TBTF November 9, 2010 - PIIGS

‘It’s finally here, It’s finally here, Oh, Oh, Oh, They Called me Pig, When I was a baby,  I was so happy, I played with my friends in the mud’ (Weezer – 2008).

With QE2 out in the open the debt market seems to have shifted it’s attention back to the perils in Europe’s peripheral countries, the so called PIIGS. PIIGS stands for Portugal, Ireland, Italy, Greece and Spain (the acronym obviously not ordered by economic weakness). Back in the spring of this year when Greece almost collapsed under the weight of their immense budget deficit the EU had to come to their rescue. Yields on the 10 year Greek bonds had passed 12% while the yield on the shorter 2 year maturity had even surpassed 18%! The EU and IMF put together a hefty 600 billion Euro rescue package which brought back some relative calm to the markets.

With the unveiling of a renewed stimulus package in the US, rates in the PIIGS shot up again. Probably on the one hand because a weakening of the $ will mean less economic growth in the already fragile export-driven euro zone, while on the other hand Spain is exhibiting weaker than expected growth, Portugal and Ireland are having troubles getting their budget for 2011 in order, while strikes against pension and other budgetary reforms broke out all over Europe.

Germany in the mean time reiterated their stance to ‘not bail out’ anymore countries should they come begging for money. According to Markel and Schaeubele, it is time for bondholders to take a haircut, in other words: the buck stops here, partial default of euro countries is now an option. Germany can’t and won’t shoulder any more of the financial problems created by lax fiscal policies and corruption in the outer euro zone countries.

An illustration of how bad the situation on the European debt markets is right now can be seen from the following graphs displaying the spread between PIGS 10 year yield and Germany’s 10 year long bond yield:

As you can see yields in Greece and Spain have almost reached pre-spring-crisis levels, while the situation in Portugal and Ireland (the 2 countries that are having trouble with their budgets for the coming year) has dramatically deteriorated, with yield at new all-euro-time highs.

On the shorter end of the yield curve the movement has also been on the upside, with the spread on Irish-German bonds reaching a new all time high:

Both the Irish and the Portuguese can stay away from the capital markets until Q2 2011, but then they will have to start raising fresh money at some point.

Budget deadline in Ireland is December 7^th. Something new to look forward to!

In the mean time ….

Happy Hunting & Let’s Be Careful out there!!!

TBTF November 8, 2010 - Rise, Rise, Rise

‘Rise, Rise, Rise, Keep on risin’ Rise, Rise, Rise, Yeaheaheaheah’ (Soul Providers – 2007).

Over the weekend Bernanke defended the Fed’s expansion of record stimulus at a conference in Jekyll Island, Georgia, as he has done over the past 4 days, ever since the announcement of QE2. Instead of commenting on the supposed merits of the program Bernanke should take his cue from Ex-Fed President Gary Stern, who eloquently described what must be the prevailing opinion amongst the Fed policy committee members:

“I would have voted in favor of it mainly because I think it’s worth a try and might have marginally positive effect on the rate of growth of the economy and unemployment”

In other words, why not, if it doesn’t help it won’t hurt. And that is exactly where I strongly disagree with the Fed at the moment, in my view it will hurt because it will spark uncontrollable inflation. Bernanke actually made some comment on inflation during a panel discussion:

“I have rejected any notion that we are going to raise inflation to a super-normal level in order to have effect on the economy…, our credibility must be maintained, it’s critical for us to maintain inflation at an appropriate level. Our purpose is to provide additional stimulus to help the economy recover and to avoid potentially additional disinflation which I think we all agree would be a worse outcome”

Obviously Mr. Bernanke doesn’t see inflation as a problem, he probably feels he can always raise interest rates to contain inflation, inflation that is as of yet nowhere to be seen according to the Fed Chairman.

I disagree with him on both points. If  inflation starts to become a problem he could very well be able to raise interest rates, for that to be a possibility it means all his stimulus must have worked, economic growth will have to be at or above average levels and unemployment must be down, for if not he will stop any economic recovery in its tracks. The federal deficit will also have to be brought down to sustainable levels, else a raise in real-interest rates will only aggravate the financial burden this administration is transferring upon the shoulders of the next generation. So, even though Ben might be convinced inflation won’t become a problem I don’t share his optimistic view.

The one thing Mr. fed and I will be disagreeing on even more is the gauge for inflation. According to him inflation is too low at the moment and there are no signs that inflation will rise to his target of 1.8% - 2% in the near future. I will make the bold statement right here and now that inflation is already here, it’s not going anywhere and it will get worse, much worse. How can we have such different views on inflation you might ask, I can explain it very easy, Mr. Bernanke looks at the Core-CPI and I say that the core-CPI is not a real measure of real-inflation, but an easily manipulated index devised to make the lives of Central Bankers easier.

What exactly is the CPI and how does it measure inflation. On the website of the Bureau of Labor Statistics, the government agency that calculates the inflation gauge, we can find that the CPI is the “Change in prices paid by urban consumers for a representative basket of goods and services”. So far, so good.

The goods and services in the CPI index are categorized in the following 8 groups:

1.      Food and Beverages

2.      Housing

3.      Apparel

4.      Transportation

5.      Medical Care

6.      Recreation

7.      Education and Communications

8.      Consumer Expenditure

These 8 groups are then each assigned a weight within the Consumer Price Index and this is where the first interesting observation can be made. The group with the highest weight is Housing 42% of the CPI (within the Housing group Fuels and Utilities in and around the home makes up for 5% of the 42), next come Food & Beverages 15%, New and Used Motor Vehicles 6% and Motor Fuel 4.5%

As you can see, Housing, which has seen prices slide or stabilize in the last 2 years has an almost 40% impact (if you take out heating oil and electricity) on the CPI. Used Motor Vehicles, a big ticket item, not something consumer go out and by again and again each month weighs for 6%. So, almost 50% of the CPI is made up by items that do not change much in value in normal economic times, and have certainly not been going up in the last 2 years.

Volatile goods like Fuel and Food & Beverages make up for only 20% of the index and this is what people have to buy week in week out, year in year out.

So it seems there is a mismatch in what the CPI says the prevailing Inflation-Rate is and what people feel in their wallet. The $1.500 in rent or mortgage payments is not what make inflation, it’s what you can do with the money that is left after you paid for the roof over your head. Can we still get food on the table, can we fill up our car this week or are we going to have to take public transportation to go to work.

To make matters even worse, central bankers and politicians around the world don’t use the CPI as the measure of inflation, but the Core-CPI, the CPI number excluding Food and Energy because these components are too volatile. So when gas doubles at the pump it’s not real inflation for the theorists among us, but it hurts in my pocket anyway, it hurts a lot.

I can understand that politicians and central bankers cannot adjust their chosen policies anytime someone corners the Wheat- or Oil markets, but if and when commodities have been rising steadily but surely over a prolonged period of time it seems rigid and wrong to hold on to the perception that inflation can be measured by Core-CPI. And this exactly what has been happening ever since QE1, QE-lite and now QE2 have been announced. Raw goods have been rising in price steadily, they have had an impact on the Producer Price Index (+4% YoY in September and expected to be up 4.6% in October versus 1 year ago), but because we are still in a recession (that’s a disagreement I have with Mr. Bernanke that will have to wait until another time) producers haven’t been able to pass those elevated prices on to consumer, just yet.

The following graph shows just how much prices of basic raw materials have risen since March 2009 (when QE1 was announced), through the latest round of QE. It takes not much imagination to see that this huge run up in raw goods will raise inflation numbers sooner rather than later. We can only hope the good Dr. Bernanke won’t be stuck in his simplistic view of inflation, as measured by the CPI-ex Food & Energy, or the man in the street will be victim of ‘Zimbabwian-esque inflation, before the Fed chairman acknowledges inflation has crept up past the 1.8% - 2% target and will proudly announce his master-plan has worked and QE15 will begin to be unwound.

Happy Hunting & Let’s Be Careful out there!!!

TBTF November 4, 2010 - Nothing left to say

‘When there’s nothing left to say, And the conversation is over, The silence just gets in the way’ (Staind – 2008).

Wednesday has come and gone and there is nothing left to say. Everything is out in the open. The market knows what it wanted to know, got what it wanted to get and can go back to sleep….

Tuesday we had mid-term elections in the US. As expected, the Republicans took over the House of Representatives while they gained in the Senate, but did not get a majority. So Obama will have to govern the last 2 years of his Presidency (I never thought he would be a 2-term President and now his chances are even slimmer) with a Republican Congress. This means he will have to move to the right to get anything done. So he will probably extend the Bush Tax-cuts, be less strict with new financial regulation, run a tighter fiscal budget and perhaps make changes to Medicare. All of this can be explained favorable for equities. We will know more in the coming weeks.

Yesterday was the most anticipated FED-meeting in the history of the FED, it was like the moment Neil Armstrong set foot on the moon, when the Berlin Wall came tumbling down, a landmark moment and we can tell our grandchildren that we were there! We were there when Mr. Ben drove the last nail in the coffin of the once ‘almighty’ Greenback.

What did he deliver to the markets? (FED statement, statement regarding purchases of Treasury Securities):

·         Further purchase of $600 billion of longer-term Treasury securities by the end of Q2 2011, about $75 billion per month

·         Reinvestment of principal payments, a total of about $250 billion to $300 billion over the same period, about $35 billion per month

·         Taken together this will amount to a total of between $850 billion and $900 billion or roughly $110 billion per month

·         Assets purchased will have an average duration of between 5 and 6 years

·         The current per issue-limit of 35% will be temporarily relaxed

·         The program will be adjusted as needed to best foster maximum employment and price stability

There is actually not much news in there. By announcing a headline number of $600 billion, Bernanke gave the markets just about what was expected on the low side of QE2 and by re-investing principal payments he satisfies those who were looking for $1 trillion (so I guess only Goldman Sachs was disappointed today). All in all it seems it is just a little more than the markets expected, but not much. As a result equities rallied just a bit, Gold came back from it’s lows, but still closed in the red, the Oil rally continued, the Euro and Yen strengthened against the $, volatility got hammered and the yield curve steepened, with the 30yr losing ground while the shorter end of the curve strengthened somewhat. So it seems for the first 115 minutes of trading Bernanke got just what he expected.

Will he still be so satisfied with himself 6 months down the road, only time will tell!

So what can we say about the markets in the near term, apart from the obvious fact that they will be underpinned by 1 trillion freshly printed dollars. Let’s take a look at some charts:

The S&P, after having rallied 150 points from sep 1^st, has 17 more points to go before it sets new highs for the year, which were set back in April. Should they break this resistance, 1.300 will be the next level. If they fail to take out new highs, 1.140 is the first support zone.

Gold has been in an uptrend since the beginning of 2009, when QE1 was first suggested. It is trading right in the middle of it’s trading band, with $1.325 as a short term support and $1.250 being the lower end of the range. As long as the $ keeps sliding versus most major currencies Gold has room to go up and it will.

The DAX has already been making highs for the year and is rapidly approaching the 7.000 mark which could be psychological resistance. Remember, 8.100 is the all-time high for the German Index. It’s hard to believe we are trading just 18% below those levels.

So far this year Germany has been outperforming most other European indexes this year. It might be because of the composition of the DAX but I think it’s more a safe haven play then anything else. Just as people want to be invested in Bunds they favor the DAX over, for example, the CAC.

All in all, QE2 should underpin equities and commodities well into next year, we have some room to continue going higher, but we are nearing resistance levels and if the economy does not start to show signs of growth it will be difficult to break through these barriers, as far as I can tell.

After the markets digested the outcome of the elections and Ben’s renewed liquidity boost equities managed to eke out a gain:

Dow +0.24% SP500 +0.37% Nasdaq +0.27% EUR$ 1.412 WTI 84.9 Gold $1348.5

Financials were the strongest sector +1% as hopes for less strong regulation and the hopes of a steeping of the yield curve attracted fresh money. Basic Materials ended the day softer -0.38% as commodities were subject to profit taking in the wake of the QE2 announcement.

Now that QE2 has been established there is a chance investors will actually start looking tat corporate earnings and economic data again. In Europe the financial sector is starting to report Q3 numbers, but the next highlight of the week will be the Non-Farm Payrolls report on Friday. Yesterdays ADP showed unexpected growth in the number of jobs, which might bode well for Fridays numbers. Then again, the correlation between ADP and NPF is statistically not relevant.

For now, I go back to sleep….

Happy Hunting & Let’s Be Careful out there!!!

TBTF November 2nd, 2010 - Wake me up before you go go

‘Wake me up before you go go, Don’t leave me hanging on like a yo yo, Wake me up before you go go, I don’t want to miss it when you hit that high’ (Wham! – 1984).

Is it Wednesday yet? Please someone wake me up when it’s time. I can’t take this anymore… If the most important news of the day comes courtesy of E-Online: Kim Kardashian's Latest Non-Hookup: LeBron James! Then we know we are in trouble.

What headlines did we take for granted today, while we are in a FED-watch induced coma:

·         U.S. Treasury forecasts $700 billion gross borrowing need by end of March 2011, To bust debt ceiling in Q1 2011

·         Iceland on watch for new volcanic eruption

·         Ireland may have just one month to stave off bailout danger

·         General Motors IPO said to seek $10.6 billion to cut U.S., Canada stakes

·         Oil rises second day on Chinese manufacturing, U.S. stimulus speculation

Wake me up when it is Wednesday….

The upside to having so much free time (as there’s no trading to be done) is that I can think. Granted, it doesn’t always lead to something sensible, as was the case with today’s mental exercise. I dubbed it the ‘I am Ben and I have a plan’ mental gymnastics event of the day:

Will Ben know, by now, what he is going to do come Wednesday?

I imagine him walking around the house, talking to his dog Lewis (no idea if he has one, but hey…these are my thoughts), asking him for advice about the wording of the accompanying text of his QE2 announcement. He wanders over to his next door neighbor, Mr. Jamie D., while chatting about the weather he slips in a question about the ideal duration of QE2. Next he goes to the bakery on the corner where the owner Mr. Lloyd B. tells him he should buy 3 loafs of bread instead of 1, because you can never have enough bread!!! He hesitates a bit, but decides Lloyd is usually right and buys 3 big loafs of bread. Walking back home he almost gets run over by a skateboarder. It’s the nasty kid from 3 houses down, Tyler D. who shouts at him he should be more careful, “Carrying around all that bread is blocking your view of the sidewalk, it just might be your downfall”, Kids these days….. When he gets home he retires to his bedroom but he is afraid to go to sleep. He has been having these nightmares lately, about growing economies, shrinking economies, deflation, run-away inflation, jobs, jobs and even less jobs and no matter what, he can’t seem to get a handle on things while he’s asleep. It’s better to stay awake; at least he’s in charge of the world in his waking hours. He turns on his bedside lamp, opens up his 1^st edition of ‘The General Theory of Employment, Interest and Money’ and reassures himself everything will be ok. Ben has a plan, Ben has a plan, Ben has a plan, Ben should have a plan by now…..

Wake me up when it’s Wednesday….

Mid-term elections 2 days away, QE2 3 days!

Happy Hunting & Let’s Be Careful out there!!!