Reality

The political left misunderstands the causes of income inequality —confused by the belief that government can somehow challenge the corporate and financial power it created in the first place — and thus proposes politically unrealistic (non-) solutions, particularly campaign finance reform, and raising taxes on the rich and corporations. Yes, the left are well-intentioned. Yes, they identify many of the right problems.  But how can government effectively regulate or challenge the power of the financial sector, megabanks and large corporations, when government is almost invariably composed of the favourite sons of those organisations? How can anyone seriously expect a beneficiary of the oligopolies — whether it’s Obama, McCain, Romney, Bush, Gore, Kerry, or any of the establishment Washingtonian crowd — to not favour their donors, and their personal and familial interests? How can we not expect them to favour the system that they emerged through, and which favoured them?  In reality, the system of corporatism that created the income inequality will inevitably degenerate of its own accord. The only question is when…

While one can talk until one is blue in the face about the pros and cons of the current central bank's (mis)deeds over the past 7 years, the reality is that most people are backward-looking (i.e., economists), not forward (which of course explains the prevalence of speculation as to whether the Fed's exponentially rising balance sheet will result in hyperdeflation or hyperinflation). As such, one can, for now at least, judge the Fed merely in the context of what it has achieved to date, not by the seeds of destruction it has planted. So how has Ben Bernanke performed so far when compared to his previous 4 predecessors, at least based on those two now completely irrelevant, but still oddly believed mandates: inflation and unemployment (because by now we all know that even the Chairman himself admitted the only thing that matters to the Fed is the Russell 2000 closing value). Below we present the Fed's accomplishments in the arena of inflation and jobs in the context of the past 60 years split by Chairmen starting with Martin (remember the 1951 Accord?), then going to Burns/Miller, Volcker, Greenspan and finally Bernanke. So who has been the fabbest among the Fed-est? You decide.

Over the past month, the world has finally awakened to the reality that when it comes to easing, there is more than just one central bank (i.e., the Fed). in fact, as we have been showing since early this year, the bulk of the easing over the past 5 months has happened elsewhere, primarily in Europe with LTRO 1+2, and subsequently at the BOE, and more recently at India and Brazil. Yet some holdouts still remain. One of these naturally is China, which everyone would love to see cut RRR or even the benchmark rate, yet which as recent CPI data has shown still has lingering packets of inflation precisely where it hurts: food (and of course recall China's Schrodinger economy). Which leaves Japan, which already eased more a few months back when it expanded its LSAP program... but it is never enough. Needless to say strategists, in their quest to shake any and every central banker here or there for some free money, have been seeing imminent BOJ easing in the form of yet another Y5 trillion LSAP any second now. Yet it is one thing for bankers to do what they are programmed to do, which is demand more free money, it is something very different when politicians step in and defuse the myth that any central bank is even remotely independent, especially when reelection is at stake. As Bloomberg points out this morning, the fight for the BOJ's "independent" balance sheet is starting to get lethal.

What do you get for $50 billion? Happy Talk...

Keeping it simple, Europe was a sloppy mess today. In an almost perfect copy of last week's sovereign, corporate, and financial credit market movements, today saw all of these assets plunge back near post-Non-Farm-Payroll lows. Equity markets, which had miraculously managed to regain those pre-NFP levels this morning after the Spanish auction knee-jerk, rapidly retraced and aside from some stick-save efforts from US markets and Lagarde, keeps the chaos-ball rolling with yet another multiple-sigma flip-flop. Ugly all around as it seems the reality check we discussed on the Spanish auction overnight was better received than the spin the Euro-Elite tried to put on it as we reinforce our view of the instability as the LTRO Stigma widens further to post LTRO1 wides as 10Y Spain approaches 6% yield and 425bps spread and Italian CDS over 440bps as 10Y yields break back above 5.5%.

Continuing today's disappointing data releases, we now get the Philly Fed, Existing home sales (aka the NAR's monthly advertising update), and Eurozone confidence. Sure enough, all missed, since we are now in NEW QE prep mode.

• Philly Fed: 8.5, missed expectations of 12.0, and lower than the previous print of 12.5 (source)
  • New Orders down from 3.3, to 2.7
  • Prices Paid spike from 18.7 to 22.5,
  • but, just to add confusion to injury following the much weaker claims data, the Employment index rose from 6.8 to 17.9
• Existing home sales, reported by the inherently conflicted NAR, missed, dropping from 4.61MM to 4.48MM, a data set which we caution readers is about 0.0% accurate and valid.
  • Total housing inventory at the end of February rose 4.3 percent to 2.43 million existing homes available for sale, which represents a 6.4-month
  • The national median existing-home price for all housing types was $156,600 in February, up 0.3 percent from February 2011.
  • All-cash sales rose to 33 percent of transactions in February from 31 percent in January; they were 33 percent in February 2011
  • Single-family home sales declined 1.0 percent to a seasonally adjusted annual rate of 4.06 million in February from 4.10 million in January
• Finally, Eurozone consumer confidence also missed sliding to -19.8, on expectation of an improvement to -19.0 from -19.1

Judging by the kneejerk reaction lower, the misses were not big enough to send the market soaring.

There are those who thought last week's massive Initial claims miss was the last one. They were wrong. Instead of printing at the expected 370K, an improvement from last week's already big miss of 380K, this week came at a whopping 386K, the worst standalone print in 4 months. Well, until last week's revision that is: instead of the 380K print that stunned everyone, last week's number has now been revised to a massive 388K. Why? So that mainstream media can declare, with a straight face, that this week saw the number of initial claims decline! Here is the reality: last week's expectation was for a print of 355K. Instead we got a number of 380K. Now this number is being revised to 388K, and is the biggest initial expectation to revision miss since early 2011. Needless to say, this means two things: 1) the transitory bump associated with record warm weather, which was nothing but pulling from the future, is now over, and 2) the April NFP print will be another disaster, which is just as the Fed wants it -  after all it is time to start setting the stage for the NEW QE (and certainly not QE3 which is already in place as Jeff Gundlach was so kind to explain) now that Obama is the margin hiker in chief.

Presented with little comment, except to note that as of a few minutes ago European equities were still at pre-NFP levels while credit was trading dramatically wider. In the last few minutes, equities are starting to catch up to that semblance of reality in a replay of last week.

In the past 30 minutes, Europe has turned downright ugly, with short-term Bunds soaring to a record 140.64, and weakness creeping across the peripherals, as the realization that not only was the Spanish bond auction unsustainable, but also a French downgrade rumor once again making its way (the source of this is a Citi note by Michael Saunders who said that it is likely that Moody's will follow S&P, and put the French Aaa rating on review for possible downgrade by the autumn, after the country's supplementary budget is formalized). The result is a sudden and swift slide in the EURUSD to 1.3070 or the LOD. Here are some of the other recent surprising developments in the aftermath of what the propaganda machine wants to spin as a "successful" Spanish bond auction.

Bank of America reported results earlier, which were somewhat amusing: reported earnings were $653 million or $0.03 per share. Yet the number that the market is fascinated by is the one arising from "negative valuation adjustments" of $4.8 billion, which included $1.5 billion in DVA "resulting from the narrowing of the company's credit spread", and resulted in a $0.28 per share addition. This is the same number that we were told to ignore when it did not help the bottom line. We will be told to ignore it again next quarter when spreads once again balloon, but for now it leads the market to see a $0.31 adjusted EPS number. In other words, one time items are to be ignored when negative, and praised when providing a "one-time benefit." These also included $0.8 billion in litigation expenses, which are also supposed to be excluded, even though the bank has now been sued by virtually everyone due to its Countrywide legacy portfolio. Yet all of this is accountant fudge heaven: there are only three things that matter. 1) The approaching refi cliff, in terms of tens of billions in maturities, including FDIC-funded TLGP, which are as follows: "$34B of parent company maturities in 2Q12 including the remaining $24B related to the Temporary Liquidity Guarantee Program" 2) sliding sales and trading revenues which dropped from Q1 by $546 million from a year ago to $2.844 billion in FICC, and by $332 million in Equity income to $907 million; and finally 3) and reserve release gimmicks: specifically BAC took a $1.6 billion reserve release even as the net chargeoff percentage increased. Specifically look at the first chart below showing the $1.8 billion surge surge in junior-lien Non-Performing Home Equity Loans due to regulations finally catching up to reality. Also, the bank charged off more in Reps and Warranties than it reserved, even as everyone is now suing the bank for precisely this issue. And this is the environment in which the firm books profits from reserve releases?

This strange event happened this past Tuesday in the COMEX New York markets but I didn't have time to post it until now. Not much to add here in the commentary that the pictures don't say themselves, except that market prices of two different assets do not plunge in tandem by 1.2% within a matter of half-an-hour or so at precisely the same time and then gain everything back in the next two hours if their prices are set by free and fair markets.

"You apparently can survive betting against bull market irrationality if you meet three conditions. First, you must allow a generous Ben Graham-like “margin of safety” and wait for a real outlier before you make a big bet. Second, you must try to stay reasonably diversified. Third, you must never use leverage."...It is the classic failing of value managers (and poker players for that matter) to get impatient and bet too hard too soon. In addition, GMO was not always optimally diversified. We are generally more cautious (or, if you prefer, “more experienced”) now than in 1998 with respect to, for example, both patience and diversification, and at least we in asset allocation always stayed away from leverage. The U.S. growth and technology bubble of 2000 was by far the biggest market  outlier event in U.S. market history; we had previously survived the 65 P/E market in Japan, which was perhaps the greatest outlier in all important equity markets anywhere and at any time. These were the most stringent tests for managers, and we were 2 to 3 years early in our calls in both cases. Yet we survived, although not without some battle scars, with the great help that we did, in the end, win these bets and by a lot. Hypothetically, resisting the temptation to invest too soon in 1931 may have been a tougher test of survival in bucking the market. Luckily we, and all value managers, were not around to be tempted by that one.

Post-illusion choices. 

It appears that after months of abuse for their water-is-wet economic insights, the San Francisco Fed may have stumbled on to the cold harsh reality that this post-great-recession world finds itself in. The crux of the matter, that will come as no surprise to any of our readers, is credit and "its central role to understanding the business cycle". Oscar Jorda then concludes, in a refreshingly honest and shocking manner that "Any forecast that assumes the recovery from the Great Recession will resemble previous post-World War II recoveries runs the risk of overstating future economic growth, lending activity, interest rates, investment, and inflation." His analysis, which Minsky-ites (and Reinhart and Rogoff) will appreciate - and perhaps our neo-classical brethren will embrace - is that the Great Recession upended the paradigm that modern macro-economic models omitted banks and finance and this time it really is different in that the 'achilles heel' of economic modeling - credit - cannot be considered a secondary effect. His analysis points to considerably slower GDP growth and lower inflation expectations as he compares the current 'recovery' to post-WWII recoveries across 14 advanced economies - a sad picture is painted as he notes "Today employment is about 10% and investment 30% below where they were on average at similar points after other postwar recessions."

The Centre for European Policy Studies published their own findings this week and they estimate that the Real Estate accumulated overhang is actually almost $500 billion which equates to 59% of the IMF revised projections for Spain’s GDP. The EU and the ECB may not mandate that the Spanish banks have to mark-to-market in the normal fashion but a quick calculation indicates that the equity of the major Spanish banks is well into the red and past the blood line of any sustainable position. In my opinion, I would state, that the Spanish banks are in fact bankrupt and are only still alive given the financial shenanigans of how Europe allows the numbers to be calculated. I am well aware that many in Europe do not like to be confronted with the truth and that the stock market in the United States is so myopic that they wish to ignore the truth but the numbers are right in front of your nose if you care to look and reality has a funny way of catching up with the markets and reminding them one still equals one in the end. I am an adherent of the Greater Fool Theory and the trick is to let the other guy be the Greater Fool and not one of us. The “when” is unknowable but the “if” is behind us now and I suggest great caution.