Archive - Jul 2013 - Story

Healthcare insurance illustrates how incremental increases can lead to systemic collapse.

The Innovator’s Dilemma strikes again, this time with the news that the city of Detroit has filed for bankruptcy protection.  As a business term, ConvergEx's Nick Colas reminds us that the “Dilemma” describes how successful companies fall from grace because they ignore new competition with disruptive technologies at the low end of their markets.  In a world that increasingly revolves around intellectual capital (a.k.a. people), government at all levels needs to think about how they do not fall prey to the same error.  As for Detroit, any lasting solution likely needs far more government intervention than is currently possible. And so to where Detroit goes from here, we’ll borrow from another business paradigm that parses all solutions to troubled operations into three buckets: "Fix, Close or Sell." In summary, Detroit’s failures are certainly of its own making. The way forward will need leadership that is unavailable locally.

Those trading microcap uranium supplier USEC Inc (USU) were treated to a rare spectacle moments ago: one or a series of absolutely berserk algos took the stock up from $8 to nearly $16 in a wondrous example of momentum ignition, where one algo was telegraphing it knew something in a bid to get other algos to ramp the thinly traded stock , and succeeded. This move followed Friday's comparable surge by 70% on even more "no news." A circuit breaker halt followed and then the usual $1 bid/ask spreads as algo after algo was positioning to frontrun other algos, but by then all hell had broken loose. Volume as of moments ago: over 2 million on a stock that has ADV of under 100k. Management reiterated what it said on Friday, namely that it had no comment: "In view of the unusual market activity in the company’s stock, the New York Stock Exchange has contacted the company in accordance with its usual practice. The company stated that its policy is not to comment on unusual market activity" ensuring that the newsfree lunacy would continue.

"It's hard to make the case that [US stocks are up 17% on a 2.5% earnings rise] based on fundamentals alone - it's money in motion," is how Barclays' CIO Hans Olsen describes the unreality occurring in US asset markets currently. He noted in last week's interview with CNBC that Bernanke's experimentation has created asset-inflation "that would make the stock market bubble of 2000 look like a day at the beach. It's really quite remarkable." Critically, as many have noted, he notes "let the market start to price things based on fundamentals again rather than money printing. The sooner we get back to a market pricing, the more sustainable it becomes." What is ironic is that Olsen is overweight stocks in spite of all this - but like everyone else in the status quo - is hoping Bernanke keeps the house of cards from collapsing. Olsen appears to be among the very few career bankers willing to tell the truth - the fear being, of course (as we showed here) that it would mean their "skills" are completely meaningless.

"Today’s markets have a vulnerability that has not existed through most of history. Today’s valuations only make sense in light of low expected cash rates. Remove that expectation, and pretty much every asset across the board is vulnerable to a fall in price, as the rising real discount rate plays no favorites. There is no asset class you can hold that would be expected to do well if the real discount rate rises from here. Under normal circumstances, a rising real discount rate would probably come on the back of rising inflation or stronger than expected growth, which are diversifiable risks in a portfolio. But May’s shock to the real discount rate came not because inflation was unexpectedly high or because growth will be so strong as to lift earnings expectations for equities and other owners of real assets, but because the Fed signaled that there was likely to be an end to financial repression in the next few years. And because financial repression has pushed up the prices of assets across the board and around the world, there is unlikely to be a safe harbor from the fallout, other than cash itself." - GMO

Without doubt, Iceland was the canary in the coalmine for the sovereign debt crisis that is unfolding across the world right now. Today, Iceland is held up as the model of recovery. 'Famous' economists like Paul Krugman praise the government for rapidly rebuilding the economy without having to resort to austerity. This morning’s headline from The Telegraph newspaper sums it up: “Iceland has taken its medicine and is off the critical list”. It turns out, most of these claims are dead wrong. Despite being so widely reported by the mainstream financial media, Iceland is not a story of model economic recovery. It’s a story of how to fool people. And for now, it’s working.

With gold now up an impressive 13.1% from its post-Bernanke lows 3 weeks ago (notably more than the +8.8% in US equities), it appears the physical demand is quietly catching up to the paper supply. As we noted here, shorts covered around 11% of their positions in the last week and we suspect today's surge is yet more covering as the massively over-crowded paper-short gold position starts to unwind. Of course, this surge is disappointing to many (including China we suspect) as the 'transitory' end of the price beatdown means we can buy less physical (and take immediate possession) now than at the June lows of $1180. With gold testing its 50DMA for the first time since February, we suspect the momo crowd will be quick to jump ship should we push on through.

Back in June 2011 we first reported how "Goldman, JP Morgan Have Now Become A Commodity Cartel As They Slowly Recreate De Beers' Diamond Monopoly" in an article that explained, with great detail, how Goldman et al engage in artificial commodity traffic bottlenecking (thanks to owning all the key choke points in the commodity logistics chain) in order to generate higher end prices, rental income and numerous additional top and bottom-line externalities and have become the defacto commodity warehouse monopolists. Specifically, we compared this activity to similar cartelling practices used by other vertically integrated commodity cartels such as De Beers: "the obvious purpose of "warehousing" is nothing short of artificially bottlenecking primary supply." Over the weekend, with a 25 month delay, the NYT "discovered" just this, reporting that the abovementioned practice was nothing but "pure gold" to the banks. It sure is, and will continue to be. And while we are happy that the mainstream media finally woke up to this practice which had been known to our readers for over two years, the question is why now? The answer is simple - tomorrow, July 23, the Senate Committee on Banking will hold a hearing titled "Should Banks Control Power Plants, Warehouses, And Oil Refiners."

While Egypt may have left the front pages of the mainstream media, the boiling pot of tension is bubbling up nce again this morning. Ahram Online reports that violent clashes have occurred between pro- and anti-morsi groups near Tahrir Square, and the military has intervened with tanks. These clashes come on the heels of the Muslim Brotherhood calling on Egyptians to lay seige to the US embassy (for what he said was American support for Morsi' ouster) "US Diplomats should leave Egypt... [we] hope they won't be harmed." and the family of the deposed leader claiming the military 'kidnapped' him.

The chart below lays out what lies in store (no pun intended) second half earnings as indicated by companies themselves.  What it shows is that optimism in corporate earnings (ignoring the persistent optimism in the economy which always without fail, leaves everyone disappointed despite the fifth ongoing year of QE) is once again misplaced and that EPS are set to disappoint, especially if the stock buyback wave - certainly not facilitated by the rise in interest rates - is finally over.

For the first time since November, PBOC data indicated banks, including the central bank itself, sold a net CNY41.2 billion in June. This compares with the huge average CNY315.2 billion in net purchases by banks during the first five months of 2013. While some claim this outflow as 'transitory' due to Bernanke's 'Taper' talk in June (that has been walked back since), as MNI reports, China's ongoing economic slowdown has market participants continuing to brace for a return to capital outflows. With reform plans critical to China's transition, this 'outflow' adds to the leadership's concerns especially in light of what very few have reported, as SocGen's Albert Edwards notes, the fact that China is on the verge of outright deflation (GDP deflator lowest in over 4 years) as China's over-investment comes home to roost.

Existing home sales dropped 1.2% month-over-month - the biggest drop in 2013 - against expectations for a 1.5% rise. Critically though, this is for a period that reflects closings with mortgage rates from the April/May period - before the spike in rates really accelerated. Inventory rose once again to 5.2 months of supply (vs 5.0 in May) and you know the realtors are starting to get concerned when even the ever-optimistic chief economist of the NAR is forced to admit that 'stunningly' "higher mortgage rates will bite." With mortage applications having collapsed since May, we can only imagine the state of home sales (especially as we see all-cash buyers falling) for July.

By now even the most confused establishment Keynesian economists agree that when it comes to economic "growth", what is really being measured are liabilities (i.e., credit) in the financial system. This is seen most vividly when comparing the near dollar-for-dollar match between US GDP, which stood at $16 trillion as of Q1 and total liabilities in the US financial system which were just over $15.5 trillion in the same period. What, however, few if any economists will analyze or admit, and neither will financial pundits, is the asset matching of these bank liabilities: after all since there is no loan demand (and creation) those trillions in deposits have to go somewhere - they "go" into Fed reserves (technically it is the reserves creating deposits but that is the topic of a different article). It is here that we can discern directly just what the contribution of the Fed to US GDP, or economic growth.

Two minutes of rational thinking in the world of irrational omnipotence in which we live. Howard Marks explains that we’re in a low return world. Refuse to recognize that and demand traditional returns, without recognizing that the market simply may not accommodate you, at your own risk - "The market is not an accommodating machine... it will not 'give' you consistently high returns. Blindly accepting more risk to get the returns you 'expect' or 'deserve' is a big mistake."

In Portugal, it seems the compromise deal between the ruling party and its junior partner is back on track following the failure of all-party talks last week. As Citi notes, PM Coelho is on the wires saying he will once again reshuffle his cabinet, with Paulo Portas likely to become deputy PM in charge of negotiating with the Troika. Portas has made it clear he wants to discuss a softening of the terms of the country’s bailout program which obviously will make for a bumpy road ahead in terms of relations with the Troika, but is probably necessary if the ruling coalition is to hold on to power amid growing popular unrest. While debt restructuring remains a tough proposition (given the contagion and precedent - Portugal debt-to-GDP is lower than Italy's for instance), the likelihood of a further substantial bailout (up to EUR76bn) remains high.