Reality

Perfectly summarizing the cognitive dissonance of the mainstream media (and their drone-like viewers), this duel of the Soft-Money-Honey Maria B and Hard-Money Golden Boy Peter Schiff was a tragic farce. Maria comes out swinging, "whether this is a manufactured market or not, you've got no alternative but stocks - where's my yield?" Schiff counters, "there are alternatives" - summarily scoffed at (a-la his housing appearances in 2006/7) by Maria - "we have a completely phoney economy driven 100% by cheap money; the minute you take it away, the whole thing implodes." And while the 'fight' moves on, we are left thinking they are in two different rings since whatever point is made by Schiff is summarily ignored for the status quo. "QE will be here until we have a USD crisis and the Fed can't get away with it anymore," Schiff reminds, adding, "There is no exit strategy... the Fed is bluffing; exit is impossible." The glancing blows continue deep into the late rounds. "The reality is we are living in a bubble; and all bubbles burst," (reminding us of Sam Zells' comments to the very same CNBC anchor a few weeks back), "it's unfortunate we didn't learn that lesson in 2008 but we're about to learn a much bigger lesson." Disingenuous laughter follows at Schiff's suggestion at holding Gold with Maria's anchoring bias loud-and-proud - "I'm looking for alternatives to stocks, and I can't find any."

For 727 editions, and nearly 30 years, Bill Buckler, the "captain" of the free market-praising Privateer newsletter provided a welcome escape from a world overrun with "free-lunch" economists, "for-hire" politicians, "crony-capitalist" oligarchs, "heroin-addict" bankers, "the-solution-to-record-debt-is-more-record-debt" Keynesians, and all those other subclasses of that species which Einstein, or whoever, described so aptly in saying that they all expect a different, and happy, outcome when applying the same flawed methods over and over. And for 30 years, Buckler's steadfast determination and adherence to his arguments, beliefs, reasoning and ironclad logic brought him countless followers, all of whom are now able to see past the bread and circus facade of a world every day on the edge of political and social collapse. Sadly, all good things come to an end, and so does The Privateer. We are delighted to celebrate its illustrious memory by presenting to our readers the final, must read, issue of the newsletter which encapsulates the philosophy and ideology of its author - a man much respected and admired in the free market circles - and thirty years of objective, unbiased market and economic commentary, best of all.

The world is awash in contradiction with stocks rising to new highs as interest rates reflect a slowing economy. It is an upside down world according to PIMCO's Mohamed El-Erian. As Lance Roberts annotates, the moustaced maestro explains individuals are both excited and anxious. They are excited by the rally in the markets as they see their portfolios increase in values but at the same timed overwhelmingly concerned about the economic future. It is a world with an enormous contrast between the markets and the real economy. That is the world we are navigating and it is incredibly unusual. This is why it is an unloved rally. His discussion at the recent Strategic Investment Conference is about a simple framework to reconcile these issues. The long term view matters greatly - but the short term matters also.

You know the market is frothy when the greatest concern among professional money managers is "Asset Bubbles." As interest rates rose in the early part of this year, the 'great rotation' - with outflows out of bonds and in to stocks - was heralded by many as ammo for the next leg higher in stocks; now over a quarter of investors - a share that rose 100% since BofAML's previous (March) survey - believe 'the great rotation' will never happen (only another 73% to get to reality). Instead, there are increasing concerns about inflows leading to bubbles – mainly in high yield, where investors appear uncomfortable with flows-driven spread tightening without fundamental improvement and higher interest rates (and implicitly the linkage between equity valuations and credit bodes ill for the latter, as opposed to supportive). In fact, asset bubbles now rank as the number one concern on investors’ minds, while a slow recovery moved up into second spot. So despite the best efforts of the 'marketing' arms of the big sell-side shops (so-called 'strategists'), the professional buy-side is not 'adding' at these highs, but becoming increasingly skeptical.

While Harvard historian Niall Ferguson's off-the-cuff remarks during the Q&A were in his words "as stupid as they were insensitive", the core message of his presentation was clear: the party of the last 20 years is now over and the longer we fail to address the real issues the bigger the hangover will be in the future. The central question Ferguson asks is whether our institutions, corporations and governments, are degenerating. As Lance Roberts of Street Talk Live notes Ferguson believes that without addressing the structural problems that plague the economy from production to employment – stimulus will fail. The reality is that the 'punch bowl' won't fix employment growth, economic growth or the rule of law.

“Labor market conditions are affected by a variety of factors outside a central bank’s control,” admitted the Fed's Jeffrey Lacker after the employment report bounced around the world.

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 world's central banks have printed unimaginable amounts of money in recent years - "these guys are really more powerful than the government." Neil Macdonald explores what this means for the global economy and for your financial well-being - "can you imagine if the American public knew there was this 'club' that met secretly in Switzerland and made decisions that dramatically affected their lives, but we're not going to tell you about it because it's too complicated." This brief documentary should open a few eyes to the reality behind the world's most powerful (and real) cabal.

With macro data becoming worse and worse (more and more bullish for Fed free money) and stocks off to the races (despite earnings that are abysmal), we thought a litle reminder of just what is driving this un-reality in nominal price moves. As the following chart, inspired by UBS, shows, each time the S&P 500 shows any sign of weakness, US money grows dramatically (money defined as the sum of M2 and foreign custody repo-able holdings at the Fed). Simply put, this is the reaction function of the Bernanke Put and explains why any weakness in Europe causes problems for the US - as the foreign banks repatriate and impact this 'growth' support. Correlation is not causation, but it is a strong hint.

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.”

While everyone's attention this morning will be focused on the sheer, seasonally-adjusted noise that is the monthly NFP report (keep in mind that any number +/- 200,000 of the actual, is entirely in the seasonal adjustments and is thus entirely in the eye of the Arima X 13 beholder), which is expected to print at 140,000, resulting in an unemployment rate of 7.6%, there were some events overnight worth noting. First, the China non-manufacturing PMI printed at 54.5 in April, down from 55.6, and tied with the lowest such print in two years. The biggest red flag was that New Orders dropped below 50, with the price index also declining sharply, indicating that either the Chinese slowdown is for real, and the national bank will have no choice but to ease unleashing inflation, or that the politburo wishes to telegraph to the world that China is slowing, because what goes on in China, and what data is released out of China are never the same thing. Elsewhere, in Europe Mario Draghi's henchmen were stuck in damage control mode, and Ewald Nowotny said markets over-interpreted a signal yesterday that the ECB would consider a deposit rate below zero. Policy makers have “no plan in this direction,” Nowotny said in an interview with CNBC today. This helped boost the EUR from its languishing levels in the mid 1.30s higher by some 50 pips following his statement.

Here is why for the 2013 edition of "attempt to decouple reality from stocks (and fail every time)", the global central banks realized that just the Fed (2011), and/or just the Fed and the ECB (2012) would not be enough. Thus, welcome Japan and your unsterilized $75 billion per month, and lots and lots of prayer that third time will be the charm to enable the "market" finally to break free from the tyrrany of evil fundamentals, macro factors and, generally, reality.

With any and every asset-gatherer capable of forming a sentence being trotted out on business media to proclaim victory and elucidate on why "there is no where else to invest but stocks" and "the US is the cleanest dirty shirt," we thought it might be useful to reflect on just how clean that shirt can remain as the rest of the world's growth slows down significantly. In the last decade, there has been particular growth in inter-regional trade, with a dramatic expansion in trade vis-à-vis Asia, reflecting globalization. At the same time, the deepening in global trade relationships means that the potential for a sudden shift in demand in one region can have a more significant impact on the rest of the world. This has been seen particularly in recent years, with the sharp retrenchment in domestic demand in southern Europe affecting the economy of Asia, particularly Japan. Looking at the rate of increase in regional imports (which we assume is what the 'heads' believe will power the US 'clean' shirt) and the picture is ugly. And while copper is enough of a tell for most, even the IMF (usually extraordinarily optimistic) sees World Trade slowing dramatically - and given these interconnections, perhaps being the cleanest shirt merely shows the stains even more clearly when they finally hit.