Thursday, April 24, 2014 - The Bridge From Bubbles to Prosperity

The Bridge From Bubbles to Prosperity

by Sinclair Noe

DOW unchanged 16,501
SPX + 3 = 1878
NAS + 21 = 4148
10 YR YLD unchanged 2.69%
OIL + .46 = 101.90
GOLD + 10.20 = 1294.90
SILV + .20 = 19.75

The Dow closed unchanged. That is just one of those freaky things that happens every few years. I remember it happened in 2008, and 1998 and 1996. I’m fairly sure there were other days where the Dow closed unchanged. I don’t know if there is any particular significance.

Orders to factories for durable goods rose 2.6%, adding to the 2.1% rise in February. The back-to-back gains followed two big declines in December and January, which had raised concerns about possible weakness in manufacturing. The earlier declines, however, were likely tied to bad winter weather.

On the jobs front, the number of people seeking unemployment benefits jumped 24,000 to a seasonally adjusted 329,000 last week. The four-week average of weekly unemployment claims decreased to 316,750, which puts us back to 2007 levels.

The big earnings report today was Microsoft, which posted income of $5.6 billion, or 68 cents per share, compared with $6 billion, or 72 cents, in the year-ago quarter. They beat estimates of 63 cents per share, but take it with a grain of salt; the estimates started the quarter around 80 cents per share.

Yesterday we talked about a tech bubble, and whether we were in one or not, and we looked at comments from Greenlight Capital manager David Einhorn; he says there is a bubble but it doesn’t necessarily mean the bubble will pop any time soon.

Today, Warren Buffet weighed in on whether stocks are too frothy. Buffett says, “we’re in a range, and it's a big zone always of reasonableness." He went on that "Stocks will become worth more decade after decade, not in any precise manner, not in an even manner or anything of the sort, but 10 years, 20 years, 30 years from now, stocks will be worth more than they are today."

A friend stopped by this morning and asked about bubbles; apparently this is a hot topic these days. How do you know you’re in a bubble? The most obvious answer is when it pops, but there are more helpful ways to address the issue.

The first indicator is that prices spike; a parabolic increase in prices. From March 1999 to March 2000, the Nasdaq rose 110%. Think of an airplane that climbs too fast; it stalls out, rolls over and plummets to the ground; same thing in most markets.

The next thing to watch is valuation. Prices can go up very fast, and if valuations also go up fast, we call that “growth”. When prices go up but valuations lag, we call that a divergence, and a bubble in the making. For stocks, this means that earnings need to keep pace with price.

Back in 2000, the P/E passed 44 based upon inflation adjusted 10 year average earnings, or what’s known as the Shiller P/E; now the Shiller P/E stands at 16. However, for some sectors, we are seeing a divergence; the P/E for internet stocks is up around 47. The P/E for utility stocks is 19, but that is significantly above the historical median of 16. One reason for that divergence might be the recent spike in natural gas prices combined with investors chasing dividend yield. A parabolic spike is relative to the underlying asset, which makes it a bit more difficult to identify, but some examples are not tough to spot.

Look at the spike in Bitcoin about 6 months ago; it went from around $150 to almost $1200 in about one month, and its underlying value was impossible to quantify; that was a bubble. It popped. Remember when gold prices jumped up in spring of 2011? Pop. How about bond prices right now in Spain and Italy? Up 1.1 percentage points in 12 months and just slightly above comparable US Treasuries. It might be a parabolic price increase in combination with a divergence from the underlying asset; or maybe it says something about US Treasuries. You decide.

Of course, the valuation of the underlying asset can change very quickly due to an exogenous event. For example, if Russia shuts off nat gas supplies to Europe, it would quickly change the underlying value of Italian or Polish bonds. When the tsunami hit Fukushima, it changed the value of nuclear sector stocks. When the Hindenburg exploded, it was a black swan event for manufacturers of dirigibles.

And then the other indicator to consider is the madness of the masses. As investors identify a price move, they jump in; when everybody has jumped in, there is no one left. Or as Joe Kennedy said in the winter of 1928: “You know it's time to sell when shoeshine boys give you stock tips. This bull market is over.” By the way, the shoeshine boy reportedly told Kennedy to buy stock in the Hindenburg.

So, markets can get frothy and remain frothy, prices fluctuate, and the market can remain irrational longer than you can remain solvent. Spotting bubbles is possible, but tricky; so it’s important to remember you won’t go broke taking a profit.

Some things seem pretty straightforward. You accept that some things will work in very specific ways. You drive over a bridge and you expect that bridge to not fall into the river below. Yea, good luck with that. A report, released today by the American Road and Transportation Builders Association, warned that there are more than 63,000 bridges in this country in need of urgent repair; the dangerous bridges are used some 250 million times a day by trucks, school buses, passenger cars and other vehicles.

 Pennsylvania led the list of structurally deficient bridges, with 5,218, followed by Iowa, Oklahoma, Missouri and California. Nevada, Delaware, Utah, Alaska and Hawaii had the least. Overall, there are more than 607,000 bridges in the United States, according to the DOT's Federal Highway Administration, and most are more than 40 years old, and more than 10% are considered structurally deficient.

States rely heavily on federal funds to pay for road and bridge projects. The Fed collects 18.4 cents-a-gallon tax on gasoline and 24.4 cents-a-gallon tax on diesel to fund the Highway Trust Fund, which then pays out to the states. The Highway Trust Fund may be insolvent by this time next year unless Congress extends a temporary funding measure which is scheduled to expire in September.

The American Society of Civil Engineers estimates it will take $20.5 billion annually to clear the bridge repair backlog, up from the current $12.8 billion spent annually. That’s just the backlog; to really make a difference, it will take an investment of $3.6 trillion by 2020 to keep the transportation infrastructure in a good state of repair.

Meanwhile, we’ve been watching the Fed’s quantitative easing plan for some time and wondering why it hasn’t really helped the broader economy; it has helped banks, but not much beyond Wall Street. This is not to say the large scale asset purchase program hasn’t had an impact; it has. There is fairly concrete evidence that it has led to lower long-term interest rates; which in turn helped lift some real estate markets that were battered after the housing bubble burst. Some real estate markets are downright hot. Home values in San Francisco and Honolulu are at least 20 times as high as estimated rents. In other words, prices have jumped up and there is a divergence with the underlying asset, which has the makings for a bubble, but that just a couple of markets.

The broader real estate market has experienced a slowdown in the recovery and one cannot help but wonder about the extent to which Fed actions to pull back on their large scale asset purchases is implicated in the said slowdown. When former Fed chair Bernanke set off the "taper tantrum" in a press conference in June of last year by pointing out that at some point, the Fed would start scaling back the LSAP, bond and mortgage rates spiked. The 30-year fixed-rate mortgage went up about a point around then from the mid-threes to the mid-fours and has stayed there.

The Fed has tried to explain away the housing slowdown on the bad winter weather, but that’s just part of the problem. The other part of the problem is that the housing recovery only helped recover lost equity, it didn’t help create equity. In other words, it was a recovery effort not a wealth creation effort.

Kind of like the situation right now with bridges. From the day President Eisenhower signed the Federal-Aid Highway Act of 1956, the Interstate System has been a part of our culture; as construction projects, as transportation in our daily lives, and as an integral part of the American way of life.  Every citizen has been touched by it, if not directly as motorists, then indirectly because every item we buy has been on the Interstate System at some point.  President Eisenhower considered it one of the most important achievements of his two terms in office, and historians agree.  Economists recognize that this enormous public works project helped propel the economy, and still does.

Right now, interest rates are low; they won’t stay low forever. Right now, people need jobs; a massive infrastructure project would provide jobs, especially for long-term unemployed workers. Putting more people to work would mean more money moving through the economy, increasing demand, improving productivity. It seems like a no-brainer, until you remember that the problem rests squarely with our elected officials. Maybe the Federal Reserve could stop its insane and ineffective large scale asset purchases; stop the helicopter drops over Wall Street and instead make helicopter drops of cash strategically, directly over about 63,000 bridges. 

Wednesday, August 21, 2013 - Ticking Away the Minutes

Ticking Away the Minutes

by Sinclair Noe

DOW – 105 = 14, 897
SPX – 9 = 1642
NAS – 13 = 3599
10 YR YLD + .04 = 2.85%
OIL + .04 = 105.00
GOLD – 4.20 = 1367,80
SILV - .14 – 22.89

Stocks slid, clawed back to breakeven, then sold aggressively into the close. News of the day in the form of FOMC minutes showing policymakers are talking about pulling away the Quantitative Easing punchbowl. The Dow closed below 15,000 for the first time since July 3; the Dow is now down for six sessions; the S&P ended negative, dragged by utilities and financials; techs held up relatively well. Yields on the benchmark 10-year Treasury hit a fresh session high of 2.88%. The dollar held up against most currencies, and most emerging market currencies continued to take a beating.

So, what did the Fed say in the FOMC minutes? Nothing unexpected. Policy makers were “broadly comfortable” with Bernanke's plan to start reducing bond buying later this year if the economy improves, with a few saying tapering might be needed soon. But they weren't saying they had to taper right this moment.

The central bankers did not signal as to whether such a taper of the $85 billion-per-month bond purchase plan would come in September, October or December, the three remaining meeting dates for 2013, but they indicated they would like to have it tapered down by the middle of next year.

“A few members emphasized the importance of being patient and evaluating additional information on the economy before deciding on any changes to the pace of asset purchases,” the minutes show. “Almost all participants confirmed that they were broadly comfortable” with the committee moderating “the pace of its securities purchases later this year.”

Some participants indicated that “overall financial-market conditions had tightened significantly,” the minutes said. “They expressed concern that the higher level of longer-term interest rates could be a significant factor holding back spending and economic growth.”

Several others said the rise in rates “was likely to exert relatively little restraint.” In addition, these participants thought that rising stock prices and easier bank lending standards would offset the impact of higher borrowing costs. Some of the officials welcomed the rise in rates “insofar as those developments were associated with an unwinding of unsustainable speculative positions.”

In other words, there was concern about the stock markets and housing markets, or pick a market... overinflating; possible asset bubbles. One area of concern for the Fed is probably its own balance sheet. The Federal Reserve has set a new record, but it’s not one exactly worth celebrating. For the first time ever, the Fed owns more than $2 trillion in US debt, which is to say, in US Treasuries. On Dec. 31, 2008 that statistic consisted of less than a half-trillion in Treasury securities, but efforts undertaken by the Fed to revive the economy — so called “quantitative easing” — have instead left the bank to bear record amounts of national debt. China, the second place holder with regards to US debt, was owed $1.27 trillion by the US as of late June.

There is another problem for the Fed; if, when, or as the Fed winds down QE and they reduce purchases of mortgage backed securities then interest rates will rise and bond prices will fall. That could raise the federal deficit (because the government would have higher borrowing costs) and slow the housing market (because mortgage rates could rise further). The basic math is that prices fall when interest rates rise, and the longer the maturity the more severe the price drop. This is a big deal with the Fed. As of August 15th, it owned mortgage-backed securities worth $1.264 trillion as well as notes and bonds worth $1.9 trillion. In effect, by tapering the Fed will force down the current value of its own securities portfolio.

The FOMC minutes also revealed the Fed is considering other tools, such as a new overnight reverse repo facility. They also discussed lowering the 6.5% unemployment rate threshold. That's the target they set for an exit from QE. So, they think the economy is headed for lower unemployment. Maybe, but will that mean better jobs? Maybe not.

Businesses are hiring at a robust rate. The only problem is that three out of four of the nearly 1 million hires this year are part-time and many of the jobs are low-paid. Employers say part-timers offer them flexibility. If the economy picks up, they can quickly offer full-time work. If orders dry up, they know costs are under control. It also helps them to curb costs they might face under the Affordable Care Act, or at least that has become an easy scapegoat. Obamacare is only one factor. The surge in part-time employment also reflects an economy that has struggled to maintain decent growth.

In a paper published last month, the San Francisco Federal Reserve Bank said uncertainty over fiscal and regulatory policy had left the U.S. unemployment rate 1.3 percentage points higher at the end of last year than it otherwise would have been. The jobless rate stood at 7.8 percent in December; it has since fallen to 7.4 percent.

Maybe part-time hiring and the low wages environment will fade away as the economy regains momentum, starting in the second half of this year and through 2014. Maybe not. Businesses have learned how to function with fewer workers. One study found that profit per employee at privately held companies jumped to more than $18,000 in 2012 from about $14,000 in 2009. Private employers are either able to make more money with fewer employees or have been able to make more money without hiring additional employees. The lesson learned for businesses during the downturn was to have lean operations. There are limits to running a lean operation, and the big question is whether we are now at those limits.

Many of these part time, low paying jobs, aren't really part time, low paying jobs. In the small “d” depression of the past few years, good jobs were transformed into bad jobs, full-time workers with benefits were transformed into freelancers with nothing. From the end of an “average” American recession, it ordinarily takes slightly less than a year to reach or surpass the previous employment peak. As of June 2013, four full years after the official end of the Great Recession, we had recovered only 6.6 million jobs, or just three-quarters of the 8.7 million jobs we lost.

One of the tricks to running “lean operations” was to dump entire departments and reorganize them so that the same work, the same jobs, requiring the same skills, would henceforth, in good times and bad, be done by contingent workers. One sign of that: during the course of the downturn, corporate profits went up by 25%-30%, while wages as a share of national income fell to their lowest point since that number began to be recorded after World War II. This is more than a matter of factories firing and burger joints and Wal-Mart hiring; this was a switcheroo; the good jobs were transformed into bad jobs, and if that wasn't good enough, the other option was no job.

Eventually the hours will start to creep back up, and at some point labor will gain strength, or maybe even flex muscle, but not today. Until then, be careful you don't become a part-timer, without even trying.

Still, the FOMC minutes reveal Fed policymakers optimistic about the job market. The June Job Openings and Labor Turnover Survey (JOLTS) data released by the Bureau of Labor Statistics paint a grim picture of job opportunities in the labor market. The “hires rate”—the share of total employment accounted for by new hires—is an important comprehensive measure of the strength of job opportunities because it incorporates two components: 1) net new hires, and 2) new hires that are due to “churn”, i.e., hires that are replacing vacated or lost positions. In June, 3.1 percent of all jobs were hires. This was a substantial drop from May, when the hires rate was 3.3 percent.

The JOLTS data are a regular reminder that there is always a great deal of “churn” in the labor market. In July, the economy added 162,000 jobs, net. Over the last year, an average of 4.3 million workers were hired every month and an average of 4.2 million workers either left their jobs voluntarily or were laid off every month. These hires and separations numbers, however, are currently very low; when the labor market is stronger, there is much more churn. Nowadays, employed workers are less likely to quit the job they have. Back in 2006, about 3 million workers quit their job each month. Last June, 2.2 million workers voluntarily quit their jobs. Because leaving a job for a better opportunity can be an important way for workers to advance, this persistent depressed rate of voluntary quits represents millions of lost opportunities.

Unemployed workers far outnumber job openings in every major sector. This means the main problem in the labor market is a broad-based lack of demand for workers—not, as is often claimed, available workers lacking the skills needed for the sectors with job openings.

The Federal Reserve might be ready to taper, but the reasons for taper are more about the Fed's balance sheet and asset bubbles than about the strength of the economy, and certainly the labor market. And maybe QE hasn't and can't do anything to improve the labor market, but it would have been nice if the FOMC minutes had actually covered the mandate regarding full employment.

Wednesday, May 22, 2013 - Throwing Ben From the Chopper

Throwing Ben From the Chopper

by Sinclair Noe

DOW – 80 = 15,307
SPX – 13 = 1655
NAS – 38 = 3463
10 YR YLD +.08 = 2.03%
OIL – 1.53 = 94.65
GOLD – 6.30 = 1370.70
SILV - .16 = 22.37

Federal Reserve Chairman Ben Bernanke went to Capitol Hill this morning and that was followed by the release of the Federal Open Market Committee, or FOMC, minutes from their May 1^st meeting and that was followed with a big swing lower for stocks on very heavy volume and a big swing lower for bonds and everything was just rocking and rolling.

Bernanke was appearing before the Joint Economic Committee this morning; the gavel fell; Bernanke delivered some prepared remarks: "A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further."

So, that sounded like no tapering off of QE anytime soon. Stocks and bonds inched a little higher. Bernanke went on to say that fiscal policy continues to be a drag on the economy. Right, we've heard it before.

Then, Bernanke stressed that slowing asset purchases would not be the automatic beginning of the exit. The flow of purchases could be ramped up depending on the data. Now, the markets were trying to figure out which direction he's going.

Asked when the Fed will slow down asset purchases, Bernanke says it could come in "next few meetings”, but he won't give a date. Then he says financial stability is biggest risk of asset purchase program, but a weak economy comes with its own stability concerns. Then he says the Fed does not have to sell any agency mortgage-backed securities when the central bank exits its easy policy stance. The markets start to tank.

Is the Federal Reserve doing too much to stimulate the economy, or not enough? Many of the questions directed at Bernanke this morning were about the risks of the Fed doing too much and whether their monetary policy was hurting savers and creating asset bubbles. An equally valid question is whether the Fed is pushing hard enough, given that the economy is growing more slowly than the Fed wants it to and the jobs market remains stagnant and inflation is running well below its target.

Helicopter Ben, the student of the Great Depression willing to throw cash out of a helicopter; that Fed Chairman was nowhere to be found; replaced by a Chairman willing to stand pat despite failing to achieve the Fed’s own self-imposed targets.

Bernanke isn’t ruling out stronger action. In his testimony he said that depending on incoming data, “we could either raise or lower our pace of purchases.” But raising purchases is clearly not Plan A. As the outlook for the labor market “improves in a real and sustainable way, the committee will reduce the flow of purchases,” the chairman said, without specifying a time.

Bernanke says for the record that the Fed could do more if necessary, but he is behaving as if he believes monetary policy is at or near its limit. He testified: “Monetary policy does not have the capacity to fully offset an economic headwind of this magnitude.”

That doesn't really sound like Helicopter Ben. Has he lost his swagger? Hang on. He's saying the Fed is willing to hold on to all the Mortgage Backed Securities they've been buying, maybe just stick them in the vault and wait; that is not an acknowledgment of failure in monetary policy, but it is looking like an acknowledgment of asset bubbles.

And then we got the FOMC minutes.

The FOMC minutes showed they were still waiting for more progress before they would slow Quantitative Easing, but they were thinking about an exit plan; they discussed the old plan form 2011, debated whether it was still valid or needed updating, talked about the possibility of slowing asset purchases as early as June, that didn't fly, and then the punchline– assett bubbles.

The FOMC minutes say, in writing: "a few participants expressed concern that conditions in certain U.S. financial markets were becoming too buoyant.... One participant cautioned that the emergence of financial imbalances could prove difficult for regulators to identify and address, and that it would be appropriate to adjust monetary policy to help guard against risks to financial stability."

The big question is whether the Fed will actually have a mutiny and throw Bernanke from the helicopter and abandon super-easy monetary policy? So, let's dig a little deeper into the minutes: “Regarding the composition of purchases... ,in light of the substantial improvement in the housing market and to avoid further credit allocation across sectors of the economy, the Committee should start to shift any asset purchases away from MBS and toward Treasury securities.”

Where do we go from here? The Fed holds on to its existing asset purchases; they won't shy away from ZIRP, the Zero Interest Rate Policy; they are getting closer to using some new tools, and it's probably more than just a shift from MBS to Treasuries. What tools? We didn't really get a clue today, but we did get some acknowledgment that they recognized the limitations of the tools they've been using. So, we should be looking for new tools, or look for Bernanke to be tossed from the helicopter – it could go either way.

The latest poll of Morgan Stanley's top clients from across the world says it all. Not a single investor at the bank's Florence forum thought the world economy would rebound with any strength later this year.

Just a quarter expect a return to trend growth. Some 57pc think there will be no escape from the "twilight" conditions afflicting the western world, and 20pc expect an full-blown global recession. That is a remarkably bearish set of views. Yet the same investors are overwhelmingly bullish on stocks and property.

This schizophrenic exuberance seems entirely based on the assumption that QE and central bank largesse will keep the game going, flooding asset markets with liquidity. Indeed, 80pc think the ECB will cut rates again, and half think it will have to swallow its pride and join the QE club in the end.

Eighty percent think equities will gallop on upwards over the next year. Complacency is rife. It became very clear, and many investors were quite explicit about this, that markets are lulled by the lure of liquidity resulting from negative real interest rates and global QE. When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.

Yesterday, shareholders at JPMorgan Chase decided to keep Jamie Dimon as chairman and CEO. The shareholders trying to take away Dimon's chairmanship weren't trying to take the job of running JPMorgan away from him. They just wanted to give the board's oversight function to somebody else -- they didn't want Dimon being his own boss. But even this minor tweak to Dimon's job function would have been such an outrageous affront to Dimon's royal personage that he might have taken his indispensable skills away from the bank forever, causing the stock price to collapse, or so the bank told shareholders, at least in private. Jim Cramer said it publicly: "If you voted for Dimon to lose chairmanship, you voted for a lower stock."

The Office of the Comptroller of the Currency cut it's rating of the bank's management and says it need simporvement, but shareholders weren't buying it. Last weekend I heard one analyst explain that concerns about out of control trading, and the trading losses of the London Whale, and allegations of money laundering, institution wide regulatory violations, and auditors that are on the verge of throwing up their arms; for a complete list of violations, there is a report entitled “JPM – Out of Control” , which basically describes a criminal enterprise. Any way, the analyst over the weekend was saying that shareholders should forget about all that because Dimon delivers record profits, and that's all that really matters. Rather than humbling Dimon, JPMorgan shareholders have declared, loudly, that Dimon alone should hold their fate in his hands. They had better hope it doesn't go to his head.

Hurricane Sandy was the deadliest and most destructive hurricane since Katrina. It caused 285 total fatalities and was the second-costliest hurricane in United States history.

During the immediate aftermath of this act of Nature, Senators Inhofe and Coburn from the state of Oklahoma, were among many who decided to use the disaster as a political platform. They voted against a full FEMA / Army Corp of Engineer reconstruction, and repeatedly delayed votes to fund any for of rescue. The Republican Governor of New Jersey went postal against the GOP House members as well as these two Oklahoma Senators. Eventually, federal aid for Hurricane Sandy was passed. A big chunk of the Sandy emergency package replenished FEMA, which had been underfunded by the usual suspects. The Sandy relief package replenished its coffers. The votes in favor of Sandy Aid ironically funded FEMA, and it is helping with the rescue and clean up efforts in Oklahoma. Now Coburn is insisting that any federal aid to deal with the tornado in his home state must be offset by budget cuts, but he says that “as the ranking member of Senate committee that oversees FEMA, I can assure Oklahomans that any and all available aid will be delivered without delay.”

Thursday, May 16, 2013 - What's Next For the Fed

What's Next For the Fed

by Sinclair Noe

DOW – 42 = 15,233
SPX – 8 = 1650
NAS – 6 = 3465
10 YR YLD - .08 = 1.87%
OIL + .95 = 95.25
GOLD – 6.60 = 1386.90
SILV + .10 = 22.79

The Labor Department reports the consumer price index dropped 0.4% in April from March, the biggest monthly drop since December 2008. The main reason the index fell was that gas prices plunged 8.1 percent. Excluding the drop in fuel costs, prices were largely unchanged. For the 12 months that ended in April, overall prices rose 1.1 percent — the smallest year-over-year increase in 2½ years. Excluding volatile energy and food costs, “core” prices ticked up 0.1 percent last month. Core prices have risen only 1.7 percent in the past 12 months. That’s below the Federal Reserve’s 2 percent inflation target. Yesterday, we reported that wholesale prices declined last month.

Inflation is not the problem right now; it might be a problem at some point down the road, but not now.

John Williams, the San Francisco Fed president gave a speech in Portland and he indicated that the Fed's Quantitative Easing program can be reduced soon, and that the whole program may be halted this year. He pointed out the pace of job growth has picked up since the program was launched in September, with an average pace of job growth of 200,000 over the last six months.

Williams said: “Assuming my economic forecast holds true and various labor-market indicators continue to register appreciable improvement in coming months, we could reduce somewhat the pace of our securities purchases, perhaps as early as this summer. Then, if all goes as hoped, we could end the purchase program sometime late this year.”

Williams was open to the idea of ramping up bond purchases if the economy slows down.

So, let's go back to the Federal Reserve's dual mandate of price stability and maximum employment. Right now, prices are stable; even a little bit of disinflation based upon this week's producer-price index and consumer-price index. No need to taper off.

On the maximum employment side of the mandate, the Fed set a target of 6.5% unemployment, which is still a long way from it's mandate of maximum employment. One of the reasons the unemployment rate has dropped to 7.5% is because the participation rate has dropped; fewer people are considered to be in the labor pool. The economy has been adding about 200,000 jobs per month, on average, over the last six months. We know that many of those jobs are temp jobs; many are part-time jobs; many are lower paying jobs. But they are net new jobs. The problem is that 200,000 jobs is not enough to lower the unemployment rate, unless a lot more people fall out of the labor market.

This morning, the Department of Labor reported initial claims for unemployment increased 32,000 to 360,000.

So, why do we have all this talk of tapering off from QE?

In order for QE to work, rather than just inflate asset prices, there needs to be viable investment opportunities that create productive jobs in the short, medium, and long term. Infrastructure would qualify as filling the bill, but not just building bridges to nowhere. And this is the flawed premise of QE, according to a recent speech by Dallas Federal Reserve President Richard Fisher: “by driving rates to historical lows along the entire length of the yield curve, investors will rebalance their portfolios and reach out to riskier assets, providing the financial wherewithal for businesses to increase capital expenditures and reengage workers, expand payrolls and regenerate consumption. Rising prices of bonds, stocks and other financial instruments will bolster consumer confidence. The CliffsNotes account of this play has the widely heralded “wealth effect” paving the way for economic expansion, thus saving the day.”

Fisher went on to add: “Until job creators are properly incentivized by fiscal and regulatory policy to harness the cheap and abundant money we at the Fed have engineered, these funds will predominantly benefit those with the means to speculate, tilling the fields of finance for returns that are enabled by historically low rates but do not readily result in job expansion.”

There are a few problems here. Cheap money does not encourage speculation. Cheap money encourages prudent lending. If you can only get a small rate on your loan, you are more likely to make certain that loan will be repaid. This is why triple-A rated corporate bonds pay less than junk bonds. This is also why the residential housing mortgages written in the past two years are a much better vintage than the mortgages written in 2005. High rates encourage speculation. The risk is not in the low rates, but rather that the low rates push prudent potential lenders to seek higher returns elsewhere, like in the stock market.

The result, and it must be scaring the Fed, is that we are headed for a speculative bubble. If you always do what you've always done, you'll always get what you've always gotten. The Fed actually has some history with bubbles. The next time you read that a new era has dawned, that the old rules of economics don't apply, and that some asset class or other that’s been rising steadily for a while now is certain to keep on to infinity and beyond; that's just wrong. It really is that simple.  

The problem is that the Fed has been passing out cheap money to speculators and gamblers. And now they're shocked, shocked I tell you, to discover that the speculators are gambling with the cheap money. Speculation demands high rates as compensation for high risk, but the Fed has been passing out super-low rate money to the most high risk players.

And the banksters continue with their rotten ways. They take the zero-interest money from the Fed and they screw anybody and everybody they can. Today a case in point.

In 2006, Congress passed the Military Lending Act, which was designed to prevent predatory lenders from targeting men and women in uniform. But a new report from ProPublica and Marketplace entitled Beyond Payday Loans suggests aggressive lenders have merely shifted tactics and are still very actively going after military personnel.

Rather than a loophole, installment loan companies and so-called payday lenders have found huge gaps in the Military Lending Act. The Military Lending Act set a national interest rate cap of 36 percent APR (annual percentage rate) for loans to military members and their families (excluding mortgages and auto finance loans).

The Act covered three specific types of loans: payday loans (short-term, due in one lump sum after a borrower’s payroll check clears); car-title loans; and tax refund anticipation loans. Further, the loan-terms covered were restricted: 91 days or less for a payday loan, 181 days or less for a car-title loan.

As a result, lenders are offerings payday loans, which typically have annual percentage rates over 400%, with a duration of five months instead of three. Same is true of auto-title loans, which are secured by the vehicle’s title and typically have rates above 100%.

And yes it is the banksters that back the payday lenders, or in many cases the big banks are the payday lenders, through a different division of the company. QE and the other tools of the Fed have not cleaned up some of the worst abuses in the system.

Today, the International Monetary Fund weighed in, claiming the Quantitative Easing by the Fed, and the ECB, and the Bank of Japan had helped to stabilize financial markets and push asset prices higher. The IMF figured that: “While additional unconventional measures may be appropriate in some circumstances, there may be diminishing returns, and benefits will need to be balanced against potential costs.”

Maybe it is time to ask whether the Fed has been effective in its policy over the past five years. Yes, the Fed policy helped avert a global financial meltdown. Yes, the Fed policy prevented the collapse of the biggest banks. Yes, the Fed policy was a part in turning around massive job losses and helping bring down unemployment in a less-than-robust manner. No, the Fed hasn't done much to regulate the financial institutions that caused the problems in the first place. The Fed doesn't seem to believe in regulation; which is kind of like a Pope that doesn't believe in religion.

The Fed hasn't been particularly successful in its mandates. Perhaps the time is coming where they need to change the tools they're using. Maybe it is time to break away from Quantitative Easing, which mainly helps the banks, and maybe they need to start using tools that will promote a healthy economy, with maximum employment – not just a target of 6.5% unemployment – and help people find productive employment. And then they could use their regulatory tools to help ensure financial stability in what has become a casino market.

One of the better moves the Fed could consider is to open up low interest rates to entities other than the member banks; this probably exceeds the Feds generally accepted role, but not the technical limits of its tool box. Infrastructure investment still looks like the best, least speculative way to achieve the dual mandate. Imagine a country with a continental railroad - like what Lincoln did, or an nationwide highway system – like what Eisenhower did, or a country that develop science to the point we could fly to the moon – Kennedy and Johnson. Now imagine a country that is energy independent.

The time is coming for the Fed to move beyond Quantitative Easing, and this is why we've been hearing about tapering off. QE is not as effective as it once was, and it has never been as effective as it should have been. So, maybe a change is coming. The big question is where they go next.

Wednesday, May o1, 2013 - May Day

May Day

by Sinclair Noe

DOW – 138 = 14,700
SPX – 14 = 1582
NAS – 29 = 3299
10 YR YLD - .04 = 1.64%
OIL – 2.54 = 90.92
GOLD – 19.10 = 1459.10
SILV - .70 = 23.75

It's May Day. Maybe you all gathered round the May pole with colorful ribbons. Or maybe you commemorate the workers' protests of 1886. Or maybe you think it's all just a communist plot and you won't celebrate May Day at all, you will take the advice of President Eisenhower and observe Law Day.

Actually, the history of May Day is kind of interesting. It started with pagan celebrations dealing with Spring and fertility. May 1, 1886, protests erupted all across the United States, with some 340,000 workers taking part, demanding an 8-hour workday. An estimated 190,000 went out on strike. In Chicago, a center of the eight-hour day agitation, some 80,000 workers walked off the job, with most of them joining a vast parade through the city streets. Chicago police launched an assault on union members by gunning down locked-out workers at the nearby McCormick Harvester Plant. When an explosion of unknown origins went off at a subsequent protest rally at the Haymarket, a large open square in the city, police also opened fire on that worker gathering, killing some and wounding hundreds of others in what became known as the Haymarket Massacre. Radical labor agitators were arrested and blamed for the bloodshed, although most of them were not present at the rally. Four of them were executed.

After the Haymarket Massacre, the new American Federation of Labor vowed to continue the eight-hour day movement, and set May 1, 1890 as a day for further action. Joining the call for May Day protests, the International Socialist Workers Congress, in 1890, helped organize May 1 parades, meetings, and rallies throughout Europe in support of the struggles of American workers. Starting in 1891, May Day demonstrations became annual events in the United States and many other countries.

Communist governments later picked up on the idea of workers' rights and usurped May Day. In the 1950s Ike tried to get it changed to Law Day. In 1958 Congress declared May 1^st to be Loyalty Day.

All the protests and demonstrations resulted in the 1938 passage of the Fair Labor Standards Act, which brought about the 40-hour workweek and established minimum wages for American Workers. Maybe someday we can get back to those ideals. There are plenty of people working much longer than 40 hours a week, putting in extra hours at a job that doesn't have much security or working two or three jobs, or putting heart and soul, sweat and tears and precious hours to build their own business. And then there are plenty of people who would love to get up to 40 hours a week, if they could just find the work.

The Federal Reserve has said that they will keep interest rates low and continue to buy up bonds and mortgage backed securities until inflation hits 2.5% or until the unemployment rate drops to 6.5%. Today, the Fed FOMC wrapped up a two-day policy meeting and they announced they will stick with the Zero Interest Rate Policy and Quantitative Easing, but they would really like to see Washington get their act together. In their statement, they said that despite signs of recovery “fiscal policy is restraining economic growth”.

The statement is the FOMC's boldest assertion to date that Washington policy is hampering the US's fragile economic recovery. It stands in marked contrast to last month's more cautious statement, which said "fiscal policy has become somewhat more restrictive".

The FOMC released its statement after two key reports suggested that recovery in the jobs market is slowing, as end of year tax hikes and budget cuts – known as sequestration – seem to take their toll.

They increasingly view fiscal policy as an impediment to what they've been trying to accomplish and today's statement is an outright affirmation of that view. Fiscal policy 'is' restraining growth, from the Fed's point of view. And as long as fiscal policy remains constrictive, then the Fed are likely to do more rather than less.

Here is what the Fed statement said: “economic activity has been expanding at a moderate pace. Labor market conditions have shown some improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has strengthened further, but fiscal policy is restraining economic growth.”

For now, the Fed is sticking to Quantitative Easing, stating: “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”

At first, that probably frightened some traders, but the reality is that the Fed probably won't be reducing purchases any time soon, largely because the politicians in Washington aren't likely to stop the stupid fiscal policy any time soon. Expectations for tapering off of the Fed's outcome-based purchases have been pushed back due to recent softening in the economic data. Economic growth rebounded in the first quarter after a dismal end to 2012, but the 2.5 percent annual rate of expansion fell short of economists' estimates, and forecasters are already penciling in a weaker second quarter.

The housing market continues to show signs of strength, with home prices posting their biggest yearly gain since 2006. However, the industrial sector is not quite robust, with a report today showing national factory activity barely grew in April.

And the job market, the focus of much of the Fed's efforts, is just hanging on. Employers added only 88,000 workers to their payrolls in March and today payroll processing firm ADP announced that private firms added an estimated 119,000 jobs in April, the lowest ADP estimate since October 2012. Of course, Friday we get the government's monthly jobs report.

Continuing from the Fed statement: “Inflation has been running somewhat below the Committee's longer-run objective, apart from temporary variations that largely reflect fluctuations in energy prices. Longer-term inflation expectations have remained stable.”

That is a strange definition for the Fed’s favorite measure of inflation, the PCE index, that now is running at a 1% annual pace.

The Fed action was supported on an 11-1 vote. Esther George, president of the Kansas City regional Federal Reserve bank, dissented for a third straight meeting. The statement said George remained concern that the Fed's aggressive stimulus could heighten the risk of inflation and financial instability.

The yield on the bellwether 10-year Treasury note dipped to a 2013 low of 1.62% today as traders seemed more concerned about falling prices than inflationary pressures. Fixed-income traders will accept lower yields in periods of falling prices. And weak economic news of late is raising that specter. Falling government bond yields could be consider as a contributing factor to push key commodity prices lower. The price of crude oil dipped to just over $90 a barrel before finishing the day just under $91 a barrel. Two days, the price of crude oil was topping $94.50 a barrel. Gold prices are sometimes considered an inflation barometer, were down again today at $1459; just a few weeks ago the prices were above $1700.

In response to a deep financial crisis and recession, the Fed cut overnight interest rates to effectively zero in late 2008. It has also bought over $2.5 trillion in assets, more than tripling its balance sheet, to keep long-term rates low.

If the economy's fortunes do not improve, the central bank may well look for fresh ways to boost its support to the economy, and increasing the amount of assets it is buying is just one option.

The Fed could announce an intent to hold the bonds it has bought until maturity instead of selling them when the time comes to tighten monetary policy. Fed Chairman Ben Bernanke has already raised this as a possibility.

Policymakers could also set a lower unemployment threshold to signal when the time might be ripe to finally raise rates. Currently, the threshold stands at 6.5 percent, provided inflation does not threaten to breach 2.5 percent.

So, today's report seems strange; the Fed doesn't seem to acknowledge a disinflationary environment; there was almost no mention of the weak labor market; they might increase or reduce the pace of its purchases to maintain appropriate policy accommodation.

Here is the bottom line: rates aren't changing any time soon; the Fed will continue buying an incredible amount of bonds and mortgage backed securities; the housing market has been nationalized by the Fed; Bernanke and the gang will watch this Friday's jobs report and quietly curse Congress.

Someday, we'll get back to a 40-hour workweek; just not this week.

Monday, September 10, 2012 - When the Crack Pipe Fails to Satisfy

When the Crack Pipe Fails to Satisfy

-by Sinclair Noe

DOW – 52 = 13,254
SPX – 8 = 1429
NAS – 32 = 3104
10 YR YLD +.02 = 1.68%
OIL -.30 = 96.24
GOLD – 10.50 = 1725.80
SILV - .34 = 33.44
PLAT + 2.00 = 1599.00

Consumer credit shrank by $3.28 billion in July; this marked the first declines in consumer credit in nearly a year as Americans reduced credit card debt. Now for the scary part; I read a couple of stories on this today and they described the news as worrisome for the economy. I disagree. It might be worrisome for the credit card companies; it might be worrisome for the payday loan companies; it might be worrisome for the banks and other loan sharks, but I consider it good news for consumers and the economy in general. Consumer debt does not add to productivity; it doesn't manufacture things. It's debt. It's inflationary. It's takes resources which could be applied to greater purpose elsewhere. It doesn't really matter because the Federal Reserve says they revised their earlier estimates for June, and it is likely we'll all be paying with plastic again in August – you maybe, not me.

Credit has been expanding almost continuously since mid-2010 as the country recovered from the 2007-2009 meltdown. The decline in July was the first drop since August of last year. In July, revolving credit, which includes credit cards, shrank by $4.82 billion. The data looks at declining credit as a negative because it is closely correlated to consumer spending. Of course, there is the possibility that people are buying things with something we used to call money; I know that is a farfetched notion, but I'm holding out hope.

The concept of stopping the continuous compounding of debt upon more debt upon more debt; the very idea of someone in a hole, stopping digging – this notion is completely and totally alien to the Federal Reserve. And so the Federal Reserve will almost certainly announce QE3 at the end of the week, or some version of QE3, or some new catchy name for tossing out free money to the banks, while creating mountains of fresh, new debt.

The only surprise would be if the Fed did not announce QE3 and QE to infinity; in which case the market would throw a tantrum and break things, like your 401k. The Wall Street bookies, or analysts, are putting the odds of QE3 at 99%. And then you have to believe that since the market believes the Fed will deliver QE to infinity, they have already baked it into the cake. Accommodative policy is already priced into equity and bond valuations.

We know the markets love free money, but what if the Fed announced QE and the markets were flat or even worse, their response is negative because it's already priced in. And even though the Wall Street types love free money from the Fed, businesses on Main Street aren't making investment or hiring decisions based on the idea that the Fed is holding interest rates near zero. In fact, if you want to spur capital expenditures, you might want to hint that rates will go up in the future and now is the time to make your move. At some point, the Fed's action won't be enough to make a major difference in markets; I don't think we're there yet.

Yale University professor Stephen Roach and Bill Gross, the manager of the world’s biggest bond fund at Pimco say central bank money printing is losing its effectiveness in spurring growth.

Roach says: “I’ve been negative about the U.S. ever since the Fed went to their unconventional monetary policy.”

Gross, who oversees Pimco’s $270 billion Total Return Fund, wrote in the monthly commentary posted on Pimco’s website last week: “Our credit-based financial system is burdened by excessive fat and interest rates that are too low.”

After the Fed’s first round of quantitative easing, the Bank of England announced 75 billion pounds ($120 billion) of asset purchases in March 2009, and the ECB provided 442 billion euros ($565 billion) in one-year loans to the region’s lenders in its Long Term Refinancing Operation, or LTRO, three months later. The Bank of Japan said in October 2010 it would buy 5 trillion yen ($64 billion) of government and corporate debt.

The Fed cut its overnight bank lending rate to between zero and 0.25 percent in December 2008 and has indicated it may keep it there through 2014. The ECB has reduced borrowing costs to 0.75 percent and the BOE to 0.5 percent. The BOJ lowered its target rate to about zero from 0.5 percent.

Fed stimulus has typically debased the currency. The Dollar Index tracks the greenback against six US trading partners; the index dropped 13 percent between the Fed’s announcement of $2.3 trillion in easing in November 2008 through the end of the bond buying in June 2011. That might not happen this time. The index is trading around 80.5, a fairly strong level of support. Also, we’re seeing clearer signs of diminishing returns from success quantitative-easing programs. Also, it's pretty clear that the US recovery is less than robust, you might call it tepid, you might call it a non-recovery, or you might call it something we can't call it on the radio. But the rest of the world isn't in much better shape.

The Euro-zone economies contracted 0.5 percent in the second quarter from a year earlier. Japan is struggling to overcome more than a decade of deflation and the effects of last year’s record earthquake. Bill Gross wrote on the Pimco website that central banks are agog in disbelief that the endless stream of QEs and LTROs have not produced the desired result. Yep, and junkies are amazed when the crack pipe fails to satisfy; why should the debt junkies be any different.

Gross also says new regulations requiring banks to hold more capital and increased saving by households has prevented record low interest rates from sparking the recovery central bankers anticipated. As if banks having enough money to back up their bets is a bad thing, as if households not digging a deeper and deeper hole to finance day to day consumption is a bad thing. Gross is a pretty smart guy but when a man makes his living with a hammer, the whole world looks like a nail.

In addition to the Federal Reserve FOMC meeting we'll be watching the news out of Europe. Stocks declined earlier today as Greek Prime Minister Antonis Samaras was meeting officials from the nation’s creditors after failing to secure agreement from coalition partners on spending cuts. Meanwhile, Greece’s Democratic Left leader said that no decision had been made on the cuts required to obtain further aid for the country’s bailout, and that poorer citizens must be protected from austerity measures.

The German Constitutional Court will rule on the legality of the Euro-bailout fund. Also, Mario Draghi, the president of the European Central Bank still has to sort out exactly what the next steps are for the Euro-zone under his whatever it takes, unlimited conditional support, bond-buying scheme. If nothing else, Draghi has kicked the can into the politicians' court; he can claim he did his part and now it is up to the politicians and the German courts.

George Soros made his fortune betting on currencies in the midst of economic crisis in the UK; Soros says: “Lead or leave: this is a legitimate decision for Germany to make. Either throw in your fate with the rest of Europe, take the risk of sinking or swimming together, or leave the euro, because if you have left, the problems of the eurozone would get better.”

And while the Germans deliver their verdict, the Dutch will also take to the polls for national elections. The Netherlands economy is fairly strong but it has been slowing and the Netherlands is not an island, despite all the canals, it is feeling the slowing effects of the Euro-crisis.

The Dutch and the Germans have been part of the northern countries demanding austerity by the southern or peripheral countries, but now that the Dutch are feeling the slowdown, the idea of austerity becomes less appealing. While the Dutch generally still see the benefit of fiscal responsibility and financial sustainability, more and more people doubt that now is the best time to try to reign in the deficit as it is becoming clear that the cutbacks deepen the crisis rather than solving it.

Since 2008, the internet collective known as Anonymous has hacked the CIA, the Sun newspaper, the Church of Scientology, the FBI, the Arizona Department of Economic Security, Visa, Mastercard, and a host of other large corporations, sparking a global police crackdown last year. For a period in 2011, LulzSec – an offshoot of Anonymous, the internet"hacktivist" collective who came to prominence around the time of the Wikileaks affair – wreaked a trail of chaos across the web. Their actions ranged from the transgressive – they had taken down the CIA's website and hacked into Sony's database and released more than a million user names and passwords. Then they hacked PBS television after they aired a negative documentary about Julian Assange. LulzSec hacked into their website and replaced the homepage with an article about Tupac Shakur, "Tupac Still Alive in New Zealand" (I have long suspected Tupac was living in New Zealand). Then, during the Arab spring, members of the group hacked and defaced Tunisian and Egyptian government sites. One hacker (later discovered to be a 16-year-old London schoolboy), allegedly wrote a webscript that enabled activists to circumvent government snooping.

Thousands and possibly millions of websites hosted by GoDaddy.com went down today, causing trouble for up to 5 million small businesses. A Twitter feed that claimed to be affiliated with Anonymous said it was behind the outage, but this couldn't be confirmed. Another Twitter account, known to be associated with Anonymous, suggested the first one was just taking advantage of an outage it had nothing to do with. Maybe they were hacked, maybe GoDaddy just screwed up on their own. GoDaddy was a target for hacktivists early this year, when it supported a copyright bill, the Stop Online Piracy Act. Movie and music studios had backed the changes, but opponents say they would result in censorship and discourage Internet innovation. And GoDaddy sided with the censors.

The US Treasury Department said it will sell $18 billion of American International Group Inc., slashing its stake in the New York company by more than half and making the government a minority shareholder for the first time since the financial crisis was roaring in September 2008.

At JPMorgan directors are considering lower 2012 bonuses for Chief Executive Jamie Dimon and other top executives in the wake of a multibillion-dollar trading disaster. But they also are grappling with the question of how to do that without drastically reducing the executives’ take-home pay. More than 93% of Mr. Dimon’s $23 million in compensation last year came from either stock- or cash-based bonuses. Citigroup’s board, meanwhile, is expected to decide this fall how to fine-tune next year’s compensation plan to win broader support among investors. One thought is if an executive loses billions of dollars in reckless trades, maybe they don't deserve a bonus.

Transocean Ltd. and the Justice Department have discussed a $1.5 billion settlement that would resolve federal claims over the company's role in the 2010 rig explosion that led to the nation's worst offshore oil spill.

Transocean said in a regulatory filing that several issues, including the possible time period for payment, must be resolved before a deal can be completed. A Justice Department spokesman declined to comment. Transocean owned the Deepwater Horizon drilling rig, where 11 workers died in an April 2010 explosion triggered by a blowout of BP's Macondo well. Transocean also says it rejected settlement offers earlier this year from BP and a group of private attorneys for Gulf Coast residents and businesses.

Transocean was once a US company, but now they're headquartered in Switzerland. They are involved in deep-water ocean oil drilling and apparently Switzerland offered, easy coastal access.