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.

Quantitative easing, it’s reality, kind of

Posted by Ray on August 11, 2010 under Main | Read the First Comment

When I wrote last week that the Fed would do QE 2 and the trade of the century, granted that was over the top, was leveraged bull 20+ year ETF’s I received some flack, a lot actually. First, let’s talk about the economy and what is going on there. Second, let’s talk about the treasury, gold barbell trade that seems wild and crazy. To clarify something, no, I am not drunk as one commenter asked.

The economy, oh, how this recovery summer is not such a recovery after all. Perhaps Geithner’s op-ed in the Times should have read, “Sorry, we screwed up any chances of a recovery” instead of “Welcome to The Recovery.” Any improvement we have seen within the economy has been purely statistical or for the very wealthy, period. Yes, Saks and Macy’s are indeed having good years, but look at Walmart, not such a blockbuster year. If you strip away the stimulus spending and government transfers you have poor GDP readings, period. I cannot see how anyone would or could really dispute that, but I am sure there are some that will try.

The truest test of any economy is unemployment and I was saying, before it was popular by a certain ‘New Normal’ guy, that unemployment was a leading indicator, not a lagging indicator. Our employment situation is poor at best considering that we are having more and more people leaving the workforce because they are giving up. Imagine just giving up all hope of finding work, not that you don’t want a job, but you just can’t find one, but since you have given up our government says you do not count anymore, nice. Anyhow, if we include all those people who dropped out of the workforce we are up to 10.2-10.5% official unemployment. As far as the U-6 we are still around the 17% area, but I am willing to bet it is much, much higher and who knows, exactly, how many people simple have been unemployed so long they just don’t count anywhere anymore. Regardless, our unemployment issue is the truest test of our economic situation and has indicated for well over a year that the economy is in poor condition.

As far as the other economic data points and indicators, well, show me one that points to an actual positive improvement please. Hint, there is not one that points to a significant improvement in the economic condition in recent months. In fact it is so bad that the Fed is turning to a form of QE which they know will do nothing to boost the economy, but it will look like they are doing something. It is so bad you had Ben Bernanke testify in front of Congress and say; “I don’t know what is going to happen,” basically when he said ‘unusual uncertainty.’ You have the Fed Presidents talking about recessions, QE, Japan scenarios and a host of other issues, but don’t worry because CNBC says no double dip. You know what, they are right. There will not be a double dip because we never made it out of the first depression.

We got the Fed doing this reinvesting of interest and repayment of principal now, to the tune of about $300B or so, into treasuries. What is that going to do for the economy? Nothing. Ben is trying to force banks to lend by doing a bull flattener to the yield curve, good luck Ben. What he doesn’t realize yet is people do not want to borrow. In fact, people want to pay off their debts instead, go figure. Ben cannot boost demand and QE will not do anything at all besides make bond investors very happy. It is a dog and pony show to make everyone feel good and like the Fed has some ammo left, they don’t and the game is over for them. All more QE will do is damage the dollar at some point in the future, that is a certainty. Consumer demand will return only after the deleveraging period is done and that could take 10 more years, who knows. It will be a tough ride, that is for sure.

Now, for those who thought I was nuts for going long a leveraged 20+ treasury ETF and gold, well, you don’t have to say, my account says it for me. UBT was about $85 a share when the article came out and it closed today at about $90.50 and gold was at about $116.50 and it is at $117.73 (I am using GLD as a proxy). I do not believe the trade is done, I wouldn’t enter it here, but I am not exiting it either, especially after CSCO missed their revenue estimates tonight. This was not a crazy trade, it was the most obvious trade in the world. Easy money like this does not happen very often so I am not sure why anyone would think this was ‘high risk’ or abnormal. You can hold leveraged ETF’s, if they go in your favor, over a period of days, just not long-term.

Everyone knew the Fed was going to do something, anything, because the Fed is staunchly independent and not influenced by politics, yeah right. Come on, the Fed knew it had to do something to show it was helping the economy, but not too much because we have an election coming up. What could be safer than maintaining the balance sheet, but reinvesting loose change into treasuries to bring down long-term treasury rates? It does not raise any eyebrows, everyone knew they would do this and it does help borrowers, but it doesn’t help the real economy. Regardless, this was telegraphed and sets up the Fed for real money printing and QE after November.

In the meantime, I plan on locking in profits on my UBT soon and rolling into TLT on weakness. I fully expect that we see the 30 treasury move towards the 3% area, maybe 2.5% as Ben wrote about in the past. That makes longer duration treasuries very attractive still and inflation is not an issue now. However, inflation will be at some time in the future and QE will damage the dollar, hence the gold hedge. I think gold goes back to its high and make a run towards $1,300 an ounce, maybe higher is full blown QE kicks in this fall. Equities are not attractive, in my view, unless they pay an outsized dividend and have a strong balance sheet. Stocks like AAPL, no thanks, they do not work in this environment unless they pull a new killer product out of their back pocket every other month. Good luck.

Too late to go short?

Posted by Ray on July 19, 2010 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)

The Birth/Death Model

Posted by Ray on July 10, 2010 under Economy | Be the First to Comment

I just read John Mauldlin’s weekly newsletter and he apparently got into a discussion over the much misunderstood and hated, by myself and many others, birth/death model used by the BLS. I have not been receiving the newsletter on a regular basis, some type of server issue I guess, but someone did not like what he had to say about it and I guess John misspoke about it. The whole thing about the birth/death model is it is meant to be a smoothing mechanism, I know that, everyone knows that, but it stinks and is not accurate which is what John ultimately said it was in his letter or at least it has not been accurate the last few years.

Now, I may have misspoke or led many to misunderstand what the birth/death model is and does. It is this little provision that helps the BLS make up for data they either do not receive back by survey participants or never receive, but it leaves room for interpretation and is never fixed in real time. In fact, they wait until February of the following year to correct any errors in the birth/death model that it may have had on the unemployment rate, fantastic, right? The model is not seasonally adjusted so when the BLS says 83,000 jobs were created it is not as if they added in the 147,000 (June’s B/D adjustment) figure to come up with that figure, that would be lying and a government agency would never do that.

Instead, what they do is add in the not seasonally adjusted B/D figure to the not seasonally adjusted employment figure and THEN seasonally adjust it. Now, you are thinking, big deal that shouldn’t make a big difference. Well, you may be right and you may be wrong. If you are talking 1M as a figure and the B/D adjustment is 50K it is no big deal, but if you are talking about a headline figure of 800K and the B/D adjustment is 147K (June figure) or 241K (May figure) well, you tell me, would that impact the seasonally adjusted figure? I would say yes it would. I have history on my side on this as well.

You see, in the fall of 2008 when Lehman collapsed and the world came to an end we all saw unemployment shoot to the moon, remember? Well, the BLS thought since so many people were losing their jobs and the business environment was so good that must be why so many survey respondents did not get back to them, they were busy making money! So, they added in hundreds of thousands of jobs from September of 2008 until the end of 2009. They were so aggressive in their B/D modeling they underestimated unemployment by 880,000 people, that is a pretty large underestimation by anyone’s standards considering the total ‘official’ unemployment total is 14M people and the underestimate for that time frame was about 10% of the total of the newly unemployed.

One could say, well, that is within the margin of error, but I don’t buy that since the government is the one who processes unemployment benefits and receives the initial claims data. In other words, it is pretty easy to correlate the data within a reasonable time frame, in my mind at least, but I am not a bureaucrat, so what do I know. Basically, if one removes the B/D figures from the non-seasonally figures and seasonally adjusts them you would have a bit of a difference in the monthly numbers. The series would be much more volatile, but it would also, in my mind, be more accurate and real time which seems to be something no one wants anymore with this figure which is why Santelli and Liesman get into screaming matches about it every first Friday of the month.

The bottom line is the adjustments matter, they boost the jobs number every month and they don’t come clean about any adjustments until the next year. That does not help anyone except for politicians and when more and more people are saying employment is now a leading indicator we need a better way to report unemployment. At the very least the BLS can correlate with the state data bases along with the household survey and that might give us a better view of what is going on. I think it is pretty much a proven fact that when we have the government guessing at any figure it is pretty much going to be wrong so why anyone would defend the B/D model is beyond me. The idea is fine, I guess, but how the BLS does it and how no one questions it, especially when it creeps up month after month when it really shouldn’t be, is very odd as, again, the only people who truly benefit from it is the political class.

Well, what do you know?

Posted by Ray on June 30, 2010 under Economy, Markets | Be the First to Comment

Apparently it is now fashionable to be bearish since the S&P’s smashing, as in breaking below the 1040 level and 1035 for that matter, performance over the past few days. I hate to break it to everyone, but the time to be bearish was at 1120 and when the VIX was at 15, now, well, be bearish, but be careful. Those looking to jump on the short wagon might find themselves over paying for their positions and they might get squeezed out in the next few days. Don’t get me wrong, my S&P 500 target price is still 900, but I fully expect a retest of the 1040 mark in the very near term.

How bad is the economy?

Anyone even questioning how bad the economy is has their eyes closed and their head stuck in the sand. All the data is rolling over, look at the Chicago PMI today which came in at 59.1, sure, it met expectations, but it is down from where it was and is establishing a declining trend. The leading indicators are down and probably going to look horrible in the near future. I am sure initial claims will still be well over 450K tomorrow, oh, the ADP data stank to high heaven today as well so forget about an upside surprise on Friday. There is some housing data out tomorrow morning and I am sure it will not be good, it is May contract data, but never fear because Congress is attaching an extension of the home buyers tax credit to the unemployment extension, fantastic!

In short, things are much better than, say, September 2008, but things are not good and we are heading for either a double dip or very slow growth in the second half of this year. Treasury yields are telling us we got serious problems ahead and deflation, sound familiar yet, is an immediate threat. However, remember that inflation will come on very fast at some point in the future, you will never see it coming. The good news was that the ECB lending news was not as bad as I was expecting, but let’s face it, the news is still not good in Europe and the risks are very high. Spain may be downgraded, it will be very soon, which I am sure is surprising and people are wondering why such a fiscally sound country be downgraded?

The only thing I am surprised about is the U.S. and the U.K. still have the ‘AAA’ ratings after their drunken stupor of a spending spree, with much more to come before the majority is kicked out in November. After all, once your vote is cast and they lose their jobs what do they care if you dislike them or not? Expect another stimulus which is sure to extend our pain well into 2011. In the end all we will have found is that we have spent a lot of money with very poor results, just like the 1930’s. Let’s just hope this time it does not end like it did in 1941, there seems to be a correlation between poor economic stretches and wars.

What should give bulls some fuel is that everyone is so bearish it is bound to be a contrarian indicator. Am I going to bet on that? No, not yet at least. I spent the majority of this morning dumping everything I absolutely did not love to own building cash and some short positions, the markets were up this AM. While I am sure we will get a bounce in equities I am not so sure we will get it this week, a notable bounce at least. There will be short covering before the 3 day weekend, but at the same time I do not believe any one wants to be long either. What does that mean? We go lower, in my opinion at this very moment, but we could very well get a sharp bounce tomorrow before we go lower. If we break above 1040 we might go higher, but we are certainly not going to make new highs again this year, from what I see right here and now. Things are much worse than they appear unless you are 100% treasuries, suddenly that call I made back in April doesn’t look so crazy anymore either.