Wednesday, June 11, 2014 - Nowhere to Hide

Nowhere to Hide

by Sinclair Noe

DOW – 102 = 16,843
SPX – 6 = 1943
NAS – 6 = 4331
10 YR YLD + .01 = 2.64%
OIL + .14 = 104.49
GOLD + .70 = 1261.60
SILV un = 19.30

The US posted a $130 billion budget deficit in May and the smallest shortfall for the first eight months of a fiscal year since 2008. The deficit last month was about $9 billion less than May of last year. For the fiscal year, which began Oct. 1, the government is running a budget deficit 30% smaller than it was a year earlier; or about $436 billion compared with $626 billion. Revenues for that period are 7% higher than a year earlier and outlays are 2% lower.

The Congressional Budget Office in April projected that the federal deficit will decline to $492 billion this fiscal year, the smallest in six years; down from $680 billion in 2013 and down from a record $1.4 trillion in January 2009. The CBO estimates that next year, the shortfall will decline further, to $469 billion. The 2014 deficit will be 2.8% of gross domestic product, compared with 4.1% of GDP in 2013.

The World Bank has cut its global growth forecast, predicting the world economy will grow 2.8% this year, below its previous forecast of 3.2% made in January. In its twice-yearly Global Economic Prospects report, the World Bank said tensions between Ukraine and Russia hit confidence worldwide.

The bank also cut its growth forecast for the United States to 2.1% from 2.8%, citing the bad weather at the start of the year that resulted in economic contraction in the first quarter. The good news is that the lower forecast is largely a result of things that have already happened, and the US economy appears to be rebounding.

The World Bank expects growth to quicken later this year as richer economies continue their recovery. It kept its global growth forecasts for the next two years unchanged at 3.4% and 3.5%, respectively. Provided the problems in Ukraine don’t get worse, or something else nasty doesn’t pop up.

In Ukraine, government forces and rebels claiming allegiance to Russia continue to clash in the east of the country. In Brussels today, the European Union served as broker for talks between Ukraine and Russia over future natural gas deliveries. Russia offered to supply gas for about 20% below the current price if Ukraine would settle its outstanding debts; Ukraine rejected that deal.

Maybe the World Bank is looking for trouble in the wrong place. Sunni rebels from an al Qaeda splinter group overran the Iraqi city of Tikrit; you remember Tikrit is Saddam’s hometown. The other day, the rebels captured Mosul, the second largest city in Iraq; now they’re closing in on the biggest oil refinery in the country.

The point is, we don’t know where the next black swan event will occur.

Maybe an app will backfire. Yesterday we told you about Uber, the ride-sharing app; now valued at $18 billion. Today, Uber brought the city of London to its knees. Actually, taxi drivers protesting Uber got fed up and parked their taxis on the streets, and London town suffered a massive case of gridlock. In Paris, taxis slowed traffic on major arteries into the city during the morning commute. Hundreds choked the main road to Berlin's historic center while commuters packed buses and trains, or just walked, to get to work in Madrid and Barcelona. Taxi drivers across Europe say Uber breaks local taxi rules, violates licensing and safety regulations and its drivers fail to comply with local insurance rules.

Mohamed El-Erian is the chief economic adviser at Allianz and the former co-chief investment officer of Pimco, and he says “investors might be surprised to learn that they have a lot riding on something that they pay very little attention to: macro-prudential regulation, or what central banks and other government agencies do to reduce the risk of systemic financial disasters.

“The aim of such regulation is to lower both the probability and potential costs of financial accidents. It does so by enhancing the resilience of the system, establishing circuit breakers to prevent problems in one area from contaminating others and, at the extreme, containing the detrimental impact on the broader economy when failures occur.

“Authorities around the world have imposed higher and more intelligent capital requirements, required financial institutions to value their assets more conservatively and to hold more easy-to-sell assets, placed constraints on allowable risk-taking, insisted on more stable funding, and demanded greater provisions against bad loans.

“The impact of the revamped regulation has gone far beyond the targeted banks and other financial companies. It has allowed central banks to be bolder in maintaining and evolving exceptional monetary and credit stimulus, which in turn has significantly bolstered the prices of stocks, bonds and other assets as a means of stimulating the economy.”

In other words, the Fed has pumped up financial assets in the hope it will trickle down to the rest of the economy and jumpstart consumer spending and jobs and wages and such. But what if the economic recovery doesn’t follow on the heels of the pumped up financial assets? This is the lasting question for investors. What to do when the prices of assets rise above what history and fundamentals warrant?

If you think that prices are too low, you can buy. But if you think prices are too high, what should you do?  One option is to sell short; borrow the security whose price you believe to be inflated, sell it and wait for the price to fall, then buy it back at a lower price and pocket the difference. That is a very dangerous move when the markets are trading at record highs. You might pick the exact top or prices may move higher for a while, and the markets can remain irrational longer than you can remain solvent.

Policymakers face a similar asymmetry.  It’s true that for a central bank, liquidity isn’t tied to solvency, so experiencing temporary losses is more a political than an economic or operational concern, but losses still matter. Central bankers can play with the value of a currency, making moves to keep a currency from falling or appreciating; happens all the time.

Sometimes policymakers are trapped in the box that they built. It is precisely investors’ belief in the commitment of policymakers that makes them willing to view some very risky investments so casually. However, when many such investments are made over an extended period without adequate compensation for risk, sharp investors expect a round of bubble trouble on the horizon.

One of the funny things that tends to happen in times like this is that investors rush into areas they think should be safe, looking for a place to hide. Largely ignored during much of last year's 30% rally in the S&P 500 Index, the stocks leading the US market this year rank among its usually sleepiest components.

The best sector in 2014 is utilities, including Consolidated Edison, about as staid a group as one can get. They're up 14.5% on a total return basis this year, compared with 6.4% for the S&P 500 as a whole.

What's happening is the opposite of what ordinarily happens in a moving market. It relates to an investing concept known as "beta," which refers to the amount of risk a particular stock adds to a portfolio. Stocks that tend to rise or fall with the market – but in a more pronounced way – are called "high beta." They generally outperform in up markets and fall the most in down markets.

Best Buy and Priceline, two discretionary stocks that were among the S&P's strongest in 2013, are good examples because their sales and profits rise along with the economy, and they led the way last year. This year, those stocks are lagging the more boring "low beta" stocks – those that tend to move less dramatically than the market. It's a signal that investors are worried about earnings growth and U.S. economic demand, and don't want to bet as heavily on the types of stocks that generally qualify as high beta – often cyclical names in the technology, discretionary and energy sectors.

To be sure, this may change if growth picks up, but after US GDP contracted in the first quarter for the first time in three years, investors are cautious. People are still scared. They're still more worried about protecting to the downside than accentuating the upside. That's helped drive equities' rotation into the more defensive, high-dividend paying names, also typically part of the low-beta camp.

So far this year, the 50 stocks in the S&P 500 with the lowest beta scores, a group that includes ConEd and McDonald's, are up on average by 12%. Meanwhile, the 50 highest beta stocks, which include Citigroup and Best Buy, are up an average of 7%. In 2013, the 50 highest-beta S&P 500 stocks rose an average of 51.4%, compared with 21.3% for the 50 lowest-beta stocks.

Investors who have pursued the high-beta contingent have suffered. Among them are hedge funds, which kept a heavy exposure to momentum-type names and the "beta" strategy. Hedge funds now have 3.8 times more net cyclical exposure to defensive stocks. In January, that measure was 4.7 times - bets that went sour as the market corrected through the first quarter. Once that trade began to break, that also accelerated a rotation back into more value-oriented names and sectors. So, what happens when these defensive plays get overvalued? I’m not saying it has happened; today was just one day after a string of record highs. I’m just posing the question.

Monday, March 24, 2014 - Dance With the Devil

Dance With the Devil

by Sinclair Noe

DOW – 26 = 16,276
SPX – 9 = 1857
NAS – 50 = 4226
10 YR YLD - .02 = 2.73%
OIL - .15 = 99.45
GOLD – 25.10 = 1310.60
SILV - .34 = 20.03

Manufacturing activity slowed in March after nearing a four-year high last month, but the rate of growth and the pace of hiring remained strong. The flash Markit US Manufacturing Purchasing Managers Index dropped to 55.5 from 57.1 in February.

China's manufacturing engine contracted in the first quarter of 2014, according to the flash Markit/HSBC Purchasing Managers' Index.

This week’s economic calendar includes the Case Shiller home index, FHFA home prices, and new home sales reports tomorrow; plus the March consumer confidence index; Wednesday includes the February durable goods orders; Thursday brings another revision to fourth quarter GDP, and Friday’s reports include the consumer sentiment report, consumer spending, and an update on personal spending.

Ukrainian troops and their families are evacuating from Crimea, as Kiev effectively acknowledged defeat by Russian forces who stormed one of the last of their remaining bases on the peninsula. President Obama is in Europe to kick off a week-long visit that includes a G-7 meeting. He called for European allies to adopt tougher sanctions against Russia, saying Moscow’s actions must have costs.

Mohamed El-Erian, the former co-chief at Pimco says markets have “brushed aside” concerns about Iran, Iraq, North Korea and Syria, to say nothing of rising tensions in Turkey and Venezuela. With Ukraine, the market had a single day of fear over Russia’s annexation of Crimea. He lists four key reasons for market inaction: the countries involved are less systemically important; there’s little will from outside powers to get embroiled with these situations; the story of a recovering economy in developed markets has been a distraction; and extraordinary central bank support for markets has provided a layer of insulation. El- Erian went on to say things could get much worse. Consider how ugly it would be if there was an outright war between Russia and Ukraine. Or if Russia somehow decided to tap dance around US sanctions on Iran.

The point is that things can get dicey, quick. And suddenly 2014 starts to look a bit like 2008. The long lists of visible stresses in the global financial system and the almost laughably hollow assurances that there are no bubbles, everything is under control; the Fed can exit QE with no repercussions. Yea, sure. Remember when the subprime mortgage meltdown was already visible and officialdom from Federal Reserve chairman Alan Greenspan on down were mounting the bully pulpit at every opportunity to declare that there was no bubble. First, he claimed no one foresaw the crisis, and second, he attributed this failure to a lack of insight into “animal spirits,” the emotional drivers of behavior. There are plenty of indicators we could look at, and then it’s just one little spark that gets the herd running toward the cliff.

So far, sanctions against Russia look very weak, but there has been some effect: the Russian stock market is down, the currency has weakened, and sovereign bond yields are up. Russia’s central bank unexpectedly raised its benchmark interest rate by 150 basis points after the armed takeover of Crimea triggered a rout in the ruble. Even before the standoff with the West, the worst since the Cold War, Russia’s economy was facing the weakest growth since a 2009 recession as consumer demand failed to make up for sagging investment. Russia will probably dip into a recession in the second and third quarters of this year as domestic demand is set to halt on the uncertainty shock and tighter financial conditions.

The US doesn’t have a great amount of trade with Russia, so it is credible to talk about the threat of additional sanctions. The biggest damage to Russia would come from lower oil prices, and lower oil prices might be possible if Russia does anything that might hurt developed markets such as the Euro-Union. If the purpose of sanctions was to get Russia out of the Crimea, that ship has already sailed; if the purpose of sanctions is to restrain Russian proclivity for intervention, there is still a chance.

Of course the Euro-zone economies are far from solid, but the European Commission has a plan; they are apparently willing to dance with the devil. In the immediate aftermath of the financial crisis regulators called for a tough crackdown on the $71 trillion global shadow banking sector that also includes debt market repurchase agreements, securities lending, money market investment funds and some hedge funds.

With the worst of the crisis now over, Euro-commission regulators attention has turned to growth and with it the regulatory mood music has also changed; this Thursday they will publish proposals on how to fund long-term investments to boost Europe’s economies; the plan includes a fundamental shift in how the continent raises money for investment in infrastructure like roads and technology (and maybe even energy) while at the same time moving away from over-reliance on banks for fueling economic growth.

A core element involves reviving securitization, or the bundling of loans into interest bearing bonds; you may recall this market took a hit 7 years ago in the financial crisis. Now, the market for asset backed securities is only about half its pre-crisis size, or about 700 billion euros. The EC estimates that a trillion euros is needed in long term finance for transport, energy and telecoms up to 2020 to boost competitiveness and jobs and hopes that by encouraging market-based financing it can reduce the continent's reliance on banks for raising up to 70 percent of funds for the economy.

The developments in Europe come ahead of leaders of the Group of 20 economies (G20) meeting in November to endorse new rules for shadow banking. A harsh, uniform approach across all sectors has now been ruled out; the new plan is to embrace shadow banking and regulate it a little closer. If it sounds risky, well it probably is, but the Euro-zone now recognizes they need the cash and this is one way to get it, and so they are willing to dance, and put up with the heat.

Meanwhile, the United Nation’s World Meteorological Organization is meeting in Japan, and they reckon 2013 was the 6^th warmest year on record. Thirteen of the 14 warmest years have occurred in the 21st century. The UN weather agency says much of the extreme weather that wreaked havoc in Asia, Europe and the Pacific region last year can be blamed on human-induced climate change. A rise in sea levels is leading to increasing damage from storm surges and coastal flooding, as demonstrated by Typhoon Haiyan, and Australia experienced its hottest year on record, with some temps topping 129 degrees.

The costly weather disasters included $22 billion damage from central European flooding in June, $10 billion in damage from Typhoon Fitow in China and Japan, and a $10 billion drought in much of China.

Only a few places, including the central US, were cooler than normal last year, but 2013 had no El Nino, the warming of the central Pacific that happens once every few years and changes rain and temperature patterns around the world.

If climate change continues, here’s what the panel’s report predicts in terms of consequences.

For the first time, the panel is emphasizing the nuanced link between conflict and warming temperatures. Participating scientists say warming won’t cause wars, but it will add a destabilizing factor that will make existing threats worse. Global food prices will rise between 3 and 84 percent by 2050 because of warmer temperatures and changes in rain patterns. Hotspots of hunger may emerge in cities. About one-third of the world’s population will see groundwater supplies drop by more than 10 percent by 2080, when compared with 1980 levels. For every degree of warming, more of the world will have significantly less water available.

Major increases in health problems are likely, with more illnesses and injury from heat waves and fires and more food and water-borne diseases. But the report also notes that warming’s effects on health is relatively small compared with other problems, like poverty. Many of the poor will get poorer. Economic growth and poverty reduction will slow down. If temperatures rise high enough, the world’s overall income may start to go down, by as much as 2%, but that’s difficult to forecast.

Past panel reports have been ignored because global warming's effects seemed too distant in time and location. This report finds "It's not far-off in the future and it's not exotic creatures: it's us and now. According to the report, risks from warming-related extreme weather, now at a moderate level, are likely to get worse with just a bit more warming. While it doesn't say climate change caused the events, the report cites droughts in northern Mexico and the south-central United States, and hurricanes such as 2012's Sandy, as illustrations of how vulnerable people are to weather extremes. It does say the deadly European heat wave in 2003 was made more likely because of global warming.

Earlier this month, the world's largest scientific organization, the American Association for the Advancement of Science, published a new fact sheet on global warming. It said: "Climate change is already happening. More heat waves, greater sea level rise and other changes with consequences for human health, natural ecosystems and agriculture are already occurring in the United States and worldwide. These problems are very likely to become worse over the next 10 to 20 years and beyond."

Scientists in the past may have created the impression that the main reason to care about climate change was its impact on the environment. The reality is that it's going to affect nearly every aspect of human life on this planet.

Wednesday, January 22, 2014 - A Mixed Bag

A Mixed Bag

by Sinclair Noe

DOW – 41 = 16,373
SPX + 1 = 1844
NAS + 17 = 4243
10 YR YLD + .04 = 2.86%
OIL + 1.69 = 96.66
GOLD – 3.80 = 1237.80
SILV - .07 = 19.90

Another mixed day on Wall Street. It’s earnings season. IBM reported quarterly revenue that missed estimates for the fourth straight quarter, due to a steep fall in demand for servers and storage products in emerging markets such as China. IBM thinks part of the reason for declining revenue was backlash from emerging economies against US government spying. IBM was down enough to drag the Dow Industrials into negative territory for the day.

Coach, the handbag maker, was the biggest loser in the S&P 500 after posting disappointing sales in North America. United Technologies, the air conditioner and elevator company, reported higher fourth-quarter profit that topped Wall Street estimates, though revenue fell shy of expectations. Norfolk Southern posted a 24 percent rise in quarterly income.

After the close, Netflix reported higher profit for the fourth quarter as the company added 2.3 million customers to its TV and movie streaming service in the United States.

A mixed bag of earnings today. Not much to cause the bulls or the bears to run.

Target Corp said it will stop offering health coverage to part-time workers, citing new public insurance exchanges floated by the US government. Less than 10 percent of the company's 361,000 employees currently participate in the insurance plan that is being discontinued. Target is not the first or the last company to take this position.

The winter storm blanketing most of the Midwest and East Coast pushed natural gas prices to their highest level in nine months on Wednesday. February natural gas jumped 26 cents, or 6 percent, to $4.689 per thousand cubic feet. The last time natural gas prices were this high was late April 2013. Americans who use propane to heat their homes are scrambling to deal with sharply higher prices and a limited access to the fuel. Domestic production has increased to an estimated 17.8 billion gallons in 2013, from 15.2 billion gallons in 2008, but offsetting the increased production is a robust export market. The country exported an estimated 4.3 billon gallons of propane last year, compared to 800 million gallons in 2008. The tighter supply has led to wholesale price increases, to $2.20 a gallon from $1.10 a gallon a year ago. Prices for retail customers have risen to nearly $3 a gallon from $1.90 a year ago.

According to data released by the IRS, conversion from tax-deferred individual retirement accounts to Roth IRAs increased ninefold in 2010, to $64.8 billion. That was the first year when a $100,000 income limit on eligibility to convert was eliminated - and it marked the first time the amount of assets converted to Roths exceeded contributions. The higher your income, the more likely you are to convert to a Roth. Paying taxes now rather than later isn't beneficial if you expect to be in a lower tax bracket when you begin drawing down funds in retirement.

Mohamed El-Erian is stepping down as head of the asset-management firm Pimco. Bill Gross, who founded Pimco and serves as its co-chief investment officer with El-Erian, said he was in disbelief when the chief executive told him of his intentions several weeks ago. El Erian will stay on as an adviser to Pimco’s parent company, Allianz. The past year was difficult for bond fund managers and Pimco, the largest of the bond funds, saw huge outflows.

Warren Buffett is offering a $1 billion prize to anybody who can fill out a perfect March Madness bracket. The prize would be paid out in 40 annual installments of $25 million, or a one-time lump sum of just $500 million. The first 10 million people to enter the contest will be eligible for the ludicrous grand prize. If there’s a tie, they’ll split. The odds of a perfect basketball bracket are staggering; 9.2 quintillion to one. Apparently there has never been a documented perfect bracket. Madness just got crazier.

The Center for Economic Policy and Research has run some numbers on how much the housing bubble and the collapse cost. Based on Congressional Budget Office data looking at GDP growth going back to 2008, the dollar losses through 2013 are at $7.6 trillion, in 2013 dollars; or about $25,000 for every person in the country. This is just economic losses, it does not include any effort to quantify the pain that workers or their families have suffered from being unemployed or losing their homes. The numbers are speculative but likely a good guess.

Years of banking crises, credit droughts and economic uncertainty have prevented businesses investing for the future. Instead, they have clipped costs, wages and jobs and built up huge stockpiles of cash rather than investing in new plants, staff, updated technology, equipment or acquisitions. According to Thomson Reuters data, companies around the world held almost $7 trillion of cash and equivalents on their balance sheets at the end of 2013 - more than twice the level of 10 years ago. Capital expenditure relative to sales is at a 22-year low and some strategists reckon the typical age of fixed assets and equipment has been stretched to as much as 14 years from pre-crisis norms of about 9 years. At some point, the thinking goes, all that corporate cash will come flooding into the economy. Maybe.

Merrill Lynch surveyed fund managers, and a record number think companies are under-investing and most respondents want firms to deploy their cash on capital expenditures. Sounds good, but there is no obvious catalyst for such a move.

Treasury Secretary Jack Lew sent a letter to House Speaker John Boehner warning that the country would likely exhaust the extraordinary measures used to stay beneath the debt limit by late February. In a previous letter to Boehner, Lew had projected the deadline might not be hit until early March. In the deal reached in mid-October to end the government shutdown, lawmakers extended the nation's debt limit into the first week of February. It was always understood that Treasury could take extraordinary measures to extend the deadline even further. But in his note to Boehner, Lew made clear that those tools weren't as potent as they have been in previous debt limit crises, partly because of limits on borrowing capacity and partly because of financial constraints that are unique to the month of February.

But now Secretary Lew writes: "The length of time that the extraordinary measures can extend the nation's borrowing authority is significantly shorter than it was in 2011 and 2013. This is in large part because the government experiences large net cash outflows in the month of February, due to tax refunds. For example, in 2013, the government experienced net cash outflows of approximately $230 billion in the month of February, as compared to average net outflows of $45 billion in the other months of the year.”

House GOP leaders have stated that they won't simply vote to extend the debt limit without receiving something in return. The White House, meanwhile, has steadfastly refused to negotiate over raising the debt limit. So it appears we are headed for another showdown, and it is approaching much faster than you thought.

This is Day Two of the World Economic Forum in Davos, Switzerland. Over 2,500 Presidents, Prime Minsters, CEOs, Celebrities, Academics, and moneyed elites, will be holed up in a small and posh mountain resort in Switzerland to discuss, in the words of the WEF, "improving the state of the world by engaging business, political, academic and other leaders of society to shape global, regional and industry agendas."

This year's theme is "The Reshaping of the World: Consequences for Society, Politics and Business." A few words from the preamble are worth noting: "political, economic, social and, above all, technological forces... are shifting power from traditional hierarchies to networked hierarchies." That means the false idea of reducing democracy to the singular act of voting every few years is over. People are begging to assert participatory democracy and exercise people power, using many new technologies and methods of interconnection, as levels of confidence in political leadership are dangerously declining around the world.  The WEF warns its members that we are witnessing a shift of power. But those attending the WEF are largely focused on the symptoms of various crises not the causes or the cures.

The WEF's 2014 Global Report helps set the agenda and prioritization for the great and the good to discuss. Financial risk, unsurprisingly, still ranks at number one, followed by high unemployment or underemployment. Water crises come in third place with climate at fifth, behind severe income disparity. There is therefore a growing recognition that economy, ecology and equity are all in crisis; that they are all fundamentally interconnected. None can be solved without solving the others. For example, the water scarcity crisis is driven, in part, by the expansion in coal. Go to West Virginia if you need proof.

The big question for 2014 will be how the plutocrats respond. Some are still in denial. Today's economy is going so well for those at the very top that it can be hard to see how badly it is working for those in the middle and at the bottom.

Tuesday, March 12, 2013 - Smoke Signals

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.

Smoke Signals

by Sinclair Noe

DOW + 2 = 14,450
SPX – 3 = 1552
NAS – 10 = 3242
10 YR YLD -.03 = 2.02
OIL – 1.84 = 90.22
GOLD + 10.90 = 1593.70
SILV + .16 = 29.25

Today we will communicate with smoke signals, the same as the Vatican, which started its conclave to elect a new Pope with black smoke. Wall Street was blowing black smoke out of its chimneys for most of the day, and then near the end of trading, a little wisp of white smoke pushed the Dow iIndustrial Average into positive territory, and another record high close.

President Obama travels to Capitol Hill to try to sell his grand bargain on the deficit. GOP blows black smoke from its chimney. Anyway, it appears that no one wants to listen to the president, meaning a grand bargain may be no easier to strike now than it was in 2011 or 2012 or any other time Obama has failed to do it. Paul Ryan responds by trotting out the Ryan Plan, which we've seen before; but this one was updated and slightly more regressive. Ryan's budget is presented as nothing but a sober-minded effort to make "tough choices" and solve practical problems. It turns Medicare into a voucher plan, slashes spending on Medicaid and food stamps, repeals Obamacare, and cuts taxes for the wealthy.  In response, the White House blows black smoke from its chimney.

The National Federation of Independent Business says its small business optimism index improved slightly in February; up 1.9 points to 90.8. Apparently, that is still a pretty low level on the scale of optimism indices; on Main Street, earnings are depressed, sales are down quarter over quarter, and there's not much to lift spending, don't look for a boost in hiring, and small business owners report that lending options remain closed. Black smoke on Main Street.

A new Reuters/Ipsos poll finds two-thirds of Americans say they are cutting their monthly spending and almost all of the rest say their spending is little changed

The biggest reason given by those who said they are cutting spending - 72 percent of those polled - was increasing savings and paying off debts. The second biggest was higher gas prices, cited by 63 percent.

Of those cutting back specifically because of gas prices or tax increases, 81 percent said they are cutting down on meals at restaurants, 73 percent are reducing entertainment costs such as movies and concerts and 62 percent are spending less on travel and vacations.

At the same time, affluent consumers are showing signs of increased confidence, according to at least one recent survey. This bifurcation may play into concerns about income inequality and could add to pressure in Congress to resist any budget deficit cutting deal that reduces spending on the social safety net and doesn't include further taxes on the wealthy.

Mohamed El-Erian, Pimco CEO says the Fed will not tolerate a big selloff in risk assets; two, the Fed has been forcing other central banks to be more aggressive; and third, investors can shrug off political issues. El-Erian says the Fed has been "artificially altering prices" and changing investor behavior; but he doesn't think the Fed's winding down from $85 billion a month in bond purchases, aggressive forward guidance, and near zero interest rates will "come for quite a while." But when it does happen: "It's going to be incredibly complex." With the Dow at record highs, El-Erian says he doesn't see a “great rotation” from bonds to stocks, rather the money is flowing into stocks from cash and money markets. White smoke from the chimney of Pimco.

The advance to new highs on the Dow is a direct result of never-before-seen manipulation by the Federal Reserve. The next question is whether the Fed can engineer a new era of prosperity in America. Bernanke has long claimed that he can't do it alone, so we might be looking at an example of where the stock market will not predict the nation's economic future. It seems that way, but more likely, we're just seeing a lag in the smoke signals.

Historically the stock market tends to act three to six months ahead of the economy in both directions. That pattern has not gone away. The 2007-2009 bear market bottomed in March 2009 when the current bull market began. The 2008-2009 recession was proclaimed to be officially ended three months later in June, 2009.

The stock market has been factoring in the economic recovery since, and has already recovered to its pre-crisis levels, the Dow and S&P 500 now back to their peaks of 2007. Meanwhile, the economy is merely catching up to what the stock market has been predicting for it.

But as the economy catches up to the market's expectation, the market will continue to focus on what lies ahead, and at this point it may not be a continuation of what it has anticipated for the last four years. Through those years the economy has been fueled by extreme easy money policies, record low interest rates, and massive government fiscal and monetary stimulus.

The government already began reversing the fiscal stimulus last year with cutbacks in federal payrolls, and is significantly stepping up that reversal this year, with the 2% payroll tax increase in January, and now the upcoming automatic "sequester" cuts in government spending, or some negotiated form of the automatic cuts.

Meanwhile, the Federal Reserve has promised to keep its easy money policies and QE programs, including record low interest rates, going well into 2014 - unless the economy improves faster than expected or inflation heats up.

And already we're hearing hints that the Fed may also begin to remove the QE punchbowl sooner than currently expected. I don't mean to scare you. The Fed won't be taking away the punch bowl because they're scared of screwing up everything. But the politicians act like it's their job to screw things up; they roll around in dysfunction like pigs in mud. And the stronger the stock market the more they are encouraged to take away the punch bowl. Then, we head into April and May, which marks the end of the markets' best six months. It's amazing how things synch up. However, there is a chance that sly investors will try to step in front of the “Sell in May” strategy, and sell a bit early.

Consider: The quality of the recent rally seems dubious; it's based on the Fed's loose money policy. Money market and savings accounts earn next to nothing, and that is forcing investors to accept the risks of stock ownership or get paid almost nothing. This is dangerous.

The quality of the "recovery" also seems dubious. Despite a good jobs report on Friday, the economy is fragile. The housing market has shown signs of strength, but again much of the rally can be traced back to the Fed, which now controls the market for mortgage backed securities.

And there are still major risks outside the US. The Euro-zone appears to have stabilized, but it is still in a downward glide due to austerity. And the Eurobeatings will continue until morale improves. That is the consensus of the IMF and the European Council, and almost everyone in a position of power, except Beppe Grillo.

If a bank is forced to pay $54 million to regulators over bad loans should the public be made aware of it?

Probably. If for nothing else than for the sake of transparency in the post-2008 world. But since 2007, the independent US agency responsible for maintaining public confidence in the US financial system has preferred to settle wrong-doing by banks outside of court while also keeping news of settlements private.

That’s according to a report in the Los Angeles Times which obtained more than 1,600 pages of FDIC settlements from 2007 with banks and individuals accused of wrongdoing. The cases involve reckless loans to homeowners, falsified documents and among other things inflated appraisals, according to the report.

Instead of pursuing the cases in court the FDIC has been settling with defendants for a fraction of the losses incurred. But perhaps the more controversial finding is that the FDIC has agreed in “scores of settlements” to a so-called “no press release” clause that would prevent it from voluntarily making the agreements public. In other words, the agency would apparently avoid issuing news around settlements.

Restoring trust frequently requires symbolic, as well as merely effective, change to take place. One insight from the tradition of penitence and forgiveness is that it is often not enough to put matters back to where they were before things went wrong; some demonstration of a change of heart by means of restitution and a visibly robust refusal to let the same failings occur again, is necessary before a bad situation can be made good. Exactly what kind of action by the banks, or by the government, would be necessary to restore trust in this way would probably emerge if the debate about banking ethics were to take place openly in the public realm. To achieve this is not just a matter of technical “fixes” but may require public, corporate, contrition for past failings, demonstrably robust structures to ensure that old mistakes are not repeated, and possibly some symbolic steps to assure the public that the corporate culture has changed.

And from the FDIC and the banks, black smoke. And for systemic corrections and trust in public institutions - black smoke.  

Thursday, December 13, 2012 - Federal Reserve Targets

Federal Reserve Targets

by Sinclair Noe

DOW – 74 = 13,170
SPX – 9 = 1419
NAS – 21 = 2992
10 YR YLD +.03 = 1.73%
OIL - .67 = 86.10
GOLD – 14.30 = 1697.30
SILV - .91 = 32.64

What happens when the unemployment rate gets to 6.7%? Or when the inflation rate gets to about 2.4%%? Yesterday, the Federal Reserve announced it would keep interest rates at super-duper low levels and they would buy about $85 billion dollars a month in mortgage backed securities and Treasury bonds until the unemployment rate drops to 6.5% or until inflation kicks up to about 2.5%. So, what happens when the unemployment rate hits 6.7% or inflation hits 2.4%?

The next question, and it is probably going to turn into an obsession for market traders trying to figure which target gets hit first, inflation or unemployment. Of course, that is working on the assumption that Fed policy will improve the jobs picture and that the Fed's policy will result in inflation. Maybe. What we know with greater certainty is that the Fed's policy is a boon for banks. They can offer loans and keep a very wide spread, also known as a profit. And the banks can be very particular about the quality or vintage of loan they make; which in turn keeps the spread high. The banks don't really need to make mortgage loans to consumers;Ttey can get an even bigger spread on high interest credit card accounts; they can get an even higher interest on payday loans (yes, some of the biggest banks are involved in payday lending, not in their own name, but they make short-term loans at rates that would make Tony Soprano blush), and of course, the banks can make really big spreads gambling on derivatives. (Remember the London Whale?)

Low interest rates should lower the cost of capital, and that should encourage businesses to borrow money for expansion and hiring. The problem is that businesses only expand and hire when they are growing their business, not just because money is cheap. You don't hire a new employee because interest rates are at historic lows, you hire a new employee because you need to fill an order. The problem is that most businesses aren't getting new orders because consumers are holding onto their dollars until the eagle grins. The only way to get more business is to have more people in more jobs earning more money. While there have been jobs added to the economy since the Meltdown of 2008, there are just enough jobs to keep up with the population growth, and the median wage keeps dropping.

Corporate profits keep growing; they're at the highest share of the overall economy than at any time in the post World War II era, but wages are taking the smallest share than at any time since the post World War II era. So, the Federal Reserve has stepped into the breach with a fairly clear cut definition of their job responsibilities; their dual mandate is price stability and maximum employment; even though the employment part has largely seemed an afterthought for most of the history of the Fed. Nonetheless, Fed Chairman Bernanke sounded sincere when he said yesterday: "The conditions now prevailing in the job market represent an enormous waste of human and economic potential."

And the Fed's plan to buy Treasuries and MBS doesn't really go to the heart of the problem. So what happens when the inflation rate gets to about 2.4% or the unemployment rate gets to about 6.7%? Well, first off, it is highly unlikely that both the inflation rate and unemployment rate will move with pure synchronicity. If inflation picks up but hiring doesn't, well tough luck job seekers. And if the jobs picture improves without sparking inflation, why not just keep the policy in place and see if we can find a job for everyone who wants to work?

Previously, the Fed had promised to keep rates near zero until mid-2015. Fed officials still think that’s the earliest they’ll tighten, but feel more comfortable tying that decision to the state of the economy than the calendar. Yesterday, Bernanke claimed that the target isn't really a target, saying: “What it is, is a guidepost [to] when the beginning of the reduction of accommodation could begin. It could be later than that, but at least by that time, no earlier than that time. So it's really more like a reaction function or a Taylor rule, if you will -- I'm ready to get the phone call from John Taylor. It is not a Taylor rule, but it has the same feature that it [says] how our policy will evolve over time as the economy evolves.”

By the way, the Taylor Rule isn't really a rule, it's more like a guidepost, and it says the central bank should change the nominal interest rate in response to changes in inflation, output, or other economic conditions, and the basic rule of thumb is that for each one-percent increase in inflation the central bank should raise the nominal interest rate by more than one percentage point.

I'm sure Mr. Bernanke has given this careful consideration but we haven't really heard how the Fed will get out of this mess. If thresholds were simply another way to express the liftoff date for the Fed funds rate, it really wouldn't be a big deal. But set against several steps taken earlier this year, it's actually a fundamental re-positioning of how the Fed operates. It began in January when the Fed articulated that unemployment and inflation would get equal consideration in deciding when and how much to adjust interest rates. In September came the application of this new way of thinking; they announced the Fed would buy $40 billion a month of mortgage backed securities by creating money (“quantitative easing”, or QE) until the labor market had improved “substantially.”

With the latest decision it has quantified “substantially”; it is 6.5% unemployment..., or 2.5% inflation. What all these steps do is attempt to harness the public's expectations to leverage the stimulative effect of monetary policy. If investors believe the Fed will tolerate inflation above target, they will drive long-term interest rates lower even in the face of inflationary pressure. If the public believes the Fed is serious about unemployment, they will spend and invest more, helping to bring lower unemployment about. At least in theory.

But what if it is not at all clear the Fed's tools can deliver the lower unemployment it wants. If the public shares that skepticism, the expectations effect won't work. The Fed did say it would step up QE to $85 billion a month, and the markets responded with a yawn and actually closed down on the news yesterday. What if QE4, or whatever we're not supposed to call it, suppose it doesn't work. Or consider the analogy from PIMCO's Mohamed El-Erian, who said: “Consider ... the competing emotions a patient feels when confronted with news of a new drug that is yet to go through clinical testing. Professional investors welcomed the news that the Fed is "all in" when it comes to trying new drugs to stimulate the economy. And they fully understand that the transmission mechanism runs right through the equity markets. As Bernanke has stated, the Fed is looking to "push investors to take more risks." Hence the initial positive reaction to the announcement...As the day proceeded, investors realized that, like any experimental drug, there is a material risk of complications. After all, the Fed's operational modalities are not straightforward; the analytical underpinnings are far from robust; and the Fed's prior experimental measures have not succeeded in generating sustainable growth.”

Even Fed Chair Bernanke seemed to have doubts; he said: “the ability to provide additional accommodation is not unlimited.” In other words, this better work, or the whole thing is going to get ugly, and the Fed has limited tools, or at least tools that the Fed is not willing to display to the public. The truth is that the Fed is clothed in immense monetary power, and they have many, many more tools at their disposal, although some of those tools are extremely controversial. Still, you have to think this was a way for Bernanke to say to the knucklehead politicians that they need to get their acts together.

And on top of that, there has been no answer to the question: what happens if or when inflation gets to 2.4% or unemployment gets to 6.7%? At some point the Fed has to exit QE to infinity and beyond. And now the markets have a specific target, or at least guideposts. And you've got to suspect the bond vigilantes are sitting back and waiting to pounce. Unemployment near target? Look for a massive short on Treasuries, look for credit default swaps to jump, look for stocks to take a nose-dive, which in turn would cause businesses to batten down the hatches, freeze hiring, and possibly crater the economy. It's possible that by setting a target, we'll never get there. Of course, it's not easy for the bond vigilantes; remember it is not just the Fed but really all the central banks of the world have come together; and remember the old saying, don't fight the Fed.