Albert Einstein, a man who knew a thing or two about celestial mechanics, supposedly once called compound interest "the most powerful force in the universe." While the remark was likely meant to be funny (astrophysicists can be hilarious), it sheds light on the often overlooked fact that small changes, over time, can yield enormous results. The same phenomenon may be at work in our economy. A minor, but persistent under-bias in the inflation gauge used in the Gross Domestic Product (GDP) may have created a wildly distorted picture of our economic health. So the next time you see a GDP report remind yourself that the "deflator" should really be called the "distractor." It's there to distract you from the truth.
The surge in Spanish (in fact broadly European) equity and bond markets of the last few weeks has been suspiciously one-way and based (seemingly) on the hopes-and-dreams of the world's liquidity-based marginal investor finding another new normal momentum 'clean shirt' to pile into. However, despite the uptick in some data in Europe, the structural problems remain entirely unfixed and nowhere is that more evident than in the chart below. As European stock and bond markets suffer their worst 2 days in 2 months, Spanish bad loans (after a very brief pause in the exponential surge that also provided hope that the worst was over) have re-surged to a new all-time record high. At 11.61% of total lending, bad loans are now at their highest since records began in 1962.
The yield on 10 year U.S. Treasuries is skyrocketing, the Dow has been down for 5 days in a row and troubling economic news is pouring in from all over the planet. The much anticipated "financial correction" is rapidly approaching, and investors are starting to race for the exits. We have not seen so many financial trouble signs all come together at one time like this since just prior to the last major financial crisis. It is almost as if a "perfect storm" is brewing, and a lot of the "smart money" has already gotten out of stocks and bonds. Of course a lot of people believe that we will never see another major financial crisis like we experienced in 2008 ever again. A lot of people think that this type of "doom and gloom" talk is foolish. It is those kinds of people that did not see the last financial crash coming and that are choosing not to prepare for the next one even though the warning signs are exceedingly clear. The following are 18 signs that global financial markets are heading for a vicious circle...
There was a time when those who defaulted on their debt, especially mortgages, had to wait 3-5 years before they became eligible for any form of new credit, let alone a brand new mortgage. That, however, was in the Old Normal. In the New one things are different: so different, that for anyone who filed a bankruptcy on or before July 2012, we have good news for you - the FHA (subject to an explanation and several almost painless conditions) will be happy to provide you with a brand new mortgage.
The Twentieth century may be remembered as the century of excess. In every area, more things were done in the Twentieth century than in any other century in history, and in many cases, more than in all previous centuries combined. The Twentieth century saw some of the most destructive wars in history, the development of the Atomic Bomb, the beginning of air and space travel, the colonization and decolonization of the Third World, the rise and fall of Communism, dramatic improvements in the standard of living, the population explosion, the rise of the computer, incredible advances in science and medicine, and hundreds of historically unprecedented changes. The Twentieth century also produced more inflation than any other century in history.
While we have commented previously on the impact that dismal earnings-growth relative to magnificent multiple-expansion has had on the rise in nominal prices for US equities; the following two charts, perhaps better than any others, should leave more than a few investors asking "are stocks cheap?" The last 2 years have seen the largest increase in forward-P/Es since the dot-com bubble (and that ended well).
The current belief is that rising interest rates are a sign that the economy is improving as activity is pushing borrowing rates higher. In turn, as investors, this bodes well for corporate profitability which supports the current valuations of stocks in the market. While this seems completely logical the question is whether, or not, this is really the case? Increases in interest rates slow economic activity, with a lag effect, which negatively impacts earnings, margins and forward guidance. Ultimately, and it may take several quarters to manifest itself fully, the fundamental deterioration leads to a reversion in stock market prices which, ironically, will then lead to the next decline in rates.
Equity, bond, and FX markets appeared to go into hibernation once Europe closed as ranges (and volume) were very low for most of the day. Stocks opened modestly green, snapped lower (on what seems to be an avalanche of 'erroneous' options trades from Goldman which were later DK'ed) then lifted (most notably the Dow - which dipped below 15,000) up to yesterday's highs until Europe closed. Sectors moved in a highly correlated manner along the same path but once 1130ET hit, the S&P 500 traded in 3-4pt range for the rest of the day. Treasuries were similar though they rallied notably during the European day session (as EU sold off) then flat-lined in 1bps range for the rest of the day. Of course, all that changed in the final minutes of the day as all the major indices came under pressure (with Trannies and Nasdaq leading), VIX reversed higher, and the Dow closed red!
This morning's debacle in the options pit appears - just as we noted - to be due to Goldman Sachs 'erroneous' trades:
- *GOLDMAN MAY LOSE AS MUCH AS $100M ON ERRONEOUS TRADES: FT
But, as we also noted earlier, unlike Knight (which was wiped out when its market-making algos went rogue), in Goldman's case:
- *GOLDMAN SAYS 'WORKING WITH EXCHANGES' TO RESOLVE OPTIONS ISSUE
They get everything DK'ed...
During the NBC Nightly News segment last week about one of the unintended consequences of the Affordable Care Act (ACA), Lisa Myers reported speaking with "almost 20 small businesses and other entities around the country" and that "almost all said that because of the new law, they’d be cutting back hours for some employees." But the Obama administration doesn’t see why there’s such a fuss. According to Myers: The White House dismisses these examples as “anecdotal.” The president’s top economic advisor [CEA Chair Jason Furman] told us “he sees no systematic evidence the health care law is having an adverse impact on the number of hours employees are working.” So, should we take our government’s word and dismiss the examples as anecdotal?
Germany's Angela Merkel visited the German concentration camp in Dachau - the first such visit by a sitting German Chancellor- where one may say, she could have picked her words a tad more wisely:
- MERKEL SAYS NATIONS SHARING A CURRENCY WILL NEVER GO TO WAR
- MERKEL SAYS 'WORTH IT' TO FIGHT FOR UNITED EUROPE
US civil war counterfactual aside, the stunned European population was confused by the implication of her words: is it that Germany will keep ploughing German funds to keep a pacifist, socialist dream alive (which is really just a front to keep Deutsche Bank and its $50+ trillion in derivatives solvent) even as hours ago her own Finance Minister admitted that a third (and certainly not last) bailout of Greece is now just a matter of time... or was it simply a warning to Greece, Cyprus and anyone else contemplating a true recovery, one which begins with their own currency, and maybe with a few Panzers crossing the border?
Just when one though the bad news out of Fukushima would trickle down, no pun intended, if only because purely statistically it was improbable that any more bad news would leak out, here comes TEPCO which at a press conference this morning announced that "roughly 300 tonnes of radioactive water has seeped from a storage tank, marking the worst leak in more than 2½ years of efforts to contain the effects of the March 2011 earthquake and tsunami." In other words, not only is the irradiated coolant water overflowing the storage tanks, it is also leaking straight into the environment, including the surrounding soil, ocean and who knows where else.
The Brent-WTI spread has been generally quiet between $2 and $4 for the last month or so (after its dramatic collapse back to $0 mid July). However, as soon as European markets closed today, it appears someone was decidedly negative on WTI Crude as it accelerated lower from over $107 to under $105 - all the while Brent crude pushed higher. This squeezed the Brent-WTI spread up over 100% on the day to $5.50, retracing more than half the plunge from the FOMC/Taper talk highs around $10 in early June.
It appears the market may need to resurrect the implode-o-meter as surging mortgage rates and plunging mortgage applications are (unsurprisingly) taking their toll on the mis-allocated surge in mortgage lenders that 'market' signals encouraged. The latest, as Boston.com reports, is 1-800-East-West Mortgage which has largely suspended operations and laid off its workforce. "As rates rose, a number of people just went to the sidelines," the CEO said. The market, he added, "went into a drought." And yet, homebuilders (again unsurprisingly) remain as 'hopeful' as they have been since 2005 that all will be well.
Here we go again.