Archive - Oct 2011

I am not sure how high stocks can go on the basis of more debt being piled on more debt by the same people who have too much debt. Maybe this round of "all-in" fiscal and monetary irresponsibility will take us to new highs. In any case I don't think we will have fond memories of the "Miracle in Cannes" since no proposals so far do anything to fix the cause of the problem. In fact as those people in society without stocks and without assets realize the government is doing everything it can to push those prices ever further out of their reach, and doing nothing to punish those who were wrong, the disillusionment may give rise to stronger emotions. The "occupy" movement may not know what it wants, it may even disappear after the first snow fall, but more people do have to question a financial system that claims to be managed properly, but is never tested. I heard one great line with the market cap of Hermes passed that of SocGen earlier this year. And that was the fact that SocGen might have a smaller market cap than Hermes, but their employees don't need a discount to shop there.

Uh, what is going on? Are French banks selling everything USD-denominated, promptly dumping the USD proceeds, and converting everything into Euros? Someone clearly knows something and is not happy with France, and hence EFSF spreads, as both the OAT-Bund and EFSF spreads have just surged to new records... but it sure isn't the ES which, oblivious as always, just trades with 1.000 correlation to the EURUSD which continues to telegraph precisely the opposite of what most believe. Oh well.

Around here we like to track things from the outside in, as the initial movements at the periphery tend to give us an early warning of when things might go wrong at the center. It is always the marginal country, weakest stock in a sector, or fringe population that gives us the early warning that trouble is afoot. For example, rising food stamp utilization and poverty levels in the US indicate that economic hardship is progressing from the lower socioeconomic levels up towards the center -- that is, from the outside in. That exact pattern is now playing out in Europe, although arguably the earliest trouble was detected with the severe weakness seen in the eastern European countries nearly two years ago.  Because of this tendency for trouble to begin at the periphery before spreading to the center, here at ChrisMartenson.com headquarters we spend a disproportionate amount of our time watching junk bonds instead of Treasurys, looking at weak sectors instead of strong ones, and generally spending our time at the edges trying to scout out where there are early signs of trouble that can give us a sense of what's coming next. In this report, we explore the idea that Europe is the canary in the coal mine that tells us it is time to begin preparing for how the world might change if the contagion spreads all the way to US Treasurys (which is mathematically inevitable, in our view).

Presented with little comment - aside from a snark nod to Trichet's much-heralded price-stability platform - Copper (at current levels) looks set to make its largest two-day rally since MAR09 with a shift well over three standard deviations from long-run means. Its hard to comprehend a higher USD and still falling SHCOMP along with the perspective that China is a little hot and may need more tightening with this ramp-fest, but then again applying sense to these markets is now nonsense anyway.

Earlier today, the FHFA announced yet another expansion to its attempt to make near-record low mortgage payments a pervasive concept (via the Home Affordable Refinance Program or HARP), and pad retailers' bottom lines courtesy of subsidy bailouts of the GSE capital shortfall payments. The core of the announced transitions to HARP revolve around allowing borrowers to refinance mortgages regardless of how underwater homes are. Of note is the "enhancement" which removes "the current 125 percent LTV ceiling for fixed-rate mortgages backed by Fannie Mae and Freddie Mac." In other words, one can have negative equity equal to the full amount of the loan or more, and still be able to refinance into current record low mortgage rates (something which last week's near record drop in MBA refi rates of -17% may not be too optimistic on). That said, considering HARP's abysmal success record to date, with just 894,000 borrowers having refinanced using this subsidy program (considering anywhere between a third and half of all US mortgages are underwater), and since it is far more economic to be delinquent on one's loans than to refinance and actually have to pay something out of pocket in these here USS of A, we expect even this latest revision to be a massive failure. In fact, the only data that matters is the public announcement on November 3 and 4th of how many tens of billions in retail "top line" the GSEs will need to be funded for by the US Treasury, because at this point one thing is all too clear: the nationalized US mortgage industry, in which ever fewer people actually make any cash payments, is nothing but a massive subsidy pass thru vehicle for domestic retailer operations.

As we approach major resistance levels, time to review some charts. What did the markets look like in 2008?

As usual, JPMorgan's Michael Cembalest cuts to the wick of the problems facing European leaders. This time with a rather sad analogy to that head-in-the-sand abomination of a bird called the emu. The Economic & Monetary Union (EMU) and its plethora of finance ministers, leaders, and bankers appears more and more similar to its aviary analogy. Cembalest notes, Europe’s long-awaited sovereign and bank bailout package will soon attempt liftoff; we will know more after yet another summit on Wednesday. There are flaws that may weigh this emu down, as annotated in the picture below. Why is this so important? Bank recaps in Sweden (‘92), the US (’92, ‘08), Japan (’99) and Asia (’98) were close to marking the bottom of the equity market cycle….but were not designed using the equivalent of the “Goal Seek” function in Microsoft Excel.

For anyone debating whether or not it makes sense to pay some hedge fund manager 2 and 20 to "actively" manage their money, we have the definitive answer: no. As the following chart from BofA's Mary Ann Bartels demonstrates, the correlation between 1 Year rolling returns for the HF community and the S&P just hit an all time high of just under 100%! In other words, alpha is now officially dead - the only strategy left in a world in which all phone conversations with "expert networks" are bugged, and where hedge fund managers actually go to jail for insider trading, is chasing beta. The more levered the better. Which explains not only the dramatic surge in market vol in the past several months as the entire "hedge fund hotel" shifts from one side of the boat to the other at the same time to catch the next wave, but that anyone deluding themselves that there is any alpha left in this market which is now entirely controlled by the central planning authorities, should probably reassess their strategy. Bartels puts it most succinctly: "Hedge Fund 1-year rolling correlations to the S&P 500 are at historic highs. Sustainable high correlations to the equity market have not been a typical pattern. This begs the question: are there too many hedge funds chasing too few returns?" The answer is all too obvious, and absent something changing dramatically very soon, we believe this is the beginning of the great unwind for the nearly $2 trillion in AUM held by Hedge Funds, and their transition to passive strategies. After all why pay at least 20% of any upside, when one can hand over less than 1% in transactions costs to the SPY or ES or any of the 8 trillion other ETFs peddled by Blackrock?

Not again...

Following four straight days of market intervention by the ECB through Italian BTP purchases, the European central bank, defiant of all market logic, decided to make it five out of five and once again stepped in with some modest buying in Italian bonds just as they were on the verge of taking out the Friday post-intervention support. Telegraphed buying also pushed up the EURUSD in the premarket session and sent the futures to the pre-opening highs. Granted this is nothing more than just another very short-term fix. What is is quite obvious, is that despite the relentless interventions by the ECB (and central planners around the world), a takeout of the 91 level on the 10 Years (and 6%+ corresponding yield) is a given, after which there is no technical support. By then a far, far bigger EFSF better be ready for deployment. Alas, it won't be.

This misconception that the paradox of thrift applies in normal markets has done immense harm to the economy and eroded the savings of the middle-class and retirees. For three generations, central bankers attacked savers by artificially reducing interest rates — in the belief that lower savings would boost demand and stimulate the economy. Low interest rates simply forced savers to assume more risk, in order to earn a return on their investment, and encouraged speculation. The traditional work hard and save ethic that is the backbone of the capitalist system has been supplanted by the consume, borrow and speculate profligacy that got us into such a mess. High levels of public and private debt, inflation, volatile investment returns and rising income inequality are all consequences of the low-interest policy pursued by the Fed. Today’s giant casino is a far cry from the cautious, prudent investment outlook of our grandparents’ generation.

All you need to read.

Following the inevitable transition of Harrisburg, PA into bankruptcy once the realization that the can can no longer be kicked down the road, it now appears that even the formerly "safe" Jefferson County, which was expected to avoid default, may itself devolve into a Chapter 9 (Jefferson County Democratic Lawmakers May Derail Debt Deal) following another political SNAFU. So while we wait on whether another $3.1 billion in muni debt will go toward the ultimate validation of M-Dub's thesis (if not calendar of events), the next city already prepping to go down the tubes is long-troubled epicenter of the credit bubble: Stockton, CA. Bloomberg reports, "Stockton, California, which declared a fiscal emergency in May, warned it may default on redevelopment agency debt issued in 2006, citing a shortfall in tax-increment revenue. Debt service will exceed available revenue by about $858,000 in the North Stockton project area, according to an Oct. 12 filing with the SEC." As expected, just like in any other house of cards, once the first one goes, the next ones down realize that those who default first (or among the first) default best, as there will be no money left for the stragglers. Expect to see many more cities biting the bullet and making a mockery of all those who in turn mocked the bearish muni thesis.

So we are still in planning to plan mode. The markets remain calm in spite of the fact that any plan was delayed again, and it is perfectly clear no one in power in the EU had attempted to work out a single detail of any plan until last week. There is so much to say about the events of the past week, but I’m left with 4 questions, where we are being asked to believe something far different from the truth.