Archive - Aug 2010

Inflation continues to ebb away. In Japan core CPI deflation, at -1.5% is the worst on record. While in the US, the corporate sector is seeing its weakest pricing power on record ? even worse than that seen in the deflationary maelstrom during the Asian crisis (see chart below). We have consistently articulated the view that the severity of the current situation will only be appreciated when this current cycle ends in failure ? and that is not too far away. That will be the time that equities will plunge to new lows. And that, not March 2009, will provide the buying opportunity of a generation to hedge against the coming Great Inflation. - Albert Edwards

One of Zero Hedge's favorite indications of rationality (in addition to following what credit does, without fail to the chagrin of permabullish equity fanatics) in the face of Fed-induced capital markets psychopathology, is following the flow of funds into various asset categories. Last week we pointed out that ICI reported the 13th sequential outflow from domestic equity mutual funds, validating our persistent skepticism that the money pushing stocks higher on margin is certainly not coming courtesy of retail accounts, which represent the bulk of holders behind the $10 trillion market cap of US stocks. Incidentally the retail redemptions are also occurring at the ETF level, and in total now amount to $32 billion for mutual funds, and $6 billion for ETFs. The paradox of a rising stock market in the face of massive redemptions has forced others, namely BNY ConvergEx' Nicolas Colas to ask the same question: "If retail investors are leaving U.S. stocks in both 401(k)s (read mutual funds) and brokerage IRAs/investment accounts (read ETFs), then who is buying stocks so that the market is still up (modestly) on the year?" His observation is simple: "Investors are shifting assets in both mutual funds and ETFs away from U.S. stocks and into fixed income. The moves are dramatic: there is 2-4x more money moving into fixed income than is leaving stocks. Fresh savings, in other words, are going directly into bonds. There is also some modest shift to international investing, mostly in equities, but not on the same order of magnitude as the bond trade." In this environment, we believe that in addition to the recently floated idea of annuitizing 401(k), a new revision to retirement planning will be made to allocated even more capital to the equity portion of 401(k) plans, now that the Fed is about to imminently get back to monetizing treasuries thereby making the question of just who buys Treasurys on margin moot.

The weekly chartology segment from David Kostin focuses on the end of the earning season, now that 89% of companies have reported and observes what most know: that analyst estimate gaming is on like Donkey Kong: "52% of companies beat estimates by at least 1 standard deviation." Guess what that means: that the perpetually wrong cadre of analysts will now have to raise estimate going into H2 and 2011, just in time for all the economists to piggyback on Goldman's moment of bearish epiphany and cut their own economic growth projections to the mid 1% range. The clash between macro and micro has never been greater, and yes - it is all courtesy of taxpayer "mediated" deleveraging. For every dollar beat in the private sector, are many public sector dollars that will not only hinder future US economic growth (think of it as the opportunity cost of giving CEOs better cash out levels), but will certainly never be paid back.

Following up on Friday's economic forecast reduction, Goldman's economic team provides an extended analysis validating its dramatic cut to 2011 GDP from 2.5% to 1.9%, and its increase to the unemployment rate from 9.7% to 10.0%. It does so not without a decent bit of gloating: "Our forecast for a significant slowing in the second half of 2010, widely seen as implausible three months ago, is now increasingly accepted." Of course, those reading this blog are fully aware that the fake economic sugar high achieved over the entire past 2 year period is what accountants would consider a non-recurring, one-time item achieved in the face of a deflationary tide, interspersed with ever more desperate attempts by the Fed to stimulate (hyper)inflation. And the closer we get to the imminent realization that as tens of trillions of debt need to be eliminated (and guess what that means for a like amount in underwater equity value) before any form of self-sustaining growth can be achieved, the more likely it becomes that the Fed will commit to the nuclear launch codes which will eventually destroy the US currency, in what many have pegged as hyperinflation for the items we need, and hyperdeflation for the items that nobody really cares about: an outcome which will make the Schrodinger Cat nature of our economy apparent in its final wave function collapse, with the only difference that the US economy is dead in both worlds.

Distillates demand, which tends to track economic output closely, is reflecting all the economic reports over the last two months--falling off a cliff.

Whether one believes in inflation or deflation, one thing is certain: in many ways the current US experience finds numerous parallels to what has been happening in Japan for not one but two decades. While major economic, sociological and financial differences do exist, the key issue remains each respective central bank's failed attempts to reflate its economy. While long a mainstay of Japan, if the first failed version of our own QE, which pumped $1.7 trillion of new liquidity into the system, is any indication, future comparable efforts by our own Fed will be met with the same outcome (and hopefully with the same political result: the half life of an average Japanese prime minister is 6 months - if only our career politicos knew their tenure in office could be capped at half a year...). There is of course the "tipping point" optionality discussed earlier by Ambrose Evans-Pritchard, when comparing the hyperinflationary timeline during the Weimar republic, which noted that it took just a few months for the economy to slide from a period of price stability to outright hyperinflation. Either way, for an ironic look at the Japanese deflation scenario, targeted more at novices although everyone will likely learning something from it, we present the following informative clip from, ironically, the National Inflation Association, which asks whether Japan is a blueprint for America's imminent lost decade(s).

Ian Arvin's Innovative Quant Solutions has completed its July performance tracking analysis, and the result is a major weakness for quants in the just completed otherwise animal spiritsh month, as increasingly fewer factors proved successful, with pronounced weakness in the traditionally robust during the bear market rally Momentum factor. From the summary of the attached report: "The IQS model was down 1.57% for the 4 weeks ending July 31, while the sector neutral model was down 1.01%. Year-to-Date, the IQS model is down 2.74%. IQS top decile of stocks has returned +3.6% YTD, while (according to the WSJ) the DJIA has returned +0.4% YTD, S&P 500 has returned -1.2% YTD, and The Total Stock Market has returned -.04% YTD. The IQS 1000 model was down 6.03% for the 4 weeks ending July 31, and down 6.09% YTD. IQS 1000 top decile of stocks has returned -.8% YTD. Factor categories that added to performance were led by Value and Sentiment. Momentum and Improving Financials underperformed. Weekly returns were volatile – up one week, down the next. IQS 1000."

The head of floor operations at UBS, who has followed the Dow since its triple digits days, and has been covering the market for the past 40 years, shares his ever amusing insights with Eric King. Art Cashin, whose daily comments on "napkin charting" and requisite market "nimbleness" are now legendary, and have appeared many times on the pages of Zero Hedge, discusses such matters as market topping, various levels of deterioration within the economy, the ongoing wage deflation, the shift of US society to a welfare state, the deflationary collapse of the economy, and the imminent response by the Fed: never one to mince words, Cashin observes with pinpoint accuracy "if you ask small businesses why aren't you borrowing, their answer is 'send me a customer, don't send me credit.'" and concludes "the Fed is walking a tightrope in a hurricane and it's going to be tough." We just found the understatement of the weekend.

As part of its most recent FCIC grilling, David Viniar left the political theater a month ago with a homework assignment to disclose all of the firm's derivative profits, as well as provide granular detail on its derivative trades. Today, courtesy of a memo from Goldman intercepted by the WSJ, we now know that derivative trades accounted for between 25% and 35% of 2009 revenue. "Based on the percentages provided by Goldman, such businesses generated $11.3 billion to $15.9 billion of the company's $45.17 billion in net revenue for 2009." As a reminder, the Office of the Currency Comptroller noted (table 2) Goldman had $49 trillion in total derivatives as of Q1. However, the bulk of the profit comes from trading credit derivatives where Goldman, post the assimilation of Bear and Lehman into the collective, is now virtually an undisputed trading powerhouse, and due to the OTC nature of the product allowing firms to set bids and asks as is, as long as liquidity in cash products continues to decline, Goldman will continue to dominate not only the most profitable vertical of derivative trading, but CDS will continue to generate roughly a third of the firm's profits, for both flow and prop. Post the recent shifts in prop trading across Wall Street, it will be interesting to see what the impact on the top line will be now that allegedly CDS trading at Goldman will be exclusively on a flow basis. The irony is that the Volcker Rule seems to focus almost exclusively on equity trading, while the bulk of the firm's questionable flow-prop "Chinese wall" transgressions may occur precisely in derivative trading, and should be the one area under much more scrutiny by regulators and legislators.

A disappointing July jobs report came out Friday showing weak employment gains, further evidence that the economy is stalling out. What will the Fed do?

Friday was the 65th anniversary of the Hiroshima atomic bomb. A visit to the Atomic Bomb Victims Hospital. Futilely treating gamma rays and beta particles with mercurochrome and traditional Japanese folk remedies. No one could live there for 20,000 years. Every type of plant strangely flourished after the bomb, but men and women were left sterile. Where has the bomb taken us today?

Washington is now in the business of spreading rumors relating to Wall Street. Just another example of how D.C. is taking the fun out of the game.

In pursuing an answer to the most elusive question around these days, namely just what is going on in China's real estate market, Standard Chartered has conducted the first phase of an exhaustive survey analyzing precisely what the real estate trends in Beijing, Shangai, and other Tier 1, 2 and 3 cities. The survey attempts to answer such key questions as: "What is really going on in China’s real-estate sector? Are prices falling – and if not, will they? Are developers’ finances
getting tight, and if so, will they be forced to cut prices? Confronted with the State Council’s stringent cooling policies, are developers postponing project starts and stopping construction? And if they do stop building, will this derail the economy and thus force the State Council to loosen policy?" For all curious to learn more about the truth behind the hype regarding China's real estate, which has more polarizing opinions than pretty much any other issue, this is the presentation for you.

Canada’s biggest multi-employer pension plan, with 130,000 active members, says thousands could soon face future benefit cuts of 15 to 50 per cent depending on negotiations with companies.

The slope of the US Treasury curve is at or near record steep levels across most of the combinations. What determines where the curve slope will be going forward? This analysis attempts to answer that question by looking at yield per unit of duration risk. - Kletus Klump