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

I presented this week at the Ryan’s Metal conference, discussing the state of the US economy. Also presenting was Thomas Berner, Chief US Economist of UBS, who discussed the state of the global economy.

He had this terrific chart (below). It makes it pretty clear that so far — nearly a year after the point where the recession looks to have technically ended — the recovery remains weak:

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Suddenly, Gary Shilling’s Bearishness Doesn’t Seem So Nutty
Aaron Task
Yahoo Tech Ticker, Jun 16, 2010 02:14pm EDT by

http://finance.yahoo.com/tech-ticker/suddenly-gary-shilling’s-bearishness-doesn’t-seem-so-nutty-505006.html

Initial Jobless Claims remain disappointingly elevated, totaling 472k on the week, 22k above expectations, up from 460k last week and at a 5 week high. After falling a sharp 234k last week, Continuing Claims rose by 88k, 71k above forecasts. Extended Benefits though fell by a net 169k but without the extension of unemployment insurance from Congress, many are exhausting their benefits. Some however are definitely finding new jobs but the pace is still slow. Looking forward over the next few months we must keep an eye on what influence the Gulf of Mexico disaster will have on jobs but it doesn’t seem to have been an impact in this report as the states leading the rise were not down south.

May CPI was down .2% m/o/m but up .1% at the core, both in line with expectations. Outside of a 2.9% decline in energy prices and a flat reading for food keeping a lid on headline inflation, Owners Equivalent Rent (25% of overall CPI) was flat and hasn’t risen since Aug ’09. This component looking forward though will be key to as with the end of the home buying tax credit reducing the impetus to buy a home, renting may become more attractive again and the drag to inflation seen in this component over the past yr may reverse. Lifting core inflation was a .4% rise in apparel as cotton prices at 14 year highs is seeping into the finished product. Vehicle prices rose .3% and medical care was up .1%. Medical care will also be a key focus as we see the upcoming impact from Obamacare. Net-net, the benign CPI will give the Fed the belief they have more license to continue to keep rates at zero even though headline inflation is up 2% y/o/y.

Plenty of inventory. Distressed sellers. Tight credit.

File this under DUH: If you are in the market for a house, the current real estate environment is on your side.

And buyers are taking full advantage of it:

“Exacting buyers are upending the battered real estate market, agents and other experts say, leading to last-minute demands for multiple concessions, bruised feelings on all sides and many more collapsed deals than usual.

It is a reversal of roles from the boom, when competing buyers were sometimes reduced to writing heartfelt letters saying how much they loved the house and how they promised to eternally worship the memory of the previous owners. These days, it is the buyers who are coldly seeking the absolute best deal while the sellers are left in emotional turmoil . . .

Builders have been affected too. Construction of new homes in May dropped 17.2 percent from April, the Commerce Department said Wednesday, significantly lower than forecast. Permits for future construction dropped 10 percent, suggesting a cruel summer.

Even the lowest home mortgage rates in decades are not doing much to invite deals. The Mortgage Bankers Association said Wednesday that applications for loans to buy houses were down by a third compared with last year. Applications are back to the level of the mid-1990s, when the country’s housing market was smaller.”

“Upending?”  No, they are merely taking advantage of the circumstances. Its the reverse of whatsellers were doing during the upswing in the market.

On the down side of the prices, buyers are the ones who have the upper hand — and are taking full advantage. Why this is a surprise to anyone is beyond my understanding . . .

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Source:
Housing Market Slows as Buyers Get Picky
DAVID STREITFELD
NYT, June 16, 2010
http://www.nytimes.com/2010/06/17/business/economy/17slump.html

The Financial Times – Good as GLD:

While it has now become possible to buy and sell gold with a few mouse clicks through funds like the $51bn SPDRS Gold Trust (GLD), now the world’s second-largest exchange-traded fund and sixth-largest owner of gold worldwide, old-fashioned ownership of bars, coins or stakes in mines has surged too. But, unlike shakier exchange traded notes, gold ETFs are backed by physical assets rather than pieces of paper.

It is debatable whether profligate governments and easy money justify gold as a financial investment, but the notion that one can only trust tangible gold is more than a bit ridiculous. So is the notion of a gold shortage. More than any other commodity, the amount of gold above ground far exceeds actual consumption. History has shown that, even during war, hyperinflation or famine, someone will always sell or barter their gold. And suggestions that governments, whose currencies are no longer backed by precious metals, would confiscate gold as the US did in the 1930s or that they are engaged in a conspiracy to distort gold reserves, are outright paranoid. Part of gold’s historical appeal was its portability and immutability. But insisting on direct ownership only makes investing in it unnecessarily cumbersome and expensive. The only people who profit are miners, promoters and vault manufacturers, not the fearful goldbugs themselves.

Comment

As we posted on May 13, gold hit record highs in many major currencies as fears about the financial system’s stability continued to rise. Over the past year gold’s popularity has made the GLD fund the second-largest ETF with just under $50 billion in assets, trailing only State Street’s SPY fund in terms of total assets. The next largest gold fund in terms of assets, COMEX Gold Trust’s IAU, has roughly $3 billion in assets (not pictured).

<Click on chart for larger image>

With this increase in popularity comes much increased scrutiny about the fund, although a quick glance over the prospectus and quarterly statements prove many of the concerns raised by investors to be overblown.

One criticism often raised about the GLD fund is its lack of transparency regarding its holdings of physical gold. Does the fund use derivatives and own “paper gold” or does it own enough bullion to support redemptions by all its shareholders? This concern can be quickly put to rest after reading a couple points in GLD’s prospectus. First, on page 14 of the GLD prospectus (page 16 of PDF) the amount of physical gold held in its vaults is stated:

As at March 31, 2010, the amount of gold owned by the Trust was 36,324,952 ounces with a market value of $40,520,483,790 (cost – $30,289,189,919), including gold receivable of 166,431 ounces with a market value of $185,653,480 based on the London PM Fix on March 31, 2010. As at March 31, 2010, the Custodian held 36,158,521 ounces in its vault (36,158,483 ounces of allocated gold in the form of London Good Delivery gold bars and 38 ounces of unallocated gold), excluding gold receivables, with a market value of $40,334,830,509 (cost – $30,103,536,538).

Still, some are concerned that GLD may actually only own gold in paper (derivative) form rather than physical bullion. Page 16 of the GLD prospectus (page 18 of PDF) comments on the use of derivatives:

The Trust does not invest in any derivative financial instruments or long-term debt instruments.

Furthermore, investors can view a list of each individual bar of gold held in the vault by serial number which is updated daily. An independent firm verifies these holdings twice a year.

While these concerns are definitely understandable in a time when derivatives are considered toxic in every form, the GLD fund makes every effort to calm investors fears in this respect.

Helped out by the highest yields since July ’08 and a 40 bps jump just this week, Spain successfully sold 10 yr and 30 yr bonds. The 10 yr was sold at a yield of 4.86% up from 4.05% in the last one in May and the b/c was 1.89 vs 2.03 in May. The 30 yr yielded 5.91%, up 115 bps from the last one in Mar and that sharp jump resulted in a b/c of 2.45 vs 1.37 in Mar. The 5% yield level is key because it’s the price where the Euro bailout fund will likely offer its loans. Hungary also sold debt with differing maturities that was met with strong demand but at yields all above 7%. Their successful sale has the Forint at a 2 1/2 week high vs the US$. Also helping sentiment in Europe today in terms of bank transparency is the news from the German Finance Ministry that they will follow Spain and publish the results of last year’s bank stress tests. The pound is at a 5 week high vs the US$ after a much better than expected May UK retail sales figure.

“There is no trick. We can’t promise to work less, raise pensions and erase deficits.”
-French Labor Minister Eric Woerth

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The issue of government debt seems to be coming up a lot news lately. Courtesy of the credit collapse and economic recession, Deficits are front page news. Classic balance budget advocates are reiterating their views, joined by hypocritical partisans who, after a decade of spending profligacy, unfunded tax cuts, new entitlement programs and a war of choice, have “suddenly” discovered the evils of borrowing.

Then there are the major entitlement programs: Social Security, Medicare and the Prescription Drug plan. These are, we are told, an even bigger problem then the ordinary budget deficit. As presently configured, the entitlement deficits are set to skyrocket as the boomers retire. Social Security especially is a target of persistent fear-mongering.

This is all unvarnished nonsense. Social Security is at present, financially stable; As it starts to run into increasing deficits, the political classes will be forced to respond.

I am going to hazard the surprising forecast that Social Security will never run out of money. If that sounds like some sort of economic blasphemy, just take a look across the pond for a glimpse of SS’s future. President Sarkozy of France (France!) is showing not only Greece how to get its welfare state in order, but he is also demonstrating to us Americans what the future of entitlement programs look like. Following Sarkozy’s lead, in the US, we should expect to see three major changes to Social Security:

1) Your Retirement Age Will Go Up:   And up and up and up. I expect to see a staggered from 65 (66 and 67 relative to birth date), to 68 then 70 then 72 years old. France just raised their retirement age to (tee hee) 62.

2) Your Taxes Are Going to Go Up:  The Federal Insurance Contributions Act (FICA) is the payroll tax that funds Social Security. These are likely to increase, in one of two ways: Percentage paid, and gross wage amount taxed. I suspect it is the latter that will be targeted first.

Currently, FICA taxes amount to 15.30% (7.65% paid by the employee and 7.65% paid by the employer) of income. That is a big chunk of anyone’s salary, and raising that is going to be met with a fierce pushback. Perhaps a minor increase in total FICA percentage might be enacted.

However, the gross wage amount tops out at $106,800. That cap is very likely to increase — slowly at first, in COLA increments, than in greater amounts. My guess is this will top out at $200k within a decade, and a million dollars the following decade.

More controversial are other taxes that could fund SS.

3) You Will Be Subject to a Means Test: The third way SS will get its house in order will be to stop making payments to people who don’t need the money for retirement.

The political rhetoric will sound like this: Social Security was set up as an insurance fund. Just as if you don’t receive any compensation for Fire Insurance unless you house burns down, you won’t get social security unless your financial house is in ruins.

I cannot give you a timeline, or analyze whether these are good or bad modifications. That is not what I do. I can, however, look at the numbers of this, see where there are options, and estimate the most likely future occurrence based upon the mathematics. The conclusion I draw: Retirement ages are going up, Taxes are going higher, eligibility is going lower, and payments are going lower as well.

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Sources:
Sarkozy Lifts Retirement Age to 62; Unions Protest
Gregory Viscusi and Helene Fouquet
Bloomberg, June 16 2010  
http://www.bloomberg.com/apps/news?pid=20601087&sid=aigMGWBIRZB0&

Social Security Offical Website
http://www.socialsecurity.gov/

Chairman Ben S. Bernanke

At the Squam Lake Conference, New York, New York

June 16, 2010

The Squam Lake Report –the centerpiece of this conference–is a valuable contribution to the ongoing analysis of the causes of the financial crisis and the appropriate policy responses.¹ I commend the organizers for bringing together an impressive group of scholars both to produce the report and to continue the discussion of these important policy issues at this meeting.

I think we all agree on the key questions facing financial regulators: How do we strengthen the financial system and its oversight so as to minimize the risk of a replay of the recent financial crisis? And should a crisis occur, how can we limit its economic costs? The report identifies two core principles that should be among those that guide us in answering these questions. First, financial policymakers and supervisors must consider more than the safety and soundness of individual financial institutions, as important as that is; they should also consider factors, including interactions of institutions and markets, that can affect the stability of the financial system as a whole. In the jargon of economists and regulators, supervisors need a macroprudential as well as a microprudential perspective.

The second core principle put forth in the report is that the stakeholders in financial firms–including shareholders, managers, creditors, and counterparties–must bear the costs of excessive risk-taking or poor business decisions, not the public. The perception that some institutions are “too big to fail”–and its implication that, for those firms, profits are privatized but losses are socialized–must be ended.

The Federal Reserve strongly agrees with both of these principles, and both have been important in shaping our views on regulatory reform. We also broadly agree with the narrative of the crisis offered in the report, which discusses, among other things, the role of subprime lending in the housing boom and bust; the structural weaknesses in the shadow banking system, including insufficient transparency and investor overreliance on rating agencies; inadequate risk management by many financial institutions; and a flawed regulatory framework that allowed some large financial firms to escape strong consolidated supervision and gave no regulator the mandate or powers needed to effectively evaluate and respond to risks to the financial system as a whole. Weaknesses in both the private sector and the public sector, in the framework for regulation, and in supervisory execution all contributed to the crisis. The crisis in turn led to a severe tightening of credit, a collapse in confidence, and a sharp global economic downturn.

The Squam Lake Recommendations
What, then, is to be done? The Squam Lake Report provides a substantial set of recommendations. Among these are the adoption of a more systemic approach to the supervision and regulation of financial firms and markets; enhanced capital and liquidity regulation for financial firms, particularly for systemically important institutions; improved information collection by regulators and, where possible, the public release of such information; development of a resolution regime that would allow the authorities to manage the failure of a systemically important financial firm in an orderly manner while imposing losses on shareholders and creditors; and significant strengthening of the financial infrastructure, particularly for derivatives contracts. The Federal Reserve has supported legislative changes in all of these areas, and, where possible under current law, has initiated changes along these lines within its own operations. In the remainder of my remarks I will elaborate briefly on these recommendations, with particular attention to how they are currently helping shape regulatory reform and the Fed’s own regulatory and supervisory activities.

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