Tuesday, April 02, 2013 - Correlation and Divergence

Mark your Calendar, April 5 & 6 and make your reservations for the 2013 Wealth Protection Conference in Tempe, AZ. For conference information visit www.buysilvernow.com or click here or call 480-820-5877. This year's conference features Roger Weigand, Nathan Liles, David Smith, Mark Liebovit, Arch Crawford, Ian McAvity, Bill Tatro, and I will speak on Friday. There is an expanded Q&A session with all speakers on Saturday. I hope you can attend.

Correlation and Divergence

by Sinclair Noe

DOW + 89 = 14,662
SPX + 8 = 1570
NAS + 15 = 3254
10 YR YLD + .02 = 1.86%
OIL - .16 = 96.91
GOLD – 23.20 = 1577.20
SILV - .76 = 27.36

Yesterday I told you the big economic report this week will be the jobs report on Friday. Many people like to discount the jobs report, claiming it doesn't give a thorough picture of the labor market; and there is some validity to this complaint. The Philly Fed has produced a slightly more comprehensive report, known as the Coincident Index; this measures  four variables (nonfarm payroll employment, average hours worked in manufacturing, the unemployment rate, and real wage and salaries) wrapped into one index, designed so that it roughly reflects gross domestic product growth. Nationally, the Philadelphia Fed’s coincident index rose 0.3% in February for a 2.8% year-on-year gain. They also provide state by state breakdown. Alabama, Illinois, and New Mexico saw declines in the February report; 45 states notched advances.

With the stock market, or at least the Dow Industrials and Transports, and the S&P 500 hanging out around record territory, you might think we would see more signs of an improving economic cycle; bond yields should be rising at the margin, and commodities should be catching a bid. None of that is happening. While the big stock indices have been climbing other parts of the broader market have broken down since the end of January; areas that should have a correlation to stocks. One of the most common correlations is copper. If the economy is thriving, then copper should be in big demand. Copper is used extensively in construction and electronics and many other uses that would signal a booming economy. When gold outperforms, you can think of it as a risk off play, money is looking for a safe haven. So, if the economy is really strong, you would expect to see copper higher and gold flat or down. Since the start of the year, both copper and gold have been down; possibly indicating a weak economy mixed with complacency. Of course, it's easy to be complacent when the Fed is pumping $85 billion a month into the market.

This is not to say I'm bearish, certainly not bearish on a market that is consistently hitting new highs. I'm just saying that nothing has changed with the old idea of Sell in May, and the pattern of the past couple of years for a sell-off in summer. Much of the move higher can be attributed to the Federal Reserve QE to infinity, which also explains many of the divergences we're seeing from other areas. One of the big concerns is the hit stocks might take once the Fed begins to tighten. If Bernanke and Co. were crazy enough to surprise everyone by suddenly raising rates or pulling back on quantitative easing, equity markets would tank big time. But the Fed won't do that. They'll instead be very careful and transparent and appropriately plodding about unwinding precisely to avoid that melt down. "No surprises" has to be their watchword these days. Of course the Fed doesn't completely control corporate earnings, and there are usually a few surprises during reporting season.

The euro is steady even though the Cypriot central bank confirmed that large depositors at the largest bank in Cyprus would lose approximately 60% of their savings over 100,000 euros. This is well above the initially stated reduction of 30% to 40%. Other than that there was no new bad news out of the euro zone.

Fears remain that the deal to rescue Cyprus will not be enough to totally eliminate the risk of default later. Last summer at the height of the panic over Spain’s banks, the euro zone embarked on the initial step towards banking union. The idea was to break the “doom loop” under which weak banks were dragging down weak governments and vice versa. Leaders agreed that the European Stability Mechanism (ESM), the zone’s bailout fund, could be used to recapitalize bust banks, but only once an effective supervisory mechanism was in place. The European Central Bank was chosen to be that supervisor. But the countries with money didn't like the idea of bailing out the countries without money, not to mention their faltering banks. The result is that the Euro zone doesn't have a good plan in place to have banks go bankrupt.

The core countries took a hard line that no taxpayers’ money could be used to bail out the banks, meaning large depositors will face big losses. And the losses for the Cypriot depositors is looking like 60% above and beyond the 100-thousand euro insured amounts. And the Eurogroup president has let slip that this is the new template for resolving bank busts. Of course, the Cyprus banks had multiple problems, but their biggest problems came from holding Greek bonds, and when Greece imploded, the bondholders took a haircut, resulting in 2.7 billion-euro in losses for the Cypriot banks.

The bottom line to this story is that the Eurogroup doesn't have a working plan in place to deal with bankrupt banks. It's a dangerous situation. And the bottom line for Cyprus is even worse: capital is leaving the country. The draconian capital controls have restored a sense of calm to a disorderly situation but businesses don't have working capital. And nobody is talking about how to rebuild the economy.

Here are some of the other news headlines out of Europe:

New York Times: "Unemployment in Euro Zone Reaches a Record High"WSJ: "Sixth Quarter of Contraction Looms for Euro Zone">Der Spiegel: "Shredded Social Safety Net: European Austerity Costing Lives"WSJ: "Spain Says Budget Gap Is Wider Than Reported"WSJ: "Italy Unable to Form Government"New York Times: "Debt Rising in Europe"

So, while the US stock market hits another record high, the Eurozone is hitting a depression.  Washington seems determined to follow in Europe's footsteps. We've already had a couple of rounds of austerity ourselves -- in the last deficit deal, and now in the "sequester" cuts.  The president and the Republicans both employ pro-austerity rhetoric which argues that deficits are our biggest problem. They just disagree about where and how it should be imposed.

A Manhattan federal judge, Sidney Stein, has signaled he will not rubber-stamp Citigroup's proposed $590 million settlement of a shareholder lawsuit accusing it of hiding tens of billions of dollars of toxic mortgage assets. The judge asked lawyers for the bank and its shareholders to address several issues at an April 8 fairness hearing, including requested legal fees and expenses of roughly $100 million, and the absence of payments by former Citigroup executives.

The $590 million settlement resolved claims by Citigroup shareholders from February 26, 2007 to April 18, 2008 that the bank failed in those years to properly write down risky debt, often backed by subprime mortgages, and concealed the risks. The shareholder settlement is separate from a $730 million accord with bondholders last month.

Now, you may remember another federal appeals court judge in New York, Jed Rakoff, rejected a $285 million settlement between Citigroup and the SEC over the alleged defrauding of investors. Judge Rakoff thought the settlement was letting Citigroup off too easy. Last week, District Judge Victor Marrero in Manhattan cited that case (the Rakoff case) in delaying a decision to approve the SEC's $602 million insider trading settlement with a unit of Steven Cohen's hedge fund SAC Capital Advisors. Maybe there is a trend developing. When the regulators continue to let the banksters slide with nothing more than a slap on the wrist, well after a while, it's just unacceptable.