How to Kickstart the Economy
by ilene - October 21st, 2010 4:18 am
How to Kickstart the Economy
By MIKE WHITNEY, originally published at CounterPunch
On Friday, Fed chairman Ben Bernanke made the case for a second round of quantitative easing (QE) claiming that inflation is presently "too low" to achieve the Fed’s dual mandate of price stability and full employment. By purchasing long-term Treasuries, Bernanke hopes to lower bond yields and force investors into riskier assets. That, in turn, will push stocks higher, making investors feel wealthier and more apt to boost spending. (Re: "trickle down", when investors increase spending, it reduces the slack in the economy and lowers unemployment.) Thus, QE is intended to divert investment to where it is needed and to lift the economy out of the doldrums.
That’s the theory, at least. In practice, it doesn’t work so well. Over a trillion dollars in reserves are still sitting on banks balance sheets from QE1. The anticipated credit expansion never got off the ground; the banks loan books are still shrinking. Bernanke fails to say why more-of-the-same will produce a different result. QE is also risky; in fact, it could make matters worse. Unconventional methods of pumping liquidity into the economy can undermine confidence in the dollar and trigger turmoil in the currency markets. Trading partners like Brazil and South Korea are already complaining that the Fed is flooding the markets with money pushing up their currencies and igniting inflation.
The threat of more cheap capital is causing widespread concern and talk of a currency war. If Bernanke goes ahead with his plan, more countries will implement capital controls and trade barriers. The Fed is clearing the way for a wave of protectionism. Quantitative easing, which is essentially an asset swap--reserves for securities--will not lower unemployment or revive the economy. Low bond yields won’t spark another credit expansion any more than low interest rates have increased home sales. The way to tackle flagging demand is with fiscal stimulus; food stamps, state aid, unemployment benefits, work programs etc. The focus should be on putting money in the hands of the people who will spend it immediately giving the economy the jolt that policymakers seek. QE doesn’t do that. It depends on asset inflation to generate more spending, which means that we’ve returned to the Fed’s preferred growth formula--bubblenomics.
Quantitative easing is also extremely costly for, what amounts to, modest gains. Consider this, from the Wall Street Journal:
"The…
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DiggWhen the Levee Breaks
by ilene - October 15th, 2010 1:01 am
When the Levee Breaks
Courtesy of Joshua M Brown, The Reformed Broker
Here’s a riddle:
What happens when an extra half trillion dollars that has been shoe-horned into bond funds decides it’s getting a horrific return, sees the 10% rally in dividend-paying equities and decides to switch asset classes? What happens when this mass asset class transfer happens not in an orderly manner, but in a rush – between say October and the holiday season? Specifically, what happens to the stock market?
Katrina happens, Esse. People hanging in tree branches, pickup trucks lying sideways on the rooftops of buildings, Indonesian tsunami stuff.
A biblical flood-tide of misallocated cash leaves the 1.5%-yielding short-term bond market and comes sloshing back over the transom into the equity market. You may have already gotten a whiff of this hurricane-tide in the first two weeks of October. Bears are mistakenly referring to it as "just another Risk On moment". It is becoming much more than a moment.
The plunge into bond funds over the last two years has been epic; $350 billion in inflows in 2009, 2010 is on pace to see another $300 billion. This ocean of money predominantly came into these funds at the short-end of the yield curve and is currently earning a sclerotic rate of return that is dwarfed by "real" inflation (you know, like food prices, energy and stuff that matters in real life).
According to Morningstar, the pace of the out-of-stocks/into-bonds trade that has been so dominant all year is slowing.
From Morningstar via the WSJ:
Overall, long-term (bond) mutual funds saw inflows of $14.28 billion during September, lower than August’s $16.81 billion
I would not be surprised to see this trend continue and then reverse itself entirely as investors look at the paltry yields they’ve signed on for and begin reallocating back toward their forsaken stock funds again. And because we’re Americans, despite our much-mythologized "rugged individualism", we tend to stampede like a delirious herd. Because this is the case, I also wouldn’t be surprised to see this move happen en masse.
Just a heads up – the more agile among us may want to start paddling their surfboards in front of the right wave now.
******
When the levee breaks/led zeppelin
Sometimes It’s Just a Black Duck
by ilene - September 29th, 2010 5:16 pm
So if it looks like a duck, quacks like a duck, and walks like a duck, there’s a good chance it’s not a black swan no matter how much you’d like it to be one. – Ilene
Sometimes It’s Just a Black Duck
Courtesy of Joshua M. Brown, The Reformed Broker
Death Crosses, the Hindenburg Omen, the Black Swan of all Black Swans, the AIDS Doji, the Devil’s Ladder, the Europocalypse, the plagues of pestilence and locusts, the Tony Robbins Alert, the Hitler Harami formation, etc.
Here a Swan, there a Swan, everywhere a Black Swan.
Except 18 months since the bottom of the market and 13 months since the NBER-recognized economic trough, none of these "Prophecies have been fulfilled". Sleeping Beauty hasn’t pricked her finger on the spindle and that cabin in Upstate New York I stocked with guns and SpaghettiO’s lies empty still.
The trouble with the Recency Effect is that everyone all of a sudden thought they were Nassim Taleb, orinthological experts on the spotting of Black Swans. Every blip on the screen or blurb in the newspaper was fresh evidence of the next hundred years’ storm. Forget being fooled by randomness, people have become obsessed with randomness.
But as we’ve learned, not every aberration is a Black Swan in the making. Sometimes, it’s just an ordinary Black Duck. A negative event or possibility that is processed and dealt with, that doesn’t necessarily lead to contagion, panic and meltdown.
This is not to say that warning signs of future crises should be dismissed out of hand. In fact, my argument is the opposite; the more we learn not to get hysterical over every Black Duck, the better the chances are that when the real things comes along, we will be cogent enough in our reaction to them.
Iranian nukes and the Straight of Hormuz, Al-Quaeda’s next terrorism attempts, the Pension Fund Time Bomb, the Chinese Real Estate Bubble, the Treasury Bond Bubble, the disappearance of non-program trading volume in the stock market, hyper-inflation, hyper-deflation, the commercial real estate shoe-to-drop, the Municipal Bond Minefield, etc. All ugly problems, but all Black Swans?
Or just Black Ducks that will be unpleasant to deal with but dealt with regardless?
MORE BUBBLE TALK
by ilene - September 29th, 2010 5:12 pm
MORE BUBBLE TALK
Courtesy of The Pragmatic Capitalist
It’s becoming increasingly popular to describe the U.S. government bond market as a “bubble.” As I’ve previously explained, this strikes me as totally nonsensical for several reasons – the primary reason being that the term simply is not applicable to an asset in which you receive your entire principle back at maturity. The term “bubble” implies a grossly mispriced asset that is susceptible to substantial losses. If the instrument is used as intended there should be little to no risk of principal loss in a U.S. government bond. And given the weak economy and constant need for government intervention it is no surprise that investors are seeking a safe haven such as
Aside from all that, Credit Suisse recently published an interesting piece of research arguing the same point – that the U.S. bond market is not a bubble. They noted that the price action in government bonds is very different from historical bubbles:
“We note that the price action of bonds it is very different from the bubbles in other asset classes we have seen over the last 30 years. The six-month US bond return is 1.9 standard deviations above norm, compared to an average of 5.9 standard deviations during previous bubbles.”
So you can see the price action is not even remotely similar to the great bubbles in history. If investors continue to use government bonds as they are intended (for instance, don’t make a 10 year loan with the intention of demanding your money back in 10 minutes), diversify across bond markets and generally allocate bonds as they are intended (as a hedge against other higher risk assets) then there should be very little risk of you ever experiencing a catastrophic loss such as those seen after many of the great bubbles of the last 30 years.
Sure Thing?!
by ilene - September 29th, 2010 1:23 am
Sure Thing?!
Courtesy of Mish
Last week, David Tepper, a billionaire hedge fund titan and president of Appaloosa Management remarked on CNBC …
Two things are happening. It’s that easy sometimes. Either the economy is going to get better by itself, in the next 3 months and what assets are going to do well? You can guess what assets will do well – stocks are going to do well, bonds won’t do so well, gold won’t do as well. OR The economy is not going to pick up in the next three months and the Fed is going to come in with QE. Right? Then what’s going to do well? Everything! In the near term – Everything!
Video
Earnings vs. Share Prices
One might not be able to argue with Tepper’s past performance, but one sure can argue with his current logic. Stocks do not necessarily go up because earnings go up. Stocks rise or fall primarily based on sentiment.
Right now, sentiment is so bullish and earnings estimates so lofty there is room for hefty earnings expansion that falls short or estimates. Buying stocks that miss wildly optimistic earnings estimates is not likely to work out well.
Furthermore, even if earnings do come in on target, there is no historic guarantee that stock prices follow. For example, on March 31, 1973 the S& P was at 111.52 with trailing earnings of $6.80. Seven years later, on March 31, 1980 the S&P was at 102.09 with trailing earnings of $15.27.
Thus, over a span of seven years, earning rose 125% while stock prices fell 8.5%!
What happened? The PE ratio on the S&P fell from 16.40 to 6.68, that’s what.
Moreover, those were real earnings then. Now, corporations hide garbage in SIVs with the blessing of the Fed and analysts cite pro-forma earnings that throw out "one-time" charges that occur with increasing regularity.
Thus, anyone who says stock prices will go up because earnings go up, does not understand history. This does not make Tepper wrong, but it does make his argument fallacious.
What About Quantitative Easing?
Tepper also argues that everything will be good if the Fed falls back on quantitative easing. Really?
The Cleveland Fed has a series of nice charts on Japan’s Quantitative Easing Policy
Japan’s Quantitative Easing vs. Price Inflation
Japan’s Quantitative Easing in Trillions of Yen
After a series
…
Are Stocks Overvalued By $4+ Trillion? Quantifying The Fed’s Impact On The Stock Market
by ilene - September 24th, 2010 1:08 pm
Are Stocks Overvalued By $4+ Trillion? Quantifying The Fed’s Impact On The Stock Market
Courtesy of Tyler Durden, Zero Hedge
A few months ago we penned an article titled: "Bond Yields Imply The Fair Value Of The S&P Is 750" and this was when the 10 Year was still above 3.00%. It is now around 40 bps tighter, meaning the fair value of stocks is even lower based on the historical 75% regression pattern we indicated back in June. Today, David Rosenberg also chimes in on this ridiculous divergence between the S&P and bonds, and in graphic form shows that should the gap ever close, it would lead the stock market to its fair value, which ironically, is just around the March 2009 lows of 666.
Folks — something has to give … yields on the 2-year T-note (thin line, right hand side on chart below) has a 75% POSITIVE correlation with the S&P 500 and just hit a cycle low. Either it’s a short or the equity market is … take your pick.
As a reminder, historically bonds are right… about 100% of the time.
And with the S&P’s market cap at $10.5 trillion, meaning each S&P point is equivalent to about $9 billion dollars, the impact of the Fed’s intervention on stocks is roughly $4.4 trillion. Alterantively, one can argue that stocks are right, and bonds are wrong. Since the bond market is double the size of its smaller stock cousin, it would means that the Fed’s endless interventions have mispriced just under $9 trillion worth of fixed income assets.
And people want to play in a market that is as ridiculously out of sync with reality as either of these?
Good luck.
Curve Watcher’s Anonymous Investigates the Question “Is the Bond Bull Dead?”
by ilene - September 22nd, 2010 4:29 pm
Curve Watcher’s Anonymous Investigates the Question "Is the Bond Bull Dead?"
Courtesy of Mish
Curve Watcher’s Anonymous is looking at various long-term and intraday charts of treasuries and the stock market following Tuesday’s FOMC meeting.
$TNX: 10-Year Treasury Yield Intraday Chart
Click on any chart to see a sharper image.
Note the initial spike higher in yields right on the announcement. This headfake is very typical of FOMC announcements.
SPY: S&P 500 Index Shares Intraday Chart
As with treasuries, the S&P 500 had an initial spike that quickly reversed. Both charts show fat tails.
Ultimately the rally failed (which would be typical given the flight to safety trade in treasuries).
Every FOMC meeting it seems we get the same fake reaction: The first move is typically a false move. Sometimes there is a double fake, but only rarely does the initial move keep on going. I would be interested to see comments on this.
Given that I seldom concern myself with intraday or even short-term action however, the more serious question is "Where to from here?"
2-Year Treasuries vs. the S&P 500
The pattern may not continue, but for quite some time rising treasury yields have generally been directionally aligned with rising equities. In three instances (the first three red boxes), a drop in treasury yields preceded (led) a subsequent drop in equities. The fourth box (where we are now) is unresolved.
2-Year Treasuries – Monthly Chart
Two year treasury yields have fallen to a record low, yet stocks have been rising.
5-Year Treasuries – Monthly Chart
The all time low in 5-year treasury yields is but a stone’s throw away.
10-Year Treasury Yields – Monthly Chart
New lows in 10-year treasury yields are in sight.
To help put things into perspective here is a weekly chart of $TYX 30-year treasuries, $TNX 10-year treasuries, $FVX 5-year treasuries, and $IRX the 3-month treasury discount rate. The other symbols are yields.
$TYX, $TNX, $FVX, $IRX Weekly Chart
The chart depicts weekly closing values.
Is the Bond Bull Over?
Judging from 2-year treasuries or 5-year treasuries, pronouncements of the "death of the bond bull" were certainly premature. Moreover, given how weak the economy is, I think it is odds-on the 10-year treasury note touches if not breaks the previous yield lows.
Only the 30-year long bond yield seems reluctant to drop. It may not…
Beware of Greeks Bearing Bonds
by ilene - September 11th, 2010 6:52 pm
This is a fascinating study of Greece and how the largest of part of its bankruptcy may be in its collective conscience. - Ilene
Beware of Greeks Bearing Bonds
Vanity Fair’s Introduction: As Wall Street hangs on the question “Will Greece default?,” the author heads for riot-stricken Athens, and for the mysterious Vatopaidi monastery, which brought down the last government, laying bare the country’s economic insanity. But beyond a $1.2 trillion debt (roughly a quarter-million dollars for each working adult), there is a more frightening deficit. After systematically looting their own treasury, in a breathtaking binge of tax evasion, bribery, and creative accounting spurred on by Goldman Sachs, Greeks are sure of one thing: they can’t trust their fellow Greeks.
After an hour on a plane, two in a taxi, three on a decrepit ferry, and then four more on buses driven madly along the tops of sheer cliffs by Greeks on cell phones, I rolled up to the front door of the vast and remote monastery. The spit of land poking into the Aegean Sea felt like the end of the earth, and just as silent. It was late afternoon, and the monks were either praying or napping, but one remained on duty at the guard booth, to greet visitors. He guided me along with seven Greek pilgrims to an ancient dormitory, beautifully restored, where two more solicitous monks offered ouzo, pastries, and keys to cells. I sensed something missing, and then realized: no one had asked for a credit card. The monastery was not merely efficient but free. One of the monks then said the next event would be the church service: Vespers. The next event, it will emerge, will almost always be a church service. There were 37 different chapels inside the monastery’s walls; finding the service is going to be like finding Waldo, I thought.
“Which church?” I asked the monk.
“Just follow the monks after they rise,” he said. Then he looked me up and down more closely. He wore an impossibly long and wild black beard, long black robes, a monk’s cap, and prayer beads. I wore white running shoes, light khakis, a mauve Brooks Brothers shirt, and carried a plastic laundry bag that said eagles palace hotel in giant letters on the side. “Why have you come?” he asked.
That was
…
European Banks Still on the Brink
by ilene - September 9th, 2010 11:48 pm
European Banks Still on the Brink
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Courtesy of MIKE WHITNEY writing at CourterPunch
The EU banking system is in big trouble. That’s why European Central Bank (ECB) head Jean-Claude Trichet continues to purchase government bonds and provide "unlimited funds" for underwater banks. It’s an effort to prevent a financial system meltdown that could wipe out bondholders and plunge the economy back into recession.
"We have the best track record on price stability over 11 1/2 years in Europe and among the legacy currencies,” Trichet recently boasted. “What we have done and what we do with the same purpose is to help restore an appropriate functioning of the monetary-policy transmission mechanism.”
Nonsense. EU banks and other financial institutions are presently holding more than 2 trillion euros of public and private debt from Greece, Spain and Portugal. All three countries are in deep distress and face sharp downgrades on their sovereign debt. The potential losses put large parts of the EU banking system at risk. Trichet knows this, which is why he continues to support the teetering system with "unlimited funds". It has nothing to do with restoring the "functioning of the monetary-policy transmission mechanism". That’s deliberately misleading. It is a straightforward bailout of the banks.
Imagine that you are deeply in debt, but the bank offers to lend you as much money as you need to keep you from bankruptcy. To help maintain appearances, the bank agrees to accept the worthless junk you’ve collected in your attic in exchange for multi-million dollar loans. Does the bank’s participation in this charade mean that you are not really broke after all? Does it increase the value of the garbage collateral you’ve exchanged for cash?
The ECB is providing billions of euros per week to maintain the illusion that the market is wrong about the true value of the bonds. But the market is not wrong, the ECB is wrong. The value of Greek bonds (for example) has dropped precipitously. They are worth less, which means the banks need to take a haircut and write down the losses. More liquidity merely hides the problem.
This is from Reuters:
"Despite the open-arms approach, outstanding ECB lending has fallen more than a third since the start of July to 592 billion euros…. Liquidity remains abundant though. Over 120 billion euros was deposited back at the ECB overnight, the latest figures show."
So, overnight…
Goldman Marks Top in Municipal Bond Market?
by ilene - September 9th, 2010 8:28 pm
Goldman Marks Top in Municipal Bond Market?
Courtesy of Mish
History shows that whatever Goldman is peddling in a big way to cities, counties, or retail investors, be it interest rate swaps or derivatives, or advice, those investors would be better off not taking it.
With that in mind, please consider Goldman in Bond Deal
Goldman Sachs Group Inc. is about to start selling municipal bonds directly to mom and pop.
The New York company plans to enter a partnership this week with Chicago securities firm Incapital LLC to sell bonds issued by U.S. states, cities and towns to individual investors, according to a person familiar with the situation.
The arrangement will make billions of dollars of municipal bonds underwritten by Goldman available for sale by at least 85,000 brokers in Incapital’s distribution network of broker-dealer firms.
The move allows Goldman to branch out into a lucrative area of the fixed-income markets, a haven for retail investors scared off by volatility in the stock market and riskier corporate credit markets. While some municipalities are facing budget crises, it is rare for municipal bonds to default. Such securities yield more than certificates of deposit or other ultra-safe investments and are tax-free in most cases, making them a staple in retiree savings accounts.
Ultra-Safe?
Words like "ultra-safe" portend a hint of disaster. Remember when home prices could never go down? Now retail investors are plowing into municipal bonds and municipal bond funds as the next safe-haven.
Even if there is not a series of municipal bond disasters coming up, yields are so compressed, that investing in municipals makes little sense. The timing of Goldman Sachs into such offerings is icing on the "best to stay away" cake.
Look for Goldman to bet against the worst of the crap they intend to feed to retail investors.
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Philip R. Davis is a founder Phil's Stock World, a stock and options trading site that teaches the art of options trading to newcomers and devises advanced strategies for expert traders...
Ilene is editor and affiliate program
coordinator for PSW. She manages the Favorites backup site
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