It is cloudy out there as Sandy enters the mid-Atlantic region, although for all the pre-apocalypse preparations in New York, the Frankenstorm may just be yet another dud now that its landfall is expected to come sufficiently south of NYC to make the latest round of Zone 1 evacuations about overblown as last year's Irene hysteria (of course it will be a gift from god for each and every S&P company as it will provide a perfect excuse for everyone to miss revenues and earnings in Q4). That said, Wall Street is effectively closed today for carbon-based lifeforms if not for electron ones, and a quick look at the futures bottom line, which will be open until 9:15 am Eastern, shows a lot of red, with ES down nearly 10 ticks (Shanghai down again as the same old realization seeps day after day - no major easing from the PBOC means Bernanke and company is on their own) as the Friday overnight summary is back on again: Johnny 5 must defend 1400 in ES and 1.2900 in EURUSD at all costs for just two more hours.
There is down-sizing; there is trimming-the-fat; and then there is UBS. The once-giant Swiss Bank just announced it will cut up to 10,000 jobs. This comes on top of the 3,500 from last year - which makes a rather dramatic weight-loss strategy for the 63,500 employee firm. As the FT reports, they will not happen all at once (so just after the election then?) but will lead to the closure of a sizable part of UBS' fixed-income trading operations (and other capital intensive areas of the investment bank). Perhaps in the understatement of the day: "There were several options on the table but UBS has decided on the most radical one," a person familiar commented as the plan is hoped to reduce complexity and costs - so no more Bloomberg Terminals? One thing surely gone is a source of fixed income axes: "The new strategy, hammered out in several executive board meetings in New York this week and set to be announced next Tuesday, will lead to the closure of a sizeable part of UBS’s fixed-income trading operations and other capital-intensive areas of the investment bank." The winner: Goldman of course, which in a world of collapsing trading revenues has taken to Lehmaning its competition once again, only this time not using brute force but the far more classical war of attrition in a collapsing economy.
There is an interesting dynamic unfolding in the housing market. Real estate agents in places like California are arguing that there is a lack of inventory and are also generally against the government unloading blocks of properties to big investors. Why? There has been bulk selling and buying to the investor class and a large amount of crowding out has occurred. This brings about an interesting set of problems for your average buyer in the current market. They are competing with swaths of big investors but also local flippers trying to make a quick buck once again courtesy of low interest rates and another mania in some markets. SoCal is now in a mania again as you will see with some of the patterns occurring. This is also happening in many other states as well. A new feudal system has emerged. The banks were bailed out by the Fed, were allowed to circumvent accounting standards, and now deep pocket investors in the financial class are buying up these places either to increase prices on flips or to hike up rents. In the end, if you want to compete in today’s market you need to bow down to the Fed, put on a football helmet and go head-to-head with big investors, flippers, suckers, and take on a massive mortgage.
That's another $190.1 Bn available to spend on IPad Minis and IPhone 5s in the Appleconomy!
So now that Vikram Pandit has exited stage right from the CEO position at Citigroup, a number of people have asked me about the Zombie Dance Queen.
"We have just spent 15 years learning that a policy of creating asset bubbles is a bad idea, so it is hard to imagine why the Fed wants to create another one. But perhaps the more basic question is: How fruitful is the wealth effect? Is the additional spending that these volatile paper profits are intended to induce overwhelmed by the lost consumption of the many savers who are deprived of steady, recurring interest income? We have asked several well-known economists who publicly support the Fed’s policy and found that they don’t have good answers. If Chairman Bernanke is setting distant and hard-to-achieve benchmarks for when he would reverse course, it is possibly because he understands that it may never come to that. Sooner or later, we will enter another recession. It could come from normal cyclicality, or it could come from an exogenous shock. Either way, when it comes, it is very likely we will enter it prior to the Fed having ‘normalized’ monetary policy, and we’ll have a large fiscal deficit to boot. What tools will the Fed and the Congress have at that point? If the Fed is willing to deploy this new set of desperate measures in these frustrating, but non-desperate times, what will it do then? We don’t know, but a large allocation to gold still seems like a very good idea."
It seems engines are revving and it may be time to go forward to the past. Earlier this month, a large and well respected asset manager that has begun taking positions in gold expressions issued a report in which it began to justify gold’s relative value. One metric it used was comparing the quantity of currency in the world to the quantity of gold. The report concluded that using this metric, the relative value of gold would be about $2,500/ounce, a significant premium to its current spot price. The analysis posited gold’s value upon a return to the gold standard, posing the question: “what if the entire world’s gold were used to back the global supply of fiat currency?” We agree with the logic of dividing base money by gold holdings to find gold’s “intrinsic value” (as per Bretton Woods and our Shadow Gold Price), but we believe the reasonable value upon conversion to a gold standard would be many multiples higher than $2,500/ounce.
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.
Nearly two years ago, and progressing to this day, we first observed (and subsequently even the mainstream media caught on) that America's labor force is slowly but surely converting itself from a full-time to part-time worker society. The reasons for this are obvious: to corporations, the benefits associated with employing part-time workers are countless: avoiding substantial benefits-related costs, evading long-term job contracts, hourly basis wages, and many others. In fact, as long as there is slack in the economy, and there will be for a long, long time as the shift in labor demand is now secular, regardless of what the Fed wants to admit, employers will have ever more leverage, while workers have less and less (and are forced to agree to any employment terms, as long as they get some paycheck at all). This much has been known. What has gotten far less prominence is that of the much trumpeted 4+ million jobs added since the trough in late 2009, virtually all the job additions have gone to (part-time) workers 55 years and over. Indeed, as the chart below shows, starting since the official NBER end of the recession in June 2009, the US has cumulatively added 2.9 million jobs. However, when broken down by age cohort, 3.5 million of these jobs have gone to US workers aged between 55 and 69. Another 729K have gone to recent college grads aged 20-24. What about those workers in their prime years: between 25 and 54 years of age? They have lost a total of 886,000 jobs since June 30, 2009!
Each and every day, a veritable smorgasbord of CEOs are trotted out before our very eyes to spew forth their company's vision and how it's all looking so rosy. Of course we hang on every word as gospel and react accordingly. Similarly, a rise in consumer sentiment is more ammunition for bulls to argue that animal spirits are here and we can go back to the old re-leveraging ways of spending-more-than-we-have (or ever will have). There's only one problem - when push comes to shove and real capital has to be put to work, its not happening! Expectations for capital expenditure (investment in growth and maintenance) has plunged in the last few months, while at the same time, consumer sentiment has surged (no doubt led by an ebullient equity market and inherent recency bias). As we wrote previously, in an environment of soaring liquidity and free money, the hurdle rate on new investments collapses, as does the requirement to invest in CapEx, both growth and maintenance. In fact, as we have shown over the past year, the age of the global asset base has hit a record high across the world, both in the developed and developing countries, leading to record low return on assets on record low assets (and record debt encumbrance, but that's a different story). And since companies are forced to dividend cash to shareholders at a record pace (in lieu of fixed income in a ZIRP environment), there is less and less cash left to support CapEx spending (or hiring!).
No surprise Europe remains highly vulnerable to sudden sentiment shifts. How to stablise it? The usual smoke & mirrors are conveying what might or might not be good news on Greece [since denied]. The crisis in Europe may be contained, but it clearly isn't solved. "Europe is like an overweight dinosaur on a crash diet, that's got really really bad toothache with not a dentist in sight." But But But.. yesterday's ructions weren't just about the political shenanigans that pass for markets these days. There are deep undercurrents roiling these placid markets. All of which leads us to wondering what happens next? If this continues what hope for next year? Low low yields and global economic depression? Boy scout time...
Debt. There isn't a day that passes as of late that the issue of debt doesn't arise. Federal debt and consumer debt (including mortgages) are of the most concern due to its impact on the domestic economy. Debt is, by its very nature, a cancer on economic growth. As debt levels rise it consumes more capital by diverting it from productive investments into debt service. As debt levels spread through the system it consumes greater amounts of capital until it eventually kills the host. The problem is that during a “balance sheet” recession the consumer is forced to pay off debt which detracts from their ability to consume. This is the one facet that Keynesian economics doesn’t factor in. It’s time for our leaders to wake up and smell the burning of the dollar – we are at war with ourselves and the games being played out by Washington to maintain the status quo is slowing creating the next crisis that won’t be fixed with monetary bailout.
Or to put in another way, by Christmas we may very well see Case-Shiller and other indicators of home prices headed back down, erasing the gains made in housing during 1H 2012.
Government programs created in the 1960s created a culture of dependency, government control, relentlessly higher debt, materialism, and willful ignorance. The incompetence, arrogance, ineptitude and insanity of government officials at the Federal, State, and Local level are stunning to behold. We need to ask ourselves whether we the people are getting better government service and efficiency today; with government spending at 35% to 40% of GDP, than we did in the 1950’s and early 1960’s when government spending was 20% to 25% of GDP. We doubt that most people are getting 60% more value from our benevolent government today than they did in the 1950’s. By encouraging dependency and reliance upon the all-powerful government, the motivation to educate yourself, get married before having children, work hard, and pull yourself out of poverty is diminished. Can a small minority of critical thinking citizens lead a revolution that topples the existing social order and restores the Republic to its founding principles of liberty, self-responsibility, civic duty, and mutual obligation to future generations?