Archive - Jul 2013 - Story

"At all times, ultimate collateral and ultimate money remain crucial reference points in modern financial markets, but the actual instruments are important only in times of crisis when promises to pay are cashed rather than offset with other promises to pay.... Our world is organized as a network of promises to buy in the event that someone else doesn’t buy. The key reason is that in today’s world so many promised payments lie in the distant future, or in another currency. As a consequence, mere guarantee of eventual par payment at maturity doesn’t do much good. On any given day, only a very small fraction of outstanding primary debt is coming due, and in a crisis the need for current cash can easily exceed it. In such a circumstance, the only way to get cash is to sell an asset, or to use the asset as collateral for borrowing."

Excessive monetary stimulus and low interest rates create financial bubbles. This is the biggest debt bubble in history. It is a potent deflationary force and central banks are forced into deploying increasingly aggressive (offsetting) inflationary forces. The avoidance of a typical deflationary resolution to this economic long (Kondratieff) wave is pushing the existing monetary system beyond the point of no return. The purchasing power of the developed world’s currencies will have to bear the brunt of the “adjustment”. Preparations for this by the BRICS nations, led by China, are advancing rapidly. The end game is an inflationary/currency crisis, dislocation across credit and derivative markets, and the transition to a new monetary system. A new “basket” currency is likely to replace the dollar as the world’s reserve currency. The “Inflationary Deflation” paradox refers to the coming rise in the price of almost everything in conventional money and simultaneous fall in terms of gold.

It is nearly impossible to convince people that an economic ending is likely, perhaps inevitable. It is beyond anything they have seen or can imagine. We attribute that to a normalcy bias, an inherent weakness of experiential learners. For many, accepting something that has not occurred during their time on the planet is not possible. The laws of economics and mathematics may shape history but they are not controlled by history. The form of cataclysm and its timing is indeterminable. Political decisions continue to shape both. The madmen who are responsible for the coming disaster continue to behave as if they can manage to avoid it. Violating Einstein’s definition of insanity, they continue to apply the same poison that caused the problem. These fools believe they can manage complexities they do not understand. We are bigger fools for providing them the authority to indulge their hubris and wreak such damage. The political class in America, either via misguided economic policies or a deliberate attempt to hide the true condition of the country, has put us here. They will continue to employ whatever policies they believe will keep things going for a while longer. The tragic ending has been cast. Economics cannot trump mathematics.

Positive demographic cycles have been one of the key components in the strong growth trends for a number of Asian countries. As Morgan Stanley note in their most recent 'China Deleveraging' discussion, the decline in the ratio of the non-working (elderly and children) to working-age (15-64 years) population has coincided with periods of economic boom for various countries in Asia in the past 50 years. But... as Nomura's Richard Koo notes - having experienced the very same unstoppable shift in Japan - "demographics will cease to be a positive for China’s economic growth and start to have a negative impact." Fundamentally, Koo adds, this means "the nation will grow old before it grows rich." Demographics, capital accumulation and productivity are the three most important drivers of potential growth, and these three factors are intertwined to a certain extent. China has already entered its first stage of demographic challenge, with its GDP growth slowing on the back of all three contributors of growth. Given the lessons of Japan and the Asian Tigers, China is set to suffer notably from this demographic drag - and its entirely foreseeable.

Bored with the constant daily speculation about who may be the Fed's next head (short answer: whoever Goldman says), and more interested with the actual liquidity dynamics that the next Chairman (or Bernanke, as his departure is far from certain) will have to deal with? Here is the latest.

The storm that caused chaos across financial markets since May should not dissipate any time soon. As such, we retain a short bias towards China and an outright short in EM currencies. If world trade remains weak and local inflation keeps on gaining momentum, the currencies of several EM countries (ex-China) may remain under pressure. Such weakness may be exacerbated by tightening liquidity.

Nearly a month after the Egyptian military coup (that wasn't a coup according to the US), the celebrations over the democratic overthrow of the Muslim Brotherhood's president Morsi (according to John Kerry) continue with hundreds of protesters killed and injured in the latest overnight violent breakout. The reports are obviously conflicting with the Muslim Brotherhood claiming 120 were killed in violent protests with police near Rabaa Al-Adawiya Mosque, describing events as a "massacre", alternatively the government's Ministry of Health says only 38 dead arrived at hospitals so far. The tragic deaths were a logical outcome of protests which according to the head of Egypt's Central Statistics Bureau General Abu Bahar Jundi, saw as many as 35 million people taking to the streets Friday on both sides of the ideological divide. Egyptian army officials put the number at around 30 million.

Given more than his normal 30-second soundbite on mainstream media, Marc Faber is able to discuss in considerably more detail his views on the massive growth in global financialization (when compared to real economies) noting that "one day, this financial bubble will have to adjust on the downside." This will occur via either an inflationary burst or a collapse of the system. Simply put, "it's gonna end one day," either through war or financial collapse, "it will be very painful." The Gloom, Boom, and Doom Report editor notes current asset valuations are driven by excess credit creation, printing money, and distorted market signals, and the unintended consequences of the effect on investor psychology are perfectly mis-timed. Faber concludes with a discussion of the inflationary impact of US monetary policy and where it is seen (and not seen) and the global social unrest implications of middle class discontent.

How does one destroy an idea? Further, how does one destroy the truth? Corrupt governments have been struggling with this dilemma since men wore loincloths and worshiped fire. Fortunately for those of us in the “lower strata” of social organization, honorable ideas and indelible truths have a life of their own. Even when a culture as a whole remains oblivious and unguarded, the facts tend to rise to the surface one way or another. The reality which elitists at least partly understand, is that the truth cannot be destroyed, but it can be forgotten, at least for a time. This is a never-ending process...

It's been an odd earnings season so far. Talking heads are replete with examples of ad hoc names that have exceeded beaten-down earnings expectations choosing to ignore the belwether names that have missed and guided down. Data are thrown around left and right to support the argument that stocks are cheap to forward-earnings, that growth is around the corner, and that all is well in the real economy supporting the lofty exuberance among US equity markets. However, if one so chooses, the chart below should give you a glimpse behind the facade of the Q2 2013 EPS 'beat'. There is one source of the elixir of life, one provider of the mother's milk of stocks; S&P aggregate Q2 EPS is tracking $0.38 above the season start levels (around 0.8% beat) and financials account for an astounding $0.63 of that!

While the choking pollution in China, that we have discussed time and again - most recently here and here, has previously been linked with health concerns, academic studies released this week have now shown a direct link between higher cancer-rates in Central China and the level of pollution. The study published on June 25th is the first to scientifically prove the correlation between water pollution and cancer mortality in an area of China that is home to more than 160 million people. Despite government efforts to clean the water, it remains well below safety standards but local villagers continue to have no choice but to use it: "The river was black, poisonous fumes, and dead fish everywhere... the well water was also contaminated.. and during this period many died of cancer." Despite spending millions to try and prevent pollution, as one local villager exclaimed "we should re-consider the country's industrialization." What cost a 7% GDP growth print?

If our leaders could have recognized the signs ahead of time, do you think that they could have prevented the financial crisis of 2008?  That is a very timely question, because so many of the warning signs that we saw just before and during the last financial crisis are popping up again.  Many of the things that are happening right now in the stock market, the bond market, the real estate market and in the overall economic data are eerily similar to what we witnessed back in 2008 and 2009. It is almost as if we are being forced to watch some kind of a perverse replay of previous events, only this time our economy and our financial system are much weaker than they were the last time around. We have been living so far above our means for so long that most of us actually think that our current economic situation is "normal."

When is the last time you got a stock tip from a cab driver or chatty not-in-the-business neighbor?  It’s probably been the better part of a decade, if not longer.  Yes, that’s probably the most bullish argument for owning stocks just now, but, as ConvergEx's Nick Colas notes, it also raises a question.  What investments are retail investors considering, exactly?  Various online tools and resources provide some answers.  From Yahoo! Finance’s analysis of number of requested price quotes last week: AAPL, BAC, TSLA, INTC and CALL.  From Google Trends: AAPL, GOOG, and YHOO.  And from one very popular online brokerage for today’s volume: AAPL, F, BRCM, BAC, and NUGT.  Whether this interest indicates a top or a crowded momentum trade is in the eye of the beholder, of course.  But in a light volume period like summer, Nick notes, tracking individual investor attention can be an important piece of the day-to-day trading puzzle.

When Standard & Poors is not engaged in "Puffery" (a defense which admits "our entire business model is worthless") it pretends to analyze credits and assign ratings, usually with both humorous and systematically catastrophic results. Just as it has done in the chart below. In the aftermath of the Detroit filing, one may be interested to see just how the rating agency, which had Greece rated at "A" months before the Eurozone's bananaest-republic member had its first bailout, evaluated America's various states since the start of the 21st century through 2012. Among the best: Florida. Worst: California. Michigan, whose main city just went bankrupt: AA-. And with countless cross-default provisions and collateral waterfalls upon a multi-notch downgrade, one can be certain that as reality finally comes to the muni space with roughly a 3 years delay, that this too will have a happy ending.

The optimism over the housing recovery has gotten well ahead of the underlying fundamentals.  While the belief was that the Government, and Fed's, interventions would ignite the housing market creating an self-perpetuating recovery in the economy - it did not turn out that way.  Instead it led to a speculative rush into buying rental properties creating a temporary, and artificial, inventory suppression.  The risks to the housing story remains high due to the impact of higher taxes, stagnant wage growth, re-defaults of the 6-million modifications and workouts and a slowdown of speculative investment due to reduced profit margins.  While there are many hopes pinned on the housing recovery as a "driver" of economic growth in 2013 and beyond - the data suggests that it might be quite a bit of wishful thinking.