Friday, February 21, 2014 - Grab Tight and Hope for the Best

Grab Tight and Hope for the Best

by Sinclair Noe

DOW – 29 = 16,103
SPX – 3 = 1836
NAS – 4 = 4263
10 YR YLD -.02 = 2.73%
OIL - .50 = 102.25
GOLD + 3.10 = 1327.10
SILV + .03 = 21.95

Sometimes you just grab tight and hope for the best. There is a deal in the Ukraine. Ukraine's opposition leaders signed an EU-mediated peace deal with President Viktor Yanukovich. Under pressure to quit from mass demonstrations in Kiev, Russian-backed Yanukovich made a series of concessions, including a national unity government and constitutional change to reduce his powers, as well as announcing an early presidential election this year. The Ukrainian parliament then voted to revert to a previous constitution, which essentially stripped Yanukovich of some powers, sacked his interior minister blamed for this week's bloodshed, and amended the criminal code to pave the way to release his arch-rival, jailed opposition leader and former Prime Minister Yulia Tymoshenko.

The deal was mediated by the foreign ministers of Germany, Poland and France, and appears to have been a victory for Europe in its competition with Moscow for influence. The European envoys signed the document as witnesses, but a Russian envoy did not. And just because a deal has been signed it doesn’t mean it will be easy. Protesters remain encamped in Kiev's central Independence Square, where approximately 77 activists had been killed over the past week. There were some celebrations but many of the demonstrators were skeptical that Yanukovich could be trusted.

Ukraine still has problems. The country is deeply divided between Russian sympathizers and the opposition which supports the European Union. The country is broke and facing default. They are dependent on Moscow for energy imports. Putin promised $15 billion in aid after Yanukovich turned his back on a far-reaching economic deal with the EU in November, but now Russia is holding back to see how things play out. The devil is in the details but for this moment in time, they are trying to give peace a chance.

Meanwhile the city of Detroit is looking for a fresh start. You might hear that the city of Detroit officially filed for bankruptcy today; that’s not quite accurate. The state appointed emergency financial manager, Kevin Orr filed a bankruptcy plan with the courts. And that’s just the beginning of the strangeness that is Detroit.

To begin the process of restructuring and exiting Chapter 9 bankruptcy, the city of Detroit filed documents with the court outlining its restructuring plans; who might get what, and an idea of what the city might look like after it pays what it can.

Orr proposed 34% cuts to the pension checks of general city retirees and 10% to police and fire retirees, and they would lose cost of living adjustments, and it’s dependent on the city’s two independently controlled pension boards agreeing to support the plan of adjustment. The city has about 24,000 retirees. The city proposed paying about 20% to 30% of its retiree health care liabilities to a newly created trust fund.

The city proposed paying secured bondholders 100% of what they’re owed, while unsecured general obligation bondholders would receive 20%.The significant haircut for general obligation bonds now declared to be unsecured debt likely will upset participants in the $3.7 trillion municipal bond market, where general obligation bonds have traditionally been considered a safe bet for investors. A deal to end costly interest-rate hedges was not included in the plan, but there should be a plan for that within a few days.

The plan also calls for the city to invest about $1.5 billion over 10 years to improve public protection, restore services and reduce blight, including tearing down abandoned houses.

The judge overseeing the city’s bankruptcy, Steven Rhodes, must approve the restructuring plan before it can be finalized. This is likely to involve a fierce court battle with creditors over several months. Again, the devil is in the details, different parties will be upset; but the basic plan appears to be: fewer debt collectors, fewer murders, and fewer abandoned homes.

How will things work out for the Ukraine or for Detroit? We don’t know. In times of crisis, sometimes you just grab tight and hope you don’t get thrown off the horse. That appears to be the game plan of the Federal Reserve as the economy and financial markets collapsed around them in 2008. Today the Fed released transcripts of the Fed policy makers from 2008, when everything hit the fan. The one thing that becomes quickly apparent from the transcripts is that the Fed was not prepared for the meltdown and they were in no way certain about the best response.

As then-Fed Chairman Ben Bernanke said during an emergency conference call on Jan. 21, 2008: "We were seriously behind the curve in terms of economic growth and the financial situation." And so at that meeting, they cut the Fed Funds discount rate target by three-quarters of a percent. Twelve days earlier they had called another emergency meeting and made no change to interest rates. Nine days later, on January 30, they cut rates another 50 basis points.

Then at their September 16, 2008 meeting the Fed left interest rates unchanged, even though Lehman Brothers had just collapsed and insurance giant AIG was in the grips of a crisis that threatened to bring down the whole financial system. By the end of 2008, the Fed had made eight rate cuts, leaving its benchmark short-term rate on Dec. 16 at a record low near zero. It remains there today.

At the September meeting, many Fed officials were far more worried about inflation risks than about the risk of an economic collapse and depression. The word "inflation" occurs 129 times in the Sept. 16 transcript; the word "recession" was uttered just five times. ("Laughter" is noted in the transcript 22 times.)

Lehman fallout was unclear. The day after Lehman declared bankruptcy, Fed officials still didn't have a handle on what the long-term effect would be on the economy. Dave Stockton said: "I don't think we've seen a significant change in the basic outlook. We're still expecting a very gradual pickup in GDP growth over the next year."

Several Fed officials congratulated themselves on the controversial decision to deny funding for a potential acquisition of bankrupt Lehman Bros. The move, however, significantly worsened the crisis. Former Kansas City Fed chief Thomas Hoenig said: "I think what we did with Lehman was the right thing because we did have a market beginning to play the Treasury and us, and that has some pretty negative consequences as well.” And St. Louis Fed chief James Bullard said: "By denying funding to Lehman suitors, the Fed has begun to reestablish the idea that markets should not expect help at each difficult juncture."

And if they were unsure of the effect of the Lehman collapse, they totally misread the failure of Bear Stearns. In April, just after the collapse of Bear, Bernanke seemed to think the worst had passed, saying: “I think we ought to at least modestly congratulate ourselves that we have made some progress," he said. "Our policy actions, including both rate cuts and the liquidity measures, have seemed to have had some benefit. I think the fear has moderated. The markets have improved somewhat." Actually, it was just the calm before the storm. Then at the September 16 meeting, Bernnake made the mistake of self-congratulation once again, saying: “I think that our policy is looking actually pretty good.”

Janet Yellen, the new Fed Chairperson, seemed to grasp the gravity of the situation more than most of her colleagues. At an Oct. 28-29 Fed meeting, Yellen noted the dire events that had occurred that fall. With a nod to Halloween, she said the Fed had received “witch’s brew of news.” Yellen went on to say: “The downward trajectory of economic data has been hair-raising, with employment, consumer sentiment, spending and orders for capital goods, and homebuilding all contracting.” Market conditions had “taken a ghastly turn for the worse,” she said. “It is becoming abundantly clear that we are in the midst of a serious global meltdown.” Yellen had downgraded her economic outlook and was predicting a recession, with four straight quarters of declining growth. She was right about that, even if no one was sure what to do about it.

Maybe they were just tilting at windmills, as Philly Fed President Charles Plosser suggested, saying: “I don’t think that anything that we do today — cutting the funds rate 50 basis points or whatever — is going to make the next couple of months in terms of the overall economy any less painful.”

They thought they should get more regulatory powers in return for bailing out the banks. Richard Fisher, head of the Federal Reserve Bank of Dallas, said in a March 2008 conference call:  "I am just a little worried about being taken advantage of here. The question is, what do we get in return, and how do we make sure that, since we are not the regulator of these dealers, there is indeed discipline?" Of course it turns out there was no discipline. The big banks are now bigger and riskier than ever.

At times they were overwhelmed. At the September 16 meeting a Fed economist said: "We did receive a great deal of macroeconomic data since ... last Wednesday. We didn't seem to get any of it right, but it all netted out to just about nothing."  And everybody had a good laugh.

Eventually, Bernanke seemed resigned to his limitations. In October of 2008, he was asked about the future direction of rates and he answered: “I feel rather unconfident about predicting the path of rates six months in the future, because I’m not quite sure what is going to happen tomorrow at this point.”

To be fair, even though they made a bunch of mistakes, the global financial system did not collapse. Sometimes you just grab tight and hope for the best. 

Thrusday, January 16, 2014 - The “It Could Be Worse” Victory Lap

The “It Could Be Worse” Victory Lap

by Sinclair Noe

DOW – 64 = 16,417
SPX – 2 = 1845
NAS + 3 = 4218
10 YR YLD - .04 = 2.84%
OIL - .07 = 94.10
GOLD + .70 = 1243.70
SILV - .11 = 20.20

The number of Americans filing new claims for unemployment benefits fell for the second consecutive week last week; down 2,000 to 326,000. This might suggest that the December jobs report, which was a weak 74,000 jobs added, maybe that report was just a temporary slowdown.

In a separate report, the Philadelphia Federal Reserve Bank said its business activity index rose to 9.4 points this month from 6.4 in December. Any reading above zero indicates manufacturing expansion in the region.

In another report, the Labor Department said its Consumer Price Index increased 0.3% after being flat in November. In the 12 months to December, consumer prices accelerated 1.5%. A 3.1% increase in gasoline prices was mostly behind the spike in inflation last month. The increase in gasoline was the largest since June and followed a 1.6% fall in November. Food prices rose 0.1% for a third month. There is no wage inflation. Average hourly earnings adjusted for inflation fell 0.3% in December; and with the weakness in the labor market, there is very little chance of wage growth for quite some time.

The Fed targets 2 percent inflation, although it tracks a gauge that tends to run a bit below CPI. And outgoing Fed Chairman Ben Bernanke says inflation is not a problem, and he cited this morning’s CPI report. As for overinflated assets, Bernanke said the Fed is "extraordinarily sensitive" to that risk after the financial crisis, which began with the bursting of a massive property price bubble, but rather than to try to pop bubbles with the blunt tool of higher interest rates, Bernanke said in the Fed is using supervision, regulation and other microeconomic-type tools to be sure the threat is minimal.

Bernanke claims there is no fear of hyperinflation, and he believes the Fed has the tools to manage inflation and avoid bubbles and keep everything under control. And to hear Bernanke talk, you might not think that the past 5 years have been a big monetary experiment. And maybe they have and will continue to avoid bubbles, but if you believe that, then you also believe the markets are fairly valued right now. So, what would happen if the Fed just stopped QE tomorrow? Imagine a market where the Fed just stopped buying Treasuries and mortgage backed securities. You are likely imagining a market dropping about 20%; maybe more.

Anyway, Bernanke is taking a victory lap as part of his farewell tour, and to some extent he’s probably entitled; the extent being that this whole grand experiment could still end quite badly. But for now things are improving, even if it has been painfully slow improvement; still it could be worse; it could be Europe.

If we compare the economic recovery of the United States since the Great Recession with that of the Eurozone, the differences are striking, and instructive. The US recession officially ran form December 2007 to June 2009, while the Eurozone recession ran from January 2008 to April 2009, and then they dipped back into recession in the third quarter of 2011 and lingered for another couple of years. Now you can argue that the US is still in some form of economic malaise, what with 20 million unemployed, but the technical definition of a recession doesn’t always count things like people out of work. In the Eurozone, unemployment is at near record levels of 12.1%, while in the U.S. it is currently 6.7%. In Greece and Spain, unemployment is over 25%, and youth unemployment is approaching 60%.

How are we to explain these differences? The Federal Reserve lowered short-term interest rates to about zero in 2008 and has kept them there since. The Fed also signaled its intention to keep these interest rates at these levels for a long time. And venturing into uncharted territory, the Fed engaged in three rounds of "quantitative easing," or more than $2 trillion of money creation. Just how much the Fed policy served to stimulate the economy is questionable, but there has been some impact. The stock market and the housing market saw an injection of liquidity, and some people got very, very wealthy, and maybe a little  of that spilled over into the broader economy; maybe. At the least, it helped to avoid the double dip that befell the Eurozone.

In the Eurozone, the response was tightening and austerity, and the IMF has now admitted that austerity has led to even higher levels of debt than before, and reduced GDP growth. Now the question is why the Europeans have been so unfortunate to be subjected to much more brutal economic policy than what we have experienced in the United States. While there are many nuances, there are also some simple but deadly important reasons. Most vital is the accountability, or lack thereof, of the institutions making the decisions. In Europe you have the so-called "troika" -- the European Central Bank (ECB), the European Commission, and (more recently recruited) the IMF. These are much less accountable to Eurozone residents -- especially but not limited to those of the most victimized countries (Spain, Greece, Portugal, Ireland, and Italy) -- than even the relatively unaccountable Federal Reserve and US Congress and executive branch are to Americans.

Some examples: In all 27 countries, the IMF recommended budget tightening, with spending cuts generally favored over tax increases. In 15 countries there were recommendations on health care: 14 were to cut spending. In 22 of the 27 countries there were recommendations to cut pensions. In half the countries, the Fund also gave advice on employment protection; in all of them, the recommendation was to reduce employment protections. Reducing eligibility for disability payments or cutting unemployment compensation, raising the retirement age, and decentralizing collective bargaining were also recommended.

But perhaps even more remarkably, this evidence tells us why the ECB allowed repeated and severe financial crises in the eurozone to take their toll on the eurozone and world economy for nearly three years. Not until July of 2012 did ECB President Mario Draghi utter those famous three words -- "whatever it takes" -- which, backed up a few weeks later by the new "Outright Monetary Transactions" program, put an end to the threat of financial meltdown.

After more than 20 European governments have fallen during the prolonged crisis, the pace of the destructive budget tightening there is finally winding down: from about 1.5 percent of GDP in 2012, to 1.1 percent in 2013, to 0.35 percent in 2014. But who knows how many more years it will take to reach normal levels of employment.

This is not to say that the US recovery has been a shining example, and Bernanke should not take too many bows, but it could have been worse.

It is earnings reporting season. Goldman Sachs’ profit fell 21 percent, as revenue from fixed income trading dropped 11% after adjusting for an accounting charge. Fixed income trading revenue accounted for 48% of Goldman's total revenue back in 2009. In the fourth quarter of 2013, it was 25%.

Profit at Citigroup rose 21%, after adjusting for items, as it cut costs and released dipped into funds set aside for bad loans. Now worries. What could go wrong?

Right before Christmas the Emergency Financial Manager for Detroit negotiated a settlement to end a costly interest rate swap with two investment banks. Ending the swaps with UBS and Bank of America Corp's Merrill Lynch Capital Services for $165 million was a key component of Detroit emergency manager Kevyn Orr's plan to adjust the cash-strapped city's finances through the municipal bankruptcy process.

Detroit currently pays about $50 million a year to the banks in exchange for the swaps, which provided a steady interest rate of about 6% on a $1.4-billion pension funding deal. That equals nearly 5% of the city’s sparse general fund budget.

The $165 million deal represented a 43% discount from a previously negotiated deal for a payment of $285 million to the banks, which the bankruptcy judge said was far too generous to the banks. Today, that same bankruptcy judge said the $165 million is still too high a price to pay.

Bankruptcy Judge Steven Rhodes said the city must stop making poor financial decisions, and it’s his judicial responsibility to ensure it emerges from Chapter 9 bankruptcy as a financially sustainable municipality. 

It represented a major win for Detroit retirees, city residents, the pension funds, several European banks and a bond insurer called Ambac Assurance, which aggressively fought the settlement. Because Rhodes denied the deal, they stand to get more money from the city’s eventual bankruptcy restructuring. It represents a major loss for the investment banks. Before you celebrate, this just sets the stage for a possible legal battle.

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.”

Wednesday, September 18, 2013 - Surprise, Surprise, Surprise

Surprise, Surprise, Surprise

by Sinclair Noe

DOW + 147 = 15,676
SPX + 20 = 1725
NAS + 37 = 3783
10 YR YLD - .16 = 2.68%
OIL + .43 = 108.50
GOLD + 55.30 = 1366.30
SILV + 1.23 = 23.06

Record highs for the Dow Industrials and the S&P 500, topping the highs of August 2. Surprise, surprise, surprise.

It was not guaranteed the Fed would start to taper, but it was widely expected. We've talked about the reasons why the Fed might taper; the timing of the remaining FOMC meetings this year, some improvement in the economy, fear of frothy markets. Fouhgetaboutit. After two days of meetings, the FOMC decided to continue with the current quantitative easing policy of purchasing $85 billion a month in mortgage backed securities and treasuries.

The punchbowl is full and the party is still rocking. In addition to record highs for the Dow and S&P 500, we saw 5-year Treasury's biggest yield drop since March 2009, the US dollar's third worst day in a year, home-builders had their biggest rally since last summer, and gold had its best day since January 2009.

At least Wall Street institutions and traders love the accommodative policy and the morphine drip of free money from the Fed. So the patient is still on morphine and the reason is because of extreme weakness. The economy just isn't strong enough to survive on its own.

The stock market no longer rallies to the tune of increased retail sales, growing export markets or improved employment expectations, better durable goods orders and such. Good economic news is bad news for the markets because the Wall Street crowd and any investors still playing equities understand full well that any sign of fiscal improvement might mean the end of the private Federal Reserve’s morphine drip. And without the Fed’s artificial stimulus, the financial markets curls up and dies, but of course they'll wipe out your 401k when they go. Wall Street can rally on news the Fed is continuing QE, but the broader economy was never invited to the party.

For the third time this year the central bank cut its forecast for US economic growth in 2013. The Fed now sees the economy growing in a range of 2.0% to 2.3%. Earlier forecasts had predicted growth of 2.3% to 2.6% and 2.3% to 2.8%. Being wrong is nothing new for the Fed. The bank has repeatedly offered forecasts over the past few years that turned out to be way too rosy.

Some other observations noted in the FOMC statement today: the unemployment rate remains elevated, mortgage rates have risen, fiscal policy is restraining economic growth, inflation is less than expected, and the economy just hasn't picked up steam.

What they didn't specifically talk about was the frothy markets. The Fed plan has been to prop up the banks and the financial markets, creating a wealth effect on Wall Street, and then let the wealth trickle down to Main Street. They've done a nice job of creating a wealth effect on Wall Street, but there hasn't been any trickle down; there won't be any trickle down, and once again the Fed is looking like they've painted themselves into a corner with no exit.

By postponing the decision to October or even December or whenever, the FOMC may be setting the market up for an even larger correction when it finally bites the bullet. Every time the Fed has phased out one of its stimulus programs over the last few years, stocks have dropped; first in early 2010, with the winding down of QE1; then in spring 2011, when QE2 ended, and finally in 2012 with the end of Operation Twist. In fact, stocks rallied again only when the Fed announced or started a new round of stimulus.

And there are other considerations: The German election will come this weekend; the Syrian situation looks to be moving toward a solution that doesn't include military intervention although it is still full of obstacles.

Then we face those fiscal policy concerns; what could be some bruising budget battles as hard-line House Republicans vow to either shut down the government or not extend the debt ceiling unless Obamacare is defunded. It won't be defunded, and even the Wall Street Journal is calling the shutdown idea kamikaze missions.

Democrats and Republicans are far apart on spending issues. More important, perhaps, Republicans continue to insist they won’t continue funding government operations—or, when the time comes, increase the Treasury Department’s borrowing authority—until Democrats agree to defund or delay Obamacare. That’s simply not going to happen. No, this isn’t the first fiscal policy standoff of the Obama presidency. In the past, Democrats and Republicans always reached some last-minute agreement. This time each side has a lot less incentive to compromise. And there are apparently no backroom negotiations; there are no calls to dine with the opposition; there is no discussion going on at all at this point.  

What makes this time is different is that, in addition to having carved out hardline positions, neither side has an incentive to back down. In 2011, Obama was willing to give on his demand that revenue increases accompany spending cuts because he understood the apocalyptic consequences of failing to raise the debt ceiling. In late 2012, Republicans knew that the alternative to a small tax increase was for taxes to rise automatically by a much larger amount. The sequester, although unsatisfactory to both sides, was a built-in default position; and indeed that's what happened. This time, on the other hand, every party to the negotiation has reason to welcome the government shutdown that would result if they can’t reach a deal.

Start with the White House, which has been annoyingly open to concessions even when it has all the leverage. Now they are finding no constituency for caving. Add in that the elections have passed and lame ducks find it easier to grow a spine when they don't have to beg for campaign contributions. You can’t rule out the possibility that the White House will blink when the deadline gets close. At the very least, one can imagine Obama signing a short-term government funding measure (known as a continuing resolution) that leaves the automatic sequester cuts in place so long as it doesn’t touch Obamacare. Even if he were inclined to do this, Congressional Democrats seem less willing to support him than in the past. They believe they can demand much more in exchange for saving the GOP from a shutdown.

For the Tea Partiers, a shutdown would mean they forced their leadership to stand up to Obama, which plays well in their districts and the various organs of the conservative movement. And when the GOP inevitably bowed to public opinion and sued for peace, the Tea Partiers would be able to accuse their weak-kneed leadership of caving, thereby enhancing their status within the party, and greatly enhancing contributions.

Then you've got the old line GOP as represented by Speaker Boehner and McConnell from the Senate; they can't control the Tea Partiers, and it appears they will accept a government shutdown because they can't stop it. A shutdown would slow the economy and wreak havoc on people who rely on government services, and wreak havoc on companies that service the government and the people who receive government services, and there will be a massive fallout.

These consequences are nothing alongside the fallout from defaulting on our debt, which will happen if we don’t raise the debt ceiling by mid-October.So a government shutdown gives everyone a chance to sober up before we take on the substantially higher-stakes proposition of avoiding a debt default.

(Link to FOMC statement)

Friday, August 02, 2013 - Jobs and Side Bets

Jobs and Side Bets

by Sinclair Noe

DOW + 30 = 15,684
SPX + 2 = 1709
NAS + 13 = 3689
10 YR YLD - .11 = 2.60%
OIL - .95 = 106.94
GOLD + 4.60 = 1314.50
SILV + .26 = 19.99

The stock market started lower, with tepid news on the jobs front, but managed to claw back into positive territory, confirming the perverse Wall Street logic that bad is good. The weakness in the jobs market was seen as proof positive the Fed will continue with QE to infinity and beyond, and talk of taper can be set aside for the next Fed Chairman, whoever he or she may be.

The economy added 162,000 jobs last month; that was less than the estimates of 185,000 and less than the recent averages of about 192,000. Also, May and June payroll gains were revised down by 26,000.

The unemployment rate dropped to 7.4% down from 7.6%. This is the lowest level for the unemployment rate since November 2008. Most of the decline in unemployment was due to more people getting jobs but part of it was due to a slight fall off in the labor force, a signal of not-too-strong labor demand, as 37,000 workers dropped out of the labor market. In July, the number of unemployed fell by 263,000 but the number of employed increased by only 227,000. 

The participation rate ticked down one-tenth, to 63.4%, lower than it was a year ago at 63.7 %. The participation rate is at its lowest levels in 35 years and well below the 66% to 67% rate that was normal over the past 20 years. The workforce can shrink when more workers retire or go to school, but it also contracts when people give up the job hunt. The lower participation rate is partly demographics, as the baby boom generation moves into retirement, whether they want it or not. So, if we look at the participation rate for working age population, generally ages 25 to 59, we see the participation rate unchanged at 75.9%. Also, it's estimated that many people slip into the underground economy, which is not as sinister as it sounds; it simply means many people are working in an unreported cash economy.

Most industries added jobs last month; manufacturing added 6,000 jobs in July, after declining slightly in the prior two months. Over the past year, factory employment is up only 18,000.  Construction was off 6,000 last month. Professional and technical services added 21,100 jobs, almost exactly in line with its 20,000 average over the last year. Wholesale trade added 13,700 jobs, somewhat above its 7,000 average for the last year.  Health care added just 2,500 jobs, the smallest gain in a decade. 

Retailers added 47,000 jobs and restaurants and bars added 38,000. So, the composition of jobs is not great; retail and restaurants are generally lower-paying sectors, and they accounted for more than half of all job growth last month. In a weak job market, workers will be more likely to take even lower paying jobs. A recent paper by Canadian researchers suggests that many of the people taking these jobs are relatively over-educated. The authors argue that, since 2000, globalization and technological advancement have reduced the demand for "high-skilled" workers. Desperate for employment, these workers ended up pushing the "lower-skilled" out of the job market entirely. This may help explain why the share of people aged 25 to 54 counted as being in the labor force has declined by 3.5% since 2000.

Government employment was flat overall last month, but state and local governments have slowly started adding jobs in recent months, up 42,000 since January; this might be misleading because many government jobs have experience fewer hours because of furloughs brought on by sequestration.

Weekly hours ticked down 0.1% in July, and weekly earnings are up in nominal terms by 1.9 percent over the past year, about the rate of inflation; this means that most wages are not growing in terms of buying power.

The number of part-time workers increased slightly in July to 8,245 million. Those workers are included in the alternate measure of labor under-utilization, known as U-6, which decreased from 14.3% in June to 14% in July. By that measure, roughly 22 million people are unemployed or underemployed. There are about 4.2 million workers who have been unemployed for more than 26 weeks and still want a job; this is down form 4.3 million in June and is at the lowest level since May 2009. Long-term unemployment is trending down but is still very high; this number should be closer to 2 million in a healthier economy.

The economy has been adding jobs for the past 41 consecutive months, adding 7.3 million jobs since February 2010; it's just not enough. Despite 41 months of private-sector job growth, there were still 2.0 million fewer jobs on nonfarm payrolls and 1.5 million fewer jobs on private payrolls in July than when the recession began in December 2007. The analogy is that we are stuck in second gear, which is better than reverse, or better than driving into a ditch, but at this rate we'll never get to the destination of a strong jobs market.

Let's compare, and I'll try to keep it non-partisan. If we combine the Bush and Obama administrations, we can go back over the past 151 monthly jobs reports and the economy has added 3.46 million jobs in that time; that works out to about 23,000 jobs per month on average. Just to keep up with population growth, we needed to create about 135,000 jobs per month, or a little over 20 million. By way of contrast, under 8 years of the Clinton administration, the economy added just over 23 million jobs in 96 months, for an average monthly gain of 241,000.

According to analysis from  the Federal Reserve Bank of Chicago, at the current pace it would take another five years to return to full employment. This estimate includes aggressive assumptions about aging, immigration and the birthrate that make the "employment gap" smaller than many others believe. The return to full employment could take even longer if those assumptions are wrong, or if growth slows down sometime over the next five years.

With this kind of jobs shortfall, we should be able to put the idea of the Fed taper to rest for a while, and indeed, after its FOMC policy meeting earlier this week, the Fed slightly downgraded its economic view and didn’t offer any signals as to when it would start tapering asset purchases, currently set at $85 billion a month.

Still, today we heard from St. Louis Fed President James Bullard saying he believed the Fed should be careful about basing its decisions on forecasts and that policymakers should wait to see more data before deciding to taper bond purchases.

Other data today showed a slight gathering of inflationary pressure, with the 12-month reading of the Commerce Department's gauge of core inflation rising to 1.2 percent in June from 1.1 percent a month earlier. So, inflation is still nowhere near the Fed's target.

Earlier in the week, the GDP report showed Gross domestic product, a measure of the nation's economic output, grew at a mere 1.4 percent annual rate in the first half of the year, down from 2.5 percent in the same period of 2012. Most economists expect GDP will accelerate in the second half of this year, which would make it more plausible for the current hiring trend to continue, but the fact that the jobless rate has fallen steadily despite weak output might point to a frightening possibility: perhaps the economy's growth potential has fallen. Maybe this is the new normal, a structural shift to slower growth, where less output is needed to create jobs, but also slower income growth over time.

Absent significantly stronger economic data in the next few weeks, we can forget the misconceptions that the Fed will look to taper in September.

Meanwhile, fiscal policymakers should be screaming for jobs, but they aren't and it looks like the best we can hope for on the fiscal side is that they don't drive the car into the ditch. Don't forget, there will be a battle over the debt ceiling, expected to hit by around November. So, on the monetary policy side, the Fed has little economic data to support a taper, and on the fiscal side, there seems little that would encourage taper.

The new, fun parlor game for the summer is to pick the next head of the Fed; pick a candidate and place your bets. Topping the list of contenders to replace Bernanke we have Larry Summers and Janet Yellen, but there are some other names to consider as well, the dark horse candidates. Larry Summers is the front runner; he is President Obama's former chief economic advisor, but he also goes back to the days of Clinton, and Summers actually was a proponent of deregulation and Gramm-Leach-Bliley, which ended up gutting Glass-Steagall; so there is some baggage. Janet Yellen is the current vice chair at the Fed; considered very intelligent and steeped in both the practice and theory of central banking, but some think she might be soft on inflation fighting.

There are indications that Mr. Summers and Ms. Yellen disagree on a pressing issue before the Fed:  how much longer and how much harder to push for economic growth.” They share a conviction that the Fed can and should seek to stimulate the economy during periods of slack demand. Summers appears to have less confidence in the tools available to the Fed at the moment, and greater concern about the potential consequences. Yellen defends the Fed's policies as safe and effective.

The dark horse candidates to replace Bernanke include Donald Kohn, a former Fed vice chair. Then, don't forget that former Treasury Secretary Tim Geithner is helping in the selection process, so there's a slim chance he might toss his hat in the ring. Longer shots include Robert Reich or Joseph Stiglitz; interesting, but yea, that's not going to happen.

Fabulous Fab, or more precisely Fabrice Tourre, the junior level Goldman Sachs trader was convicted yesterday of misleading investors on a derivative called Abacus, which was set up to gamble on the mortgages behind the housing market run-up, but turned out to be rigged full of sub-prime. Confused?

The important thing to understand is that the securitization at issue in no way helped to create capital for anything. It was a pure gamble. One side bet that the mortgage market would collapse. The other bet it would not. 

Consider the mortgage securitization market. First, there are mortgages, which help people buy homes. Those mortgages are packaged in a securitization and sold to investors. Some investors buy tranches that give them low yields with little chance of loss. Others get tranches with higher yields, but will lose their principal if enough borrowers default. The money put up by the investors helped to finance home buyers, which is the kind of thing a financial system should do. (It did it badly, but that is not the issue here.)

The next level of security packaged a bunch of tranches from different deals and sold securities based on those assets. By raising money to finance tranches in the first level of securitizations, it indirectly helped to finance home buyers.

Note that nobody needed to bet against either of those securitizations. The money put up by the buyers was going to homeowners, or at least to those who had previously lent to those buyers.

But the securitization that Mr. Tourre helped to create was “synthetic.” It did not raise money that went, directly or indirectly, to homeowners or to those who had lent money to them. Instead, it picked a bunch of tranches from previous securitizations — tranches that no one involved in this deal had to own — and fashioned a new securitization in which one set of investors bet those securities would work out and another set bet they would not.

Goldman Sachs was the bookie.

And this is why we need Glass-Steagall. There is no reason for the banks to be bookies. Restore the separation between commercial and investment banking, let the investment banks play bookie with partners' capital, and put the commercial banks back into the lending business. After the dust settles, put the banks not only in the lending business but make mortgages "make and hold" loans that stay in the banks' loan portfolios rather than being securitized and sold off to investors.

It is then that we will see what all of the property in the country is worth. Long after we get the government out of the mortgage market and investment bankers out of the government-guaranteed market where they issue securities on the securitized property.

If you want to gamble, you're welcome to do so, but banks that have access to insured deposits and get bailed out if they get into trouble, should not be using those insured deposits to put together a betting book and taking the bookie's cut.

And so that's the main reason why I oppose Larry Summers as the next chairman of the Federal Reserve, but I wouldn't bet on it.

Tuesday, July 16, 2013 - No Inflation Except if You Drive

No Inflation Except if You Drive

by Sinclair Noe

DOW - 32 = 15,451
SPX - 6 = 1676
NAS – 8 = 3598
10 YR YLD - .02 = 2.53%
OIL - .55 = 105.77
GOLD + 8.30 = 1292.50
SILV + .08 = 21.11

Start with the big economic report of the day; the Consumer Price Index, or CPI, which measures inflation at the retail level, increased 0.5% in June. A 6.3 percent surge in gasoline prices accounted for about two thirds of the increase. In the 12 months through June, the CPI advanced 1.8 percent. Stripping out energy and food, consumer prices increased 0.2 percent for a second straight month. That took the increase over the past 12 months to 1.6 percent, the smallest rise since June 2011. No real inflation except for energy prices.

A separate report from the Fed showed output at the nation's factories, mines and utilities rose 0.3 percent in June after a flat reading in May.

Another report showed confidence among single-family home builders at a 7-1/2 year high in July, with expectations of stronger sales and buyer traffic.

In earnings news, Coca Cola reported earnings of $2.6 billion, down from $2.7 billion a year ago. They tried to blame the shortfall on bad weather but I think people are cutting back on drinking soda.

Goldman Sachs posted second quarter net income of $1.9 billion compared with $962 million, in the period a year earlier. So, profits are up 100 percent. How is that possible, especially considering the new capital requirements and all those terrible regulations being forced on the big banks? And it's not just Goldman. Just the other day, JPMorgan reported a 33% increase in profits and Wells Fargo reported a 19% jump, and Citigroup's profits are up 42%. Banks are smashing their old profit records in a sluggish economy, with moderate M&A activity, and all sorts of regulations that were supposed to keep the banks from becoming unmanageable behemoths.

Actually, most of the regulations aren't really in place, only about 40% of the rules are affecting the banks, and they are still fighting the rest of the regulations; so maybe they don't really want to talk too loudly about record profits in a harsher regulatory environment. It's like the kid who's forced to take medicine, and his health improves, but he still cries about having to take the medicine.

Tomorrow morning, Fed Chairman Bernanke will appear before the House Financial Services Committee as part of his 2 day testimony before Congress on the economy and monetary policy. He'll deliver prepared remarks and then there will be a question and answer session, which generally provides the Congressmen a chance to demonstrate their economic incompetence and for Bernanke to speak without saying anything. Sometimes Bernanke slips and there is a nugget of information. He might just give a hint about when the Fed will exit QE, or what might serve as a trigger for taper; but mainly he'll repeat the mantra that monetary policy will remain accommodative from here to eternity. Expect a boring recitation of what Bernanke has been trying to repeat and repeat again and again; that essentially QE continues. Of course, you never know. Bernanke is going to leave his role at the Fed, so maybe he could just break out and speak truth.

That might be fun. Can you imagine if Bernanke, or even Greenspan before him, had decided to cut through the Fedspeak and tell the blunt, plain truth to the politicians? Maybe Bernanke could talk about how the Fed really made the crisis of 2008 much worse than it should have been; maybe he could talk about how the Fed has failed in its role as a regulator of the big banks, and now they represent an even bigger risk than in 2008; maybe he could tell the politicians how the sequester and austerity moves are hurting the economy, and the fiscal policy is akin to bleeding a patient to restore health.

Maybe Bernanke could tell Washington that the last four years have offered the federal government a borrowing and investment opportunity that's unprecedented in modern history; and that window of opportunity won't last forever. Interest rates have been at World War II-era levels, thanks to ZIRP, while investor confidence in Uncle Sam (and fears about other investments) created a situation where they were effectively paying the government to borrow money.

We could borrow the money, invest it in job creation, and be rewarded with an expanding economy that pays us back for our investment in both human and financial terms. And it's not like we'd be creating make-work. America's falling down. Our highways and bridges are crumbling; our electric grid is vulnerable; our water systems are antiquated; our public transportation is a joke, only surpassed by the cellular network; and that's just for starters. Maybe Bernanke could tell the politicians that we are on the verge of missing a once in a lifetime opportunity to really make a difference.

Yea, that's not going to happen.

But then who would have thought the politicians would agree on anything; turns out they can, and did. The Senate has voted to confirm Richard Cordray as director of the Consumer Financial Protection Bureau, as senators approved the first of a batch of President Barack Obama's nominations freed for votes by a bipartisan agreement.

The vote came hours after Senate leaders worked out a deal freeing up seven stalled appointments for the consumer bureau and other agencies for simple majority votes by the chamber. In exchange, Democrats agreed to abandon for now an effort to change Senate rules to weaken the minority party's ability to block nominations with filibusters, and Obama agreed to submit two different nominees for two labor posts.

Obama had used a recess appointment to put Cordray in charge of the agency, an appointment that expires in January. Republicans had solidly opposed Cordray's nomination, demanding that Obama first agree to change the agency's financing and structure.

So, this proves that politicians can come together, and all it took was the threat of the “nuclear option” on filibusters. Simple.

You Will Be Paying Higher Gasoline Prices. It Is Essential You Begin to Understand Why!

In the face of escalating gas prices, the oil patch, their allies and Wall Street are counting on your ignorance permitting them to pick your pockets, spoon-feeding you nonsense while they cash in massively. Oil prices recently touched $107, a level during the current run-up not reached since May of last year. This while inventories in the U.S. are near all-time record levels, U.S. production is accelerating, the world is awash in oil, and natural gas in the U.S. is selling at an equivalent BTU content to that of oil costing $24 a barrel or less.

It just doesn't make sense, and it is not explained away by the usual industry placebos: "The driving season is upon us", "production difficulties in Libya, Nigeria or you name it," "Iran is becoming recalcitrant," "Egypt is falling apart," "the dollar is weakening," "Chinese consumption is impacting markets," and so forth. Lots of hot air without real substance nor actual impact on the price of oil at Cushing, Texas, the delivery point for WTI crude. Misinformation propagated often enough both by the industry and a somnolent press to make an otherwise bilked public (paying extortionate levels for gas and petroleum products) blindly accept the oil industry's palaver. This combined with massive industry lobbying resulting in a total lack of effectual oversight of oil industry pricing and Commodity Exchange excess and the gross distortions resulting from the financialization of energy markets.

My saying so doesn't necessarily make it so. But consider the following- only yesterday Mr. Joe Petrowski, the CEO of Gulf Oil, posited on CNBC that the price of oil should be half of yesterday's $105/bbl exchange-quoted price or closer to $50 a barrel. He cited that record amounts of oil are being produced in the United States and Canada, and that OPEC supplies are higher.

Add to this the comments of Rex Tillerson, Chairman and CEO of ExxonMobil. In case you missed it, only last week, Exxon's 2012 earnings were cited as the second most profitable corporate earnings in the world, ever.

Yet some two years ago, before a Senate Committee, the same Rex Tillerson testified that the price of crude oil was $30 to $40 higher (at that time quoted at $100/bbl on the exchanges) than it should have been were it not for the "financialization" of energy futures and options on the Commodity Exchanges. With this coming from a man of Tillerson's stature and expertise on the issue, one would have expected that someone in government would have acted to protect the public's interest, but clearly the 'oiligopoly' and the commodity exchanges have a higher priority in Washington and the Beltway.

As an example of the excesses of the financialization of oil and energy derivatives trading and how they have lost all bearing to 'supply and demand' of physical product, let me cite but one example. On Feb 8, 2012 the Chicago Mercantile Exchange Group (CME), the world's leading derivatives marketplace, announced it set a new record for trading volumes of its energy products on February 7, 2012. Their trading volume for energy futures and options contracts totaled 3,489,302 contracts higher than the previous record of 3,098,129 contracts on 02.22.10 The CME group controls more than 90 percent of listed U.S Futures Trading including the New York Mercantile Exchange (NYMERC) and according to theWall Street Journal has outspent rivals on lobbying in Washington to ensure its views are heard.

Consider trading 3,489,302 energy or crude oil equivalent contracts in one day represents 3.48 billion barrels of oil (each oil futures or option contract is for 1,000 barrels). With world consumption some 85 million barrels a day, this would mean that in one day's trading on the New York Merc, the equivalent of 41 days of the total WORLD'S consumption will have been traded. And then we are told, of course, that it's all about supply and demand.

Remember, your silence is letting the oil boys and the oil desks of the bank-holding companies and the myriad speculators take you to the cleaners.