Posts filed under “Think Tank”

Taleb Offers Positive Black Swan on Otherwise Dull Day

Good Evening: Yesterday’s stock market rally continued today when neither the earnings reports nor the economic releases contained any bombshells. CSX, JNJ, and GS all reported positive earnings, though only Goldman really surprised to the upside. Of course, since GS had its rally yesterday after the Whitney upgrade, the company’s shares barely managed to hold on to Monday’s gains. The action in GS shares was just one more reminder that expectations and pre-positioning matter just as much as the actual news when earnings are released. All in all, it was a pretty lackluster trading session. Perhaps the best way to spice up an otherwise dull day will be to examine the latest thoughts from Nassim Taleb and others on the subject of how piling on more debt during a debt crisis will only make the problem worse over time. Let’s first get a handle on the dimmdimensionthe problem facing our Treasury by hearing from Eric Sprott before we turn to Mr. Taleb for a potential answer.

U.S. stock index futures were up a bit overnight, though not as strongly as the overseas bourses that played a bit of catch up ball after Monday’s up move in Wall Street. Retail sales and PPI were both disappointing in that each statistic had a stagflationary feel (see below). Ex the sales of both autos and gasoline, the retail sales figures were well below expectations. But with the earnings news taking center stage, these data points were mostly shrugged off. After opening a touch higher, equities paid an early visit to negative territory before recovering in the late morning.

The rest of the day was then spent moving mostly sideways on light volume. The gains in the major averages ranged from the Dow’s +0.3% to +1.3% for the Dow Transports. Treasurys were hammered after the PPI data pointed to some potential pressure building in the inflation pipeline. Whether these rising raw costs ever reach their end markets is different matter, but yields rose between 4 bps and 15 bps as the yield curve resumed its steepening trend. The dollar was mixed against its rivals, but commodity prices were firm, anyway. Copper and natural gas were the standout performers helping to lift the CRB index to a gain of 1.1%.

“Central bankers and finance ministers have achieved an uncommon meeting of the minds. The cure for what ails us is the hair of the dog that bit us, they prescribe, though not exactly in those words”. (Jim Grant, Grant’s Interest Rate Observer, July 10, 2009 —

As is almost always the case, Jim Grant has it right when it comes to describing the open-throttled approach to monetary and fiscal policy around the world these days. To Jim’s clear voice, I add two others (see last articles below). In “The Solution…is the Problem”, authors Eric Sprott and David Franklin break down into raw numbers what we all know in our guts is a glut of governmental debt issuance. They break down the total U.S. Public Debt (as of September 2008) by the 11 broad categories of those who now hold it (a.k.a. our creditors). The authors make a compelling case that the math is hard enough to reconcile with a public debt of just more than $10 trillion. The current holders and other prospective Treasury buyers will likely demand higher interest rates as compensation for absorbing all the net new debt we’ll have to issue during the next few years. We’ve added another trillion to this total in just the past nine months, so it’s hard to see how the U.S. won’t be facing higher interest rates, a lower dollar, or perhaps even a funding crisis of sorts as we move through time.

Time is something we just don’t have, assert Nassim Nicholas Taleb and Mark Spitznagel, the authors of a piece in today’s Financial Times. Debt and way too much of it is what got us into this mess, and piling on more of it at the governmental level will only add to systemic instability, in their view. To them, debt is a pernicious and inflexible way to finance assets and enterprises. The risks are binary — and hidden — until the debtor cannot pay (at which point it’s too late to calmly address the problem). Debt makes for a fragile economic system, one that is highly vulnerable to cyclical downturns, secular shifts, and the occasional external shocks imposed by Mr. Taleb’s famous “Black Swans”. Equity, by contrast, is a hardier and more flexible form of capital, one that is by nature more volatile but also more transparent (the risks are more visible).

Eschewing the “stimulus and more debt” prescriptions from some of the same misguided economic minds that helped us into the credit crisis, Taleb and Spitznagel instead offer a very simple way out — a massive and pervasive exchange of equity for debt at all levels of the economy. Much the same way an overly indebted corporation seeks to restructure its balance sheet in a Chapter 11 proceeding by handing over ownership of the company to the creditors in exchange for a more manageable debt burden, the authors propose a similar swap needs to now take place among various individuals, corporations, financial institutions and the pools of capital that finance them.

If only it were that easy. In our contentious and litigious society, debtors, creditors, and stakeholders don’t make such equity for debt exchanges without at least a chat – accompanied, of course, by a battery of lawyers. Such swaps, even the appealing one proposed by the authors for residential mortgages, will be both difficult and time consuming. Then again, given the Obama administration’s strong arm tactics with the creditors of both Chrysler and GM, perhaps Washington will simply, in Wall Street parlance, “make it happen”. Considering the daunting Treasury issuance looming as the baby boom generation transitions from net contributors to net drainers of our social safety net programs, we should try to tackle this problem sooner rather than later. If the solutions we’re trying now are indeed part of the problem, then we need to find innovative, market-mindful ways of encouraging exchanges of old debt for new equity. It would be the type of change we could all believe in.

– Jack McHugh

U.S. Stocks Gain, Led by Shares of Consumer, Energy Companies
Goldman Sachs Posts Record Profit, Beating Estimates
U.S. Economy: Gasoline Pushes Up Retail Sales, Producer Prices
The Solution is the Problem
Time to tackle the real evil: too much debt

Category: Markets, Think Tank

What Is Goldman Sachs?

> Jim has run Bianco Research out of Chicago since November 1990. He has been producing fixed income commentaries with a circulation of hundreds of portfolio managers and traders. Jim’s commentaries have a special emphasis on: money flow characteristics of primary dealers, mutual funds, hedge funds, futures traders, banks, and institutional investors. Prior to founding…Read More

Category: Earnings, Think Tank

Business Inventories

May Business Inventories fell 1%, .2% more than expected and April was revised down by .2%. It’s the 9th straight month of declines. With sales down .1%, the inventory to sales ratio fell to 1.42 from 1.43 and its at the lowest level since Oct ’08 when it was at 1.36. The record low was…Read More

Category: MacroNotes

Debt and Deflation

There is a reason I call this column Outside the Box. I try to get material that forces us to think outside our normal comfort zones and challenges our common assumptions. I have made the comment more than once that is it unusual for two major bubbles to burst and for the conversation to be all about rising inflation and not a serious problem with deflation.

As Niels Jensen pointed out last week, the most important question that an investor can ask is whether we are in for deflation or inflation. And this week we read a well reasoned piece on deflation. This is one of the more important essays I have sent out. You need to set aside some time to absorb this one.

Van Hoisington and Dr. Lacy Hunt give us a few thoughts on why they think it is deflation that will ultimately be the problem and not inflation we are dealing with today. This week’s letter requires you to think, but it will be worth the effort.

And let me quote a few sentences in the middle of this letter about taxes which you need to think about.

“Thus Barro and Perotti are saying that each $1 increase in government spending reduces private spending by about $1, with no net benefit to GDP. All that is left is a higher level of government debt creating slower economic growth.”

“The most extensive research on tax multipliers is found in a paper written at the University of California Berkeley entitled The Macroeconomic Effects of Tax Changes: Estimates Based on a new Measure of Fiscal Shocks, by Christina D. and David H. Romer (March 2007). (Christina Romer now chairs the president’s Council of Economic Advisors). This study found that the tax multiplier is 3, meaning that each dollar rise in taxes will reduce private spending by $3.”

Now, if you put all of the various inputs together, Hoisington and Hunt show that theory suggests we will soon be dealing with deflation. It’s counter-intuitive to what we hear today, which is why the Bank for International Settlements used the stagflation word in a recent report. The transition that is coming will not be comfortable….

John Mauldin, Editor
Outside the Box

Quarterly Review and Outlook
Second Quarter 2009


One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

For example, total commercial bank loans have declined over the past 1, 3, 6, and 9 month intervals. Also, recent readings on bank credit plus commercial paper have registered record rates of decline (Chart 1). The FDIC has closed a record 52 banks thus far this year, and numerous other banks are on life support. The “shadow banks” are in even worse shape. Over 300 mortgage entities have failed, and Fannie Mae and Freddie Mac are in federal receivership. Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re- trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent. The 100% plus expansion in the Fed’s balance sheet (monetary base) has done nothing to rekindle borrowing and lending or revive even the smallest spark of inflation. What is clear is that as long as private market factors in the monetary/credit 1creation process are shrinking, as they are now, the risk for the economy is deflation, not inflation.



The link between Fed actions and the economy is far more indirect and complex than the simple conclusion that Federal asset growth equals inflation. The price level and, in fact, real GDP are determined by the intersection of the aggregate demand (AD) and aggregate supply (AS) curves. Or, in economic parlance, for an increase in the Fed’s balance sheet to boost the price level, the following conditions must be met:

  1. The money multiplier must be flat or rising;
  2. The velocity of money must be flat or rising; and
  3. The AS or supply curve must be upward sloping.

The economy and price changes are moving downward because none of these conditions are currently being met; nor, in our judgment, are they likely to be met in the foreseeable future.

Aggregate demand (AD) is planned expenditures for GDP. As defined by the equation of exchange, GDP equals M2 multiplied by the velocity of money (V). M2 equals the monetary base (MB) multiplied by the money multiplier (m). Professors Brunner and Meltzer proved that m is determined by the currency, time, and Treasury deposit ratios, as well as the excess reserve ratio. The money multiplier moves inversely with the currency, Treasury deposit ratios, and excess reserve ratios and positively with the time deposit ratio. For example, if those ratios rise on balance, then m will decline. By algebraic substitution AD(GDP) = MB*V*m. In our present case, the massive increase in the Fed’s balance sheet has created a sharp surge in excess reserves, and thus m has fallen.

Obviously the preceding paragraph is as clear as mud. It is included to provide mathematical proof of the complex connection between monetary actions and real world results. The practical and straightforward fact is that GDP has declined in the face of a surge in M2 growth. The labor market equivalent of GDP (aggregate hours worked) has declined at a record rate over the last 18 months, the entire span of the recession (Chart 2). That is, the monetary surge was totally offset by other factors; thus, the recession deepened and inflation was nonexistent.


The conventional wisdom is that the massive increase in excess reserves might eventually be used to make loans and reverse the economic contraction now underway, or that the velocity of money might increase. First, there is a very good explanation for the surge in excess reserves. The Fed now pays interest on its deposits, so banks have been incentivized to shift transaction deposits from riskier alternatives to the safety and liquidity offered by the Fed. Historically transaction deposits at the banks have fluctuated around 3% to 7% of a bank’s balance sheet. In the second quarter, excess reserves averaged $800 billion which is 4.4% of the $18 trillion of bank debt (including off balance sheet). If this is the amount needed for transaction purposes, then this “high powered” money is not available for making loans and investments.

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Category: Think Tank

morning stuff/Asia is where its at

There will be no bath tub shaped recovery in Singapore and indeed it could be a V as they revealed that Q2 GDP rose 20.4% q/o/q and that is well above the consensus gain of 13.4%. They raised their ’09 GDP forecast range to -4% to -6% from -6% to -9%. Australia June business confidence…Read More

Category: MacroNotes

Everett Dirksen Would be Horrified

Good Evening: U.S. stocks enjoyed a broadly based rally today, as investors took a Meredith Whitney upgrade of Goldman Sachs prior to its earnings release tomorrow as a cue to buy not only financial names, but the rest of the tape as well. Volume was light, and measures of volatility melted like a San Antonio…Read More

Category: Markets, Think Tank

10 year bond yield/50% retracement

With the sharp drop in the 10 yr bond yield over the past month after touching 4%, the move has retraced almost 50% of the rise from the 2.5% level that occurred right after the FOMC announced a step up of their QE policy on March 18th and said they were going to start buying…Read More

Category: MacroNotes

Welsh Investment letter – Update July 2009

~~~ STOCKS As expected, the S&P has declined and found initial support between 875 and 885. A number of short term indicators are a bit oversold, and yesterday there were more puts than calls traded. This suggests that a bounce is likely that could extend to 900-910. However, it is unlikely that the correction from…Read More

Category: Think Tank

While you were sleeping

It’s not even the opening yet and the S&P futures have already had a 15 point range from its open last night. Asian stocks got hit hard due to political uncertainty in Japan, word of North Korea’s leader turning ill (no pun intended) and possibly a push out to 2010 an economic agreement between Taiwan…Read More

Category: MacroNotes

Words from the (investment) wise July 12, 2009

Words from the (investment) wise for the week that was (July 6 – 12, 2009)


As I reluctantly start packing my bags after a most enjoyable two weeks of R&R in Europe (see my posts on Slovenia and Switzerland), “Words from the Wise” comes to you a bit more cryptically than usual. However, a full dose of excerpts from interesting news items and quotes from market commentators is included.

Despite having crisscrossed Heidi’s country, I have yet to find the elusive Swiss gnomes to glean what they make of financial markets at this juncture. Meanwhile, the past week has been characterized by a fresh wave of risk aversion, as uncertainty over the global economic outlook took its toll on stock markets, commodities and precious metals, and investors favored safe-haven assets such as government bonds and the Japanese yen.

The S&P 500 Index, Dow Jones Industrial Index and the Reuters/Jeffries CRB Index – all now in corrective mode – closed down for a fourth consecutive week, while US Treasuries recorded gains for a fifth straight week and the Japanese yen for four out of the past five weeks.

The yen is often seen as a global barometer of risk aversion. The graph below demonstrates the strong inverse relationship between the movements of the yen (against the euro, in this case) and those of the Dow Jones World Index. As shown, a falling yen indicates risk tolerance (and a willingness to buy risky assets) and a rising yen shows risk aversion (and an indisposition towards risky assets). A downturn in the yen exchange rate could be a good indicator to keep an eye out for confirmation of better times ahead for stocks and commodities.



Also featuring prominently in investment discussions during the week were the viability of the Public-Private Investment Program (PPIP) and the merits of a second stimulus package – calls for this comes at a time when estimates of trillion-dollar fiscal deficits and unsustainable debt levels are raising inflation expectations and putting upward pressure on long-term yields, thus partly undoing the Fed’s monetary easing.


Source: Eric Allie, July 8, 2009.

The past week’s performance of the major asset classes is summarized by the chart below – a set of numbers that indicates risk aversion is creeping back into financial markets.



A summary of the movements of major stock markets for the past week, as well as various other measurement periods, is given below. As the second-quarter earnings results in the US start rolling in, the American and most other markets closed the week in negative territory, with the Shanghai Composite Index being one of the few major benchmarks to make headway.

With the exception of the Nasdaq Composite Index, the major US indices are all back in the red for the year to date.

Click here or on the table below for a larger image.


Stock market returns for the week ranged from top performers Nepal (+5.3%), Croatia (+3.0%), Uganda (+3.0%), Ecuador (+2.9%) and the Philippines (+2.4%) to India (-9.4%), Egypt (-8.5%), Argentina (-8.2%), Russia (-8.1%) and Kuwait (-7.6%) at the other end of the scale.

Of the 98 stock markets I keep an eye on, a majority of 64% recorded losses, 34% showed gains and 2% were unchanged. (Click here to access a complete list of global stock market movements, as supplied by Emerginvest.)

John Nyaradi (Wall Street Sector Selector) reports that as far as exchange-traded funds (ETFs) are concerned, the winners for the week included “all things short” such as ProShares Short MidCap 400 (MYY) (+3.5%), ProShares Short SmallCap 600 (SBB) (+3.2%) and ProShares Short S&P 500 (SH) (+2.0%). Among the long ETFs, WisdomTree Dreyfus Japanese Yen (JYF) (+3.7%), CurrencyShares Japanese Yen (FXY) (+3.7%) and iShares MSCI Taiwan (EWT) (+2.9%) performed well.

On the losing side of the ledger, ETFs were centered in the energy sectors, including PowerShares Solar Energy (PBW) (-12.3%), Claymore Solar Index (TAN) (-12.1%) and United States Oil (USO) (-10.1%). Market Vectors Russia (RSX) (-12.6%) also had a rough ride.

The quote du jour this week comes from Richard Russell, 84-year-old doyen of newsletter writers who has been scribing the Dow Theory Letters for the past 50 years. Russell said: “The whole bailout campaign stinks to high heaven. It was created and run by Wall Street – FOR Wall Street. Again, I say, personally, I wouldn’t have lifted a finger to bail Wall Street out. Let all these Wall Street thieves stew in their own toxic juices. Thieves should be out on the street or in jail, not luxuriating in government bailout money.

“In the end, the bailouts will simply extend the bear market in stocks and the economy. The Wall Streeters will be richer, and the nation will be poorer, choking on trillions in debt that will keep future generations struggling to deal with the sins of Wall Street. Too bad Obama didn’t have the courage (or knowledge) to tell the nation what was going on. Obama should have said, ‘sit tight’ and ‘this too shall pass’. Unfortunately, after the trillions spent in bailouts, ‘this too will not pass’.

Next, a quick textual analysis of my week’s reading. No surprises here, with all the usual suspects such as “market”, “banks”, “economy” and “financial” featuring prominently. Although (interest) “rates” had some prominence, other key words such as “dollar” and “China” were relatively quiet.


Back to equities: The key moving-average levels for the major US indices are given in the table below. The S&P 500 Index on Tuesday breached the important 200-day line to the downside (for the third time in 26 trading days), joining the Dow Jones Industrial Average and the Dow Jones Transportation Index in bearish mode. The US indices are also all trading below their respective 50-day moving averages.

I have also added the BRIC countries and South Africa (my home country) to the table. All these markets are above the 200-day averages, having previously broken out of base formations. However, with the exception of China, the emerging markets have all recently broken below their 50-day moving average support lines. Importantly, the 50-day lines are in all instances still above the 200-day lines and therefore not yet threatening the bullish “golden crosses” established when the 50-day averages broke upwards through the 200-day averages.

Click here or on the table below for a larger image.


Additionally, the Dow Industrial Average and S&P 500 Index on Tuesday also broke through the “neckline” of a head-and-shoulders formation – a bearish event. For more on this, key levels and the most likely short-term direction of the S&P 500 Index, Adam Hewison’s ( short technical analysis provides valuable insight. Click here to access the presentation. The analysis was done on Tuesday, but is still as relevant today as it was a few days ago. (Adam also covered the outlook for crude oil and the dollar/yen exchange rate in recent analyses. Click the links to view these.)

The first meaningful pullback since the March 9 low has brought the bears out of the woods. According to Bespoke, the weekly poll of the American Association of Individual Investors (AAII) shows bearish sentiment currently at 54.65% – higher than any other point since March 5.


Source: Bespoke, July 9, 2009.

“The onus is now on bulls to keep stocks buoyant. The technical breakdown of stocks is complete. Unless stocks rally robustly for several days – not just a one-day surge – stocks are likely to test 850 on the S&P 500 and then the very important 825 level …,” added Bill King (The King Report).

Richard Russell, highlighted the latest statistic from Lowry Research, saying: “Turning to the current market, what to me is most significant is that Lowry’s Buying Power Index (demand) is collapsing. As a matter of fact, it’s now below the level that it was on March 9. Meanwhile, the Selling Pressure Index (supply), after moving sideways for months, is now trending higher. This is a bearish combination and calls for a very defensive stance. On top of everything else, total NYSE volume is fading, particularly on days when the broad market is higher. It’s obvious that buyers of stocks are becoming scarce. Despite ‘Green Shoots’ nonsense, the stock market doesn’t like what it sees. And neither do I.”

The last word on stocks goes to Teun Draaisma, highly regarded equity strategist at Morgan Stanley, who argued that there were “plenty of opportunities to make money beyond the market direction call” by pursuing a strategy that he described as “the middle ground”, as reported by the Financial Times.

“Macro and the next big market move have become everyone’s favourite investment topic over the past two years. We suspect it is time to move on to the micro of sectors, stocks and styles,” he said.

Draaisma’s large “middle ground” of investment opportunities includes “the forgotten market” Japan and “sectors that are cheap and under-owned with improving fundamentals” such as utilities, telcos and energy. Also “buying stocks with a management change, financial restructuring or a change of focus can be very lucrative”.

The technicals undoubtedly look ugly, and investors will now focus on the second-quarter earnings reports as a test of whether stock prices have run away from fundamental reality. While investors wait for Mr Market to show his hand, a cautious approach is warranted but that should not preclude one from finding stocks that look cheap.

For more discussion on the direction of stock markets, see my recent posts “Stock markets rolling over“, “How to play a stock market correction“, “Technical talk: S&P 500 – expect retest sequence“, “Rosenberg interview: Cold truth about the economy and markets” and “Video-o-rama: Fresh wave of risk aversion“. (And do make a point of listening to Donald Coxe’s webcast of July 10, which can be accessed from the sidebar of the Investment Postcards site.)

“Global business sentiment continues to improve. At the start of July confidence is as strong as it has been since the start of last October. Expectations regarding the outlook towards the end of this year rose strongly again last week to their highest level since spring 2006,” said the latest Survey of Business Confidence of the World conducted by Moody’s “Business sentiment remains consistent with a global recession, but the downturn is quickly moderating.”

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Category: Think Tank