece, Spain, and France. Distrust of the Union is at all time highs. On Monday, José Manuel Barroso, the European commission president said the austerity policies being applied, mainly under pressure from Berlin, had reached the "limits of political and social acceptance" and were "unsustainable" in their current form.

Here in the US, we have seen a mix of austerity and stimulus and the results have been mixed as well. We cut back on government jobs; we had the fiscal cliff; we are now facing the sequester. If you don't like the idea of long delays at the airport, sorry but that's just the beginning. The sequester is throwing around 600,000 people out of work according to the Congressional Budget Office. These are people who have the necessary skills to fill jobs in the economy but who will not be working because people in Washington lack the skills to design policies to keep the economy near full employment. It just makes sense that the government needs to address budget issues and eliminate waste and fraud and unproductive programs. Meanwhile, the Federal Reserve has been pumping money into the financial system, but not into the broader economy. The results have been sluggish growth, unsustainable growth. So, QE doesn't seem to be successful, either.

And then last week we learned that the Rogoff-Reinhart paper was based on bad arithmetic. Once the error was corrected, the "90% debt-to-GDP threshold" instantly disappeared. The discovery of this simple math error eliminated one of the key "facts" upon which the austerity movement was based. So, you might think the debate is over; the Keynesians have defeated the austerians; stimulus beats sequesters. Not so fast.

Excessive debt is still problematic, just that the specific levels of 90% debt to GDP is not a precise level. And stimulus, at least in the form of Quantitative Easing, hasn't been nearly as effective as we would like. So, what's wrong? The biggest problem is that the stimulus has been coming from the Federal Reserve in the form of monetary policy and not from the government in the form of fiscal policy. The Fed has been stimulating the banks by adding more debt to the financial system; this is the equivalent of putting out fire with gasoline.

And, all the money the Fed has been pumping into the banks, has not trickled into the broader economy.  QE does not actually increase the circulating money supply. It merely cleans up the toxic balance sheets of banks. Ben Bernanke is infamous for suggesting that the Fed could crank up the printing press, or to follow the idea of Milton Friedman, deflation could be cured by simply dropping money from helicopters. A real “helicopter drop” that puts money into the pockets of consumers and businesses has not yet been tried. Why not?

It seemed logical enough. If the money supply were insufficient for the needs of trade, the solution was to add money to it. Most of the circulating money supply consists of “bank credit” created by banks when they make loans. When old loans are paid off faster than new loans are taken out (as is happening today), the money supply shrinks. The purpose of QE is to reverse this contraction.

But QE isn't really a matter of the Fed cranking up the printing press; it is actually an asset swap. The Fed exchanges dollars for the banks' toxic assets. It's a way to clean up the banks' balance sheets; it probably keeps the banks from going bankrupt and creating another financial meltdown, but it does nothing for the balance sheets of federal or local government, or most businesses, or consumers.

Quantitative easing as practiced today is not designed to serve the real economy. It is designed to serve bankers who create money as debt and rent it out for a fee, or use it for trading. Bernanke has long claimed that he needs the help of fiscal stimulus to really stimulate the economy. Maybe, but it doesn't really seem the Fed has done it's part to stimulate the broader economy, rather it has decided that the broader economy takes a backseat to resuscitating the zombie banks. And at the same instance that Bernanke calls for fiscal assistance, the Fed proclaims it's independence from the government. Bernanke has proclaimed this independence on several occasions. The unanswered question is that if the Fed doesn't serve the government, then who do they serve?

For the austerian crowd, their debt limits have been debunked, but even worse, their timing sucks. Cutting budgets while simultaneously propping up the balance sheets of the banksters is a double whammy that drains the life blood of economic growth. The QE stimulus doesn't send money to Main Street and the budget cuts take money away from Main Street. It shouldn't surprise you to learn that this combination isn't working. Money has not been circulating. The velocity of money has now slowed to a near standstill; a mere ratio of 1.54, the lowest in more than 60 years.

So, now that the austerian arguments are in shatters, it would seem a good time to revisit stimulus; not stimulus for the big banks, but direct stimulus. And one of the questions that must be asked is what is the definition of public debt? We know there are big differences in household debts. We know that if we accumulate debt for consumer purchases, we can quickly dig a hole. But if we accumulate debt to start a business or to educate our family so we can get a better job, that debt might be worthwhile. In short, there is a difference between debt and investment.

And one lesson we should have learned from the financial crisis is that we can't count on the banks to facilitate investment in the broader economy. We have a choice to support the banks' toxic balance sheets and their gambling addiction or support investment in the local economy. Of course that would require some legislative and executive backbone; so don't hold your breath. 

Wednesday, April 24, 2013 - God Bless the Child

God Bless the Child

by Sinclair Noe

DOW – 43 – 14,676
SPX +.01 = 1578
NAS +0.32 = 3269
10 YR YLD un = 1.70%
OIL + 2.43 = 91.61
GOLD + 17.90 = 1432.50
SILV + .22 = 23.26

Them that's got shall get; them that's not shall lose; so the Bible said, and it still is news. The Pew Research Center has analyzed the most recent date from the Census Bureau, and it turns out the rich got richer and the poor got poorer. During the first two years of the nation’s economic recovery, the mean net worth of households in the upper 7% of the wealth distribution rose by an estimated 28%, while the mean net worth of households in the lower 93% dropped by 4%. From the end of the recession in 2009 through 2011 (the last year for which Census Bureau wealth data are available), the 8 million households in the US with a net worth above $836,033 saw their aggregate wealth rise by an estimated $5.6 trillion, while the 111 million households with a net worth at or below that level saw their aggregate wealth decline by an estimated $0.6 trillion.

Because of these differences, wealth inequality increased during the first two years of the recovery. The upper 7% of households saw their aggregate share of the nation’s overall household wealth pie rise to 63% in 2011, up from 56% in 2009. On an individual household basis, the mean wealth of households in this more affluent group was almost 24 times that of those in the less affluent group in 2011. At the start of the recovery in 2009, that ratio had been less than 18-to-1.

God Bless the child that's got his own.

But it's getting tougher. A new Frontline documentary aired last night and if you didn't see it, it's available online; it's called “The Retirement Gamble”. The basic premise is that even if you try to save for the future, Wall Street is stripping your retirement funds clean with fees and bad performance. The documentary spends a lot of time on a 2012 research paper by Robert Hiltonsmith of the think tank Demos, which found that a median-income, two-earner family will pay a staggering $155,000, all told, in 401(k) fees. That cash represents about 30 percent of the total retirement savings this hypothetical family would have had, if it had paid no fees.

Once upon a time, American workers were far more likely to work for a company that offered a defined-benefit pension plan, the cost of which was covered by the employer. Today, we are instead encouraged to invest in a 401(k) or similar retirement plan, which offer limited investment choices. Most of those choices are "actively managed" funds that try to beat the stock market, but charge higher fees for the privilege. It is often difficult to see what sort of investments these funds have made and the kinds of fees they are charging.

The first draft of first-quarter 2013 GDP is due on Friday, but it should be clearly noted that Friday's number is only an estimate; an initial guess; there will be revisions; the revisions might be substantial. Over the past week or so, there has been a big brouhaha over the revelation that economists Ken Rogoff and Carment Reinhart's research was wrong. They had determined that when a country's debt to GDP level reaches 90%, the result is that economic growth slows – it goes negative. Their research had a Microsoft Excel coding error, and a few problems with assumptions. And so the argument for austerity now has more holes than Swiss cheese. Unfortunately, the austerity theory was enforced and it has backfired, and there are consequences.

But if the idea of debt causing slow or no growth has been discredited, where does that leave us? Is it possible that slow economic growth causes more debt? And is economic growth really a good measure of economic performance? Can an economy be growing and still be lousy? Maybe.

Economic growth measures the increase in the gross domestic product. Economic growth only shows how much more wealth the country has as a whole. We've seen growth in GDP for about 4 years but we've also seen the gap between rich and poor growing wider and wider. Growth is not creating an equitable society; it is creating inequality. If you've ever played the board game Monopoly, you know that when one player gets all the properties and all the hotels and all the money, the game is over.

We've had growth but we haven't seen jobs; well, we've seen some jobs, just not enough. And the jobs that have been created are often in low paying fields. We're not seeing good solid job growth.

So, on Friday, we'll watch the report on GDP, but we'll watch with a skeptical eye.

Remember the sequester? When seven weeks ago the deadline to find a federal budget compromise came and went, there was much handwringing in Washington. In the event that no agreement was found there were to be cuts to public spending so severe and painful that no one would dare fail to agree. To deter Republicans from holding out, half the immediate spending savings of $85.4 billion was to be found from the defense budget, and, to ensure Democrats would work to find a deal, half from annually funded federal programs. Despite these encouragements to fiscal discipline, the March 1 deadline came and went.

We all grew sick of hearing about the sequester. This week the sequester broke surface when it began affecting air travel, causing long delays at airports, which is to be expected when you send 1,500 air traffic controllers home without pay. One in 10 controllers will stay at home on unpaid leave every day until October. With the vacation season looming, crowded airports full of frustrated passengers will become commonplace.

You may not see it but there are other problems with the sequester. Air traffic controllers are not the only federal employees being told to take the week off.

So far, the sequester appears to have pleased no one, except perhaps those fiscal hawks who agree to anything so long as the federal government is shrunk. The cuts are blind, irrational, hastily arranged, uncaring, arbitrary and dangerous. Few doubt that federal expenditure is too high, but even if one is persuaded that cuts need to be made right now – which, as we remain stuck in a stagnant economy, flies in the face of macroeconomic reason – the sequester is the wrong way to make cuts and is already cutting the wrong things. The Congressional Budget Office estimates that the sequester alone will cost 0.6 percent in GDP this year. The cuts are not merely the enemy of good economic management but an automatic depressant upon the nation’s economic health.

A government watchdog warned that regulators need to be more aggressive in reducing exposure among major Wall Street firms if they want to eliminate concerns about "too-big-to-fail" banks. Christy Romero, special inspector general for the $700 billion Troubled Asset Relief Program, said in a report that not enough has been done by government overseers to address the interconnected nature of the largest and most complex financial companies. The ties among major Wall Street firms that posed a challenge at the height of the 2008 financial crisis remain a problem.

The special inspector general's report comes amid a continuing debate over whether Washington has truly eliminated the chance a large financial firm on the verge of collapse would need to be rescued by the government. It's pretty clear that the market is saying too-big-to-fail is still a problem, that these huge Wall Street banks are too complex, too interconnected, too large. Romero suggested regulators use the detailed structural plans they are receiving from the largest banks, known as living wills, to identify and eliminate potential problem areas among major firms. Obama administration officials have stressed that the 2010 Dodd-Frank financial overhaul means no financial firm would again enjoy a government bailout. But not everyone is convinced. While current law prevents bailouts to specific institutions, there could still be a demand to use taxpayer dollars in the face of a future financial crisis.

Last week the International Monetary Fund hosted a conference of some of the world’s top macroeconomists to assess how the most intense crisis to have shaken the industrialized economies since the Great Depression has changed the profession’s collective understanding of how the world economy works. After five years of coping with the consequences of the disaster, there is still so much uncertainty about what policies are needed to prevent another financial shock from tipping the world economy into the abyss again a few years down the road.

In determining what is a sustainable level of government debt, or whether central banks should focus on anything other than inflation, or what should be done to prevent further bubbles from destabilizing economies, we still don't have the answers, even if we have learned that some of the answers we thought might work have been disproved.

If you are one of the nearly five million American workers who have been unemployed for over six months, or one of the six million Spaniards, three million Italians or 1.3 million Greeks without a job or a clear prospect of finding one, this amounts to a tragedy.

Considering that the large and complicated financial institutions that set off the crisis five years ago have only gotten bigger, too big to fail has grown even bigger than ever and if it's too big to jail, it probably its too big to be allowed to fail; and that means that the gap in knowledge is downright scary.

Some things never change. Them that's got shall get; them that's not shall lose; so the Bible said, and it still is news.

Tuesday, April 23, 2913 - A Tweet Day

A Tweet Day

by Sinclair Noe

DOW + 152 = 14719
SPX + 16 = 1578
NAS + 35 = 3269
10 YR YLD un 1.70%
OIL + .38 = 89.57
GOLD – 12.70 = 1414.60
SILV - .47 = 23.04

Some days you hear a bit of news and it's bad, really bad. And then some days, hackers hack into the Associated Press Twitter account and tweet that there are bombs at the White House, and the stock market goes into a freefall, and it's bad, but not really bad.

Yes, a false tweet sent stocks plummeting. The 143-point fall in the Dow industrial average came after hackers sent a message from the Twitter feed of the Associated Press saying the White House had been hit by two explosions and that Barack Obama was injured. The fake tweet, which was immediately corrected by Associated Press employees, caused a sensation on Twitter and in the stock market.

White House officials were unimpressed. An AP reporter apologized for the Twitter hacking at the start of the daily White House press briefing, saying the tweet had been deleted as soon as it was discovered. A stoney-faced Jay Carney, Obama's personal spokesman, thanked the reporter but did not look amused. "The president is fine. I was just with him," added Carney.

The market recovered within a few minutes of the misunderstanding, but the incident raised many questions. We still have a problem with high frequency trading algorithms that scan the news and trade quickly, causing flash crashes. And then there are people who set stop losses, who may be kicked out of a trade because someone's computer over-reacts. There's a substantial business by high-frequency trading hedge funds reading machine-readable news sold to them for big bucks by brand-name news organizations.

Fans of flash-trading robots say they make the market more "liquid," meaning stocks trade more easily. But they can also make liquidity vanish in an instant, making it harder for the few remaining human beings in the stock market to keep order when things go haywire. Remember the Flash Crash of May 2010? Remember the Facebook IPO? Remember yesterday?

Yep, yesterday. Google had a mini flash crash yesterday. And then it passed and nobody noticed much. It's actually happening all the time. And if you lose a little confidence in the markets, well you should. Now the market has almost become complacent of these errors.

And today's flash crash was a fairly simple prank hack; a one-hit wonder. Imagine if someone really wanted to be malicious. Imagine wave after wave of false news stories hitting the high frequency machines. We could one day be looking at not just a 150 point drop, but a thousand points, or maybe 10-thousand.

And if you still have some confidence in the markets, you'll love this next story. Standard & Poors, the credit rating agency is defending itself in a $5 billion civil fraud lawsuit. The government claims that S&P defrauded investors by telling them that its ratings on collateralized debt obligations were based on stuff like research and objective analysis. The government claims that, instead of objectively analyzing the CDOs, S&P analysts gave these CDOs the best possible ratings, in order to win more CDO-rating business from the banks that pay their salaries. 

The government seems to have a good case; many of the S&P analysts sent emails to each other and to their bosses explaining how bad the CDOs were and how the whole thing would end badly, and some referred to the ratings as “burning down the house”, and the whole email problem seems to indicate that the folks at S&P knew they were cheating; they really, really knew that what they were doing was wrong.

But S&P says that we should ignore those emails, that they were just part of the company's "robust internal debate." It says its ratings were just dumb and unreliable, not fraudulent. But then it also says we should go ahead and ignore its claims of objectivity and integrity, while we're at it. S&P is claiming that it's objectivity was mere puffery, which is a bit of a stretch for a legal defense, and even worse as a business model. It shouldn't come as a surprise. It has been painfully obvious that the credit rating agencies have a conflict of interests. They are paid by the banks whose products they rate.

This conflict was a problem before the crisis, and it remains a problem now. And though regulators have made loud noises about doing something about this problem, they have not done much in the way of solving it.

Which means that we could once again be in a situation in which a rating agency's ratings turn out to be woefully wrong. By that point, nobody will have any excuse for being surprised. S&P has all but told us to expect it. It is now part of the court records; their ratings are nothing more than puffery.

Speaking of puffery, it's earnings reporting season.

Apple reported fiscal second-quarter earnings of $10.09 a share on revenue of $43.60 billion versus $12.30 a share on $39.19 billion a year earlier. Better than expected. Apple is opening the doors to its bank vault, saying it will distribute $100 billion in cash to its shareholders over two years. Apple increased its dividend 15 percent to $3.05 a share and said it will expand its share repurchase program to $60 billion from the $10 billion level announced last year. 

KFC parent Yum Brands reported that quarterly profit fell less than Wall Street expected, despite a sharp drop in sales in its top market of China, and the company's shares jumped 6.5 percent. The fast-food operator reaps more than half of its overall sales in China. I did not know.

Some of the crown jewels of corporate America have reported declining revenues and earnings, and have lowered their forecasts, and in doing so, have unleashed a flood of obfuscation and excuses – from Easter falling on the wrong date to lazy sales reps. So when Caterpillar reported on Monday, it was almost refreshing in its unvarnished ugliness.

Sales plunged 17.7%, profits 44.6%. “A challenging first quarter,” Corporate Controller Mike DeWalt called it. Dealer sales had been less than expected, inventories had piled up on their lots, and they’d cut back their orders to bring down their inventories. End-user demand was down, along with sales of aftermarket parts. Everything was down. But manufacturing costs jumped, and profits sagged. The rest of 2013 would be tough, and revenue guidance was lowered by a chunk. Not a single excuse.

Then there’s IBM. Because it’s the world’s largest supplier of information technology, its earnings report is a harbinger of things to come… namely excuses. A technique it had picked up from Oracle last month. Oracle’s earnings call was a mess. Revenue dropped 1%, instead of being up. Revenues from new software licenses and cloud subscriptions dropped 2%, after the company had forecast an increase of 3% to 13%. Hardware sales were a disaster. Who did they blame? First, the government – the quarter “ended on the same day as the sequester deadline,” explained President and CFO Safra Catz – then the sales reps. Oracle had just hired 4,000 new reps around the world; that was the problem Catz and President Mark Hurd said in unison. They hadn’t been trained yet. It was just “sales execution.” Nothing else. Certainly not the economy, Catz pointed out.

“What we really saw was the lack of urgency we sometimes see in the sales force as Q3 deals fall into Q4,” Catz said. Those “new reps,” she said, “ran out of runway in Q3.” They just couldn’t close their deals. “The issue for us is simply conversion,” Hurd added. “Clearly we have work to do in training new reps on managing the sales processes,” Catz chimed in. What about the old reps? Where they all on vacation? They didn’t say. Not a good omen.

Thursday evening, it was IBM’s turn to report a first-quarter earnings shortfall and revenues that, instead of growing, had skidded 5% from a year ago. To get back on track, IBM would swing the axe, at a cost of $1 billion in the second quarter – “workforce rebalancing” was its newfangled term, “to better align our resources to opportunity.” There’d be a lot of “rebalancing.” The term was used 14 times during the call. And it would dump some businesses.  A few moments later he added that revenues in the Americas were down 3%

A scary thought that the three largest markets in the world could weaken simultaneously – despite the prodigious amounts of money that central banks have printed and handed out. That phenomenon must be hidden under layers of lazy sales reps, sequester deadlines, and badly timed holidays. Yet, at the very end, something did slip out: “We are clearly not immune from changes in the global economy,” Loughridge said during his wrap-up, the most revealing sentence of the entire earnings call.