The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Countdown to the opening bel, with Art Cashin, UBS Financial Services and CNBC’s

Via Bob Bronson, we get this very interesting way to think about the potential universe of market returns:

In addition to the almost universally improper use of the correlation function that we have presented before (our Correlation Puzzle is available on request), Alpha-Beta, Efficient Frontier, Black Scholes, VaR, stochastic modeling, and exotic derivatives from Modern Portfolio Theory and Post-Modern Portfolio Theory also variously depend on security returns being “normally” distributed, but it is demonstrable that they are not for any capital market over any time scale.

Don’t confuse the distribution of returns on a log-scale versus an arithmetic scale – see those chart comparisons further below. A common mistake made by many, especially on internet blogs, is not understanding the huge application difference between application of logarithms and percentages. A good example is the systemic drift with index funds and ETFs, especially the high (beta) multiple inverse ones.

Interesting results of Merrill’s Monthly Manager Survey: It seems that most managers are very upbeat about the economy and the state of corporate health:

• Cash balances plunge to 3.5%, lowest since July’07;

• Highest equity allocation (34% from 7%) since Oct’07;

• Bond allocation (-28% from -12%) lowest since April’07.

• Tech (28%) is the most favored sector everywhere;

• 75% believe the world economy will strengthen in the coming 12 months (highest reading since November 2003 and up from 63% in July).

• 70% of the panel respondents expect global corporate profits to rise in the coming year, up from 51% last month.

• Confidence about corporate health is at its highest since January 2004

While I keep hearing about cash on the sidelines,. the professionals seem to be “All In.”

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Source:
Merrill Lynch Fund Manager Survey Finds Economic Optimism Highest Since 2003 as Investors Put Cash to Work
August 19, 2009

http://tinyurl.com/n5ddgt

The August Philly Fed survey came in at +4.2, above the consensus of -2.0, up from -7.5 in July and follows the unexpected gain in the Empire survey seen on Monday. It’s the first positive reading since September ’08 and is at the highest level since November ’07. The data measures the direction of improvement, not the degree so don’t extrapolate that we are at November ’07 output levels. New Orders rose 6 points to +4.2. Backlogs rose 5 points but remain negative at -9.3. Employment rose by 12.4 points to -12.9. In a clear message that the inventory drawdown has run its course, inventories rose from -15.4 to +.3, the first positive number since September ’07, yes 22 straight months of declines. With the rebound in the data comes a bounce in both Prices Paid and Prices Received, both at the highest level since October. The 6 month outlook rose 5 points but is 3.3 points below the level seen in June. Net-net, the data confirms for now the 2nd half inventory/manufacturing recovery hopes. The stock market however has discounted this and will need confidence that the rebound is something that can be sustained into 2010 in order to see another leg higher.

Initial Jobless Claims totaled 576k, 26k more than expected and up 15k from the prior week which was revised up by 3k. This brings the 4 week average up to 570k from 566k. Continuing Claims were 26k more than estimated and up 2k from last week. The insured unemployment rate was 4.7%, unchanged with the prior week. Those filing for Emergency Unemployment Compensation, which includes those that have exhaused their 26 weeks of continuing claims, rose by 92k to 2.878mm, a new high in this cycle. Those receiving extended benefits, which stretch past the life of EUC, fell by 48k to 401k and we’ll see if this is occurring because all unemployment benefits are running out for these particular individuals or it’s because they are finding new jobs. Because the pace of hiring is still extremely sluggish, it is unfortunately likely the former. Bottom line, the labor market remains very difficult.

Last night, I asked what the letters “U B S” stood for — using “U Better Sing” and “Unreliable Bankers Swiss” as examples.

Readers responded with dozens of examples of possible other names that worked well. In fact, there were quite a few fantastic suggestions, which I culled down to a Letterman style short list of my favorites:

Top 10 Things the Letters “UBS” Stands For

10. Uncle Broke Sam
9. Unlocked Banking Secrets
8. Untaxed Bastards Suffer!
7. Uber Blown Secrecy
6. Untrustworthy Bankster Swine
5. Used to BS (the IRS)
4. Unconcealed Banknote Storage
3. Unlawful Benefits Seized
2. U’d Better Surrender

and the number one thing UBS stands for:

1. Utilize Bahamas, Swiftly!

Honorable Mentions after the jump . . .

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The Cato Institute hosts a discussion on increasing the public transparency of the Federal Reserve featuring Rep. Ron Paul (R-TX); with comments by Gilbert Schwartz, Partner, Schwartz & Ballen LLP, Former Associate General Counsel, Federal Reserve; and Bert Ely, President, Ely & Company, Inc. Moderated by Mark Calabria Director, Financial Regulation Studies, Cato Institute.

Full Video here

Kansas City Fed President Thomas Hoenig, the host for the annual Jackson Hole Fed confab, is utterly against bailouts, and thinks “Too Big To Fail” is a losing strategy.

As I noted previously, “Real capitalists nationalize; faux capitalists look for the free lunch.”

Bernanke has urged Congress to back part of Hoenig’s proposal for dealing with faltering big banks, which would wipe out shareholder equity in any that receive government aid. The Treasury Department’s so-called resolution authority plan, while likely to result in stockholder losses, doesn’t require it . . .

Hoenig, 62, took office in 1991 and is soon to be the longest-serving Fed policy maker. Out of the 12 regional Fed presidents, he is one of two to have served as a head of bank supervision. Hoenig is tougher than his colleagues on inflation, having dissented from interest-rate votes four times since 1995, always for tighter policy.

Alternative to Bailouts

Companies with weak capital or investor confidence shouldn’t be bailed out, Hoenig said in a private talk in Omaha, Nebraska, in March. He said the government instead should declare them insolvent, replace managers, remove the bad assets and require shareholders to take losses. Hoenig broke from his usual practice of speaking from notes on index cards for non- economic comments and released written text entitled “Too Big Has Failed.”

One of the great tragedies of the entire banking debacle — from the run up to the collapse and aftermath — is how miuch good advice was ignored. This is yet another unfortunate example . . .

See this July video, Hoenig Calls For Takeover Process For Failing Firms.

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Sources:
TOO BIG HAS FAILED
Thomas M. Hoenig President and Chief Executive Officer
Federal Reserve Bank of Kansas City, March 6, 2009

http://www.kc.frb.org/speechbio/hoenigpdf/omaha.03.06.09.pdf

Hoenig Stirs Debate on Bank Failures as Fed Forum Convenes
Scott Lanman
Bloomberg, August 20 2009

http://www.bloomberg.com/apps/news?pid=20601068&sid=aFsKPn0jLwSU

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Thomas Hoenig calls for a process of taking over financial firms that are failing letting them know they won’t get a government guarantee. (Bloomberg News)

July 01, 2009

Good Evening: Just when it looked as if the U.S. stock market would resume the Friday/Monday slide today, share prices pulled out of a morning nosedive to finish higher for a second straight session. Rising energy prices and a falling dollar both aided this light volume turnaround, with the latter receiving quite a bit of attention from luminaries located in Omaha, NE, and Newport Beach, CA. Since so many investors have previously used dollar weakness as a signal to expand their risk appetites, the warnings about the greenback from points far west of Wall Street should make for an interesting next few days.

The big news overnight was not Hewlett-Packard’s earnings (HPQ reported a beat, but its shares declined, anyway), but renewed pressure on Chinese stocks. The CSI 300 index lost nearly 5%, bringing the cumulative damage since its recent peak to 20%. With little in the way of economic data out today, the thud felt in China had an impact on other markets. U.S. stock index futures were thus indicating a 1% lower opening prior to the commencement of trading in New York. Better earnings, but only so-so guidance from Deere (- 3%) didn’t help the psychological backdrop, either.

Once stocks did open just more than 1% lower, though, the selling just dried up. Already on a bounce that would carry them back to nearly the unchanged mark, the major averages (especially the energy sensitive companies inside them) turned positive after the energy inventory data were released. Rather than the expected builds, inventories dropped and sent crude, its products, and commodities in general on a bit of a tear. Energy and raw materials names led the resulting upswing that left most of the indexes up 1% by mid day. Trading then slowed and the averages gave a little ground into the close. The Dow Transports (+0.3%) were the smallest beneficiary of today’s rally, while the Russell 2000 (+0.95%) was the best performer. In a mild upset that may or may not mean anything, Treasurys bucked the mild trend toward expanding risk appetites by rising. Yields fell 4 to 7 bps as the yield curve flattened. The dollar, however, did line up with equities when it fell 0.6%. Commodities followed energy prices higher, and the CRB index led all the other asset classes in gaining 1.6% on Wednesday.

Whereas equities have enjoyed a positive correlation to commodities and a negative correlation to Treasurys, the strongest relationship this summer has been the inverse one between stocks and the U.S. dollar. When one rises, the other falls, and vice versa. Today, one of the factors that may have inadvertently helped push equities higher was a couple of negative articles about the greenback. First, Warren Buffett took issue with what he called “greenback emissions” in the Op Ed piece for the New York Times that you will find below. The Oracle of Omaha is concerned about all the deficit spending, money printing, and the resulting surplus of dollars in the global marketplace. He plays it down the middle, careful not to blame either major party, and he actually praises both the Bush and Obama administrations for their actions during the Great Recession. But even the eternal optimist in Mr. Buffett can’t ignore what he feels is a long term threat to the U.S. — currency debasement and, ultimately, inflation.

PIMCO also piled on with its own warning about the perils of endangering the dollar’s status as the global reserve currency of choice (see below). What was interesting about the reaction in our capital markets is that market participants took the weakness in the greenback as a signal to buy stocks today. Perhaps the sense of bullish capitulation described in the Bloomberg article below is another reason large investors have been chasing stocks since March. The momentum crowd that tends to rule the short term direction in stock trading didn’t seem to catch Mr. Buffett’s strong hint that, left unchecked, the massive fiscal and monetary responses sponsored by Uncle Sam to date will someday risk a return of inflation, a funding crisis, or both. Mr. Buffett even quotes John Maynard Keynes, the patron saint of Congressional economics, when describing the risks of letting the politicians in D.C. decide whether to make tough decisions when it comes to economic matters:

“‘By a continuing process of inflation, governments can confiscate, secretly and unobserved, an important part of the wealth of their citizens…The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in a million is able to diagnose.’” (Source: The Greenback Effect).

Mr. Buffett unfortunately ignores the important role the Fed plays in this process, concluding that “Unchecked greenback emissions will certainly cause the purchasing power of currency to melt. The dollar’s destiny lies with Congress” (source: The Greenback Effect). If we have to rely on the U.S. Congress to do the right thing, then I fear Mr. Keynes will ultimately be proven right with regard to his above analysis. Bill Fleckenstein, who penned an excellent review of Mr. Buffett’s NYT piece today in his Daily Rap (www.fleckensteincapital.com), has long since reached the Keynesian conclusion about politicians and their love of inflation to cover up their sins. The masthead on his website has long read: “In a social democracy with a fiat currency, all roads lead to inflation.” Well said, Bill. Mr. Market, please copy!

– Jack McHugh

U.S. Stocks Advance as Energy, Health-Care Shares Lead Gains
Investors Pile Into Stocks as Risk Appetite Jumps, Merrill Says
Pimco Says Dollar to Weaken as Reserve Status Erodes
The Greenback Effect