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.

It finally happened

Posted by Ray on July 19, 2010 under Main | Be the First to Comment

Jim Cramer finally officially eliminated himself from any serious discussion about any economic issue, forever. I know, to many he eliminated himself a long time ago with his ludicrous housing is bottoming call a year ago, but for some reason he is still being hailed as some type of guru on CNBC. It is easy to do a hit piece on Cramer, I know, but this time he has gone a bit too far.

First, he claims he told people to sell last week before the big selloff on Friday, he did not on his Mad Money program. Second, he ran a piece tonight HERE, claiming he is giving you tomorrows headlines today, at 6 PM, what good is that, about the housing data tomorrow. Guess what he said? It is going to be bad. Really, no one had any idea since the data has been horrible for how long now? Not to mention everyone is expecting the data to be bad so even I am not convinced it will be the catalyst it should be. Regardless, the insanity doesn’t end there, it gets better.

He claims he gets his information from the home builders who sell thousands of homes and have been extremely negative on housing versus economists who own only one home. He goes on to say how overly optimistic economists are and so forth which is not shocking to anyone since they have all overestimated the economic data we have seen recently and, frankly, he had also overestimated the data as well. Basically, he is jumping on the bandwagon which means the data is probably going to be better than we all think to begin with because Cramer is the freaking kiss of death for everything, seriously, he is. But it gets even better!

Cramer goes on to say that the poor housing data doesn’t mean anything because it is such a small part of GDP. He said; “Housing, he added, is not a big percentage of the economy and said executives who have appeared on Mad Money have moved “well past” housing as the drivers of their earnings.” WHAT!? OK, housing is not a big part of the economy, sure, I guess that depends on exactly how you define housing. Sales or residential investment account for about 5% of GDP, but I would hardly call that inconsequential. However, it is the services that go into housing that is the driver of GDP growth, like appliances, materials, jobs, etc. which account for about 12-13% of total GDP. That is a combined total of 17 to 18% of GDP that is impacted by the housing market being in the tank, conservatively, according to the NAHB. That is not inconsequential to the economy and that is something that companies cannot just “move past” in their earnings cycle.

The reason housing is such a big deal is because it touches so many parts of the economy and when housing falters so does the broader economy, obviously. To discount weak housing data from the overall economy or to not know how big housing is within the overall economy is incredulous. This matters because this impacts people’s lives, especially when construction workers are one of the largest segment of the workforce unemployed right now, and shows that this person has no business talking about broader economic issues. I respect the fund manager and he has one hell of a track record, but as a macro guy or a guy putting the pieces together to figure out what the economy looks like he is officially, totally, disqualified now. His horrible housing call a year ago combined with not knowing how important or big housing is today proves it.

Too late to go short?

Posted by Ray on under Main, Markets | Be the First to Comment

The market has had a spectacular run lately, both up and down, which has been fantastic if you are a trader, but not if you are a long-term investor. Odds are that if you are a long-term investor you should be in bonds or cash anyhow at this stage of the game as the data clearly shows that equities are about to, or should be at least, take a rather large decline. The bulls have no data to stand on, zero, and the bears have all the evidence in the world including the Federal Reserve telling us that there is little to be excited about and what meager recovery we do have will take years to play out. How that could be interpreted as bullish is beyond me, but I am sure someone will read it that way. As for those waiting for quantitative easing part 2, keep waiting because it is not going to happen unless something different happens, like higher rates or a much stronger dollar.

What data am I pointing to? Pick a data series. The ECRI has been my favorite lately since it has never thrown off a head fake in the -10 range, we are at -9.8 now. Unemployment is also a favorite of mine, where is it getting better? Initial claims are stuck at 450,000+ per week, last week was a gift of seasonal adjustment, that will work itself out in the next couple of weeks. The employment reports are terrible and even the JOLT report was bad. I will say employment has stabilized kind of like how the Titanic stabilized when it finally hit the bottom of the ocean, but I fear there is a ravine close by and we are sitting very close to that edge, look for downside surprises in the employment reports. Housing is DOA and that is certainly not going to change, as I write this the Home Builder Confidence came in at a disheartening 14, need I remind you above 50 is considered positive? Tomorrow we are facing more housing data that is more than likely going to be worse than expected. Face it, there is little data in the bull’s camp except the data can’t get much worse or can it?

On the earnings front, well, we certainly had some great numbers last week, but what about this week? IBM missed on the revenue component and guided down by a couple of cents, no big deal, but big enough to emphasis a slowing in the second half. Texas Instruments met expectations, revenues were mildly light, but considering it is usually easy to beat estimates by a penny or two they couldn’t. Zions Bank, the fabled regional banks that were going to go gang busters this quarter, came in way below estimates, ($.84) vs. est. ($.54) and were light on the revenue side as well. Worse, on the top they said credit was improving, but they are setting aside more for credit losses and their charge offs increased between 1Q and 2Q10, how that is an improvement is beyond me, and we are talking about banks that get to carry loans at make believe values. Even Tupperware missed when people are spending less and eating leftovers! As I write many of these companies are trading lower off between 3 and 6%, not good news for the S&P futures.

Of course, we have a whole slew of earnings this week, a couple hundred companies, so why make big deal over these few firms. Oh, wait, they are IBM, Texas Instruments and Zions Bank, pretty big and respected companies that are leaders in their respective fields. Could earnings improve? Yes. Will they? I honestly do not know because, frankly and like it or not, earnings have been a mixed bag this quarter, but I also think earnings do not matter right now. The macro data is overwhelmingly bad and considering CEO’s do not want to repeat 2009 with negative warnings it is unlikely they will give negative guidance. I do not blame the CEO’s since they were punished relentlessly by the likes of Cramer in 2009 for not being positive enough and even today you only see CEO’s that give the most optimistic forecasts given air time on the TV. It is also or should be widely known that CEO’s are terrible at giving accurate forecasts, look at 2000 earnings releases and see what kind of guidance CEO’s gave back then. Clearly they did not see the slowdown coming when people like myself saw it a mile away, the same may hold true today.

So, is it too late to get short this market? Maybe, it depends on what happens tomorrow. My forecast is for the S&P 500 to initially drop to the 960-980 area where it will rebound, I obviously have no idea when it will happen or how long it will take. After it rebounds I believe it will drop to 860 so there is plenty of time to get short, depending how you plan on shorting it. If you are using options you have to be careful and trade them. If you are using leveraged ETF’s I think there is a lot of danger in holding them, but unleveraged ETF’s, like SH (I own SH), is safer to hold. I believe the best time to get short was 100 points ago, obviously, but last week was a great opportunity as well. Tomorrow, Tuesday, everyone is going to be looking to get short so you will pay a premium to jump on the bandwagon and will be assuming more risk than reward in the short-term.

What is interesting is that the rally, the whippy 7% gain, was a 61.8% retracement from the lowest closing low, 101ish on the SPY. It goes to show that the rally in itself was nothing more than a technical bounce and was rejected when it tried to go higher. That, to me, confirms that there is much more room on the downside than there is on the upside right now. Yes, stocks can move higher depending if ‘something’ happens like a stress test that was designed to not fail actually impresses people, but I actually believe that is irrelevant at this point. Europe is not the cause of our problems, we are as the data is all U.S. data that shows we are if not in another recession/depression certainly going to slow down significantly. I am short so I do not have to worry about working in new positions, I hope you were short as well. (I own various SPY put options, SDS, SH, TZA, BGZ, TYP)

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.

The Death of M3

Posted by Ray on July 15, 2010 under Economy, Main, The Federal Reserve | Be the First to Comment

All the talk of the town is deflation, disinflation or disinflationary trends, what does all of this mean, is it bad and more importantly, should the Federal Reserve try to stop it? First, deflation is negative price growth year-over-year, we are not there yet even though I often say we are in a deflationary period, because we will get there, in my opinion. Disinflation or disinflationary trends are signals that show prices are declining and is how many economists or snarky bloggers, like myself, describe the trend before we hit outright deflation. In a nutshell, deflation is demand destruction or no end demand which means companies must drop prices in order to attract business. The most commonly referenced period of deflation is the 1930’s where, sadly, food was cheap, but people starved, houses were cheap, but people went homeless. Deflation has been framed as ugly, horrible and something that must be avoided at all costs.

Deflation during the good times is fine and we all reap the rewards, such as cheaper technology, i.e. cell phones or computers, which become cheaper because of competition from outsourcing and technological advances. No one minds paying lower prices during these periods of times and the Fed even doesn’t mind deflation during these periods, but they like it to remain in check. Because lower prices do not mean people are not buying the products, the opposite is typically true. Plus, other indicators usually show that only certain items are prone to deflation under normal conditions, usually technology related items. The Fed would only be concerned if they saw other items start to lose pricing power and the money supply shrinking, people saving more money, basically.

When people save their money, in an economy such as the U.S., it is devastating because such a large portion of our domestic growth comes from spending money freely on stuff we really don’t need. When we save we stop that wasteful spending this grinds our economy to a halt. In order to get sales going again companies start to offer incentives to get shoppers in the door. This usually means lower prices through either temporary or permanent sales on the price of the products they sell. Since these products are not selling the stores are not ordering new products which mean the raw materials to make the clothes or whatever begin to decline. Even if the product begins to move at reduced prices the company selling to the end user begins to demand lower prices for the product and even if they don’t ask for it the orders are so much smaller prices would fall anyhow. Essentially it is a chain reaction, this is pretty common knowledge, but it comes from one simple thing happening, people saving their money.

The other part of the equation of people saving their money is that money is taken out of circulation. This sounds counterintuitive to those who rail against the fractional reserve banking system since this system allows for more loans to be made if the deposit base grows. However, if the economy is bad banks simply do not make loans because they fear not getting repaid. Therefore, a higher savings rate means lower monetary circulation, commonly referred to as M3, which the Fed no longer produces by the way. In order to boost the money supply the Fed will try to encourage banks to make riskier loans by lowering interest rates. By lowering interest rates banks make lower rates of returns for doing nothing with their money so by loaning out the money to borrowers banks can make higher interest rates. In turn the borrower will go out and spend that money which will ultimately boost the money supply and, hopefully, boost final demand.

That is how things work in normal business cycles, but that is not what we have now. We have a very abnormal business cycle that happens once every few generations where we go through this huge leveraging cycle and then have to live through a period when we deleverage all the debt. The last time we went through this was in the 1930’s and the time before that was about 60 years before the 1930’s so about every 60 to 80 years we go through a super cycle of debt leverage that blows up. During these super cycles the consumer has so much debt that they just try to pay it off and does not waste much money on other items. This is bad for our economy which is built on a consumption model to the tune of 70% of our GDP. This lack of demand or demand destruction means people just will not spend unless it makes absolute sense to them, i.e. a generous tax credit from Uncle Sam. This demand destruction leads to lower prices which starts out as disinflationary forces, moves to deflation when prices finally start dropping YoY, which will happen soon.

No matter what the central bank does, the Fed, it on its own cannot change this deflationary trend when it has spent all of its ammo. When interest rates hit zero there is nothing the Fed can do to spur demand from a monetary policy point of view. Remember, this is a very unusual situation because in these super cycles not only are consumers saddled with debt, but so are the banks and the banks are usually saddled with worthless debts which make them insolvent. That was true 80 years ago and the same thing is true today because banks are not making loans nor do they want to. So what can the Fed do? They have insolvent banks and consumers that don’t want to spend and are trying to shed their debt loads.

Some people say more quantitative easing will be helpful. I ask how? We already did how much QE? $2T+ that we know of and that did nothing. In fact, mortgage rates have dropped even more after QE stopped and we have falling demand for housing so what will another round of QE do? All it would do is cripple the dollar and trust me, the dollar is going to be in trouble soon enough anyhow because of the bloated balance sheet the Fed has and our national debt load. QE will not boost money velocity at all. It might give banks more money for their balance sheets, but other than that it will not boost the overall money supply so I am totally perplexed as to why anyone thinks QE will work. We have no problem selling our debt right now either, so it is a total waste of time and resources. The negatives far outweigh the positives.

What else can the Fed do? Nothing. They are done or have done everything they can do. Sure, they can roll out with TALF again, but the market has no problem placing junk paper right now so what would the point be? The problem is simple, the consumer does not want to spend. Businesses do not want to spend. Does anyone know why this is happening? I think it is pretty simple, no one knows what is going to happen. The President is keeping everyone in the dark about where taxes are going to go, heck, we are not even going to get a budget for 2010, unreal! We still have no idea how health care reform is really going to impact us yet, how much will it cost, etc. The business environment is weak at best and CEO’s are too afraid to admit it, look how they get treated by the administration, as traitors!

The consumer, well, I wonder why they aren’t spending. We have weekly initial unemployment claims coming in at well over 400K, 4 week average is 455K. We have more firings than hiring’s going on right now. The work week declined and so did wages. There are 6 people for every open job. It is taking 35 weeks to find a new job if you get fired. People were feeling more secure about their job, but when initial claims began to heat up again that confidence disappeared, even H-P started laying people off again and I bet Google will announce layoffs very soon. Their debt loads are through the roof and banks raised all their fees on the consumer so it is taking longer to pay down debt. Foreclosures, delinquencies and now a story broke tat home owner associations are foreclosing on homes for pennies on the dollar over the dues not being paid, come on. To top it all off the Senate is not extending unemployment benefits, but they can pass a 2,300 page Fin Reg bill with no problem, what is wrong with those people?

It is fair to say that there are plenty of reasons to not spend money from the consumer’s point of view. From corporate America’s point of view there is also little reason to spend money and even if they did it is so little of GDP it doesn’t even matter. The bottom line is how do we get M3 to increase? Can money velocity get positive again and should we even try? In my opinion, I do not believe we can get money velocity to get positive again without a drastic event such as WWII. These super cycles have to work themselves out and that takes time and the more tinkering we do the longer it takes. Look at housing, if we did not do the tax credit we might have bottomed in housing prices already, but we will never know now.

The Depression lasted as long as it did because of the tinkering and those who say we had a relapse because stimulus was removed in 1937-38 simply do not get it. If we cannot attract buyers to the housing market at 4.5% interest rates and prices significantly lower than the peak it just is not going to happen for some time to come. The market has to find its own bottom and it will be painful, but we cannot simply throw money at it and hope it works out. We could do that in the 1930’s because we had savings and we had manufacturing, we have neither now. We started out in a horrible position, greatly in debt, and to get ourselves out we are advocating going much deeper in debt. The problem is we cannot grow our way out of the debt we have, we cannot afford another New Deal. The most important thing to remember about the New Deal to begin with was that it did not work, it was a majorly failed policy.

As painful as it is going to be I say we have to let it be. No more QE and I hope we do not do another stimulus, but we will, look for a Bush style check coming right around October. Money velocity will sort itself out when the deleveraging is over and that could be as fast as next year or as long as 2015, no one knows except the collective minds of the consumers. The bottom line is we may come out, the consumer and corporate America, stronger than when we came into this thing with less debt and important lessons learned. Our government and the Fed, well, I do not believe they learned anything and look for QE and stimulus money just in time to buy your vote in November.