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Below is my video on TechTicker today. Get on the phone and call your Senator.

VIDEO

I thought the residents of The Big Picture would like to see some of the photos I took on this year’s fishing junket and economic debate session at Leen’s Lodge in Grand Lake Stream Maine. Our host Charles Driza did a tremendous job of taking care of our various wants and needs.  If you ever want to take the family on a really great vacation, call Charles at  800-995-3367 or go to www.leenslodge.com.   Here is a sunset shot from day 1.

Copyright 2009 RC Whalen

The photo below shows Charles Driza in a rare moment of rest during one of the lunches he organized for us each day.  Charles is a mechanical engineer by training and a registered Maine Guide.   Besides running Leen’s, Charles is particularly known for his excellent hunting trips, both in ME and in LA during the winter months.

Copyright 2009 RC Whalen

We had great weather this year and the cooperation of the Almighty in this regard also allowed me to capture some of my favorite economists and analysts for posterity.   First of course is our gracious host on TBP Barry Ritholtz, who is shown here in the dining room of the main lodge after a bit of surfing on his ever ready MAC notebook.  And yes, Leen’s has WiFi and the BB even works a little.  I left my BB in the cabin where it belongs.

Copyright 2009 RC Whalen

Barry looks like a very happy cat because we were all waiting for dinner, which at Leen’s is a feast.  I am amazed I was able to get back into my car after five days of eating great food and drinking the endless supply of wine provided by David Kotok, the genius behind this event.  As I said at dinner on day 2, David Kotok is not only a great manager of other people’s money and a great friend, but he is also a committed public citizen because he has taken as his mission in life to broaden dialog and understanding among financial professionals all over the world.    See David below holding forth on an island in the middle of the Big Lake during the lunches the the Maine Guides put on for us each day.

Copyright 2009 RC Whalen

We had almost 50 participants in this year’s fishing trip, including a number of new inductees.   We did not catch enough catfish to have the traditional investiture ceremony as last year, but we still had some fun with the newbies.  One of the names the readers of TBP will recognize is our friend Josh Rosner, who arrived at Leen’s sporting a very impressive rod and reel that it took us several days to learn how to operate.   Something about magnets and centrifugal force.  Finally, we read the instructions.  Duh!  The photo below shows Josh in the bow of a guide’s canoe.

Copyright 2009 RC Whalen

When we are out on the lake, we generally use these beautiful hand-build canoes with small outboard motors.  These craft have square sterns and are remarkably stable.  Our guide for the past several years has been Dale Tobey (djtobey[at]netzero.net), the past president of the Maine Guides Association and a real honest-to-God woodsman who builds his own canoes in the wintertime, raises hounds and hunts and traps in the woods of Maine.  In the photo below, you see Dale with Matt Greco of CNBC, who caught a good number of bass on the last day.

Copyright 2009 RC Whalen

Besides Charles Driza, the people who really make the trip work are the guides and the staff of Leen’s, who all live in the local community and work from dawn till late at night to make our experience a real treat.  The first photo below shows the Maine Guides after the lunch on Saturday.  The lady on the far right of the photo, Sue, baked us fresh pies and cobblers in a dutch oven over an open fire.  Randy Spencer of the Maine Guides is in the center front row.  Randy and CNBC’s Steve Liesman provided great musical entertainment in the evenings for the group.  Randy writes and performs songs, and has also written a history of the Maine Guides.

Copyright 2009 RC Whalen

Here are a copy of photos of Steve and the other campers during one of the lunches on an island in the middle of the Big Lake, including Bob Eisenbeis, Harvey Rosenblum and Jay Dwight.  There is also a shot of the canoes used by the group.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Finally, we have to pay a special tribute to Laura King, our hostess at Leen’s Lodge. Laura is a Passamaquody Indian who lives in Princeton Maine. A life-long resident, Laura has many duties at the lodge, including cooking & telling the guests where the fish are! Laura is known for her helpful attitude and great desserts. Laura’s family members, including her husband Gary, and daughters Bea and Fay, are often helping her at the lodge as the work load increases in the summer season.   Leen’s Lodge is blessed to have Laura King and the other members of the Leen’s family to serve its guests.  And beware:  Laura is a great poker player.

Copyright 2009 RC Whalen

Tight lines,

Chris

Here is an excerpt from our latest issue of The Institutional Risk Analyst comment and some additional thoughts since we’ve published.  Got some very good responses/retorts that we’ll share with with la famiglia ritholtz as with previous comments.

Good Evening: Multiple crosscurrents prevented stocks from making much headway in either direction today, with the major averages finishing appropriately mixed on light volume. Negative stories about the banks and their impending need to raise capital clashed with positive surprises from today’s economic data releases. Given that the banks have been the leaders in both directions since this bear market began, the recent underperformance in the KBW bank stock index may portend a downward resolution to the sideways range the averages have been in for most of April.

Depending upon the news service one chooses to frequent, the swine flu is either dangerously spreading or is well on its way to being contained. Fearing the former, most foreign bourses were under decent pressure last night, but the stocks and bonds in the flu epicenter of Mexico were actually higher at one point today before finishing with modest losses. Perhaps the safest thing to say about this story is that it’s too early to really know whether this strain of swine flu can spread as rapidly around the globe as has the media hype surrounding it. In any case, U.S. stock index futures were down 2% or so as Tuesday dawned. That the Wall Street Journal ran a story about some major banks needing more capital probably also contributed to the early weakness (see excerpt below).

Yet, for the second day running, U.S. stocks suffered only half as much damage as the futures had been indicating. Some analysts take this action as a sign of latent buying power on dips in equities, but a better explanation (at least for today) lies in a piece of less negative than expected news on the housing front (see below). The S&P Case Shiller home price index, released 30 minutes prior to the commencement of trading, showed metropolitan home prices slipped 18% in February versus the negative 19% reading in January. Some tried to herald this better than expected data point as evidence that home prices are bottoming, but, as anyone with a “for sale” sign in their front yard can tell you, a slower rate of decline in price is cold comfort for those trying to sell a home.

After dropping approximately 1% just after the opening bell, equity prices were already on the comeback trail when the next economic news items hit the tape. Consumer confidence in April jumped to 39.2 from March’s 26.9 reading, the largest such rise in three years. Since most of the gains came from the “future expectations” aspect of the survey, economists were quick to hail the results as indicative of a pick up in consumer spending. I’d be happy if the vaunted U.S. consumer somehow found a way to climb up off the canvas, but taken in the context of the whole data series, a reading of 39.2 is not exactly bullish. Consumer confidence was in the 40s back during the dark days of last November, for example, and readings around 110 were not uncommon back in early 2007. Thus, while 39.2 may not be a great number, it was good enough to push stock prices into positive territory today. This happy economic backdrop was only reinforced when the Richmond Fed reported that manufacturing in its district declined at a pace that was gentler than had been forecast.

The major averages responded well enough to these data points to stay mostly above the unchanged mark. Helping to hold prices in check, however, was a follow up to the Journal’s story about the capital needs among the major banks. According to FBR, which administered its own, slightly more rigorous version of the government’s stress test on these institutions, said that Bank of America may need as much as $70 billion in fresh equity (see below). In a further blow to Ken Lewis and his directors, CalPERS announced it was voting against Lewis and his BOD slate at the upcoming annual meeting. BAC shares declined, as did those of Citigroup and other financial companies.

Despite these concerns, equities enjoyed an afternoon rally that saw the major averages logging gains of 1% or more. But this strength didn’t last and prices fell back at the closing bell. The final tally was mixed, with the Russell 2000 sporting a gain of 0.7%, the NASDAQ giving back 0.33%, and other averages finishing with fractional losses. Call today a draw. In contrast to the lack of volatility seen at the NYSE, the Treasury market saw plenty of it. Government bonds were down across the board, and yields rose between 5 and 14 basis points in a decidedly steeper curve environment. The dollar responded by dropping 0.7%, but, like equities, commodities were mixed. Other than a decent drop in metals both precious and base, most sectors comprising the CRB were trendless as the index itself dropped just less than 0.5%.

By almost any measure, fundamental or technical, the U.S. stock market looks to be a bit confused. Biding their time and waiting for more information, prices are thus moving sideways. The economic data has indeed seen some green shoots emerge, but it seems too early to tell whether these growings will become either flowers or weeds. The economic data and corporate earnings have been mixed, and about the best one can say about them is that the rate of decline is slowing. Given the Herculean efforts by the Fed, Treasury, and Congress, such an outcome, while not pre-ordained, is not surprising. The question before investors is whether this “less bad than expected” news flow is enough to signal the type of change President Obama promised when he was swept into office.

I’m no expert, but looking at the internal indicators of the market’s health, it’s just as hard to use technicals when trying to pinpoint an imminent trend in stock prices. The plunge into the early March lows and subsequent rebound into April has left the averages trading sideways at levels just below where they entered the year. Volume and volatility have both eased, and while the lows on the chart are rising, so too are the highs falling. One gets the sense that the indexes are coiling and ready to break out from their recent mid point at 850 or so in the S&P 500. Both the bulls who’ve declared a new bull market and the bears who are selling into what they perceive to be a bear market rally have both been disappointed of late.

Divining a directional change in market prices is tricky, even foolhardy, but perhaps the market leadership names will be instructive. Ever since the great bear market of 2007-2009 began, it has been led by the financial stocks. No matter which direction Mr. Market has chosen to wander, it has been the KBW bank index that has fallen hardest or soared the most. Falling more than 85% into March, the BKX rose just over 100% into mid April. But, while the other averages have been marking time, the BKX is now down 16% since its April 17 high. No matter what our government says about the true health of bank balance sheets, the real stress test for the U.S. stock market lies in what happens next to the BKX. I have a feeling the major averages will start following the banks should they continue moving lower, but who really knows? The safest prediction I can make is that the S&P 500 won’t be hanging around 850 much longer.

– Jack McHugh

U.S. Stocks Retreat, Led by Banks on Balance-Sheet Concern

U.S. Economy: Consumer Confidence Leaps, House-Price Drop Slows

Bank of America’s Lewis Loses Calpers Support, May Need Money

Fed Pushes Citi, BofA to Increase Capital
(subscription required for full article)

Good Evening: The major U.S. stock market averages declined on light volume today, and an outbreak of a new strain of swine flu was deemed the primary culprit. Upon closer inspection, however, it seems as if the sloppy — even hoggish — bank lending practices of the previous up cycle are as much to blame for today’s pullback as any potential pandemic.

While I was away late last week, stocks tried to best the recent highs they had set in anticipation of Friday’s release of the “stress test” parameters. The less than stressful reality of these tests for large banks proved anticlimactic, and equities were unable to muster the energy to reach fresh, post-March 6 highs. As such, the averages may have been looking for an excuse to retreat when the news from Mexico made the rounds over the weekend. A strain of swine flu known as H1N1 was reported to be responsible for more than 100 deaths in Mexico. Though no deaths have been reported in other countries, tests have confirmed that this flu has spread to parts of the U.S. and as far away as New Zealand.

In reaction to these reports, the World Health Organization raised its alert level and investors accordingly raised their level of concern during today’s trading. Fears surfaced that global travel would be disrupted and that overly cautious trade sanctions (e.g. pork imports) would be put in place. The playbook from the 2003 SARS outbreak was dusted off and put to use, with hotels, airlines, cruise lines, and casinos among the day’s biggest losers. Since H1N1 appears to be treatable with Tamiflu and other anti-viral drugs, it came is no surprise that biotech and assorted health care names were among Monday’s winners. Eyebrows were raised, though, when GM managed to gain 20% in the wake of an equity-for-debt swap offer that will likely gain little traction (see below). Short-covering and capital structure arbitrage strategies aside, GM common and the company itself will need enormous measures of both luck and skill to survive in anything resembling current form.

Stock index futures were indicating losses of up to 2% prior to this morning’s open, but the actual damage was approximately half that amount when the opening bell rang in New York. Market participants were soon of a mind that the media was over-hyping the flu story, and they managed to push equities back above unchanged before lunchtime. The averages then resumed sinking during a relatively quiet afternoon before closing just above their worst levels of the day. Helped by GM, the Dow (–.65%) suffered least, while the Dow Transports (-4.7%) understandably brought up the rear. Just as they did during the SARS outbreak in 2003, Treasurys performed well. A large 2 year note auction was quite well received, and yields fell between 4 and 8 basis points. The dollar was somehow deemed a beneficiary of the swine flu, and it rose 1.4% today. Commodities were much less fortunate, as fears of protectionism hiding behind a fig leaf of health concerns hurt almost every major sector. The CRB index declined more than 2%.

While it’s still early by flu outbreak standards, most health experts seem to believe that the H1N1 strain of swine flu is unlikely to reach pandemic proportions. If so, and I’m particularly unqualified to doubt medical professionals, to what can we better attribute to today’s decline in the stock market? I have two candidates and the first is a piggish rise in bullishness among large institutional investors. The latest “Barron’s Big Money Poll” came out this weekend, and the results display anything but doubt for the future of either U.S. stocks or the U.S. economy. Fully 59% of portfolio managers in the survey counted themselves as bullish on equities, while only 13% said they were negative. Readings of 4-1 bulls over bears are usually reserved for the frothier portions of bull markets — or, perhaps, at the peak of a vigorous bear market rally. As BAC-MER economist, David Rosenberg, points out in his piece below, the figures are even more striking (in the opposite direction) for Treasurys. 84% are bearish on securities issued by our government while a mere 3% are constructive. I may not be bullish on U.S. debt, but maybe the overwhelmingly bearish sentiment means it’s a bit too early to short them.

Given today’s 5% drop in the KBW bank stock index, my other candidate for an old affliction that might be responsible for weighing down stock prices today is the epidemic of shoddy bank lending practices during the previous boom. Infecting far more than just subprime residential real estate, this contagion spread to commercial real estate, leveraged loans, junk bonds, CDS, and even plain old corporate bonds. This strain of poor lending was evident in the narrow spreads seen for all types of credit in the run up to mid 2007, and despite repeated assurances from so many government officials and bank CEOs to the contrary, this problem is still not contained. The contagious desire among banks to extend credit to so many parties with hardly more upside than the generation of upfront fees is the real swine flu of our generation. And, just like its pandemic namesake, this strain of sick lending can be found all over the world.

Let’s look at Wells Fargo, a bank that has been in the news quite a bit of late.. The Bank of Buffett, according to the Oracle himself, stayed mostly out of trouble during the last cycle by avoiding doing the “dumb things” that so many of its competitors felt an irresistible urge to do on the lending side. “But they’ve never felt compelled to do anything because other banks were doing it, and that’s how banks get in trouble, when they say, ‘Everybody else is doing it, why shouldn’t I?’” (source: Fortune article below). As a Wells Fargo mortgagee myself, I agree with Mr. Buffett that Wells maintained a unique sense of discipline during the last cycle. But now WFC is lugging around the old Wachovia, which was a poster child of “me too” credit practices prior to its merger with Wells. Strictly because it now owns Wachovia, I’m a lot less sanguine about the future of Wells Fargo, a sentiment apparently shared by Dick Bove (see below).

This Rochdale Securities analyst has been favorably disposed toward banks for quite some time (read: bullish at much higher prices than these institutions fetch today). For Mr. Bove to cut Wells Fargo from a buy to a hold and question WFC’s cash levels and ability to digest the Wachovia transaction may thus actually be news. Mr. Bove agrees with Mr. Buffett that Wells is very well run, but he also agrees with me that Wells will be hampered by Wachovia going forward. Trying to keep up with the Joneses in New York, the Charlotte-based bank caught the “everybody else is doing it” syndrome so abhorred by the management of Wells and its famous shareholder. Let me repeat: I’m not saying Mr. Buffett is wrong and I’m not advocating anyone be short of Wells Fargo. What I am saying is that bullish market sentiment is already running a fever just as a flu scare strikes a global economic sentiment that is already bedridden. H1N1 may or may not have much of an impact on the world, but the real swine flu is still wreaking havoc.

– Jack McHugh

U.S. Stocks Fall as Swine Flu Drags Down Travel, Hotel Shares

GM Bondholder Group Says Offer Isn’t ‘Reasonable’

Warren Buffett on Wells Fargo

Ahead of the Bell: Bove cuts Wells Fargo rating

Big Money Poll meets Bob Farre.pdf

This AM I was on CNBC discussing the banks with Paul Miller of FBR.  Paul is a first rate analysts, IMHO.

I suggested that the big banks should not be allowed to repay TARP equity to long as the government is guaranteeing their debt. That is, if a bank wants to repay TARP capital, they must end the use of debt guarantees AND be able to refinance all guaranteed debt before the TARP capital is repaid.  Link below:

We will develop this further.  Look forward to your comments.

Best,

Christopher Whalen
Managing Director
Office: 914-827-9272
www.institutionalriskanalytics.com

As if the global economy, let alone the world itself, needed another thing to worry about, swine flu comes along. Having lived through the experience of SARS 6 years ago, the Hang Seng and Shanghai stock markets were hard hit. Economically sensitive commodities such as crude and copper are also weak.

The Mexican peso is having its biggest one day decline vs the US$ since Oct 22nd also in response as businesses where people congregate temporarily close. Most global bond markets are the sole beneficiary of the nervousness.

May German consumer confidence was a touch better than expected but the Euro is lower as two ECB members over the weekend said they will support another rate cut next week. The only question over the next few months is if they stop at 1% or not from 1.25% now. Earnings, auto restructurings, bank stress test capital raises and US Treasury supply will again be the focus this week.

>

Today – SPMs are down 14.60 in Sunday night trading because Obama’s chief economic adviser, Larry Summers, asserted while appearing on Fox News Sunday, that the economic freefall is over but, “I expect the economy will continue to decline… [with] sharp declines in employment for quite some time this year.” (Reuters)

• “The anticipation over the white paper appears to be much ado about nothing,” said Josh
Rosner…“The most significant numbers provided by the Fed in the paper appear to be the page
numbers.”…
• “A lot of triple talk,” said Jim Glickenhaus… “I think they’re going to say while things are bad, the end is not at hand. Maybe.”
• “The question I have, by using fourth-quarter numbers, is this skewed positively?” said Lawrence Kaplan, an attorney with Paul Hastings, who served as a senior attorney in the chief counsel’s office at the Office of Thrift Supervision. “Because January and February were pretty lousy, and as a result that’s when it hit the fan.” (Bloomberg)

As most people guessed, the ‘stress test’ is an innocuous exercise based on rosy economic projections. Besides, why is a ‘stress test’ needed when there are already three agencies (Fed, FDIC, OCC) that apply metrics to measure banks’ solvency and financial condition?

A major problem with the ‘stress test’ is it depends on modeling and it’s the precise practice responsible for much of this economic and financial mess. It’s extraordinary that so many people believe that the Fed and Treasury, after missing the financial disaster, housing debacle, recession and derivative implosion, can now extrapolate economic conditions and resultant financial affects from its models. How did all that rocket-science modeling for subprime defaults and securitization workout? Yet many people already forget or ignore this reality.

Here’s another reality that most investors are missing – banks must raise more capital. So who’s the patsy in recent days that has been driving financial stocks higher? The FT: Fed will seek bank capital increase. Some of the country’s biggest banks will be asked to raise more capital by US authorities following the completion of bank stress tests, senior Federal Reserve officials said on Friday. (Financial Times)
Banks May Need $1 Trillion After U.S. Tests, KBW Says (Bloomberg)

What few analysts realize is that economic ‘muddling’, the best case scenario for the next two years, gives no relief to an economy burdened with record debt. If you lose a high paying job and you are struggling to pay your debts, you will not suddenly be able to pay your debt with a job a Wal-Mart.

What analysts should do is quantify the US private and public sector debt load and then extrapolate the needed income and GDP to service the debt. And then they should calculate how much debt will implode with little or no income and GDP growth.

The ‘real budget deficit’, “Treasury Gross Public Debt”, is now $1.85 Trillion (Barron’s p. M70).

The most disturbing aspect of the current scheme to manipulate markets, economic data and industrial data into something benign enough to increase consumer confidence and reinflate assets is that it is the precise scheme that Easy Al and others perpetrated over many years. And it created the current mess.

Solons again are trying to inflate assets to a level that is a huge disconnect with economic reality in
the misguided belief that they can paper over structural US economic problems and fostering
‘confidence through asset bubbles’ that will translate into economic activity. We are back to square one in ‘the new economy’ gambit.

And because we are back to square one in ‘the new economy’ of inflating assets to paper over problems, the markets are diving back into inflation mode. Commodities are soaring; bonds are struggling even with Fed support and the dollar is finally buckling.

~~~

Bill King is a Wall Street veteran with 35 years of institutional equity, proprietary and derivatives trading experience, giving him a unique perspective on current market conditions and forecast. As author of The King Report, Bill’s candid observations and forecast on the economic, financial, and political forces that are impacting the markets is read by major institutions and hedge funds. However, this report is not the usual garden variety tripe that is issued by the financial media and Wall Street. Bill, in plain language, refutes conventional rant about Wall Street activity and articulates the real factors and impetuses that drive market activity. The inside world of Wall Street is far different than what is disseminated to the masses. Wall Street insiders seldom adorn their own portfolios or trading accounts with ‘recommended list’ issues.

Words from the (investment) wise for the week that was (April 20 – 26, 2009)

“Words from the Wise” this week comes to you in a shortened format as my traveling in the US precludes me from doing my customary commentary. However, a full dose of excerpts from interesting news items and quotes from market commentators is provided.

On Friday, Federal Reserve regulators have released a white paper outlining the criteria they used to assess the financial health of the nation’s 19 biggest banks. On the same day they also briefed the banks about how their companies had fared in the examination. The banks will have until Tuesday to dispute any of the results before they are made public on May 4.

According to the Financial Times, senior Fed officials said US authorities will ask some of the country’s biggest banks to raise more capital following the completion of bank stress tests. The officials also indicated that a second, larger, group of banks will be asked to improve the quality of their capital by increasing their amount of common equity.

Last week investors’ mood was also influenced by tentative signs of economic stabilization in a number of countries and a barrage of earnings report – generally better than feared. As the equity rally ground to a halt on some bourses, the US dollar and government bonds offered little safety appeal and edged weaker. Gold, on the other hand, advanced after China revealed it has almost doubled its gold reserves since 2003. Treasury Inflation Protected Securities (TIPS) also improved on the week.

The performance of the major asset classes is summarized by the chart below, courtesy of StockCharts.com.

After rising for six consecutive weeks, global stock markets experienced a volatile week, including the worst losses since early March on Monday. In the end, the MSCI World Index gained 0.1% (YTD -4.1%) on the week and the MSCI Emerging Markets Index 0.7% (YTD +14.2%), but the S&P 500 Index shaved off -0.4% (YTD -4.1).

Click on the table below for a larger image.

As far as the earnings season is concerned, Bespoke indicated that 156 S&P 500 companies had reported earnings by Thursday, beating estimates in 67% of the cases. Also, so far earnings are down 16.6% versus the first quarter of 2008. While down, this is much better than the -37.3% expected at the start of the earnings season. “The earnings season still has a long way to go, but the current trend has investors optimistic,” said Bespoke.

In an attempt to cast light on the debate of whether we are dealing with a bull market or a bear market rally, William Hester (Hussman Funds) highlighted the following: “Contracting volume is not enough evidence to qualify that this is a bear-market rally with certainty. There are other measures that are showing more strength – such as various indicators of market breadth. But new bull markets, whether at their inception or soon after, have a history of recruiting noticeable improvements in volume. So far this rally lacks that important quality. Over the next few weeks stock market volume will be a metric to watch closely.”

The stock market will show its hand in due course, but it is crucial that the lows of March 9 hold in order for base formation development to remain intact. Should these levels – 677 for the S&P 500 and 6,547 for the Dow Jones – be breached, further downside movements may be in store.

For more discussion on the direction of stock markets, see my recent posts “Video-o-rama: Economy – Recovery or relapse?” and “Has stock market rally run its course?” (And do make a point of listening to Donald Coxe’s webcast of April 24, which can be accessed from the sidebar of the Investment Postcards site.)

Next, a quick textual analysis of my week’s reading. No surprises here, with key words such as “banks”, “market”, “economy”, “economic”, “government” and “prices” featuring prominently.

Economy
“Global business sentiment remains very poor, but it has taken on a slightly better hue in recent weeks. Broad assessments of current and prospective conditions have also moved up measurably since the beginning of the year,” said the latest Survey of Business Confidence of the World conducted by Moody’s Economy.com. “It is premature to conclude that businesses are turning measurably more upbeat, but recent survey results are somewhat encouraging.”

For a further perspective on the outlook for the global economy, also read my posts “Economic rate of decline slowing down?“, “Goldman raises China’s growth forecasts” and “Chinese economy on the rebound“.

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Back to the Future Recession

April 24, 2009
By John Mauldin

Financial Innovation: The Round Trip

Back to the Future Recession

The Fed at the Crossroads

How Did We Get It So Wrong?

The Trend Is Not Your Friend When It Ends

Orlando, Naples, Cleveland, and Grandkids

This week we look at the second half of my speech from a few weeks ago at my annual Strategic Investment Conference in La Jolla. If you have not read the first part, you can review it here.

The first few paragraphs are a repeat from last week, to give us some context. Please note that this is somewhat edited from the original, and I have added a few ideas. You can also go there to sign up to get this letter sent to you free each week.

MV=PQ

Okay, when you become a central banker, you are taken into a back room and they do a DNA change on you. You are henceforth and forever genetically incapable of allowing deflation on your watch. It becomes the first and foremost thought on your mind: deflation, we can’t have it.

MV=PQ. This is an important equation, right up there with E=MC2. M (money or the supply of money)
times V (velocity — which is how fast the money goes through the system — if you have seven kids it goes faster than if you have one) is equal to P (the price of money in terms of inflation or deflation) times Q (roughly standing for the Quantity of production, or GDP)

So what happens is, if we increase the supply of money and velocity stays the same, and if GDP does not grow, that means we’ll have inflation, because this equation always balances. But if you reduce velocity (which is happening today) and if you don’t increase the supply of money, you are going to see deflation. We are watching, for reasons we’ll get into in a minute, the velocity of money slow. People are getting nervous, they are not borrowing as much, either because they can’t or the animal spirits that Keynes talked about are not quite there.

To fight this deflation (which we saw in this week’s Producer and Consumer Price Indexes) the Fed is going to print money. A few thoughts on that. The Fed has announced they intend to print $300 billion (quantitative easing, they call it). That is different than buying mortgages and securitized credit card debt — that money (credit) already exists.

When they just print the money and buy Treasuries, as with the $300 billion announced, they can sop that up pretty easily if they find themselves facing inflation down the road. But that problem is a long way off.

Sports fans, $300 billion is just a down payment on the “quantitative easing” they will eventually need to do. They can’t announce what they are really going to do or the market would throw up. But we are going to get quarterly or semi-annual announcements, saying, we are going to do another $300 billion here, another $500 billion there. Pretty soon it will be a really large total number.

When we first started out with TALF and everything, it was a couple hundred billion, and now we just throw the word trillions around and it just drips off of our tongues and we don’t even think about it. A trillion is a lot. It’s a big number. And the total guarantees and backups and all this stuff we are into — I saw an estimate of $10-12 trillion. That’s a lot of money.

Understand, the Fed is going to keep pumping money until we get inflation. You can count on it. I don’t know what that number is; I’m guessing maybe as much as $2 trillion. I’ve seen various studies. Ray Dalio of Bridgewater thinks it’s about $1.5 trillion. It’s some very big number way beyond $300 billion, and they are going to keep at it until we get inflation.

Side point: what happens if the $300 billion they put in the system comes back to the Fed’s books because banks don’t put it into the Libor market because they are worried about credit risks? It does absolutely nothing for the money supply. Okay? It’s like, goes here, goes back there — it doesn’t help us. The Fed has somehow got to get it into the financial system. They’ve got to figure out how to create some movement.

Will it create an asset bubble in stocks again? I don’t know, it could. Dennis [Gartman] talked about being nervous yesterday. I would be nervous about stock markets both on the long side, as I think we are in a bear market rally, but also there is real risk in being short. Bill Fleckenstein will be here tonight. He is a very famous short trader. He closed a short fund a couple of months ago. He says he doesn’t have as many good opportunities, and basically he’s scared of being short with so much stimulus coming in. So it’s going to work, at least in terms of reflation, but the question is, when? A year? Two years?

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