Double dip recession Google trends

Nouriel Roubini was talking today about the possibility of a “U-shaped” economic recovery or a double dip recession, just one of a growing number of people who have been mentioning the dreaded “W-shaped” outcome, at least according to data collected by Google trends.

Roubini said there is just a small (but increasing) probability of this scenario and, if it occurs, it will be due to policy makers not getting the “exit strategy” right. Based on this logic – our economic future being dependent upon Washington economists doing a better job coming out of the recession than going into the recession – you’d think the odds of a “W-shaped” future would would be appreciably higher than as stated by Nouriel.

A Look Back in Time

It’s been a year since Lehman Brothers bit the dust, and Britain’s Guardian has put together a cool interactive timeline, “The Collapse, Week by Week,” that details how shockwaves from the Wall Street bank’s collapse spread around the world.

Lehman Shock Waves


The Fall of Lehman Brothers: An Unhappy Anniversary
Peter Storey and Graeme Wearden
The Guardian, September 3, 2009

Annotated Dow

Here is Dave Singer’s latets annotation, from earlier this week:


Annotated Dow

annotated Dow

What’s a Four Letter Word for Risk Aversion?

Good Evening: After giving ground in recent days, U.S. stocks found their footing on Thursday. The S&P 500 had been fidgeting around just below 1000 since Tuesday’s downdraft, but the widely watched index managed to finish above this psychological barrier today. Whether this rebound after the 4% pullback from last week’s high signals either a pause in the selling or a resumption of this year’s rally is debatable, since the market action on the Thursday before Friday’s employment release is usually attributable to noise and position-squaring. After a bevy of firm economic reports this week, among the less debatable notions is that the U.S. manufacturing sector has climbed up off the canvas. At issue, therefore, is just how sustainable will be this uptick in activity, as well as just how much of it was anticipated in the S&P’s 55% rally since the March low. After shunning risk in the seventeen months subsequent to October of 2007, market participants have gorged themselves on risk positions during these last six months. It seems fair to ask if risk appetites might be getting set to shift back toward abstinence, and it might also be worth entertaining a notion or two about what might cause investors to push back from the table. Would it surprise you to learn that chief among the threats to wealth preservation might be our elected representatives in Washington, D.C.?

A small rebound in Asian equity prices during the overnight hours had our stock index futures pointing to modest gains this morning. An uptick in both initial and continuing jobless claims then undercut the bullish sentiment somewhat, but equities nonetheless managed to open higher. The major averages were hovering with gains approaching 0.5% when the ISM non manufacturing (read: services) survey results were posted. Though the headline number of 48.4 was just about in line with expectations, the U.S. service sector is still contracting, and the details of this report made for interesting reading. BAC-MER covers the positive and negative aspects of this release quite well in the piece below, but what caught my eye were the inventories and prices paid components.

Contrary to the widely perceived notion that inventories are falling (thus leading to a boost in production in the months ahead), the majority of respondents indicated inventory levels were too high, implying future production cutbacks. Unless one expects a disheartening bout of stagflation, it was just as disturbing to see the prices paid component spike to 63.1 in August from 41.3 in July. Note please that the size of the service sector of the U.S. economy dwarfs that of the manufacturing sector, so it’s interesting to see the services survey tell such a different story than the highly touted manufacturing survey released this past Tuesday. While I don’t want to make too much of this one economic release, the service sector will bear watching in the months ahead.

U.S. equities dropped back below the unchanged mark in the wake of this data point, but they didn’t stay there for long. Investors were happy to see ECB president, Jean-Claude Trichet, murmur his concern about the fragility of the European economy (see below). Trichet’s reluctance to take his foot off the monetary accelerator any time soon was especially well received. Taken in context with yesterday’s minutes of the August FOMC meeting, it seems as if Western central banks still lack the will to remove the monetary stimulus programs now in place. Without the will to do more than talk about a distant “some day”, it seems a safe bet that the Fed, ECB, and BOE can find a way to keep the policy throttles wide open.

Perhaps it has been the promise of central bank accommodation for an “extended period” that has been bolstering equities since last spring, but precious metals market participants, too, have started to take notice (see below). Gold and silver are attempting to break out to the upside after a long period of consolidation. The upside eruptions by Au & Ag are, in part, computer-driven by trend-chasing CTAs, but it is hard to ignore that these rallies have coincided with statements made by Western central bankers. Central bankers in the rest of the world have also provided a bulwark of support for the yellow metal. Almost unmentioned in the press was last month’s announcement by the World Gold Council that central banks have become net buyers of gold for what seems the first time in eons. My thanks go to Bill Fleckenstein for pointing out this nugget of information.

With mining stocks leading the way for a second straight day, the major U.S. averages drifted higher for most of the rest of today’s session. When an afternoon sell off fizzled, a late rally took hold that sent stocks out on their highs for the day. Though tomorrow’s employment data loomed in the windshield, investors drove the averages to gains of between 0.7% (Dow Industrials) and 2.3% (Dow Transports). The grab for stocks put a small dent in the demand for Treasurys, though, and yields rose between 2 and 5 bps across the curve. After their nice run of late, bonds were due for a breather, and the same looked to be true for the dollar. Suffering declines in recent days, the greenback made a comeback of sorts today by finishing mixed after opening lower. Commodities, at least the ones not found in the periodic table, were down today. A drop in energy and agricultural prices more than offset the rally in the metals complex as the CRB index retreated 0.3%.

When Lehman failed almost one year ago, the desire to take risk all but disappeared. Down went almost every currency and nearly every asset class; only the U.S. dollar, Treasurys, and certain sovereign bonds found willing buyers. Even gold succumbed to the “risk aversion” trade in 2008, but 2009 has been a different story. Gold rose with risk appetites for most of this year, and now that risk aversion may be reasserting itself, gold continues to levitate. The wings beneath gold’s feet may or may not be technically driven and temporary, but it may be a little-noticed and still-developing tailwind that is causing investors to rethink where their portfolio risks might now lie.

The final two articles you see below will rivet your attention, and they do not make for happy reading for equity investors. Rising stock markets have tremendous healing powers, but they may soon be called upon to help heal the budget deficits in the U.S. and the U.K. The AFL-CIO is pushing the Democratic party for a transactions tax on equity trades, while the Chairman of Great Britain’s FSA has proposed a similar tax in the U.K. Most readers will scoff at this concept, rightly branding it as misguided, foolhardy, and bearish for stock prices (and therefore counterproductive). But unsound economic policy concepts have found their way through the legislative process before, or have we already forgotten the “windfall profits tax” on oil companies during the 1970’s?

Wall Street has suffered during the Great Recession, but not, at least in the eyes of many average citizens, as much as has Main Street. The recriminations and paybacks for the sins committed during the credit bubble have been on hold, awaiting their turn in the new administration’s busy domestic agenda. Stimulus came first (done); reforms are second ( in process, a new push in healthcare begins next week); and tax policy is slated for 2010 (hint: the phrase “fair share” will figure prominently). I don’t really give the equity transactions tax idea much of a chance of passing, but it’s a lead pipe cinch the thirst for revenues and the anger at Wall Street will intersect somewhere in the 2010 tax code, leaving investors feeling less than joyful. The long arm of the law (more precisely, of the lawmakers) will soon be reaching into a pocket near you. It will be left to the sticky legislative process to determine just which ones will be pilfered, but the sitting Congress did not get elected on a platform of “soak the poor!”.

Left to contemplate just what risks to wealth might be coming, and from which direction, Mr. Market’s growing fascination with gold starts to make sense. No matter what the Labor Department conjures up in its employment estimates tomorrow, the potential danger to wealth preservation from monetary policy (quantitative easing and its grudging withdrawal) and fiscal policy (increased taxes cum spending) is clear and present. Risk aversion may soon have a new, four letter word to describe it — gold.

– Jack McHugh

U.S. Stocks Gain as Retail Sales Beat Forecasts, China Rallies
Gold Rises to Six-Month High as Weak Dollar Spurs Metal Demand
Trichet Expects ‘Uneven’ Recovery, Signals No Rush on Exit
Fed Tries to Prepare Markets for End of Securities Purchases
Turner’s ‘Tobin Tax’ Proposal Criticized by Kaufman, Ferguson
AFL-CIO, Dems push new Wall Street tax
Service sector still contracting.pdf

Heading in Different Directions

Talk that the economy is on the road to recovery is growing louder. On Monday, for instance, MarketWatch reported that “economists say the recession is over.”

Of course, Wall Street has been quick to jump on the bandwagon. A recent Bloomberg survey of U.S. users, many of whom work in the financial industry, found that optimists on the economy nearly equaled pessimists for the first time since its Professional Confidence Index was introduced in November 2007.

Yet ordinary Americans aren’t buying it. In fact, a new CNN/Opinion Research Corporation poll reveals that 87% of those surveyed say the country remains in recession, a 13 percentage point jump from June’s tally.

Heading in Different Directions

Given how much closer-to-the-mark the average Joes have been during the past few years when it comes to reading the economic tea leaves , especially in comparison to those who are supposedly in the know, it makes sense to bet on the amateurs.


Americans Think Nation Still Mired in Recession, CNN Poll Finds
Paul Steinhauser, September 3, 2009

All Bad Things Must End – Economists Say Recession Is Over
Greg Robb
MarketWatch, September 1, 2009

Global Confidence Increases on Signs Recession Is Nearing End
Shamim Adam
Bloomberg, August 13, 2009

Asia Leads Futures Higher

The Shanghai index gained nearly 5% overnight, the biggest one day move upwards in 6 months. US Futures, after a few rough days, are pointing higher.

I wonder if Global market leadership is shifting — It used to be that whatever the happened in NY would move the global markets. Now, the leadership role seems to be moving from a US-led world towards China being the market leader.

Perhaps this is only temporary.  Time will tell.

Here’s Bloomberg:

“Stocks in China rose the most in six months, driving the yen and Treasuries lower, on speculation the government will adopt measures to boost equities after the Shanghai Composite Index fell into a bear market.

The Shanghai gauge gained for a third straight day, closing 4.8 percent higher, while the MSCI World Index of 23 developed countries advanced 0.2 percent at 11:40 a.m. in London. Futures on the Standard & Poor’s 500 Index climbed 0.4 percent before a report that may show the pace of contraction in U.S. service industries slowed. The yen weakened against all 16 of the most- traded currencies and the yield on the U.S. 10-year note climbed 3 basis points.”

Defending the Fed

Now, here’s something you don’t see every day…

Amid a growing backlash against the Federal Reserve, whose popularity has been plunging in public opinion polls since they started spending trillion of dollars to prop up the financial industry, a lone voice defends their practices and argues against any audits.


Don’t Punish Fed with Audit

Is the Federal Reserve hiding the identities of banks who received up to $2 trillion in loans in the last year? Representative Ron Paul (R:TX) and now Representative Barney Frank(D: MA) think the Fed should be audited to reveal the names of these foreign and domestic banks. Federal Reserve Chairman Ben Bernanke opposes Paul’s audit bill, saying it would make it seem like the Fed was no longer setting interest rates independently of political oversight. This perception alone would increase inflation. However, the real threat is even worse than that.

The Federal Reserve has acted quickly and creatively to pull the economy back from the brink of a major depression. It did so because of its ability to act swiftly without going to Congress for approval. Secrecy was needed last year to allow banks to apply for liquidity from the Fed without fear they would be tagged as failing banks. Congressional auditing ability would seriously hamper the Fed’s ability to act at a time when this creatively and innovation is needed the most.

Well, that’s one school of thought.

There’s a completely different line of thinking that involves the central bank having been created by and for big banks in order to foist bank losses on the public while keeping the gains private.

Moreover, some object to the not-so-inconsequential matter of a nearly century long debasement of the currency, where America’s money has lost more than 90 percent of its value since the creation of the Federal Reserve in 1913.

And just what does Mrs. Amadeo think about money?

Her views are made abundantly clear at her website – World Money Watch.

Money is a mental concept. It is no longer based on anything tangible – not gold, not business values, and certainly not home values. Money has become an exchange of energy. As such, it provides a useful footprint that reflects the awareness level of the human race. Watching trends in the world’s money helps us track our evolution.

Well, that explains a lot.

Interestingly, there’s a section for comments on the article.

After a brief survey, my favorite comment is the third one:

Pull your head out of your a$$

Of course we need to audit the Fed. All government activity should have accountability. It is almost treasonous not to hold the government accountable for their actions…

There are a total of 36 comments and, save for the one titled “I Love My Overlords” (which is believed to be facetious), none defend Ms. Amadeo or the Fed though a couple are critical of Ron Paul, figuring that Barney Frank has been brought on board to help Dr. Paul sell his forthcoming book titled “End the Fed“.

Tim Iacono is the author of the blog The Mess That Greenspan Made

Blaming the Wrong Group

Dan Gross is one of America’s best financial journalists, but that doesn’t mean he always gets it right (He did, after all, publish a book in the spring of 2007, just before the financial world fell apart, which claimed that “bubbles are great for the economy”).

In his latest column for Newsweek, “The Failure Caucus,” Gross maintains that those who are skeptical about the near term prospects for a sustainable recovery have a vested interest in a different kind of outcome — they want to see the U.S. economy fail.

Most Americans have a lot riding on the success of the government’s efforts to pull the U.S. economy out of its ditch: individual investors, bankers, Federal Reserve Chairman Ben Bernanke, Democratic politicians, and taxpayers. A somewhat smaller group has a lot riding on the failure of these efforts. I’m not simply talking about investors who are betting against the markets and who believe the recent stock-market rally is overdone. I’m talking about the Failure Caucus, a group spanning the political spectrum that has invested reputations, egos, and, in some instances, their political futures on the notion that we’re in for several more years of economic trauma.

Unfortunately, Gross relies on the old propagandist’s trick of lumping fools and crazies together with rational observers who have legitimate cause for concern, in a way that discredits them all.

Worse, he fails to see the irony of his position: it’s actually the permabull posse of policymakers and financial leaders — not to mention the cheerleaders in the media  – who failed to see the disaster coming, and who now argue that a debt-and-speculation-fueled overdose can only be cured with more of the same, who are the ones betting on failure.

In fact, the real risk right now, to paraphrase Michael Darda, an optimistic economist cited by Gross, is in being too positive.


The Failure Caucus
Daniel Gross
Newsweek, September 02, 2009 11:47 AM ET

Global stock market performance roundup (thru 8.09)

Global stock market performance roundup (August 31, 2009)

The performance of a number of global stock markets is given in the table below in local currency terms for different measurement terms ended August 31. The numbers speak for themselves, but it is noteworthy that the MSCI World Index (+3.9%) and MSCI Emerging Markets Index (-0.2%) followed separate paths in August as China, Hong Kong and India underperformed.

Click here or on the table below for a larger image.


Top performers during August included Austria (+11.3%), Ireland (+10.9%) and Venezuela (+10.6%). At the bottom end of the performance rankings countries included China (-21.8%), Hong Kong (-4.1%) and India (0%).

The key moving-average levels are also given in the table above. With the exception of the Chinese Shanghai Composite Index, which fell below its 50-day moving average about two weeks ago, all the indices are trading above their respective 50- and 200-day moving averages. The 50-day lines are also above the 200-day lines in all instances.

The gains/declines mentioned above are all in local currency terms. However, converting the movements to US dollar gives a better picture, in general, for the non-dollar countries (see table below).

Click here or on the table below for a larger image.


As mentioned in a post yesterday, “I suspect we may see at least some degree of reversion to the 200-day moving averages in a number of instances, but will be watching closely to ascertain whether we are dealing with a normal short-term correction or a more significant move threatening the primary trend. In the meantime, sit tight and be cautious as markets hopefully realign with the reality on the ground.”

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Q2 2009 Bank Stress Test Results: The Zombie Dance Party Rocks On

Here is the latest issue of The Institutional Risk Analyst for your reading pleasure.   Chris

Q2 2009 Bank Stress Test Results: The Zombie Dance Party Rocks On
The Institutional Risk Analyst
September 1, 2009

“The causes were many: interest rates too low too long, allowing speculation on un-owned assets, a surplus of cash that begged to be invested, etc.; but the bottom line problem was one of perception. I grew up on a farm and a cow pie even if chopped into small pieces, mixed with other like items, painted gold, and doused in perfume is still manure. The market let the small pieces, paint and perfume confuse them. John Deere is a great company, but the one piece of equipment they won’t stand behind is their manure spreader. Those investing in and creating new markets should be so wise.”

A reader of The IRA in TX

The second quarter FDIC data is online for consumer and professional users of The IRA Bank Monitor. The results of our Q2 2009 stress test of the US banking industry are pretty grim. Despite all of the talk and expenditure in Washington, the US banking industry is still sinking steadily and neither the Obama Administration nor the Federal Reserve seem to have any more bullets to fire at the deflation monster.  With the dollar seemingly set for a rebound and the equity and debt markets looking exhausted, one veteran manager told The IRA that the finish of 2009 seems more problematic than is usual and customary for the end of year.

Plain fact is that the Fed and Treasury spent all the available liquidity propping up Wall Street’s toxic asset waste pile and the banks that created it, so now Main Street employers and private investors, and the relatively smaller banks that support them both, must go begging for capital and liquidity in a market where government is the only player left. The notion that the Fed can even contemplate reversing the massive bailout for the OTC markets, this to restore normalcy to the monetary models that supposedly inform the central bank’s deliberations, is ridiculous in view of the capital shortfall in the banking sector and the private sector economy more generally.

As with Q1 2009, the Q2 preliminary Stress Index calculated by IRA jumped to over 6.7 or more than half an order of magnitude above the 1995 base year of 1, but then subsided down to “only” 3.11 vs. 2.8 in Q1 2009. As in the previous period, the preliminary score reflects the tough reality facing smaller community and regional banks, while the final score of 3.11 reflects the huge subsidies flowing through the top institutions. Whereas in past years the inclusion of the larger money center banks would skew the risk profile of the banking industry to a more risky posture, today, as zombie GSEs, the top banks make the industry look more conservative.

IRA Banking Stress Index Distribution – Q2 2009







Preliminary Stress Index 6.77 (7,622 banks)







Final Stress Index 3.11 (8,643 banks)







Source: FDIC/The IRA Bank Monitor

As you can see, the number of “A+” banks is retreating fast from the 6,000 plus at the high tide of the credit bubble in 2006. Our colleague Dick Bove puts the prospective bank dead pool at several hundred. The FDIC now admits to some 400 banks on the troubled list. But we’d tell you that looking at the Q2 results, at least half of the banks now rated “F” in our last stress test survey are ripe for resolution. The reason we predict over 1,000 banks resolved through the cycle, as we predicted a year ago and more, is described in detail by IRA CEO Dennis Santiago in our Picking Nits blog.

Dennis provides tables for the final IRA Bank Stress ratings matrix for Q2 2009 and also a new table showing the distribution of the ratings by assets of the banks. Suffice to say that the proverbial barbell is getting more and more distorted and stretched, with virtually no banks rated “C” or “D,” and over 2,200 rated “F” or about where the US banking industry was at the end of 2008. The final result of financial innovation seems to be bank resolution, and the scope of the train wreck facing US financial institutions is vast, according to our latest stress test.

“The economist Hyman Minsky noted some time ago that economic stability fosters increased risk-taking that eventually can lead to financial instability,” writes our friend Martin Barnes in the Bank Credit Analyst after attending the Jackson Hole conclave. “Policymakers generally paid little attention to that view, but this has recently changed.”

Perhaps there is revisionist thinking at the Fed at long last, but not nearly soon enough to do anything about the impending implosion of the US banking sector in 2010. The significant point to us is not the cost to the FDIC insurance fund implied by the rising Bank Stress Index score, a cost which the banking industry will absorb and repay. But the real point is the permanent diminution of economic activity in local communities caused when good community and regional banks die due to the end-result of bad fiscal and regulatory policies in Washington. In that regard, see our letter in the Financial Times today, “Simplify and focus the Fed’s job and we will progress,” about systemic risk and the debate over giving the Fed more authority to regulate same.

In Q2 2009, the queen of the zombie dance party remains Citigroup (NYSE:C), which was rated “F” in Q2 2009 by the IRA Bank Monitor’s stress test survey, down from “C” in Q1 2009 because of a large jump in the score for ROE and deterioration in the score for loan defaults. As we told subscribers to the IRA Advisory Service on Monday, credit losses at C could require additional injections of capital a la Fannie Mae and Freddie Mac, even with the flow if subsidies that has increased C revenue greatly from 2008 run rates.

It is interesting to note that the prospective marriage of Fannie and Freddie, some call it Frannie, seems to be on hold now. The lawyers were working furiously up till about two months ago, but now nothing. This is significant because during the recent influx of speculators into the moribund equity of these two insolvent GSEs, we’ve heard vague references to post-merger synergies. It says something of the extreme speculative tenor of the markets today that we sell ourselves the delusions of the GSEs as “investments,” all the while watching as the Treasury writes a check for hundreds of billions per year in subsidies to keep the two GSEs from defaulting on their unsecured debt.

Likewise C is one of the banks rated “F” in our stress test survey and one of the zombie girls still rocking out at the House Bernanke dance party. You have to wonder why serious, smart people we know on the Buy Side see value in what remains of C — even before the resolution process is complete. Keep in mind that unlike your mere TARP bank, C is halfway in the grave via the loss sharing agreement with the FDIC.

The mere fact of loss sharing at C makes us wonder why any manager of the average equity mutual fund would deploy capital in that name. To us, buying C common equity is like investing in a company with a going concern flag from the outside auditor. Whether or not there is value inside C is not the issue; it is just not kosher, to us, for a manager to put investment grade investors into a situation that is basically a restructuring, with the government as the largest, senior creditor – and one in which the ultimate liabilities are as yet to be quantified. As with GM and Chrysler, the private shareholders and even the creditors of C will take what they get from Uncle Sam.

We have a good friend, a former bond trader and Goldman partner now retired, who’s been asking us about C for the past several months. Call buying C equity a punt on the corporate state for consenting adults. Keep in mind that C reported 412bp of default (annualized) in Q2 2009. All of the good people at C and their large bank peers know that we are perhaps a couple of quarters away from the peak in loss experience. Even with Uncle holding 34% of the equity, C remains an organization with 3.8% tangible common equity or “TCE” at the parent level and above-peer loss rates. Click the link below to see a chart of C’s bank charge-off experience from Q2 2009 going back to 1989 from The IRA Bank Monitor:

Notice that the rate of increase in charge-offs slowed in Q2 2009, both for C and for the large bank peers. The only decision we all need to make now is whether the rate of increase in bank defaults grows or continues to fall in 2H 2009 and beyond. Unfortunately, the data and our gut suggests that we will see more rapid increases in loss rates in the next several quarters — even with growing forbearance by regulators regarding charge-offs and real estate owned post foreclosure or “REO.”

The other question that is starting to get attention and on which we are spending a lot of time in the IRA Advisory Service is the duration of the period of peak loss, yet another toggle in the Fed’s SCAP stress test assumptions that we believe ought to be subject to revision. Notice that in the early 1990s, C was above 250bp of default for over two years. If C gets up to say 5.5 to 6% charge-offs in this cycle and then lingers around those levels, all the while dealing with asset valuation issues that such a loan loss rate suggests, then the bank will probably need more capital from the Treasury.

Q: What do you suppose aggregate banking industry loss and recovery rates look like when outliers like C are in the 6% default range? And remember that the rising bank default rate is as much a function of the lack of credit availability as anything else. When no deals, even deals that make sense, are getting done in the private marketplace, then the entire economy must shrink and even good depositories must horde cash.

As one old friend noted recently, many commercial banks have largely withdrawn from the lending market, leaving the housing GSEs the only game in town in that particular asset class. Other GSEs such as Export-Import Bank have, says one insider, “moved to direct loans vs. bank guarantees because our illustrious banks refuse to take ANY risk (which begs the question as to why you need them) and of course you must be prepared for daunting fees.”

But despite the efforts by the GSEs, the reduction in credit available to the US economy is having a negative impact on the overall level of activity, which creates a feedback loop of deflation and displacement that can only negatively impact depositories and their customers. Like the matrix of risk event possibilities we discussed in last week’s comment, “Systemic Risk: Is it Black Swans or Market Innovations?”, the number of failures of banks and private obligors is a moving target that still depends in great measure on the decisions we make in the days and weeks ahead. It’s probably too late for more excuses from the Fed and the Congress, but it is not too late for the Fed and federal other agencies to make a very positive difference in how this story ends. More on that in our next comment.

Questions? Comments?

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The Battle Between Politics and Economics Goes Global

Good Evening: U.S. stocks finished a strong August on a down note, causing investors to wonder what awaits them during the seasonally weak months of September and October. With some strong (though admittedly junior) economic data released this morning, today’s downdraft had little to do with the U.S. economy. Global market participants were instead more focused on political and economic events in China, Japan, and Brazil. It’s hard to say whether nascent worries on these fronts will morph into genuine concern, but perhaps such volatility should be expected when governments around the world become so involved in economic affairs.

China’s stock markets were hit hard overnight, as stories circulated that bank lending cooled off dramatically in recent weeks after setting a torrid pace during the first half of ‘09. Other equity markets suffered, too, as did most commodity prices. A lot has been riding on Chinese demand, and all threats to its voracious consumption of raw materials sends tremors through world markets. An earthquake of a different sort hit the Japanese archipelago when the DPJ party tossed out the long-ruling LDP. Handicapping just what policy changes might be in store for Japan is a difficult task, but any move away from the sclerotic LDP might be very good for the Japanese economy. Unfortunately, it’s hard to be optimistic about President da Silva of Brazil and his latest oil policies. “Lula” looks like he’s sponsoring a government grab for some of Petrobras’s most valuable energy assets, reminding both domestic constituents and foreign investors that this formerly leftist leader has not forgotten his roots.

Global stock prices and U.S. equity index futures were thus under pressure prior to this morning’s open in New York. Futures would no doubt have been lower still had some takeover activity not been part of the early news flow. Disney threw its arms around Marvel, while Baker Hughes announced its intention to acquire BJ Services. Sellers of energy, materials, and other commodity sensitive names overwhelmed the M&A activity, though, and the major averages were soon down between 1% and 1.5%. The skid was halted when the Chicago PMI vaulted all the way back to the neutral 50 mark this morning, a level last seen when Lehman was still breathing. Though I didn’t see the exact figures, I’m told Dallas and Milwaukee PMIs were both supportive of better economic growth, but it will be tomorrow’s national number (and especially the services survey that follows on Wednesday) that will be more revealing.

After the pop following the Chicago PMI release, equities then went nowhere fast for the rest of the session. A small upside flourish at the bell helped most indexes halve their losses for the day, with the Dow (-0.5%) faring best and the Dow Transports (-1.5%) bringing up the rear. Treasurys were in a summertime mood most of the day, finishing with modest gains. Yields fell between 2 and 7 bps. The dollar gave some ground after being firm this morning, but it didn’t help commodities. The stories out of China brought an early autumn chill to the pits, especially in those pertaining to energy. Led by a 4% decline in crude oil prices, the CRB index fell 1.6% today.

“Government’s view of the economy could be summed up in a few short phrases: If it moves, tax it. If it keeps moving, regulate it. If it stops moving, subsidize it.”
– Ronald Reagan

Though not cited as often as it used to be, this quotation attributed to our 40th President became a philosophy of what good government should try to avoid. More often than not, lower taxes, less regulation and a dislike of subsidies were policy goals in the U.S. for more than two and a half decades. As the financial crisis reached its zenith during the fall of 2008, however, many Americans believed Warren Buffett (and others) that the philosophy behind these policies was at the root of our financial problems. Voters really didn’t need much convincing and hey swept Barack Obama into office with a demand for change. Well, change is here, and its the subsidies that have arrived first. Stand by for higher taxes and heavier regulation.

This increased role of government in our economy has left many investors looking overseas for ideas, hoping to cash in on the growth they see in the BRIC nations (Brazil, Russia, India, and China). Emerging markets have thus housed the leading equity markets for years. As this weekend’s news flow from abroad highlights only too well, the BRIC nations, too, have their political risks (see stories below). Reports of a reversal in China’s overly easy lending policies were the rationale behind today’s decline in both stocks and commodities, and few want to see the green shoots of Chinese demand wither any time soon. And just when investors were starting to think Brazil offered the best mix of growth, resources, and enlightened policy-making, along comes Lula with his loony idea to loot Petrobras and leave shareholders holding the bag. Is this what a bull market in government-sponsored economic activity really looks like?

We all know Russia disdains capital and private property, and we also know that the risk of investing in China involves having the mandarins in Beijing foist the wrong 5 year plan on its hard-working citizens. We also know that Brazil used to be little better as an investment destination than places like Venezuela, Bolivia, or Argentina, but the move against Petrobras today was still a shocking reminder that looking overseas carries as much political risk as subjecting our dollars to the “new normal” here at home. If Ronald Reagan’s big government version of the political economy becomes the Modus Operandi everywhere, then returns on capital will likely shrink. It’s possible that even the return OF capital will become an issue in some countries. Investor sentiment and economic growth are fragile enough without throwing into question the countries that have been trying to lead us out of the Great Recession.

So what’s an investor to do? Wouldn’t it be interesting if one of the safest place to put one’s money during the next few years is in a nation where it has been treated so shabbily for the past twenty? I’ll have more to say about Japan later this week, but with two lost decades almost under their belts (the Nikkei peaked in December of 1989), the Japanese might finally be due. Then again, and in the interest of full disclosure, I might be early with this call. My Chicago Cubs now have 10 lost decades under their belts, and I’ve been bullish about their prospects for a quarter of a century.

– Jack McHugh

rVloZqEO.w”>Stocks Decline, Trimming S&P 500’s Sixth Straight Monthly Gain
Japan DPJ Election Win Brings ‘Bloodless Revolution’
Asian Currencies Drop, Led by Rupee, as China Cools Lending
Lula Increases State Control Over Brazil Oil Reserves

History Repeats?

Lorne points us to this comparison between the 1929 Dow and the 2000 Nasdaq, overlays some fib retracements, and wonders if history isn’t repeating itself:
click for ginormous chart
history repeat

Driving the Stock Market

In this week’s Barron’s, Mike Santoli asks:

“How is it possible, though, that Citigroup (ticker: C), Fannie Mae (FNM), Freddie Mac (FRE), Bank of America (BAC) and AIG (AIG) — with a combined market value near $200 billion-could “drive” a stock market worth more than $10 trillion and that has added about $1 trillion in value this month, as measured by the Wilshire 5000?”

A friend who runs a hedge fund suggests a better query:

“I think another question to consider might be, How is it possible that those 5 stocks have a combined $200 billion market cap?”

Bernanke’s Identity Theft a Shame on Many Levels

Good Evening: Like a self-sealing tire, U.S. stocks were punctured this morning but managed to reflate this afternoon. Some grim news about the health of non-TARP banks was behind the decline, while speculation in financial firms that DID receive bailouts helped launch the comeback. If you think it is bizarre to see taxpayers actively chase the stub equity pieces of firms they already passively own, you are not alone. Like the identity theft of our Federal Reserve Chairman, the fever to acquire companies whose proudest achievement of 2009 is effecting a 1 for 20 stock split, this too shall pass. What might be a shame, though, is that the band of thieves who stole the identity of our top central banker didn’t perpetrate their crime years ago.

Today’s economic data were mixed and thus had little impact on today’s proceedings. The government’s second guess about Q2 GDP didn’t budge from the previous -1.0% estimation, but the price deflator did when it dropped to the zero mark. Q3 looks to be a positive number, but Q2 kept alive the quarterly streak of negative nominal GDP figures. Jobless claims were a bit higher than expected, and they remain stubbornly high for what so many say is an economic recovery. Stocks opened lower in part due to more rumors that China is seeking to rein in bank lending, but they dropped more than 1% once the FDIC story started to circulate (see below). The number of problem banks — which could be counted using one person’s fingers only three years ago (a great coincident indicator of extraordinarily easy credit and leading indicator of trouble) — is growing so fast the FDIC insurance fund is at risk of being depleted. Stand by for yet another bailout.

Stocks didn’t linger at today’s lows for long, however, as speculation soon ran rampant in names like AIG and Citigroup (see below). Neither entity would exist today if not for the generous assistance provided by taxpayers, so why companies like these (FNM, FRE, and a few others also qualify) haven’t been diluted down to penny-sized proportions is beyond me. And yet, because taxpayers have received relatively small stakes for providing emergency capital and then backing the debt issuance of these firms, folks like John Paulson will continue to take stakes in companies like Citigroup. They are a call option on the survival of these firms, as well as a bet that Uncle Sam won’t further dilute current investors at some point down the road. The AIG situation is even more egregious, but all it took was some chatter about Hank Greenberg’s possible involvement with his old firm to really squeeze the shorts who rightly think the equity should have little or no value. AIG was up a head-scratching 27% today and has tripled in just the past three weeks!

In addition to some momentum chasing in financial stocks, a turnaround in materials and commodities names also helped the tape firm up in the afternoon. After a slow and steady climb back to unchanged, the major averages turned positive late in the session and stayed there. By day’s end, index returns were bracketed between a loss of 0.25% for the Dow Transports and a gain of 0.4% for the Dow Industrials. Treasurys traded on both sides of the flat line before closing with small losses. Today’s 7 year note auction went well enough, but those results didn’t stop yields from rising 1 to 3 bps at the close. Like stocks and commodities, the dollar reversed today. Starting mixed against its rivals, the greenback headed south the rest of the day and skidded 0.75% in the process. The buck’s weak knees emboldened the non vacationers left in the commodity pits, and the CRB index was able to finish with fractional gains after being down more than 1% this morning.

I abhor identity theft, and my first thought when the news hit the wires that Ben Bernanke’s identity had been stolen after his wife’s purse had been snatched last year was probably similar to the one most people had: It could happen to anyone. On top of insult to potential financial injury, this whole episode struck the Bernankes late last summer, just as the credit crisis needed his full attention. I’m sorry it happened, but I do have a couple of questions for the perpetrators. How, oh members in the “Cannon to the Wiz”, did you finally get caught? Did you assume the Bernanke persona and try to run the printing presses to your advantage? If so, how did anyone notice a change in the brisk gait of money printing? Furthermore, why didn’t one of your clever bunch try to use Mr. Bernanke’s credentials to head on over to the Eccles building to Chair an FOMC session or two? One must think big during these troubled times, but “Big Head” and his ring of thugs apparently decided against it.

To the criminal who actually stole Ms. Bernanke’s purse and is still at large, I offer this piece of advice. Before turning yourself in, do yourself and your country a favor by handing Mr. Bernanke’s identity information to someone like Paul Volcker. You’ll get a shorter sentence and your country will benefit. Speculation would be tamed, and long term inflation expectations would probably fall far enough to shrink the budget deficit by obviating the need for more bond purchases. If someone else must possess the Chairman’s identity, who other than Mr. Volcker would be more responsible in assuming it? We’ll need Volcker’s tough-mindedness to stare down Congress if we are to ever exit all these stimulus programs. It’s a shame that the Mr. Bernanke had his identity stolen last fall, but the tragedy is that someone didn’t steal Mr. Greenspan’s in the 1990’s.

– Jack McHugh

U.S. Markets Wrap: Stocks Gain on Fuel Rise; Bonds, Dollar Fall
FDIC Problem Bank List Surges, Putting Fund at Risk
AIG Gains on Speculation Greenberg May Help Insurer
Bernanke Victimized by Identity Fraud Ring

Four Stages of Secular Bear Markets

As promised earlier, I pulled up a chart showing the stages of Secular Bear Markets historically.

This fascinating composite chart below is courtesy of the Strategy desk of Morgan Stanley Europe. It shows what the average of the past 19 major Bear markets globally have looked like:


Typical Secular Bear Market and Its Aftermath



The Chart represents typical secular bear markets based on MS’s sample of 19 such bear markets as shown after the jump.

There are obvious differences and similarities — the SPX fell 43% over 18 months, and snapped back 50% in 6 months. Almost but not quite as deep, but much faster a fall. What that means for the snapback is anyone’s guess.

There is no guarantee that the current market will track that amalgam, knowing what a composite of past Bears looks like can be helpful to your understanding of what is typical.

This table shows Secular Bear Markets and Subsequent Rebound Rally:




The Aftermath of Secular Bear Markets
Authors: Teun Draaisma, Ronan Carr, CFA & Graham Secker, Edmund Ng, CFA and Matthew Garman
Morgan Stanley European Strategy  10 August 2009

Kass Calls The Top

Doug Kass made a top call this week (mentioned yesterday here).

While I disagree with the timing of his market conclusion — historically, bear markets can run much further than we’ve seen so far — I am in agreement with his economic assessment. I will dig up a few historical analyses of what Secular Bear markets look like; As I have mentioned ad infinitum, 1973/74 is my favored comparison.

I suspect we will see a healthy correction of the market eventually, I remain unconvinced that we have seen the high print yet of this up-leg. Strong Momentum from a deeply oversold condition and popular underinvestment are a powerful and dangerous combination. (We are 60% long/40% cash at the moment).

Here are Doug’s 10 reasons why the rally has run out of steam and has “likely topped:”

1. Cost cuts are a corporate lifeline and so is fiscal stimulus, but both have a defined and limited life.

2. Cost cuts (exacerbated by wage deflation) pose an enduring threat to the consumer, which is still the most significant contributor to domestic growth.

3. The consumer entered the current downcycle exposed and levered to the hilt, and net worths have been damaged and will need to be repaired through higher savings and lower consumption.

4. The credit aftershock will continue to haunt the economy.

5. The effect of the Fed’s monetarist experiment and its impact on investing and spending still remain uncertain.

6. While the housing market has stabilized, its recovery will be muted, and there are few growth drivers to replace the important role taken by the real estate markets in the prior upturn.

7. Commercial real estate has only begun to enter a cyclical downturn.

8. While the public works component of public policy is a stimulant, the impact might be more muted than is generally recognized. There may be less than meets the eye as most of the current fiscal policy initiatives represent transfer payments that have a negative multiplier and create work disincentives.

9. Municipalities have historically provided economic stability — no more.

10. Federal, state and local taxes will be rising as the deficit must eventually be funded, and high-tax health and energy bills also loom.

Good stuff, Doug.


Kass: Market Has Likely Topped
Doug Kass, 08/26/09

What Do You Catch When You Chase Your Tail?

Good Evening: U.S. stocks went virtually nowhere today, allowing both the bears and the bulls to claim victory. Those predicting an imminent decline in U.S. share prices took note that a slight majority of stocks went down on a day when the economic data came in stronger than expected. For their part, those forecasting a continuation of the rally since March can rightly say that the major averages have held in well and refuse to sell off in spite of a laundry list of worries. Perhaps we are all straining our eyes too much in looking for directional clues. To me it seems as if everyone wants to chase what’s “working now” in favor of what is well priced to work in the future.

Stock index futures weren’t doing much prior to this morning’s data releases, and market participants were nonplussed by both a rise in mortgage applications and a surge in durable goods orders (see below). This usually volatile statistic jumped 4.9% in July, thanks mostly to orders in the transportation sector (think: cash for clunkers). The 0.8% rise in the ex-transportation component actually just fell shy of consensus estimates of 0.9%, so there wasn’t much news in this release.

Equities opened 0.5% this morning before swinging higher by the same amount after new home sales figures were announced. Market participants double-checked their screens when they saw sales rise almost 10%. Double digit sales gains and housing have not shared the same sentence for many moons, but percentages can play tricks on the mind when the base is low enough. Plus, new home sales are but 15% of total sales (existing home sales account for the other 85%). It was thus easy to understand why the averages rolled over and went back below unchanged in the wake of this report.

The trading was then very dull for the rest of the day. The averages bobbed over and under the unchanged mark all the way into the bell. By day’s end, only the Dow Transports (-1.3%) were more than a fraction away from Tuesday’s closing levels. Treasurys, too, saw a pretty slow session. A 5 year note auction was fairly well received, and it helped support bond prices after an early decline. Yields finished 1 to 3 bps lower. The U.S. dollar index (+0.4%) caught a minor bid, while commodities went the other way by a similar amount. A 1% retreat in crude oil and other energy products paced the CRB index to a loss of 0.5%.

It’s been 3 years since traders, salespeople, and investors have been able to take a vacation in August without too much angst about the next twitch in stock prices. I guess we’re all a bit out of practice when it comes to relaxing during the two weeks preceding Labor Day, and it shows. You can’t open up a newspaper, go to a financial website, or turn on Bubblevision (a term for CNBC that Bill Fleckenstein coined more than a decade ago) without being assaulted by the latest speculative opinion about which direction the stock market is headed during the next 5 minutes — give or take a commercial break.

The bull/bear debate I described in the opening paragraph is symptomatic of our instant gratification, gotta-know-now society. Like waiting for the latest polls during election season, equity investors have fallen prey to waiting for the latest bit of information to seize upon before deciding what to do next. And earnings season has almost become a joke, since the only thing that seems to matter is whether or not a company “beat the Street” last quarter. Investors only want to see a win, and they don’t seem to care what has actually been “won” or how victory has been achieved.

Take Williams-Sonoma — please! Down on this struggling, mid to high-end retailer going into today’s earnings report, analysts were expecting the company to lose 9 cents a share (see below). When the company revealed that it actually MADE 5 cents, the buy orders flew in well ahead of the serious questions about how WSM did it (the stock rose 11.25% to finish the day at $15.47 — I have never owned or shorted a single share). The company turned punk revenues into a profit by closing stores, slashing their advertising budget, and delaying planned capital expenditures — hardly the strategy one hopes to see in a growth stock. But is WSM a value stock at these levels? Let’s say the company’s thriftiness persists and it continues to earn a nickel every quarter. Let’s also be generous and say the company triples this amount during the quarter encompassing the holiday season. After a year, WSM would post a profit of .30 versus a stock price north of $15 per share. Paying 50 times earnings for a company that is trying to shrink its way to prosperity is hardly the stuff that would make Ben Graham or Warren Buffett reach for a buy ticket. True, “normalized” earnings might well be more than $1.00 per share, but this is the “new normal” for consumers, not the old normal.

I hope more people get to experience the strange feeling I had today when I tried to establish a small long position in a tiny company that I think has a strong balance sheet and a bright future. The Charles Schwab order system wouldn’t allow me to place the order, however, offering me a phone number to call instead. When I actually reached a live person, I soon discovered the problem. I couldn’t buy the name because Schwab doesn’t log a stock into its database until someone wants to buy (or sell) it. That’s right; I’m the first investor in Schwab history to try to buy shares in this thinly traded name. “Wow”, said the order taker on the other end of the line, “I’ve never seen this happen before. And you know what? There’s no listing of any analyst coverage, either!” I may or may not make a dime owning this company, but it sure felt nice to be far away from the pulsating throng that felt the need to compete over shares of Williams-Sonoma today

What’s been lost in the modern approach to investing is a true sense of value. It’s been replaced by a deification of momentum. Thus conditioned, the investor class is starting to become a herd of momentum seekers, chasing the latest information or movements in price. Judging from the email traffic I’ve received from readers, even smart people are trying to game what the less cranially endowed crowd is doing so they can try to profit from zigging after the next zag. No matter where the market goes in the next month or two, let us hope all the short term focus, this zany worshipping of momentum, starts to fade in favor of a return to the basic principles of value. If chasing momentum was such a fruitful endeavor, then why do we laugh at dogs that chase their tails?

– Jack McHugh

Most U.S. Stocks Drop After Report on Orders for Durable Goods
U.S. Economy: July Home Sales and Goods Orders Jump
Williams-Sonoma Rises After Profit Beats Estimates