Gross Domestic Product

Financial markets operate on a number of implied assumptions about growth, policy direction and other factors. Experience tells us that these assumptions often turn out to be erroneous. A modern economy is an incredibly complex entity that involves millions of transactions every day. The notion that this vast and largely self-governing system can be controlled through tools such as government spending and/or an increase in the quantity of money is - to say the least - bizarre. A flood is rarely a cure-all solution to a drought; it just creates new problems for an already suffering population. From 2002 to 2007, we witnessed a massive attempt by central banks to manipulate interest rates and currency exchange rates. The consequences of this action came due in 2008-2009. Criminal psychologists have long known that villains frequently return to the scene of their crime—in the case of western policymakers, they seem to be looking to finish off a caper that went badly wrong at the first attempt. The end result for the broader community is unlikely to be pretty.

Across the five valuation methodologies that Goldman's David Kostin uses to consider the S&P 500's richness, the current price (around 1600) represents the average. While the Fed Model (bond vs stock value) is the one significant 'framework' suggesting upside potential but as Kostin notes, it is bonds that are more mispriced than stocks and the gap could close from bond side (significantly reducing the upside potential of this model). His macro-valuation framework, as well as the ROE vs P/B relationship and the Discounted Dividend Model all suggest year-end 2013 fair value at around the current price (i.e. 0% upside). And remember, as we noted recently, this 'expectation' still relies on the H2 2013 rebound in GDP and implicitly EPS (+28% in Q4 2013!) that is so hoped for.

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.

The biggest problem with the financial system is that of bad measurement. Without accurate data, no analyst can make sound investment judgments. Unfortunately for all of us, the data is gimmicked to the point that nothing is valid any longer.

Jeff Gundlach has been asked "Why Own Bonds?" twice in his career. The first time was in the 90’s when bonds and stocks were highly correlated. If stocks rose, bond prices fell, and vice versa. Therefore, investment managers decided that they should only own stocks as there was no advantage in being diversified. Unfortunately, we all know how well this turned out. Today, investment managers are making the same decision but for a different reason. With the Fed’s artificial suppression of interest rates to historic lows; the return from owning bonds has become painful particularly for underfunded pension funds. That pain, combined with the inflation of asset prices via continuing QE programs, has forced managers into overweighting stocks. The other reason that managers are jumping into stocks is due to the belief that interest rates are going to start rising on “Tuesday.” Gundlach clarifies, “Let me be clear. This is absolutely wrong. Yields are NOT going to rise any time soon.”

Nomura's Richard Koo destroys the backbone of the modern central bankers only tool in the tool-box in his latest paper. "As more and more people began to realize that increases in monetary base via QE during balance sheet recessions do not mean equivalent increases in money supply, the hype over QEs in the FX market is likely to calm down ...The only way quantitative easing can have a positive impact on economic activity is if the authorities’ purchase of assets from the private sector boosts asset prices, making people feel wealthier and thereby encouraging them to consume more. This is the wealth effect, often referred to by the Fed chairman Bernanke as the portfolio rebalancing effect, but even he has acknowledged that it has a very limitmed impact... In a sense, quantitative easing is meant to benefit the wealthy. After all, it can contribute to GDP only by making those with assets feel wealthier and encouraging them to consume more."

The middle class is being absolutely eviscerated, and poverty is soaring to unprecedented heights.  The fact that 90 percent of the population is constantly sliding downhill is not good for our society.  The United States is supposed to be a land of opportunity with a vibrant free market system that enables average people to make better lives for themselves. Unfortunately, free enterprise is being strangled to death in the United States today.  Entrepreneurs and small business are being pounded into oblivion by rules, regulations, red tape and oppressive levels of taxation. Our founding fathers warned that we should not allow such large concentrations of wealth and power, because they tend to funnel the rewards of society into the hands of a select few. The following are 22 facts that prove that the bottom 90 percent of America is systematically getting poorer...

There is not one single example in history in which QE has successfully created jobs. The UK has engaged in QE equal to over 20% of its GDP and hasn’t seen a real recovery in employment. Similarly, Japan has employed QE equal to nearly 25% of its GDP and GDP growth continues to slow while unemployment stays elevated.

By now everyone, even CNBC, admits that the only reason stocks are where they are is due to the G-7 central banks. What many may not know, however, is how we got here, and where we will be at the end of this year. The answer, as provided by JPM Asset Management CIO Michael Cembalest in the chart below, is at the dot in the top right. This will represent the addition of $10 trillion in liquidity, or alternatively the conversion of the "planetary nebula" of central bank balance sheet expansion, in the past seven years. And considering that, as we explained yesterday, there is another $10-11 trillion in scarce "quality collateral" that has to be injected into the financial markets via central banks collateral transformations, the number in yet another 7 years will be at $20 trillion if not exponentially higher, or higher than where US GDP will be.

With the ECB's rate cut decision already wreaking havoc on logic and common sense everywhere, pushing the EUR much higher, and the USd and JPY lower, one can't wait just what non-standard measures Mario Draghi will come up with next to send the EUR to record highs, providing a boon to German IMports. Wait, but the GDP calculation said that net imports are... oh, nevermind. Perhaps Not so super Mario will announce a free Forex trading account for every unemployed European, with half functionality allowing only purchases of EUR, not sales. Look for that, and for further confirmaion from the former Goldmanite that the bailout mechanism at the heart of Europe's "sustainability", the OMT, still does not exist and never will, as it is simply impossible to actually agree on a legal term sheet which will govern it.

• *DRAGHI: CREDIT CONDITIONS FOR SMALL, MEDIUM-SIZED FIRMS TIGHT
• *DRAGHI SAYS ESSENTIAL TO REDUCE FRAGMENTATION FOR TRANSMISSION

...  Until His Iron Deficiency Goes Away

With last night's China PMI disappointing expectations and eking out a just-expansionary miasma of hope for the growth enthusiasts, the very real question of global growth sustainability (while not on US equity market participants' minds) is coming to the fore. As Michael Pettis notes, Martin Wolf's recent perspective that it may be useful to think about Japan as a model for understanding the adjustment process in China since the Japanese model shows how risky it is to shift to a slow-growth model. While expectations for a 'relatively moderate' slowdown are common (at rates considered rapid for most economies); Pettis asks rhetorically, if part of the explanation for China’s spectacular growth of the past three decades has to do with the positive feedback loops that are so typical of developing countries with fragile and unsophisticated financial systems, then a moderate slowdown in growth may be an impossible target to achieve. Once growth starts to slow, the self-reinforcing impact on urbanization, on credit growth, on financial distress, and on expectations may force growth rates to drop far more sharply than any 'plausible' analysis would suggest.

A major issue in America today is the growing gap between the rich and the poor, and the popular narrative is that the disparity is caused by capitalism run wild and only the firm hand of government can fix the problem. But what if this narrative has it backwards? What if the growing wealth disparity in America is actually caused by the government? Take Warren Buffet, a man often at the center of this debate, as not only is he a billionaire, but also a vocal advocate for higher income taxes on the rich. Many are aware of his acumen in making investments that have a “margin of safety” – or minimal downside – but few are aware of the greatest source of such safety for Mr. Buffet in recent years, the US Government.

Lamborghini sales hit the highest level in 14 years, Ferrari sales jumped 40% for the first quarter, luxury retailers forecast fat profits....

While some might scoff, there appears little the European leaders will not swoop to when it comes to papering over cracks and changing rules, we suspect that when they find out that by the mere waive of the May Day holiday they could increase output across the euro area (the majority of which is on holiday today) by an impressive $22.9 billion. Germany and France alone lose $11 billion of output for this holiday, according to Bloomberg Briefs. So is the next 'growth-and-austerity' plan to ban public holidays and boost GDP...