There have been a litany of articles written recently discussing how the stock market is set for a continued bull rally. There are some primary points that are common threads among each of these articles which are that interest rates are low, corporate profitability is high and the Fed's monetary programs continue to put a floor under stocks. The problem is that while we do not disagree with any of those points - they are all artificially influenced by outside factors. Interest rates are low because of the Federal Reserve's actions, corporate profitability is high due to accounting rule changes following the financial crisis and the Fed is pumping money directly into the stock market. Being bullish on the market in the short term is fine. The expansion of the Fed's balance sheet will continue to push stocks higher as long as no other crisis presents itself. However, the problem is that a crisis, which is always unexpected, inevitably will trigger a reversion back to the fundamentals.
So, apparently, according to Jon Hilsenrath, "QE to Infinity" is actually "finite" after all. There is no doubt that the Federal Reserve will do everything in its power to try and "talk" the markets down and "signal" policy changes well in advance of actual action. However, that is unlikely to matter. The problem with the financial markets today is the speed at which things occur. High frequency trading, algorithmic programs, program trading combined with market participant's "herd mentality" is not influenced by actions but rather by perception. As stated above, with margin debt at historically high levels when the "herd" begins to turn it will not be a slow and methodical process but rather a stampede with little regard to valuation or fundamental measures. The reality is that the stock market is extremely vulnerable to a sharp correction. Currently, complacency is near record levels and no one sees a severe market retracement as a possibility. The common belief is that there is "no bubble" in assets and the Federal Reserve has everything under control. Of course, that is what we heard at the peak of the markets in 2000 and 2008 just before the "race for the door." This time will be no different.
Put down the Sunday newspaper; grab a pot of coffee; and call 'mom' and tell her she has to read this. Doug Rudisch has written a far-reaching summary of the true state of the world and 'why policy has failed'. Simply put, there is no faith in the system; real underlying faith and trust in the system, as opposed to the confidence born from economic steroid injections or entitlements. There also is a subtle but important distinction between faith and trust versus confidence. Faith and trust are longer term and more powerful concepts.There is more going on than a temporary lull in animal spirits that current fiscal and monetary policy will cure. If that was the case, it would be working already... We have ended up with a system where the worst of the risk takers have the ability to take the most risk and are currently taking it at extreme levels. We wish we could be more prescriptive and offer more solutions for the problems. But in order to solve a problem, you must first realize you have one. With respect to the Fed, we don’t think the U.S. realizes it has a problem.
If the American people truly understood how the Federal Reserve system works and what it has done to us, they would be screaming for it to be abolished immediately. It is a system that was designed by international bankers for the benefit of international bankers, and it is systematically impoverishing the American people. The Federal Reserve system is the primary reason why our currency has declined in value by well over 95 percent and our national debt has gotten more than 5000 times larger over the past 100 years. The Fed creates our "booms" and our "busts", and they have done an absolutely miserable job of managing our economy. So why is the Federal Reserve doing it? Sadly, this is the way it works all over the globe today. In fact, all 187 nations that belong to the IMF have a central bank. But the truth is that there are much better alternatives.
One of the widely accepted misconceptions surrounding the so-called "housing recovery" fanfared by misleading headlines such as this "Remodeling activity keeps up positive momentum", which in reality has merely turned out to be a housing bubble in various liquified "flip that house" MSAs (offset by continuing deteriorating conditions in those places where the Fed's trillions in excess reserves have trouble reaching coupled with ongoing foreclosure stuffing), is that "renovation spending", the amount of cash spent to upgrade and update a fixer-upper, has surged. Sadly, this is merely the latest lie about the US economy: as the attached chart showing renovation spending in the past 6 months, it has absolutely imploded, confirming that not only is a broad housing recovery a myth (instead of localized pockets of bubbly liquidity here and there), but that the US home-owning household is now more tapped out than at any time in the past two years.
A. Gary Shilling's discussion of how to invest during a deleveraging cycle is a very necessary antidote to the ecstacy and euphoria that surrounds the nominal surges in risk-assets around the world sponsored by central banking largesse. Shilling ties six fundamental realities together: Private Sector Deleveraging And Government Policy Responses, Rising Protectionism, the Grand Disconnect Between Markets And Economy, a Zeal For Yield, the End Of Export Driven Economies, and why Equities Are Vulnerable. The risk on trade is alive and well - but will not last forever. We are still within a secular bear market that begin in 2000 with P/E ratios still contained within a declining trend. Despite media commentary to the contrary - this time is likely not different.
FX market overreacted yesterday to ECB developments. Europe has corrected it and now participants will take a fresh look after the US employment report.
The man who is the chief advisor to the US Treasury on its debt funding and issuance strategy was just promoted to the rank of second most important person at the biggest commercial bank in the US by assets (of which it was $2.5 trillion), and second biggest commercial bank in the world. And soon, Jamie willing, Matt is set for his final promotion, whereby he will run two very different enterprises: JPMorgan Chase and, by indirect implication, United States, Inc.
And that, ladies and gentlemen, is how you take over the world.
US commercial bank loans and leases flat since Lehman, and yet US GDP higher by $2 trillion since the biggest bankruptcy in history. How does one reconcile this monetary and growth quandary? Simple. Enter the Fed.
The week ahead brings key leading indicators of global activity. The flash PMI's in China and Euro area will be published on Tuesday. Bloomberg consensus expects the China flash to be slightly lower than the previous reading and that the Euro area flash releases for manufacturing and service activity will rise slightly. In addition, Korean 20-day export data for April will provide a good guide to both the external sector in Korea and the likely momentum of Asian exports more broadly. For the same reasons, Taiwan export orders are worth a look as well. The week ahead also provides Q1 GDP prints in US, UK, and Korea. Goldman expects US GDP to rise by 3.2%. The Australia CPI print may open the door to an RBA rate cut as soon as May and Japanese CPI is likely to underscore why the BoJ policy has shifted aggressively. Friday also brings an update of the BoJ's outlook, along with the next BoJ meeting (unchanged policy expected).
When the BOJ announced two weeks ago the full details of its expanded easing program, which amounts to monetizing a whopping $720 billion in government bonds over the next year (a move which makes even the Fed's own open-ended QE appear like child's play in perspective), one thing it did was lay to rest any hope of a rotation, great or non-great, out of bonds and into equities. The reason is simple: while the Fed is en route to monetize $1,080 billion in UST and MBS debt in the current year, when there is just $760 billion in net US issuance, what the BOJ has done is add a bid for another $720 billion when Japanese net supply of debt is just $320 billion in the next 12 months. In other words, between Japan and the US, there is now some $660 billion in secondary market debt that the two banks will have to purchase over and above what their respective treasury departments will issue.
Curious how Abenomics is progressing six months after its announcement? These charts courtesy of Diapason should provide a convenient status update.
Ever since Moody's head economist Mark Zandi, together with Princeton's Alan Blinder, authored a paper in July 2010 titled "How We Ended The Great Recession" (which incidentally is wrong on two key counts: i) it is a great depression not recession, and ii) it has not ended) it became clear that the Keynesian sycophant would not rest until he somehow found a way to penetrate deep inside one or more of the darkest administrative orifices of the Obama regime. Surely, Zandi must have been heartbroken when it was not him but Jack Lew picked to replace Tim Geithner - a post the Keynesian had a desperate craving for. Yet his recent appointment to head up the ADP "payroll" joint venture, which was nothing more than a test of his propaganda skills, should have given us advance notice something was cooking. Further notice should have emerged when the US Department of Injustice launched its rating agency witch-hunt campaign only against S&P, not Moody's, where the abovementioned Zandi still officially works. Last night all of this finally fell into place, when the WSJ reported that Zandi has emerged as the leading candidate to head the FHFA - the regulator in charge of the two zombiest of zombie US institutions: the still insolvent Fannie and Freddie, in the process kicking out current FHFA head Ed DeMarco who recently emerged as Obama's persona non grata number 1 for his stern refusal to espouse socialist practices and wholesale debt forgiveness and principal reduction.
Many have argued that sovereign CDS markets 'caused' the problems in Europe - as opposed to simply 'signaled' what was in fact being hidden by cash market manipulation. But as the IMF notes in a recent paper, there are times when the CDS market leads the cash bond market and other times when it lags. But as far as looking at risk in Europe and the US, based on a wonderful model that uses Markov-switching to predict what the probability of the world being in a low-risk or high-risk state, we are as 'low risk' as we have been since the crisis began. Each time that level of complacency was reached before, equity markets have rapidly sold off. What is perhaps most notable is the systemic compression of every risk indicator, first VIX (Kevin Henry and the fungible excess reserves of every prime dealer whale), then the liquid SovX index (via Greece CDS auction uncertainty and 'naked' short bans), then the Euro TED Spread (via LTRO), then individual Sovereign CDS (via Draghi's 'promise'). The result, the 'free-market' signal of risk is non-existent.
There is "not a chance," that the Fed will be able to unwind its balance sheet in an orderly manner, "because everybody is front-running [them]," as the Fed is creating "serial bubbles," that are increasingly hard to manage since "we're getting in deeper and deeper every time." David Stockman has been vociferously honest in the last few days and his Bloomberg Radio interview with Tom Keene was extremely so. While Keene tries his best to remain upbeat and his permabullish self, Stockman just keeps coming with body blow after body blow to the thesis that this 'recovery' is sustainable. "They are using a rosy scenario forecast for the next ten years that would make the rosy scenario of the 1981 Reagan administration look like an ugly duckling," he exclaims, adding that the Keynesian Krugmanites' confidence is "disingenuous" - "the elephant in the room - the Fed," that are for now enabling rates to stay where they are. The full transcript below provides much food for thought but he warns, if the Fed ever pulled back, even modestly, "there would be a tremendous panic sell off in the bond market because it is entirely propped up... It's to late to go cold turkey."