"Unemployment is sky-rocketing; deflation is in our future for the first time since the Great Depression. I don't care whose fault it is, it's the truth." - John Mellencamp
Economics is a very strange discipline. It tries to work out what will happen to an economy given certain inputs and structural changes. For example, how will a change in the tax rate help or hurt the economy or how will massive stimulus from the Federal Reserve stimulate economic growth? The problem with economics is that there are just so many moving parts that the chances of actually get the answer right is pretty much impossible. What you can do is hypothesis about the future and base it on historical data points and then rely on your instinct to guide you. Changing your mind is part and parcel of the process as new data is constantly available and there is always the Black Swan event lurking around that will throw all assumptions out of the window and create havoc with your hypothesis.
When I look at the massive quantitative easing program of the Federal Reserve the questions are is it working and will it result in inflation? Consensus says that it is working (at least that is what it appears when you look at the stock market) and that inflation, while it will rise will be moderate. At present I disagree with both of these views which is why I am in the camp that is negative on the market because if it is not working and inflation will not be moderate in the future then the market is setting everyone up for a massive reversal.
Now what if we are all wrong? What if inflation not only remains subdued but due to all of the easing we end up with deflation? I have mentioned in last week's blog that Japan is already exporting deflation to the rest of the world, but what if deflation takes hold globally? If I look at the Federal Reserve who has increased their balance sheet by almost $3 trillion you would expect massive inflation but at present it seems relatively mute.
Consider this equation created by Irving Fisher that GDP = MV. That is to say the size of the economy is equal to the money supply multiplied by the velocity of money. Now if the velocity of money remains constant (does not change) then by increasing the supply of money through the Federal Reserve monetary expansion then GDP has to increase. This is inflation. Now as there is minimal inflation at present and GDP is not growing very fast (if at all) let's dig a bit deeper to see what is going on in the inner workings of the equation.
Money supply as measured by M2, the monetary base, expanded by $277.5 Billion last quarter as the Federal Reserve expanded its balance sheet by that amount. M (money supply) however declined by $55 Billion to $10.45 Trillion. This is only possible if the money multiplier shrank. The money multiplier is the value assigned to the expansion of the money supply when a bank lends out a dollar. This expansion occurs because the dollar lent does not just stay in your wallet but is used to buy goods and services and is then spent again and again. This one dollar multiplied itself by a factor of 9 in 2007 when the economy was booming, but today that number has fallen to 3.6. So the first problem that the Federal Reserve has is that it cannot create demand by printing money.
The second part to the equation is the velocity of money. Velocity of money was thought to always remain stable but it turns out that this too is a variable. It appears that the only way in which the velocity of money can remain stable or expand is through lending to increase production. Lending to finance consumption does not generate a productive income stream and it cannot create resources to repay the debt so therefore velocity collapses. In fact the current velocity of money stands at a six decade low.
Now the inflation advocates point to the fact that once things turn around you will have an increase in the velocity of money and an increase in the money multiplier and a huge increase in the monetary base and this will lead to outlandish inflation. The problem is that the money printed is being used to finance consumption and this could result in a spiral into the abyss that is deflation. This is what Japan has been dealing with for decades. They too have and are pumping money into an economy in the hopes that it will eventually get their economy started but after more than 20 years there is still no sign of life. Worse than that they now owe more than 200% of GDP in government debt.
This could easily be the outlook for the United States and if it is then the euphoria of the stock market will quickly turn to dismay. The reason is that deflation is the worst possible world for the stock market. The economy is essentially shrinking as prices fall and consumers put off purchasing goods and services as they learn that these will be cheaper in the future. Businesses struggle to grow and can only keep profits up by stealing market share from others or by cutting overhead such as labor. If this sounds familiar then you are right as this is where the United States is now. The problem is that the market and most pundits expect inflation to begin any time soon and as the market looks forward the expectations for inflation are now baked into the prices. Should this expectation change as the reality sets in then the market will be in for a long downward spiral. In Japan the market has recently rallied to over 13,000 but that is still a long way from 38,916 which was the all time high set in December 1989!
Friday, April 26, 2013
Friday, April 19, 2013
A Shudder Is Felt
"Excuse me, why have the engines stopped? I felt a shudder." - Rochelle Rose as Countess of Rothes in Titanic
This week it was evident that there is trouble in global markets. Now not to discount the fact that the Federal Reserve and other central bankers of the world will rush to support the one beacon of success the stock market, surveying the movements in the markets this week seems to point to a shift in the bullish stance.
The first graph that I look to in these times is our old friend Dr. Copper. As you can see from the chart below there is a lot of concern about global growth. China in particular is looking weak and this is feeding into global growth projections and notably the copper price.
Gold also took a tumble recently as concerns for inflation are being replaced with concerns for deflation. That said I still believe in the value of allocating a portion of your portfolio to this metal as it appears that the gold haters one this round but the long run bull market for gold is still intact.
Deflation is being fueled by the Bank of Japan's massive quantitative easing program as their disdain for their currency is giving them the ability to undercut their rivals and hence export their deflation to the world. This in turn is fueling their stock market which too is spiralling higher, but the repercussions of Japan's move will be felt throughout the globe and will not have a pleasant impact on their trade partners. As an example expect Toyota to take market share from the resurgent US automaker as they will be able to under cut their their American competitors.
All of this news and some poor earnings from the some of the US bell weather stocks is having an impact on the performance of the stock market. As I mentioned before though the Federal Reserve will put in a big effort to support this market as it is the shining beacon of its success.
So whether this is just a brief pullback or the start of something bigger the global metrics continue to point to weakness and this will fuel a large pullback at some point in the near future. I believe though that when that time comes, much like the Titanic, there will be little time to exit so make sure you heed the warnings early.
This week it was evident that there is trouble in global markets. Now not to discount the fact that the Federal Reserve and other central bankers of the world will rush to support the one beacon of success the stock market, surveying the movements in the markets this week seems to point to a shift in the bullish stance.
The first graph that I look to in these times is our old friend Dr. Copper. As you can see from the chart below there is a lot of concern about global growth. China in particular is looking weak and this is feeding into global growth projections and notably the copper price.
Gold also took a tumble recently as concerns for inflation are being replaced with concerns for deflation. That said I still believe in the value of allocating a portion of your portfolio to this metal as it appears that the gold haters one this round but the long run bull market for gold is still intact.
Deflation is being fueled by the Bank of Japan's massive quantitative easing program as their disdain for their currency is giving them the ability to undercut their rivals and hence export their deflation to the world. This in turn is fueling their stock market which too is spiralling higher, but the repercussions of Japan's move will be felt throughout the globe and will not have a pleasant impact on their trade partners. As an example expect Toyota to take market share from the resurgent US automaker as they will be able to under cut their their American competitors.
All of this news and some poor earnings from the some of the US bell weather stocks is having an impact on the performance of the stock market. As I mentioned before though the Federal Reserve will put in a big effort to support this market as it is the shining beacon of its success.
So whether this is just a brief pullback or the start of something bigger the global metrics continue to point to weakness and this will fuel a large pullback at some point in the near future. I believe though that when that time comes, much like the Titanic, there will be little time to exit so make sure you heed the warnings early.
Friday, April 12, 2013
A Lot of Data
"This is referred to as data mining. They slice and dice these numbers a thousand different ways. They analyze patterns. If your NSA, you look for suspicious patterns." - Leslie Cauley
The first thing that you always have to be careful of when look at a lot of data points is that you are not mining data to fit your theory rather than looking at all the data points from a rational perspective. It is an easy trap to fall into as we are normally biased towards our own opinions and can spend hours explaining the virtues of our position (just listen to any sports enthusiast arguing about the referee calls). However when the data points overwhelmingly in your favor you have to act and that is one of the arts of trading.
Recently there has been a slew of poor information and it all points to the economy slowing and at a far more rapid pace (actually all the analysts are expecting growth) than was anticipated by the market consensus. The first and most recent data point was that PC sales fell by 14%. This is the largest decline in the history of PC sales. Pundits tried to push this aside as a migration to the tablet and the mobile phone and while I will admit that a lot of people have migrated to those platforms the underlying trend is worrying.
There is no way that the market implosion of PCs is only related to tablets. This is a direct result of very weak consumer spending and a weak global economy. Ask anyone who owns a tablet how much business they actually do on a tablet and the answer is normally not much. This weakness will feed into weak chip sales, chip development, software and numerous other industries. Remember when the NASDAQ was flying and technology was the place to be well it appears that those days are over and to me this is even more scary as without a technological recovery I am not sure what other industry can drag the global economy back on its feet.
The next data point is poor consumer spending numbers which have fed poor retail sales. As I have mentioned repeatedly, the tax effects and increased costs of health insurance and other expenses combined with little to no job growth or increases in pay will have a massive impact on consumer spending. This is starting to raise its ugly head as retail sales fell 0.4% in March. Following this up was another poor number out of the consumer as consumer sentiment fell again in April. Admittedly this is a preliminary number but it is not a good omen.
The final data point I want to talk about is the revelation from Pimco's Bill Gross that the Federal Reserve is now publishing different reports for different groups. The Federal Reserve issues a separate release to lobbyists and congressional staffers. In addition there are certain funds and banks that receive the data sooner than others! Now why is it that some are insiders and others are not? So much for independence and for looking out for the benefit of the economy! No it is certain that they are cherry picking those who they want to benefit at the expense of everyone else and this is outright discrimination and needs to be stopped immediately.
Outside of that they did caution that the duration of their quantitative easing strategy was under consideration to be shortened. In effect they are finally admitting that it is not working as why else would they start talking about curtailing it when nothing has recovered? Should they stop printing I would expect a huge market correction for the simple reason that they are manipulating the market openly. Stop manipulating and down it goes as all that the market will have for a backstop then will be poor economic data and outlook.
As you all know I have been calling for this for a long time and I have been wrong to date but until the economic indicators turn themselves around there is no reason to be long the market particularly when the people controlling it are openly manipulating the data and providing it to their friends first!
The first thing that you always have to be careful of when look at a lot of data points is that you are not mining data to fit your theory rather than looking at all the data points from a rational perspective. It is an easy trap to fall into as we are normally biased towards our own opinions and can spend hours explaining the virtues of our position (just listen to any sports enthusiast arguing about the referee calls). However when the data points overwhelmingly in your favor you have to act and that is one of the arts of trading.
Recently there has been a slew of poor information and it all points to the economy slowing and at a far more rapid pace (actually all the analysts are expecting growth) than was anticipated by the market consensus. The first and most recent data point was that PC sales fell by 14%. This is the largest decline in the history of PC sales. Pundits tried to push this aside as a migration to the tablet and the mobile phone and while I will admit that a lot of people have migrated to those platforms the underlying trend is worrying.
There is no way that the market implosion of PCs is only related to tablets. This is a direct result of very weak consumer spending and a weak global economy. Ask anyone who owns a tablet how much business they actually do on a tablet and the answer is normally not much. This weakness will feed into weak chip sales, chip development, software and numerous other industries. Remember when the NASDAQ was flying and technology was the place to be well it appears that those days are over and to me this is even more scary as without a technological recovery I am not sure what other industry can drag the global economy back on its feet.
The next data point is poor consumer spending numbers which have fed poor retail sales. As I have mentioned repeatedly, the tax effects and increased costs of health insurance and other expenses combined with little to no job growth or increases in pay will have a massive impact on consumer spending. This is starting to raise its ugly head as retail sales fell 0.4% in March. Following this up was another poor number out of the consumer as consumer sentiment fell again in April. Admittedly this is a preliminary number but it is not a good omen.
The final data point I want to talk about is the revelation from Pimco's Bill Gross that the Federal Reserve is now publishing different reports for different groups. The Federal Reserve issues a separate release to lobbyists and congressional staffers. In addition there are certain funds and banks that receive the data sooner than others! Now why is it that some are insiders and others are not? So much for independence and for looking out for the benefit of the economy! No it is certain that they are cherry picking those who they want to benefit at the expense of everyone else and this is outright discrimination and needs to be stopped immediately.
Outside of that they did caution that the duration of their quantitative easing strategy was under consideration to be shortened. In effect they are finally admitting that it is not working as why else would they start talking about curtailing it when nothing has recovered? Should they stop printing I would expect a huge market correction for the simple reason that they are manipulating the market openly. Stop manipulating and down it goes as all that the market will have for a backstop then will be poor economic data and outlook.
As you all know I have been calling for this for a long time and I have been wrong to date but until the economic indicators turn themselves around there is no reason to be long the market particularly when the people controlling it are openly manipulating the data and providing it to their friends first!
Friday, April 5, 2013
Markets Rise Everywhere With No Jobs To Support Them
"Double, double, toil and trouble; Fire burn and cauldron bubble." - The witches chant from William Shakespeare's Macbeth
This morning the United State reported disastrous employment news. It really should not have come as a surprise as I have been reading of layoffs from large and small companies across the country for months now. I am now also watching as the S&P 500 which dropped over 1% on the news claw its way back towards the gain line once again. It is certainly apparent that no matter what the news, the markets are going to go higher and if you listen to CNBC or one of the other market cheer leading channels within minutes you will be told just why things can only go higher from here!
Let me lead you through a number of very poignant metrics and you can make your own conclusions.but suffice it to say that I have now put on some S&P puts! Not a large amount but enough to make me feel better. :)
First off you need jobs to create a strong economy. Look at any model of economic strength and you will see a low unemployment number. Jobs are the economy. No jobs, no economic recovery period. At present looking across the globe you have the Euro zone with unemployment above 12% the highest it has ever been and this masks the disasters that are Greece and Spain where unemployment is well past the Great Depression levels. The United States has unemployment at north of 14% if you include the underemployed and some metrics have it as high as 20%. Worse still is that 48 million people are now on food stamps in America up from 28 million just 5 years ago. That is 11% compounded annual rate of growth! What portfolio would not die for that number over the last five years? So we have mounting unemployed and 15% of the people cannot feed themselves without government aid and the United States is supposedly the richest country in the world.
Without jobs the consumer has no spending power. With no spending power companies cannot sell their products and profits slip (I expect a lot of companies to miss or lower their earnings targets going into this quarter's earnings reports). So why is the market continuing higher? It is very simple, the Federal Reserve is pumping money into the system and that money has to be invested. With bond yields at historic lows the stock market and real estate are the direct beneficiaries. Real estate is up over 8% nation wide while the yield on junk bonds has fallen to less than 3%. Both of these are unsustainable. First off housing prices cannot keep up this pace as consumers do not have the ability to purchase the houses. The house prices are being propelled by large funds that are scooping up millions of houses at once because they can borrow money for next to nothing and this investment creates a better yield on their investment than the bond market. This is not consumer demand this is speculation at its worst.
Furthermore with treasury yields falling to next to nothing bond buyers have once again ratcheted up the risk by buying junk. This demand has pushed the price of these high risk bonds up reducing the yield to next to nothing. The risk is not being met with commensurate return and this is a disaster waiting to happen. To me it is not a case of if it will unravel but when. Trying to even hazard a guess as to when this will unravel is futile as it will only occur when there is a loss of faith in the Federal Reserve's ability to control the markets.
For this reason sentiment indicators are worth watching and the most recent one was consumer confidence which dropped precipitously to 59.7 in March from 68 in February. Consumers are starting to feel the very real pinch of lower income as another bite is being taken out of their pay with the tax increases, health care increases and gasoline and food price increases. While this is not a good signal the Federal Reserve continues to believe that printing more money is the answer and is cajoling money printers around the world in Britain, Japan, Switzerland and others to join in the party. This juice is what is fueling these speculative frenzies in the stock, bond and real estate markets. Switch this juice off (which they will have to eventually) and all of these markets die virtually instantly as we have seen with the end of each of the previous 3 rounds of quantitative easing (or is it four, there have been so many I can barely keep up).
Do not get sucked in. Keep your money in cash, gold or something that is safe and protected against a downturn as that is the best way to survive the storm as it appears that there are more than a few black clouds on the horizon.
This morning the United State reported disastrous employment news. It really should not have come as a surprise as I have been reading of layoffs from large and small companies across the country for months now. I am now also watching as the S&P 500 which dropped over 1% on the news claw its way back towards the gain line once again. It is certainly apparent that no matter what the news, the markets are going to go higher and if you listen to CNBC or one of the other market cheer leading channels within minutes you will be told just why things can only go higher from here!
Let me lead you through a number of very poignant metrics and you can make your own conclusions.but suffice it to say that I have now put on some S&P puts! Not a large amount but enough to make me feel better. :)
First off you need jobs to create a strong economy. Look at any model of economic strength and you will see a low unemployment number. Jobs are the economy. No jobs, no economic recovery period. At present looking across the globe you have the Euro zone with unemployment above 12% the highest it has ever been and this masks the disasters that are Greece and Spain where unemployment is well past the Great Depression levels. The United States has unemployment at north of 14% if you include the underemployed and some metrics have it as high as 20%. Worse still is that 48 million people are now on food stamps in America up from 28 million just 5 years ago. That is 11% compounded annual rate of growth! What portfolio would not die for that number over the last five years? So we have mounting unemployed and 15% of the people cannot feed themselves without government aid and the United States is supposedly the richest country in the world.
Without jobs the consumer has no spending power. With no spending power companies cannot sell their products and profits slip (I expect a lot of companies to miss or lower their earnings targets going into this quarter's earnings reports). So why is the market continuing higher? It is very simple, the Federal Reserve is pumping money into the system and that money has to be invested. With bond yields at historic lows the stock market and real estate are the direct beneficiaries. Real estate is up over 8% nation wide while the yield on junk bonds has fallen to less than 3%. Both of these are unsustainable. First off housing prices cannot keep up this pace as consumers do not have the ability to purchase the houses. The house prices are being propelled by large funds that are scooping up millions of houses at once because they can borrow money for next to nothing and this investment creates a better yield on their investment than the bond market. This is not consumer demand this is speculation at its worst.
Furthermore with treasury yields falling to next to nothing bond buyers have once again ratcheted up the risk by buying junk. This demand has pushed the price of these high risk bonds up reducing the yield to next to nothing. The risk is not being met with commensurate return and this is a disaster waiting to happen. To me it is not a case of if it will unravel but when. Trying to even hazard a guess as to when this will unravel is futile as it will only occur when there is a loss of faith in the Federal Reserve's ability to control the markets.
For this reason sentiment indicators are worth watching and the most recent one was consumer confidence which dropped precipitously to 59.7 in March from 68 in February. Consumers are starting to feel the very real pinch of lower income as another bite is being taken out of their pay with the tax increases, health care increases and gasoline and food price increases. While this is not a good signal the Federal Reserve continues to believe that printing more money is the answer and is cajoling money printers around the world in Britain, Japan, Switzerland and others to join in the party. This juice is what is fueling these speculative frenzies in the stock, bond and real estate markets. Switch this juice off (which they will have to eventually) and all of these markets die virtually instantly as we have seen with the end of each of the previous 3 rounds of quantitative easing (or is it four, there have been so many I can barely keep up).
Do not get sucked in. Keep your money in cash, gold or something that is safe and protected against a downturn as that is the best way to survive the storm as it appears that there are more than a few black clouds on the horizon.
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