Too Big To Flail - January 31, 2011 - The Streets of Cairo

‘I was bruised and battered and I couldn’t tell what I felt, I was unrecognizable to myself, I saw my reflection in a window, I didn't know my own face, Oh brother are you gonna leave me, Wasting away, On the streets of Philadelphia’ (Bruce Springsteen – 1993)

‘The Streets of Philadelphia’, it really should have been ‘The Streets of Cairo’ or maybe I should’ve gone with ‘Winds of Change by The Scorpions. What’s transpiring in Egypt or Northern Africa for that matter is extraordinary. Regimes that have been in place for 25+ years are all of a sudden being challenged by the people on a large scale. Not only in Tunisia and Egypt, but also in Syria, Yemen and even in Libya, on a smaller scale, people are taking to the streets, demanding their freedom, their dignity and above all affordable food. It’s extraordinary because no one could have predicted the swiftness or tenacity with which it all takes place, but it is by no means unprecedented. Rewind 20 odd years and here in Europe we experienced the same with the break-up of Russia and the demise of the dictators of Eastern Europe.

It took the Tunisians a couple of weeks to get rid of their once fearless leader and see him fly off in his private airplane, filled with gold (if he had ridden into the sunset through the desert on a horse with a couple of gold-bars it would have been a scene straight out of a medieval Hollywood blockbuster, but, this is, regrettably, fact and not fiction). The Egyptian protests have gone into day 7 now and even though thousands are defying the curfew, they have far from succeeded in chasing away President Mubarak. It shows that it’s really helpful to be backed by the U.S. Government. The biggest question is whether the protests will actually work and if so, what will be the implications for the region.

Let’s assume the ‘million man march’ scheduled for tomorrow is the final straw that breaks Mubarak’s proverbial back then a new government will have to be formed. Mohammed El-Baradei, the former International Atomic Agency chief and a prominent political opposition figure in Egypt, has already announced that he is willing to form a new government with the other opposition parties such as the Muslim Brotherhood. As good as it may sound that a new structured government will be formed (or at least an attempt will be made) within the weeks following Mubarak’s dismissal, the chances for a lasting new government are actually not that big. As history has taught us, the transition from a dictatorial form of government to one of democracy has often been met with violence. It’s just that, a transitional government. If we look at the analogy with Eastern Europe and the former U.S.S.R., most former republics are now ruled by a dictator, there’s a decade long war raging in Chechnya, the economic turn-around in most of Eastern Europe never took place and the former Republic of Yugoslavia went through a major civil war.

My girlfriend, who studied Political Science, told me on Saturday: ‘With Democracy comes responsibility’ and that is more than true. For us living in the West democracy is something so obvious, we often forget we have responsibilities, instead we rely on the government to take care of us. So how can we expect people that have been living in poverty, in fear, people who have been suppressed all their lives, who have never known democracy, how can we expect them to start to take responsibility out of the blue?  For all their good intentions, it just doesn’t work that way. It will get better, but they have to take baby steps, they have to restrain themselves and not think they will achieve tomorrow all that they have been denied for so long, that, in itself, will be the biggest task ahead.

The fall of Mubarak will have implications for the entire region. Seeing as he has been a prominent moderate voice in the Arabic community (the main reason why he is backed by the U.S.) for over 30 years, his resignation will no doubt have a big impact.

  

It will instill fear in other regimes, and most countries in the Middle East are just that: non-democratic governments, and fill the hearts of the people with courage and belief that they too can make a change. Already Moammar al-Qadhafi in Libya (wedged between Tunisia and Egypt) has announced emergency measures in the hope he will keep the people off the streets. Protest demonstrations, albeit really small, were held in Yemen and Syria and so it seems to be spreading to the east bit by bit.

The crucial question is: will the unrest reach Saudi Arabia? Besides their vast oil reserves, Saudi Arabia plays an important geo-political role in the region as they are the biggest U.S. allies, the U.S. has a large military presence there and the Saudis are an opposing voice to Iran. There already have been protests in the past, but so far the security forces of the Kingdom have been able to control them. It’s my understanding that the people are comparatively wealthy (compared to the rest of the region) so their impetus to revolt is much lower. That being said, I don’t believe Saudi Arabia will become a problem anytime soon.

Although Egypt has already been marked by some in the financial markets as a ‘Black Swan’ event, they seem to be ignoring it for the most part. Last Friday there was a mild sell off on the European and U.S. markets (1% - 2% down) but there is little to no spillover effect today. It seems strange on the surface, since there could be some major geo-political shifts as a consequence of what’s happening right now, it could affect the price of Oil in a structural way, but for now people seem unwilling to gamble on such an extreme outcome. Apparently the inflow of ‘cheap -FED-money’ is still more important than tens of thousands of protestors on the streets of Cairo, than regimes being toppled. Obviously the FED can keep printing money longer than the protestors can stay in Taharir-Square. Business as usual. There has to be a POMO somewhere we can front-run.

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

TBTF January 26, 2011 - State of the Union

‘He shall from time to time give to Congress information of the State of the Union and recommend to their Consideration such measures as he shall judge necessary and expedient.’ (Article II, Section 3 of the U.S. Constitution)

So today I did not start off with a song but with that all important sentence in the U.S. Constitution that led to what we call today: ‘The State of the Union’

Yesterday, Tuesday January 25, President Obama delivered his State of the Union for 2011. As expected the state of the economy took center stage, but there was also emphasis on clean energy and more important education.

Some key statements from the speech (full transcript & video):

 “Over the next 10 years, nearly half of all new jobs will require education that goes beyond a high school degree. And yet, as many as a quarter of our students aren’t even finishing high school.”

“The future is ours to win. But to get there, we can’t just stand still. As Robert Kennedy told us, ‘The future is not a gift. It is an achievement.’”

“But if we want to win the future – if we want innovation to produce jobs in America and not overseas – then we also have to win the race to educate our kids.”

"We are living with a legacy of deficit-spending that began almost a decade ago. And in the wake of the financial crisis, some of that was necessary to keep credit flowing, save jobs, and put money in people's pockets."

"But now that the worst of the recession is over, we have to confront the fact that our government spends more than it takes in. That is not sustainable.

"We need to get behind this innovation. And to help pay for it, I'm asking Congress to eliminate the billions in taxpayer dollars we currently give to oil companies. I don't know if you've noticed, but they're doing just fine on their own. So instead of subsidizing yesterday's energy, let's invest in tomorrows."

"Now it's our turn. We know what it takes to compete for the jobs and industries of our time. We need to out-innovate, out-educate, and out-build the rest of the world. We have to make America the best place on Earth to do business. We need to take responsibility for our deficit, and reform our government. That's how our people will prosper. That's how we'll win the future."

"To help businesses sell more products abroad, we set a goal of doubling our exports by 2014 - because the more we export, the more jobs we create at home. Already, our exports are up. Recently, we signed agreements with India and China that will support more than 250,000 jobs in the United States."

"We will put more Americans to work repairing crumbling roads and bridges. We will make sure this is fully paid for, attract private investment, and pick projects based on what's best for the economy, not politicians."

To be honest, it felt like more of the same. Not many new economic policies announced, no new stance with regards to India or China and certainly no ground breaking fiscal reforms to bring the budget deficit under control. As to how he is going to try and change the state of the American educational system, no concrete plans there either. Unfortunately ‘it’s the economy, stupid’ has been replaced by ‘it’s education, stupid’.  In a report out last month the U.S. now ranks 25^th in math, 17^th in science and 14^th in reading out of 34 countries as compiled by the OECD. Without a skilled workforce there will be no sustainable economic growth, perhaps it’s time for a new approach, re-build the economy from the ground up and start with the education system.

So much for the ‘We can’t win the future if we stand still’ – quote. I guess it’s hard to start running when you have become complacent and have been standing still for so long already.

So that was yesterday, today across the street Mr. Ben Bernanke and his open market committee members voted on monetary policy. Guess what, they don’t like change either and decided to leave interest rates on hold (for an extended period of time) and QE2 in place.

Some key points from the statement (full text):

 “The economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions. Growth in household spending picked up late last year, but remains constrained by high unemployment, modest income growth, lower housing wealth, and tight credit.”

“Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate is elevated, and measures of underlying inflation are somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate.”

“In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011.”

In other words: anemic economic growth, no job growth and no inflation whatsoever. No inflation, it must be good to be Ben Bernanke and to live in a bubble. At least he let go of his fear of deflation.

The one thing that was different about this statement was the fact that it was a unanimous decision. Where Mr. Hoenig dissented on each and every occasion last year, his successor (Philly Fed president and arch-hawk) Mr. Plosser decided to sit this one out and vote for instead of against Mr. Bernanke. It will be interesting to see if and when he starts voicing his opposing views.

With Obama saying nothing new and Bernanke being stuck in last year’s groove, is there nothing for to the markets to take their cue from you might ask.

Actually there’s an event coming that holds some predictive value and therefore might cause some upheaval in the next week and a half. It’s Super Bowl time. I won’t get into the Super Bowl indicator right now, because I want to devote next week’s blog exclusively to the Super Bowl and the predictive value of the Super Bowl indicator.

The markets today did next to nothing. The Dow Jones hovered around the 12.000 mark all day long, the S&P 500 could not break 1.300 and the Nasdaq flat lined just before lunchtime and could not be revived over the remainder of the session.

Dow 11.985 (+ 0.07%) S&P 500 1.296 (+ 0.42%) Nasdaq 2.739 (+ 0.74%) WTI $87.30 EURUSD 1.3680 Gold $ 1.346

I would like to end my blog with an interesting ‘statistic’ (I say statistic, but these are in fact the lives of real people) tweeted yesterday by Nicole Lapin (CNBC):

‘99ers hit a new milestone- 1.4 million people have been of work for 99 weeks (the limit for unemployment benefits)’

Oh, and the other milestones we're looking at -- 12k on Dow, 1300 on S&P...Thanks, Helicopter Ben - but your job was also, um, JOBS!

Enough said !

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

TBTF January 23, 2011 - Back To Life, Back To Reality

‘Back to life, Back to reality, Back to the here and now, I live on top of the block, No more room for trouble or fuss, Need a change, a positive change look, Look it’s me writing on the wall’ (Soul II Soul – 1989)

It’s been a long time since my last blog, much too long. But I am back, I am back to stay. I will however, change the format. I will blog bi-weekly and do day to day updates via twitter @toobigtoflail and facebook.

So what has happened in the world of finance and geo-politics since the last time I wrote this blog:

China has been dominating the market headlines as of late, lending a helping hand to Europe while tightening their monetary policies because of inflationary pressures. Rates in the United States have gone up even though the FED is monetizing all the debt that the Treasury department issues weekly, Republicans took over the House of Representatives and threatening to NOT raise the debt ceiling. And oh yes, a government in Tunisia has been toppled after social unrest broke out because of ever higher food prices. There is much to talk about, so let’s get started.

Inflation

Inflation in most of the developed world has been subdued. The latest CPI numbers in the U.S. put inflation (including Food & Energy) at a modest 1.5% (YoY) while the CPI in the Euro zone came in at a benign 2.0% (YoY). Nothing to worry about you would say, well in China the CPI came in at 4.5% (YoY) and in Tunisia food prices shot up so high there was a public uprising which eventually chased the President out of the country. Apparently the inflation numbers in the ‘modernized’ world always undershoot the real inflation as experienced by day-to-day purchases. I guess our bureaus of statistics are cleverer in manipulating the facts.

Let’s take a look at agricultural prices (S&P Agricultural Index):

As you can see from this graph, prices advanced by 36%, from Jan 1st 2010 to last Friday, with Wheat +38% YoY and Corn +44% YoY leading the way.

The same can be seen when we look at oil prices +17% YoY and Heating Oil + 20.5%

In countries where people don’t spend most of their disposable on luxury items as IPads, Ferraris or Apartments, but where they barely have enough money to put food on the table or heat their homes (if they are not re-possessed), the impact of skyrocketing food and energy prices are undeniable and cannot magically disappear by tweaking the basket of goods used to measure inflation. And those are the countries where the public uprising appears first, but let’s be clear about it, for a lot of people in the U.S. (and to a lesser degree in Europe) rising food and oil prices do matter, so I wouldn’t be surprised if it is just a matter of time until we see demonstrations in the Western World as well, no amount of statistical manipulation can prevent that.

As of October 2010 43.2 mln people in the US were using the Supplemental Nutrition Assistance Program, also known as Food Stamps. This is up from 37.6 mln a year earlier, an increase of almost 15% which is almost 11% of all Americans. I say that’s a fairly high percentage to say the least.

I can imagine the leadership in China is worried about the food and energy inflation. The social and economic inequality between is so huge between many of their regions (most of the wealth is concentrated in the South East) that even though their per capita income was up 13% in 2010 (2010 data from the IMF and 2009 data from the World Bank, so the 13% might not be completely true, but is probably a good guesstimate) something tells me most Chinese did not get a 13% rise in their paycheck but they were however exposed to sky rocketing food prices, making the economic inequality even bigger. After what happened in Tiananmen Square 21 years ago, I don’t think President Hu Jintao is particularly fond of a public uprising in the Chinese heartland, so he is doing whatever he can to stop the inflation from rising further which means slamming on the economic breaks. In the mean time the FED keeps flooding the world with cheap money to get the U.S. economy back on its feet (or at least stop it from sliding further), which of course works contrary to what the Chinese are trying to achieve.

And this is precisely why Geo-politics is so much fun.

Financial Markets

What do the various financial markets make of all this:

While the U.S. and European markets have been rising on an almost daily basis since the FED hinted at a new quantitative easing program, the Shanghai stock market has been falling ever since China started their monetary tightening campaign, trading down over 10% since the beginning of November.

Shanghai:

S&P:

DAX:

What is really interesting has been the fact that the equity markets kept being strong, while interest rates in the U.S. started to move up during the last month of 2010. Some of the move can be explained by the fear that the now Republican Congress voiced concerns over raising the debt ceiling. The treasury secretary, Mr. Timothy Geithner, had asked congress to vote yes to raising the debt ceiling, as this magical number of $ 14.3 trillion will most likely be reached by April 1st, maybe even sooner. If the ceiling is not raised, the U.S. can do nothing but start to default on its debt, thereby forcing credit agencies to cut their triple-A rating.

Also not helping was the sell-off in municipal bonds when it became clear President Obama would not extend the Build America Bonds program, which was part of the recovery act, in exchange for republican support of an extension of the ‘Bush tax cuts’. Meaning it will be harder for cities and states to raise much needed capital.

U.S. 10 Year Rate:

Europe

Europe is still having problems of its own. In December Ireland was ‘forced’ to accept financial support from the EFSF. My guess is they came begging for money, but to keep up appearances it was decided to have them accept the money reluctantly.

2 down, 4 to go.....

I say 4, since not only Portugal, Spain and Italy are slowly getting into more and more trouble, but Belgium was also suddenly thrown to the wolves. General elections were held more than 7 months ago in Belgium and they are still unable to form a new government. Not very surprisingly, since the party that won the elections is pro the segregation of Flanders from Wallonia (i.e. the Dutch speaking from the French speaking part). For now it proves that a government is not always necessary, since the country still exists, but bondholders are getting more and more restless.

Portugal and Spain were given a new lifeline as China vouched they would keep on buying their debt, as does the ECB on a daily basis. Even with the Chinese guarantee, both Portugal, Spain and the ECB thought it wise to introduce a new way to raise money, a private offering. It’s a simple way to keep alive the Ponzi scheme that is the Mediterranean part of Europe. How does it work?

Spain’s treasury needs 4 billion euro. What can they do? They can auction the debt in a public auction, but then the outside world knows the exact participation rate of direct and indirect bidders, i.e. how eagerly investors want Spanish debt. They can also issue the debt through a private auction, where they call up Santander, Banco Popular and Banco Bilbao Vizcaya, force them to take the entire 4 bln euro issue at a reasonable rate. Why would these banks do this? Because they can turn around, call Jean Claude Trichet, deposit those bonds as collateral and get more liquid instruments in return.

But wait, isn’t this exactly what the FED is doing every single day with their POMO’s? Well yes it is, but here in Europe we don’t call it printing money or monetizing, because our central bank is not allowed to do that.

Long story short, Portugal managed to raise about 2.5 billion euro in their last public offering (at least for the time being), Spain just around 4 billion euro and a sigh of relief was felt throughout Europe. I guess it wasn’t so much the relief that they raised the cash as much as it was the relief of nothing having to endure the global panic that would have ensued if they hadn’t been able to raise a measly 7 billion euro combined.

Well, I guess there is always next time.

That’s all for today, I will write the next blog Wednesday evening and will use twitter and facebook for updates during the week.

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

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!!!

TBTF November 1st, 2010 - Forever Autumn

‘The summer sun is fading as the year grows old, and darker days are drawing near, the winter winds will be much colder, now you’re not here’ (Justin Hayward & Jeff Wayne – 1974).

Here in Europe we said goodbye to summer(time) 2010 and stepped into autumn. More rain, more wind, lower temperatures, a lit fireplace and since the clock went back one hour over the weekend, it will be dark one hour earlier than last week as well. Darkness is descending over Europe, and I’m not only talking about the nearing economic depression. It also implies that the time difference between Europe and the US East Coast is only 5 hours this week, so QE2 will be announced at 19:15, not the usual 20:15, this Wednesday (unless Bernanke comes to his senses…..yeah right!).

It was also Halloween weekend and this started off with quite a scare. For a brief moment the mid-term elections and QE2 were pushed to the background by Friday’s news that 2 bombs were found inside printer cartridges on planes from the middle-east en route to Chicago. One bomb was intercepted in Dubai, while the other was caught in London. No one knows as of yet if those 2 bombs were the only ones bound for the US, let’s hope they were. On the markets there was NO reaction at all, the S&P traded in a tight 6-point trading range all day. Apparently terrorist threats have become part of our everyday lives, which is scary in itself, or maybe QE2 is believed to be anti-terroristic as well. We choose to believe everything fairy tale Bernanke tells us anyway.

So here we are, 2 ½ trading days before what will be a game-changing event: QE2. The chance that there will be QE2 of some magnitude is 99.9%, so the bigger question is: what will happen after it has been announced, in 3 months, 6 months or even 2 years down the road.

The answer is: NOBODY knows. The only thing that is clear is that the risks, introduced in the economy, are growing as a result of monetary easing and it’s not clear if the FED can counter those risks in the future. It’s a tightrope that Bernanke is walking and the risk of falling off a cliff left or right is extremely high.

On the one hand QE2 might achieve nothing which almost certainly means the US will follow down the path of Japan, where the economy has not been growing in the last 15 years. On the other it might introduce inflation, a lot of inflation, but inflation itself will not stimulate the economy, the mechanism that takes care of that is the ‘velocity of money’. This has been hit hard by the deleveraging in the economy, on the banking side as well as on the consumer side. Introducing more liquidity (as if there is a liquidity shortage at the moment) won’t increase the velocity of money if on the other side de-leveraging still continues. But it does have an inflationary impact through a lower dollar. If this is the case, higher inflation without a higher velocity of money and therefore a still sluggish economy, then what can the FED do to stop inflation from spiking higher and higher? They won’t be able to do what they always do: raise rates, they will drive the economy into a deep depression if those measures are taken. So we will have runaway inflation with no means to hold it back, not a pretty picture at all.

Gonzalo Lira, on his blog this weekend, calls for a steadily increasing CPI averaging 30% by the end of 2012 culminating in the collapse of the $ and the US economy. Just in time for the end of the world, as predicted by The Mayans. Goodbye money, goodbye earth. Maybe that’s why Bernanke is not looking for a real solution to these problems at hand, we won’t last long enough anyway. (Don’t go throw away all your hard-earned cash just yet, because some scientist figured out that the Mayan calendar doesn’t stop in 2012, but in December 2208, good thing I did not go see that movie after all.)

The markets ended the week just like they had been trading all along, unchanged. October 22^nd the S&P500 closed at 1.183,08 while this Friday it closed at 1.183,26 A whopping gain of 0.18 points! The VIX however closed 2.4 points higher as more and more market participants are trying to insure themselves against a lower than expected QE2 announcement and trade-war tensions keep building.

Dow +0.04% SP500 -0.04% Nasdaq +0.00% EUR$ 1.392 WTI $1.4 Gold $1360

Treasuries ended higher, sending yields on the 10yr lower to 2.60%

We have a lot of economic data this week, ranging from ISM to Non Farm Payrolls, but Wednesday’s FED meeting will be the most watched event of the week.

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

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