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

Hedge fund manager Bill Fleckenstein discusses whether the Federal Reserve caused the recent commodity inflation.

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This is my favorite of all of the Existing Home Sales series — Non Seasonallly Adjusted (NSA).

(Check out Calculated Risk’s existing home sales graphs in his graph gallery).

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click for ginormous chart

Nowhere Near Over
David R. Kotok
February 23, 2011
www.cumber.com

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This is nowhere near over.

By “This”, we mean the regional contagion, spreading violence and rising geopolitical risk in the Middle East and North Africa. Reports say that Libya has stopped producing oil and that pipeline delivery to Europe (Italy) is interrupted. Libya seems headed for complete dismemberment and full-blown civil war.

Note that China is evacuating 15,000 workers. China! Imagine that we learn there are as many workers from China in Libya as there are workers from Egypt. Anyone still think this is a local idiosyncratic event.

We are watching a “sea change” occur among one tenth of the world’s population and among the world’s low cost marginal producers of the world’s energy. Scenarios with benign outcomes and peaceful transitions appear remote.

Note how the region’s worst of the bad actors seize their opportunities where they find them. Every success emboldens them. A case study is Iran’s two ships transiting the Suez. Also, note how the most suppressive regimes like Syria, Iran, Saudi Arabia, Libya have learned how to suppress social networks, cut off cell phones, block internet traffic and reverse or alter the information flows.

Consider that suppressive regimes are not an encouraging environment for business risk taking and capital investment. This true around the world. Despots maintain their power with only harsh methods whether in the Middle East or North Korea or Venezuela. Simply put: a thug is a thug. Their actions eventually stymie and persecute thoughtful and creative internal forces. Despots raise costs and lower production. In addition, the energy dependent western democracies are now learning that despots are also not reliable longer-term partners.

Also, consider that success by demonstrators and protesters leads to additional demonstrations and increasing demands for reforms. We believe that the turmoil and regime change in the region has a long way to go. We also believe that forecasting the outcomes is a highly problematic exercise. Do we end up with open democracy or Islamized fundamentalist states or something else? This is going to be determined on a case-by-case basis. We do not know the outcomes. History says that emerging democracies are rare in the Middle East.

A sea change can bring on a protracted period of higher oil and energy pricing. The US economy is ill prepared for it. Our policies border on madness. We do not drill for oil off our coast. In the Gulf, deep water drilling is encouraged in Cuban national waters but not in American waters. On American land, we spend billions subsidizing an uneconomic program called ethanol. We raid the federal treasury to put money in the pockets of the politically connected few. In addition, we raise the price of corn and farmland and global Ag output to increase the starvation of millions of people. Thank you Washington and specifically a few members of America’s congress.

Back to the Middle East. Consider that a 1-penny increase in the price of a gallon of gasoline acts as a sales tax on consumers at the rate of 1.2 billion dollars a year (Naroff Economics estimate). A one-dollar rise in the price of oil eventually leads to a 2.5-cent increase in gasoline on average (Moody’s estimate). It is easy to get to a $4-$5 range for gasoline in the US.

Add that to the food price surge and we have a shock. We have already consumed about half of the 2% payroll tax cut. It appears higher gas prices will use up the other half and more by Memorial Day. Gasoline at 4 to 5 dollars a gallon will be enough to turn the improving consumer sentiment numbers into deteriorating ones and will hurt the fragile economic recovery. It will also set back any hope for stability in the housing sector.

If we flirt with a double dip recession, the Fed may be debating QE3 by late summer. So far, QE2 seems to have little impact. It may turn out to have been too small to do very much. A few hundred billion in a mass of many trillions is not very much.

Consider that there has been no significant increase in the amount of federal debt reaching the markets. To get to that conclusion, add up all the new treasury issuance, subtract the shrinkage of Fannie and Freddie debt and subtract the Fed’s purchases. The net result is that most of the federal deficit is being financed without increasing the publicly traded portion.

So why have treasury bond interest rates risen since QE2, if they are not driven by the deficit. They may be driven by inflation expectations or flight from the dollar or re-allocation of portfolios. However, they do not seem to be higher due to direct federal borrowing from the markets.

So where is this going?

Any slowing of the US economy from this energy shock may act to lower interest rates and dampen inflation expectations. Higher energy prices can mean that something else does not get purchased. We may see substitution and not inflation.

At Cumberland, our US ETF accounts are in the highest cash position they have seen in over two years. We think being full invested when there is a shooting war in a major oil producing country is folly. There is one position that must be maintained. We are high in energy overweight. We are underweighted in consumer discretionary exposure.

This is nowhere near over.

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David R. Kotok, Chairman and Chief Investment Officer

Barry Ritholtz

Editor’s Note: What follows is part I of Paul Desmond’s interview with TheStreet.com contributor Barry Ritholtz. Tune in tomorrow for part II.

Paul Desmond, president of Lowry’s Reports, is known as a “technician’s technician.” In 2002 he won the Charles H. Dow Award for excellence in the field of technical analysis for his studies on how market bottoms are formed.

More recently, he’s been looking in the other direction, studying how market tops are formed. It has been a long time coming: Many years ago, Desmond’s firm bought microfiche of The Wall Street Journal for 1920-1933. They laboriously converted the printed stock tables into digital form — that’s all market activity for every operating company stock listed in the stock tables, including the opening and closing prices and high and low volumes. From this unique data source, Desmond analyzed the 14 major market tops from 1929 to 2000, trying to identify similarities. His findings are startling and impressive.

Let’s talk about bottoms a little bit because I recall reading a paper that you did that won the 2002 Charles Dow Market Technician Association award. The study on 90% downside days.

Yes. I had been reading a great deal of material about what market bottoms looked like. And one of the people that I happened to be reading was a fellow named of S. Gould, who talked about a classic market bottom in which he assumed it all occurred in a single day. That the volume was very heavy in the morning on the down side, that is stabilized in midday, and then by the afternoon, it was again rallying strongly again on substantially expanding volume. I simply went back through our history — which extends back to 1933 — and I was looking for those classic bottoms as Gould had defined them. I found very few, maybe one or two cases that fit his definition. But it became apparent to me that what he was talking about was an idealized situation and not actual experience.

So I went not only through his work, but through a number of other people’s work where they were talking about what a market bottom looks like. I could not find any of them that really worked or fit preconceived notions. So we started looking for some pattern that would help us to identify a market bottom. We knew that the most important consideration of a market bottom was panic; the final step in a downtrend is that investors panic and throw in the towel. They want to abandon the stock market without any consideration of the value of their portfolios.

The classic expression is, just get me out, I don’t care about the price, I gotta make the pain stop.

That’s exactly right.

Looking at 1987, many people generally think that that was a one-day wonder to the downside — that it was a one-day debacle. But I’ve looked at the month before and saw a big build-up in volume and a pretty hefty decrease in price before that single-day crash. How did you find 1987 to be, compared to other bottoms?

Well, the panic stages of it occurred in three particularly important days. The first one was on the 13th of October, a Wednesday. And then the 14th was a Thursday, and that was a 100-point downside day. Now at that point, a 100-point downside day then was something very spectacular. The 14th was a 100-point downside day on the Dow and it showed intensity, and that is where we had our major sell signal on the 14th for October. Then Friday the 15th, the market also dropped 100 points. So, to have two back-to-back 100-point downside days was pretty spectacular. Then on Monday morning, the 19th, the real crash, the 500-point drop, occurred. Now that was 90% downside day, which showed that there was real panic. (Editor’s note: Lowry’s defines a 90% downside day as a session with 90% downside volume in conjunction with 90% downside price action, meaning 90% (or more) of the price movement of all stocks on a given exchange is lower.)

I’m looking at a chart of October ’87, and the Dow was about 2700 in the beginning of the month. Before we even got to that Wednesday (the 13th), the Dow was down to 2500. The volume really started ticking up on that 13th, 14th, 15th. The 19th and 20th were both the biggest-volume days of the selloff.

That’s right. Actually, the interesting thing about 1987 is that most people incorrectly say ‘it just came out of nowhere.’ That the market was going up one day and suddenly crashed. And yet, we had a whole series of classic warning signs that the market was weakening. For example, the advance/decline line, which is a simple measurement of the number of stocks going up vs. the number of stocks going down, topped out in early April of 1987, showing that that was the point in which the largest bulk of stocks was starting to peak in price.

Read the rest of this entry »

This infographic comes to us Ciaran Hughes of Programme 4 in Britain:

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via Channel 4

Fool Me Once…
February 22, 2011
Bob Eisenbeis, Chief Monetary Economist
www.cumber.com

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I don’t normally pen an economic commentary on an article that has appeared elsewhere, but David Enrich’s Wall Street Journal article of February 17, 2011, entitled “Banks Find Loophole on Capital Rule,” raises some important concerns and is worthy of additional observations. The article notes that Barclays changed the legal classification of its main US subsidiary so as to no longer be subject to US bank capital standards. Enrich goes on to state that several other institutions, including Deutsche Bank and other foreign primary dealers, may be also considering such changes. Two points are worth noting. First, regulatory arbitrage is alive and well. Institutions have begun actively seeking ways to avoid the new capital standards, even before they are put in place. Second, such actions are inconsistent with the primary thrust of the proposed new Basel III capital standards that attempt to restore a meaningful 4 percent Tier 1 minimum capital ratio and to impose even higher standards on systemically important institutions.

The WSJ goes on to mention another worrisome issue. It reports the capital ratios for several institutions whose US holding companies fail to meet the US requirements. Deutsche Bank’s Taunus subsidiary allegedly has negative capital. The US holding company subsidiaries of Barclays, Toronto-Dominion Bank, and Rabobank Group fall below the new Tier 1 leverage ratio of 4%, while HSBC is just slightly above that threshold.

These are troublesome statistics, especially in view of the injection of home-country taxpayer funds into such institutions during the financial crisis. They raise substantive questions about what their home-country regulators are actually doing at this point to shore up their institutions’ capital positions. Why would they even contemplate accommodating a change in status if it meant perpetuation of further weakened capital positions, especially given the thrust of the new Basel III capital standards?

The Federal Reserve is certainly not helpless in dealing with such changes, and one hopes to see new standards emerging from the Fed promptly. Deutsche Bank, Barclays, and HSBC are primary dealers. Remember that the primary dealers are supposed to be the soundest institutions. They are market makers in Treasury obligations, participate in Treasury auctions, and are authorized to deal directly with the Federal Reserve System Open Market Account as the Fed conducts its daily open-market operations. Remember that some primary dealers, including Bear Stearns, Countrywide, Merrill-Lynch, and Lehman Brothers, either failed or were merged because of financial difficulties; and others such as Deutsche Bank, BNP Paribas, Citigroup, Goldman Sachs, Morgan Stanley, Royal Bank of Scotland, and UBS were recipients of government-sponsored rescues and injections of taxpayer funds. They apparently fooled the Federal Reserve into believing they were in much better financial shape than they actually were.

The Federal Reserve should step forward and put a stake in the ground when it comes to actions by Barclays and others to avoid having their US subsidiaries meet US capital standards. It would be a simple matter for the Fed to require that primary dealers and their affiliates and subsidiaries operating in the US meet minimum capital standards. Any actions to avoid them should result in revocation of primary dealer status. During the financial crisis, Barclays, Deutsche Bank, and others were significant beneficiaries of the Fed’s emergency Primary Dealer Credit Facility and US taxpayer subsidies inherent in that support. It is time for the Fed to put teeth in its capital programs and use whatever leverage is available, especially when it comes to foreign institutions, to ensure that it is truly dealing with sound financial institutions. The Fed may claim to have been fooled by the dealers once. If so, then shame on the dealers. But the Fed should not risk being set up to be fooled twice.

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Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at www.cumber.com. He may be reached at Bob.Eisenbeis-at-cumber.com.

Chart Store week continues at the Big Picture. Today’s TCS graph is the NYSE Market Capitalization, shown over time as a percentage of US GDP:

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click for larger graphic

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My unpaid endorsement: TCS subscribers ($239 per year) gain access to great weekly chart porn, and their library of more than 5,000 historical and updated charts.

Via Word Spy, comes today’s word of the day: shelter porn n. Images and text that glorify or fetishize high-end architecture, home furnishings, and interior design.

Example Citations:

The devil on my left shoulder whispers this: “Bird Cloud” is an especially off-putting book about a wealthy and imperious writer who annoys the local residents (she runs off their cows), overwrites about nature and believes people will sympathize with her about the bummers involved in getting her Japanese soaking tub, tatami-mat exercise area, Mexican talavera sink and Brazilian floor tiles installed just so. “Bird Cloud” is shelter porn with a side of highbrow salsa.
—Dwight Garner, “A Novelist Wills Her Dream Home Into Being,” The New York Times, January 4, 2011

In gardening parlance, the exuberantly shaded urns might be regarded as a delicious folly, a needlessly flamboyant landscaping gesture designed to delight the senses. (I know such terms because I worked for years at Canada’s premier gardening magazine, now, like so many other examples of food and shelter porn, sadly defunct.)
—Danny Sinopoli, “Eye-popping planters,” The Globe and Mail, January 29, 2010

Earliest Citation:
Design buffs are mad for “Wallpaper*,” the magazine that takes readers inside homes that don’t exist to visit people who don’t really exist, either.
—Rene Chun, “Shelter Porn,” New York Magazine, October 13, 1997

Having gotten curious about the situation in Wisconsin, I decided to see what data I could pull to get a feel for the size and scope of the problem.  First up, a look at union membership in the state, via BLS.gov:

Source:  Union affiliation of employed wage and salary workers by state, BLS.gov

The trend is clear:  “Members of Unions” has declined from 456,000 to 355,000 from 2000 to 2010, as the percentage of employed who are members of unions has declined from 17.8% to 14.2%.  Note that the table does not represent solely public employees — it represents the entire work force of the state, both public and private, which is to say the problem Governor Walker is targeting is some fraction of the “Members Of” or “Represented By” Unions.

Via another BLS database (a bit dated, but it’s the most recent available and likely close enough to current numbers for discussion purposes), I thought it would be interesting to see who’s actually breaking the bank in Wisconsin.  So I pulled a group of occupations that I’d consider “the usual suspects” — teachers, fire fighters, police, librarians — and compared mean and median annual wages for those jobs in Wisconsin versus the United States as a whole.  Lo and behold, it appears we might lay blame for the crisis at the feet of Wisconsin’s  Teacher Assistants, who are pulling down, on average (not median), $240 more than the $24,280 being paid to their counterparts in other states.  I’ve highlighted in green the wages in Wisconsin that are higher than those with the same occupation in other states;  it occurs in 3 of 16 potential possibilities.

(Click through for larger image.)

Source:  BLS.gov

(Note:  It should go without saying that this raw data does nothing to account for cost of living differences in various parts of the country.)

I could add to the list — drop other potential culprits in comments — but figured I’d start with the most egregiously greedy bastards who came immediately to mind.

For the record, here’s a complete list of what we pay our police and fire fighters nationwide.  If we are to have an honest debate about what folks are paid and what benefits they should (or should not) receive, we owe it to ourselves to at least start with some facts, and I’d suggest what appears below is the bare-bones minimum.  Wisconsin is 21st in Patrol Officer pay and 43rd in Fire Fighter pay nationwide.

Finally, I’d dare say that this budgetary problem seems to have crept up and taken most governors by surprise, as evidenced by the fact that references to it (in State of the State speeches) skyrocketed over the course of one short year, going from only 20 mentions (of 44 speeches) to 33 (of 42 speeches) from 2009 to 2010.  Even fewer — far fewer – have been mentioning “Pensions/OPEBs” (Other Post-Employment Benefits).  Have they just not been paying attention?  If I didn’t know better, I’d swear it smells a bit political.

Source:  The Council of State Governments

For an interesting look at state government compensation by state and branch, see here (pdf).

And for an outstanding look at state-by-state budgets, see here (pdf) — this is an excellent piece that I only found this morning and am still exploring.  It is a veritable treasure trove of budget data by state nationwide.

More on this file as time allows.

Adding: I appreciate the thoughtful commentary on both sides.  I intend to further explore many of the comments that have been made.