Archive - Feb 13, 2013

The rise in energy prices; the surge in food prices; and the march higher in nominal stock market indices - all symptoms of one thing - central bank (or government) policy; and CNBC's Rick Santelli is calling them to task for their two-faced ignorance. "What is the difference between outright currency manipulation versus the collateral damage to one's currency based on central bank programs?" he rhetorically asks, "in my mind, very little, but obviously, in the minds of many leaders of G-7 developed economies, there's a huge distinction." And therein lies the rub. As Japan follows Bernanke's decade-old plan to reflate by literally printing money into existence - just as every other developed fiat currency nation - their argument is that they are fighting deflation - or stimulating growth - when, in fact "The distinction between collateral damage and outright manipulation is absolute malarkey." Now that the currency wars have gone global - no matter what well-placed op-eds will try to convince otherwise - Santelli sums it all up perfectly, "in the end when you don't have a standard and you have printing and fiat currency, what level of value is real?" We remind those bullish Japanese stocks that the 11% rise in the NKY since the holidays has created 0% wealth for a USD investor thanks to the JPY destruction - ask the Zimbabweans how wealthy they felt.

One of the fundamental creeds held by the proponents behind every new technology and gizmo market, including cell phones, smart phones, tablets, Sony Walkmen, 8-tracks, VHS tapes, juice extractors, tape rewinders, etc., is that their growth rate (and by implication the consumers' discretionary income), is completely dissociated with gravity and will grow at a far faster pace than global economic growth virtually in perpetuity. This is the case until empirical evidence reminds them, and everyone else, that gravity eventually always wins. Which is precisely what happened with global mobile phone sales, which in 2012 posted their first decline since the cataclysmic 2009. Gartner reports that the global cell phone market declined by 1.7% in 2012, down from 1.78 billion devices sold in 2011 to 1.75 in 2012. "Tough economic conditions, shifting consumer preferences and intense market competition weakened the worldwide mobile phone market this year," the report says.

On Monday we reported that a car bomb with Syrian plates had exploded at the Turkish-Syrian border crossing. The aftermath included the death of nine people, major devastation, and the latest sharp deterioration in Turkish-Syrian relations. We now have the dramatic footage from this explosion, which we present below courtesy of Reuters. Expect more such explosions as every attempt is made to drag Syria into war with one or more of its neighbors.

It was well-known that today's 10 Year auction would price somewhere north of 2.00%, for the first 2%+ print since April of 2012, it just wasn't known where. Sure enough, moments ago the US Treasury priced $24 billion in 10 Year paper at a high yield of 2.046% (38.76% allotted at high), the highest since last March when we had a 2.076% 10 Year auction (and a carbon copy environment in which every pundit was screaming about a great rotation out of bonds), only to see the April and especially May auction tumble in yield when Europe once again became unfixed. What was notable about today's auction is that it tailed the When Issued modestly, which was bid 2.039% at 1 pm, implying a 0.7 bps tail. Also notable: the Bid to Cover dropped to 2.68, below January's 2.83, and well below the 12 month TTM of 2.99. Dealers took down 47.7% of the auction, Directs as has recently been the case ended up with a sizable 24.2%, while Indirects took only 28% of the auction, higher than the December 24.2%, yet worse than all other auctions going back all the way to April 2009. For those confused - don't be - we have been here in 2012, and 2011, and 2010, when risk assets were surging, and when yields were sliding, only to see a modest subsequent pick up in inflation, mostly in China, but certainly Europe, at which point the global liquidity glut ceased and the economy (if not the centrally-planned market) resumed on its downward glideslope.

As if the 20% JPY devaluation over the last few months was not enough, the Japanese government is going directly at the core of the inflation manufacturing business... they have imposed sanctions that Japan's five largest refiners cut their production by 1.1million barrels per day (or 20%). We recently noted (here and here) the rise in both the price of gasoline (at record highs) and JPY-based price of the raw material (WTI or Brent) - and it seems Abenomics can only see the upside of the inflationary cycle (as they cut supply) - as opposed to the consumer-sentiment-sapping margin-crushing deflationary impact of higher input costs to life. One thing is for sure, Abe is all-in - no matter what G-20 defense he offers. Perhaps this is why JGBs have not reacted as much - they are seeing through the short-term inflationary hope to the longer-term deflationary dump.

The vise is tightening.

One of the recurring memes of the now nearly 4 years old "bull market" (assuming the recession ended in June 2009 as the NBER has opined), is that corporate profits are soaring, and that despite recent weakness in Q4 earnings (profiled most recently here), have now surpassed 2007 highs on an "actual" basis. For purely optical, sell-side research purposes that is fine: after all one has to sell the myth that the US private sector has never been healthier which is why it has to immediately respond to demands that it not only repatriate the $1+ trillion in cash held overseas, but to hand it over to shareholders post-haste (see recent "sideshow" between David Einhorn and Apple). However, a problem emerges when trying to back this number into the inverse: or how much money the US government is receiving as a result of taxes levied on these supposedly record profits. The problem is that while back in the summer 2007, or when the last secular peak in corporate profitability hit, corporate taxes peaked at well over $30 billion per month based, the most recent such number shows corporate taxes barely scraping $20 billion per month!

We have shown divergence after divergence as an indication of the market's relative exuberance. One of the key 'supports' for these hope-driven nominal levels has been forward inflation expectations. In fact, inflation expectations have become the anchor for higher equity (P/E) valuations and yet, they remain unconvinced that this time is different. As Barclays' Jordan Kotick notes, perhaps it is inflation break-evens lack of confirmation of new equity highs that is the chart to watch for the 'believers' to really think this time is different.

We are far enough and deep enough into the most heroic monetary and fiscal efforts ever undertaken to finally ask, why aren't these measures working? Or at least we should be.  Oddly, many in DC, on Wall Street, and the Federal Reserve continue to steadfastly refuse to include anything in their approaches and frameworks other than "more of the same." So we are treated to an endless parade of news items that seek to convince us that a bottom is in and that we've 'turned the corner' – often on the flimsy basis that in the past things have always gotten better by now. Oil is the primary lubricant of economic growth and that it is not just the amount of oil one has to burn but also the quality, or net energy, of the oil that matters. If we want to understand why all of the tried-and-true monetary and fiscal efforts have failed, we have to appreciate the headwinds that are offered by both a condition of too-much-debt and expensive energy.  Neither alone can account for the economic malaise that stalks the world.

With stocks pushing to new multi-year highs - seemingly all-in on the Fed's newfound transmission mechanism - the bond market is beginning to quake just a little. 10Y rates shifted quickly through 2.00% today - hovering around 10-month highs - but the question is, just how bad could it get for bondholders if the Fed were to lift their repressing foot of the yield-seeker's throat. While we believe they are missing the circular nature of any Fed implied tightening on stocks (and therefore bonds reflexively), Goldman sees 10Y yields 120-240bps under 'fair' currently thanks to Fed QE efforts - and believes 4.0% yields are on the cards by 2016. Our question - what exactly would HY spreads look like under this 'bullish' scenario? And for the stock bulls - is this just catch-up by bonds or the great rotation so many hope for? And if Goldman believes this - why is their (and their primary dealer friends') holdings of Treasuries so extremely high?

As we noted yesterday, the credit bubble is in full swing as high-yield covenant protections hit a new low in January. At the same time, new issue premia in high yield credit has remained extremely low (meaning demand is high) - even as leverage (measured in a number of ways) surges to post-financial-crisis highs. With low yields and technical demand so abundant, firms appear to be leveraging-up in favor of shareholders. But, as is always the case, there is a limit to just how much leverage can be piled on before credit spreads 'snap' and raise the cost of capital - hindering the equity price. Finally, for the 'cash on the balance sheet' advocates, US firms' Cash/Debt is its lowest (worst) since pre-crisis. Banks continue to delever, sovereigns relever, and non-financials taking their lead - this didn't end well last time... and this time, exuberance and positioning is very heavy.

Europe’s banks are totally insolvent and have not been fixed. No EU leader is going to tell you this because their jobs depend on convincing people that everything is fine. Bankia was supposedly “fine” right up until the truth came out. Just like the Wall Street banks were “fine” going into 2008.

Per C-Span: "The Senate Finance Committee will hold a confirmation hearing Wednesday for Treasury Secretary nominee Jacob "Jack" Lew. If approved, he will replace Timothy Geithner. Among the topics he will address include the state of the economy, strategies for reducing the budget deficits, economic ties with China along with questions about global currency war. Sen. Orrin Hatch (R-UT), Ranking Member of the Senate Finance Committee, said in a statement that the "We need a better understanding of his role at Citigroup, what his knowledge is of financial markets, whether he supports reforming our tax code, whether he believes in a robust trade policy and what kind of plan the Obama Administration has to confront our skyrocketing debt and our broken entitlement programs. As we move forward, I’m hopeful that Mr. Lew will answer some remaining questions that I have." According to AP, "After Wednesday's hearing, committee members will have two days to send questions to Lew to answer before they vote. The full Senate could vote on the nomination late this month."

Oh, this 35% Apple correction, drop in margins, increase in competition and decrease in competitiveness of products is a temporary thing. Seriously!!! That Reggie guy shouldn't even be allowed on TV. Really!!!

Reports indicating that Americans have invested more in equity funds here in 2013 than they did all last year have given rise to talk of the "Great Rotation". The idea is that Americans are selling fixed income investments bought during the financial crisis and now buying shares. We are less sanguine. There is a third asset class that needs to be integrated into the analysis: cash. After surveying the data and various reports, it looks to us that the flows into equities is not coming out of fixed income but rather money market funds and deposits.