Archive - Jan 2011 - Story

The key macro meme over the past 3 months, starting with Goldman's "thematic" validation for the surge in the market (which was purely QE2 driven) leading to the firm's 180 degree shift in outlook from pessimistic to optimistic, had to do with the passage of various recent fiscal US-centered stimulus programs, which were explained by the punditry as a means for America to avoid the fate of the global capital markets (most of which are now if not declining (Shanghai), then in slow down mode (Europe)) through "reverse decoupling" whereby the US takes the global economic growth baton from China. While we can only laugh at the assumption that the US can compensate for a Chinese clampdown on liquidity, that is not the issue. A far greater question is just how can US stocks ride to previous records without the rest of the world's participation. Nicholas Colas explains the quandary: by isolating the Dow Jones Industrial Average, and specifically the 13 stocks that account for two thirds of the index, the BNY strategist looks at what are the gating items preventing the DJIA to hit 13,000...and 14,000 in the next year. And while Colas comes to the conclusion that valuation in itself is not a great stretch (13K is a 13.2x multiple of projected 2012 earnings estimates, while 14K is 14.2x), not major outliers to historical forward earnings multiples, what is unique about the current situation is that the "average company on the Dow heavy hitter list has only 43% of its revenues originating in North America." Colas concludes: "A better U.S. economy, without uptake from other parts of the world, is not enough to give stocks the earnings power they need to reach Dow 13,000 or 14,000." Without the benefit of a suddenly fiscally austere Europe, and a suddenly monetarily shy China (and Japan which is more focused on rescuing the EUR than its own market), more than half of the projected growth in the DJIA earnings will be based on nothing but hopium.

The growth of state power demonstrates beyond all doubt the trend away from representation and toward centralization. At the time of its founding, the combined civil and military employment of the United States’ then-federal government was perhaps 2,500 peoplevii, or roughly one federal worker for every 1,600 citizens, while its now-central government employs some 14.6 million people, or more than one central worker for every 21 of the nation’s present population. Amounting to a growth rate of nearly 7,600%, it is little wonder, then, that Americans’ tax burden has grown even more. For while the average U.S. citizen paid a paltry $20 a year in federal taxes at the time of the nation’s founding, today the average citizen pays over $10,000 a year in inflation-adjusted terms, amounting to a growth rate of fully 50,000%.

The Cravens' Brothers summary:

Slow Growth Period: Debt payments consume disproportionate amount of consumer income.

Accordion-­Shaped Markets”: Markets that go up and down in dramatic fits and starts. Currently, markets are in a positive trend due to government stimulus.  However, we still believe that stocks are in a long-­term secular bear trend.

Risk of Global Debt Reset: There is a distinct possibility that countries and banks will have to take “haircuts” on their foreign debt holdings, leading to bank failures and a second financial crisis."

A look at the week ahead, which is expected to be more of the same. Per Goldman: "The Econfin meeting on Monday will keep the focus on the Eurozone periphery and the governments' ability to enhance the framework already in place. Inflation data out of Malaysia, UK, New Zealand and of course China will keep the issue of inflationary pressures on the agenda. Of these prints, the most critical is China’s CPI and the question of China tightening. We do expect inflation to have softened in December to 4.2%, but rising food prices through January so far suggest this softness will be short lived. We expect the Central Banks of Poland and Brazil to hike rates by 25 and 50bps respectively in response to inflationary pressures. Rates are likely to be kept on hold in Canada, Mexico and South Africa. The Turkish central bank is expected to cut rates by 25bps. The November TIC data will be dissected to determine foreign appetite for US assets."

A few days ago Robert Lenzner of Forbes had a column discussing what he termed "phantom income" created by $1.4 trillion of delinquent mortgages, based on an analysis from TrimTabs' Madeline Schnapp. As usual, we decided to bypass the messenger and go straight to the source. Below is Madeline's clarification on the issue. As we expected, it is not so much an issue of bank mortgage fraud and cash flow deficiency (which by now everyone knows is pervasive, and everyone knows is being backstopped each and every quarter by the GSEs to the tune of tens of billions of dollars every three months like clockwork). Incidentally, a topic we are surprised nobody in the media has picked up on, is that indeed banker bonuses appear to be running well below last year's levels for many institutions. The reason: while accounting gimmickry allows banks to pad their bottom line, it does little to actually stimulate the cash flow statement. And since investment bankers prefer to be paid with cash and not out of accounts payable, the truth is that banks are actually hurting when it comes to actual cash retention: a big red flag to cut through all the FASB accounting fraud. But back to Schnapp's point: a far more important observation, and one which we have been claiming since 2009 is the primary reason for the consumer "renaissance", is that the "phantom stimulus" which allows consumers not to pay their mortgages (with the banks' and the GSEs' blessing) is equivalents to about $84 billion annually, or 0.5% of GDP. Add to that the $120 billion in payroll tax cuts and $60 billion in "Make Work Pay" tax credit, and one can easily see how that government's fiscal largess immediately accounts for more than half of the projected 2011 GDP growth, the other half being more than accounted for through (now years of) inventory restocking.

It was just under a year ago that we first learned that Greece had been cleverly scheming to fool the EU, EuroStat, and investors, foreign and domestic, about the true nature of its fiscal deficit courtesy of various currency swaps constructed by none other than Goldman Sachs: a process which would end up being the first time the "Greeks" were butchered by Goldman. The whole purpose of Goldman's innovative "revenue scheme" was to allow the Greek government to skirt the 3% fiscal deficit limit imposed by the EU on peripheral countries, in essence making Greece appear far stronger for years than it really was. It is this deceit that laid the seeds for the current Eurozone insolvency which requires a virtually daily bailout. Amusingly, yesterday we also learned that it was the US Federal Reserve which knew about this willfully fraudulent misrepresentation as long ago as March 2005, as disclosed in the most recent Fed minutes: "CHAIRMAN GREENSPAN. Can we borrow from the Greeks? [Laughter] MR. KOS. It’s interesting, since they are at about double the 3 percent limit. So the markets are not punishing anybody for not complying." Of course, nobody is laughing now that the markets are certainly punishing those for not complying with a vengeance. Had the Fed brought attention to this, the outcome for the now doomed Eurozone and the EUR would have been different. Now it's too late. And in this vein, on Friday it was once again Goldman which put the last nail in the coffin of the "Greeks" only this time not so much the insolvent nation, as the much-suffering letters α and β. The reason for this is that also on Friday, the WSJ ran a great article which basically blasted hedge fund groupthink, confirming that the only so-called strategies that work now are those that copycat the whale asset managers (courtesy of much delayed 13F/G filings). David Kostin, fearing that his groupthink-promoting authority is being challenged (not to mention his recent promotion to partner at Goldman), immediately came to the rescue of the hedge fund hotel habituals, in essence saying that beta is really alpha, and only fools don't do what the big boys are doing. In traditional Goldman fashion, ruin follows about 5 years later to all who follow the firm's advice (long after the commissions have been converted to gold stores in various non-extradition countries). This time we are confident the event horizon will be far shorter.

Nothing moves a subject forward like exploring open problems. Think of this as a first (actually second) entry in a collection of puzzles, hopefully added by more than just myself. In the tradition of the Scottish Book, each entry will include an attribution/dedication, a problem statement, data that provide some motivation, and associated hypotheses, and conjectures.

It appears that Irish savers are sufficiently smart to realize that their money is no longer safe in a banking system whose existence is now only backstopped merely from referendum to referendum. As it is very unclear what will happen to the IMF/ECB rescue mechanism once the Irish election is held in March, with a material possibility that the whole plan will be unwound, leaving the country's financial system in the wind, a behind the scenes bank run is accelerating. Incidentally while this was the topic of the December letter by Guggenheim's Scott Minerd, which we discussed in a post titled "Scott Minerd's Detailed Pre-Mortem On What Europe's Bank Run Will Look Like, And Other Observations", his just released January missive deals with precisely the same topic (see chart below). So faced with the prospect of accelerating deposit redemptions, what does the Irish Central Bank go ahead and do? According to the Independent it has gone ahead and proceeded with that traditional recourse to all regimes in the bring: print money. "The Irish Independent learnt last night that the Central Bank of Ireland is financing €51bn of an emergency loan programme by printing its own money." In other words, whereas Ben Bernanke may be 100% confident that US inflation courtesy of POMO and inflation printing will be absorbed by the "massive" excess slack in the economy (oddly enough it wasn't in Tunisia, as food prices hit records despite surging unemployment), we wonder if he feels the same way about other countries in the world, which are already part of a monetary union, yet which have decided to boost the "other assets" line in their balance sheets.

Two years ago when the US bailed out UBS and Switzerland from a brief but potentially terminal liquidity crisis, it succeeded in extracting a historic pound of flesh: it forced UBS to declassify thousands of bank accounts of US tax evaders which was the first nail in the centuries-old concept of Swiss bank secrecy. Today, Rudolf Elmer, a former COO of one of the biggest Swiss banks, Julius Baer, may have just nailed the last, and with that set off a chain reaction that will force a huge outcry against pervasive global tax fraud (but likely achieve nothing ultimatel). According to the Guardian, tomorrow Elmer will hand over details of 2,000 "high net worth individuals and corporations" to WikiLeaks which will make him "the most important and boldest whistleblower in Swiss banking history." And since among those exposed will be "approximately 40 politicians" expect all hell to break loose as photos of Assange having a underage orgy with Al Qaeda members are suddenly made public to diffuse what is bound to be another huge (if brief - after all human kind cannot bear very much reality).

When bipartisanship breaks out in Washington DC, check to make sure your wallet is still in your pocket. Every time you fill up your car this winter you are participating in the biggest taxpayer swindle in history. Forcing consumers to use domestically produced ethanol is one of the single biggest boondoggles ever committed by the corrupt brainless twits in Washington DC. Ethanol prices have soared 30% in the last year as the supplies of corn have plunged. Only a policy created in Washington DC could drive up the prices of gasoline and food, with the added benefits of costing the American taxpayer billions in tax subsidies and killing people in 3rd world countries.

We have a bone to pick with Goldman's John Noyce. Last week Goldman's (quite respected) strategist, when discussing his specialty, the EURUSD, said that "selling a bounce toward the middle of the consolidation at 1.3250 would seem attractive." Well, in typical Goldman fashion it didn't take his colleagues in the tactical division even one full week before pulling the rug from under all who listened to John, and putting out their own EURUSD target of 1.37. Either way, for those who enjoy decoding dodecatuple reverse psychology, here are John's latest charts that matter next week.

The WSJ has an adorable article titled "The Fed's Laugh Track" in which it has done a word search for "laughter" and come up with some amusing results. Of course it would be far funnier if the WSJ had an article disclosing all the conversation transcripts between Jon Hilsenrath and the various Fed's presidents and executives. We won't hold our breath on that on. We would, however, like to present one of tha laugh tracks that the WSJ conveniently decided to drop. Not surprisingly, the topic of that particular transcript disclosure is, well, gold.

If you still have any doubts of Fed's bias towards sustaining bubbles and being late on fighting inflation, the latest release of 2005 Fed meeting minutes should help you see it more clearly. There's some good humor and cynicism there, which certainly deserves respect. It's also obvious that many Fed officials and economists, including Greenspan and Geithner, had by 2005 at the latest realized the bubble in housing and the systemic risks posed by big banks (and Lehman and Bear Stearns in particular). Impressive foresight. But the good news stops there. Were the bubble and risks just a goddamned joke to them? They saw it quite well, made some smartass jokes and had some good laughs, and did NOTHING. When Bernanke said it takes 15 minutes to raise rates, he was being too modest. The final tally to vote on the decision, I'm sure, takes at most one minute. But this is an insult to the questioner and the audience, isn't it? The real question is how long it would take from rising inflation to them seeing it, then making the decision to act on it, then to inflation being tamed.

About the time that the Federal Reserve was created, H.G. Wells proposed a conspiracy theory.   It wasn’t a cabal of small and secretive group of people. His goal was to drive the progress of mankind:  the Open Conspiracy.  Anyone could join, in the words of Nancy Zimmerman, if they:

• Endorse the aim of the Open Conspiracy—the betterment of the human race.
• Strive to understand the world, to determine the institutions and practices that work and those that don't—what things contribute to human progress, and what things did not.
• Communicate what they learn to others.
• Listen to what others have to say independent of who they are:  “no one has a monopoly on truth or on insight, and good judgments can only be arrived at by close and open-minded scrutiny of evidence and opinions.”

The point of this Open Conspiracy is to understand and maybe domesticate risk; to turn the future into something we don’t fear.  The very attempt is itself the stuff that contests all the change and adversity that feed fear and insecurity. Even in an unpredictable, always morphing universe there is value in problem solving.  And one can find the human instinct for problem solving in virtually all institutions, even the dreaded credit default swap.

After a brief stint in the end of November dethroned Citi from the title of "most hated company" if not in the world then at least on the S&P, and replaced it with the traditional hedge fund long position offset, the SPY, December has seen a valiant rebound by Citi shorts, which successfully pushed Pandit's company back to the top. And with 355 million shares short, Citi is no danger of being overtaken any time soon by runner up, SPY. The surge in shorting also likely explains why the same company has, courtesy of various forced buy ins, once again pulled a March 2009, and soared on absolutely nothing, as a short covering spree has taken the name double digits higher in days. We would have hoped that realist speculators would know by now that any time there is a surge in the short interest, it is immediately reported by the exchanges and the brokers to the custodians who in turn enjoy institute HTB days, which just sometimes see pervasive forced buy ins to generate an industry wide short squeeze. Just like we have seen in financials in the past several weeks.