Comstock: Indebtedness May Cause Two Lost Decades



When I make presentations, I use a chart showing the long term ratio of (all US, private and public) Debt to GDP. The chart above is a variation of that.


The CHART OF THE DAY shows U.S. total debt and gross domestic product since 1952, along with the ratio between them, based on data compiled by Bloomberg. The ratio rose in the first quarter to 372 percent even as household borrowing dropped for a second straight quarter, an unprecedented streak.

The U.S. is headed for “a deleveraging period” in which the amount of so-called private debt, including consumer borrowing, collapses as government borrowing explodes, Comstock wrote.

Assuming that private borrowers pay down debt at the same pace as they did in Japan after its 1980s economic bubble burst, the savings rate will climb to about 10 percent in 2018, the report said. The estimate was made in a study by the Federal Reserve Bank of San Francisco that Comstock cited. It’s more than double the 4.6 percent rate for June.

Comstocks suggest the U.S. economy may be entering into a lost decade like Japan’s economy. Comstock Partners they expect  a 20 period of substandard performance.

My fear is that zombie banks can turn us Japanese, but 20 lost years? Sheesh, I shudder to think about it.


Lost Couple of Decades’ Looming for U.S. Economy: Chart of Day
David Wilson
Bloomberg, August 7 2009

What do PG and AXP Tell Us About the Economy?

Good Evening: And so it continues. The pattern of an early drop in stock prices, followed by a late day rally held true to form again today. This trend has become so entrenched in recent weeks that, according to CF Global’s Philip Grant (who writes a fine market recap of his own), “the S&P 500 has now gone twenty one consecutive trading days (dating back to July 7) without sustaining a loss of 0.5% or greater.” Despite some choppy economic data and an earnings miss by Dow stalwart, Procter & Gamble, all it took was a hint of improvement in the July charge off data from American Express to bring the major averages back from their early declines. Since the transaction volumes at AXP are still falling at a double digit rate, what struck me about today’s news flow is that PG, AXP, and the ISM services survey all portray a less healthy U.S. consumer than Mr. Market would have us believe.

When Procter and Gamble announced an 18% decline in its Q4 earnings this morning, U.S. stocks were bound to take an early hit. Sales fell across the board for PG, a company that is supposed to be in the “recession-proof” category. The pre-opening economic data didn’t help, either. The employment data (Challenger Job Cut Report, ADP payroll estimate) were both on the weak side, setting up a potentially wider range of outcomes for Friday’s unemployment figures. The first dip in equities was bought once trading commenced, but that buying dissolved as soon as the ISM services survey results were posted. Against consensus estimates for a rise to 48.2, this survey of non manufacturing businesses inconveniently fell to 46.4 in June. Since, like many other data points of late, this piece of data had been getting less bad (remember, 50 is zero growth), a relapse for the worse was unwelcome. Factory orders were on the high side of expectations, but the major averages wasted little time in dropping 1% to 1.5% in the wake of the ISM release.

After bouncing around in the lower half of the day’s range for the next few hours, stocks recouped all their losses after American Express told analysts that AXP’s charge off rate in July would likely fall to 9.2% in July, versus 9.9% in June. The green shoots crowd seized upon this wonderful piece of news and bid up the company’s shares (AXP rose 5.75%). Not satisfied, market participants then presumed that all financial companies would soon see declining credit losses and bid up the whole financial sector (the BKX finished + 3.5%). Buyers even latched onto the lowly AIG and sent it zooming ahead to the tune of almost 63% today. First, the shorts trying to cover sent the name higher; then, rally established, the trend-seeking Quants bought more.

After trading above the unchanged mark for a short spell, the averages fell back a bit into the close. Wednesday’s losses ranged from 0.3% for the S&P to 0.9% for the Dow Transports. Treasurys had been up this morning, despite a larger than expected refunding schedule announced for next week, but the equity rally acted like gravity on government securities as the day progressed. Two year notes were flat, but yields rose as much as 8 bps on the long end of the curve. The dollar was a bit weaker and commodities were a bit firmer. The CRB index finished with a gain of 0.5%.

Just last year, Procter and Gamble was raising prices on many of its household products to combat the rising costs of raw material inputs. Presto! Margins were restored. But the consumer products giant will now have to rethink its strategy due to falling volumes (see below). Consumers are cutting back, even on items in PG’s sweet spot that are considered non-discretionary. Procter’s troubles aren’t behind it, either, since the company said it expects the weakness to continue for the rest of the year.

This picture of a consumer who is skimping on the basics was also confirmed by American Express today, it’s cheerful credit news notwithstanding. According to Reuters, CFO, Daniel Henry, said billed business declined 13 percent in July, compared to a 14 percent fall in June and a 17 percent drop in May. Double digit declines in a company’s main business are not good, even if the trend has a gentler negative slope. Consumers are charging less on their credit cards, including items like Crest, Tide, and quadruple-bladed Gillette razors. With today’s ISM non manufacturing survey saying that the largest sector of the U.S. economy (services) is still under pressure, it’s hard to see how PG and AXP will see better days any time soon.

If these behemoths are struggling, then what do their woes imply for the rest of the economy — or the stock market? Now that Q2 earnings season is largely in the books, the basic theme has been one of falling revenues but better than expected profits. The difference has been cost cutting (layoffs, less travel, etc.), but one company’s cost cuts hit the revenue line of other businesses. In the final article you see below, Charles Rotblut, CFA. and Senior Market Analyst & Editor at Zacks, argues this trend cannot persist.

Zacks lives and breathes earnings estimates, and Mr. Rotblut notes that earnings estimates aren’t rising as much as they should be if a recovery were truly taking hold. Even using the highest estimates for the combined earnings of the S&P 500 ($60.00), an index level of 1000 puts the P/E at a non bargain level of 16.67. These are only operating estimates (the “as reported” figures are far worse), so I think Mr. Rotblut’s caution is justified. The economy may be getting less worse, but the 50% leap in the S&P since March implies an economy that is getting better. All the more reason to pay close attention to Friday’s employment data. More than the number of the newly jobless, and more than even the unemployment rate, I’ll be watching to see if hours worked and average hourly earnings can tick higher. These last two series are the stuff of real incomes, the very stuff, in fact, that consumers need in order to pay for a load of P&G items with their American Express cards.

– Jack McHugh

U.S. Markets Wrap: Stocks Drop on Economic Data; Bonds Fall
P&G Profit Declines as Consumers Curb Spending
American Express card defaults fall, stock surges
Why Aren’t Profit Forecasts Higher?

Trading Observations

A friend (A) at a major trading house is a young but astute market oberver.

He notes some details of today’s action:

1. Volume is tracking for 11.7 billion shares, which if accomplished would be the largest volume day since June 26th. On that particular day, personal income and spending data for May revealed a sharp rise in the savings rate to 6.9% (which was revised down yesterday to 6.2%). Breadth is negative for both the NYSE and the Nasdaq, but the Arms Index (the ratio of NYSE advancers to NYSE decliners divided by the ratio of NYSE up volume to NYSE down volume) is ridiculously low at 0.37, indicating an outsized amount of volume in advancing stocks relative to the number of stocks which are advancing. Thank Jim Cramer: his call on Mad Money last night to buy Bank of America (its price is high enough now that institutions will feel comfortable buying it…the logic of which I think speaks for itself) has galvanized the bank stocks amidst an otherwise negative tape. JPMorgan’s tender offer for $3.4 billion of its preferred notes for roughly 60 cents on the dollar is also helping sentiment, as is what I’m guessing is a short covering exercise in Citigroup shares ahead of its preferred-to-common conversion tonight. Bank of America is up by about +5%, as is Citigroup, with those two stocks accounting for 1.2 billion shares so far today (at 1:15 p.m.). That puts the better than usual volume in perspective too.

2. Tech is dragging us lower today, both in price and breadth. An “MGIP” chart on Bloomberg reveals that the separation between the two occurred at 10:00 a.m. when the June Factory data (better than the Street’s expectation for -0.8% m/m at +0.4% m/m, with the inventory/shipments ratio declining to 1.42 from 1.45 which indicates that the inventory bulge is moving through the supply chain) and weaker-than-expected ISM non-manufacturing data came out. We saw an immediate separation between the two indices at 10:00 a.m. of about 20 basis points, and that has since widened out to about 50 basis points. Breadth for the two indices also diverged, with NYSE breadth improving after a 10:30 a.m. bottom (-1124 on the A/D line) while Nasdaq breadth rolled over and made a new intraday low just after 1 p.m. (-1144 on its A/D line).

Source for all data is Bloomberg.


Federal Reserve Coupons

Bet you didn’t realize the Fed offered discounts to anyone outside PIMCO, BlackRock, JPM and GS…

Retail Me Not is a searchable coupon tracking site that refers users to deals. You can suggest coupons and sites, and download a widget which will pop up when the site has a coupon code in its database for you visit.

Looks like someone was having some fun with the coupons







Hat tip Bryan

Toothless SEC Leaves SOX Full of Holes

Good Evening: After a morning decline, the major U.S. stock market averages rallied back to close higher today (this is a recording). Worries about a drop in personal incomes was overcome by a rise in pending home sales, though, as we’ll see, the former should matter more than the latter. The reflation trade (stocks & commodities up; Treasuries & the dollar down) thus survived another test today. Ben Bernanke, the FOMC, and investors are all counting on a continuation of these trends, so the payrolls data on Friday are once again setting up to be important. Unemployed people don’t have healthy incomes, and the 2003-2007 period aside, they usually don’t qualify for mortgages. Housing has received a lot of attention of late, so let’s delve into a few numbers to see how applicable the pending home sales index is to actual home sales. To close, I’ll be asking why senior GE managers won’t be doing the jail time prescribed by Sarbanes-Oxley.

Stocks overseas were on the defensive overnight, and it weighed on our stock index futures heading into Tuesday morning. Futures were further strained when the personal income and spending data came out an hour before the open. While spending came in as expected (+0.4%), incomes fell in both real and nominal terms. Incomes had been flattered by federal stimuli in the months preceding this reading, but to drop 1.3% month over month and 3.4% year over year does not bode well for future spending. Just as automakers can’t forever count on 0% financing or the occasional “cash for clunkers” program to boost sales, U.S. GDP cannot forever count on stimulus packages to pull demand forward (and finance it, to boot!). Credit isn’t (and shouldn’t be) easy to come by these days, so it will fall to income growth to support the consumer spending that comprises some 70% of GDP.

U.S. equities opened 0.5% to 0.75% lower this morning, but the lows were in almost as soon as the NYSE bell stopped vibrating. The move back toward unchanged was then aided when pending home sales were reported to have jumped 3.6% in June. This figure was proof positive to some that housing has now bottomed, but I question the validity of this supposedly forward-looking statistic. Pending sales are just that — pending — and they usually depend upon things like mortgage approval or the sale of a previous residence to become final sales. Comparing January to June pending sales with existing home sales for the same period gives us a hint why realtors post “Contract Pending” on the sign out front in lieu of the “Sold” they would rather place in its stead. Pending home sales have risen for 5 straight months and are up 17.6% since January. Existing home sales are only up just more than half as much (+8.9%, according to Bloomberg) during the same period. If Yogi Berra became a real estate broker, he might say, “it’s not sold until you sell it”.

After climbing back into green territory this morning, the major averages settled into a sideways range for most of the rest of the session. The averages were edging lower when a late rally surfaced in the final minutes to leave all the averages in the plus column. The fractional gain in the Dow Transports wasn’t too far behind today’s leader, the Russell 2000 (+0.9%). Treasurys were once again weaker, though the bears didn’t seem to put their hearts into today’s decline. Yields rose between 2 bps and 6 bps as the yield curve steepened. The dollar also had a sleepy session, with the greenback finishing on the positive side of mixed. Commodities likewise snoozed through Tuesday, though gains in the precious metals did allow the CRB index to finish 0.3% higher.

Friday’s employment data will be given thorough scrutiny, since incomes, spending, and even future home sales all depend, to varying degrees, on job growth. Inventory replenishment and deficit spending can only carry GDP so far before real, final demand has to pick up the slack. If the articles you see below about housing are any indication, then don’t count on high income earners to shoulder the demand burden any time soon. In the first piece, Barry Ritholtz rightly wonders how a firefighter qualified for a mortgage of nearly half a million dollars for a condo in Fort Meyers, FL. The sale closed in 2008, which is just a tad after the point at which unsupportable mortgage applications were supposed to be stamped “DOA” at the lender’s desk. I would further ask just why this family is the sole occupant in a multi-story condominium building (see photos accompanying the article). Hasn’t the rest of Florida read the newspapers? Housing has turned the corner, right?

Not in my hometown of Kenilworth, IL, according to yesterday’s Wall Street Journal (see below). Of the 800 homes in my village, some 65 are officially for sale. Having 8% of the town’s housing stock with “For Sale” signs on the front lawn doesn’t sound like a lot, but it’s approximately four times the normal 2%. Even more homes would be on the market, but they are being rented until prices recover. I’m glad other towns are starting to see “bidding wars”, but the article does not make it clear whether these fights are erupting over fully priced homes or distressed sales (i.e. foreclosures).

This is not some highly localized phenomenon, either. The upper end of the housing market is being squeezed across the nation. As the article points out, the culprits range from a dysfunctional jumbo mortgage market to government housing incentives that essentially read, “affluent need not apply”. High salaries have also been quick to feel the corporate knife during this cycle, and real estate taxes have risen in spite of the lower prices fetched among the homes that do eventually sell. And yet, whining about a problem doesn’t solve it. Perhaps higher marginal income tax rates next year will do the trick!

Finally tonight, I’d like to ask why our supposedly reinvigorated SEC is letting GE off the hook so easily. Some will read that GE is paying a fine of $50 million and think the SEC is back on the beat and handing out tickets. But, as Bill Fleckenstein remarked this afternoon in his always excellent Daily Rap (, $50 million is little more than a parking ticket for GE. Note please that GE’s accounting sins came in 2002 and 2003, or just after Sarbanes-Oxley was passed. Read the following about what became the law of the land in July of 2002 and see if you also think the SEC should set an example by slapping the bracelets on the GE corporate officers who officially signed off on what can now be described as inaccurate, if not fraudulent, earnings results:

Sarbanes-Oxley Section 302: Internal controls
Under Sarbanes-Oxley, two separate sections came into effect—one civil and the other criminal. 15 U.S.C. § 7241 (Section 302) (civil provision); 18 U.S.C. § 1350 (Section 906) (criminal provision).
Section 302 of the Act mandates a set of internal procedures designed to ensure accurate financial disclosure. The signing officers must certify that they are “responsible for establishing and maintaining internal controls” and “have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared.” 15 U.S.C. § 7241(a)(4). The officers must “have evaluated the effectiveness of the company’s internal controls as of a date within 90 days prior to the report” and “have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date.” Id.. (source: Wikipedia

Sarbanes-Oxley Section 802: Criminal penalties for violation of SOX
Section 802(a) of the SOX, 18 U.S.C. § 1519 states: “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.” (source: Wikipedia op. cit.)

By putting senior executives on the hook — personally — SOX was supposed to scare straight the tricky managers who would otherwise cook the books. “No more Enrons or WorldComs!” thundered Congress at the time the legislation passed. Do you think writing a corporate check out of petty cash will deter others from engaging in illegal accounting practices? You be the judge.

– Jack McHugh P.S.

U.S. Stocks Advance as Home Sales Overshadow Valuation Concern
Treasuries Decline as U.S. Pending Home Sales Surge in June
GE Pays $50 Million to Resolve SEC Accounting Probe
Alone in a 32 Story Condo: How Did This Mortgage Close?
High End Homes Frozen Out of Budding Housing Rebound

Pending Sales Rise 6.7%

The NAR’s Pending Home Sale index rose 6.7% over June 2008. Monthly gains (caused in large part by seasonal factors) were also up 3.6%. The biggest gains were in the South and West, regions where the foreclosure rates are the highest.

This annual number is actually a significant data point. It reflects several short term positives for Housing:

1. $8,000 tax credit (soon to be expiring)
2. ZIRP: Mortgage Rates, while up from lows, remain competitive
3. Most foreclosure moratoriums have ended; This will continue driving down prices even further, especially at the lower end of the market.

Good news: More foreclosures going forward should be stimulative of more transactions.

Bad news: July/August is the peak of transactions on a seasonal basis; Look for falling monthly sales starting in the fall through the annual January low. Also, note that once the first time tax credit is expiring, and California subsidies are being canceled due to lack of funds.


I’ll see if I can pull the trailing numbers to identify how easy or difficult the annual comparisons will be going forward.


Uptrend Continues in Pending Home Sales
National Association of Realtors, August 04, 2009

Reflation = S&P 1000; What’s Next?

Good Evening: U.S. stocks once again surged ahead on Monday, leaving the widely watched S&P 500 above 1000 for the first time since last autumn’s precipitous fall. Leading the way were the economically sensitive materials, energy, and industrial names, which themselves were the beneficiaries of a strong tailwind in the commodity pits. As soon as China’s PMI logged its 5th consecutive reading above the 50 mark last Friday morning, natural resource firms around the world have outperformed. This morning’s economic data in the U.S. only added to the momentum behind these resource plays, and today’s proceedings left the S&P up more than 50% since the March lows. Such a prodigious climb in less five months is a quite the achievement for a broad market index. It leaves open only one little question: Where to from here?

Overseas markets were higher overnight, as Asian markets continued to bask in the afterglow of last week’s positive Chinese PMI reading (see below). European markets were also firm in the wake of better than expected earnings announcements from both Barclay’s and HSBC. U.S. stock market futures were some 1% higher prior to the open, and those gains were extended when Monday’s economic data hit the tape (see below). The national ISM survey posted an upside surprise, coming in just below 50, the fulcrum level between expansion and contraction in the manufacturing sector. Construction spending likewise exceeded consensus expectations, but it was the auto sales data that set tongues a wagging. Aided by the “Cash for Clunkers” program (which was oversubscribed in less than one bureaucratically administered week), auto sales were up for what seemed like the first time since the onset of the Great Recession. Ford’s 2.3% gain, for example, was the first uptick for the last U.S. automaker standing since 2007.

Stocks leapt as these data points were revealed, doubling the early gains of 0.5% to 1%. Once the S&P vaulted into 4 digit territory, however, market participants backed off a bit to see if the market could maintain those early gains. The averages traded mostly sideways for the rest of the session, though some late buying left the indexes near their best levels of the day. Reflation and beneficiaries of Chinese demand were the dominant themes, as the averages advanced between 1.25% (Dow) and 2.65% (Dow Transports). Historically, Treasurys have embraced anything having to do with the words recession and deflation. But add “re” to “flation” and you have a word that keeps bond investors up at night. Spying this less than welcome word in the press more than once today, Treasury market participants marked up bond yields between 7 and 16 bps. 5’s, 7’s, and 10’s bore the brunt of the selling. The dollar was also weak, losing a further 1% today, and commodities again soared in response. Crude oil climbed back into the low 70’s, grains roared ahead, and even the metals did their part as the CRB index rose almost 3.5%.

Back on January 2, I decided to hazard a few guesses about 2009. About the S&P 500, I said it might “trade in a wide range. Upper end for S&P is 1000 to 1100, while there is a better than 50/50 chance we see the November 2008 low of 741 taken out in 2009″. Honestly, I thought the rally to 1000 would come first, offering up a four digit welcome mat to the newly elected President, Barack Obama. I thought the reality of a faltering economy and souring loan portfolios would then snap investors back to reality, but while both ends of this forecast have (as of today) now come true, I got the timing exactly backwards. Whereas investors believed back in March that policy actions taken to revive the financial system were too little and too late, here in the first week of August some are even talking about welcoming Goldilocks back to her former perch at the corner of Wall and Broad.

Swinging from optimism to pessimism and back again is old hat for Mr. Market. Just when investors think they know which direction the old geezer is headed, he often — and inconveniently — does an about face. After plunging to the depths just as this past winter was ending, U.S. equities rose with the first green shoots of spring. Now up more than 50% since those harrowing days 5 months ago, many now claim stocks are headed another 10% to 20% higher before the calendar says 2010. Mr. Market doesn’t even look winded. Of course, he looked every bit as spry to NASDAQ investors twice during the crackup, only to later fall over and set new lows. And, in perhaps his most legendary pump-fake of all time, Mr. Market fooled even the most experienced professionals after the Great Crash in 1929.

As you will see by clicking on the final link below, the Dow dropped from a 1929 high of 381.17 to 198.69 after “Black Tuesday”. Sensing a washout that had purged the market of its sins and populated the tape with astonishing values, the professionals snapped up the bargains the public had left like litter on the NYSE trading floor. By the following April, the Dow had clawed its way back to 294.07, a gain of nearly 50% in just less than six glorious months. Unfortunately, the TARP-less Dow then trapped an entire generation of bargain hunters when it then dropped to 41.22 by 1932.

I relate this old tale (akin to a ghost story for asset managers) not to say something similar is about to befall post-millennial bargain hunters. The advent of the digital age allows the Federal Reserve to create a trillion or two with a few keystrokes, and its Great Depression-phobic Chairman, Ben Bernanke, will move mountains (of money) to prevent another depression. I write about the 1929-30 experience as a warning to those whose great grandfathers thought they, too, had nothing to worry about by buying stocks after a huge decline. They were quite sure of themselves, these long ago contrarians, and yet they were quite fooled by what was to come next.

We may not make the same mistakes made 8 decades ago, but that does not imply we will not make some of our own. I guess it’s possible that the alchemists at the Fed have found a way to turn paper into gold and that it’s onward and upward from here for both our economy and markets — but I doubt it. As for what comes next, I honestly don’t know. The one thing I do know is that marching into a cable T.V. studio and telling viewers exactly what will happen next is foolhardy. Foresight is a rare commodity in this environment, and even hindsight can play tricks on us.

For evidence I submit the action in the S&P 500 during the week AFTER Lehman failed. On Friday September 12, the last trading day before the nerve-fraying announcement that LEH would file for bankruptcy protection, the SPX closed at 1252. So, take a guess: Where did the SPX close on the following Friday — after the Lehman earthquake sent tremors around the globe? How much of your life savings would you put on the line — even with the full benefit of hindsight! — if I gave you even money odds on the simple, binary choice of higher or lower? The correct answer is “higher”. The S&P 500 closed at 1255 on September 19, 2008. If you don’t believe me, you can look it up. Mr. Market can throw you for a loop even when you know how the story turns out. What happened to those who bought stocks in early 1930, as well as to those who bought in because they thought Lehman’s failure marked the panic lows, should teach us to be a little more humble when it comes to investing. If not, Mr. Market has a way of teaching us this lesson the hard way.

– Jack McHugh

U.S. Markets Wrap: S&P 500 Tops 1,000; Metals Rise, Bonds Fall

U.S. Economy: Factories Steady, Stimulus Helps Demand

China Manufacturing Expands a Fourth Month, PMI Shows

Chart of the Dow Jones Industrial Average: 1920 to 1940

What You’ve Been Waiting For

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Insights from The Big Picture Conference

If you could not make the Big Picture Conference, here’s your opportunity to hear straight from some of the most interesting commentators on the markets, the bailout, the press and myth of risk management.

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-Rep. Alan Grayson explains his position on oversight of the Fed’s bailout and discusses reforming the banking system with Nassim Taleb.

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Markets: Today versus March 9 Lows

Rosie via Abelson:

“DAVE ROSENBERG IS AMONG the vanishing breed of die-hards (we confess, in case you haven’t guessed, to being another) who still cling to the notion that stocks’ explosive rise since March is perhaps the mother of all bear-market rallies, but nonetheless still a bear-market rally. The essence of his skepticism — which we happily second — is simply that the economy, contrary to Wall Street’s jubilant insistence, has yet to turn the corner.

He wonders, moreover, whether the March 6 lows in the stock market were the real McCoy. Although, in contrast to us, Dave persists in keeping an open mind, he’s doubtful that they were. On March 6, he recounts, the market was trading at two times book, with a 13 times multiple on forward earnings and a P/E of 18 on trailing earnings, and a 3% dividend yield. Pretty rich valuations by all three measures of earnings, but pretty skimpy on yield, to rate as a true market low.

And today, after a 45% rise, the metrics, to dip into the Street cliché, are positively mind-boggling. The dividend yield on the S&P 500, Dave notes, is a meager 2¾%, and payouts so far this year have lagged some 32% behind last year’s not-exactly-torrid pace.

In a like astounding vein, he observes, the trailing P/E on operating earnings (adjusted, he explains, “to take out everything that is bad”) is now at 24 times, while — and if you have a queasy stomach you can skip this number — on trailing reported earnings, the multiple is a mere 760-plus!

“Something tells us,” Dave sighs, “that the marginal buyer of equities today at that price may well be the same person who was loading up on real estate during the summer of ‘06.”

Fascinating stuff . . .


The Great Beer Bash
Barron’s, August 3, 2009

Discrete, discreet trading

One of the things I was concerned with many moons ago is the difference between the types of behaviours you can get in discrete and continuous time. Continuous functions are funky beyond belief, and the less you have to reason about them, generally the better. (For a sample of some of the pathologies, see this book.) Therefore I was particularly interested to read a suggestion by Michael Wellman on making equity trading safer (and, by disallowing order sniffing robots, more discreet) by making it, well, more discrete. Here's the idea: Wellman suggests
a discrete-time market mechanism (technically, a call market), where orders are received continuously but clear only at periodic intervals. The interval could be quite short--say, one second--or aggregate over longer times--five or ten seconds, or a minute. Orders accumulate over the interval, with no information about the order book available to any trading party. At the end of the period, the market clears at a uniform price, traders are notified, and the clearing price becomes public knowledge. Unmatched orders may expire or be retained at the discretion of the submitting traders.
This is really a nice idea. Real users would notice no difference between a market discretised in ten second blocks and a continuous one, but at a stroke bad high frequency trading would be eliminated. Add in a minimum (but low) bid/offer spread too, and the system becomes significantly more robust. The high frequency traders can no longer take your money off the table.

YTD Index Performance

That’s all for July! With the 7th month of the year now in the can, let’s take a quick look at YTD performance:

Dow Jones Industrial Average +4.3%

S&P 500 INDEX +9.24%


52 week performance is a tad less robust.

Is Big Really Beautiful?

Bill Dunkelberg is currently a professor of economics at Temple University where he served as dean of the School of Business from 1987-95. Prior appointments were at Purdue, Stanford and the University of Michigan. He has served as the Chief Economist for the National Federation of Independent Business for 35 years, is the Chairman of Liberty Bell Bank (NJ) and Economic Strategist for Boenning & Scattergood (1914, Philadelphia).


In a recent Financial Times editorial (July 30), Josef Ackermann of Deutsche Bank made his case for larger banks, arguing that they are beneficial and only the “interconnectedness” of banks caused our massive financial market failure. “Big , beautiful banks” may have nice, expensive buildings (if you happen to be in one) but little else to recommend them. Small banks may not have ornate, expensive buildings, but they get the job done with far less risk and cost to consumers and shareholders. Research undertaken by the Board of Governors of the Federal Reserve found few if any benefits to scale beyond $5 or $10 billion in asset size. So, for customers and shareholders, big is not obviously better, although for executives, life is good, pay is great.

The ultimate in “interconnectedness” is one bank with thousands of branches. So with one bad decision at headquarters, the entire system goes down. Credit standards are set by one officer for the entire economy, there is no “competition” for innovation in lending technologies or risk-taking. Mr. Ackermann is correct about the risk of interconnectedness as was illustrated by news headlines last fall: “Credit markets frozen – banks wont led to each other.” I thought banks were supposed to lend to consumers and businesses, not to each other. That was indeed the start of our troubles.

In a globalized market, “trapped pools of liquidity and capital” would not occur, capital flows easily where returns call. But with many independent suppliers of capital, there is more scrutiny, less chance that one big pool of capital will be poorly allocated or put at risk by risk-taking adventures or bad decision making.

Studies of the National Federation of Independent Business’ (U.S.) hundreds of thousands of members revealed that SMEs were best served in the U.S. in unit banking states (banks were allowed only one branch) and least well served in states allowing state-wide branching. Loan terms and satisfaction were always highest in states permitting only one bank branch. Big banks do not serve this vital economic community well. The 8,000 independent banks in the U.S. buffered the financial shock for SME’s, and now are unfortunately being required to pay for the losses to depositors generated by “large” banks. FDIC insurance costs are typically 500% higher than just two years ago, seriously impairing the earnings of these smaller banks.

Maybe we wouldn’t need “internationally coordinated crisis management” if we didn’t have mega banks lending to each other into markets that they are unfamiliar with, taking risks they should not take with our money. Large banks may be useful for large firms, but they need not be nearly as large as those we have today or that we had last year before they brought down our financial system.

The Great Recession is Over! Long Live the Ordinary Recession . . .

There will be some good news and some bad news this morning at 8:30. That’s when GDP will be released.

The Good News will be that we are no longer contracting at the painful rate of 6% annually; Call it the end of the Freefall period we saw from September 2008 to March 2009. The Bad News will be twofold: 1) That the national economy is still contracting; the 2) Why we are contracting — the real world factors — will show the recession marches on.

My best guess — and given the oddities of this data point, we can only accurately call this a guess — is 1.5- 2.0%. If the number comes in negative, it will be the 4th consecutive quarter in a row of contraction.

In an odd twist, US consumers are weaker than their Asian and European counterparts. This turns out to be positive for the GDP data. Why? When imports fall faster than exports, it is a net gain for the way GDP is calculated. I know that sounds bizarre, but on a relative basis, less US consumption of imports, is additive to the final GDP number.

What else do we know about economic activity this quarter?

• Unemployment has risen;

• Wages continue to slide;

• Industrial production has fallen every month;

• Deflation continues to stalk many asset classes;

• Credit availability is weak, lending standards are tight;

• Capacity utilization is at a very low rate of 68%;

• Retail sales (other than gasoline price increases) are soft;

What does this mean in terms of the end of the recession? The NBER calls a recession –the way they use the word– as “a period of diminishing activity.” If economic activity is poor, but flat — meaning, a low plateau at the trough — they very well could call the end of the recession.

However, they describe their procedure for identifying ends of recessions by looking at when the contraction ends. That is unlikely to be Q2 of 2009.

As Paul Vigna notes in this morning’s WSJ, “The elements that will drive a recovery — rising wages, consumer demand, production and sales — haven’t appeared.”

Hence, regardless of GDP data, the Recession is likely continuing, albeit in an ordinary, form.

Backbone Not Likely in Fed’s Exit Strategy Toolkit

Good Evening: Just when market participants had grown used to the stock market’s recent pattern of falling in the morning and rising in the afternoon, U.S. share prices pulled a George Costanza and did the opposite today (if you are unsure what this “Seinfeld” reference means, click here). Higher markets overseas, some decent earnings reports, and a positive interpretation of the jobless claims figures were all factors in pushing stocks to new highs for the year this morning. Some profit taking left the market looking a little winded in the afternoon, but it was a good day for the bulls nonetheless. Perhaps a few more sessions like today will cause the Fed to start thinking about implementing the “exit strategy” Ben Bernanke offered Congress earlier this month, but, to turn a cliché on its head, for every way there must first be a will.

Stocks in Asia and Europe were green enough this morning to propel our stock index futures higher. Positive earnings reports from MasterCard, Visa, Cigna, and Motorola only added to the anticipation prior to this morning’s open, even if Exxon and Symantec missed. Initial jobless claims scooted higher during the latest reporting week, but analysts (like those at BAC-MER, see below) pointed to the third consecutive drop in continuing claims as a reason to keep thinking the recession is over. Distortions caused by mis-timed seasonal factors this year, as well as the increasing number of those who are rolling off the continuing claims report because their benefits have expired, were brushed aside. The data point to “fewer layoffs at hand”, says Bank of America/Merrill Lynch. We’ll find out soon enough with next week’s non farm payrolls numbers, for which the early guesstimates are centering on 300K to 350K.

As if hearing Cramer’s soundboard shouting “buy, buy, buy!”, investors bid up stock prices as soon as the opening bell rang in New York. Within sixty minutes of trading, the major averages were sporting nifty gains of 2% or more. Twenty minutes and another 0.5% later, the highs of the day were in. Peaking at just over 996, the S&P 500 just missed out in its first attempt to surmount the 1000 level since just after Lehman Brothers went the way of the Dodo bird. Roaring back due to a fierce rally in commodity prices, the energy and materials names that were so weak on Tuesday and Wednesday were the leaders today. After trading sideways for the next few hours, the indexes were hit by some profit taking during the final hour. Though half the day’s best levels, the closing gains were still notable, ranging from the Dow’s 0.9% to the Dow Transport’s 1.8%. It’s far too soon to say if the pattern change away from morning weakness and afternoon strength means a trend change is at hand, but it will bear watching.

Like the 7 year note auction, Treasurys fared better today. With the 7’s receiving more numerous and higher quality bids (read: foreign central banks) than at any auction this week, the rest of the curve benefited — if unevenly. Yields on shorter dated maturities fell only a couple of basis points, while those at the long end fell as much as 10 bps. The yield curve’s penchant for flattening this week persisted today. The dollar fell with the renewed level of risk taking, and commodity market participants took full advantage. Crude oil regained most of what it lost yesterday, and the grain markets behaved as if no rain will fall between now and Labor Day. Posting a gain that approached 4%, the CRB index was the site of the real action today.

Elevated stock prices and buoyant commodities prices have been an unspoken goal of Fed policy ever since the GSEs jumped into the waiting arms of Hank Paulson a year ago. Already then operating at a feverish pace to plug the growing holes in the financial system, the Bank of Bernanke hit the panic button in September when LEH failed. Ten months later, the system is limping along well enough that exit strategies are up for discussion, if not action. No doubt Mr. Bernanke would prefer robust economic activity to the increased levels of speculation so evident this morning, but the Chairman will probably take what he can get until economic activity picks up. Come that happy day, promises Mr. Bernanke, the Fed will use numerous and considerable tools to withdraw the massive stimuli now in the financial system.

This “we put it in and we’ll take it back out” pledge is easier said than done, according to FT columnist, Wolfgang Munchau (see below). Mr. Munchau doesn’t doubt the Fed, ECB, and other central banks have “a toolkit of policies to prevent an increase in inflation once the economy starts to recover…but simply possessing such tools does not make an exit strategy.” He cites, among other obstacles, the politics that will complicate the timing of any move to remove bank reserves. When unemployment push comes to inflation shove, voters and the politicians they elect tend to emphasize the growthy half of the Fed’s dual mandate of full employment and price stability. President Obama wasn’t swept into office with a mandate for price stability.

Once growth finally does return, the real risk won’t be that the FOMC doesn’t have the tools with which to fight an incipient inflation, but whether or not they have the will to use them. Perhaps Bernanke believes that just talking about an exit strategy will forestall the need to implement one by keeping inflation expectations in check. But talk is cheap, as Hank Paulson discovered when the markets called his Bazooka bluff a year ago. Mr. Bernanke had better hope there is a backbone in the toolkit he showed Congress earlier this month. If the 4% rally we saw today in the CRB some day becomes a habit, he’ll need a Volcker-sized one.

– Jack McHugh

U.S. Stocks Rally, S&P 500 Nears Nine-Month High, on Earnings
Initial claims rise, but fewer layoffs at hand
There is no easy way out for central banks

Ned Davis on Secular vs. Cyclical Bull Markets

Mark Hulbert looks at the question of whether this is a once-in-a-generation stock market low (secular bull market)  or a mere “cyclical” low.

To figure out which, he looks to Ned Davis of Ned Davis Research.  NDR  identified seven factors to determine if any given market low is a secular low, setting up the next lasting Bull Market.

The Seven Factors: There should be:

1. Money, cheap and amply available;
2. Debt structure that’s been deflated;
3. Large pent-up demand for goods and services;
4. Stocks that are clearly cheap;
5. Investors who are deeply pessimistic;
6. Major investor groups with below-average stock holdings;
7. Fully oversold, longer-term market conditions.

Looking at these elements, how does this cycle measure ?

1. Cheap MoneyNeutral. You might think that this factor should be rated as “bullish,” given how accommodative the Federal Reserve is currently. But Davis notes that banks are also significantly tightening their lending standards. Given the heavy load of debt under which both consumers as well as corporations suffer (see next criterion), banks are finding it “increasingly hard to find ‘credit-worthy’ borrowers.”

2. Debt structure deflated? Bearish. This is the most negative of any of Davis’ seven dimensions, since by no means is the debt structure deflated. On the contrary, Davis calculates that the total credit-market debt load right now is nearly four times the size of gross domestic product, and that it takes more than $6 of new debt for our country to produce just $1 of GDP growth. That’s almost double the amount of debt required in the 1990s.

3. Pent-up demand? Bearish. Davis acknowledges that there has been improvement along this dimension from where things stood at the beginning of the bear market. But he is particularly worried by the ratio of total Personal Consumption Expenditures to Non-Residential Fixed Investment, which currently stands at a record high. At the secular bear market low in 1982, in contrast, this ratio was at a record low.

4. Cheap Stocks? Neutral. Though the stock market “got undervalued at the March lows,” it never became “dirt cheap.”

5.  Sentiment? Bullish. Davis says that past secular market lows were accompanied by an extreme amount of pessimism, and his indicators show a similar extreme existed earlier this year.

6. Stock vs cash reservesNeutral. While foreign investors have record-low stock holdings, according to Davis, household holdings — while low — are not nearly as low as they were at prior secular bear market lows. And institutional investors’ stock holdings “are only down to an average weighting historically.”

7. Oversold longer-term market condition? Neutral. Davis believes that, though many of the excesses of the real-estate bubble have been worked off, some still exist. That’s particularly a problem, he says, given that the stock market bubble of the late 1990s never completely deflated either. “As we saw in Japan after 1990, a double-bubble in stocks and real estate leaves it difficult to put ‘humpty dumpty’ together again.”

According to Davis, there is but one of the seven foundations of a major secular bull market in place. Three are neutral, three are bearish.

Conclusion This is a Cyclical Bull market . . .


Secular bear, cyclical bull
Mark Hulbert
MarketWatch Jul 30, 2009, 12:01 a.m. EST

Settling For Less in the New Normal

Good Evening: Just as they have during 9 of the past 10 sessions, U.S. stocks suffered a setback in the morning, only to rally late in the day. Unlike so many recent sessions, however, all the major averages remained in the red as the closing bell rang on Wednesday. A sell off in China, some weakish economic data, falling commodity prices, and a poor 5 year note auction gave Mr. Market a list of reasons to retreat today. That he cedes ground only grudgingly is a testament to the old gentleman’s resilience, but it may also mean a larger move (up or down) is coming. The VIX, for example, is proving just as resistant to decline as are the main indexes. PIMCO’s Bill Gross would argue that the old man would be well advised to keep his pulse in check until nominal GDP growth shows some resilience of its own.

The big news overnight was not earnings related, but China related. Whispers are flowing from Beijing that the central government either is, or soon will be, attempting to rein in the breakneck pace of lending by that nation’s banks. I have no idea whether these rumors will prove to be true, but they were given currency by a 5% fall in Chinese stock prices today, as well as by the large thumping delivered to the types of commodities China loves to consume. Then again, these moves could simply be a corrective head fake after long upside runs, so market participants will be watching China’s next PMI number (Thursday night) for clues. Since Chinese demand has been the fertilizer to the green shoots spotted here and in Europe, any threats to that demand will likely have a cooling effect on global risk appetites.

U.S. stock index futures were thus on the defensive this morning when word hit the tape that Yahoo! and Microsoft had finally struck a deal. In an interesting display of how things have changed over the 20 month courtship between the two companies, Yahoo went from being the subject of a $40 billion takeover to simply sharing some search assets with MSFT. No cash will be changing hands, so Microsoft will be getting most of what it wanted from Yahoo, while YHOO’s shareholders are left to wonder why its former CEO didn’t simply hit a bid and get a check back in 2007. Above $34/share back when the takeover talk was thick, YHOO today finished just north of $15. Settling for less than one had hoped (just ask anyone trying to sell a home) has become a theme since the great tumult arrived, and what happened to Yahoo! is emblematic of our times.

Stocks opened 1% lower this morning before recouping most of those losses. Durable goods orders sent a mixed message, with the headline figure a disappointment and the ex-transportation figure an upside surprise (see below). The Fed’s Beige Book was similarly filled with positives and negatives for analysts to argue over, but after the morning lows more or less held this afternoon, the major averages rallied into the bell. As they did yesterday, energy and materials names weighed on the averages. For once, though, the indexes were all moving together, and the final losses ranged from the Dow’s 0.3% to the Russell 2000’s 0.65%.

Treasurys were up when stocks were down this morning, but they, too, finished mixed after a poor 5 year note auction. Both the bid to cover and indirect bidder ratios were much weaker than in other recent auctions. I guess that’s what happens when a government offers record amounts of new paper. The dollar built upon yesterday’s rally and finished 0.7% higher, a fact which only encouraged further liquidation in the commodity pits. The rumors from China and the firm greenback were already conspiring against commodities when a report showing a huge build in crude oil inventories knocked that market for a loop. Falling energy prices were the biggest factor in today’s 2.7% drubbing suffered by the CRB index.

Tonight I’d like to discuss two different articles that came out today, and while the authors (Barry Ritholtz and Bill Gross) may not have much in common, they both would like to remind investors not to get too carried away with the recent batches of less poor economic data. Barry’s gripe has to do with the latest housing data, and it’s posted on his fine website, The Big Picture (see Permalink below). I’ll let Barry tell the tale in his own words, but the key point to take away is that the reported rise in the June new home sales figures was less than meets the eye. New home sales for June of 2009 were in fact the worst totals for any June since 1982. Barry offers multiple charts to buttress his main point — that a return to “a healthy market cleared out of excess inventory with genuine price increases is likely years away . . .”

PIMCO’s Bill Gross would also like to waggle a finger at those who think global warning better describes the current investment climate. Though many investors may think they’ve found a “love potion” in the frisky stock market action since March, Mr. Gross warns folks not to be led astray by hope. He contends that our leveraged economy was structured to live in a world of 5% nominal GDP growth, a rate he sees as unattainable in the “New Normal”. Returns on risk assets will suffer in this environment, Gross says, and those who hope all the government’s efforts at stimulus will return the U.S. economy to status quo ante are bound to be disappointed.

There are what he calls “quality constraints” (i.e. collateral haircuts and actual down payments!) on most of these federal lending programs, and he sees nominal GDP settling in around a sub par 3%. He wraps up by saying that “a 3% nominal GDP ‘new normal’ means lower profit growth, permanently higher unemployment, capped consumer spending growth rates, and an increasing involvement of the government sector, which substantially changes the character of the American Capitalistic model”. Rather than a love potion, it would seem Doctor Gross is prescribing a dose of the Cod Liver Oil remedy of past generations. Well, just as Yahoo’s shareholders realized today, I guess we’ll all have to settle for less in the “new normal”.

– Jack McHugh

U.S. Markets Wrap: Stocks, Treasuries, Oil Drop, Dollar Rises
U.S. Durable Goods Orders Rise Excluding Cars, Planes
Worst June New Home Sales Since 1982, by Barry Ritholtz
Investment Outlook: Investment Potions, by Bill Gross, PIMCO

Beige Book: Less Bad Is the New Good

The Current Economic Conditions, aka The Beige Book, is a Federal Reserve report published 8X/year. Each Fed District gathers anecdotal information on current economic conditions in each District and reports back to the Fed.

The Beige Book summarizes this information by District and sector. An overall summary of the twelve district reports is prepared by a designated Federal Reserve Bank on a rotating basis.

Current findings are that the “Pace of Economic Decline” is slowing.

Way behind . . .

Good show — first time I met Arianna Huffington, and we obviously disagree about Foreclosure, but she was very nice.

I’ll get the video posted as soon as it comes out.

Late getting back to the office from 30 Rock — I need a few minutes to catch up


Madoff Video

Housing Video