Archive - Sep 2013

Why aren't rising stock markets being greeted with wild celebrations? We think the study of socionomics may offer some clues.

Nowhere is China's historic misallocation of capital (resulting from a pace of credit creation that makes even the most fervent Keynesian western central banker green with envy) more evident and tangible, than in videos showing the tumbleweeds floating down the main streets of its ghost cities. We did that first in 2009, then followed up two years later only to find nothing has changed. Today, on yet another "two years later" anniversary, we go back to the scene of the excess capacity crime, to find out if thing may have finally normalized. For that we follow SBS' Adrian Brown who back in 2011 did an extensive report on what were some of the then unknown ghost cities dispersed across the mainland. What we find is that not only is the overcapacity problem nowhere close to being resolved, but that 20 new "ghost" cities are taking shape in this year alone.

The FOMC shocked markets by deciding not to slow its large-scale asset purchase program, after all the signals it had sent out in previous months that it would do so. While increasing policy risk, JPMorgan notes, this puts the asset-reflation trades back on the table. In their view, the main driver of gold’s performance over the past five years has been QE. As QE continued and inflation expectations remained subdued, the demand for an inflation hedge subsided, ETF positions were unwound and gold prices fell. However, JPM now believes, as a result of the Fed's volte-face on tapering, uncertainty about future inflation may pick up and suggest a long position in gold. Of course, the question is - are they buying or is this a last ditch effort to drain what little remaining gold they have in their vault to their hapless clients?

What Ben Bernanke did by not Tapering was expose the fragility of the US economy for all to see. His actions, Mises Institute's Peter Klein explains in this brief clip, based on the premise that the US economy was not capable of sustaining any reduction in the $85 billion per month stimulus free-money, means once again "the economy is so dependent on artificial stimulation from the central bank... that the economy is in another artificial boom just like the artificial boom we have been trying to get out of." Critically, for all those proclaiming the US as a "cleanest shirt," Bernanke proved them wrong (and exposed the fallacy of data such as the unemployment rate and jobless claims as having any value - as we have explained). In conclusion, Klein notes "any signs of economic growth or progress that we have experienced since 2008 are solely the result of government stimulus; in other words, more malinvestment." This will not end well.

Since the global economic crisis began in 2008, Italy’s GDP has declined by about 8%, nearly a million workers have lost their jobs, and real wages have come under increasing pressure. The most striking aspect of Italy’s recent turmoil is what has not happened: citizens have not poured into the streets demanding reform. Indeed, throughout the crisis, Italian society has remained uncharacteristically stable. Japan’s experience – characterized by more than 20 years of economic stagnation – offers important lessons for crisis-stricken democratic countries with aging populations. During Japan’s “lost decades,” successive Japanese governments allowed public debt to skyrocket and refused to confront the economy’s deep-rooted problems, allowing sclerosis to take hold. In fact, Japan’s leaders had little incentive to pursue bold reform, because voters consistently failed to demand it. The question now is what kind of shock would be required to motivate Italians to demand similar action.

As we noted earlier, Bernanke's actions this week make it very clear that between "financial conditions" and the fragility of growth, the US is incapable of surviving without ZIRP and QE (for now). As Barclays notes, ultimately, normalisation should proceed according to a timeline that does not threaten recovery, yet will result in a neutral monetary policy by the time the economy reaches full capacity and the desired inflation rate. However, there are many uncertainties along this path. Given we now know that 'tapering is tightening', the implicit rate hike from a reduction in QE will mean a 600bps tightening in financial conditions. Do you believe in miracles? Simply put - how do you think our easy-money, share-buying-back, leverage at all-time highs corporations will cope with a 600bps rise in the cost of capital over the next three years?

The economy is like a machine. At the most fundamental level, Bridgewater's Ray Dalio explains in this excellent video introduction, it is a relatively simple machine. But, he adds, many people don’t understand it – or they don’t agree on how it works – and this has led to a lot of needless economic suffering. The clip and article below shares his simple but practical economic template explaining how he believes it works. As he notes "my description of how the economy works is different from most economists'. It has worked better, allowing me to anticipate the great deleveragings and market changes that most others overlooked." The likely reason for this is because it is more practical. Simply put, Dalio notes, "This different way of looking at the economy and markets has allowed us to understand and anticipate economic booms and busts that others using more traditional approaches have missed."

The last two years have been disappointing for gold investors and what happened this week to the yellow metal epitomized the frustrating price movement. Yet the case for investing in gold does not depend on the market’s reaction to the Fed’s latest doings. For the investor, whether or not to buy gold necessarily entails forming a judgement about the larger and more enduring forces that impinge on its price. Is our politico-economic system, in other words, congenitally disposed to the cheapening of the currency? Those who invest in gold basically answer yes. And they have very solid grounds for that stance. Over the past forty two years, one would have been better off holding what Keynes called the barbarous relic than what are commonly described as the safest securities in the world. Unless there is a tectonic change in our politico-economic structure - such as a return to a hard money standard - it’s hard to see how this will change.

... the relationship would look something like this sensitivity table between GDP and EPS.

When Risk Premium on Canadian lending oustrips real interest rates at same time Bail-in provisions are implemented, is the writing on the wall (street)?

There was a time, long ago, when some still believed the myth that the Federal Reserve, and the selection of its Chairman, were supposed to be apolitical and impartial. Luckily, that was a long time ago, because otherwise some may question not only the logic, but the motives, behind what the media reports is an aggressive push by White House officials to "muster support among Democrats on the Senate Banking Committee to back Federal Reserve Vice Chair Janet Yellen," according to Reuters which cited three sources said on Friday, laying the groundwork for her expected nomination to the Fed's top job. If the White House is suddenly intent on picking Mrs. Yellen (or is that Mister?), one wonders just how diluted her "runner up" credibility at the Fed would be, since it has been made quite clear she was continuously Obama's B (or lower) grade choice to head the Fed, with Summers at the very top. And of course, a just as important question is how even more diluted is Obama's credibility and political brand if a few ultra-liberal Senators can impose their choice for next Fed head over that of both Larry Summers, of the "Committee to save the world" and the president himself.

BREAKING: Israel Shin Bet security agency: Soldier was abducted and killed by Palestinians in West Bank.

— The Associated Press (@AP) September 21, 2013

Raghuram Rajan has been in his job at the head of the Reserve Bank of India for just a few weeks now and already changes are being made as the 23rd President

As we wrap up a most interesting, and volatile, week there are some things that we have discussed previously that are now brewing, interesting points to consider and risks to be aware of.  In this regard we thought we would share a few things that caught our attention:

1) Angela Merkel Election No So Assured
2) The Debt Ceiling Debate
3) The "Taper" Indecision Is Back
4) In The "Economy Is Improving" Camp
5) Syria Already Set To Miss A Deadline
6) Everything Else...

Simply put, complacency is not an option; Stocks are overvalued, rates are rising, earnings are deteriorating and despite signs of short term economic improvements the data trends remain within negative downtrends.   Investors, however, have disregarded fundamentals as irrelevant as long as the Federal Reserve remains committed to its accommodative policies.  The problem is that no one really knows has this will turn out and the current assumptions are based upon past performance.

Given Bullard's earlier comments on 'bubbles' being so obvious to spot in the prior two examples he noted, we thought the following chart was instructive. As Global Financial Data's Ralph Dillon notes, They often say that the past is a mirror of the future. This has rung true a few times in our markets' history and this chart demonstrates that precisely. Except for one thing...