Wednesday, August 13, 2014 - Oil, At Least in Theory

Oil, At Least in Theory
by Sinclair Noe

DOW + 91 = 16,651
SPX + 12 = 1946
NAS + 44 = 4434
10 YR YLD - .03 = 2.41%
OIL - .04 = 97.33
GOLD + 3.70 = 1313.20
SILV - .11 = 19.91

The economic news today did not point to a positive session for Wall Street. Retail sales for July were flat compared to June. Excluding autos and gas, retail sales were up just 0.1%. Clothing sales increased 0.4% but that was primarily due to extreme discounting. That report was confirmed by an earnings report from Macy’s, which missed expectations on earnings and revenue, and then lowered guidance. In after-hours trade, Cisco reported better than expected earnings and revenue.

The US has deployed 130 Marines and Special Operations forces to northern Iraq to help assess ways to rescue thousands of members of the Yazidi religious group taking refuge on Mount Sinjar. Those military advisers will not have a combat role, but the Defense Department left open the possibility that US troops could help create a safe passage for the Yazidi off Mount Sinjar. That might put US troops in direct combat with the ISIS militants trying to kill the Yazidi, a proposition President Obama has not signed off on, but one the military advisers are exploring.

The US and Iran don't agree on much, but it appears the two countries are backing Iraqi Prime Minister Nouri al-Maliki's replacement, Haider al-Abadi. Iran's endorsement on Tuesday means that Maliki, who has indicated he won't go quietly, will have an even harder time holding onto his position. The United States and its allies hope that replacing Maliki, who alienated the Sunnis of Iraq, will undermine support for the militant group the Islamic State in Iraq and Syria (ISIS). For now, Maliki is trying to cling to power, but his days appear numbered.

There are daily multiple sorties by US fighter bombers flying off a US Navy aircraft carrier in the Gulf, some resulting in airstrikes on advancing ISIS forces that have threatened civilian refugees and the Kurdish capital of Erbil. Unmanned US drones are in the air gathering a constant stream of intelligence which is being fed back to a US-manned operations center in Baghdad and then shared with America's allies.

There are close to 1,000 US military advisors in Iraq, including Special Operations forces, divided between Baghdad and Kurdistan and the CIA is believed to be running an operation to supply Kurdish forces, the Peshmerga, with arms and ammunition. Iraqi Kurds have overtaken 2 northern oilfields.  The two oilfields are said to have a combined daily output capacity of some 400,000 barrels per day. The operations are most certainly not entirely humanitarian. France and Germany both say they will send military equipment to help the Kurds defend themselves. Hercules transport planes have been dropping aid to civilians fleeing from the onslaught of ISIS.

While the case for intervention on humanitarian grounds to save the lives of thousands of fleeing refugees is overwhelming, there is now the risk of what is known as "mission creep"; of a small, narrowly defined operation ballooning out of control, sucking in Western countries into a lengthy conflict with no clear exit. Politicians are fond of saying "there will be no boots on the ground" but in practice there are already growing numbers of US military personnel deployed to Iraq behind the scenes. The ISIS fighters are now embedding in residential areas like Mosul, essentially using civilians as shields. Already Iraqi government airstrikes around Mosul have led to reports of civilian casualties. What if advice and air power alone are not enough to prevent the ISIS from taking more towns in Iraq and Kurdistan? What if Baghdad itself or the cities of Kirkuk or Irbil look threatened?

The militants from ISIS have been causing problems in Iraq and Syria for several months, but then they took control of the area around Kirkuk, a gigantic oilfield; then they captured the Mosul Dam, which controls electricity and might serve as a weapon; and then they encroached on the Kurdish capital of Erbil, an oil boomtown which happens to have a US consulate but also has hundreds of employees of companies like Chevron and ExxonMobil; that’s when the airstrikes against ISIS started. To be fair, it was also when ISIS became especially barbaric, and tens of thousands of Yazidi refugees became stranded. The current US intervention certainly has humanitarian purpose, but it would also be wrong to pretend that oil is totally irrelevant to the larger crisis in Iraq.

Meanwhile, the markets are discounting any disruption in distribution in Iraq; Iraq is currently the world's seventh-largest oil producer, churning out some 3.3 million barrels per day; Kurdistan in the north is only responsible for about 10% of the national production; most Iraqi oil exports come from the southern part of the country, and those oil fields are far away from the current fighting, so it’s highly unlikely that there will be a disruption, at least in theory.

In theory, all oil sales in Iraq are supposed to be handled by the central government in Baghdad, which then splits revenues among the various regions according to an existing agreement. Iraqi Kurdistan has been pushing to sell more of its own oil directly to other countries, bypassing the central government entirely, because Kurdish officials claim that the central government hasn't been sending Kurdistan its promised share of oil revenue.

The United States is officially opposed to Kurdistan's direct sales of oil abroad because it might undermine the unity of the Iraqi government. There's currently an oil tanker filled with about 1 million barrels of Kurdish oil parked about 50 miles offshore from Houston that can't unload its crude. State Department officials have been quietly warning any potential buyers of the Kurdish oil that they could face "serious legal risks." But now, the Kurds are stepping up the fight against ISIS.

Iraq has scheduled to export about 2.4 million barrels per day of Basra Light crude in September, up from 2.2 million in the previous month. Libya has resumed shipments of crude. According to the IEA: "The Atlantic market is currently so well supplied that incremental Libyan barrels are reportedly having a hard time finding buyers." If Iraqi oil goes offline, even for a short time, the rest of the world does not have enough spare capacity to replace that production; that would likely push oil prices over $125 a barrel, and that might then increase the leverage for Putin.

And it had been thought that sanctions imposed on Russia over its support for Ukrainian rebels might cause disruptions in oil distribution. Russia is the largest oil producer in the world, at over 10 billion barrels equivalent per day or 13% of world supply. However, the markets are looking at Russia and saying that Putin needs to sell oil even more than the EU needs to buy it. Russia turning the taps off would cause an oil shock in the West as it would cause a steep rise in prices and significant disruption, however it would also bankrupt Russia. At least in theory.

Ukraine vows to stop Russian-supply convoy unless conditions are met. Wary that the Russians may be trying to move military supplies into their country to aid pro-Moscow separatists, Ukrainian officials said they would not allow a convoy of 280 Russian trucks to cross the border unless the Red Cross took over the delivery. Ukraine says the cargo, which Russia insists is humanitarian aid, must be loaded onto other vehicles by the Red Cross. It will take the trucks about two days to make the 620 mile trip from Moscow to eastern Ukraine.

Ukrainian state-run energy firm Naftogaz said yesterday that the ongoing dispute over natural gas prices between Kiev and Moscow may lead to disruption in Russian gas transit to the European Union (EU) countries. Kiev and Moscow have been locked in a dispute for three years over a 2009 contract under which they agreed to tie the price of gas to the international spot price of oil. In June, Russia's energy giant Gazprom has cut all gas supplies to Ukraine after the two sides have failed to reach an agreement on payments. The dispute between the two former Soviet countries triggered fears that Russian gas transit to Europe may be halted. Currently, around 15 percent of EU gas supplies flow through Ukraine.

Yesterday, the International Energy Agency (IEA) said: "Oil prices seem almost eerily calm in the face of mounting geopolitical risks spanning an unusually large swathe of the oil-producing world." Global oil prices have fallen to their lowest levels in 13 months. Brent crude is trading around $103 a barrel, and WTI is around $97, then 10^th straight session with prices under $100. Retail gas prices have dropped about 23 cents a gallon since April.

And you probably remember back in 2008, when tensions with Iran helped push oil prices up to a record $148 a barrel. So, with all the problems around the world now, why are oil prices dropping? The US is pumping the most oil in 27 years, adding more than 3 million barrels of daily supply since 2008. Supplies from the Organization of Petroleum Exporting Countries, which pumps about 40% of the world’s oil, rose to a five-month high of 30 million barrels a day in July as Libyan output recovered and Saudi Arabia increased production. At the same time, global demand is weak, although it is expected to pick up towards the end of the year. Meanwhile Mexico has privatized its oilfields, at least partially. The state-owned energy group Pemex will lose the monopoly it has held since nationalization in 1938. Mexico’s oilfields had been underperforming and production dropped by more than a million barrels per day in the past few years. So, if we can just hold it together for a couple more years, North America could become energy independent. Until then, it could go either way, at any moment, and send the economy into a tailspin in a heartbeat, at least in theory.

Tuesday, July 15, 2014 - The Path We're On

The Path We’re On
by Sinclair Noe

DOW + 5 = 17,060
SPX – 3 = 1973
NAS – 24 = 4416
10 YR YLD + .01 = 2.54%
OIL - .74 = 100.17
GOLD – 13.20 = 1294.60
SILV - .19 = 20.82

We’ll start with a couple of quick economic reports.

The Commerce Department reports retail sales increased 0.2% in June. The sales figures from May were revised from a 0.3% increase to a 0.5% increase. The increase in June was below consensus expectations of a 0.6% increase; however sales in April and May were revised higher, so it all levels out and was fairly strong report. Sales were up 4.3% year to year.

The Empire State Manufacturing Survey for July was up 6 points to 25.6, a four year high.

The state of California released its monthly cash report for June; the state’s General Fund ended the fiscal year with a positive cash balance for the first time since 2007, so the state won’t have to borrow to meet all of its payment obligations.

Federal Reserve chairwoman Janet Yellen delivered her semiannual Humphrey Hawkins testimony before the Senate Banking Committee today. Tomorrow, Yellen will repeat the process with the House. Yellen said progress has been made to restore the economy to health and strengthen the financial system, yet too many Americans remain unemployed and inflation remains below targets and there hasn’t been enough financial reform.

After prepared remarks, Yellen fielded questions from the senators, and this is where it gets a little interesting. Yellen said, “equity valuations of smaller firms as well as social media and biotechnology firms appear to be stretched.” Some folks felt this was an “irrational exuberance” moment for Yellen. Social media and biotech stocks declined immediately after her comments. Yellen has a good reputation on forecasting. Back in 2006, when she was president of the San Francisco Fed, she gave a speech pushing back against former Fed Chair Alan Greenspan’s claim, with respect to the housing crisis, that the “worst of this may well be over.” Greenspan was wrong, Yellen was right, or at least not as bad as Greenspan.

Yellen said the Fed is still concerned about the housing market: “While this sector has recovered notably from its earlier trough, housing activity leveled off in the wake of last year’s increase in mortgage rates, and readings this year have, overall, continued to be disappointing.”

The housing market slowed last year when mortgage rates spiked on the possibility of taper. Yellen said that while the rise in rates is “the most obvious explanation for the weakness in the housing market over the past year,” it “seems unlikely that interest rates are the whole story.”

Yellen says the Fed is keeping a close watch on what it sees as potentially excessive risk-taking in the market for leveraged loans, but downplayed the possibility that its policies of ultra-low interest rates could be fueling asset bubbles. Still, there are some areas of financial markets, such as lower rated corporate debt, that are showing looser underwriting standards. Yellen and her Fed colleagues seem generally unfazed by concerns of bubbles and she said in testimony that the prices of real estate, stocks and corporate bonds “remain generally in line with historical norms.”

Yellen said most officials expect rates to start rising in 2015 and to finish the year around 1%. “That gives you a feeling for what participants thought would be appropriate given their projections in June,” she said. “What will actually happen clearly is going to depend on the progress the economy makes.”

Yellen seems pleased with the trajectory of the economy; investors seem complacent. She reiterated the Fed’s view that the economy will continue to grow at a moderate pace, and that the Fed is in no hurry to start increasing short-term interest rates.

All in all, Yellen’s testimony didn’t reveal much new. The Fed has been telegraphing this information for some time. The idea is that they can float information, and if the trial balloon gets shot down, they aren’t stuck in actual policy; if the trial balloon is accepted they can slowly implement the policy. It’s called forward guidance, and it seems to be working. The problem with forward guidance is that the Fed doesn’t know the future, and so they keep the guidance a little on the vague side, and then everybody fills in the blanks based upon their own particular bias.

It is earnings season and a couple of the big banks posted today.

JPMorgan reported a profit of $6 billion, or $1.46 a share, down from $6.5 billion, or $1.60 a share, a year earlier. Goldman Sachs posted net income of $2.04 billion, compared with year-earlier net income of $1.93 billion. Both banks saw share prices move higher after the reports.

These earnings came during a quarter in which fixed-income trading and mortgage refinancing were weak; so in that regard, the banks performed well. More likely the banks managed earnings expectations.

Johnson & Johnson reported higher-than-expected quarterly results on strong sales of its new hepatitis C drug. J&J said it had earned $4.33 billion, or $1.51 per share, in the second quarter. That compared with $3.83 billion, or $1.33 per share, a year earlier. They also raised guidance for the full year.

Intel posted better than expected Q2 revenue and profit; then they raised their Q3 revenue forecast well ahead of expectations; then they announced they would increase their share repurchase program. Intel posted a profit of $2.8 billion, or 55 cents a share, from a year-earlier profit of $2 billion, or 39 cents a share. Gross margin widened to 64.5%, compared with 59.6% in the first quarter. Intel still makes most of its profits from chips for computers; they’re still trying to get into the mobile market, but this past quarter they made more than a half billion in profits making chips for the internet of things, which is basically the idea that all of our mundane possessions will eventually be connected devices.

A study by the International Data Corporation calculates the internet of things market will grow to $7.1 trillion in the next 5 years. More than 1.9 billion once-inert devices are already connected to the internet, from parking meters to home thermostats, and by 2018 that number will top 9 billion.

The Federal Communications Commission website has crashed. Today is the last day to submit comments on the FCC’s proposal to regulate the internet. The proposal at issue would allow internet providers to charge content companies for more direct connections to their customers. These so-called “fast lanes” have sparked a vehement reaction from internet activists, who claim that the new policy could turn the web into a plutocracy where companies that are willing to shell out cash receive premium treatment. As of last week, the FCC had received almost 650,000 comments, mostly in favor of net neutrality; which is another way of saying no toll booths on the information superhighway.

Real highways are another matter. This afternoon the US House approved an $11 billion plan to replenish the federal fund for highway and mass transportation projects, but just through next May. Passage of the bill only puts off a larger debate over raising taxes to pay for long-term infrastructure financing. This was a stop-gap measure, as federal funds were 2 weeks from drying up which would have resulted in work stoppages during the peak of the summer roadwork season.

The Department of Transportation has said that without an agreement in Congress, federal payments to states will begin to slow by the end of the month. Also, the existing two-year law authorizing about $50 billion in highway and transit funding annually expires on Sept. 30; and with it the ability of the government to levy the 18.4-cent-per-gallon gas tax that finances the work.

Longer term plans have been dragged down by disagreements on how to fund projects. The short-term proposal signed today, raises money through an accounting gimmick called pension smoothing, which allows for a delay in the payments that corporations make to their pension funds resulting in a higher corporate tax bill. It’s a temporary, inadequate response to a long-term problem, better than nothing, even if it doesn’t do what it needs to do; which seems to describe everything in Congress these days.

The road ahead may be full of potholes, but on the road of life, most people think the ride will be smooth. A new survey conducted by the National Council on Aging, Untied Healthcare and USA Today finds that older adults are pretty optimistic; 89% say they’re confident they can maintain a higher quality of life through their senior years. On the financial front, 45% of the older group surveyed said they wished they had saved more money; almost one-third (31%) said they wished they had made better investments. The new survey finds more financial optimism than last year, but still almost half (49%) of the 60-and-older respondents say they're concerned that their savings and income will be sufficient to last the rest of their lives. In 2013, 53% expressed that concern.

So what is behind the optimism? The reasons vary, but support of family and friends is at the top, followed by being happy about their living situation, and being in good health.

There seems to be something to the good health part of the optimism equation. The medical journal JAMA released a study today showing people are having fewer strokes and dying less often in the wake of strokes. It’s still a big problem, striking 800,000 people a year and killing 130,000, but the numbers are down.

Another study released this week says better heart health and more education means the onset of Alzheimer’s begins later in life now than 30 years ago in developed nations. One trial in Finland suggested the body can be conditioned to hold off mental decline with gym exercising, good food choices and cognitive training.

It is good to have an end to journey towards, but it is the journey that matters in the end.

Tuesday, May 13, 2014 - Record Highs and Dow Theory

Record Highs and Dow Theory

by Sinclair Noe

DOW + 19 = 16,715
SPX + 0.8 = 1897
NAS – 13 = 4130
10 YR YLD - .03 = 2.62%
OIL + 1.38 = 101.97
GOLD – 1.00 = 1295.70
SILV + .03 = 19.63

Record highs are seldom pretty; they tend to be sloppy affairs, much like our celebrations. You would like a nice neat procession, but people are marching in different directions, candles blow out, hot wax is spilled.

It doesn’t seem like we should be having record highs in the first place, but there it is:  the S&P 500 hits 1900 for the first time ever; the Dow Industrials at record highs; the Dow Transportation Average confirms with record highs. This is important because it goes back to one of the more important technical indicators in the US stock market, the Dow Theory.

The Dow Theory is based on the writings of Charles Dow, the founder and editor of the Wall Street Journal, and dates back more than 100 years. There are actually several tenets of the theory that examine the major trends in the market and posit that the market is efficient, that it incorporates and discounts all news with greater accuracy than any individual. Once a trend is in place it is likely to continue until there is definitive evidence of a reversal; in this light, the slog through the first quarter might be considered as nothing more than market noise. Dow Theory also holds that volume confirms price trends.

And the theory also holds that the Dow Transports should confirm the Dow Industrials. The idea was that the Industrial average reflected the factories scattered around the country and the transportation average consisted of the companies that hauled the goods from the manufacturer to the market. If manufacturers are producing more, they have to ship goods to consumers, so if you want to know about the health of manufacturers, look to the performance of the companies that ship the goods. The two averages should be moving in the same direction; that is, they should confirm. So, if the Transportation average hits record highs, which it did, the Industrials should also hit new highs, which happened yesterday.

In mid-March, the transports broke above prior 2014 highs while the Industrials still lagged below their corresponding 2014 high. This could have been interpreted as a divergence, and even a signal to sell the industrials. However, Dow Theory tells us that industrials lag transports. It makes sense, because goods need to be transported before they can be sold.

Now, if you want to try and front-run Dow Theory, you want to pay attention to sales. Today, the Commerce Department released April sales figures, and they were flat, up just 0.1%, but this follows a revised 1.5% increase in March; that was the largest increase since March 2010 and reflected pent-up demand after a brutally cold winter. So, March sales were spectacular, and that was reflected in the Dow Transportation Average, and eventually the Dow Industrial Average confirmed the Transports. And now, the April numbers look weak despite data like employment, as well as manufacturing and services industries surveys, suggesting the economy regained strength early in the second quarter.

A second report from the Commerce Department showed that retail inventories excluding automobile stocks barely rose in March. The government had assumed a big increase in these stocks when it made its advance growth estimates last month for gross domestic product at 0.1% growth. March trade, construction spending and factory inventory data, which the government did not have in hand for the GDP estimate, suggest downward revisions to output; likely showing the economy contracting slightly. Core sales were down 0.1% in April; core sales strip out automobiles, gasoline, building materials and food services, and correspond most closely with the consumer spending component of the GDP.

Meanwhile, the Fed reported today that Americans racked up more debt in the first quarter, the third straight quarterly increase, thanks in large part to heftier mortgages. The report on household debt and credit showed however that mortgage originations dropped to their lowest level since the third quarter of last year. Outstanding household debt rose by $129 billion from the previous quarter, boosted by a $116 billion jump in mortgage debt and smaller rises in student and auto loans.

And in the sometimes twisted logic of Wall Street, this might be considered good news, the economy isn’t collapsing but it certainly isn’t growing enough to warrant a change in interest rate policy from the Fed. Any increase in interest rates could hobble consumers, businesses, and even the government.

Prices and wages been have sluggish since the 2007-2009 recession, and especially so in the past couple of years. Inflation remains low, and it undershot the Fed’s 2% target for the 23^rd consecutive month in March, based upon the personal consumption expenditures price index. Stubbornly elevated unemployment puts downward pressure on inflation. We still have slack in the labor market, so we’ll likely have very low interest rate targets for quite some time.

Meanwhile, we’re wrapping up earnings reporting season and according to Bloomberg research, almost 76% of the 453 companies in the S&P 500 that have reported earnings had results that were higher than analysts' estimates and approximately 53% of them exceeded revenue estimates. I know this is a rigged game between corporations and analysts, but companies are making money and sitting on piles of cash.

The corporate cash pile reached $2.02 trillion in the latest quarterly filings of 2,300 non-financial companies in the Russell 3000 Index. According to Bloomberg, the total rose about 13% from a year earlier in each of the two latest quarters, the fastest six-month gain since mid-2011.  If investors aren't applying some sort of haircut to the valuations of companies with hefty amounts of cash overseas, perhaps they should be; that is the mantra of activist shareholders. And so companies are beginning to pick up M&A activity as well as share buybacks and dividend increases. Capital spending on structures, equipment and intellectual property by all US companies in 2013 increased 3.9%, the slowest pace in three years. Eventually there will be value in reinvesting in the company to grow revenue; we’re not there yet, but we’re getting closer.

Again, one of the tenets of Dow Theory is that a trend in place is likely to continue until there is definitive evidence of a reversal; we’re not there yet. The trend is bullish; the supporting data is only mildly positive. In this instance, you stay in the market and remain alert to possible reversals. The level of support for the Dow, now moves up to the 16,550 range. On the upper end, there really is no level of resistance when you hit new highs, with the possible exception of Fibonacci expansion levels, which could put a ceiling around 16,800.

Meanwhile, if you’re looking for a negative divergence, you need look no further than the Russell 2000 Index of small and mid-cap stocks. The Russell has been persistently below its 50 day moving average since early April, and last week it dipped below the 200 day moving average; yesterday it bounced up above the 200 day and remained above the average today, despite losing 12 points. So, if you are looking for an early warning, this is a good place to look. If the Russell can move above the 200 day average here, it would have to be considered positive and also confirmation of the blue chips. If there is a breakdown from here, it might drag the blue chips lower.

Now, even if the market moves lower from here, it doesn’t mean we’re crashing back down to the 2009 levels; there is no definitive evidence for that kind of a move; there is plenty of fear mongering; there are plenty of perma-bears and they are about as accurate as a broken clock. The world is not coming to an end, at least not today; the market is not crashing, at least not today. In fact, we’ve been going through one of the best five year bull runs in market history. The VIX, the volatility index is at its lowest levels in more than a year. The major trend is bullish but this is no time for complacency. One of the tricks to profitable trading is knowing when to let winners run, and when to lock in profits.

These are the days of milk and cookies. Enjoy it while you can.

Thursday, February 13, 2014 - The Popsicle Economy

The Popsicle Economy

by Sinclair Noe

DOW + 63 = 16,027
SPX + 10 = 1829
NAS + 39 = 4240
10 YR YLD - .02 = 2.73%
OIL - .02 = 100.35
GOLD + 11.00 = 1303.80
SILV + .25 = 20.59

According to the latest AAII Investor Sentiment Survey, over the last week the number of self-described bulls jumped to over 40% while bears plunged from over 36% to 27%. Did all those people suddenly become timing experts or is this an indication that it’s time to take profits?

The number of Americans who applied to receive unemployment benefits rose last week and the gradual decline in claims since last year appears to have halted. Initial jobless claims climbed by 8,000 to a seasonally adjusted 339,000 in the seven days ended Feb. 8.

RealtyTrac reports monthly foreclosure filings — including default notices, scheduled auctions and bank repossessions — reversed course and increased 8% to 124,419 in January from December. One month does not make a trend, but the foreclosure rebound pattern is not only showing up in judicial states like New Jersey, where foreclosure activity reached a 40-month high in January, but also some non-judicial states like California, where foreclosure starts jumped 57% from a year ago, following 17 consecutive months of annual decreases. As a whole, 57,259 US properties started the foreclosure process for the first time in January, rising 10% from December but still down 12% from last year.

On a monthly basis, retail sales decreased 0.4% from December to January (seasonally adjusted), and sales were up 2.6% from January 2013. Sales in November were revised down from a 0.2% increase to a 0.1% decrease.

In its monthly budget report, the Treasury Department said that the deficit for January was $10.4 billion. For the period from October through January (the first four months of this budget year), it totaled $184 billion. That is down $106 billion from the same period a year ago and puts the country on track for a further improvement in the budget deficit.

The Congressional Budget Office is projecting that the deficit for the current budget year will decline to $514 billion. That would be the smallest imbalance in six years. The deficit last year was $680 billion. The CBO's deficit projection for this year would represent a drop of 24% over the 2013 deficit. The CBO's latest forecast issued earlier this month projected that the deficit will decline to $478 billion in 2015 before starting to rise again in 2016 and keep heading higher for the rest of the decade.

As we know, Congress agreed to approve a suspension of the federal debt limit through March 2015. If it sounds like a bipartisan agreement, that doesn’t really describe what happened; more like a game of chicken taken to extremes, and hope for avoiding another head on collision. Ted Cruz’s best efforts notwithstanding, the United States will not dabble in first-time debt defaulting until next year, at the earliest.

Dallas Federal Reserve Bank President Richard Fisher made a speech the other night and blamed Congress for the sluggish economy. Fisher said: “For far too long, the greatest obstacle to our nation’s prosperity, has resided in this building right here: the Congress of the United States.”

Fisher said Congress has repeatedly failed to develop a tax or fiscal policy that would boost the economy. He pointed out an editorial in the Financial Times this week that concluded – ”Fiscal policy is still not an ally of U.S. growth,” and then added, “Fiscal policy is not only not an ally of U.S. growth, it is its enemy.”

This week when Janet Yellen testified before House lawmakers we learned more about how she's thinking about the labor market. In her prepared remarks she pointed to concerns including the long-term jobless as well as part-time workers who would like more work. And during her testimony, she indicated she believes the increase in unemployment since the financial crisis is cyclical, related to the business cycle and related to demand.

The reason that's important is if you think it's cyclical, then you think monetary policy can help. That's opposed to structural unemployment which is longer-term and due to fundamental shifts in an economy, which would require fiscal and regulatory policy response.

Another key aspect of the labor market story is the decline in the labor force participation to a 35-year low. Yellen told lawmakers while a significant part of this decline is structural due to demographics, she said some of it may be cyclical. The difference between unemployment and being out of the labor force is not just statistical: if you are unemployed you are job ready, if you're out of the labor force it takes a big effort to get back in the labor force.

America’s real job creators are consumers, whose rising wages generate jobs and growth. If average people don’t have decent wages there can be no real recovery and no sustained growth. If the Fed and/or Congress wants to see economic growth, it starts with jobs.

Comcast is acquiring Time Warner Cable. It's a $45 billion deal that would combine America's top two cable TV companies for a total of about 30 million subscribers, who are already among the least-happy customers in all of Corporate America. When it comes to customer satisfaction cable companies rank very low, and Comcast and Time Warner rank among the worst. The history of mergers suggests customer service might only get worse for these two companies. Coupling companies typically struggle to knit together their massive systems, and customers get lost in the process. When Comcast bought AT&T Broadband for $50 billion in 2002, customer billing problems led to such a backlash that the company ultimately launched a "Think Customer First" training program.

A BusinessWeek study of 28 mergers between 1997 and 2002 found that customer-satisfaction ratings dropped significantly after the unions, with the effect lasting for years. Cable companies suffered some of the biggest drops in that study. If there's any reason to hope, it's that both companies are suffering from the broader long-term trend of customers dropping cable subscriptions in favor of other alternatives. One of those alternatives is broadband Internet, which both companies also offer. Maybe they can learn from their mistakes. Yeah, that’s not going to happen.

After years of lamenting the factory sector’s diminishing role in the American economy, many American firms are counting on the domestic energy boom, rising overseas labor costs and stronger domestic demand to revive the long-stagnating manufacturing sector. The International Monetary Fund, the iMF, has just published a paper that says a US manufacturing renaissance is probably not gonna happen.

Manufacturing has become an increasingly smaller share of U.S. economy for the better part of a century. At the end of World War II, more than a third of all U.S. workers held manufacturing jobs. That figure fell below 10% in 2008 and manufacturing employment has failed to rebound to prerecession levels, according to Labor Department data.

After the Great Recession, a depreciating dollar, falling natural gas prices and declining unit labor costs boosted U.S. manufacturing production, the IMF economists write. Recent data shows that several durable goods sectors have rebounded strongly after the recession, potentially foreshadowing a strong manufacturing presence in the global marketplace, they said.

In 2010, the manufacturing sector grew by 6.8%, outpacing the nation’s growth in gross domestic product of 2.5% that year. Increasing consumer demand in the U.S. and abroad propelled factory output. Exports grew 11.5% in 2010.

Manufacturing exports could provide “non-negligible growth opportunities” for the American economy, especially as new technology allows energy companies to tap massive domestic deposits of natural gas and oil reserves, IMF economists added. The shale energy boom could add up to 0.3 percentage point a year to growth by 2020.

But a surge in manufacturing — as a share of the U.S. economy — has failed to materialize. Growth in the manufacturing sector trailed the overall economy in 2011 and 2012, according to Commerce Department data released last month. The pace of export growth has tapered off since 2010 and  manufacturing employment increased more slowly than total U.S. payrolls the past two years.

Still, the IMF economists said that the U.S. energy jolt, combined with further dollar depreciation and swelling consumer demand from China, India and other emerging markets could gradually increase U.S. manufacturing output over the longer term.

Despite the boost from energy, the researchers found the U.S. is unlikely to be able to significantly offset the gains made in many emerging markets as companies move their operations where manufacturing is less expensive.

Paul Krugman writes: Bloomberg reports on the soaring prices of trophy apartments in Manhattan. The biggest sale so far was former Citigroup head Sandy Weill’s apartment, which he sold for $88 million to the daughter of a Russian oligarch. But $100 million listings are out there.

For a bit of perspective: the median full-time worker in the United States makes about $40,000 a year. So it would take the typical worker 2,000 years to earn enough to buy the Weill apartment.

Still, people like Weill are exemplars of the free market at work. They work in an industry that delivers clear value to the economy, and has never relied on government bailouts. Oh, wait.

Even if you have a pricey Manhattan apartment, it’s still snowing in New York. More than 700,000 people, including residents of Georgia and South Carolina hit by a heavy blast of ice a day earlier, were without power as the storm made its way up the coast, closing much of Washington and threatening to drop up to 18 inches of snow in some areas.

Tuesday, August 13, 2013 - Metric Disconnects

Metric Disconnects

by Sinclair Noe

DOW + 31 = 15451
SPX + 4 = 1694
NAS + 14 = 3684
10 YR YLD + .11 = 2.71%
OIL + .42 = 106.53
GOLD – 15.90 = 1322.40
SILV + .03 = 21.56

Retail sales rose 0.2% in July, following an upwardly revised 0.6% increase in June; retail sales are now up for 4 consecutive months. The retail sales report is important because consumer spending accounts for about 70% of the economy. We've heard that so frequently that it sounds like a cliché, but when we spend, that money circulates through the economy and it is the vital life blood of the economy. Areas showing gains included restaurants and bars, grocery stores and sporting goods outlets. Within general merchandise, department stores showed a 0.6 percent increase in sales last month

Another Commerce Department report today showed inventories at US companies were little changed. Merchants had enough goods on hand to last 1.29 months at the current sales pace in June.

Atlanta Federal Reserve bank President Dennis Lockhart says he thinks policy makers should move cautiously this year to scale back its bond buying program. Lockhart says the Fed might make its first reduction before the end of the year, maybe as soon as September, and that it should be thought of as a cautious first step. So, Lockhart was a bit more dovish than other Fed policy makers of late, and as he made the comments, small losses on Wall Street gave way to modest gains.

The equity markets have come to play an outsized role in the US from a policy and practical level. It’s never a good idea to try to assess complex phenomena with a single metric, yet for much of the public and the officialdom, the level and trend of the stock market is a proxy for the health of the economy. Fed policymakers now have a vested interest in keeping the stock market up, both to boost confidence and maybe out of personal vanity; if the stock market were to fall, that would mean they’ve done a bad job. Can’t have that!

Equity is a residual claim: payments to shareholders come after paying suppliers and employees, bondholders, leases and licenses, legal claims, and taxes. But our new ideology is that the last should come first. And to achieve that, companies in the US have abandoned the model of sharing the benefits of productivity gains with workers. Once upon a time increases in productivity moved up in tandem with increases in wages, but that changed in the 1970s. Since the end of World War II, productivity has increased by 254%, but real hourly compensation has only increased by 113%. As I say, they used to move in tandem; the disconnect happened about 40 years ago.

According to Bloomberg data, trailing 12-month earnings per share for the S&P 500 are 16 per cent above their level of October 2007 (when both earnings and share prices peaked before the financial crisis). On the same basis, earnings for the MSCI EAFE index, covering the rest of the developed world, are down 37 per cent. Those for the FTSE-Eurofirst 300 are down 42 per cent.

Earnings for the MSCI emerging markets index are up since October 2007 – but by only 13 per cent, having peaked and started to decline two years ago.

Look closely at the raw numbers for the US and they turn out to be less inspiring. S&P 500 companies are on course to increase earnings by 3.6 per cent year on year for the second quarter. But they have declined by 1.3 per cent once financials are excluded. During those 12 months, bear in mind, the S&P gained 18 per cent, and its financials index gained 33 per cent.

Companies are not generating that much in revenues but, over the past 12 months, they returned a record amount of it to investors. This is an admission that they see few opportunities to invest for growth. But, in an environment where investors take little on trust and are desperate for a yield from anywhere, it has helped the rally keep going. This is not a strategy that can last forever. At some point, companies must start generating more revenues and profits with which to make these payouts.

And if you still think its safe to jump back in;Apparently FINRA is looking into whether sell-side research analysts are doing some naughty things, which is an evergreen topic. It’s hard to tell if the analysts are doing naughty things but, probably, right? Basically the analysts are meeting with potential issuers before those issuers’ IPOs, which is fine. But at those meetings, which tend to be arranged by “so-called I.P.O. advisers” they might be talking about the IPO and the analysts’ views of the issuers, which is not fine. 

Yep, the IPO market is back in a big way. Initial public offerings are up 40% from a year ago; 126 companies have raised $27.1 billion, on track to $43 billion for the full year. Mark Hulbert at Marketwatch writes: "When companies are rushing to sell their shares, it often means that the overall stock market has become not just fairly valued, but actually overvalued.”

As Hulbert points out, companies aren't selling you stock out of the goodness of their hearts, but to make their executives, employees and bankers rich. What better time to get rich than when you think your stock is probably overpriced? The last big IPO boom featured dumb money chasing quick riches on first-day stock pops, a game that was heavily rigged in favor of insiders.

Hulbert's own inflation-adjustment of the IPO data suggests the market is on pace for the biggest dollar amount of IPO issuance since 2000, just at the popping point of the dot-com bubble. Estimates like these are going to vary depending on what sort of method you use to adjust for inflation; suffice to say there are a lot of IPOs these days.

IPOs may be back in fashion but mergers just took a hit.

The Department of Justice and several states has sued to block the proposed merger of American Airlines and US Airways. Arguing the combined airline would reduce competition for air travel in key markets. European regulators recently approved the deal after the companies agreed to give up two daily slots at London’s Heathrow Airport.

The airlines claim the merger would cut costs by streamlining operations and scaling back on unprofitable routes. They claim this would be good for customers because it could result in lower costs. However, the merger would also create a monopoly in several areas, such as nonstop service between Miami and Philadelphia or Nashville and Washington DC. The combined airline would also dominate some key hubs.

If not challenged by DOJ, the merged American would surpass United to become the largest U.S. passenger airline by several measures. While US Airways and American overlap on only 12 nonstop routes, no other nonstop competitors exist on 7 of those 12. The merger would also mean less competition along 1,665 other routes within the United States, while boosting competition along just 210 routes. According to the Justice Department, If the US Airways-American merger went through, the four biggest airlines would control more than 80 percent of the domestic air-travel market.

This doesn't mean the merger won't happen; it is still a possibility, but there would likely be some major concessions as talks continue.

Have you experienced a power outage lately? We had one at the studios about a week ago. It happens, and it is happening with greater frequency. The Department of Energy has a new report that shows the power grid is suffering more blackouts, a lot more over the past 20 years.

The report notes that “thunderstorms, hurricanes and blizzards account for 58 percent of outages observed since 2002 and 87 percent of outages affecting 50,000 or more customers.” The rest are caused by things like “operational failures, equipment malfunctions, circuit overloads, vehicle accidents, fuel supply deficiencies and load shedding — which occurs when the grid is intentionally shut down to contain the spread of an ongoing power outage.”

The report estimates that over the past 10 years, weather-related outages have cost an average of about $18 billion to $33 billion per year, adjusted for inflation. So, is severe weather the cause of the blackouts, or is the problem related to old infrastructure? Yes. The grid is old; there's been almost no new construction in the past 25 years, and that makes it vulnerable to severe weather. Grid resilience is increasingly important as climate change increasesthe frequency and intensity of severe weather. Greenhouse gas emissions are elevating air and water temperatures around the world. Scientific research predicts more severe hurricanes, winter storms, heat waves, floods and other extreme weather events being among the changes in climate induced by emissions of greenhouse gasses.

The Energy Department report says the grid should be modernized and made to tougher standards especially where severe weather may be a problem. Yes, it would be expensive to upgrade the grid, and it would be more expensive to wait.

Yesterday, we reported that a couple of lower-level traders at JPMorgan might face the possibility of arrests in connection with the London Whale trades. It doesn't look like Bruno Iksil, the actual London Whale will be arrested; he's cooperating with the investigators.

Almost everyone, from President Obama to his ideological foes in the Republican Party, wants the government out of the business of guaranteeing almost every mortgage loan made in the U.S. That's all well and good, but there is no reason to think that private investors will be willing to fund the types of mortgages people expect at rates they consider "affordable" in the absence of government guarantees. The government could help assuage investor fears by proving that it is committed to upholding the rule of law and punishing individuals who commit financial fraud.

The government, in turn, has shown almost no interest in charging individuals with criminal conduct. Somehow one of the most destructive and widespread frauds in recent history happened without anyone causing it; except for Fabrice Tourre, and that was a civil suit, not criminal. Bank shareholders have certainly spent money on settlements, but the actual perpetrators, whoever they were, have gone unscathed. Given this backdrop, who would pour money into a rejuvenated "private-label" MBS market in sufficient size to offset a large decline in government support?

From the perspective of investors, lying about the quality of the loans they were packaging into securities wasn't even the worst thing the banks did. In many cases, banks failed to ensure that the securities they were selling were even legal. And it now appears that many of the mortgage backed securities weren't really backed by mortgages, maybe more than $1 trillion dollars worth of the stuff.

Of course, the lack of proper documentation didn't prove much of an obstacle to banks that wanted to foreclose on delinquent (and current) borrowers -- they just forged the paperwork they needed.These fraudulent foreclosures harmed investors and the broader economy, although they boosted the earnings of the big banks.

State attorneys general and the Department of Justice eventually settled with the big banks over this practice. None admitted wrongdoing, and no individuals were punished. Far less money actually reached the victims of these fraudulent practices than was expected -- and many had to endue long delays before getting what little they were owed, and then many people received a check in the mail and it bounced; yep, the settlement checks sent out by the banks, bounced. As if that weren't bad enough, the court-appointed settlement monitor says that many of the banks are still breaking the rules. 

The government's failure to prosecute wrongdoing has created an environment of legal doubt that keeps investors away. Not only are investors unable to trust the government to enforce the law -- they can't even trust the government to tell them how bad a job it has done enforcing the law. It all leaves you wondering why anyone would buy private-label MBS until that changes. 

Monday, July 15, 2013 - Lazy Days of Summer

Lazy Days of Summer

by Sinclair Noe

DOW + 19 = 15484
SPX + 2 = 1682
NAS + 7 = 3607
10 YR YLD - .04 = 2.55%
OIL + .52 = 106.47
GOLD – 1.60 = 1284.20
SILV + .01 = 20.03

On a quiet Monday in the middle of the summer, in the middle of July, stocks pulled out modest gains today, but it was good enough for another record for the Dow Industrials and the S&P 500. The S&P posted its 8^th consecutive advance. The Nasdaq 100 posted its 14^th consecutive advance. Volume was light, the slowest trading session of any full trading day this year. So, this record setting rally is looking a little long in the tooth.

The Commerce Department reports retail sales rose a seasonally adjusted 0.4% last month, that was less than expected. Let's break it down: Sales got a big lift in June from the auto industry, with purchases up 1.8%. That’s the biggest gain since last November. Gasoline sales, meanwhile, climbed 0.7% on a seasonally adjusted basis.  Sales also rose for home-furnishings, pharmaceuticals, personal care, clothes and hobby items. Sales fell 2.2% at home-improvement stores, by 1.2% at bars and restaurants and by 1% at department stores.

The auto sector generates about one-fifth of all retail spending. Excluding autos, sales were unchanged. So, here's what is happening; the price of gas is going up; people are trading in their old gas guzzlers for more fuel efficient cars; the savings on gas pay for the newer car. Take away autos and higher gas prices and sales were negative.

Consumer spending is the main engine of economic growth, so if retail sales drop, that means we probably need to revise expectations for gross domestic product. The estimates are that second quarter GDP would be about 1.4%, now we can probably lower that to 1%. Without stronger growth in consumer spending, businesses won’t invest as much.

Remember that oil prices are a huge economic driver in this country. Rising oil prices, probably more than the sequester or most other issues, tends to affect consumer behavior about as much as anything. The basic reason is that prices are posted on the street corner. We are all acutely aware of prices and for most of us we have to drive. One of the few options is to get a new fuel efficient car. If a person (or state government, or other organization that cannot easily pass through its costs) faces an increase in oil costs, it has a tendency to cut back in discretionary spending, since many oil expenditures are for necessities, like commuting to work. 

Also, food prices tend to rise at the same time as oil prices. This occurs because oil is used very extensively in raising crops (operating farm machinery, herbicides and pesticides, irrigation, fertilizer) and in food transportation and packaging.  Higher oil and food prices directly affect the inflation rate. Furthermore, if prices of other types of goods rise because of higher transportation costs, this also tends to raise inflation rates.

In the 2004 -2006 period, when oil prices rose, the Federal Reserve raised target interest rates, from 1% to over 5%, specifically mentioning rising oil prices, and their expected impact on inflation rates as a problem. To the extent that these higher interest rates affected consumer loans, the higher interest costs also acted as a reduction to income, over and above higher food costs.

If oil and food prices are higher, some of the more marginal buyers are likely to find it difficult to keep up their payments, and miss payments, creating an increase in debt defaults.

Now remember back to economic slowdowns in this country and there has typically been a hike in oil prices in the general vicinity. A Financial Times blog by Gavyn Davies says something very similar:

Each of the last five major downturns in global economic activity has been immediately preceded by a major spike in oil prices. Sometimes (e.g. in the 1970s and in 1990), the surge in oil prices has been due to supply restrictions, triggered by Opec or by war in the Middle East. Other times (e.g. in 2008), it has been due to rapid growth in the demand for oil.(or speculation.)

But in both cases the contractionary effects of higher energy prices have eventually proven too much for the world economy to shrug off.

Most economists reckon that the price of oil would have to rise to at least $120 a barrel, and stay there, to threaten the recovery. Or maybe the level is $110 a barrel. It's tough to determine exactly; the figure used to be $80 a barrel. At any rate, we start to feel the slowdown long before we hit the specific price level.

If there were no problem with oil prices leading to recession, prices could keep on rising as much as they need to, to encourage additional production and to encourage alternatives. It is the fact that high oil prices cause recession, and the fact that recession tends to cause oil prices to drop, that prevents oil prices from continuing to rise, in a fashion that would allow oil companies, and makers of alternatives to be able to rely on the higher prices. This hampers the continued growth of oil supply.

So, there is a balancing act between production and recession, and included in that balancing act is that much of our oil comes from oil exporting countries, and they have specific oil prices that they require, not just for exploration and drilling but also to maintain their state budgets and their own economies.

So, on a slow summer day we can look at earnings. S&P 500 companies' second-quarter earnings to have grown 2.8 percent from a year earlier, with revenue up 1.5 percent from a year ago. The big earnings announcement today from Citigroup; its second-quarter profit rose 41%. Net income rose to $4.2 billion compared with $2.9 billion a year ago. Big revenue gains in emerging markets and Citi's securities business; profits improved with cost cutting measures.

On Wednesday, Fed Chairman Bernanke is scheduled to delivery his semi-annual Humphrey Hawkins testimony on Capitol Hill, and following all the ruckus past comments caused, we can expect the most non-committal, bland, boring testimony you can imagine.

And there is some expectation that the second half will pick up, but there isn't much to indicate a big increase. The global economy isn't going to drive economic growth in the US. The global economy may no longer be able to rely on China to be the growth engine it’s been in the past. China’s official statistics agency announced the world’s second largest economy grew 7.5% in the second quarter as industrial production and fixed asset investment continued to dip.  While the slowdown came in line with expectations, it presages further slowdowns, as China’s GDP will probably average 7.5% this year, falling to 6.9% next year, which given the size of China’s economy has important implications for global growth going forward. No hard landing for China, but continued growth contraction for several quarters to come.

A final note on Citigroup today:

Last week, four senators unveiled the 21st Century Glass-Steagall Act. The pushback from people representing the megabanks was immediate but also completely lame -- the weakness of their arguments against the proposed legislation is a major reason to think that this reform idea will ultimately prevail.

The strangest argument against the Act is that it would not have prevented the financial crisis of 2007-08. This completely ignores the central role played by Citigroup.

It is always a mistake to suggest there is any panacea that would prevent crises -- either in the past or in the future. And none of the senators -- Maria Cantwell of Washington, Angus King of Maine, John McCain of Arizona, and Elizabeth Warren of Massachusetts -- proposing the legislation have made such an argument. But banking crises can be more or less severe, depending on the nature of the firms that become most troubled, including their size relative to the financial system and relative to the economy, the extent to which they provide critical functions, and how far the damage would spread around the world if they were to fall.

At its peak in 2008, Citigroup's assets were around $2.5 trillion -- we can call that over 15 percent of GDP. It was the largest bank in the U.S. and arguably the largest bank in the world. As a result of the crisis and the bailout measures put in place by both the Bush and Obama administrations, we have five groups of firms (with a holding company at the core) that resemble Citi in the run-up to 2007: JP Morgan Chase, Bank of America, Goldman Sachs, Morgan Stanley, and Citigroup itself.

All of them are now undoubtedly too big to fail.

The point of the New Glass-Steagall Act is to complement other measures in place or under consideration.

Nothing can completely remove the risk of future financial crisis. We can have a safer financial system that works better for the broader economy -- as we had after the reforms of the 1930s. Or we can have a system in which a few relatively large firms are encouraged to follow the model of Citigroup and to become ever more careless and on a grander scale.

Monday, November 19, 2012 - Debtmageddon: the Non-Problem Problem

Debtmageddon: the Non-Problem Problem

by Sinclair Noe

DOW + 207 = 12,795
SPX + 27 = 1386
NAS + 62 = 2916
10 YR YLD +.04 = 1.61%
OIL + 1.22 = 86.67
GOLD + 18.20 = 1732.90
SILV + .80 = 33.21

Pete Domenici and Alice Rivlin are co-chairs of the Bipartisan Policy Center for Debt Reduction Task Force, offering the following recommendations in an article in the New York Times over the weekend:

Economic growth must precede full-scale debt restraint.

Congress should take action now to pass legislation phasing in tax reform that yields new revenues and restructuring entitlements to curb the continued growth of federal spending, particularly for health care.

We cannot resort to such ham-handed mechanisms as the approaching sequester cuts, large across-the-board tax increases and other elements of the “fiscal cliff.”

In late 2010, the task force recommended a holiday from the full 12.4 percent Social Security payroll tax, not the partial 2 percent cut that Congress ultimately passed. The idea is that whether it comes in the form of a payroll tax holiday, an income tax rebate or another similar mechanism, the most pressing priority is to get the economy out of “stall speed.”

The task force also suggested a possible “framework” for the lame-duck Congress to pass a modest down payment on deficit reduction in December, while pursuing a comprehensive agreement, a “grand bargain” of sorts, in 2013.

If I may break it down in a nutshell; growth before austerity.

Federal Reserve Board Chairman Ben Bernanke will travel to New York City tomorrow to deliver a speech in which he will explain that the central bank is not having any second thoughts about its ultra-easy monetary policy stance. Bernanke will likely use his speech to emphasize once again that monetary policy will remain highly accommodative and will stay that way even after the recovery strengthens. Fed watchers generally think the Fed will boost its easing power in December by converting its expiring Operation Twist program into an outright Treasury purchase plan program. At the moment, the Fed is buying $45 billion of Treasurys per month under this plan, but the purchases are offset by sales of short-term securities. Don't expect any groundbreaking news from the Fed head, but expect a tone generally supportive of further easy monetary policy. The next Fed FOMC meeting is December 12-13.

Bernanke and the FOMC will likely adopt a wait and see attitude. They will wait to see if the dysfunctional Congress will really run like lemmings over the fiscal cliff. They might, but we have to let it play out. Policymakers are faced with a new round of momentous choices – how to balance the imperative for job creation with the pressure to address budget shortfalls. There will be temptations to hold firm and there will be temptations to cut a deal. The whole framework around cutting a deal is based on the idea that we must reduce the deficit and there must be fiscal responsibility. You could replace fiscal responsibility with austerity for the purposes of discussion.

The federal budget deficit isn’t the nation’s major economic problem and deficit reduction shouldn’t be our major goal. Our problem is lack of good jobs and sufficient growth. Deficit reduction leads us in the opposite direction — away from jobs and growth. Too much deficit reduction, too quickly would suck too much demand out of the economy; however, more jobs and growth will help reduce the deficit. With more jobs and faster growth, the deficit will shrink as a proportion of the overall economy. Europe offers the same lesson in reverse: Their deficits are ballooning because their austerity policies have caused their economies to sink. Yes, they are cutting spending but their economies are shrinking faster than the spending cuts; and the debt-to-GDP ratio grows. In fact, if there was ever a time for America to borrow more in order to put our people back to work repairing our crumbling infrastructure, it’s now.

And yet, there is still a loud chorus for debt reduction, and the media has bought into the idea, or at least they've hooked onto the fear factor involved with the phrases “fiscal cliff” and “debtmageddon”. They repeat the talking points of a small cottage industry that has sprung up around debt reduction. They say that it is a given that tax rate will go up; they say it is a given that spending will be cut; it's a given that deficits are bad. There has been very little discussion and debate about the dangers of deficit reduction. And so, the closest we've come to a serious debate is to discuss the timing: It all boils down to timing and sequencing: First, get the economy back on track. Then tackle the budget deficit.

Sounds good, but why does the deficit have to be tackled? Deficit hawks routinely warn unless the deficit is trimmed we’ll fall prey to inflation and rising interest rates. But there’s no sign of inflation anywhere. The world is awash in underutilized capacity As for interest rates, the yield on the ten-year Treasury note is about 1.6%, near record lows.

We certainly don’t want to go where Europe has been going lately. They’re a great example of how NOT to manage your way out of a debt crisis. It would take superb timing to avoid the fate of the Eurozone nations by planning for deficit reduction later, or at all? The assumption here is that there must and will be a time when we can reduce the deficit without harming the economy. What if there’s no such time? What if any substantial deficit reduction to under 4% of GDP, a figure envisioned in most of the deficit reduction plans being offered, means making the private sector poorer in the aggregate? Wouldn't that get priced in?

That's not just a theoretical question. Right now, the US imports more than it exports in an amount greater than 4% of GDP. If we continue to do so, and the Government deficit is forced down to a number below 4% of GDP, then a private sector surplus in the aggregate will be literally impossible to attain, and, if we continue with such a policy, year after year, the private sector will lose more and more of its net financial assets as the Government eats the private economy in a fit of fiscal irresponsibility, that since it’s now way past 1984, the austerity advocates label fiscal responsibility.

Public investments that spur future job-growth and productivity shouldn’t even be included in measures of government spending to begin with. They’re justifiable as long as the return on those investments – a more educated and productive workforce, and a more efficient infrastructure, both generating more and better goods and services with fewer scarce resources – is higher than the cost of those investments.

In fact, we’d be nuts not to make these investments under these circumstances. No sane family equates spending on vacations with investing in their kids’ education. Individuals can differentiate between spending and investing. Yet the politicians can't seem to do that with our federal budget.

I suspect the real concern over a “deficit problem” is due to fear of the markets and,maybe, just maybe there is no problem with running continuous deficits provided the Fed, along with the Treasury, control interest rate targets, and that the bond markets are powerless to impose their will on Mr. Bernanke and the Treasury Secretary if they want to keep rates near zero, or at any other level of interest they would like the US to pay. Well, guess what, the bond markets and the ratings agencies are basically powerless to drive up interest rates against the combined determination of the Fed and the Treasury to keep them low.

Of course, too much deficit spending can cause inflation, but the remedy for that is to raise specific taxes and lower specific spending in such a way that price stability and full employment result from fiscal policy. The best fiscal policy is one that spends what the US needs to spend to solve its serious problems.

Gross domestic product probably increased at about a 2.9 percent annual rate in July-September, according to economists from Goldman Sachs and Barclays. That would be the fastest quarterly growth this year, beating the Commerce Department’s initial estimate of 2 percent. Help is coming from a housing recovery, strengthening job market and healthier household finances that are driving gains in consumer confidence and spending. While the damage from Sandy and an anticipated tightening of fiscal policy mean growth will decelerate this quarter and next, the economy may emerge on stronger footing in the second half of 2013.

Sales of previously owned homes climbed in October. Purchases increased 2.1 percent to a 4.79 million annual rate. According to the report from the National Association of Realtors property values rose over the past 12 months by the most in seven years as inventories dropped to the lowest level in almost a decade.

Thirteen cents of every retail dollar is spent at gas stations, but that level has stagnated in recent years amid weaker demand. Americans spent some $47.85 billion at gas stations in October; that represents 13% of the $367.56 billion spent at all retail locations in the month. That share has increased a bit in recent months, but overall it’s little changed over the past two years. In the third quarter it was 12.5%, the same level as the first quarter of 2011.

The American Petroleum Institute reports US oil demand fell 2.3% in October from a year earlier, to 18.4 million barrels a day. Demand in the first 10 months of the year was 2.1% below the same period in 2011. A modest economic recovery and continued high unemployment, as well as higher fuel-economy standards, have reduced demand.

Another factor in reduced demand for gasoline, in relation to retail sales, is that e-commerce continues to grow. More than five cents of every dollar spent at retailers in the July-to-September period was spent online. That share has basically quintupled in the past decade, and while growth slowed slightly during the recession, it has continued to steadily march upward. The more goods people can get online, the less time they need to spend in the car traveling to brick-and-mortar retailers.

The shadow banking industry has grown to about $67 trillion, $6 trillion bigger than previously thought. The Financial Stability Board, or FSB says the size of the shadow banking system, which includes the activities of money market funds, monoline insurers and off- balance sheet investment vehicles, “can create systemic risks” and “amplify market reactions when market liquidity is scarce.”

The FSB, a global financial policy group comprised of regulators and central bankers, found that shadow banking grew by $41 trillion between 2002 and 2011. The share of activity based in the US has declined from 44 percent in 2005 to 35 percent in 2011, moving to the UK and the rest of Europe.

While regulatory watchdogs believe they have reined in excessive risk-taking by banks in the wake of the collapse of Lehman Brothers in 2008, they are concerned that lenders might use shadow banking to evade the clampdown. Already, the European Union is planning to target money market funds in a first wave of rules for shadow banks next year.

The FSB also targeted repurchase agreements and securities lending for tougher rules, recommending that regulators implement minimum standards for calculating losses on the different types of collateral used in the transactions.

Repurchase agreements are contracts where one investor agrees to sell a security and then buy it back at a future date and a fixed price. Securities lending agreements involve institutional investors such as pension funds lending financial instruments against cash collateral. The group is also concerned that regulators are unable to monitor the scale of the trades. 

The FSB says large firms should disclose more information about the deals to investors and may be required to publish regular statements detailing how much collateral they have and what it is used for. The need here is simple: a lack of transparency and disclosure results in counterparty risk, which in turn can lead to credit freeze, runs, and a general repeat of 2008. In other words, the FSB report tells us that the problems of 2008 haven;t been fixed, they've only grown in size.

New research from the Federal Reserve Bank of New York finds cheaper monthly mortgage payments significantly reduce mortgage default risk even when the principal value of the home stays the same. The report was based in part on findings on the performance of Alt A adjustable-rate mortgages, between 2008 and 2011.

The report says: “Interest rate changes dramatically affect repayment behavior. Our estimates imply that cutting a borrower’s payment in half reduces his hazard of becoming delinquent by about two-thirds. Government or lender programs that allow underwater borrowers to refinance at a lower rate, or loan modifications that lower the interest rate, have the potential to significantly reduce delinquencies, and the view that principal reduction is the only way to meaningfully reduce defaults is incorrect.”

Here's the scary part; they're just figuring this out.  Years ago, most people learned that when the loan sharks put the rates too high, it resulted in default; when rates were lower and closer to reasonable, people tended to pay their debts.