From Mark Grant, author of Out of the box and Onto Wall Street
Edging Down The Holmesian Path; Painful Revelations
"I consider that a man's brain originally is like a little empty attic, and you have to stock it with such furniture as you choose. A fool takes in all the lumber of every sort that he comes across, so that the knowledge which might be useful to him gets crowded out, or at best is jumbled up with a lot of other things, so that he has a difficulty in laying his hands upon it. Now the skillful workman is very careful indeed as to what he takes into his brain-attic. He will have nothing but the tools which may help him in doing his work, but of these he has a large assortment, and all in the most perfect order. It is a mistake to think that that little room has elastic walls and can distend to any extent. Depend upon it - there comes a time when for every addition of knowledge you forget something that you knew before. It is of the highest importance, therefore, not to have useless facts elbowing out the useful ones."
-Sherlock Homes, A Study in Scarlet
The way the news is often presented and then digested can be mis-leading. Some event is announced and then there is the commentary on that event and it is burned into your mind as a singular and separate occurrence. This is not the correct way to envision the world. What is critically important is to consider each event as appended and tied to all other notable events so that put together; they may be considered as a whole. This is the correct methodology for astute comprehension and then for making informed decisions. I point out this rather banal fact this morning because many do not do it well so I bring it to your attention.
This all can be exemplified by what occurred last Friday. We got the jobs report which came in somewhere between bad and really bad and a surprise to virtually everyone because the deterioration in employment was forecast by no one. You can blame the weather and goblins in the Labor Department but the slowdown in the creation of jobs was noticeable. Then there was a second announcement having to do with credit creation that was far less than prognosticated by anyone. Here we have two clear signals of a slowing economy which then gets appended to the Fed shutting off new monetization which will surely bite in the months ahead as the 7 trillion supplied by the Fed, the ECB and other of the world’s central banks is drying up. As a totality then; one can envision the upcoming landscape.
Treasuries will move based upon the degree of the slowdown and the severity of the recession and its consequences in Europe. Equities have and will continue to go down and perhaps severally down as the obvious implications are calculated and acted upon. Risk assets, credit assets will widen to Treasuries as forward earnings decline in valuation and as Risk overtakes Greed as the markets’ driving force. With the Fed shutting off monetary easing and the ECB still keeping their pipeline open the Euro will decline against the Dollar in a marked fashion. A currency has no Real Value except the cost of the paper and, whether green or blue, the value is never Real but just Relative and Intrinsic so that the currency with their central bank still printing always declines against the ones that have stopped. Of all of these announcements the Fed’s is the most important one because we have been living off of Quantitative Easing for the last four years and the stoppage will have magnified effects on all manner of economic announcements in the months ahead and they will all have negative consequences so that profits should be taken and moves should be made into assets that step up or float with Inflation or even have a fixed coupon now and float later because those that remain with nothing but bullets will lose their profits and those in equities will follow the same path. You do not have to even consider Europe to reach this conclusion and when Europe is thrown into the mix then the odds for deterioration increase dramatically.
Europe
“So now, as an infallible way of making little ease great ease, I began to contract a quantity of debt.”
-Charles Dickens, Great Expectations
You can visualize a chart and note the increase in the borrowing of the Italian and Spanish banks at the ECB but then you must apply the methodology of Holmesian thinking to arrive at the appropriate conclusions. For Italy it is up 776% from a year ago at $354 billion which is an all-time high. For Spain it is up to $200 billion and also a record. For these two countries it is now 14% of all ECB lending and a clear indication of the deterioration in their economies as exemplified by these kinds of increases. Do not stop here however but keep going!
Since the Italian and Spanish banks are pledging collateral for their loans to the ECB and that collateral is no longer on their balance sheets while the loans are included on the liability side of their ledgers we are going to see some very impaired financials for the banks of these two countries in the upcoming months and then downgrades from the ratings agencies as investors flee the landscape in both equities and debt. Then as Spain cannot finance Spain nor can Italy finance Italy any longer you will see the sovereign credits back-up sharply in yield as the LTRO funds run dry which is already occurring. Paying off debt with new debt and printing money to do this has consequences and further increases will not just create zombie banks but banks that are identified as bankrupt and unable to pay their debts so that counterparty risk and flights of capital will force their capitulation in the end. It is quite possible now that there will be a run on the Italian and Spanish banks at some point as Fear caused by these balance sheets infects the market.
Now let us take another step down the Holmesian path. As the economies in Italy and Spain deteriorate who will be seriously affected: Germany. Two of their largest buyers of their goods and services will radically cut back on their purchases and the German economy, for the first time in this cycle, will suffer as buyers are no longer able to afford various services. The circle always completes and the consequences will not be pleasant; this circle, in fact, will resemble a noose that is pulled tighter and tighter with each passing quarter and the pay master for the European Union will shrink as their economy, currently at the $3.2 trillion mark, sinks back towards $2.5 trillion during the next year. There will be screams of anguish aplenty and you might begin now to make the necessary adjustments to this coming reality. Then as Italy and Spain soon line up at the till you will see the Real Hurt being on which is why Europe is begging the IMF, the G-20, China and Japan for funds because they now have the burning smell in their nostrils of damaged flesh that has been singed and is about to be cooked and served up fresh in the begging bowls of those urchins turned out into the street.
“Then a dog began to howl somewhere in a farmhouse far down the road, a long, agonized wailing, as if from fear. The sound was taken up by another dog, and then another and another, till, borne on the wind which now sighed softly through the Pass, a wild howling began, which seemed to come from all over the country, as far as the imagination could grasp it through the gloom of the night.”
-Bram Stoker, Dracula