Tuesday, December 03, 2013 - But Be Afraid

But Be Afraid

By Sinclair Noe

DOW – 94 = 15,914
SPX – 5 = 1795
NAS – 8 = 4037
10 YR YLD - .01 = 2.78%
OIL + 2.22 = 96.04
GOLD + 5.00 = 1225.30
SILV - .03 = 19.28

Stocks down again today for the third straight session, the first three-session losing streak since late September. It isn't a trend, yet; as we said yesterday, it's only a reason to stay cautious. I'm reading the rationale for today's decline:

“Traders blamed the slide on worries about the Federal Reserve winding down its economic stimulus program earlier than expected due to strong readings on November manufacturing and construction spending released Monday. Weaker-than-expected consumer spending for the kickoff to the holiday shopping season also has investors on edge.” (USA Today)

And now I'm more confused than ever. Traders claim the economy is too strong, then we hear that consumer spending is too weak, and the worry is the Fed will taper. Flip a coin – you'll be more accurate.

The bulls’ case appears increasingly strained. One argument is that there is enough talk of bubbles that there can’t possibly be one. But in fact, in the dot-com era, there was plenty of discussion of frothiness of the tech stocks. Remember irrational exuberance?

Similarly, contrary to popular perceptions, mortgage industry insiders were concerned about the subprime market starting in 2005, with every conference featuring a panel on whether that market was getting out of hand.

And at least those overdone bull markets were built on the back of solid fundamental growth. By contrast, the U.S. recovery is more technical than real, with headline unemployment failing fully to capture the dire state of labor conditions. Estimates that include underemployment at near Depression eara levels. College grads face an unprecedentedly hostile job market and many are also mired in student debt. Not surprisingly, consumer confidence has dropped over the past seven months. And the recovery in the housing market? We'll get to that in a moment.

The Fed’s policies of super-low interest rates and quantitative easing, which have lowered yields on Treasury and mortgage bonds, have sent investors scrambling for returns. And the Fed’s efforts have been compounded by similarly aggressive policies in Japan and China, and even a willingness to be more accommodative by the once austerity smitten European Central Bank. Market trading has been driven by anticipation of Fed action rather than economic fundamentals.

In a May 2013 testimony to the Joint Economic Council, Federal Reserve Chairman Bernanke stated that the FOMC has made it clear, "it is prepared to increase or reduce the pace of its asset purchases to ensure that the stance of monetary policy remains appropriate as the outlook for the labor market or inflation changes." Alongside additional answers he offered concerning the rationale and timing of such tapering, the financial markets immediately swooned.  A number of Federal Reserve officials had immediately and ever since come out to distort and negate some of the Chairman's communications, in an attempt to reduce the apparent runaway rise in borrowing costs, particularly on shorter-tenured bonds. we also do know that growth, revenue, and earnings, have all just been ok throughout the year. So,it makes sense that the Federal Reserve has had an outsized role in changing the trajectory of market performance, at least since June and probably into the New Year

Bill Gross, the head of bond giant Pimco, in his most recent investment outlook wrote: “Don't fight central banks, but be afraid.” Markets that have "excess liquidity" compliments of central banks become skewed toward the speculative end of the spectrum. Speculative markets can continue to rise much longer than rational people believe, or maybe the speculative market ended last Friday. Markets cannot rise forever based on printed money. At some point, the economy needs to carry more weight, but fear is not a valid investment strategy; discipline is.

Sales over the Thanksgiving weekend may have been a disappointment for the nation’s retailers, but they were a boon for the automakers, lifting their sales in the United States for November to the best rate since before the recession. Industrywide sales rose 8.9 percent in November to 1.25 million vehicles. At that pace, automakers predicted a seasonally adjusted annual rate of 16.3 million vehicles sold, the highest since May 2007. For the year, the industry is expected to sell 15.6 million new vehicles.

Corelogic released its report on home prices for October. The Corelogic Home Price Index is a 3 month weighted average, and it shows prices increased just 0.2% compared to September. Year over year, home prices, including distressed properties, nationwide increased 12.5%; this marked the 20^th consecutive monthly increase in home prices.

The housing market recovery is uneven, and home prices in 12 states remain at least 20% below local peak levels. Nevada’s home prices in October, including distressed sales, were 41% below a 2006 peak, the largest drop from bubble levels, despite explosive growth of 26% over the past year. Prices in Florida and Arizona in October were more than 30% below local peak levels. In California, home prices are still about 22% below the peak. In October, national home prices were down 17% from a bubble peak. Only 1.88 million homes were for sale at the end of October, down 2.1 percent from the previous month and the fewest since March. The shortage of inventory has slowed sales. Home re-sales fell in October for a second straight month to a seasonally adjusted annual pace of 5.12 million.

Michigan home sales were up 14% over the past year. That seems surprising in light of the news out of Detroit today, but Michigan is a big state. Detroit is in bad shape. Detroit is in far worse fiscal shape than other major American cities and cannot mount a sustainable recovery without a drastic overhaul that will certainly impose harsh sacrifices. The city of Detroit today officially became the largest municipality in U.S. history to enter Chapter 9 bankruptcy after US Bankruptcy Judge Steven Rhodes declared it met the specific legal criteria required to receive protection from its creditors. The landmark ruling ends more than four months of uncertainty over the fate of the case and sets the stage for a fierce clash over how to slash an estimated $18 billion in debt and long-term liabilities.

Whether Rhodes would deem the city insolvent wasn’t much of a question. If Detroit isn’t insolvent, what place is? Less clear was the status of pensions. The bankruptcy judge said he will allow pension cuts in Detroit's bankruptcy, even though pensions were protected under Michigan's constitution; but he also said he won't necessarily agree to pension cuts unless the entire reorganization plan is fair and equitable. The average Detroit General Retirement System pensioner nets less than $20,000 a year; for police and fire retirees, it’s about $34,000 annually.

Judge Rhodes said he will not issue a stay on the bankruptcy, meaning the case will proceed. And even though an appeal has already been filed, and more will come in the days ahead, the bankruptcy code provides for Chapter 9 to continue while appeals are pending that challenge. Rhodes also scolded the city for rushing through negotiations with its creditors, noting they only had 30 days to offer a counter-proposal. Saying that amount of time is “simply far too short,” Rhodes ruled the city did not satisfy good-faith requirements to try to negotiate with creditors outside of bankruptcy court. Bankruptcy protection limits the legal actions the city's 100,000 creditors can take to collect money owed to them. So, it looks like the Judge is pointing all parties back to the negotiating table.

America is doing a lousy job of educating our kids. According to the latest results of a comprehensive set of international tests, America's teens have remained mid-pack among their peers worldwide and utterly stagnant in reading, math and science over the last 10 years.

America's 15-year-olds failed to improve on the Program for International Student Assessment; meanwhile, East Asian countries maintained their top slots, and other countries not generally known for their academic prowess have become breakout stars of a sort. Poland, Germany and Ireland showed tremendous growth, and Vietnam, which administered the exam for the first time in 2012, wound up among the top-performing countries, eclipsing the US in math and science. Yes, the US now trails Vietnam in our ability to educate our teenagers.

In fall 2012, the Organisation for Economic Co-Operation and Development tested 28 million students between ages 15 and 16 in 65 economies, including 34 OECD countries. Among those 34 countries, the US performed slightly below average in math, scoring 481, and ranked 26 (though the report notes that due to measurement error, the ranking could range from 23 to 29.) Shanghai, Singapore, Hong Kong, Chinese Taipei, Korea and Japan came out on top, followed by such European countries as Liechtenstein, Switzerland, Netherlands, Estonia, Finland and Poland. Peru, Indonesia, Qatar, Colombia and Jordan came in last.

In reading, the US performed around the OECD average of 496, ranking 17 (or between 14 and 20) with an average score of 498. Again, Shanghai, Hong Kong, Singapore, Japan, Korea, Finland, Ireland, Taipei, Poland and Estonia came out on top, with Argentina, Albania, Kazakhstan, Qatar and Peru filling out the bottom.

The US also came in around the OECD science average of 501, ranking 21 (between 17 and 25) with an average score of 497. Top scorers included Shanghai, Hong Kong, Singapore, Japan, Finland, Estonia, Korea, Vietnam, Poland and Canada. The lowest performers include Peru, Indonesia, Qatar, Albania and Tunisia.

We've tried to chronicle the misdeeds of Wall Street banksters leading up to and following the financial crisis, so it might surprise you to learn that, according to a survey from the Economist Intelligence Unit, 60% of those surveyed said they had a positive view of Wall Street's reputation for ethical conduct; of course those surveyed were Wall Street financial industry executives. A separate survey by Edleman interviewed 31,000 regular people, and they concluded that the financial services industry was the least trusted of 18 industries to do the right thing by the general public.

The quote of the day goes to Goldman Sachs CEO Lloyd Blankfein, speaking at an industry conference today, saying “This country does a great job of creating wealth, but not a great job of distributing it.”