Posts filed under “Think Tank”
The Beige Book said economic conditions “have generally improved modestly since the last report.” 8 of the 12 districts saw some “pickup in activity” while 4 others said things were “little changed and/or mixed.” Consumer spending picked up modestly with non auto retailers having lean inventories going into the holidays. Manufacturing was “steady to moderately improving” and nonfinancial services “strengthened somewhat.” Residential RE improved somewhat “from very low levels…led by the lower end of the market.” CRE and construction “were depicted as very weak and, in many cases, deteriorating.” Labor markets “remained weak…though there were signs of stabilization and scattered signs of improvement.” Some districts saw upward pressure on commodity prices but no upward wage pressure or “any significant increase in prices of finished goods.” Net-net, no surprises.
Investment Newsletter – November 24, 2009
HAPPY THANKSGIVING! I hope you are surrounded by family and friends on Thanksgiving. We have much to be thankful for.
The Real Elephant in the Room
Throughout history, there have been a numerous investment manias, covering a wide range of ‘investments’. One of the more fascinating aspects of each mania is how similar the price pattern has been. In each case, a gradual price increase over a number of years, accelerates, until the rise appreciates into an almost vertical trajectory. Like a pilot who takes off and then aims the nose of the plane toward the sky, until there isn’t enough lift under the wings and the plane stalls. At that point, the nose of the plane rolls over, and a harrowing descent toward earth begins. This flight pattern is evident in the wake of every investment mania. For instance, between 2004 and early 2007, crude oil rose from $30 to $60, then soared to $147 in July 2008, before crashing 77% to $33 in November 2008. In early 1995, the Nasdaq Composite was trading under 800, rose to 1400 by October 1998, then almost tripled as it jumped to 5,100 in March 2000.
After that meteoric rise, the NASDAQ lost 66% in just 13 months! During the 1980’s, the Japanese Nikkei rose from 5,000 to 39,000 at the end of 1989, only to collapse 75% to under 10,000 within a few years. I could cite other examples going as far back as the tulip bulb craze in 1637, which all sport a similar parabolic signature price pattern.
The key point is that after a parabolic increase stalls, the price has collapsed, whether it was oil, stocks, silver, soybeans, the South Sea Company (1720), or Tulip Bulbs. If you compare the charts of the NASDAQ, Nikkei, South Sea Company and Tulip Bulbs to the following chart, the parabolic increase is clearly evident. The only difference is that the collapse in price after the parabolic stalls has not begun. The Federal Reserve has and will continue to do everything it can to prevent a collapse, since this chart is the ratio of total debt to GDP. Since 1982, this ratio has soared from $1.65 of debt to $3.70 of debt for each $1.00 of GDP. Over the last 12 months, as consumer borrowing has declined, Federal government debt spending has expanded rapidly, which has pushed the ratio even higher. This is unsustainable. But there is no easy or painless solution.
In order for the ratio of debt to GDP to stabilize, GDP must grow faster than the growth in debt. This has not happened in the last 30 years. A good portion of GDP growth since 1982 came from the increase in debt, which means GDP growth will on average be lower, without the debt steroids of the past 25 years. Slower economic growth in coming years will generate less tax revenue for all levels of government, which will force most states to raise taxes. The Federal government is expected to run $1 trillion deficits for a number of years, which will cause the debt to GDP ratio to continue to rise. At some point, the Federal government will be forced to increase taxes on anything that moves, including the middle class. Higher state and Federal taxes will reduce disposable personal income, which will already be growing more slowly due to weaker overall GDP growth. Shrinking disposable income will make it more difficult for stretched consumers to service and pay down existing debt, resulting in an increase in the number of consumers who are forced to default on their debts.
As glum as the preceding scenario sounds, it beats the alternative. Rather than an orderly paying down of consumer debt over an extended time from disposable income in a slow growth environment, the ratio of debt to GDP falls through debt liquidation. In this scenario, the combination of a weak economy and higher taxes forces an increasing number of consumers to default on their mortgage, credit card debt, and auto loans. As more foreclosed properties are dumped by stressed banks, home prices fall further. Already, nearly 25% of homeowners owe more on their mortgage than their home is worth, and another 5% have less than 5% equity left. As debt liquidation progresses, bank balance sheets and future lending contracts causing money supply and the velocity of money to decline, which leads to more asset deflation. Ironically, widespread debt liquidation would create a shortage of dollars, and lead to a significant rally in the dollar. Over the last six months bank lending has contracted by 6%, bank balance sheets required an infusion of almost $1 trillion so they wouldn’t shrink, and the velocity of money has declined. This has occurred even as the Federal Reserve has expanded its balance sheet from $900 billion to $2.2 trillion.
Category: Think Tank
ADP said there were 169k private sector jobs shed in Nov, 19k more than expected but down from 195k (revised from 203k) in Oct and is the smallest amount of job losses since July ’08. The goods producing sector lost 88k jobs and the service sector shed 81k jobs with small businesses leading the decline….Read More
The best way to describe Fed actions over the past few years is that of an asymmetrical policy. Slash rates when the economy was faltering and the financial system was facing extraordinary stress and keep them at zero even after the emergency has passed and the economy has stabilized, however fragile. This begs the question…Read More
Oct Pending Home Sales rose 3.7% m/o/m vs an expected fall of 1%. Gains were led by a 19.9% jump in the Northeast, an 11.6% rise in the Midwest and a 5.4% lift in the South. The West saw contract signings down 11.2%. The overall y/o/y gain is 28.6% as the comparisons begin to get…Read More
Long time Outside of the Box readers are familiar with John Hussman of the eponymous Hussman Funds. And once again he is my selection for this week’s OTB.
This week he touches on several topics, all of which I find interesting. As he notes:
“We face two possible states of the world. One is a world in which our economic problems are largely solved, profits are on the mend, and things will soon be back to normal, except for a lot of unemployed people whose fate is, let’s face it, of no concern to Wall Street. The other is a world that has enjoyed a brief intermission prior to a terrific second act in which an even larger share of credit losses will be taken, and in which the range of policy choices will be more restricted because we’ve already issued more government liabilities than a banana republic, and will steeply debase our currency if we do it again. It is not at all clear that the recent data have removed any uncertainty as to which world we are in.”
Have a good week.
John Mauldin, Editor
Outside the Box
John P. Hussman, Ph.D.
I was wrong.
Not about the implosion of the credit markets, which I urgently warned about in 2007 and early 2008. Not about the recession, which we shifted to anticipating in November 2007. Not about the plunge in the stock market, which erased the entire 2002-2007 market gain, which was no surprise. Not about the “ebb and flow” of short-term data, which I frequently noted could produce a powerful (though perhaps abruptly terminated) market advance even in the face of dangerous longer-term cross-currents. I expect not even about the “surprising” second wave of credit distress that we can expect as we move into 2010.
From a long-term perspective, my record is very comfortable. But clearly, I was wrong about the extent to which Wall Street would respond to the ebb-and-flow in the economic data – particularly the obvious and temporary lull in the mortgage reset schedule between March and November 2009 – and drive stocks to the point where they are not only overvalued again, but strikingly dependent on a sustained economic recovery and the achievement and maintenance of record profit margins in the years ahead.
I should have assumed that Wall Street’s tendency toward reckless myopia – ingrained over the past decade – would return at the first sign of even temporary stability. The eagerness of investors to chase prevailing trends, and their unwillingness to concern themselves with predictable longer-term risks, drove a successive series of speculative advances and crashes during the past decade – the dot-com bubble, the tech bubble, the mortgage bubble, the private-equity bubble, and the commodities bubble. And here we are again.
We face two possible states of the world. One is a world in which our economic problems are largely solved, profits are on the mend, and things will soon be back to normal, except for a lot of unemployed people whose fate is, let’s face it, of no concern to Wall Street. The other is a world that has enjoyed a brief intermission prior to a terrific second act in which an even larger share of credit losses will be taken, and in which the range of policy choices will be more restricted because we’ve already issued more government liabilities than a banana republic, and will steeply debase our currency if we do it again. It is not at all clear that the recent data have removed any uncertainty as to which world we are in.
Taking the weighted average outcome for the two states of the world still produces a poor average return/risk tradeoff. Taking the weighted average investment position for the two states of the world is somewhat more constructive. As I noted several weeks ago, I have adapted our weightings accordingly. As a result, we have been trading around a modest positive net exposure, increasing it slightly on market weakness, and clipping it on strength, as is our discipline. Currently, the Strategic Growth Fund has a net exposure to market fluctuations of less than 10%, but enough “curvature” (through index options) that our exposure to market risk will automatically become more muted on market weakness and more positive on market advances, allowing us to buy weakness and sell strength without material concern about the (increasing) risk of a market collapse.
Category: Think Tank
If Dubai World can achieve success in its debt discussions (defined as pushing out its maturity schedule), amend and extend is the official global bank strategy in dealing with over leveraged situations as buying time to a better economic environment is the preferred path as opposed to debt writedowns and bond holder haircuts. We’ll see…Read More
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 (bio here). He may be reached at Bob.Eisenbeis -at- cumber.com.
November 30, 2009
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@cumber.com.
In an unusual communication on Sunday in the Washington Post, Fed Chairman Bernanke drove a stake in the ground to his inquisitors in advance of his confirmation hearing latter this week. He wrote about the Fed’s role in stemming the financial crisis and the importance of not tampering with the structure of the Federal Reserve. He makes a number of points.
First, he argues that despite the public outcry at the costs, the bailout of financial institutions saved the country from financial and economic collapse. Second, he admits to regulatory failures on the part of the Fed and its foreign counterparts, but argues that these have now been fixed. Third, he argues that because of the Fed’s unique role in monetary policy it is also qualified to continue its role in supervising large, complex institutions. Fourth, he states that it is important to maintain the independence of the central bank, especially since not to do so would run counter to trends in other countries.
Critical assessment of these arguments will obviously take place during Confirmation and Congressional hearings, but there is a risk that the key issues will soon be forgotten as the regulatory reform process unfolds.
Let us consider the points raised above. First, his assertion that Fed actions saved the US economy is not verifiable. Such assertions aren’t evidence, nor are the claims for Bernanke’s special expertise. What we do know is that the rescue efforts cost taxpayers more – several multiples more – than the thrift crisis of the 1980s. In fact, the final taxpayer cost of saving AIG may probably exceed the entire cost of the thrift crisis. No analysis has as yet been done of the true exposure to counterparties of AIG, Bear Stearns, or Lehman Brothers. What we do know is that the unwinding of Lehman Brothers under current bankruptcy statues has proceeded in a more orderly way than most might have guessed.
The Nov Chicago PMI was a better than expected 56.1 up from 54.2 in Oct and vs the forecast of 53. It’s the highest since Dec ’07 and measures the direction of change, not the degree. New Orders rose to 62.8 from 61.4 to the highest since May ’07 and Backlogs were up 4.6 pts…Read More
The UAE over the weekend provided a partial ‘Bridge Over Troubled Waters’ to those impacted by the Dubai request for a debt restructuring by giving assurances to local banks that have exposure to Dubai but they did not give any commentary on what they will do directly with Dubai and other creditors. Will it be…Read More