BusinessWeek: The Case for Optimism

current_120x160I am not sure what to make of this BW cover: It shows an Ostrich, with its head buried in the ground, making the case apparently for Blind Optimism.

Consider the following if you want to think of this as good advice or as a contrary indicator:

-Could this cover have come out in late February or early March?
-Or, does it take a 50% rally to give nerve to the editors who made this decision?”

I suspect it is the latter.

Hence, why this is more likely a contrary indicator than good advice.

Excerpt:

Sure, it has been a harrowing storm. And now is no time to discount the dangers that still exist. But opening your mind to optimism can help you seize the opportunities ahead

The U.S. economy is in such bad shape that the loss of (just) a quarter-million jobs in July was greeted as good news. Long-term unemployment and foreclosures continue to mount in the worst economic downturn since the 1930s. Health-care costs are out of control. An aging population around the globe is driving government spending through the roof. And scientists say we need an expensive crash program to fight global warming or we’ll incinerate ourselves. It’s little wonder that despite some positive news lately, the daily Gallup Poll on U.S. economic conditions as of Aug. 11 found that 53% of Americans think the U.S. economic outlook is getting worse (yes, even worse), vs. 42% who think it is getting better.

But before you assume a purely defensive posture—knees pulled to chest, hands on head—remember this: Just as people become overly exuberant in good times, they tend to get too pessimistic in bad times. While the economy remains deep in a hole, and could indeed get worse, the truth is that nobody really knows what will happen next. Prudence demands that you prepare yourself for all possible outcomes, including some highly positive ones.

Note: My motto is “Hope for the best, prepare for the worst.” No excessive optimism or pessimism required . . .

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Source:
The Case for Optimism
BusinessWeek, August 24 and 31, 2009
http://www.businessweek.com/magazine/toc/09_34/B4144magazine.htm


Checking Back in with Taleb

Good Evening: U.S. stocks today recovered almost half the losses they suffered yesterday. Credit for today’s light volume comeback goes to the combined effects of a recovery in Asian equities (China’s CSI 300 was up 1%), some analyst upgrades in the tech sector, and earnings beats by some retailers. What the future holds for U.S. equities is anyone’s guess, but many will be looking to the charts for clues. If the averages really are set to correct, then the S&P 500 should run into stiff resistance between 990 and 1000 during the next day or two. A close above 1000 will probably reset the clock on any near term correction, but should the widely watched benchmark continue to close below the 4 digit mark, then a test of the 950 level is likely imminent. A break of 950 will set up tests of support between 900 and 875. Below those levels will put the cat once more among the pigeons, but it’s too soon to speculate about a resumption of the primary bear market. As for reasons why such a possibility is not out of the question, perhaps it will help to check back with Nassim Taleb to get his latest views.

Since it was angst about Chinese equities and the implied lower demand for commodities by that nation that helped pressure stocks during the previous two sessions, an overnight rally in China helped stabilize stock prices around the world. Accordingly, our index futures were already in positive territory this morning when Home Depot and Target reported better than expected earnings (Saks reported a narrower than expected loss, though TJX disappointed). These retailers recorded punk top line sales, but both managed to cut costs and manage inventories well enough in Q2 to outstrip analyst expectations. Analysts were also responsible for a pop in technology stocks, with the most noteworthy upgrade coming for the entire mobile handset sector. Thus inspired, the NASDAQ then led the indexes higher for most of Tuesday’s trading, though it was interesting to see Google sit out the festivities. One day does not make a trend, but a leader like GOOG should not be a wallflower.

Stocks opened to the upside and were 0.5% higher during the first hour of trading. The economic data seemed to have little impact on today’s events, with PPI and housing starts coming in well below expectations. Perhaps there was some confusion as to whether falling producer prices were either good news or bad at this point in the cycle, and the same could also be said about the housing data (see below). While overall starts fell short of the mark (and remain far, far below peak levels), the glass half full contingent pointed to rising single family starts for the 5th consecutive month as unalloyed good news. Though I’m glad folks are gainfully employed while erecting these structures, the last thing an oversupplied housing market needs is more homes.

If any of the foregoing bothered equity investors, they didn’t show it. Stocks rallied 1% to 1.5% by mid day before settling in to a dull and narrow range. The averages went out near their highs, with the Dow (+0.9%) lagging, while the 1.7% gain in the Dow Transports led the way. Treasurys also played their “counter-trend Tuesday” role in giving up about half of yesterday’s gains. Yields rose between 2 and 5 bps. The dollar followed suit in falling after two days of gains, while commodities made it a clean sweep by rising. A 3.7% rise in crude oil set the pace as the CRB index rose 1% today.

Nassim N. Taleb needs no introductions to regular readers of these commentaries. I’ve read both his books, and recounted at length some of the interesting views he espoused at Barry Ritholtz’s conference back in June. I missed his appearance on CNBC last week, but a video and a capsulated version of his comments from that interview can be found below. I will let Mr. Taleb speak for himself, though I will say that sound-bite T.V. is not the best format for his powerful intellect. He is at his best when he writes about a topic, or when he is allowed to discuss it at length. Being wedged in between commercial breaks on Squawk Box does him little justice.

Though he revisits many of the topics he discussed back in June (like swapping debt for equity to aid the deleveraging process), he raised a few eyebrows when the subject turned to Fed Chairman Bernanke. Mr. Taleb is stoutly opposed to Bernanke’s reappointment, saying Bernanke, Geithner, and Summers have been part of the problem — so why reward them? When pressed for just who he would support to replace Mr. Bernanke, Taleb offered up Paul Volcker. I would love to see Volcker back at the helm, but he’s been marginalized inside the administration by Mr. Summers. Besides, like my favorite choice for the job (Jim Grant), Mr. Volcker would probably turn the offer down. Given how our politicians and the voters who elect them have little stomach for making hard choices, the job is almost impossible to do well these days. Any warm body can print money; the hard part is dealing with the consequences.

– Jack McHugh

U.S. Markets Wrap: Stocks, Oil Advance as Target Tops Estimates

U.S. Economy: Single-Family Home Starts Rose in July

‘Incompetent’ Leaders Pose Threat to Recovery: ‘Black Swan’


Tuesday Nite Open Thread

OK, kids, its about that time!

What is on your collective minds? Stocks, music, sports, politics?

I only ask you keep it both civil and informative.

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What say ye?


Widespread Fraud, Option Backdating, Exec Felonies

The amount of Corporate Fraud in our system is far greater and more endemic than most people want to believe.

That is the conclusion I have reached after watching The Street and senior corporate executives for 20 years. Not just at Wall Street banks, but at a vast number of publicly traded companies, the executive suite is rife with moral relativism, a daring catch-me-if-you-can attitude, and plain old venal criminality.

Now, there is further quantitative proof of this:

“The majority of companies that improperly backdated stock options never were caught by regulators or confessed to the practice, according to a new academic study.

Researchers at the University of Houston’s C.T. Bauer College of Business used a sophisticated statistical test to sift through more than 4,000 publicly traded companies for those with patterns of granting options at abnormally favorable times, often at low points for their share prices.

The study identified 141 companies with such advantageous options-granting practices that the researchers concluded they were highly likely to have been involved in backdating. Ninety-two of those companies never were publicly linked to investigations or announced earnings restatements related to backdating.”

So much for the market discovering and punishing transgressors . . .

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backdate-20090817

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Source:
Backdating Likely More Widespread
MARK MAREMONT
WSJ, AUGUST 18, 2009
http://online.wsj.com/article/SB125017806662329445.html


Some Thoughts About the Pullback in Equities

Good Evening: Global equities suffered a broad retreat today, with most of the damage centered in Asia. China in particular has been a standout to the downside of late, a situation I tried to call attention to last Wednesday. Including Monday’s 6% drubbing, the major Chinese indexes have declined 15% or more (the CSI 300, for example, is down almost 17.5%) since their intraday highs on August 4. The major U.S. averages have been slower to correct, with the benchmark S&P 500 down less than 4% since setting its high on August 7. Economically sensitive equities have been leading the way lower, and, with risk appetites are suddenly on the wane, I will offer some thoughts as to why the storm clouds of correction seem to be gathering in what was only last week a seemingly crystal blue sky. My preliminary conclusion would be that it appears sentiment has leaped ahead of the fundamentals.

With Chinese demand for commodities and the resulting economic growth figures in that nation increasingly under question last week, Thursday marked a bit of a turning point in perception. July retail sales in the U.S. were very disappointing, especially in light of the tailwind provided by the “Cash for Clunkers” program. Since U.S. consumption is the final resting place for much of the world’s excess production, the retail sales figures were particularly unwelcome in markets outside the U.S. Our markets would probably have retained their early losses on Thursday if not for some euphoric hoopla surrounding John Paulson’s reported purchases of certain financial stocks.

Mr. Paulson did indeed see the credit crisis coming — and profited handsomely from its arrival in 2007/08 — but the fanfare given his purchases of Bank of America, Regions Financial, and others seems a bit misplaced. After all, these purchases were made during the quarter ending June 30, and we have little to no idea what has become of them since that date. Furthermore, Mr. Paulson set up a separate fund vehicle in late 2008 with the expressed purpose of buying distressed financial companies. It’s hard to draw performance fees from T-Bills these days, and those investing in his new fund were likely happy to see Mr. Paulson add some fallen angels during Q2 to what might have previously been lightly populated quarterly statements. Thus, the names that caught this smart investor’s fancy are likely less a commentary about Mr. Paulson’s bullishness on the whole financial sector as it might be on the relative attractiveness of the specific companies in which he took a stake. Whatever the real story may be, the averages re-tested their August 7 highs with the ringing of Thursday’s closing bell.

Friday brought a surprising decline in the University of Michigan’s consumer sentiment survey, a fact which only underscored the nascent concern surrounding retail sales and the health of U.S. consumers. The major averages took a 1.5% tumble early Friday morning, only to have a late rally halve those losses at the close. But investors in Asian securities handled these two economic data points with far less aplomb this morning. Adding to the angst in the Far East was a less than stellar GDP report for Japan. The resulting damage then spread to Europe, and our stock index futures were indicating losses of more than 2% early this morning. Lowe’s, itself a model of retail spending, then laid an earnings egg before trading commenced in New York. Neither the first positive reading in months for the Empire manufacturing survey, nor a surprisingly decent TIC report could stem the tide of selling at today’s open.

U.S. stock market indexes were 2.5% the worse for wear within minutes this morning, and they never did recover this lost ground. The rallies were as tiny as they were brief, and an uptick in the Housing Market Index was quickly dispatched. The 50 mark is neutral, so when the wire services hailed a reading of 18 as “a new high for 2009!”, the news was properly viewed as being little more than the tallest of this year’s 8 dwarves. When the Fed later released a survey showing bank loan officers continued to tighten lending standards last quarter, it overshadowed all the other economic data points (see below). If credit is the lifeblood of economic activity, then the U.S. looks set to remain a couple of pints short until lenders once again start saying “yes!” to loan applicants.

After the early drop, stocks mostly went sideways for the rest of Monday’s session. The vaunted late day rally was a no show today, and the major averages went out with losses ranging from 2% for the Dow, to 3.5% for the Dow Transports. Treasury investors were already in fine spirits (last week’s auctions went well), and the weakness in equities further enlivened them. Yields fell between 3 and 9 bps as the yield curve flattened. The dollar enjoyed a knee-jerk, flight to quantity rally of 0.5% today, and commodities continued to sink. Hit hard last week, prices fell in every sector of the CRB today as that index posted a loss of 1.6%.

Stock Market Has Gotten ‘Overly Optimistic’: El-Erian

As I left for home last Thursday evening, I really felt that what I was going to write about that night would prove useful for some readers. I had lined up both articles and data to support a conclusion that would be evident from the title alone: “Investor sentiment is way ahead of the economic fundamentals”. Alas, due to a last second change in my family’s social calendar, the bulk of the piece went unwritten. I toyed with the idea of trying to send out a brief version of it on Friday morning, but PIMCO’s Mohamed El-Erian beat me to it. As you’ll see from this story and its accompanying video, Mr. El-Erian’s comments rendered mine to somewhere just above copycat status. Given today’s worldwide downdraft in equities, however, I’ve decided to give last week’s thoughts another chance.

Massive headwinds restrain Consumer
Retailers massively disappoint

By the middle of last week, most economists and pundits were declaring the Great Recession over. Happier times lay dead ahead, at least in the eyes of the many economists who never saw our credit crisis coming. But I think U.S. consumers will be challenged to spend as much as they did when they had swollen amounts of equity in their homes and their stock market portfolios — not to mention access to overly easy credit. Now that equity values of all types still pale compared to those fetched only a year ago, and with credit standards still Scrooge & Marley tight, I have to agree with both Mr. El-Erian and the economists at BAC-MER when they conclude the 70% of the U.S. economy devoted to consumption will hobble GDP growth in the quarters ahead.

Investor Survey Results (an AAII exclusive) — Released August 17, 2009

Reported Date Bullish Neutral Bearish
August 13: 51.00% 16.00% 33.00%
August 6: 50.00% 14.84% 35.16%
July 30: 47.67% 20.93% 31.40%
July 23: 37.60% 20.00% 42.40%
July 16: 28.68% 24.26% 47.06%
July 9: 27.91% 17.44% 54.65%
July 2: 37.84% 17.57% 44.59%
June 25: 28.00% 23.20% 48.80%
June 18: 33.33% 20.24% 46.43%
June 11: 39.25% 21.50% 39.25%
June 4: 47.56% 15.85% 36.59%
May 28: 40.37% 11.01% 48.62%
May 21: 33.72% 20.93% 45.35%
May 14: 43.81% 20.95% 35.24%
May 7: 44.09% 22.58% 33.33%
April 30: 36.09% 20.30% 43.61%
April 23: 31.82% 29.55% 38.64%
April 16: 44.14% 20.00% 35.86%
April 9: 35.71% 20.00% 44.29%
April 2: 42.66% 20.28% 37.06%
March 26: 39.13% 18.48% 42.39%
March 19: 45.06% 16.67% 38.27%

Stock Bulls Increase as Survey Shows Most Optimism in Two Years

If the foregoing analysis about the disconnect between the economic facts on the ground and the quoted prices for so many securities in the ether is on target, then what does investor sentiment tell us about the potential for a reversal of what have heretofore been growing risk appetites since March? I submit the table and article above. The table, courtesy of the American Association of Individual Investors (AAII), is meant to measure sentiment among individual investors. Unsurprisingly, this latest reading depicts the highest level of bullish sentiment since this bear market grew claws. The Bloomberg article you see below it attempts to measure the sentiment levels among institutional market participants. Here, too, are new highs, though still quite a bit below peak readings. If individuals and institutions are getting more bullish as the market goes higher, then who, pray tell, will be left to turn bullish?

Cramer: Why Media is Wrong About Market

Enter CNBC’s Jim Cramer. Faced last week with what he considers undo pessimism in the media about the market in general and some of his favorite stocks in particular, the video above in defense of S&P 1000+ is nothing short of a rave. Cramer squawks so much about why everyone should be bullish that I think he should co-host with Mark Haines and Erin Burnett every morning. Cramer screams and rants that the media is simply too negative about the stock market, that investors should be thankful many of the companies mentioned aren’t going bankrupt. Agreed, Mr. Cramer; we’re all grateful. What price should we then feel safe in paying for a business where revenues are down and earnings exist only due to the type of cost cuts that can neither easily be repeated nor can be called a macro positive for the rest of the economy? His rant is a great example of just how market prices can become disconnected from reality — at least in the short run. No wonder sentiment measures peaked almost as soon as this broadcast aired. I guess no price is too high when a market is going higher, but there’s an old saying on Wall Street: “When you’re yelling, you should be selling”. Cramer was yelling last week at the highs. Hmmm; what should we at least think about doing next?

– Jack McHugh

Stocks Slide on Economy Concern; Yen, Dollar, Treasuries Gain
Fed Says Banks Tightened Lending in Second Quarter


Fair-Value Accounting

I cannot figure out why some people (like my pal Brian Wesbury) want to hide investment values from Shareholders.

As a company, if you don’t want to report the daily price fluctuations, you can easily move any investments into an account that is “Held to Maturity.” That way, there is no reporting of volatility unless there is an actual (realized) loss.

Of course, that leaves room for not reporting losses ntil the very last possible undeniable minute. But that is still better than mark-to-make-believe.

But not reporting the actual value of trading assets? That is fraud as far as I am concerned.

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mark-to-market-accounting-rules

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Source:
Fair-Value Accounting Is ‘Horror Flick Monster’: Chart of Day
Brendan Moynihan and Tom Contiliano
Bloomberg, Aug. 14 2009
http://www.bloomberg.com/apps/news?pid=20601109&sid=a1Qa_Q_PbGWc


Look Out Below

Today we will get a real test for whether the recent pullback is merely a buying opportunity, or the start of something more serious.

- Shanghai shares fall the most in 9 months, hitting a 2-month low;
- Nikkei Index fell 3.1%;
- HK shares post biggest drop in 4-½ months;
- Hang Seng falls 3.6%;
- Oil, coal, metals stocks hit by lower commodity prices;
- Singapore dropped 3.2%.

Here is what the Shanghai Index looked like prior to today’s fall:

shanghai1

chart courtesy of Investech

US Futures are down significantly:

817-futues

Asian bourses fall:

asia-indices


Hoover on the Recovery

A few good quotes:

“The spring of 1930 marks the end of a period of grave concern…American business is steadily coming back to a normal level of prosperity.”
– Julius Barnes, head of Hoover’s National Business Survey Conference, March 16, 1930

“While the crash only took place six months ago, I am convinced we have now passed through the worst — and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us.”
– Herbert Hoover, May 1, 1930


Busy Weekend in the Hamptons

File this one under anecdotal evidence:

Back on Memorial Day weekend, I noted it was very Quiet in the Hamptons. The crowds weren’t here, the restaurants were empty, and despite the gorgeous weather, the beaches were surprisingly human-free.

This weekend is the opposite: Crowded roads, lots of traffic, full restaurants, busy shops.

Whether its something significant or merely one of those random things, I can unreservedly say thing seems much more active here than they did at the beginning of the Summer.

I still see plenty of For Sale signs around — but the vibe is definitely totally different. Whether that translates into a sustainable recovery or a mere bounce has yet to be determined.

The world, it seems, is no longer coming to an end . . .


Leen’s Photos: Driza, Ritholtz, Rosner, Kotok, Tobey, King et al.

I thought the residents of The Big Picture would like to see some of the photos I took on this year’s fishing junket and economic debate session at Leen’s Lodge in Grand Lake Stream Maine. Our host Charles Driza did a tremendous job of taking care of our various wants and needs.  If you ever want to take the family on a really great vacation, call Charles at  800-995-3367 or go to www.leenslodge.com

The photo below shows Charles in a rare moment of rest during one of the lunches he organized for us each day.  Charles is a mechanical engineer by training and a registered Maine Guide.   Besides running Leen’s, Charles is particularly known for his excellent hunting trips, both in ME and in LA during the winter months.

dsc01590

Copyright 2009 RC Whalen

We had great weather this year and the cooperation of the Almighty in this regard also allowed me to capture some of my favorite economists and analysts for posterity.   First of course is our gracious host on TBP Barry Ritholtz, who is shown here in the dining room of the main lodge after a bit of surfing on his ever ready MAC notebook.

dsc01545

Copyright 2009 RC Whalen

Barry looks like a very happy cat because we were all waiting for dinner, which at Leen’s is a feast.  I am amazed I was able to get back into my car after five days of eating great food and drinking the endless supply of wine provided by David Kotok, the genius behind this event.  As I said at dinner on day 2, David Kotok is not only a great manager of other people’s money and a great friend, but he is also a committed public citizen because he has taken as his mission in life to broaden dialog and understanding among financial professionals all over the world.    See David below holding forth on an island in the middle of the Big Lake during the lunches the the Maine Guides put on for us each day.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

We had almost 50 participants in this year’s fishing trip, including a number of new inductees.   We did not catch enough catfish to have the traditional investiture ceremony as last year, but we still had some fun with the newbies.  One of the names the readers of TBP will recognize is our friend Josh Rosner, who arrived at Leen’s sporting a very impressive rod and reel that it took us several days to learn how to operate.   Something about magnets and centrifugal force.  Finally, we read the instructions.  Duh!  The photo below shows Josh in the bow of a guide’s canoe.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

When we are out on the lake, we generally use these beautiful hand-build canoes with small outboard motors.  These craft have square sterns and are remarkably stable.  Our guide for the past several years has been Dale Tobey (djtobey[at]netzero.net), the past president of the Maine Guides Association and a real honest-to-God woodsman who builds his own canoes in the wintertime, raises hounds and hunts and traps in the woods of Maine.  In the photo below, you see Dale with Matt Greco of CNBC, who caught a good number of bass on the last day.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Besides Charles Driza, the people who really make the trip work are the guides and the staff of Leen’s, who all live in the local community and work from dawn till late at night to make our experience a real treat.  The first photo below shows the Maine Guides after the lunch on Saturday.  The lady on the far right of the photo, Sue, baked us fresh pies and cobblers in a dutch oven over an open fire.  Randy Spencer of the Maine Guides is in the center front row.  Randy and CNBC’s Steve Liesman provided great musical entertainent in the evenings for the group.  Randy writes and performs songs, and has also written a history of the Maine Guides.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Here are a copy of photos of Steve and the other campers during one of the lunches on an island in the middle of the Big Lake.  There is also a shot of the canoes used by the group.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Finally, we have to pay a special tribute to Laura King, our hostess at Leen’s Lodge. Laura is a Passamaquody Indian who lives in Princeton Maine. A life-long resident, Laura has many duties at the lodge, including cooking & telling the guests where the fish are! Laura is known for her helpful attitude and great desserts. Laura’s family members, including her husband Gary, and daughters Bea and Fay, are often helping her at the lodge as the work load increases in the summer season.   Leen’s Lodge is blessed to have Laura King and the other members of the Leen’s family to serve its guests.  And beware:  Laura is a great poker player.

Copyright 2009 RC Whalen

Copyright 2009 RC Whalen

Tight lines,

Chris


Overdue: Market Correction Begins

hp_indu

Dow falls 140 plus points as “Confidence” drops.

There seems to be this subsection of pundits who believe that if we only could manipulate the sentiment, everything else would improve. This of course gets it exactly backwards — when the economy’s fundamentals improve — jobs, wages, credit, etc. — sentiment will follow.

indices


Kass’s Summary of Bearishness

Doug Kass very publicly made a prescient bottom call in early March. He has now flipped Bearish, and explains why:

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.

Doug points to the animal spirits in full force, shorts scrambling to cover, and a crowded bullish sentiment as additional reasons for the tactical shift. He believes a “self-sustaining economic recovery appears doubtful”

That fits in well with my 1973/74 parallel of the current market environment.

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Source:
Kass: A Summary of My Bearishness
Doug Kass
The Street.com, 08/10/09
http://www.thestreet.com/story/10569021/1/kass-a-summary-of-my-bearishness.html


Where to Next for Commodities?

Good Evening: U.S. stocks took a bit of a breather today after seeing little to dislike in Friday’s nonfarm payrolls report. The slight trimming to Friday’s gains came on light volume, and then only after another series of afternoon upticks. The weakest performers on Monday (and, actually, for much of the past week) were the economically sensitive names like materials and industrials. If the green shoots are indeed sprouting into something more substantial right before our very eyes, then why are these companies underperforming? As has so often been the case in recent years, the answer may lie with potential policy changes in China.

Friday’s employment figures were indeed better than had been expected, even as the U.S. lost more than another quarter million jobs in July. -274K didn’t beat the “whisper number” estimates for -250K or less, but it did beat the average prognostication, and the revisions were positive to boot. The unemployment rate actually dropped (though mostly a statistical quirk), the work week expanded, and average hourly earnings rose. Losing fewer jobs isn’t exactly the stuff that makes for economic growth, but it was a solid report for this point in the cycle. Stocks went out at their best levels of the year on Friday, despite some late profit taking as investors headed out to the beach.

Wall Street’s celebration spilled over into Asian trading overnight, but not so with Europe this morning. U.S. stocks thus opened a 0.5% lower on Monday before clawing back most of those losses within 90 minutes. Risk aversion made a small comeback in the early afternoon, though, as stocks weakened while Treasurys and the dollar rallied. The S&P gave back almost 1% and tested the 1000 level, but, holding firm at this millennial mark, the S&P and the other averages then rallied into the close. The final tally left the indexes down between 0.1% (Russell 2000) and 1% (Dow Transports). Treasurys found buyers ahead of this week’s large refunding, and yields fell 6 to 8 bps in the process. The greenback added 0.3% to Friday’s strong showing, and most commodities finished mixed. With only the precious metals sporting noteworthy declines (gold and silver were off 1.5% and 2% respectively), the CRB index still managed to finish unchanged on Monday.

On a day with little news flow and even less volume, it is tempting for a writer to ascribe “signal” to what is mostly just noise. I will take that risk tonight by wondering what lies in store for commodities and their associated equities. Those of us domiciled here in the U.S. tend to view global economic activity through an American-centric lens. But when it comes to commodities, the most important marginal buyers are in Asia. We all know the 40% of one ton gorilla is China when it comes to raw materials, so in thinking where commodities might be headed, we have to look at what the Cadres in that country might be up to before registering any potentially useful guesses.

Easily distracted readers will want to skip to the final paragraph, but some history probably is in order. Since no matter how capitalistic many individuals and businesses have endeavored to become in the decades since China began to open up, it is important to remember that China is still a centrally planned, command economy (with emphasis on the second to last word). As its needs for grain, oil, copper, and other consumables rose during the ’70’s, ’80’s, and 90’s, it fell to the functionaries in Beijing to direct the buying. It seemed that whenever the sharpies in the global commodities markets had China’s buying patterns figured out, the purchasing commanders in that nation found a way to game the system that tried to game them.

Suddenly plentiful grain harvests would be announced, or new coal mines in the interior would be found, and the resulting price drops in various commodities could be brutal when China supposedly didn’t need as much as had been forecast. In the run up to the 2008 Olympic games, for example, commodity longs came to count on Chinese demand for just about anything that could be grown, drilled, or dug from the ground. Once the Olympics went off without a hitch, Chinese demand just stopped — cold. Tanker shipping rates collapsed and commodity prices were decimated in the wake of the Chinese demand drought. The credit crisis in most Western nations then exacerbated the problem.

Upon seeing the prices of raw materials fall between 50% and 80%, China announced a stimulus package over the winter and went on a restocking binge. Even when global equities hit bottom in March, global commodity prices never again reached their 2008 lows. China, courtesy of the generous bank lending instigated by the powers that be, was back. The Fed and other central banks may have lent an unwitting hand to China’s commodity appetite in the first half of 2009 with their wanton efforts to reflate. After all, commodities are real goods priced in nominal dollars, so what better way for China to hedge against Western monetary debasement than to stock up while prices were at WalMart levels? So strong was the demand for commodities during the opening two quarters of 2009 that green shoots were sighted, shipping rates shot up, and commentators openly worried about a bubble in China (see below). Andy Xie, Morgan Stanley’s former expert on China, is bearish; others, including Templeton’s Mark Mobius, are cautious but don’t see a bubble (see below).

Fast forward to today, and worries about Chinese demand have resurfaced. Shipping rates have started to fall again, and commodity prices are just now starting to wobble. Whether they fall may depend on what happens to Chinese economic activity, which, in turn, depends upon what the mandarins have decided to do about reining in bank lending. If lending is in fact set to drop, then commodity prices will likely again feel the effects of gravity.

But take a look at the Rio Tinto story before jumping to the conclusion that Chinese demand will soon be back in hibernation. Iron ore rates are up for renegotiation, and Rio Tinto is a primary supplier to Beijing. So what shall we make of the arrest of Rio Tinto employees? Is industrial espionage truly at work, or is China hoping for Rio, BHP, and the others to cry “Uncle” once again on pricing? The rumors of a drop in Chinese bank lending support China’s negotiating stance, too, so the stories may not be just a coincidence.

Like everyone else outside the Forbidden City, though, I really have no idea what China is up to these days. The evidence can be interpreted in whichever way a commodity bull or bear would like. I do know this, however. The FOMC is unlikely to do anything more than just talk about exit strategies when it meets this week. Promises, as opposed to action, will probably continue well into next year, too. Chairman Bernanke will do everything in his power to avoid having a “D” (for deflation) show up on his report card. So rather than deciphering the inscrutable maneuverings in China, all we have to remember is that the Fed looks set to keep right on printing fresh greenbacks. Over any short period, commodities can literally go anywhere, just as they both skyrocketed and crashed during calendar 2008. Long term, however, they will be moving higher. Not even China’s best gamesmanship can prevent it.

– Jack McHugh

U.S. Stocks Fall on Valuations; 3M, Eli Lilly, Best Buy Drop
China to Cut Loans as Stocks ‘Bubble’ Grows, Xie Says
China Rally Will Last, No ‘Bubble’ Seen, Harvest Says
Templeton’s Mobius Says Stocks Face 30% ‘Correction’
Baltic Dry Index Has Worst Week Since October as Demand Slows
Rio Tinto Accuser Says Article Was His Own Opinion


Comstock: Indebtedness May Cause Two Lost Decades

debt-gdp

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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.

Bloomberg:

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.

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Source:
Lost Couple of Decades’ Looming for U.S. Economy: Chart of Day
David Wilson
Bloomberg, August 7 2009
http://www.bloomberg.com/apps/news?pid=20601109&sid=aX39_VW6pf3U


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?