Monday, January 28, 2013

Today's links

1---Pending Home Sales index declines in December, calculated risk

2---Are Main Street investors warming up to stocks?, USA Today

The Wilshire 5000, the broadest measure of the U.S. stock market, on Thursday crossed over its all-time high of 15,813.52, meaning that the nearly $11 trillion in stock market wealth lost in the bear market has now been restored.....
Optimism is rising. Bullishness reading of 52.3% the week ended Jan. 23 was the highest in two years, says American Association of Individual Investors.

3---The Coming Oil War ... Against al-Qaeda, oilprice.com

The International News Safety Institute said it was alerted by "credible sources'" that terrorist groups may be planning attacks on oil fields in Libya. The warning said it considered Benghazi a likely target given the large number of oil fields in the western port city. INSI's advisory came as the U.S. and British government issued similar warning for citizens remaining in Libya.

4--Capitulation Everywhere, John Hussman Funds

What we actually observed prior to QEternity was a market decline of just 8%, and a subsequent recovery that has now run about 11%. Investors have already enjoyed most of the likely benefit of QEternity. It’s possible that continued quantitative easing will help to mute the potential for sustained market weakness until investors have a sense that the Fed will discontinue its purchases, but in my view, the likelihood of further material gain is limited. With no prior 6-month losses to recover, it seems likely that other factors will exert a stronger effect on market returns going forward than if the Fed’s easing had been initiated in response to a major low.

5---Shiller: Housing market comeback may be an illusion, Bloomberg

“The housing market has been declining for something like six years now, it could go on, that’s my worry,” Shiller told Tom Keene in a Bloomberg Television interview today in Davos, Switzerland. “The short-term indicators are up now, it definitely looks better, but we saw that in 2009.”....
.
“It’s a good housing market in the sense that mortgage rates are very low and prices have come down to normal levels, so yes, it’s a good time to buy if nothing bad happens,” Shiller said. “But it’s also a very bad housing market in that most of the mortgages are being supported by the government, and we have the Fed and this buying program. It’s a very abnormal market. There’s a lot of uncertainty going forward.”...

We’ve been five years in a slow economy, and it could go quite a bit longer,” he said. “We’ve seen gross domestic product growth at sub-normal levels.”
He added, “I think we’re pretty far from irrational exuberance, maybe 50 years away.”

6---Pending Home Sales Fall Due to Dwindling Supply, CNBC

Much of last year's gains in existing home sales was driven by investor demand for foreclosures and other distressed properties. Millions of dollars, largely in cash, from private equity, flowed into the market, pushing supplies down dramatically and even causing bidding wars in some of the previously hardest hit markets. That pushed prices up in the double-digit range, but critics caution that this is not a real organic recovery in the overall market. These existing sales numbers as well as a disappointing read last week on sales of newly built homes are bolstering that warning.

7---Financial Market Outlook for 2013--"The end is nigh", Robert Oak, economic populist

On December 12, the Fed quietly announced it would be buying $45 billion every month in Treasuries from the market, and when you put this together with its other regular purchases, the Fed will buy over 75% of all of the debt issued by the federal government in 2013.

This is a very, very bad thing, and that can’t be overemphasized. A government which has to buy its own debt either is issuing too much debt, or is not as credit-worthy as it once was, or it has somehow perverted the pricing mechanism to prevent interest rates from reflecting the true cost of selling so much debt. All three of these things are at play here. Interest rates are being artificially kept low by the Fed’s Zero Interest Rate Policy, which it has announced will be in place at least through 2015.

 This isn’t a matter of convenience or of intelligent monetary policy – this is a necessity. The US Treasury after 2008 ceased to issue any new paper with maturities much beyond two years; it is in a sense hiding out in the tall grass of the short end of the maturity spectrum, where the Fed can protect it because the Fed can keep short term interest rates close to zero. The Fed has far less control over interest rates beyond two years, and the Treasury knows this, which is why it does not dare show itself in public in the Treasury note or bond market.

Because the Treasury no longer is issuing paper with maturities beyond two years, the long end of the bond market is shrinking, and this is made much worse by the Fed’s practice of buying up for itself whatever paper is out there (Operation Twist, for example, specialized in buying 10 year notes). Prior to 2008, the Fed had very few holdings in this part of the maturity spectrum – its balance sheet consisted of $800 billion of Treasury bills and some paper out to five years. Now it has a balance sheet that just passed $3 trillion, consisting of highly illiquid mortgage backed securities, and a great deal of Treasury bonds with 10 – 30 year maturities. In some of these issues, the Fed owns up to 70% of the paper auctioned, which is its limit in any issue......

What is left in the market is a much smaller pool of Treasuries in private hands, which means less liquidity in the market, which means more volatility in pricing. We are already seeing the effect of this. On December 12 when the Fed announced its new $45 billion monthly Treasury buying program, rates should have gone down and prices gone up on news of the increased demand. The opposite happened; 30 year bond prices moved from 2.69% to 3.15%. They now appear to be heading to 3.50%. The market is less liquid now, and it takes but a few large players to get nervous and begin selling in order to create a sharp move in rates.

Bubbles Everywhere
Remember December 12, 2012. It may have been the day when the financial markets finally said “enough is enough” to the Fed. Enough destruction of the bond market. Enough monetizing of the deficit (Bernanke says he is not doing that, but he would have to say that). If it is such a brilliant idea for one arm of government to buy on the open market the debt issued by another arm of that same government, central banks would have been doing this for years. The fact is, every time it has been tried has been a disaster, going as far back as the hyperinflation situation in Weimar Germany to the most recent hyperinflation in Zimbabwe (and now also in Iran).

One bond guru after another in the US has been warning about hyperinflation, including the famous Bill Gross of Pimco. You don’t need hyperinflation to inflict grievous damage on the economy. Out of control inflation will do, and especially the type that the Fed deliberately ignores – asset inflation. We’ve already chronicled how a mini bubble exists in the housing market, and one more in the government securities market. Even some of the Fed governors are noticing the phenomenon, and a few have cited the explosion in farm land prices, or the out-of-control student loan market
....

We forgot one last thing – the stock market bubble. This is a deliberate distortion of the equity markets by the Fed – they have said for quite some time now that their Quantitative Easing programs, along with Zero Interest Rates, are designed to force savers into speculating in the stock market, which they hope will be higher “than it otherwise would be.” Boy, did they get that right....

Another study showed that intraday, the stock market moves ahead every time the Fed finishes a bond purchase, all of which are telegraphed in advance to the banks who have to find the paper to deliver to the Fed in exchange for cash. It is as if these banks turn around immediately and place the cash in the stock market, and the equity traders position themselves in advance. The third tell that the stock market is in a Fed-induced bubble is that on those infrequent spells when the Fed is not pumping the economy full of liquidity, the stock market suffers a setback. Late last year Goldman Sachs published a study that showed that not just the stock market, but the entire US economy, moves in cyclical synchronicity with Fed liquidity programs. Why this is, is not exactly clear, but it seems to indicate that all economic actors in the US are focused first and foremost on whether the government is continuing to push cash into the economy to keep it afloat.

When the Fed takes its foot off the monetary pedal, the economy begins to sink again. A curtain is drawn back, revealing the real underlying economic conditions: non-existent growth in real personal income, mediocre individual consumption, stagnant industrial and manufacturing production, flat corporate revenues, a chronic trade and current account deficit, and declining consumer sentiment and confidence in the economy. ....

Even if another credit blow-out occurred, we all know how that would end – very badly, as in 2008 credit crisis all over again. Unfortunately, without another credit splurge the results are the same. When the credit stops flowing, income is hit hard, because most of the growth in income in the economy is produced by debt, and it is not organic growth that would result from a normal recovery generated through capital investment, wage and benefit increases, revenue advances, and expanded global trade. This is precisely what the Fed understands, and why it is expanding its balance sheet ceaselessly, and enabling the Congress and Administration to build up debt at the tune of a trillion dollars a year. All this credit is the lifeblood of the economy, allowing the government to make Social Security and Medicare/Medicaid payments, feed 48 million people through food stamps, fight wars in multiple hot spots around the world, pay interest on the debt to keep bondholders happy, and shift unemployment money to the states.

The problem for the Fed is that the unraveling is already beginning...

This does not contradict what I wrote earlier – that the Fed cannot reduce its balance sheet. True as that is, the Fed does not need to begin selling securities it already owns. To damage the economy, all it needs to do is stop buying any more securities. As we’ve seen in the past, that constitutes a form of monetary tightening that effects the economy immediately and for the worse.....

This does not contradict what I wrote earlier – that the Fed cannot reduce its balance sheet. True as that is, the Fed does not need to begin selling securities it already owns. To damage the economy, all it needs to do is stop buying any more securities. As we’ve seen in the past, that constitutes a form of monetary tightening that effects the economy immediately and for the worse.

The Fed Loses Control Over Interest Rates I noted that the Fed has never had strict control over long term rates, and that 30 year bond rates have begun creeping up despite the Fed being an active purchaser of bonds in that maturity. Fed control over short term rates is assumed, but what if this assumption is wrong? Could short term rates begin to head up in the market despite the Fed? The link between the Fed, commercial banks, and the economy is broken to a degree already. Zero interest rates have served to benefit the banks, but have not been passed on to the economy. Nobody on the consumer side is allowed to borrow money at anywhere near zero percent. Credit card rates are still anywhere from 15% to 35%., and fees in that business have expanded to encompass just about any mistake a consumer can make. Even 30 year mortgage rates, quoted at 3.5%, are given only to a small number of very wealthy clients; everyone else borrows near 5.0%. So ZIRP has been a bust, other than to serve as a way to transfer wealth to banks. Short term interest rates could therefore creep higher still no matter what the Fed does. The Fed could jawbone banks and pressure them to keep rates stable, but when self-interest or self-survival comes into play, the banks will and in fact must ignore the Fed. The Fed could begin buying Treasury bills for maturities under one year, but the FOMC is already nervous about expanding the central bank’s balance sheet any further. Statistics have shown over the years that the Fed follows the market when setting rates, and if the market deems that even short term rates are too low, inevitably the Fed must to some degree accept this. As to why the market would come to such a conclusion, it really is all a matter of confidence. If investors lose confidence that the US will ever gets its fiscal house in order, one hundred years of global economic dominance and reserve currency status is not going to save the day for America.

Asset Inflation Breaks Out Elsewhere Currently asset inflation is contained to the US, but it could occur globally now that central banks in the UK, Europe, China, and Japan have all joined the Fed in its unlimited quantitative easing program......

Multinational corporations have been beneficiaries and instigators of global labor arbitrage and the deflation which ensues (everyday low prices at Wal-Mart, as an example), and their power remains unchecked at this point. A global deflationary collapse of the financial system has remained an increasing risk in this environment, and was only forestalled in 2008 by the concerted efforts of central banks and governments to prop up the major banks. Ever since then, central banks have been obliged to replace commercial banks as the purveyors of credit to the global market. This is a game the central banks cannot win. The global forces of deflation are too strong, unless you assume a billion Chinese citizens are going to be pushed backed into subsistence living under Communism, and so the central banks can only fight this battle by constantly escalating their efforts until no more escalation is possible. Compared to a year ago, the global economy has seen massive escalation of money printing, yet growth has shrunk or been converted into economic contraction in the UK and other parts of Europe, and in Japan. This is a losing battle; at some point living standards in the developed world are going to have to ratchet down to meet up with rising living standards of the middle classes in China and India. That “lurch down” is what we are worried about. It will be dramatic, and permanent, making this current depression much worse and far more memorable than anything that happened in the 1930s. The collapse of the system which propped up Western living standards for 25 or more years – a system built on credit and debt – is closer than ever. No one can predict when it will occur, but that it will happen is harder to deny as we all watch the central banks pull out every conceivable money printing trick, with no success to show for their efforts other than holding off the inevitable.

No comments:

Post a Comment