Where are we?

Posted by Ray on May 12, 2011 under Main | Be the First to Comment

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.

The Bulls Still Have to Make Their Case

Posted by Ray on February 9, 2011 under Main | Be the First to Comment

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.

Well, it has taken some time

Posted by Ray on August 24, 2010 under Economy, Main, Markets | Be the First to Comment

I have been writing about the decaying economic data for some time now and have taken some heat for being a pessimist or a permabear, but now it appears that I was correct. It is also striking that almost a year ago I called this current economic funk we are in a Depression. I said one of the reasons why we do not recognize a modern Depression is because there is no need for soup lines and the like. In today’s world everything is automated with food stamps, 40M Americans are currently on food stamps a huge YoY increase, we have unemployment benefits (99 weeks currently), the HAMP (loan modifications), energy assistance, public housing and a slew of other safety nets available to those in absolute need.

Since we have all of those programs our growing economic troubles can remain out of sight and mind. We can be told things are improving because the data says it is. Never mind the fact that unemployment is “only” at 9.5% because people are so discouraged that they left the workforce. To me the most telling sign is the food stamp data which is just unbelievably high with almost 12% of Americans in need of public assistance just to feed themselves, think about that for a minute. That kind of takes the wind out of my sails about being right about the current economic climate. I never wanted to be right, but the data was never strong nor did it point to a sustainable recovery, which was merely a statistical recovery to begin with.

I have been silent for a few weeks because I have not felt so hot and I was letting the data set in. I think it is clear now that the recovery was not really a recovery and when the stimulus stops we are in deep trouble. As Rosenberg said, when businesses are dependent upon government spending for growth we got serious problems, I am paraphrasing the statement, but it is close enough. He was right all along and the permabulls have a rude awakening coming their way in the near future. Whether it is the Hindenburg Omen or just a slew of bad data, which will get worse, stocks are way overpriced, period. We will or the market will correct this error for us by forcing a multiple compression and it will either happen all at once or over a period of days, but it is coming.

My last call was to look into leveraged ETF’s for long dated treasuries, UBT or TMF, and gold, GLD or physical. This trade was profitable, UBT, which I own, was about $86 and it is now $102.43 and GLD was about $116, it is currently $120. Those were good trades that required guts in the face of deflationary forces and the fact that you were looking at a leveraged ETF, which are very dangerous, but they worked. I suspect that it will continue to work, but I would not, besides gold, buy the pair trade here. The Fed told us what they were going to do, monetize some debt on the longer end of the curve, and I suspect they will continue in the near future, we might now Friday for sure, but if they do more QE look for a $1-2T figure.

Ben Bernanke wants to flatten the yield curve to force lending by banks, but it will not work. It is a good theory for Ben, but the reality is banks do not want to lend and consumers do not want to borrow. QE will also not do anything to boost money velocity and I am not sure why anyone would possibly think it would. Banks will merely do what they did before the credit crisis and take on more risk so they can play a different yield curve other than treasuries. As we know, that did not work the last time so why anyone would think it will work now is beyond me, but I am sure that banks will take more risk to boost profits. After all, they are too big to fail.

The outlook for the markets is not good as Ireland just got downgraded and I think we will see some weak data at 8:30 tomorrow as well. Unemployment claims, a leading indicator according to, well, me and PIMCO, are rising and another week +500K will be devastating. Also, the employment report survey was out the very week we saw that 500K print, not good news for the unemployment figure out a week from this Friday. The Philly Fed, Richmond Fed and the Empire Report’s were not very good and I think we will see close to 50 on the ISM survey out next week, perhaps lower than 50 so be ready. All the data is pointing to very, very weak near-term economic pain ahead, there is little doubt about that.

I realize that balance sheets are rich with cash right now, but that means nothing as companies are merely hoarding cash at this point. It is, the cash on hand, good for corporate bonds though, which I still love. The outlook from CEO’s is also becoming more mixed, John Chambers from Cisco was not optimistic, this should scare you because this guy is always optimistic. Basically, much like in 2000, CEO’s merely did not foresee a slowdown in the immediate future, which is very surprising and takes down the credibility of many corporate leaders, in my opinion.

Because of all of this I am more bearish now than I have ever been in the past. I am positioned for a correction and pulled most longs off the table. I am in longer duration treasuries along with my UBT play, long gold, silver, corporate bonds (no high yield to speak of), some international holdings (frontier markets), a few biotechs, and inverse ETF’s. My long holdings are all dividend paying stocks with very low P/E’s and strong balance sheets. Blind belief that the market is going to head higher is insane and, frankly, we have just seen an insane rise in equity prices to begin with. That time is now over and the bears will come back to take control. I find it difficult to believe no one saw this coming, I have written about it and many others as well. The data never lies, ever, but the people reading the data usually have a reason to spin it in their favor.

The trade of the decade?

Posted by Ray on July 31, 2010 under Economy, Main, The Federal Reserve | Read the First Comment

The 2Q10 GDP report came out and it was an eye opener for many people as it showed that the recession, depression, was deeper than most believed and things are surely not as rosy as we are being told. Aside from the inventory rebuild there is not much else going on, final sales are dead as a door nail and some firms, like Samsung, are reporting good earnings, but warning of weaker times ahead. I take the Samsung warning pretty seriously as they are a large or the largest supplier of electronics which had shown signs of strength recently. So when they say things may not be rosy in the near future I suspect that will apply to more than just TV sales.

What made the news cycle this week was a report by Fed President Bullard about the threat of a Japanese style deflation here in America. I am kind of shocked that people were caught so of guard by this news, about 10 economic data points already indicated this to be if not already occurring a very real near-term threat. I suspect we are in for some really tough times ahead and worse yet I suspect we will see the Fed start moving towards quantitative easing, again. As I have said, repeatedly, this will not do anything to boost economic demand as we must wait for the deleveraging cycle to be completed by the consumer before demand will return. Zero Hedge just wrote a piece about this tonight which illustrates exactly what I have been saying for a month now, but no one is listening. Here is what they said:

“In other words, all those who say QE2.0 will do nothing to stimulate the economy are correct, as all such a greenlighted action would encourage is the warehousing of yet more cash by banks. And since banks have no incremental incentives to lend it out, it doesn’t matter if the Fed’s liabilities are $2.5 trillion or $2.5 quadrillion. Instead of stimulating inflation, which is the end goal, all such an action would do is to create further doubts about the stability of the dollar, which in turn, as Ambrose Evans-Pritchard discussed, is a sure way to go to hyperinflation without first passing either Go, or inflation.”

They also indicate my thoughts exactly, we bypass money velocity inflation and go straight to dollar devaluation, i.e. currency crisis, hyperinflation. The irony is that you would only feel this pain on imported goods and we do consume 87% of what we produce domestically so it may take some time before any real currency devaluation hits home. Regardless, Bullard indicated along with prior reports by Ben Bernanke himself that QE is on the table. The question is what kind of QE, treasury purchases or other asset purchases? Also, how much, I bet $3-5T in total purchases, but who knows.

What we do know, compliments of David Rosenberg, is that Ben Bernanke said IF we hit a Japanese style deflation that the target rate on the 30 year treasury would be 2.5%. Rosenberg says that if we hit that rate, down from the current 4% yield, one would receive about a 30% rate of return. I think he is right and if one followed his recommendations of treasuries and gold, along with high yield stocks, you would have avoided much volatility this year and had nice returns. I am happy to say I bought 2’s and 5’s when the yield was 1.10% and well over 2% so I am happy. I suspect the rally in treasuries will continue and if QE happens, wow.

The trade of the century, although risky, would be to leverage a long position into the 20+ year treasury market, UBT (2X bull) or TMF (3X bull). IF Rosenberg and I are right and this happens, QE, deflation or a major selloff in equities, those positions would do very well. However, they are risky, they are leveraged ETF’s, but if you time it right I believe that you could do very well. I also believe that the bull market in bonds is in full force again, very similarly to the summer of 2008 I might add which adds a bit of mystery to the rally in treasuries. The mystery is, what is going on and is the bond market telling you that something really bad is coming?

A look at the chart above looks like there is something going on in the bond market. We broke above the 123/4 mark on the 30 year futures and now that is support. I believe it goes higher because of, at least, of deflationary pressures and, at worst, because of QE. However, while I am short-term bullish on treasuries I hate them long-term since it will be impossible for the U.S. to meet its long-term debt obligations which means they will default somehow in the future, in my opinion. I also believe, as stated earlier, that QE will wreck our currency maybe not now, but at some point in the near future which makes gold very attractive as well. If QE is announced treasuries will go nuts and so will gold. If one is levered into treasuries you could do well, if you want the risk.

What QE means for stocks, I do not know. I would think QE would be bad for stocks as it signals things are not good and the economy is weak, but we are living in bizzaro world where good news is fantastic and bad news is even better.

Forget the ‘dark cross’

Posted by Ray on July 18, 2010 under Economy, Markets | Be the First to Comment

Much has been made about the death cross of late, the 50 day moving average crossing through the 200 day moving average, although I think and know it is a significant event it is nothing compared to something else I have noticed. We are all aware of the primary reason of the bull run over the past 12 months, massively oversold markets, combined with marginally better economic data and, most importantly, a weakening dollar. Why the dollar weakened is important to note, quantitative easing via the Federal Reserve’s asset purchases or the printing of money. Although we will not know the long-term implications of QE for some time to come it is safe to assume it accomplished its goal, weaken the dollar and boost the economic data through negative interest rates, essentially.

We all know the market action of late, a horrendous selloff which was only a surprise to the parade of bulls on CNBC and those who kept their heads buried in the sand, but those out in the real world knew it was coming. What was unexpected was the 4^th of July rally that took us back up some 7% on the backdrop of pretty bad economic data. Some of the bounce was because of a technical bounce and some of it was because of the expectations of stronger earnings which started last week. I fully expected 2Q10 earnings to be good, but I expected to see more top line misses and the outlook from CEO’s to be downgraded as well. So far, it is a mixed bag, but the outlook or guidance remains very bullish for many firms, however, a look back through prior earning announcements, particularly 2000 releases, as Mark forwarded to me, shows that Intel did not foresee a slowdown there either, so trust the economic data rather than CEO guidance going forward.

Back to what is going on in the equities market and why the dark cross is less important than the other ‘grey swan’ that is going on. First, everyone and their grandmother knows or knew about the dark cross, not that it takes away from its importance, but when everyone knows about it very rarely does the market deliver the results we are looking for. Except the market kind of did deliver, but stopped short and rallied all the way back to some important moving averages where it failed to break through, very bearish from my lens. At the same time we saw the selloff begin the dollar was moving towards the 89 mark on the DXY, but it stalled after a dramatic breakout and reversed course. Not only did the DXY reverse course, but it got crushed moving down from 89ish to about 82.5, not an insignificant move.

Exhibit 1-1 2 Month DXY Chart

Why is this a big deal? It is a big deal because stocks went up on a weak dollar trend which meant a better environment for U.S. companies to sell products abroad. Basically, a weaker dollar is better for U.S. exports and sales as we become more competitive in the world. It made sense for the markets to not like the move of the DXY from the low 70’s to 89, but to not like the move from 89 to 82.5, well, I am perplexed. The market should love this and we should be flying to at least 1,100 on the S&P 500, but we are not. This is a huge warning sign that stocks cannot rally on a weak dollar and it means more than the dark cross.

Exhibit 1-2 1 Year S&P 500 and DXY

The charts show the trends pretty clearly, lower dollar higher equity prices, higher dollar, lower equity prices, but over the past couple of months things have been out of whack. What else is going on during this time period? Treasury yields are collapsing to historic lows. We have the 2 year treasury under .60%, the 10 year under 3% and the 30 year under 4% which is a sign of 2 things, risk aversion and fear of deflation. My belief is deflation is the clear danger as of right now, it is fairly evident from my lens and the market is pricing it in as we speak. The credit markets have been pricing it in for some time and will continue to, I am bullish on debt securities, have been for some time now, but the equities markets, well, it has not priced in any real deflationary pressure at all.

Exhibit 1-3 Yield Curve

Granted, we have not seen total deflation yet, just the beginning sign of it, but the evidence is pointing towards it. Here is the rub, everyone says the Fed will do QE2, but they won’t do it. See my other posts as to why they will not do it, but from my lens they would be insane to even attempt QE2 at this point. The problems in the U.S. economy has nothing to do with what is happening in Europe, a little I suppose, but not directly related. My past posts about Europe relate directly to actual defaults by countries and to corporate earnings. I think anyone will find it hard to believe that the Jones’s are not buying that new car because they are worried about Hungary being kicked out of the IMF-EU rescue package. They are not buying a car because they are worried about their job and do not want to take on much debt or because their credit score is so lousy they cannot get financing, 25% of Americans have a credit score below 600 now. Instead the Jones’s are paying off debt and buying what they need, not what they want which is deflationary.

This trend will continue and so far only the credit markets are pricing this in, the equity markets are in La-La Land, still. The DXY – S&P cross is very bearish if the trend continues and will mean a big correction in the near future especially if commodities head lower as well. Commodities are not performing well and that is reflected in the Baltic Dry Index and combine that in with the above information and it is putting the explanation point on the whole theory. So far the only strategist I know for sure who is putting all of these pieces together, and has been ridiculed relentlessly by the bulls on CNBC and such, is David Rosenberg. All of the rest of the strategists are telling you to buy the dips even when they see everything I presented to you, they know what it means and, to top it off, they know the ECRI is rolling over and housing is going down the tubes. It is incredible to say the least. Be ready for some fireworks soon unless this trend breaks.

What works in a deflationary environment? Income and dividends, pure and simple. I like (and own) the following: CTL, MO, PM, WM, PFE, MRK, LLY, BPT, RYU, PEY, INB, DNH, CGO, VZ, high quality corporate bonds, strategic income bond funds, emerging market debt funds (PCY has been good to me), short and intermediate term treasury funds. Many of the above mentioned stocks have underperformed, which I like, and pay very nice dividend yields, which I love, but may not do well in an inflationary environment. This is why one has to hedge with precious metals or, at the very least, TIPS.