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

Greek 5 yr CDS is blowing out by about 100 bps to 950-990 bps after Austria threatened to withhold its portion of the Greek bailout funds because they don’t believe Greece has met the conditions for the next round of money. “We are getting indications that the Greeks can’t stick to their plan in a sufficient manner, in particular on the revenue side” said the Austrian finance minister.

The Conference Board did their annual looks at Institutional investors by the numbers.

No surprises here: Things were improved in 2009 than 2008. However, the credit crisis and market crash of 2008 means the industry continues to suffer the impact of that collapse.

Here are the key data points:

• Institutional assets rose to $25.351 trillion at the end of 2009

• Total assets increased 14% in 2009 versus a -21.3%: decline in institutional assets in 2008

• Assets invested in equities represented a 40.4%: share at end of 2009 versus 38.6%: share in fixed income;

• Mutual Fund Outflows: Market declines plus capital withdrawals totaled $2.533 trillion — about 31.1% of their 2007 value.

• Pension funds lost 17.9% of their 2007 asset value; Insurance companies experienced an 8.6% contraction. (Pension funds are 39.9% of total institutional assets)

• Alternative Investments:  27.9% of total pension fund assets were invested in alternative instruments — real estate, private equity, hedge funds, and cash equivalents — as of 12/31 2009.

• Mortgage investments: Due to a surge of loan defaults, the share of assets invested in mortgages fell to 50.5% down from 59.4% at the end of 2008 and a peak of 69.1% at the end of 2006.

• The industry’s best performance was from 1995 to 2007, when growth was “an unprecedented 23.3% annualized;

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Source:
2009 Rebound of Institutional Investments Restored Securities Market to Pre-Crisis Levels
The Conference Board, November, 11 2010
http://www.conference-board.org/press/pressdetail.cfm?pressid=4058

Mirror, Mirror: Lighting Up the Desert
ROBIN GOLDWYN BLUMENTHAL
Barron’s NOVEMBER 13, 2010
http://online.barrons.com/article/SB50001424052970204870904575602603387187816.html

The Shanghai index took it on the chin again overnight falling 4% due to worries that China won’t stop with its moves to tighten financial conditions for property buyers and to also tame the concerning rise in food inflation. The index is now down 8% from its recent high. South Korea unexpectedly raised interest rates by 25 bps to 2.5% to deal with inflation. Ahead of a meeting today with EU finance ministers, the PM of Ireland said he will consider help in order to further recapitalize its banks but their is nothing concrete in that pronouncement. Any money Ireland does get would go directly to its banks as opposed to funding their budget, in contrast to the situation Greece found themselves in where they literally ran out of money. Germany’s Nov ZEW 6 month economic outlook was unexpectedly positive at 1.8 vs the forecast of -6 and was a bounce from -7.2 in Oct. UK Oct CPI was 3.2% y/o/y, a 10th straight month above 3%.

According to Bankrate.com, long term mortgage rates have officially round tripped the post Jackson Hole ‘we will do more if need be’ Bernanke speech on Aug 27th. The average 30 yr rate was 4.5% on Aug 26th and last night it rose 8 bps to 4.51% and up 31 bps just over the past week.

Before we get into this week’s outstanding Outside the Box, I want to comment on QE2 and the efforts by some Republican economists to urge legislators to get involved to stop it (see the front page of Monday’s Wall Street Journal). That pushes my comfort zone a little too much.

First, I am not a fan of QE2. Never have been. If it had been my call, I would have punted and told the guys in the Capital that the ball was in their court to get their fiscal house in order, because that is the main source of the problem. But Bernanke and the Fed felt they had to “do something,” to demonstrate they got the seriousness of the situation. If the only policy tool you have left is the hammer of printing money, then the world looks like a nail.

Second, I doubt it works. It might be interesting to see what would happen (theoretically) if they decided to print $3-4 trillion. Now that would have a (probably very negative) impact. But it would show up on the radar screen. I think $600 billion just gets soaked up in bank balance sheets, sloughed off to world emerging markets (that don’t want it) and other hot spots, with some drifting into the stock market. But does it increase real final demand, which is what the Keynesians are so seemingly desperate for? I doubt it. And I just don’t see the transmission mechanism for QE2 to produce new employment of any statistical significance.

Third, targeting the middle of the yield curve is about as benign a way as you can do it, as far as QE goes. It certainly is not bringing down mortgage rates (so far). This is not exactly shock and awe QE.

Now, if the real plan, which no one can mention in polite circles at G-20 meetings, is to weaken the dollar, then QE2 just might work at doing that. But do we want it to? Do we want our input prices to go higher? A weaker dollar cuts both ways. And Germany seems to be able to work with either a strong or a weak euro. Are they that much better than us? Really? I sincerely hope we can take Bernanke at his word that this policy is not meant to weaken the dollar. Currency manipulation is not what we need from the world’s reserve currency, nor will we hold that status much longer if we embark down that path.

Back to the Republican sortie against QE2. As long as it stays on a debate level, or even as a resolution, then fine. There is considerable room for debate, and some very serious economists on both sides of the issue. This is new territory and deserves to be debated vigorously. This is, after all, affecting the public. Fed policy is too important to be talked about only inside a conference room with a few appointed governors and economists.

But I do not want to see anything that would reduce the independence of the Fed from the political process (any more than it already has been reduced). I don’t want Republicans dictating Fed policy. Or Democrats. Or the President, beyond his power to appoint. That is the path to becoming a banana republic.

If We the People want to change Fed policy, then we need to realize it is important who we elect as president, because he appoints the chairman and the governors. Ideas matter and have consequences. How many times do presidential candidates get asked about their views on monetary policy in national debates? Are you a proponent of Keynes? Or Friedman? Fisher? von Mises? Which of these four dead white guys have you read and studied? These elections of ours are more than taxes and health care. The Senators who sit on the committees have the right to review appointees, though few understand the real issues regarding the Fed, I am afraid. (Wouldn’t it be fun to have Rand Paul on that committee? He could tag team with his dad in the House. Just a thought.)

Final thought. Maybe the reason for a less than shock and awe QE is that the Fed can get to the end of it and say, “Look, we tried. But the money just went back onto our balance sheet. Printing more doesn’t seem to be advisable.” (Especially if the public pushback gives them some cover.) Then they can back off and let Congress know that they have no intention of monetizing their fiscal profligacy and that Congress must get its house in order before the bond markets react negatively.

And then again I may be wrong. Maybe QE2 does do something. No one really knows because this is truly uncharted territory. We’ll find out in the coming months. And this Friday, in my weekly letter, we’ll look at the prospects for the economy going forward. I get back home tonight and will be home for two weeks. I am looking forward to catching up on my reading.

Now, for this week’s OTB I offer a review of Gary Shilling’s brand new book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation.

Gary has long been a proponent of the idea that we are in for a period of deflation, and was writing as far back as the ’90s about the coming deflation. I am already into the book and am enjoying his wonderful prose, but must admit I skipped ahead to see his predictions, some of which are in the review below. You can buy the book at Amazon.com.

Have a great week. And think about a few more fun things than QE2 every now and then.

Your loving the La Jolla weather analyst,

John Mauldin, Editor

Outside the Box

In his new book, The Age of Deleveraging: Investment strategies for a decade of slow growth and deflation, published by John Wiley & Sons, Dr. A. Gary Shilling makes the case for slow economic growth and deflation for many years ahead as well as lays out the investment strategies that flow from this forecast—12 sectors to sell or avoid and 10 to buy.

This new age of deleveraging was sired by the back-to-back collapses of the housing and financial bubbles in 2007 and 2008, both of which he had been forecasting since early in the 2000s. He begins his new book with a look at how both of those bubbles were created, how they grew and how he was lucky enough to have spotted them in their infancies. Gary loves to be among the few to spot them and predict their demises. He also reviews the five other Great Calls he’s made in his 40-year forecasting career, including the 19691970 recession, the early 1970s inventory bubble and 1973-1975 recession, disinflation starting in the early 1980s, the demise of Japan’s 1980s bubble and the dot com blowoff in 2000.

After four decades of leveraging up by the global financial sector and a three-decade borrowing-and-spending binge by U.S. consumers, deleveraging is underway. The good life and rapid growth that started in the early 1980s was fueled by massive financial leveraging and excessive debt, first in the global financial sector, starting in the 1970s, and later among U.S. consumers (Chart 1). That leverage propelled the dot-com stock bubble in the late 1990s and then the housing bubble. But now those two sectors are being forced to delever and, in the process, are transferring their debts to governments and central banks. The federal budget deficit leaped from $187 billion in the 12 months ending December 2007 to $1.3 trillion in the 12 months ending August 2010, but it had little net effect on the economy as private sector retrenchment more than offset the deficit jump (Chart 2 ). Federal borrowing relative to GDP leaped from 3.0% in the third quarter of 2007 to 10.7% in the second quarter of 2010, a 7.7-percentage point climb, but private borrowing fell from 15.2% to a negative 3.4%, a drop of 18.6 percentage points, or more than twice as much.

This deleveraging will probably take a decade or more to complete—and that’s the good news. The ground to cover is so great that if it were traversed in a year or two, major economies would experience depressions worse than in the 1930s. This deleveraging and other forces will result in slow economic growth and probably deflation for many years. And as Japan has shown, these are difficult conditions to offset with monetary and fiscal policies.

Read the rest of this entry »

“When will these guys ever learn that maybe, just maybe, these Fed policies aimed at targeting asset prices at levels above their intrinsic values is probably not in the best interests of the nation?”

-Dave Rosenberg, chief economist and strategist at Gluskin, Sheff

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It is taken for granted that a rising stock market stimulates the animal spirits, sending consumers off shopping.

The basic premise of the wealth effect is well known: As the value of stock portfolios rise during bull markets, investors enjoy a feeling of euphoria. This psychological state makes them feel more comfortable  — about their wealth, about debt, and most of all, about spending and indulgences. The net result, goes the argument, is that consumers spend more, stimulate the economy, thus leading to more jobs and tax revenues. A virtuous cycle is created.

The rule of thumb has been that for every one dollar increase in a household’s net equity wealth, spending increased 2-4 cents. For residential RE, the increase is even greater: Consumer spending increases 9-15 cents (depending upon the study you use) for every dollar of capital gain.

The problem is, the theory is its mostly nonsense.

I make this statement for two reasons: 1) the distribution of equities in the United States; and b) the classic causation/correlation issue.

Let’s start with equity ownership. The vast majority of Americans have a rather modest sum of cash tied up in equities. 401ks, IRAs, investment accounts — these are primarily the province of the well off. Ownership of equities is heavily concentrated in the hands of the wealthiest Americans. Start with the top 1%: They own about 38% of the stocks (by value) in the US. The next 19% owns almost 53%. That leaves the remaining 80% of American families with less than 10% stake in the stock market (See Federal Reserve’s Z.1 Flow of Funds report for the most recent info).

How is THAT going to cause a wealth effect? Especially when you consider the median family’s stock portfolio is worth well under $50k. These are the millions of families who are the principle consumers of cars, food, clothing, electronics, energy, health care, etc. To them, a rising stock market is nearly meaningless.

The biggest investment for the typical American household remains their home, with a median value of ~$200k. Put 20% down, and you see a 10 to 1 leverage. The impact of Real Estate on any wealth effect is much greater than the stock market. Unfortunately, homes remain somewhat overvalued — 10-15% by our measures — and are in a downtrend. They are not contributing to improvements in consumer spending in any meaningful way.

Our second factor is quite simple: The causation/correlation problem. In the 1990s, the Fed under Alan Greenspan focused in the past wealth effect of stock market gains. But I suggest they would have been better off looking at the myriad factors impacting consumer’s psyches: Plentiful jobs, wage increases, economic expansion, labor mobility, modest inflation, and bountiful credit availability. These are sufficient to explain the behavior of consumers. Its not a secular bull market in stocks that causes the consumer spending — its all the other contemporaneous elements that are the prime drivers.

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Regardless of your views of QE2 — if the Fed is doing it create a wealth effect, they are wasting their time and money.

Read the rest of this entry »

Bloomberg: Stocks fell for a seventh day, the longest losing streak since January, on concern China will take steps to curb inflation and as European finance officials met over Ireland’s debt woes. European Bourses were off 1-1.5%, and the yield on the 10-year U.S. Treasury note slipped five basis points to 2.91 percent.

U.S. index futures dropped, bonds rebounded after a two-day slide and the dollar strengthened.

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US Futes

Apple finally has won the digital rights to the Beatles catalogue, according to the WSJ. After a 30 year long negotiation, a deal was struck, with an announcement coming on Tuesday.

The announcement has led to only a handful of bad Beatles puns:

-Steve Jobs is nearing the end of his long and winding pursuit of the Beatles catalog (WSJ).

-Working It Out, iTunes to Sell Beatles Titles (NYT)

I guess we should be thankful

Video after the jump

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Source:
Apple Finally Snares Beatles
ETHAN SMITH
WSJ, NOVEMBER 16, 2010
http://online.wsj.com/article/SB10001424052748703326204575617004052395816.html

Read the rest of this entry »

The Wall St. Journal, and perhaps other outlets, published an open letter to Ben Bernanke pleading for the immediate discontinuation of QE2:

We believe the Federal Reserve’s large-scale asset purchase plan (so-called “quantitative easing”) should be reconsidered and discontinued. We do not believe such a plan is necessary or advisable under current circumstances.

The letter has 20+ signatories. It is noteworthy how outrageously wrong most of this team of incompetents were — on the recession, the credit crisis, and the markets; James Grant and Seth Klarman being notable exceptions.

Many of the names you will recognize (there are some I don’t) appear to have hard right conservative leanings. Paul Krugman takes down a couple of the signers, wondering what economic credentials William Kristol has (Or credentials of any sort for that matter).

Of course, one might level the same charge at another of the letter’s signers, former Bear Stearns economist David Malpass. BR has taken down Malpass here and here (to cite but two), but I don’t think Barry ever got to this one, in January 2008 (what we now know was the second month of the worst recession since the Great Depression):

Malpass’s message minimized the impact of both the ongoing U.S. housing recession and the credit crunch.

To an audience of guests representing top French financial institutions like BNP Paribas, Calyon and Natixis — all of which have been singed by the subprime crisis — Malpass sided with what appears to be a majority of U.S. economists in predicting that the U.S. economy would skirt the current crisis without falling into a formal recession.

“We will have a slowdown month by month for the next six months,” Malpass said. “But we will look back and we will say there was not a material recession.”

And here’s open letter co-author Kevin Hassett from the American Enterprise Institute (June 2008) in an article titled Seeing Recession When There’s None to Be Found, displaying near perfect partisan hackery, the lede of which was:

Are we in a recession? Despite what the media has led the public to believe, director of economic policy studies Kevin A. Hassett compares today’s economy to past recessions and finds that the current situation does not seem all that dire.

If a Democratic-leaning press can convince everyone that the economy is in recession, then it can influence the election. [...] The politically motivated pessimism, like the computer virus, can have real consequences.

I’d be remiss if I didn’t also note that Mr. Hassett was co-author of the timely (November 2000) howler Dow 36,000.

A third co-author, Michael Boskin, also did not see the recession that was already staring us in the face (October 25, 2007, emphasis mine):

LAS VEGAS (MarketWatch) — Despite severe problems in the housing market, a credit crunch and record-high oil prices, the U.S. economy will skirt a recession in the coming few quarters and get back on a solid growth path after that, economist Michael Boskin told real estate industry executives Thursday at the Urban Land Institute fall conference.

Another co-author who is uniquely unqualified to discuss recession (or anything economic for that matter) is Amity Shlaes. Back in July 2008, while we were into the 8th month of the recession — just weeks before the entire financial edifice collapsed — Shlaes wrote a Washington Post OpEd, titled “Phil Gramm Is Right.” Shlaes was defending Gramm, who had  said “the country was not in a true recession but a “mental recession.” He also said, “We have sort of become a nation of whiners. (Nice call, superlative timing).

Charles Calomiris is yet another co-author. Up until 2007,  he was the codirector of AEI’s Financial Deregulation Project; he spent the years since trying to blame Fannie Mae/Freddie Mac for the collapse, insisting that radical deregulation had nothing to do with crisis.

Peter  Wallison is Calomiris’ co-author on this WSJ OpEd: Blame Fannie Mae and Congress For the Credit Mess, as well as the QE letter. As prime proponents of the radical deregulatory scheme that contributed so mightily to the credit collapse, they have desperately sought some other McGinty to blame for the crisis — anything but their own fecklessness. Wallison is, for lack of another adjective, hallucinatory.

Also on the list: Cliff Asness of AQR Capital Management is another co-author. According to Bloomberg, his flagship Absolute Return fund went the wrong way three years ago, as the credit crisis was starting, falling more than 50%.

So how’d those calls work out? Many of the people who are criticizing the Fed Chief aren’t capable of seeing the worst recession in generations halfway through it; Why on earth should anyone care what their views on Quantitative Easing might be? These people should be working at Mickey Dees, not think tanks and hedge funds.

Is this a crew to which Bernanke should be paying any attention whatsoever? This is not a time for our economic policies to be hijacked by partisan ideologues who, frankly, don’t seem to be offering up any viable alternatives.

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For what it’s worth, the Empire State Manufacturing Index printed this morning, and the number — along with most of the underlying components — simply tanked.

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Empire State Manufacturing Survey:

The Empire State Manufacturing Survey indicates that conditions deteriorated in November for New York State manufacturers. For the first time since mid-2009, the general business conditions index fell below zero, declining 27 points to -11.1. The new orders index plummeted 37 points to -24.4, and the shipments index also fell below zero. The indexes for both prices paid and prices received declined, with the latter falling into negative territory. [Invictus: emphasis added]

A veritable trifecta of bad news — poor headline, crappy new orders and shipments, and disinflation/deflation in prices paid and received. Astute students of the economy will note that in “mid-2009″ we were emerging from recession. We’ll see what we get out of Philly on Thursday morning, but the news out of NY is clearly not good. (Separately, Retail Sales were about as expected.)

Krugman rightly asks what the letter writers are modeling, and as best he can ascertain, it’s “wild stories about how Obama’s Sharia-law Marxism has unnerved business, or something, with the effects mysteriously spreading to Spain and Latvia.”

ADDING: Should anyone care — and I can’t fathom why anyone would — in the pre-recession era I was volunteering my services over at Blah3.com.  Those who’d like to examine my public record in the fall of 2007 and early 2008 are invited to peruse these search results (or this Sept. 2007 post in particular:  “The labor market — which Bush and his sycophants have repeatedly pointed to as evidence of our economy’s strength — is clearly showing signs of fatigue, and has been for some time (the vaunted 4.6% unemployment rate notwithstanding). Bush’s economic policies will have failed before the end of his term — with higher unemployment, insignificant wage growth, tax cuts for the rich, and a recession as his legacy. This much becomes more and more clear with each new economic data point we receive. The question now would seem to be how much the economy will slow and how deep the recession might be.”).  Or view my entire body of work there, if you are having trouble sleeping.

SECOND ADD (Nov. 16):  John Mauldin puts up a very interesting piece in the Think Tank, and in it essentially sums up my own thoughts:  “If it had been my call, I would have punted and told the guys in the Capital that the ball was in their court to get their fiscal house in order, because that is the main source of the problem. But Bernanke and the Fed felt they had to “do something,” to demonstrate they got the seriousness of the situation. If the only policy tool you have left is the hammer of printing money, then the world looks like a nail.”

Previously:
The “Chutzpah” of Bear Stearns (August 7th, 2007)

Smackdown: Paul Kasriel vs Michael Boskin (September 10th, 2010)

Michael Boskin on “The Obama Crash” (December 7th, 2009)

Why Michael Boskin Deserves Our Contempt (January 19th, 2010)

Not sure what I’d pay to see a hologram, but since the “star” (hopefully) doesn’t have an onerous contract rider (or contract, for that matter), need to be fed or otherwise pampered, it wouldn’t be much.

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I took the 10 question quiz, and my results are above. Its pretty much where I imagine myself — fiscally conservative, socially progressive. I don’t have a problem with gay marriage, legalized pot, cutting spending, or letting insolvent companies die.

If you want to take the quiz, just go to theadvocates.org/quiz, and it tells you where you stand politically. It seems to go beyond the Democrat, Republican, and Independent spectrum.

The Washington Post said it has “gained respect as a valid measure of a person’s political leanings.” The Fraser Institute said it’s “a fast, fun, and accurate assessment of a person’s overall political views.

http://www.theadvocates.org/quiz