Posts filed under “Think Tank”

Let’s get real about dollar-equities causation

The following is a guest post from a market strategist at a major research firm . . .

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The dollar rallied, did it? That was the “cause” of yesterday’s weakness in the energy and metals commodities, which in turn “caused” the related equities to sell off? Hogwash! Stocks are calling the tune here, folks.

The bond market may have preoccupied U.S. Presidents and Federal Reserve governors in the Eighties, and indeed the threat of higher interest rates always hangs over the stock market like the Damoclean Sword, but today’s policymakers have targeted stocks and spreads (they haven’t had to worry about interest rates since the Asian crisis in the late ‘90’s shocked the Asians into pursuing mercantilist trade policies that require large scale, price insensitive buying of U.S. debt).

If traders flipping E-mini S&P 500 futures are watching the DXY (the Dollar Index) or the EUR/USD cross for clues about risk appetites, then yes, on a day to day basis we can say that a stronger dollar may have “caused” equities to weaken. You can trust, however, that traders flipping DXY futures or euros are taking their cues from the stock market and that as often as the dollar moves the stock market, the stock market moves the dollar (specifically, “the dollar” as it is traded real time against other currencies, commodities, and assets).

We’re not watching one phenomenon (either a weakening dollar, or a rising stock market) occur, and then judging how that phenomenon will affect other markets, we’re watching all markets react in lockstep to policy.

Here’s an easy example: the Federal Reserve Bank of New York bails out AIG by taking its assets onto its balance sheet in exchange for loans and lines of credit. Anyone with a dollar bill in their pocket assumes a tiny bit of AIG’s risk (the Fed’s liabilities are dollars, don’t forget), and, assuming that AIG had to be rescued because its losses made it insolvent, anyone with a dollar bill in their pocket has a dollar bill that is worth a little bit less than it was prior to the bailout. This policy action therefore weakens the U.S. Dollar. Simultaneously, AIG’s creditors, which would have faced massive losses themselves, no longer face these losses. Their share prices rise because they are suddenly worth more. This policy action therefore supports the stock market.

This “policy ethos” has been in place since “the troubles” began in 2007. In conclusion, did the dollar rally “cause” weakness in the stock market yesterday? Possibly. But, does it make more sense to say that ongoing belief in the continuance of a “weaken the dollar, strengthen the stock market, shrink all risk premia” policy ethos ebbed briefly yesterday while from a weekly or monthly perspective it continues to flow? In my humble opinion, definitely.

If you want to know why this policy ethos has been chosen, look no further than the second quarter Flow of Funds report. Of all the frankly frightening, Frankenstein-ian data contained in the FoF (summarized by Doug Noland here), the financial media was buzzing about the $2 trillion rise in household net worth in Q2, the first such rise since 3Q07 (how ironic that the Federal government borrowed at a nearly $2 trillion
annualized pace in Q2!).

Stock market up, household net worth up, confidence in spite of falling wages and rising unemployment up, debt-fueled consumption up, and voila! It’s 2006 again. Or, look no further than yesterday’s comment from Lennar CEO Scott Shipley: “The sense that now is the time to buy is starting to gain momentum as potential qualified purchasers are getting confirmation from news reports and the overall stock market that prices are at or near lows.”

Take an image of Federal Reserve Chairman Ben Bernanke silently wiping a single tear of joy from his cheek as that comment scrolled across his Bloomberg terminal. Too bad about the dollar, though, right? (source: Bloomberg; Federal Reserve; Federated Investors)

Category: Currency, Think Tank, Trading

Mortgage rates below 5%, Fed high five!

The MBA said the average 30 yr mortgage rate for the week ended Friday fell below 5% for the first time since late May, at 4.97%. In response, refi’s rose 17.4%, the highest since May while purchases were up 5.6%. This news comes as the FOMC discusses the fate of their purchases of MBS/Agency debt…Read More

Category: MacroNotes

The Dollar’s Role in Rising Risk Appetites

Good Evening: After a couple of wobbly sessions on Friday and Monday, U.S. stocks resumed rising on Tuesday. With little in the way of economic news, it was left to a falling dollar to buoy investor risk appetites. The greenback obliged by setting a new low for 2009, and commodity prices understandably reacted by heading…Read More

Category: Markets, Think Tank

The Drunk and the Liquor Store

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).

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A few thousand miles of flying gives one a chance to catch up on some research reports. In this case the stack was about the debt-to-GDP ratio and what it means.

It is clear that the United States is on a borrowing binge. And also clear that the Nancy Pelosi-led US Congress has no will to restore any discipline to its spending habits.

Now we all know that borrowing at increasing rates cannot go on forever. And we also know that it can go on for a long time. And history shows that the adjustment process is non-linear. In other words, there is a period when the increased borrowing in order to finance consumption seems to be painless. We are in that period now.

This usually is followed by a shock. What triggers the shock? When does it occur? These are the types of questions we wrestle with each day as a money manager. And these are exactly the questions without easy answers. A bunch of research reports has proven that to these tired eyes.

Here is what we do know. The total of all government debt in the US has now breached the 100% of GDP level. We get this number courtesy of Ned Davis and by tallying up all the debt of the federal, state and local governments. This ratio has not been this high since World War II. It is climbing in a vertical fashion and can be projected to set a new record each and every foreseeable month.

Unlike World War II, the US debt explosion is not due to military and interest expense. Ned Davis has calculated the spending to GDP ratio without interest payments or defense. Again we are at an all-time high in the post World War II period. We cannot blame the spending spree on the army.

Total credit market debt to GDP in the US is a record 373% as of June 30th. In the UK it is 233%. In Japan it is 225%. We have become the most profligate borrower of the large countries in the world.

Private sector and household debt is not the problem. In the last two months the household debt declined by a huge $37 billion. Non-financial corporate debt is also not the problem. It is barely increasing.

The problem simply is government. It is borrowing at all levels and without restraint.

From Japan we learned that increasing borrowing can continue for a very long time. And that we can get it without much inflation and with persistent very low interest rates. The reason is that borrowing is a way of loading a debt burden on the economy. The larger the debt burden the slower the economy will grow. This is especially true when the borrowing is for consumption purposes. That is the current condition of the United States.

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Category: Think Tank

July FHFA Home Price Index

The July FHFA Home Price Index rose .3% m/o/m, .2% less than expected and June was revised lower to a gain of .1%, down from the initial report of up .5%. Y/o/Y prices are down 4.2% and are (only) 10.5% below its April 2007 high. According to the FHFA, their index is back to the…Read More

Category: MacroNotes

Will the US$ be an FOMC topic of discussion?

As the FOMC begins their two day meeting today not only will they have to juggle the current stabilization in the US economy with their extremely accommodative policies, I wonder whether they will discuss the US$ and the price of gold as price stability (stable currency) is one of their two mandates. The $ index…Read More

Category: MacroNotes

Did Policy Economists Get It That Wrong?

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.
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It has become fashionable for commentators to bash economists for having missed the financial crisis of 2007-2009. Nobel Prize winner Robert Lucas provided a recent rebuttal to critics in a guest article in The Economist of August 6, 2009. Unfortunately, it was a rather unconvincing effort.

More recently, Nobel laureate Paul Krugman, in his NY Times article of September 2, 2009 entitled “How Did Economists Get It So Wrong?” took his own shots at the profession. He essentially repeats two criticisms that were addressed in Lucas’ article. The first is the profession’s fixation on elegant mathematical models, and the second is its belief in efficient markets – the idea that market participants use all available information when making economic decisions and pricing securities. He claims that in the world of theory – which many economists tend to believe is the “real” world – markets are inherently stable and do not admit the possibility of “catastrophic failures in a market economy” like the current crisis. Should a problem occur then it could be easily corrected by appropriately administered Federal Reserve policy. Are these criticisms well-deserved and are they directed at the right people?

Krugman’s critique has brought forth a host of rebuttals from academic economists who defended their performance. Still, one has to concede that Krugman has some valid points. The first concerns the bias among theorists for stability and stationarity in their models. Models serve a useful purpose in all fields of physical and social science. In economics, the trend has been toward building models that exhibit stationarity and stability, so that they tend toward a fixed long-run equilibrium and naturally return to that equilibrium if shocked. Publish these types of models and you will advance your academic career. There has been relatively little interest in the contemporary academic profession in market imperfections or in models that may admit such properties.

However, what critics also fail to recognize is that academic economists are not engaged in the same activity as business and policy economists. Academics are not building forecasting and prediction models of the kind the critics seem to be demanding or expecting. Academic economists are mostly unconcerned and largely uninformed about the week-to-week data releases or the policy moves that the Federal Reserve makes and that fill time on CNBC, Fox Business, and Bloomberg TV. In fact, academia puts little value on forecasting. Once you have built a forecasting model, there is nothing more to be gained intellectually from the academician’s perspective by running the model week by week as new data becomes available. This is really the province of the Federal Reserve and other government agencies, economic consultants, the business economists that populate Wall Street and large corporations who have to make business and policy decisions based upon the outcomes of those forecasts.

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Category: Think Tank

When do we junk the velcro for the shoelaces?

As my 7 year son last week junked his velcro sneakers for a pair of Nike’s with shoelaces as he finally learned to tie them, it was hard not to think about when the private sector was finally going to learn how to tie its shoelaces again without the help of government velcro. The FOMC…Read More

Category: MacroNotes

Words from the (investment) wise 9.20.09

Words from the (investment) wise for the week that was (September 14 – 20, 2009)

Marking the one-year anniversary of the Lehman Brothers demise, risky assets last week again marched higher to the tune of economic data supporting the argument of a global economic recovery. A realization among investors that the economic transition from recession to recovery was gaining momentum, resulted in many global stock markets scaling fresh peaks for the year.

Ben Bernanke, Federal Reserve chairman, on Tuesday said the US recession “is very likely over”. However, he remained cautious about the shape of the recovery and said he expected a “moderate” recovery in 2010 with growth “not much faster than the underlying potential growth rate of the economy”, i.e. approximately 3%.

“At the moment we don’t see (the economy) getting better or worse, but that’s better than you could say six months ago,” added Warren Buffett. “The terror of last year is gone and that’s thanks in part to the government.”

20-09-09-01

Source: Tom Toles, Slate.com

Not only did the US stock market indices record up-days on every day except Thursday, but all ten economic sectors that make up the S&P 500 also closed the week in the black. Most other stock markets (mature and emerging alike), commodities, oil, precious metals, high-yielding currencies and corporate bonds also put in a stellar performance as a bullish mood prevailed.

The CBOE Volatility Index (VIX), or “fear gauge”, traded at about the same level (23.9) as before the Lehman bankruptcy in September last year. Also, government bonds and other safe-haven assets such as the US dollar and Japanese yen were out of favor as investors sought higher returns elsewhere.

As investors started assuming more risk since March, the US Dollar Index headed lower, hitting a one-year low last week and trading in a confirmed downtrend as far as primary trend indicators are concerned. The combination of low interest rates and quantitative easing has made the US dollar an attractive currency for funding carry-trade transactions (i.e. selling low-yielding currencies to finance the purchase of higher-yielding currencies). (Click here for a short technical analysis.)

The declining dollar, central bank purchases, the de-hedging by gold producers and rising inflation expectations served as catalysts for gold bullion’s strength, causing the yellow metal to close above the $1,000 level for the sixth consecutive day on Friday. While gold’s move grabbed the headlines, platinum (+42.5%) and silver (+50.5%) have actually outperformed gold (+13.9%) significantly since the start of the year.

20-09-09-02

Source: StockCharts.com

The past week’s performance of the major asset classes is summarized by the chart below – a set of numbers that indicates an increase in risk appetite.

20-09-09-03

Source: StockCharts.com

A summary of the movements of major global stock markets for the past week, as well as various other measurement periods, is given in the table below.

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Category: Think Tank

The Hole in FDIC

The Hole in FDIC
September 18, 2009
By John Mauldin

Elements of Deflation, Part 3
Outrageous! – Artificial Deflation!
If You Are in a Hole, Stop Digging!
The Hole in the FDIC
How Can Just Four Stocks Be 40% of the NYSE Volume?
New Orleans and a Mauldin Migration to Europe

This week we continue to look at what powers the forces of deflation. As I continue to stress, getting the fundamental question answered correctly is the most important issue we face going forward. And the problem is that we cannot use the usual historical comparisons. This week we look at one more factor: bank lending. I give you a sneak preview of what will be an explosive report from Institutional Risk Analytics about the problems in the banking sector. Are you ready for the FDIC to be down as much as $400 billion? This should be an interesting, if sobering, letter.

But first, Dennis Gartman and Greg Weldon will be joining me next week for another Conversation with John Mauldin. This is my subscription service where I sit down with my friends and let you eavesdrop on our conversations (we also transcribe them). Dennis and Greg are two of the premier traders and data mavens in the world, and we will be all over the world of commodities, currencies, and the markets. I can tell you, it will be one exciting conversation for me.

It won’t be too long before it will be time to do another Geopolitical Conversation with George Friedman. George and I are doing a conversation quarterly, and right now it is a bonus if you subscribe to Conversations with John Mauldin, but the plan is to offer it separately for $59. Now, here is the important part:

all current subscribers and anyone who subscribes now will receive these Geopolitical Conversations free, as a thank you. If you have not yet subscribed, you can do so and receive a discount by clicking the link and typing in the code JM49
to subscribe for $149. This is a large discount from our regular price of $199; plus, we are including the bonus Geopolitical Conversations that are worth $59.

And now, to the regular letter.

Outrageous! – Artificial Deflation!

Speaking of deflation, let me mention something I find totally outrageous. Normally, I actually take up for the bureaucrats who are stuck with the task of trying to monitor inflation. It is a tough job, and like Monday-morning quarterbacks, everybody thinks you should have done it differently. I can understand the rationale for hedonic measurements, housing rent equivalents, etc., even if I don’t agree with them. You have to set some rules and live with them. But the latest imbroglio is disgraceful.

It seems the US Bureau of Labor Statistics, in the CPI next week, will treat the subsidy received by those 800,000 car buyers who bought a car in the “Cash for Clunkers” program as if the price of a car fell by $4,500. Really? My tax dollars account for nothing?

This does several things. It will decrease the inflation used to adjust the GDP for this quarter. Not the end of the world, but annoying But what really matters is that the CPI is used to calculate Social Security increases and interest paid on TIPS.

If I tried to defraud one of my clients using such accounting legerdemain, I would be shut down, sued, and taken to court (at the minimum) by the host of regulators who look over my shoulder. And I should be! You don’t make such changes in the rules to your own benefit. But that is what the BLS did. This policy should be overruled immediately. There are enough deflationary forces in the world without having to artificially create some more. OK, off the soapbox and onto the banking system.

If You Are in a Hole, Stop Digging!

Right outside my office window I am watching what is to me a visual parable for the banking crisis that has beset the world. I lease a rather large home in a nice, quiet neighborhood in Dallas, and moved my office here last year, as we can use the extra bedrooms and sitting areas. Besides saving a lot (!) of money (always a good thing), it gives me a ten-second commute as I walk down the hall to the back of the house. Tiffani and I each save over a month in driving time a year. That is huge.

My quiet neighborhood changed a few weeks ago. Trying to sleep in the morning after the Paul McCartney concert, I awoke to find with my bed literally vibrating. Earthquakes in Texas? No, it seems my neighbor decided he needed a bigger home, and the first thing to be done was to tear down the old one, which they did rather efficiently, if not quietly, over the next few days. We
literally had glasses and other items vibrating in the house.

Then, after removing a large pecan tree, they proceeded to dig 25-foot-deep holes (26 of them!) and fill them with iron and concrete piers on my side of the lot. The plans called for a rather large basement, and the very experienced builders (exceptionally nice guys) wanted to make sure the earth did not move, causing my home to have problems. So for three days I had a very noisy drill literally ten feet away from my window (I wrote an e-letter during one of those days).

Now, since the other sides of the lot were on a street or backed up to an alley, they did not put in piers there. No homes to worry about. I did not think much of it, as these guys had built some of the biggest and nicest homes in the area. They then proceeded to dig a very large hole, as the basement was going to be quite expansive. It turns out you have to dig the hole bigger than the actual size of the basement, since you have to have room to put up forms to pour concrete, etc. And you have to excavate on an angle. At the end of the process, most of the lot was slanting downward toward the end of the hole near
the alley.

Then the clouds darkened, and the builders realized we were in for a little rain. (You can start to guess!) They took precautions and put heavy plastic over the sides of the hole to keep the sides dry. And then the rains came. Texas rains. The plastic was pulled from its wall and the street side of the hole began to literally wash back into the hole as we watched, going all the way back to and under the sidewalk. The poor builders showed up and began the process of trying to mitigate the damage, but it had been done and only got worse as it continued to rain for three days. The next morning I was the temporary owner of lake-front property. Those piers on my side were starting to be exposed.

They brought in crews for emergency repairs to the sides of the hole, and they really went after it. What to do then? It seems that the only thing to do was to fill the hole back up and start all over, only this time putting piers around the whole property. Which is what they are doing now. But since they had taken all the original dirt away, they are now having to take dirt from the rest of the property to fill the hole they will redig later.

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Category: Think Tank