Where are we?

It has been almost 3 years since the collapse of the banking sector and the governments of the world have spent trillions to not only save the banks, but to stimulate the economy as well. We have been told for the better part of 2 years that we are recovering, and we are to a certain extent, but the headlines remain exactly the same over the last few years. They say something similar to: the recovery is on the way, is the recovery in jeopardy, the recovery is in full swing and so forth. Well, we are either recovering or we are not and it is difficult to believe the news when the headlines and underlying story remains the same, a weak recovery.

I view the economic data as severely mixed 3 years into this thing that we are in. Some data is good, but it is largely inconsistent with one month being great and the next being so-so. What has remained constant is the employment situation which is a leading indicator for this recovery. The labor markets stink, to be blunt, and we have only a few good reports to talk about. Unfortunately even those good reports are not enough and do not even keep up with the population growth. We need some 350K jobs created every month to see a real impact on the employment situation. It is clear that we are far away from a number above 300K in the employment report given that we are still seeing initial claims coming in above 400K a week, a few sub-400K claims reports are not encouraging given we are 3 years along and in a “recovery” mode in the economy.

I fear that many companies have learned that you can grow a business with less people. This is apparent with many firms having stellar earnings along with sky high profit margins. If a company can make more or the same with less overhead they know that there is no point in hiring extra bodies until they absolutely have too. That is not good news for the employment situation by anyone’s model and it is unlikely to improve anytime soon.

On top of the unemployment headwind we are now back to $4 a gallon gas. Very few people realize the impact of high gas prices on the cost of living until they go shopping. We are still very much in an oil driven economy and as the cost of oil rises so do the prices on everything from toothpaste to ice cream since some products are made out of oil and all products are shipped by burning oil. This is not news, but it is important to emphasis the importance of energy in our economy since higher prices lead to lower consumption and creates a negative feed loop on everything from jobs to retail sales. Obviously other commodities also play a role and all commodity prices are very high which does not help anything.

So, where are we? I think stagflation is the word we should use. We have a stagnant economy with jobs but rising commodity prices, which is also considered inflation. We are 3 years into this thing and we have been getting beaten over the head with the term “recovery” so much that I believe we have forgotten what a recovery really looks like. I can assure you that this recovery is not normal and for many Americans there is no recovery at all. I remain convinced that we have largely been through a statistical recovery and there has been little improvement in the real, American, economy. Overseas or emerging market economies are booming and largely responsible for US company’s great earnings, but since most of our manufacturing was outsourced this boom is leaving many Americans out in the cold. This also explains why our manufacturing economy, 12% of our GDP, has been doing so well, growth is coming from abroad, not from inside the US economy.

I realize this may not be news for many people but it might be as the permabulls need to understand what is going on. Yes, there is a recovery, but not for most Americans. More importantly this bull market we have is not real. Sure, stocks have done extremely well, but this growth is coming from everywhere else but the US and all the growth is driven by very cheap money. Once external growth slows or the cheap money comes to an end there will be a price to pay when it ends. The question to ask is when will it all end? I do not know, no one knows, but my guess is the tightening in China is a clue that we are much closer to the end than the middle. In fact, even in the US the cheap money may stop in June, unlikely, but possible as QE2 ends.

I had turned bullish a few months ago and stated that once the liquidity from the Fed ends we will have to pay the piper in the form of a correction. I believe that statement to still be true, but I do not believe the Fed will stop its QE programs for very long. Nothing is normal in our economy when we have had the US government spend trillions and the Fed expanded its balance sheet the way it did plus do 2 rounds of QE… that is not normal. But this abnormal behavior saved stocks so keep the bet going until June, but I believe when the VIX is under 18 one should be a buyer and at 15 everyone needs to own the VIX in some way. Since everything remains abnormal be cautious, buy protection through the VIX, buy commodities on the dips and look for dividend yield in stocks.

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The dollar is dead

We have witnessed the Middle East go up in flames and the troubles in Europe start to percolate again, but the dollar is not doing anything. I am only surprised that it is happening so soon, I thought there was more time. While I highly doubt that anyone will rush back into the greenback it could happen. The world’s faith in the US has been shaken by our inability to seriously discuss our deficit and debt problems. A perfect example is the latest round of talks encompasses cutting some tens of billions of dollars from a mere 12% of our total budget leaving the entitlements and military spending off the table, is it any wonder why no one trusts us to seriously address our debt issues?

If people are not buying dollars what are they buying? Gold and silver. The prices do not lie and both metals have moved significantly over the past few weeks as the Middle East began to demand regime changes. All the while the USD has basically treaded water or moved slightly down. Not only does the lack of interest coincide with the latest budget battle but it also coincides with the fact that we are right in the middle of QE2 which was frowned upon by most nations. The double whammy of our inability to seriously deal with our debt and our very own central bank monetizing large amounts of our debt, over mythical low inflation figures I might add, makes other countries stop and think about how to allocate their assets during times of uncertainty.

Overall the US total debt and monetary policy is also inflationary which makes an inflation protected asset more attractive than UST’s and dollars. Why would investors choose gold and silver over TIPS? Because no one trusts the government to actually track inflation honestly which is why you are seeing lower inflation expectations in TIP yields right now. Again, gold and silver fit the bill as an alternative as a flight to safety. Granted, gold is considered safer than silver, but lately silver has picked up more prestige and I believe silver will make some spectacular moves in the near future. In other words, gold has likely picked up more of the safe haven assets than silver but it is clear that both metals have outperformed the dollar and may be replacing the dollar until something else comes along.

So, is the dollar dead? I think it is one its way if we do not address our debt and annual deficits this year. The deficits are so bad, so outrageous and so dangerous that ignoring them for one more year may be devastating. Our total national debt, officially, if 100% of GDP and our unfunded liabilities is tens of trillions of dollars… we got serious problems. Adding insult to injury is the whole QE situation which is debt monetization no matter how you slice it. This shows weakness and is highly inflationary which will drive foreign investors away from the USD. Why would you buy an asset today that you know will be worth less in the future? You wouldn’t and either will other countries when it comes to USD’s.

The fact that we have had a few governments get toppled and a few more on the way in the most volatile region in the world and the dollar has not rallied is kind of scary. Instead we have seen commodities continue to rally, stocks (I guess the only source of our economic success) go straight up, and the dollar trend a bit lower. In the meantime gold and silver are being treated as currencies and when turmoil kicks up they go up in value. I have known for a long time that the dollar is in trouble and would blow up because we have a lack of leadership in Washington who do not want to make hard choices and the Federal Reserve who seemingly has lost its mind and has missed every major issue with our economy over the last 10 years who has decided to monetize our debt.

This will end with high inflation and the fact that the Fed disagrees is exactly why you should agree with me. Gold and silver make sense, own them physically, along with other soft commodities. I fear that the dollar has seen its best days and while I do not know exactly what will come in the longer term I do know it will not be pretty. I think you will know who to blame by then, I hope at least.

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The Bulls Still Have to Make Their Case

I have stated that you have to be long this market until the Fed pulls the ample liquidity it has been pumping into the markets for the few months now. Before the Fed announced QE2 I was right to be bearish as the indices were heading lower under numerous stresses from both domestic and foreign sources. It was in August when Ben gave his speech about asset purchases and then the next meeting which started them that caused the markets to take off. Up until that point there was no real reason to be bullish.

Frankly, outside of the excess liquidity, there is still little reason to be bullish. Just because stocks move higher it does not mean that the economy is all better, sorry, but it does not work that way. I believe that the economic data we are seeing is heavily distorted and if we are in fact having 3-4% GDP growth, like several Fed officials claim, where are the jobs? That is a huge jump in GDP growth and that would certainly create jobs, but here we are witnessing the greatest exodus from the job market since the data has been tracked. The U-6 data is way up over 17% and Shadow Stats says we are saddled with 20%+ of unemployed/underemployed.

If we are experiencing 3-4% GDP growth why in the world are we still experiencing ZIRP and QE of any kind? It makes no sense at all. I know, because “inflation is too low.” Inflation as defined by Ben Bernanke and not by people who have to buy food and energy every day. The fact that we are arguing over the definition of inflation is asinine. Normal, sane people, would define inflation as the normal cost of living items, but the insane people say that inflation should be measured by the cost of computers and flat screen TV’s, that makes sense. The bottom line is Ben is distorting everything with this insane monetary policy and is causing food prices to rise around the world, including right here in the USA.

The economy is better, I have admitted this for some time now, but it is still sick and not functioning correctly. What we are seeing now with runaway government spending and excess Fed easing is a serious risk to the US dollar. I realize that every country wants a weaker currency so they can export their way to prosperity or so they can grow their way out of their debt problems, but this will not work for the US. The US debt issues are so large and the trade imbalances are so out of balance that it is impossible for the US to grow its way out of its debt problems.

While Ben tells Congress that the US must get the deficits under control immediately, a first I might add, it is impossible to do so. Have you ever wondered why the US cannot cut annual spending? They tell you it is because of entitlement programs, right? They also say these entitlement programs are solvent, at the moment at least, right? Wrong. The proof of this is in the annual deficits. When you received your paycheck there were federal income taxes withheld and FICA taxes withheld, for Social Security and Medicare. Supposedly the FICA taxes went into separate accounts to be used at a later date but our leaders used that surplus money to plug holes in previous deficits and gave the SSA and Medicare IOU’s instead. Now the SSA and Medicare are cashing in those IOU’s which is why the government cannot cut the annual deficit and it proves that the programs are insolvent.

All of this is evidence that the economy and economic health of the US is not good. We are still in trouble and all we did in 2008-2009 was transfer the bad debts from the banks to the US government, kicking the can down the road, and the banks are still in bad shape. The economy is not replacing lost jobs and probably never will replace all those jobs lost in the last few years. The only way the unemployment numbers will get better is because of how the BLS calculates the unemployed, i.e. not counting the ones that fall off the rolls.

The bulls need to make the case that the economy has really recovered. I am a bear and I said to own stocks, and commodities, and I was right too, but I am under no illusion that things are that much better. A stock market going up doesn’t really mean anything especially when the Fed is giving primary dealers billions of dollars every week to do something with. Not to mention that rising stock prices only help the investing class anyhow which is a shrinking portion of America nowadays.

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The Employment Report and Current Events

The world is in a very tough spot right now and the word of the day is social unrest. On top of the news from the Middle East we got some, in my opinion, pretty bad jobs numbers on Friday. Of course if it was a good report it is because of the ‘economic recovery’ and when the report is bad it is because of snow, rain, wind, Earth or whatever else they want to say instead of the truth, the economy stinks.

There was not one good piece in the jobs report, not one. Sure, an unemployment rate of 9% was the headline given to us, but doesn’t this strike you as being odd since the BLS just added in some 300K under reported job losses from last year? On top of that we had, unadjusted, horrible initial claims reports for January and even the adjusted reports stunk. Even though the economy did add jobs governments are laying people off which is a problem as this will likely continue on into the future. Overall, there is still some 5 people for every open job right now, think about that and then think about how long it will take for unemployment to actually come down, especially with new workers coming into the work force through population growth.

We are not going anywhere in the near future and for proof of this look at Bernanke’s speech the other day when he basically guaranteed QE3. As an aside, I love how he said QE2 worked because asset prices, stocks, and bond yields were going up. Umm, wasn’t QE2 supposed to create negative real interest rates? And since when do we use the stock market as a barometer for economic growth? In fact, QE2 did work if you thought it would benefit stocks, but it has failed miserably for the other areas it was supposed to help, i.e. jobs, economic growth and negative real interest rates.

However, QE2 did have a successful side effect that only a few people have realized, it has overthrown a couple of governments and probably will topple a few more in short order. Remember how I said you can get inflation without money velocity? It is kind of happening and just imagine what will happen when banks actually lend again. Now, Ben says food prices are from emerging market demand which is true, but it is also because of bad harvests, which will continue, and the fact that commodities are valued in USD’s which have been sliding down in recent weeks.

This means food prices have risen for the poorest countries in the world to levels that are just unsustainable. When food prices rise in America we can weather the storm for a while, but in some countries food at lower prices consume 50%+ of the average families budget so they do not have the luxury of riding out the storm or cutting back they simply go without. They can only do this for a little while before something gives and we have witnessed what happens when that something gives way. I also believe we have only seen the beginning of the problem as no one has figured out that this year’s wheat harvest is likely to be very, very, bad and we will see much higher prices in a few months. The weather is whacky and I have a strong suspicion that the Midwest will not produce what we are used too this year. If that happens things could get very interesting and perhaps, just maybe, we will stop paying farmers to grow food in order to turn it into fuel, use sugar instead which we pay farmers to not grow… get the picture yet?

Things are getting interesting and I am trying to stick around to see how it all ends. In the meantime I believe that one must be long commodities, silver and softies for sure, and stocks until QE is over, which is likely to be never. I say that with a caveat as I believe if QE3 does happen stocks might get very choppy and at some point people will figure out that ZIRP + interest on excess reserves + QE = Really Bad News and is bad monetary policy. Then again, only a few have figured it out so far so maybe I am too optimistic.

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Schizophrenia, that sums up

Here we are in a New Year and as is tradition we see countless forecasts for what will transpire this year. My personal feeling is that they are all worthless since no one knows what the Fed is going to do and there is no denying that the Fed and the Fed alone has total control over the markets. Without the Fed we would not have seen positive returns in 2010, IMHO, and we only got those returns because the central bank flooded the market with extraordinary liquidity, again. The irony is that everyone knows something isn’t quite right, but they seemingly cannot put their finger on what is not normal.

As the weekly headlines come and go they are almost humorous now and completely contradict previous headlines. It is this that is contributing to that unsettling feeling most people have but cannot identify right now. Any given day you read about the recovery, often from a heavily seasonally adjusted figure, which signals a recovery in the economy, even though the unseasonal adjusted figure shows the data is not so hot, and everyone is bullish again. The next week we get a data point that is horrible and the world is coming to an end. Perhaps this is what many economists mean when they say this is a ‘muddle through economy.’ Regardless, things are better there is little question about that, but I would say we have stabilized ourselves in a less bad environment versus a real economic recovery.

I had previously said stocks would move higher and they did, but that is only because of the liquidity the Fed bestowed upon us and not because of truly better data points. We have seen unprecedented stimulus over the past 3 years from the federal government and the Federal Reserve which explains pretty much any positive data point. When you examine the real economy, i.e. Walmart, it is a different story. Frankly, when Walmart which has the largest customer base in the US is struggling when so many are preaching the resilient consumer something isn’t right. I know the high end retailers are doing OK and that proves my point which I made about a year ago that the recovery, thanks to the bailouts, and I use that term loosely, was lopsided to only the wealthy and not to Joe Six Pack.

This is also reflected in the unemployment figures and pretty much anywhere else you want to look. The rich are doing just fine thank you very much, but if you are in the middle class or poor the SNAP program is this way. While this is not fair it simply is what it is and is not going to change anytime soon, sorry. Perhaps that is what scares me the most right now, the inequality of wealth in America, don’t get me wrong I am a capitalist through and through, but it doesn’t take a rocket scientist to read history and what happens when the wealth gap gets this wide. On top of the middle class and poor becoming poorer we are now seeing what I thought was going to happen, inflation without an increase in money velocity.

Those who thought it was impossible for a country to experience inflation without money being in the hands of the people, well, you were wrong. When the central bank plays games, untested games, like QE it hurts the currency which drives up currency sensitive items, food and energy. When prices rise and wages stay the same it will more than likely exacerbate the underlying problems we are suffering from and may lead to civil unrest. We have food prices at the highest level ever and oil about to burst through $100/barrel, where is the outrage from the media on this, and people already feel poor, not a good combination. Again, all of that without an increase in money velocity, go figure.

Now, there are other reasons for the rise in commodities, but they are irrelevant in my opinion since Joe Blow could care less about why prices are rising he just cares about being able to feed his family. What is frustrating to Joe is that he is being told how great things are when he feels poor, is probably going to lose his house, can barely afford food, gas or his power bill. Joe is wondering what planet the commentators on CNBC are from when it is plain as day that things are not right in the real world. What Joe doesn’t understand is that the ivory tower announcers and the Fed are looking at the core CPI which says everything is hunky dory. The question is, do you think Joe cares that deflation is occurring in LED TV’s as much as Ben Bernanke does? Of course not because Joe looks at food and energy, but all economists look at is core CPI which excludes food and energy. That is where the disconnect is coming from, partly.

The public is slowly starting to not believe what they are being told anymore and that is a good thing. Remember how we were told that retail sales were going to be fantastic? They did not look so hot today, except for some high end retailers I might add. What I am getting at is simple, the real economy is catching up with the market. The really sick part is that when the economy does improve the Fed will have to kill the liquidity which will crush stocks. Those that preach stocks are a win-win because the Fed will pump money when the data is bad which is good for stocks or when the economy improves stocks should go higher are wrong, pure and simple.

This is the largest liquidity driven rally in the history of mankind or what TVland would call a bubble. Stocks are expensive and only going higher because of the Fed. However, when the Fed stops feeding free money to the banks it will end, badly. You can disagree with me all you want, that is what makes a market, but you know it is true. This is not a win-win situation for stocks. How can it be when just 6 months ago when liquidity was drying up the market tanked? We only saw a rebound when Ben spoke at Jackson Hole and said he would print and then he followed through, that is not the sign of a healthy market.

What we have is still a whole lot of uncertainty going on in the whole world. Nothing is certain except that central banks will merely print us into oblivion. Europe is a mess, we have some countries wishing to slow down fund flows to them, Korea’s on the brink of war, again, China is not buying UST’s like they once did, the US is awash in debt, which will not be solved by the Republicans, rising prices for food and oil about to go ballistic again. All that stuff is off the top of my head and I know I left a ton of stuff out, but this is enough, hopefully, to make one stop and think.

I said before that stocks will move higher and I continue that thought until one of two things happen, either the data really does improve or until QE2 ends in 2Q11. Both items are basically indications that the punch bowl or liquidity will dry up. I also believe stocks will underperform commodities, specifically silver and copper, in 2011 simply because the Fed will never stop the printing presses, they cannot. We are in a very odd period of time and, frankly, these are scary times with so many unknowns out there and a public slowly waking up to the fact that things are not as they seem, but that is a good thing, IMHO.

2011 will be a rollercoaster year with the schizophrenia kicking into high gear as far as the media is concerned, the world will be growing or coming to an end every other day, which should add more volatility to stocks. I also think we will see some things come to the forefront of discussion this year. How it ends is anyone’s guess and I will not even venture agues at the results. What I do know is that it probably will not be good. Here are my issues I think will be front page news this year:

-          Food prices continue to rise to scary levels

-          Treasuries begin to see a steep selloff

-          The US’s national debt will be a hot issue with China downgrading us, rightfully so, to junk level

-          The US is put on negative ratings watch by Fitch, but who cares about Fitch… right?

-          The tax cut extensions will prove to be a horrible idea, they really were to begin with

-          The Social Security tax break everyone gets moves up the date of depletion of the trust fund to, “officially,” the 2020 decade

-          Oil breaks through $100 probably eclipsing 2008 record price

-          The dollar will rally hard before it falls

-          Food shortages around the world will be a major problem

-          The Fed looses massive amounts of money on their treasury holdings

-          China openly sells US treasuries

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