Archive - May 3, 2013

A. Gary Shilling's discussion of how to invest during a deleveraging cycle is a very necessary antidote to the ecstacy and euphoria that surrounds the nominal surges in risk-assets around the world sponsored by central banking largesse. Shilling ties six fundamental realities together: Private Sector Deleveraging And Government Policy Responses, Rising Protectionism, the Grand Disconnect Between Markets And Economy, a Zeal For Yield, the End Of Export Driven Economies, and why Equities Are Vulnerable. The risk on trade is alive and well - but will not last forever. We are still within a secular bear market that begin in 2000 with P/E ratios still contained within a declining trend. Despite media commentary to the contrary - this time is likely not different.

The bespectacled Robin to Buffet's Batman is at it again. After casting disparaging remarks about the hard-money fanatics of the world with his "only old jews like gold" comment last year, in a brief interview on CNBC today, Charlie Munger explained how "bankers should not be trusted" adding that "they are like heroin addicts." He was reflecting on the debacle that occurred in Cypriot banks of course - but his perspective is likely useful for a broader remit of investment professionals with endless fungible free money as their backstop. So that's the pair; hard- and soft-money partakers be damned. The irony of his firm reporting dramatically better-than-expected profits on the back of a surge in insurance-selling (not at all like CDS) is not lost on us.

The world's central banks have printed unimaginable amounts of money in recent years - "these guys are really more powerful than the government." Neil Macdonald explores what this means for the global economy and for your financial well-being - "can you imagine if the American public knew there was this 'club' that met secretly in Switzerland and made decisions that dramatically affected their lives, but we're not going to tell you about it because it's too complicated." This brief documentary should open a few eyes to the reality behind the world's most powerful (and real) cabal.

The pricing of 'safe' assets reflects the ongoing uncertainty in a world that is in the grip of the lunacy of policymakers who have seemingly lost all sense of perspective and are engaged in a huge gamble. This essential fundamental backdrop has not changed for the better lately, but for the worse. What this once again demonstrates is that intervention by central banks is creating incentives for many institutional investors to take inordinate risks in the name of preserving the purchasing power of the savings that have been entrusted to them. The problem is that the gains of today are absolutely certain to become the losses of tomorrow for investors taking the bait, as the echo bubble created by loose monetary policy is fated to turn into a major bust once the boom has played out. When the tide is going out, a great many naked swimmers will be revealed.

"We believe that the global central bankers, led by the Fed as “thought leader,” have no idea how much pain the world’s economy may endure when they begin the still-undetermined and never-before attempted process of ending this gigantic experimental policy. If they follow the paths of the worst central banks in history, they will adopt the “tiger by the tail” approach (keep printing even as inflation accelerates) and ultimately destroy the value of money and savings while uprooting the basic stability of their societies....  At some stage, central banks inevitably realize, regardless of whether they admit the catastrophic nature of their own failings, that the cessation of money-printing will cause an instant depression. Even though at that point the cessation of money-printing may be the only action capable of saving society, that becomes a secondary consideration compared to the desire to avoid immediate pain and blame."

With Iron Man 3 taking the theaters by storm this weekend, it is only appropriate that Iron Ben would make a cameo appearance now that the impregnable Dow crossed 15K, the S&P is over 1600, and pretty much everything is higher, literally and metaphorically, than it's ever been.

With macro data becoming worse and worse (more and more bullish for Fed free money) and stocks off to the races (despite earnings that are abysmal), we thought a litle reminder of just what is driving this un-reality in nominal price moves. As the following chart, inspired by UBS, shows, each time the S&P 500 shows any sign of weakness, US money grows dramatically (money defined as the sum of M2 and foreign custody repo-able holdings at the Fed). Simply put, this is the reaction function of the Bernanke Put and explains why any weakness in Europe causes problems for the US - as the foreign banks repatriate and impact this 'growth' support. Correlation is not causation, but it is a strong hint.

According to the media hype, stocks are never expensive; but if you care a little about the actual price you are paying for stocks, perhaps the following two charts will at least raise a doubt about chasing this fun-and-games. The prospective P/E on both US and non-US equities are now at the top of the post crash range. Multiple-expansion has driven the rally in large part on the basis that central banks have removed the downside tail to investing but at these valuations (and with the expectations that are still priced in for H2 2013 earnings - up 14% vs up 4% in H1) surely caution is warranted.

Succinctly summarizing the positive and negative news, data, and market events of the week...

Physical demand for coins and bars internationally continues and is the strongest since the immediate aftermath of the Lehman Brothers collapse on September 15, 2008, and the consequent global financial crisis.

Government mints, refiners and bullion dealers internationally are reporting demand as high as in the aftermath of the Lehman crisis.

"Records being smashed left and right on Wall Street today" Better-than-expected 'mediocre' payrolls data was enough to drive pre-open S&P futures well over 1600, provide just the right sprinkling of short-covering scramble and euphoria to smash the Dow through 15,000 and the S&P through 1,600 and up to its long-term up-trend. Treasuries snapped higher in yield, catching up to equity exuberance (after disagreeing all week). The Brent Vigilantes are awake and paying attention with their biggest 2-day rise in nine months with WTI back above $96. Copper also surged (+3.9% on the week) and Gold/Silver ended +0.5% on the week. FX markets went wild around the NFP print - JPY crumbled (ending the week -1%) but EUR round-tripped from its initial dip; JPY-carry was very supportive of today's excitement (until late on). Risk markets in general stayed highly correlated until some give back into the close that stocks ignored. Credit markets were not amused and faded the initial equity spike all day.

Following today's flashback to the most euphoric and irrationally exuberant days of market peaks (and bubbles) gone by, driven entirely by the now constant central-planner dilution of current and future wealth, these selected excerpts from Seth Klarman's latest letter to investors is just the cold water of common sense everyone needs:"The average citizen knows that a society's wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse. For if you must rescue everything, then ultimately you will be able to rescue nothing. They also know that the only reason paper money, backed not by anything tangible but only a promise, has any value at all is because it is scarce. With all the printing, the credibility of our entire trust-based monetary system will be increasingly called into question. And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed's balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else--even, or perhaps especially, the  policymakers—does either."

That modern markets are broken beyond repair should by now be clear to everyone: with liquidity that can be shut off at the flick of a switch, 70% of overall market "volumes" merely churning between various rebate collecting HFT algos, and the consolidated quote tape stuffed by billions of cancellation-sniffing quotes, it is surprising that major, marketwide millisecond +/- 2% swings are not a daily occurrence (as opposed to single-stock flash crashes and smashes which now do take place daily). However, said realization must also be followed by political and regulatory action, which will not come as these same politicians and regulators are beholden to precisely the same financial parties that have broken the market microstructure and who generously benefit from their Marketstein monster creation. Which means the best everyone else can do is sit back and watch the accelerating cannibalization with which these same market players go after one another until there is nothing left, and there is no other choice but to go back to the drawing board and start from scratch. To help pass the time, here is a short clip from Nanex showing just what happens at the proper timescale of modern "markets" - half a second - in the trading of Johnson & Johnson stock. If anyone had any doubts as to the stability of the market before, this should alleviate all doubt.

The biggest problem with the financial system is that of bad measurement. Without accurate data, no analyst can make sound investment judgments. Unfortunately for all of us, the data is gimmicked to the point that nothing is valid any longer.