Archive - Jul 22, 2013

A lot of Americans have an impression that drone strikes are less damaging to civilian populations that conventional airstrikes. This would be false. In fact, earlier this month I highlighted an article from the Guardian that demonstrated how in reality drone strikes are 10x more likely to harm civilians per incident. Now, thanks to a recently leaked document we find that many more civilians including children have been killed in these strikes than many of us would like to admit. In fact, of the 746 people killed in drone strikes in Pakistan from 2006-2009, an incredible 20% were civilians and 94 (13% of the total) were children.

Earlier we reported about Southwest flight 345 which in a hard lending replica of the US (or is that Chinese?) market, had its front wheels "come off" upon landing at Laguardia airport earlier today. If only the Chairman was there in time to print it a backup set of wheels, just as he did with the S&P. Below is the first released video of what happens courtesy of NBC4, showing the plane skidding on the Laguardia tarmac in a sea of sparks. Luckily, nobody was seriously hurt although we can only hope the pilots were not of Korean origin.

Following earlier comments that 7.0% is China's bottom-line GDP growth for the year (they promise), rumors are emerging of a much more significant shift in China's mis-allocation of capital strategy. UBS reports rumors that the PBOC is planning to take the ultimate step in stopping the over-capacity problem stifling the cement and steel industry by banning banks from making new loans to these industries (and disallowing the companies from issuing short-term debt to meet their liquidity needs). Have no fear though, as the cessation of credit provision to these over-stuffed industries 'directly' will be met by an indirect mis-allocation of capital via a CNY260 billion rail-road investment fund (aimed at maintaining stable economic growth and employment) including building the world's longest tunnel. The ultimate in central-planning largesse - directing both fiscal investment into dead-end projects (see Spain) and ad hoc monetary injections to save banks one by one.

As we warned here most recently, the shadow-banking system remains the most crisis-catalyzing part of the markets currently as collateral shortages (and capital inadequacy) continue to grow as concerns. In recent weeks, between The Fed, Basel III, and the FDIC, regulators have signalled the possible intent to change risk, netting, and capital rules that could have dramatic implications on the repo markets and now, it seems, the SEC has begun to recognize just how big a concern that could be. As Reuters reports, the SEC urged funds and advisers last week to review master repurchase agreement documentation to see if there are any procedures to handle defaults, and if necessary, prepare draft templates in advance. A retrenchment in repo markets is unwelcome news for the liquidity of the underlying securities and the impact on the derivative portfolios should not be underestimated.

When the city of Detroit filed for bankruptcy last week, it became the largest such filing in United States history. Detroit’s population has dropped from 1.8 million in 1950, when it was America’s fifth-largest city, to less than 700,000 today. Its industrial base lies shattered. And yet we live in a world where cities have never had it so good. More than half of the world’s population is urban, for the first time in history, and urban hubs generate an estimated 80% of global GDP. These proportions will rise even higher as emerging-market countries urbanize rapidly. So, what can the world learn from Detroit’s plight? Stories like Detroit’s have played out several times in developed countries during the last half-century. And, as the fate of Mexico’s northern towns suggests, emerging economies are not immune from this process. Detroit’s fate should serve as a warning, not only for China, but for the next generation of urbanizing countries (for example, India) as well. 

This might just be the cruelest time to be an asset allocator. Normally we find ourselves in situations in which at least something is cheap; for instance when large swathes of risk assets have been expensive, safe haven assets have generally been cheap, or at least reasonable (and vice versa). This was typified by the opportunity set we witnessed in 2007. Likewise, during the TMT bubble of the late 1990s, the massive overvaluation of certain sectors was offset by opportunities in “old economy” stocks, emerging market equities, and safe-haven assets. However, today we see something very different. As Exhibit 2 shows, today we see something very different. As Exhibit 2 shows, today’s opportunity set is characterized by almost everything being expensive. As I noted in “The 13th Labour of Hercules,” this is a direct effect of the quantitative easing policies being pursued by the Federal Reserve and their ilk around the world.

Monetary history teaches us that governments always abuse their money-printing powers. Debt crises are not new. The scale and scope of today's debt crisis, however, is unprecedented.

While record shorts in Gold and record longs in Japanese stocks are apparently generally ignored - since they are 'with the status quo positive consensus' - the massive explosion in speculative (non-commercial) net longs in WTI Crude futures is perhaps the last-best hope for the US economic outlook (on a short-covering scramble). Given the lag in the production cycle, gas prices (which have risen 20 in the last 10 days) look set to extend their rise in the next month - overtaking record-high prices for the time of year and eating dramatically into the average US citizen's pocket. With oil spec longs as a percent of open interest in an extreme over-crowded long position, BofAML notes, a break below $103.38 may be the signal to cover (and save the US from its implicit tax hike at a time when GDP expectations drop lower and lower).

BREAKING PHOTO: Wheels just came off a Southwest flight at LaGuardia Airport - @BobbyAbtahi pic.twitter.com/j1coXlxuSU

— Breaking911 (@Breaking911) July 22, 2013

Anyone that thinks that the U.S. economy can keep going along like this is delusional.  We are in the terminal phase of an unprecedented debt spiral which has allowed us to live far, far beyond our means for the last several decades.  Unfortunately, all debt spirals eventually end, and they usually do so in a very disorderly manner. 

Financial asset investors may continue to benefit in the short term while stocks and bonds remain well bid, but production and labor in over-levered economies should continue to wither. When we take it to its logical conclusion, central banks cannot withdraw debt support (on a net basis) and so our baseless currencies seem highly likely to fail to provide sustainable purchasing power. (This happens as producers demand more currency units for their labor and resources, not when consumers drive prices higher by competing with each other for finite supplies of labor and resources.) Continued inflation of all global currency stocks is likely. This implies to us that fundamental expectations of the inevitability of price inflation across borders and in all currencies must change, from unlikely to highly likely. Since very few investors expect rising inflation anytime soon, the return skew is overwhelmingly positive in its favor.

While the NFLX results for the quarter beat on the bottom line with EPS at $0.49 vs Exp. $0.40, and revenue coming right on top of expectations of $1.07 billion, the stock is currently sliding after hours. The reason: despite a massive spending ramp up in the quarter with substantial costs raked up for new content, the firm generated just 630K net total "member additions", below the expectations of a 700K number, and well below recent quarters which saw subscriber growth ramp up to over 2 million in the past quarter. In fact, with all the content spending, NFLX added just 105K more total subs in the June quarter compared to a year ago.

Gold surged 3% on the day (back above its 50DMA) - its biggest daily rise in over 13 months - as it appears weak macro data (CFNAI and home sales miss) only served to spur the overnight gains on un-Taper talk and short-covering. Silver's 5.2% gain is it second largest of the year pushing it back above $20. The USD slid 0.5% on the day (JPY strength notable) and WTI fell back modestly to around $107 (with Brent outperforming for a change). Treasuries and stocks tracked amid low volumes in a narrow range ending the day practically unchanged (after the S&P failed to test 1,700 intra day as Europe close). VIX closed down 0.25 vols (well off opening highs) at its lowest close in over 3 months on one of the lowest volume days of the year for stocks. Credit markets faded notably into the close.

“All warfare is based on deception.” – Sun Tzu

Spain's slow-motion implosion into an insolvent singularity has been one of the most amusing sideshows for over a year. The chief reason for this is the sheer schizophrenic and absurdist polarity between the sad reality, visible to everyone, and the unprecedented propaganda by the government desperate to paint a rosy picture. While on one hand the economic data shows very clearly the painfully obvious sad ending for this chapter of European integration, it continues to be punctuated almost daily by such amusing confidence games as Spain's Economy Minister de Guindos telling anyone who cares to listen that the labor market is improving "beyond the seasonal pick up" and that Q2 GDP would be close to zero (because 0% GDP is the new killing it). That's the good news.  The bad news is that as Reuters reports, and contrary to fairy tales of unicorns and soaring 0% GDP, Spain's government is so insolvent, it was just forced to "borrow" from its social security reserve to fund pension payments.