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

Robert Skidelsky, the British biographer of Keynes, put up a post yesterday wondering about life after capitalism. His concern is that capitalism, having done the job of bringing wealth to large numbers of people in the developed countries, was running out of productive goals:

This is not to denigrate capitalism. It was, and is, a superb system for overcoming scarcity. By organising production efficiently, and directing it to the pursuit of welfare rather than power, it has lifted a large part of the world out of poverty.

Yet what happens to such a system when scarcity has been turned to plenty? Does it just go on producing more of the same, stimulating jaded appetites with new gadgets, thrills, and excitements? How much longer can this continue? Do we spend the next century wallowing in triviality?

Skidelsky quickly transitions into a moral argument about the uses of wealth. But there’s another, perhaps more important question to explore here. What if capital itself is running out of places to generate returns.

After all, we’re told that one of the prime causes of the worldwide housing bubble was an excess of capital sloshing around the world. In the US, the financialization of the economy is direct product of over-capitalization.

Finally, the latest driver of the economy, the technology business is rapidly de-materializing uses for capital. Facebook, Apple, Google even Goldman Sachs don’t have their capital invested in things. The money that makes up their capital is mostly invested in human beings.

We don’t know where Facebook plans to spend the billions it is raising. There’s talk of moving to a new corporate campus, of keeping talented engineers on staff and surely they need some server space. Groupon doesn’t seem to need the money they’re raising so much as they’re raising money because this is their time.

Maybe these are just anomalies around specific businesses. But it is troubling that these are the success stories of our time and it’s hard to see where the capital is beyond digits on a screen.

I was discussing how much the Fed has distorted the stock market earlier today with my friend and canoe buddy, Scott Frew, who runs the Rockingham Capital hedge fund.

He sent over these charts that look at the relationship between GDP growth and stock appreciation in the 5 Quarters that follow the official NBER declaration of the end of the prior recession.

Note that this go round, the stock gains relative to GDP growth are rather outsized — up 24% for a mere 4% GDP. What is even more astonishing is this follows an already substantial 60% gain — SPX 666 to 919 — prior to the recession being declared over.

Looking at long term measures of valuation, such as Tobin Q ratio or Shiller’s Cyclically Adjusted  Price/Earnings ratio, the market is significantly over valued. The likely cause is the Fed.

The caveats are that markets can remain over valued for extensive periods of time, and the Fed can keep the spigots open indefinitely.

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2009-10

1949-51

1954-55

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7 additional recession recoveries after the jump

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Yesterday’s discussion of the intensity and duration of bull markets — and the current powerful market — led to an interesting question: Exactly how much has QE1 & 2 impacted stocks?

The Fed’s historically unique monetary policy is obviously a factor in the current market — but how much?

Perhaps we can fashion a guess looking at duration and intensity of market moves.

Let’s use the averages of the rallies over 12 and 24 months, going back to the 1930s: After 12 months, returns range from  21.4% (1987) to 121.4% (1932). But its worth noting that the other post-depression rally (1935) was 81.4%; remove these two outliers, and the next most intense move was 1982 at 58.3%. That is, until the 2009 rally. After 12 months, it stood at 68.6%. The average of these rallies at the 1 year mark was 47.3%.

After one year, we had a rally that was 20% stronger than the previous post-WW2 rallies, but not as strong as the post depression rallies.

Looking at these rallies after two years is where things get very interesting: On average, the rallies strengthened, from 47.3% to 56.1%. This despite by month 24, the two post depression rally outliers had given up all their gains and were in the red.

I have been saying for several years now that 1973-74 is an excellent parallel to the current crash/recovery. And indeed, up until 2009, the strongest rally from post Great Depression was 1974 — at 65.7% after 24 months.

Until 2009. After just 22 months, this market broke through the 90.1% level. No other rally even comes close, and 1974 as the runner up. The current run is a full 37% greater than the next closest rally, and over 60% greater than the 2 year average.

How much of this is attributable to the Fed? Its only a guess, but if merely half of the markets excess gains (over the past rallies) are attributable to the Fed,it means that the US Central Bank has artificially created several trillion dollars in market capitalization.

The end game of this, and the unintended consequences, are beyond my ability to guess . . .

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Tables after the jump . . .

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With German bund yields already moving higher due to the belief that their financial responsibility for some of their EU friends will only continue to grow, a new record high in the German IFO business confidence figure has the bund yield rising to the highest since April after touching the most since Feb earlier in the morning. Also, French business confidence rose to the highest since Mar ’08 with both countries, due to large exposure to Asia, remaining immune to the financial issues of other European countries The bonds of Italy, Spain, Greece and Portugal are rallying on the possibility of the EFSF being used to buy back existing debt. While the Shanghai index bounced back somewhat after sharp selling over the past week, other Asian markets got hit with Indonesia falling to a 4 month low, Thailand to a 5 week low and Japan, South Korea, Singapore and Malaysia falling to 3 week lows.

Sometime in the not-so-distant future, when we are looking for the moment when the book publishing business was finally and fully transformed, we’ll surely point to this month in 2011. Of course, given what’s happened since Amazon launched the Kindle and Apple made the iPad an overwhelming success, it’s no surprise that Barnes and Noble would make some changes in the organization.

The fact that the bookseller reorganized its buying operations to eliminate 45-50 positions while trying to keep every detail quiet suggests there’s a real shift going on in buying habits. The lost positions at B&N primarily deal with the persons who choose which books go into the stores. The company says they’re being replaced with people on the digital side.

That dovetails with a report from USA Today that shows the heart of the business–bestselling books that bring traffic into stores–is rapidly moving to e-books:

For the third week in a row, more than a third of the top 50 books on USA TODAY’s Best-Selling Books list sold more e-book copies than print versions. Among the 19 books more popular in digital form was Kathryn Stockett’s novel, The Help, a sleeper hit from 2009.

Millions of readers got Kindles and iPads this Christmas. They clearly like the new devices. With more tablets on the way and Android’s Honeycomb OS teed up for a launch this year, one can only assume that the numbers we’ve already seen will only be amplified.

By the end of 2011, will the number of bestsellers that outsell in e-book be 32 instead of 16 for USA Today’s top 50? With much of the bestseller market already going to Costco, Wal-Mart and Target, how big wil the impact be on Barne & Noble?

Even with a successful Nook business, the physical stores will lose a key driver of traffic. The buyers who were let go this month didn’t just choose the bestsellers for the front of the store, they stocked the categories that are supposed to be the Superstore’s appeal. Barnes & Noble’s selling proposition is that their stores carry 100,000+ titles so you’ll always be able to find what you’re looking for. Will that be enough to drive foot traffic?

Probably not. With the loss of Borders, which will surely go out of business this year, and the potential for a greatly reduced Barnes & Noble that these staff changes portend, the distribution channel for physical books will only get smaller. That will put more emphasis on e-books to the point where publishers start orienting all of their publication strategies around generating e-book sales, a sea change in what it means to publish a book.

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“Inflation is Always and Everywhere a Monetary Phenomenon” – Milton Freidman

Monetarism as a theory, which states that the variation in the money supply has major influences on national output in the short run and the price level over longer periods, died during the 1980′s.   Economists noticed that the monetary aggregates,  GDP, and inflation were no longer stable in their relationship to one another.   Milton Friedman was the father of Monetarism and Paul Volcker was one of the last great Monetarists.

The rapid advances in financial innovation and the rise of of the shadow banking system made the measurement and even the definition of money increasingly difficult.   At one point, the Fed studied and even considered including equity mutual funds in one measure of money.   During the height of the dot.com bubble some were even using stock options in start up tech companies as a medium of exchange — the purest form of money.

One of the basic tenets of monetarism is the concept of dishording.   If people hold too much money, they dishord the excess balances and buy goods and services.     We would add assets to that mix and think one of the problems today is that the excess money balances are disproportionately distributed throughout the global economy.   The helicopter drop is resulting in collateral damage in higher prices for consumer necessities,  such as food and transportation fuel.

The  bulk of the excess cash, in our opinion,  has been created and held by central banks in the form of  foreign exchange  reserves.   In addition, the money created by the Federal Reserve is not being circulated throughout the wider economy because of the broken financial sector in the United States, which is the country’s  main credit creation and money machine.

Thus, all this excess money is distributed among sovereign wealth funds, hedge funds, and money management firms, which sloshes around the world looking for a home.    These managers  are smart enough to know that much of the excess liquidity and reserves in the system is in the form of “high powered money“, which can be multiplied by a fractional reserve global credit system.

In other words,  the global monetary punch bowl is heavily spiked by a monetary base which has gone parabolic in the past five years (see chart below) and when credit creation is finally added to the mix the result will be, and to some extent already is, a toxic brew of inflation.

We are already seeing this in the emerging markets and even in parts of Europe.   The dishording and search for a “store of value” is becoming  an obsession and driving  everything from equities to onions.   Throw in a supply shock or two to lather up the specs and the party really gets going.  Take a look at the charts below.

Today’s Economist published a piece on the how the price of fine wine and crude oil move together.    What the heck does crude oil and $5k bottles of Château Pétrus  have in common?  Some economists and academics can spin a story  that maybe wine demand is driven by the OPEC countries or the emerging markets.  Yada, yada, yada!

These are the same guys that told us the housing market was driven by fundamentals.  A good fundamental story is  a necessary condition for a bubble, with excess liquidity the sufficient condition.   There’s just too much money chasing too few goods.   Punto!

Ironically,  unless wages and household wealth keeps pace,  food and energy inflation is ultimately deflationary in other sectors and will depress economic growth as real wages fall.  We think the Chinese government understands this and is rapidly increasing the minimum wage throughout the country, in effect, trying to monetize the food price inflation.   This is why we believe China will have a more difficult problem containing their inflation and risks an inflationary spiral.

Inflating a stock market or housing bubble feels good for everyone x/shorts, can create temporary wealth and economic growth,  and  potentially increase the popularity of  governments.   A commodity bubble is a different story, however.   Though gold is a benign store of value and actually should be encouraged by governments, in our opinion,  higher food and energy prices are a potent political mix.   Go no further than North Africa to see the results.

We bet many governments are hoping the commodity markets roll-over with the Shanghai as we wrote about on Tuesday.  Just not the commodities they export.  Stay tuned!

A look at why investors should get into cash now, with Barry Ritholtz, FusionIQ.

Thurs. Jan. 20 2011 | :24:0 11 ET

The yellow dots are aircraft.

It is a 24 hour observation of all of the large aircraft flights in the
world, condensed down to about 2 minutes. You can tell it was summer
time in the north by the sun’s footprint over the planet. You could see
that it didn’t quite set in the extreme north and it didn’t quite rise in
the extreme south.

Notice that as evening approaches, the traffic is predominantly from the US
to Europe and when daylight comes, the traffic switches and it
is predominantly from Europe to the US.

Attention Teachers, Police, and Firefighters: You are royally fucked:

“Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.

Unlike cities, the states are barred from seeking protection in federal bankruptcy court. Any effort to change that status would have to clear high constitutional hurdles because the states are considered sovereign.

But proponents say some states are so burdened that the only feasible way out may be bankruptcy, giving Illinois, for example, the opportunity to do what General Motors did with the federal government’s aid.

Beyond their short-term budget gaps, some states have deep structural problems, like insolvent pension funds, that are diverting money from essential public services like education and health care. Some members of Congress fear that it is just a matter of time before a state seeks a bailout, say bankruptcy lawyers who have been consulted by Congressional aides.

This raises so many more questions than it answers:

Why should anyone lend money to States again?

Should state employees be induced to take less salary in exchange for greater benefits , especially pension and retirement plans?

How will Unions negotiate with States and CIties going forward? Is it now all about cash upfront, with future promises/incentives looked at as meaningless ?

I expect the repercussions of this are far exceeded by the States’ fiscal condition.

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Source:
Path Is Sought for States to Escape Debt Burdens
MARY WILLIAMS WALSH
NYT, January 20, 2011 http://www.nytimes.com/2011/01/21/business/economy/21bankruptcy.html

Why the dollar will rise in 2011, with Keith McCullough, Hedgeye Risk Mgmt.

Airtime: Thurs. Jan. 20 2011 | 8:57 AM ET