Archive - Oct 2012 - Story

FBI arrests police officer yesterday in conspiracy to kidnap, cook, and eat women. #nyc

— FBI New York (@NewYorkFBI) October 25, 2012

Europe is closing on a decidedly negative tone led by weakness in Spain specifically. EURUSD in 80 pips off its earlier highs (under 1.2950) as Spain's 10Y spreads rises once again (now up 33bps in thelast few days) and its stock index (IBEX) is down 4.25% since last Thursday (as is Italy's FTSEMIB). The front-end of the Spanish yield curve is also leaking higher in yield rather quickly as fast money exits. Credit markets tracked stocks but were less volatile on the day. Europe's VIX dropped modestly which combined with credit and equity weakness suggests perhaps hedges being lifted and real-money unwinds. The Draghi-rally trend is now over - as S&P futures test the Dream lows (with European stocks still outperforming US post-Draghi).

ConvergEx's Nick Colas dusts off a golden oldie of stock market valuation – the "Rule of 20." The basics of this heuristic are simple: the addition of the U.S. equity market’s price/earnings ratio and the current inflation rate as measured by the Consumer Price Index should trend around 20.  If the current inflation rate is 2%, for example, then stocks should trade to an 18x current multiple.  That may sound too simplistic, but since 1914 the average of this summation is 19.3 – pretty close to the catchier “20.” But, as Nick explains, what the “Rule of 20” handily captures is the essential relationship between corporate earnings (a.k.a. cash flows) and discount rates (primarily driven by marginal inflationary expectations.) Here is where the current “Rule of 20” math takes a surprising turn.  With CPI inflation at 2%, the market should be trading for 18x current earnings.  We, like Nick, see the reasons for this shortfall: either the market is worried that corporate earnings are about to tumble or inflation is much more of a threat than a Fed-supported yield curve currently indicates.  Or… gulp… both.

While there is little news aside from a modestly disappointing pending home sales print, risk assets in general are bleeding quite notably. USD is strengthening and Treasuries are rallying as commodities slide and stocks tumble. The chatter is a rumor that Fitch is about to downgrade the US below AAA. We find this highly suspect as there would be hell to pay for doing this two weeks before an election (and Fitch themselves have said that there would be no downgrade until 2013 at the earliest). Of course, this is merely the market gurus attempting to come up with a narrative to explain yet another intraday sell-off, which is now coming with dangerous regularity for the bulls.

Go to any university, any center of equities trade, any meeting place for financial academia, any fiscal think tank, and they will tell you without the slightest hint of doubt in their eyes that the U.S. economy is essential to the survival of the world.  To even broach the possibility that the U.S. could be dropped or replaced as the central pillar of trade on the planet is greeted with sneers and even anger.  But let’s set aside what we think (or what we assume) we know about the American financial juggernaut and consider the sordid history of the money powerhouse myth. China’s incredible gold buying extravaganzas over the past few years indicate that they are indeed hedging against what they obviously expect will be devaluation in the dollar or multiple currencies around the world including the dollar.

Whether it's deleveraging, spare capacity, dollar debasement, productivity gains, or just plain old obesity, in real purchasing power terms, an hour of your time has never been worth less. In the 40 years since Nixon's 1971 fiat-fiasco, the value of the average hourly earnings for US citizens has dropped 90% in terms of Gold. The last time that our labor's efforts garnered such a low value saw a twenty year credit-blown releveraging (from 1980 to 2001) to save-us-all; we suspect that debt saturation will limit the ability of any central bank to create such a 'recovery' in labor-value once again. Since the peak in 2001, 60 minutes of your valuable time has lost 81% of its purchasing power! Is this what globalization looks like?

The fast-approaching US presidential election is perhaps one of the most important in recent history, with Goldman noting that the fate of near-term US economic growth, medium-term US fiscal stability (and, with it, the US sovereign debt rating) and monetary policy hinging on the outcome. In an effort to provide as succinct a view of these potential events, we present a four-part series previewing the big day. Below, we lay out the key dates and likely paths to resolution of the "fiscal cliff"; the most important and most imminent challenge that the elected candidate will be forced to face just after the election.

There are two countries that are going to give you a whopper of a headache in the coming months. We are leaving Greece to the side for a moment because that country could provide a heart attack and necessitate bypass surgery as the Troika fiddles while Athens burns. We are just waiting to see what is agreed to for Greece and then how the citizens of that country respond but the home of Democracy is not the only place that could ratchet out of control; keep your eyes on Spain and France. Yes, France, while no one has paid particular attention to the antics in Paris and Monsieur Hollande scurries about siding with the troubled nations and advocating a 75% tax burden and leaving Berlin to wallow in schemes of their own making; they are on the verge of getting in real trouble. Furthermore, they say that beauty is in the eye of the beholder, and in my eyes, the finances of Spain are one ugly mess of spoiled tapas. We recall Prime Minister Rajoy’s “A great victory for Europe speech” and we state that the last time Europe had such a victory it was at Waterloo!

When we reported on the surge in last week's initial claims from 342K to 388K, we made one simple forecast: "Remember: this number will be revised to 391K next week." We were off: it was revised to 392K. In other words, the data charlatainism at the DOL continues unabated. And of course, today's Initial Claims number which magically "beat" expectations by 1K, printing at 369K, on expectations of 370K, will be revised to a miss of 372K next week. The BLS has become a total farce. In other manipulated news, the BLS reported the culprit for last week's surge in Claims: it was California, which saw a +26,935 jump in initial claims, due to "Layoffs across all sectors, with the largest share from the service industry." This somehow is supposed to offset the -4,979 claims drop from the week before, when all those plunges and jumps in claims took place. Elsewhere, the number of Americans on extended claims and EUCs dropped to 2.1 million, down 1.4 million from a year earlier.

There were moments yesterday when it felt we stood at the edge of the abyss preparing to take a giant leap forwards. Apparently Draghi did a great job meeting German legislators yesterday; Greece is being touted as a crisis averted - if you believe all the guff; and more of the same from Spain. However, it does feel the crisis is developing in some new directions. Until recently it’s been about sovereigns and banks – but now we’re seeing corporates struggle. There is a general consensus France had no choice but the bailout Peugeot’s finance arm PSA. So why are the problems of the French car industry so important for the Euro? If French industrial policy is founded on preserving the country’s manufacturing base is that really something German/Finish/Dutch taxpayers could have been bailing out through a single European banking union. Perhaps not! These are national choices that illustrate sovereign self interest not European hegemony. We simply ask the question how is Europe supposed to move towards closer Union when national interest remains paramount?

Bloomberg reports that Chinese silver demand is set to climb nearly 10% next year as investors look to preserve their wealth. Although China as the 2nd largest world economy may be in an economic slump, investors are seeking out silver as a value alternative investment.  Silver climbed 15% this year and ETF’s holding silver have gained 6.5%. Research from Beijing Antaike said that 33% of the country’s demand comes from jewellery and coins, the rest for use in photography, solar panels electrical appliances.  “Many producers and investors have hoarded the precious metal in the form of ingots or unwrought silver.” After the US Fed’s QE1, (December 2008-March 2010) silver rocketed 53%, almost twice the jump as gold, and for QE2, (ending June 2011) silver rose 24%. Morgan Stanley predicts that silver will again return more than gold after QE3 was announced this September. Chinese national statistics show that jewellery sales rose 19.3% for the first eight months compared to last year.  “I’m bullish on silver, so I personally have stockpiled 3 tons of it at home,” Yang Guohui, president at Hunan Yishui Rare & Precious Metals Recycling Co., said in Xiamen on Oct. 17. Yishui is based in Yongxing County, Hunan province, where about 20 percent of China’s silver is from, according to Huang Xiaoming, head of the local precious metals management bureau.

Heading into the North American open, equities in Europe are seen higher, supported by financials and basic material stocks. With banks benefiting from improved credit spreads in Europe, while reports from the Chinese industry ministry saying that China’s industrial output may be faster in Q4 than in Q3 underpinned the strength by basic material sector. In terms of EU related commentary, the Spanish treasury chief has said that Spain is almost fully funded until year end and can start funding itself for 2013 adding that the ECB has already been very explicit about details of a potential bond-buying plan for Spain. He added that Spain's central government funding program for 2013 will also cover regions' financial needs. In turn, spreads tightened, with SP/GE below the 400bps level, with cash inflows via looming redemption/coupon payments also weighing on German Bunds. However the focus has been on the latest UK GDP print, which came in much higher than the median estimate and also above the upper est. GBP/USD continued to advance, with EUR/GBP on path to make a test on 0.8000 to the downside. Going forward, the second half of the session sees the release of the latest weekly jobs and durables reports.

• Japan grapples with own fiscal cliff (Bloomberg)
• Japan Protests After Four Chinese Vessels Enter Disputed Waters (Bloomberg)
• Asian Stocks Rise as Exporters Gain on China, U.S. Data (Bloomberg)
• An obsolete Hilsenrath speaks: Fed Keeps Rates Low, Says Growth Is Moderate (WSJ)
• ECB Said to Push Spain’s Bankia to Swap Junior Debt for Shares (Bloomberg)
• Spain’s Bad Bank Seen as Too Big to Work (Bloomberg)
• China postpones Japan anniversary events (China Daily)
• Carney Says Rate Increase ‘Less Imminent’ on Economy Risk (Bloomberg)
• Credit Suisse to Cut More Costs as Quarterly Profit Falls (Bloomberg)
• Obama offers a glimpse of his second-term priorities (Reuters)
• Draghi defends bond-buying programme (FT)

The last few years have been a wild ride in the world's equity markets. None wilder than the US equity markets. The only fly in the ointment is that we've seen this kind of 'wild ride' before, the kind of unbridled nothing-can-stop-us-now, its-all-priced-in, Central-Bank-sponsored rallies that have been the bread-and-butter of every BTFD'er since March 2009. Presented with little comment - this time it's different, we really hope...