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Yield Heading Lower ?

The following via Ron Griess of The Chart Store

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One of the suggestions I made in the new chapter of Bailout Nation (written for the paperback prior to fin reg passing) was some common sense advice to the SEC:

“To root out more corporate fraud, [the SEC] should establish an aggressive whistle blower program that rewards those who identify fraud with a percentage of any recovery of penalties imposed (similar to the program the IRS has).”

It turns out that the the financial reform legislation has big cash rewards to whistleblowers who report fraud and other wrongdoing at publicly traded firms and Wall Street banks:

“Under the program, which is already live, anyone who provides a tip that leads to a successful Securities and Exchange Commission action will be able to collect between 10% and 30% of the amount recovered — as long as the total amount exceeds $1 million. This means the minimum payout is $100,000. The whistle-blower could be a company insider or a private investor, if they’re able to offer information or analysis that leads to an action. And with potential payoffs netting millions — or even tens of millions — of dollars, experts are bracing for a surge in tipoffs.”

We should look forward to the annual SEC reports of how much in fraud and corruption was rooted out by whistle blowers.

I also expect to see this become somewhat institutionalized — we might see some well capitalized hedge funds hiring or funding whistle blowers to gain insight into stocks to short;

I wonder if we might see a new hedge fund model: A fund that is formed and funded to literally chase whistle blower rewards with a similar pay structure as traditional 2/20 hedge funds.

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Source:
SEC Now Offering Big Payoffs To Whistle-Blowers
Janet Morrissey
Time, Aug. 19, 2010
http://www.time.com/time/business/article/0,8599,2012066,00.html

Greek debt traded poorly again today. The 2 yr note yield is now approaching 11% at 10.98%, up 29 bps on the day and now exceeds the 10 yield of 10.90%, up 15 bps on the day. Also, 5 yr CDS is wider by 40 bps to 920 bps, the highest since late June. In addition to continued fears that the Greek economy is choking on its austerity program, earlier this morning the Bank of Greece said bank deposits by households and businesses in Greek banks fell for a 6th straight month. In response, the euro is falling to a 5 1/2 week low vs the US$ and to just shy of a 9 year low vs the yen.

Fascinating graphic art looking into our title question over at Recombinant Records — an oddly intriguing  series of cartoons by Stuart McMillen.

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click for full sized version

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Hat tip Josh

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A Guide to Federal Reserve Monetary Policy, the Economy, and Financial Markets

By James Welsh, Registered Investment Advisor                   jwelsh@welshmoneymanagement.com

Investment letter – August 15, 2010

My approach combines both fundamental analysis and technical analysis, which is unusual. Most economists and market strategists rely almost exclusively on fundamental analysis, which focuses on the economy and estimates for corporate earnings. Technical analysis utilizes measures of price momentum, moving averages, and charts of the major market indices like the DJIA and S&P 500. I believe the combination of both disciplines is better, since each provides a different perspective. The probability is higher that my analysis is on target, when the fundamentals and technical indicators are aligned, especially at major turning points in the economy and stock market.

In the June 14 letter, I reviewed the Major Trend Indicator (MTI), which is a proprietary technical indicator that attempts to confirm the onset of bull and bear markets. It is far from perfect, but overall is pretty good. Although the MTI indicated that a new bear market began on June 8, I expected that the S&P would rally up to 1,130-1,150. As the S&P approached the 1,130 level, I sent out a Special Update on August 4, which suggested it was time to sell into strength and become more defensive.

“I think this rally is another opportunity for investors to sell into strength and become more defensive. The market is near at least a short-term high. As long as the S&P holds above 1,080, the uptrend from the July low is still intact. It is possible that the S&P could make a new high above 1,220, as long as selling pressure remains muted. Although this Friday’s jobs report could obviously bring in some selling if it is a disappointment, I don’t see much on the near term horizon that is likely to cause a period of sustained selling. This suggests the market could hold up until Labor Day, and grind higher. The problem for most investors is that when the market turns south, it is likely to come without much warning. That is why selling into strength makes sense, even if the S&P pushes a bit higher in coming weeks.”

Over the next 4 trading days, the S&P tested the 1,130, with highs of 1,126.56, 1,123.06, 1,129.24, and 1,127.16. From the high at 1.127.16 on August 10, the S&P dropped more than 50 points within hours to 1,087.68 on August 12. It is clear that the market made a short term high in early August. More importantly, the Major Trend Indicator gave a sell short signal as of the August 13 close. This suggests that the high just under 1,130 may mark more than just a short term peak. In April, I suggested selling and becoming more defensive, when the S&P was above 1,210. The S&P peaked on April 26 at 1,219.

From a practical sense this sell short signal from the MTI suggests investors should become even more defensive. As discussed in the July 13 letter, and the August 4 Special Update, “The potential for additional gains from current levels is certainly possible. However, if I’m right about the coming economic slowdown in the second half of this year, and especially in 2011, the approaching high in the market should be followed by a nasty decline. If and when the S&P falls below 1,040, the next stop will be 950 or lower.” So this signal could be an indication that this decline has commenced. However, it must be noted that the MTI is not immune from an occasional head fake.

After the market bottomed in September 2001, the MTI gave a bear market buy signal in early October, as noted on the chart above. That rally lasted until January 2002, when the MTI turned down. Although it is not marked on the chart, you can see the decline in the MTI, under 2002 on the S&P chart. This was a sell short signal. The S&P fell until late February, and then launched another bear market rally into late March. The sell short signal in late March 2002 turned out to a great signal, after the head fake signal in January. The same pattern occurred between December 2002 and February 2003, just before the S&P fell into the March 2003 low.

In the very short term, based on a 60-minute S&P chart, a quick drop below last week’s low at 1,076.69 looks like it will complete the first portion of the decline from the high last week at 1,129.24. If correct, the completion of this first leg down should be followed by a rally that retraces at least a portion (35% to 70%) of the decline, and results in an S&P rally back to 1,090 to 1,106.

Just as it seemed like a good idea to sell into strength with the S&P above 1,210 in April, and near 1,130 last week, investors should sell into any rally back toward 1,100. It is certainly possible that the market could hold up until Labor Day. With the election coming up in November, the urge by both parties to say whatever it takes to win could give the market a lift.

And, it is possible that investors will conclude that another round of Quantitative Easing by the Fed is the right medicine for what ails the economy. I don’t agree with that view, and believe it is just a matter of time before investors realize that another round of QE by the Fed is failing to prevent the contraction in credit from continuing. As noted in the July letter, for the first time since 1960, the 12 month growth rate in M3 money supply has not only fallen below zero, it has contracted by -5.6% over the last 12 months. Since peaking in October 2008, total commercial and industrial loans by large banks have plummeted by 24%. The Fed is not planning more QE because the first round was such an overwhelming success. They are doing it because they don’t have any other options.

Aggressive investors can establish short positions, by either buying the short S&P ETF SH or SDS, which will approximate a 200% over time. I would recommend scaling into positions, since there is a good chance of a bounce back toward 1,090-1,100. Conversely, a decline below 1,056 would suggest the rout is on.

Fundamentally, the U.S. economy is fading as forecast. Whether it turns into a double dip is secondary. As the economy slows, concern that it might develop into a double dip should be enough to cause selling pressure to increase. In addition, the EU stress test does not change the fact that European banks are in worse shape than their U.S. counter parts, or that Ireland, Spain, and Portugal are accidents waiting to happen. And, over the next 12 months or so, it is going to become apparent that Chinese banks were too aggressive in lending the equivalent of 25% of China’s GDP in a single year, and there will be losses.

The U.S. consumer represents 70% of U.S. GDP. The next two charts show you everything you need to know about the level of consumer demand in coming months. Without more jobs, consumer spending is going to be weak, which is why retail sales are far weaker than in prior recoveries.

As you can see, other than gasoline sales and car sales, most retail sales categories were negative. Overall retail sales were up .4%, but if gasoline and automobile sales were excluded, sales were down -.1%. It should be noted that the increase in car sales was driven by deep discounting, which suggests that some of the July sales were drawn forward so sales in coming months could be weaker. The chart below shows how the current recovery stacks up to the recoveries following the last four recessions 31 months after each had begun. Thirty-one months after the beginning of the 1973-1974 and 1981-1982 recessions, retail sales were up more than 20%. The 1990-1991 and 2002 recessions were followed by tepid recoveries. Still, retail sales had gained 10% after 31 months. Despite all the fiscal stimulus and Quantitative Easing, retail sales are still down about 4% from 31 months ago. Who knows. By the time the Fed is executing QE3, rather than buying Treasury bonds or mortgage backed securities, the Fed may start buying cars, washing machines, and homes directly from underwater home owners!

DOLLAR

Investors can buy the Dollar bullish ETF UUP on a pullback below $23.80, using $23.35 as a stop.

Jim Welsh

With little direction of its own, the S&P futures bounce is following a rally in Europe. Europe shrugged off a slightly weaker than expected Aug PMI Services and Manufacturing index which is still at good level led by Germany and France, the two countries who have a much greater burden now to carry the economic load for the continent with southern Europe facing enormous fiscal pressures. 3 month Euro LIBOR fell to a 4 week low and European credit is relatively calm today. With the yen hovering around 15 year highs vs the US$, Japanese PM Kan and the BoJ Gov spoke over the weekend but supposedly no discussion of FX intervention took place. As I mentioned last week, the BoJ intervention experience in ’03-’04 was text book spitting in the wind after they spent 35T yen to no avail.

I spoke with David Streitfeld of the NYT last week about the future prospects for Homes as an investment (I have a short quote in today’s Housing Fades as a Means to Build Wealth, Analysts Say):

“Housing will eventually recover from its great swoon. But many real estate experts now believe that home ownership will never again yield rewards like those enjoyed in the second half of the 20th century, when houses not only provided shelter but also a plump nest egg.

The wealth generated by housing in those decades, particularly on the coasts, did more than assure the owners a comfortable retirement. It powered the economy, paying for the education of children and grandchildren, keeping the cruise ships and golf courses full and the restaurants humming.

More than likely, that era is gone for good.”

I don’t disagree much with any of the others quoted in the article. (Stan Humphries, chief economist for Zillow; Yale’s Bob Shiller; Dean Baker of Center for Economic and Policy Research). I find our variances are mostly matters of nuance.

The chat I had with Mr. Streitfeld ranged far and wide, and tried to put some context on the entire Housing problem, which remains poorly understood by many. The rest of the conversation was rather intriguing. Some of the ideas batted about include:

• Housing over the past century managed to just outpace inflation (by 1.1%, according to Shiller);

• The bond bull market that began in the late 1970s has driven mortgage rates down from the peak by as much as two/thirds — as high as 15% down to ~5%.

• The post WWII growth of suburbs and the subsequent baby-boom demographic surge created a massive demand for Housing unlikely to be equaled inthe next few decades;

• The three decade long decrease in the cost of credit was an enormous source of Real Estate appreciation over that same period (1980-2005);

• Bull Markets eventually end with a blowoff top; In doing so, they pull forward a decade or more of future returns;

• We remain 5-15% overvalued n home prices nationally; That could be worked off by a big drop tomorrow, or by a 7-15 year period of no appreciation, depending upon inflation and wage gains;

• Housing has problems with both too much supply and not enough demand. Bring in 3 million qualified home buyers from abroad and the Housing issue goes away.

A few other thoughts worth sharing:

It is safe to buy 2 kinds of properties right now: The first is simply math: If you are planning on living in a specific location for at least 10 years , then the calculus of rent vs own likely favors the buyer once you figure in mortgage tax deduction. The numbers are obviously determinative, so do the math of your income, tax situation, and alternative rental options. Renting might put you into a less desirable school district in parts of the country; that is a non-monetary factor that needs to be considered.

Second, I would not be afraid to buy a “unique” or vacation property. By unique, I mean not a tract home or development, but a something special: Beach front, lake side, mountain view, etc. kind of place that cannot easily be replaced or reproduced. The kind that 10 years from now, you kick yourself for not buying. A truly unique purchase avoid Real Estate regret.

I was surprised when he mentioned I was one of the more bullish housing analysts he spoke with! My answer to that was the time to be an über-bear on Housing (or anything, really) is before the collapse — not afterwards.

Lastly, I must always remind people that there are no such things as toxic assets — only toxic prices.

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Previously:
Prior Housing commentaries can be found under the category: Real Estate.

Source:
Housing Fades as a Means to Build Wealth, Analysts Say
David Streitfeld
NYT, August 22, 2010
http://www.nytimes.com/2010/08/23/business/economy/23decline.html

See also:
Housing Diagnosis: Still Weak (WSJ)

Housing Slide in U.S. Threatens to Drag Economy Into Recession (Bloomberg)

Are We In An Economic Purgatory?
Greenspan/Bernanke Put, Moral Hazard

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What to buy now

David R. Kotok
Chairman and Chief Investment Officer
Mid-August Bullets
August 22, 2010

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Middle East geopolitics raise the fear quotient. The Obama administration’s response to Middle East tension remains a mixed message.

Israel faces another “flotilla” plus the Iranian nuke threat. For Prime Minister Netanyahu, this is a two-front geopolitical war that can threaten the survival of his country. For the United States, this piles on top of Iraq uncertainty, Afghanistan irresolution, and Russian snubbery.

All this is happening in the heat of an election year, with President Obama’s approval ratings so low that some political pundits now forecast a swing of 50 to 80 House seats. This outcome would leave the Democrats a bruised and repudiated minority. Their replacement would be an energized and harshly vindictive Republican majority. Acrimony will remain the dominant emotion on the political stage, even though the cast of characters may change.

In both world and domestic politics, with threats of war markets gravitate to higher-quality or insular sectors. We have seen that underway since the start of July. Examples: Treasuries (flight to quality) have rallied robustly. Big-cap stocks have outperformed small- and mid-cap stocks. Growth has been doing better than value. Defensive areas like utilities and pharma have gained relative strength.

Let’s get to the Federal Reserve. Bernanke’s big speech from Jackson Hole will focus attention on the new Fed paradigm.

In the pre-Lehman days, the old Fed managed interest rates as their primary policy tool. The Fed’s balance sheet approximated $900 billion, mostly Treasury securities, on the asset side. The liability side was essentially the US dollar-denominated currency circulating throughout the world or held by banks as reserves while being parked in ATM machines. That paradigm is dead.

The new Fed paradigm adds over $1 trillion in securities on the asset side. The Fed is trying to transition from GSE-sourced mortgage paper to Treasuries as a substitute. On the liability side, the Fed now holds $1 trillion of excess reserves, parked with the Fed by the large banks. Nobody knows what the appropriate size of the Fed’s balance sheet should be in a climate characterized by trillion-dollar Federal deficits, 10% unemployment, growing regulatory oppression, high political uncertainty, and the rising geopolitical risk outlined above.

Bernanke is the classic “man in the middle”. His policy back is against the wall of the zero boundary in nominal interest rates. He fully understands the rising risk of deflation. He knows he must do whatever it takes to keep the United States from sliding into a Japanese-style lost decade. Markets wonder whether the Fed is running out of “bullets.” Bernanke’s task at Jackson Hole is to make the Fed’s arsenal credible.

We believe the Fed has the arsenal. They have worked on it for nearly a decade. Clues may be observed in earlier Fed speeches by Bernanke, Reinhart, and others. One needs only to read that history.

Juvenile market observers don’t read history these days. Eyestrain from text has been replaced by irritating TV sound bytes and 30-second summaries. In times like this, we take comfort in being among the “old dogs.”

Our bond accounts are fully invested in high-credit-quality spread instruments. There are plenty of opportunistic places for bond investors. Treasuries are rich. Tax-free munis and Build America Bonds are cheap.

Cash earns zero. At Cumberland, our allocation to cash is zero.

Many of the stock markets of the world are cheap. That includes the US, selected countries in Europe, South America, and Asia, and selected currencies, regions, and sectors. We are nearly fully invested in our ETF accounts worldwide.

Lastly, the next eight weeks are the treacherous part of the investment calendar. September in particular is the most dangerous month. During years when the Fed was tightening, the outcomes have included the famous market crashes of 1929 and 1987. We thank Guy Rosa for the reminder.

During years when the Fed was easing, their actions neutralized the seasonality. The Fed has just affirmed maintenance of its balance sheet size. The Fed did not commence shrinkage. Transition from rapidly prepaying mortgages to substitute holdings in Treasuries is not a tightening, it is a lateral transfer of an easing position.

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David R. Kotok, Chairman & Chief Investment Officer, Cumberland Advisors, www.cumber.com