More Contradictions in Third Quarter GDP

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The Commerce Department reported today that third quarter GDP increased at a 2.5% annual rate. A supposedly much lower inflation rate created significant improvement over numbers from earlier in the year. There was also a surge in consumer and business spending reported, although other recent surveys contradict the claims in the GDP release.

Real personal consumption expenditures (consumer spending) increased by 2.4% compared to only 0.7% in the second quarter. Most of this was caused by a 4.1% increase in durable goods purchases. Nondurables were barely changed. Delayed auto and parts shipments from Japan because of disruption from the massive March earthquake can account for more sales being reported in the third quarter, but not likely to be repeated in the fourth. Despite claims of much higher consumer sales, businesses barely increased inventories in the third quarter — something they would do if they saw their sales climbing. Moreover, consumer confidence surveys indicate consumers were gloomy in the third quarter and readings have now fallen as low as they were around the bottom of the 2008/2009 Credit Crisis. Consumer confidence surveys are not controlled by the government and act as a check of the reliability on government statistics. 

While businesses didn't seem to notice any increase in customer spending, there was nevertheless a frenzy of equipment and software buying going on. This supposedly increased by 17.4% during the quarter. Apparently, I missed the all the news about major software upgrades and equipment innovations that took place this summer. Nonresidential structure spending was almost as buoyant increasing by 13.3%. Where this building boom is taking place isn't exactly clear. Coincidentally, the unemployment rate among U.S. construction workers is also 13.3% (See Household Data Table A-14 of the September Non-Farm Payrolls Report). As bad as this is, it is still a year over year improvement.

GDP figures are also boosted if the inflation rate is lower. It's a lot easier to report better inflation numbers — all it takes is some statistical adjustments — than it is to actually improve the economy. Inflation was supposedly 3.3% in the second quarter, but only 2.0% in the third quarter. Nominal GDP is reduced by the inflation rate to get the final figure. The change in inflation, whether or not it actually took place, added much of the improvement seen from the second to third quarter, not an increase in economic growth.

Mass media coverage about GPD was of course ebullient about what good shape the U.S. economy is in. Of course, we won't know the actual number for several more years. This report is only preliminary and there are two adjustments that will be made to it and then annual revisions every July. In the last several years, adjustments have been mostly down, sometimes by very significant amounts. Even then, that number is going to still be overstated because the U.S. consistently understates its inflation rate. To find an approximate level of the actual GDP, just subtract 3% from the reported number. This will give you a more accurate sense of what is going on in the economy. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

It's a 50% Default for Greece

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

EU leaders have agreed to seek a 50% reduction in Greek debt from bondholders. This supersedes the 21% reduction decided on in July that was supposed to resolve Greece's financial problems. Apparently $30 billion will be given to the banks as an inducement for them going along with the plan. The EU and IMF will also give Greece an additional 100 billion euros in bailout aid.

While the announcement was delivered with a sense of finality, the first bailout of Greece in May 2010 was supposed to solve Greece's debt problems and so was the second bailout this July. It has only taken three months since the  "everything is really fixed now" July announcement before a much bigger bailout and debt writedown proved to be needed. Until fairly recently, EU officials have constantly denied that this would be necessary or that Greece would default. Not paying 50% of your bond debt is not only a default, but it's a major default.

EU officials still seemed mathematically confused about the situation in Greece. EU President Van Rompuy claimed that the current deal will reduce Greece's debt to GDP ratio to 120% by 2020. If so, Greece is still likely headed for more trouble. Since it is estimated that Greece's debt to GDP ratio is around 160%, it should fall to 80% if all bondholders took a 50% hit. Perhaps all bondholders will not be taking a reduction after all. Both the IMF and ECB hold large amounts of Greek government debt and have in the past been reluctant to accept any writedown of their investments.

The pre-dawn news for the EFSF (European Financial Stability Fund), which is supposed to receive 440 billion euros, is that it will be leveraged up to a trillion euros. The U.S. has been pressing for two trillion. This money can be spent to bail out all the EU banks hurt by the Greek default, but only if they can't raise additional capital in the open markets. So the debt problem will be solved by incurring additional debt and borrowing against it. If this isn't a financial system ticking time bomb, nothing is.

The unanswered question is what is going with happen to Portugal (the next most likely crisis), Ireland, Spain and Italy. EU officials tried to minimize the situation by saying Greece is a special case. It would have been more accurate to say that its problems were more extreme and urgent. They are not unique.  The other countries are already somewhere on the path to insolvency and this will have to be dealt with in the future. The only question is how soon that future will arrive. 

 Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

October Consumer Confidence Well Into Recession Territory

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The October Consumer Confidence number fell to 39.8. It is once again approaching the all-time lows that occurred at the bottom of the Great Recession. The number has never reached the 90 level since 2009, which is the cutoff for a healthy economy. The continually poor levels of consumer confidence  bring into question whether the last recession ever really ended.

While U.S. consumers are gloomy about almost all aspects of the economy, they are most pessimistic about employment prospects. Only 3% of U.S. consumers think that jobs are plentiful. While it is true that this number could have been lower during the 1930s Depression when millions of ordinary Americans went hungry and were homeless, the lowest possible value is only zero. And the current reading could actually be zero since zero lies within the statistical margin of error for the survey. In contrast, those who say jobs are hard to get came in at 47% and that would definitely had been much higher during the 1930s.

The Present Situation Index — how consumers see the state of the economy currently — was a very dismal 26.3 in October. This number has remained at fairly low levels for four years now. What has caused the overall consumer confidence  number to rise has been expectations for a future improvement in the economy. The government and mainstream media has continually told U.S. consumers the economy is getting better and will continue to get better. So, consumers have told the survey takers that don't see things as being in good shape now, but they were hopeful about the future. Consumers are starting to lose hope however. The future expectations number fell from 55.1 in September to 48.7. Apparently, you can only fool the public for so long.

The "don't believe what you see with your own eyes, but believe what the government tells you" efforts are still going strong however. Media reports cited better retail sales and a big stock market rally since early October as indications that the U.S. economic situation is improving. Retail sales may have indeed gone up since they are not adjusted for inflation and higher prices make them look better even if fewer units are being purchased. As for the wild behavior of the stock market, explosive rallies are common in bear markets and not in bull markets. They can also occur at any point because of liquidity injections into the financial system from central bankers in Europe, the UK, and the U.S. as would happen during a banking crisis like the one currently taking place in the EU. They don't last for long however.

No matter how you look at the consumer confidence, the numbers are ugly. They are not just indicating recession, they are shouting recession. Only 11% of Americans think that business conditions are good.  The Present Situations Index has dropped six months in a row. Some of the components are at rock bottom levels. Yet, the government and mainstream media keep reporting that the economy is on track for improved growth in the second half of 2011. How can such diametrically opposed views be reconciled? The simplest way to explain the discrepancy is that someone is lying. Any guesses as to who that might be?


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Can the EU Solve Its Debt Crisis with More Debt?

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

European and U.S. stocks were rallying on Friday in what appears to be a liquidity frenzy supplied by the central banks. The market is once again hopeful now that EU leaders are beginning six days of meetings on how to save Greece and the euro. Based on their previous track record, which has led to the current crisis, there is little reason for long-term optimism.

Stock prices have not been the only thing rising lately.  Interest rates have been too in the credit- challenged Eurozone countries. While yields of Greek one-year governments have fallen back to only 180%, they were as high as 189% on October 19th. Greek two-years are at a more manageable 77%. Rates keep increasing in Greece despite the bailouts and this indicates the bailouts aren't nearly large enough and will have to continue and get bigger to keep the country out of default.  The political will for ongoing and ever-larger amounts of bailout money doesn't exist in the EU or does it?

While the EU voting public doesn't approve of spending more rescue money, the EU has created the EFSF (European Financial Stability Facility) — a 440 billion euro fund to help bail out its member countries that have debt problems and to bail out the banks that lent them the money that allowed them to have those debt problems. Much remains to be decided on how the EFSF will actually function. There is disagreement of how to use it to bail out failing banks for instance (this is currently being referred to as recapitalization since bank bailouts are also unpopular with voters). There is also a proposal to leverage EFSF funds up to five times, so there will be more than two trillion euros available. This idea is apparently a "helpful" suggestion made by the U.S. monetary authorities.

While the stock market is showing almost as much enthusiasm for the leveraged bailout proposal as it did for the great innovation of triple A rated subprime mortgages in the mid-2000s, such financial trickery ended badly the first time and is likely to fall apart even faster this time. Mainstream media coverage, at least in the U.S.,  rarely looks at where the money is coming from for the EFSF. Technically, the money is being borrowed. So in order to deal with a debt crisis that is wreaking havoc on the financial system because of too much risk, more money will be borrowed and then that money will be leveraged (a form of borrowing in and of itself) to magnify the risk of the new borrowing. If this appears not to make any sense at all, that's because it doesn't. When the default comes — and there is 100% chance that it will —  the end will be much, much worse.

A case can be made however that the EFSF money isn't really borrowed, but a form of money printing instead. If governments borrow without the ability to actually pay back the money without inflating their currency, they are printing money. EU countries are already highly indebted just like the United States (Japan is in even worse shape). The fact that there is a debt crisis in a number of Eurozone countries is confirmation that the level of debt is beyond the point of no return. So a more accurate portrayal of what is going on with the EFSF is that money will be printed, this counterfeit money will be leveraged by borrowing against it and this will solve the problem of too much debt. 

The world has already lived through a debt binge in the early 2000s. The current crisis centered in Europe is simply a continuation of the unraveling of that debt. Governments handled the first implosion with trillions of dollars of bailouts, by running trillions of dollars in budget deficits, and by printing trillions of dollars of money. Debt problems keep resurfacing however. Could it be that engaging in additional reckless and irresponsible financial behavior isn't a solution for reckless and irresponsible financial behavior? EU leaders may wish to ponder this before going forward. 

Disclosure: None


Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Inflation Picking Up Globally Leading to Stagflation

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Britain shocked the markets on October 18th when it reported an inflation rate of 5.2% for September. This was up from 4.5% the previous month and well above government projections. Inflation isn't just rising there, but higher prices are a global phenomenon.

The world seems to be entering a new period of stagflation similar to the 1970s. Stagflation is high inflation and low GDP growth. This is very evident in the UK where GDP growth for the second quarter was only 0.2% — a full 5% lower than the current CPI (the difference between the UK Retail Price Index is even greater).  The only surprising thing about the UK inflation rate is that the official rate is so low given the amount of money printing done through quantitative easing in 2009 and 2010.

Despite the low growth and high inflation that has resulted from it, the Bank of England (BOE) has just started another round of QE. BOE Governor Mervyn King recently stated, "Without monetary stimulus  — low interest rates and large asset purchases — there is a risk that growth will stall and inflation fall below our symmetric 2 percent target." As of September, the UK inflation rate has been above the bank's target rate for 22 months in a row. This is happening even though unemployment is also at a 17-year high. Central bankers have consistently maintained the inflation can't be elevated if the economy is weak. They have apparently managed to do so because they don't let real world observations intrude on their thinking.

Inflation is also rising elsewhere as well. On the European continent, the official EU rate rose from 2.5% in August to 3.0% in September. GDP increased by 0.2% there in the second quarter. Inflation has already been elevated in China and India for some months. China's inflation rate in September was 6.1% with food prices increasing at 13.4%. The price of necessities is rising faster there than the price of other goods. This is a common pattern in a number of countries. The yearly inflation rate in India was 9.0% in August.

In the U.S., the CPI for September indicated a 3.9% year over year rise in consumer prices.  This rate severely underestimates actual inflation. According to the alternative numbers produced by Shadow Stats, the current U.S. inflation rate is approximately 11% (Shadow Stats calculates its numbers with the formulas utilized by the U.S. government in the 1970s and this is the only way to get valid comparisons of U.S. inflation numbers across time). Official U.S. GDP growth for the second quarter of 2011 was 1.3% — well below even the government's reported inflation rate.
Even though a clear picture of stagflation is emerging globally, expect this to be continually denied by mainstream news sources. Even yesterday in its reporting on U.S. producer prices, one of the major news services stated, "the strong rise in wholesale prices last month is unlikely to prompt a broad increase in inflation pressures given the weak economy." This is actually pure misinformation. There is a long, long history of high inflation throughout the world during periods of low economic growth or even severe decline. One of the most recent cases historically was in the 1970s when inflation skyrocketed in 1974 during the worst economic downturn since the 1930s depression. Both  Fed Chair Ben Bernanke and BOE Governor Mervyn King were around at that time, but apparently can't seem to recall it. Perhaps if central bankers had better memories, they wouldn't be repeating the mistakes of the past today.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security

2011 Budget Deficit Third One Over a Trillion Dollars

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

U.S. budget deficit figures released on Friday afternoon indicate that the deficit for fiscal year 2011 (ending on September 30th) came in at $1.3 trillion. This is slightly higher than the 2010 deficit and the third trillion dollar deficit in a row.

Total federal spending (on-budget items) came in at $3.6 trillion. Revenues were $1.3 trillion, over 4% higher than in fiscal year 2010. Revenue rose slightly to $2.3 trillion. As bad as the budget deficit appears (and a trillion dollar deficit is really extreme), the Congressional Budget Office estimated in January that the 2011 budget deficit would reach $1.5 trillion. The fight over raising the budget deficit ceiling postponed federal spending for a few months until a deal was reached in August however. It is likely that this spending will show up in the 2012 fiscal year.

While there is a special congressional committee looking for $1.5 trillion in savings, its actions are not going to reduce the total federal spending by enough to reduce the budget deficit to something manageable. The amount being cut is for a 10-year period and averages only $0.15 trillion per year. If this had been done last year, the 2011 budget deficit would have been $1.15 trillion — still an astronomical amount.

It is also safe to assume that the budget deficit in the next five years can easily grow much faster than the intended cuts. When they did their projections for future fiscal years, the Obama administration assumed that U.S. GDP would be growing by over 5% a year until 2016. While this figure was never plausible because it is much higher than the potential growth rate of the U.S. economy, now that the U.S. is facing a possible recession and negative GDP growth, it is even more absurd.

Investors should assume that a continual stream of major budget deficits awaits the U.S. in the future. At this point, the massive cutting that is necessary to get the budget under control will cause a hit to the economy resulting in lower tax revenues, which in turn will make the budget deficit worse, not better.  This is the downward spiral that Greece currently finds itself in. More cutting actually is leading to a higher debt to GDP ratio. The U.S. debt to GDP ratio is approaching 100%. Once this number is over 90%, a country's economy becomes permanently weakened. When it reaches 150%, and it will  for the U.S. if its budget deficits remain as large as they currently are, the probability of default becomes almost 100% certain.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

60% Cut for Greek Bondholders on the Table

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.
Bloomberg reported overnight that Greek bondholders were preparing to lose 60% on their investments. This is much bigger than the constructive default of 21% proposed with the second bailout in July. A big cut in the value of Greek bonds will cause major problems for German and French banks — and the ECB itself.

Rumors have been floating around the markets for days about a managed default of Greek debt at around the 50%, or greater, level and an occasional brief or cryptic comment has been made publically by EU officials. While this news was reported by the Helicopter Economics Investing Guide blog days ago, it is only just now filtering into the mainstream news services even though a large cut on Greek debt is an arithmetic inevitability. The only alternative would be a second bailout package several times larger than the proposed 109 billion euros (say 500 billion euros or more). Considering that populations of the EU countries are hostile to spending even the 109 billion euros, additional bailout funding is highly unlikely.

Bloomberg quoted a number of well-placed financial executives, including the CEO of Deutsche Bank, in its report indicating a general consensus was building that Greek bondholders would accept a deep reduction in their holdings. There ECB (European Central Bank) seems to be a major exception however. The ECB had amassed a considerable holding of Greek debt earlier on in an attempt to hold down interest rates there. Interest rates have since gone as high as 141% on Greek one-year governments. The ECB subsequently bought up debt from Portugal, Ireland, Spain and Italy to hold interest rates down in those countries. Investors should expect that ultimately these efforts will prove just as successful as they have in Greece.

Recapitalization (a euphemism for "bailout") will be necessary for EU banks if they have to take major losses on their Greek loans. Dexia, the largest bank in Belgium, folded almost overnight recently and its exposure to Greek debt was only a little over 1% of its loan portfolio — and this was before talk of a 60% haircut for Greek bonds. Imagine what would happen to banks with larger exposures? EU banks also hold substantial amounts of loans to Ireland, Italy, Portugal and Spain. The largest holders of Greek debt by far are of course Greek banks themselves. Proton Bank recently closed there, but officials made it clear that it was because of alleged criminal activity and not because of the debt crisis.

Sovereign credit and bank downgrades throughout the EU are becoming increasingly common.  S&P downgraded Spain's long-term credit rating from AA to AA- with a negative outlook (meaning more cuts are likely) today. The agency predicted Spain would miss its deficit cutting targets for 2011 and 2012. S&P downgraded the credit ratings of a number of Spanish banks three days ago including Santander (STD). Credit Suisse analysts just declared the Royal Bank of Scotland (RBS) to be the "most vulnerable" bank in Europe. RBS is 87% owned by the UK government. Credit rating agency Fitch threatened across the board downgrades of the banks yesterday. This potential downgrade would impact Barclays (BCS), BNP Paribas (FR: BNP), Credit Suisse (CS), Deutsche Bank (DB), Goldman Sachs (GS), Morgan Stanley (MS), and Société Générale (FR:GLE) among others.

Perhaps in the next few weeks there will be some temporary resolution to the Greek debt crisis. Unless the cut that bondholders are forced to take is big enough, it won't last however. Whatever happens with Greece won't solve the problems in Ireland, Italy, Portugal, Spain, and possibly in Belgium. To be effective, the recapitalization (bailouts) of EU banks will have to be substantial. This will by necessity involve using money printing to resolve a debt crisis.  That's actually already been done since 2008 and look at what great shape the global financial system is in now. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Wishful Thinking on Economy and Europe Driving Markets

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


U.S. stocks had a major rally on Columbus Day based on the French and German leaders' mystery plan to recapitalize EU banks and on raised forecasts for U.S. economic growth in the second half of 2011. While both news items seemed to contain nothing but wishful thinking, that's often enough for short-term traders.

The Dow Industrials closed up 3.0% and Nasdaq 3.5% on low trading volume. Big moves in the market are more likely when many traders are away and the people who want to move the market know this. Huge rallies under such circumstances are common in severe bear markets. Nasdaq  for instance went up 4.9% on Friday July 5th in 2002 when almost everyone was off on a four day weekend. The market then had an ugly selloff later in the month and an even bigger drop in September and October.

It shouldn't be surprising that "good" news on the economy appeared on Columbus Day. The timing had probably been carefully planned. Goldman Sachs and Macroeconomic Advisers raised their growth forecasts for third quarter U.S. growth to 2.5 percent from about 2 percent and this created the predictable cheerleading coverage from the mainstream media that the U.S. was avoiding a recession. While it is certainly possible that the government will report GDP growth of 2.5% in the 3rd quarter, this does not mean that the U.S. is avoiding a recession, or even that the U.S. isn't currently in a recession. The original GDP numbers at the beginning of the Great Recession weren't that bad either, but they have since been revised down.... again ... and again ... and again. This is how GDP reporting works in the United States. Good numbers are released when everyone is watching and the downward revisions, which can go on for years, are reported when no one is paying attention.

Adding juice to the rally was the news that the German and French had a plan to recapitalize the EU's crumbling banking system. No details of the plan were available however. The lack of information can mean only one of three things. The first possibility is that there is no plan at all or the details are so sketchy that releasing them would make it clear that nothing significant had occurred. Alternatively, there might be a plan that could work, but the chances of getting it approved by everyone involved are close to nil. Or there could be a plan that has a good chance of being approved, but wouldn't be very effective. Regardless, there was no good reason for a market rally from this "recapitalization you can believe in" piece of news.

The EU banking/debt crisis has no easy solutions and will have an ugly ending of some sort despite the mainstream media's constant stream of upbeat "things are getting better" articles. ECB president Trichet admitted today that the EU's debt crisis has become systemic and has moved from the smaller countries to the larger ones.  The rumors of a possible 60% haircut on Greek debt (reported by the Helicopter Economics Investing Guide on Monday and in the financial pages throughout the EU on Tuesday) may even be optimistic. When Luxembourg's Prime Minister Juncker was interviewed on Austrian TV late yesterday about the rumors of a 50% to 60% reduction in Greek debt having to be taken, he replied "we're talking about even more."

A credit crisis can have a devastating impact on the global economy as was made quite evident in 2008. While a case can be made that the monetary authorities have learned how to handle a credit crisis from their recent experience, they have less to work with than they did three years ago. Fed funds rates have already been close to zero for almost three years in the U.S. Quantitative easing has already been done twice in the U.S. and is on its second round in the UK, although it's already run into a glitch there. The BOE refused to buy gilts for the first time ever on Monday because they were too expensive. Maybe money printing isn't the panacea it's supposed to be after all. If not, the global financial system is in a lot of trouble.

Disclosure: None.

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Is Dexia Bank the Bear Stearns of the Current Credit Crisis?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Over the weekend French President Sarkozy and German Chancellor Merkel said they had come to an agreement on recapitalizing EU banks. No details of their mystery plan were released. Plenty of details were forthcoming however on how Dexia bank was going to be bailed out and they indicate that it's time for EU leaders to stop talking and to start acting. 

Before its recent failure, Dexia bank was described as one of the strongest banks in Europe. It had no trouble passing the recent EU stress tests for banks (so much for the accuracy of those tests, which I have maintained for some time are nothing but a meaningless public relations gambit). Its Greek debt exposure was cited by the mainstream media as a primary reason for Dexia's demise. Dexia though had only 5.4 billion euros of Greek debt on its books out of an asset base of 518 billion euros according to Bloomberg. So, Greek debt was a little over 1% of Dexia's loans. Apparently this was enough for wholesale funding for the bank to dry up. Like most banks, consumer deposits were not enough to maintain Dexia's operations, it needed to continually borrow in the interbank market.

Dexia was a Franco-Belgium bank created 15 years ago by a merger of banks from the two countries. It also operates in Luxembourg and owns a 75% stake in Denzibank AS in Turkey, which it purchased in 2006. The Belgium government agreed to buy Dexia for 4 billion euros.  The French and Luxembourg units will be sold. Together, the three European governments will guarantee 90 billion euros of interbank and bond funding for 10 years. Belgium's share will be about 15% of its GDP. Guaranteeing bank debt has its risks and this is why Ireland required an EU bailout. Could Belgium be next?

If Dexia can fail, what EU bank is safe?  Moreover, the failure happened without a default by Greece, so it is clear many more bank failures are possible regardless of the outcome of the Greek debt crisis.
It can also be assumed that default will make the situation much worse. There are reports from German news agency DPA that Eurozone finance ministers are working on a plan involving a 60% reduction in Greek debt (previous reports indicated a 50% reduction).

The recent Dexia failure just like Bear Stearns failure in March 2008 happened because confidence from lenders in the interbank market disappeared. This can happen overnight. The monetary authorities patched things together temporarily after Bear Stearns demise, but the overall situation continued to deteriorate until Lehman Brothers failed six months later. A Greek default is likely to be the Lehman moment for the current credit crisis and Dexia's sudden collapse is similar to Bear Stearns. More bank failures in the EU will be a warning that the current crisis is escalating out of control.

Disclosure: None
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.
 

U.S. Employment Still at Recession Levels in September

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The non-farm payrolls report for September indicated the U.S. economy added 103,000 jobs last month. Mainstream media immediately jumped on the number as proof the U.S. is not in a recession. It indicates no such thing.

While it seems reasonable to assume that employment can't increase at the begging of a recession, this did not happen in December 2007 when the Great Recession began. Total U.S. non-farm payroll employment actually peaked in January 2008 at 137,996,000. It then declined until hitting a low point of 129,246,000 in February 2010, many months after the recession supposedly bottomed in June 2009. Total employment in September 2011 was only 131,334,000, not even remotely close to levels four years earlier. These figures can be viewed at: http://research.stlouisfed.org/fred2/data/PAYEMS.txt.

The internals of the employment situation for September were not encouraging either. In their press release, the BLS admitted right up front that the end of a strike by the Communication Workers union added 45,000 jobs to the 103,000 total. This leaves only 58,000 jobs being created during the month. More than that amount came from only two sources -- health care and construction. The largest increase in jobs was 41,000 and they were created in the "health care and social assistance" category. Like education, many of these jobs are funded by the government either directly or indirectly, yet they are counted as private sector jobs. The government promulgates this fantasy and the mainstream media mindlessly repeats it.

Another 26,000 jobs somehow came from construction. At least the BLS didn't claim they came from the struggling residential real estate market. Almost all of these new jobs came from the heavy and civil construction category. Perhaps the federal government is building another Hoover Dam and forgot to mention it to the public? This is sort of an eyebrow raising number to say the least.

So in September 2011, there were 6,649,000 less employed people in the U.S. than when the Great Recession began in 2007. This is after over two years of supposed recovery. Based on the recent net increases in the labor force, the U.S. needs to create approximately 150,000 new jobs a month for the employment situation to just hold steady. To reduce the official unemployment rate of 9.1% would require adding a much larger number of jobs every month. This is not happening. As for whether or not the U.S. is in a recession, an unemployment rate of 9.1% has always indicated a recession in the past. Is there any reason to think "things are different" this time around?

Disclosure: None.

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

BOE Kicks Off New Global Money Printing Cycle

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Markets like money printing. The Bank of England (BOE) today announced its own QE2.  Statments from Fed Chair Ben Bernanke and talk of the EU recapitalizing its banks was already juicing up global stocks before the BOE took this earlier-than-expected action.

In its latest round of quantitative easing, the BOE will be purchasing 75 billion pounds in bonds. While some news reports euphemistically described this action as the BOE will be "spending" the money, the correct phraseology is that it will be "printing" this money. The BOE has previously printed 200 billion pounds to buy bonds starting in 2008 during the first credit crisis. The U.S. Fed has already engaged in two rounds of quantitative easing (only one of many ways that money can be printed) and a third should be expected.

Stocks had already turned around on Tuesday with big rallies. Fed chair Ben Bernanke made a statement that he was willing to do more to help the economy. Bernanke has been "helping" the economy since he started lowering the fed funds rate in September 2007. While he has helped the economy, the U.S. has experienced the worst recession and worst bear market since the Great Depression in the 1930s, the official unemployment numbers have remained close to double digits, the U.S. has had the largest number of bank failures since the Savings and Loan crisis, and thanks to his quantitative easing, the U.S. has been able to run a series of trillion dollar plus budget deficits that are going to lead to serious problems in the future.  Why shouldn't markets rally with more of that in prospect?

In the short term, markets don't care about dire consequences that are somewhere down the road. They rally based on liquidity and money printing provides it for them. While the news that the EU is going to recapitalize its banks sounds positive, there is little if any discussion in any article about where the money is going to come from. For the answer, picture a giant printing press spewing out fresh euro bills at break net speed. Investors should also expect a lot of nationalizations as part of this process. Belgium has just announced it will take over failed bank Dexia (described by the news media as "troubled"). Dexia is the largest bank in the country.

Market volatility is common during credit crises. Investors should expect continued market selloffs interspersed with big rallies. Ultimately, money printing will not save the day however because real value can't be created out of thin air. The day that will happen, is the day that PIIGS will fly. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Updating the Definition of a Bear Market

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While there is a lot of talk about the S&P 500 being in a bear market because it fell 20% from its high, this definition is not particularly useful to traders or investors. The focus should be on whether or not the market is trending down and will continue to do so. A market having fallen by so much, regardless of what the amount chosen is, does not provide that information.

The term bear market dates backs to at least the 18th century and was in common use on Wall Street in the 19th. All calculations were done by hand back then and changes in prices were all traders had to go on. Just as is the case today, much of trading took place based on momentum. Traders assumed that if the market was going down, it would continue to do so and vice versa. At some point a 20% drop became the rule of thumb that a drop was serious and likely to continue. While 20% certainly indicates a  major fall in prices, the markets may or may not continue to fall after that level is reached.

A much better approach, the concept of moving averages and the idea of using them as trading guidelines didn't develop until the twentieth century. The 50-day and 200-day moving averages became the standard benchmarks for determining bullish and bearish patterns. This approach could only be widely implemented after computers became generally available. A bear pattern was established when the price fell below and remained below the 200-day moving average (the price would be trading at or below the 50-day as well). The bear would be confirmed when the 50-day moving average crossed the 200-day from above and moved below it. This is nowadays referred to with the dramatic term "death cross".  This generally takes place before a market has lost 20% of its value.

The so called death cross took place for all the major U.S. indices in August and for many this confirmed that stocks were in a bear market. The 50-day, 200-day cross is prone to failure however. It tends to give too many false signals, as was the case in the summer of 2010 when all major U.S. indices also made this cross and then reversed shortly thereafter. Not only was there no bear market, but a major rally followed.

Instead of using the 50-day and 200-day moving averages as benchmarks, a more accurate bear market
reading can be obtained from using the 50-day and 325-day moving averages (or 10-week and 65-week moving averages).  While this will provide a bear market confirmation later, it will be more accurate when it does so. It takes a lot of selling energy to drive the 50-day moving average below the 325-day and if the market can't accomplish this, a real bear market doesn't exist.  Although this provides a later sell signal, it provides an earlier buy signal on the way back up.

The S&P 500 and the Russell 2000 made the 50-day, 325-day cross in mid-September, but had already made the 10-week, 65-week cross by the beginning of the month.  The Dow industrials and the Nasdaq made the daily cross at the end of September, but had already had a cross on the weekly charts by the middle of the month. Based on the weekly charts, the S&P was already in a bear market for a month before the 20% intraday drop took place on October 4th.

Investors and traders need not rely on just moving averages to find out whether or not a bear or bull market exists. Volatility can provide an important additional clue. The daily price swings for stocks in the summer of 2010 were relatively minor compared to those in August 2011. Volatility is bearish for markets and its presence recently is just another confirmation of a serious and prolonged downturn.

Modern technical analysis also provides a whole bag of tricks to help determine if a bear or bull market exists. The DMI (directional movement indicator) is the most directly applicable. Investors want to look for a  clear sell signal with a rising trend line on the DMI  on the weekly charts (the daily charts are too "noisy"). A sell signal was given in late July on the S&P 500, the Russell 2000 and the Dow Industrials. The trend line has been going up since then indicating a strengthening downtrend. A sell signal appeared in August for Nasdaq. It then failed, but a new sell signal was given in September.

There is more than enough reason to believe that U.S. stocks are in a bear market regardless of what percentage drop has taken place. Moving averages, volatility and technical indicators are all indicating that a bear market started in the U.S. somewhere between late July and mid-September 2011. This bear will not end until the 10-week moving averages cross back above their respective 65-week moving averages, volatility calms down, and DMI buy signals are given on the weekly charts.  

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

S&P 500 Joins Global Bear Market

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Markets opened October with almost all assets declining everywhere. The S&P 500 entered bear territory on Tuesday.  Few assets other than treasuries and the U.S. dollar are doing well, as is typical during a credit crisis.

The big talk on Monday, the first trading day of October, was about the S&P 500 making a new closing low for the year. The intraday low was only slightly lower than the previous one in early August, so peak to trough the index was off 19.8%. The big drop on the opening on Tuesday created a 20% loss, putting the S&P 500 officially in a bear market.

The small cap Russell 2000 already entered bear territory on August 8th. The Russell had another mini-crash on Monday, dropping 5.4% on the day. That was its fourth mini-crash since August. Mini-crashes are common during credit crises, but not at other times.

The selling on Tuesday first showed up in Asia with the Hang Seng in Hong Kong losing 3.4% to close at 16,250 and South Korea's KOPSI dropping 3.6%.  The ugliness then spread to Europe with the German DAX, the French CAC-40 and the UK FTSE down more than 3% during the  trading day. U.S. stocks opened then opened lower with the Dow losing more than 200 points in early trading.

As usual in Europe, banks were at the epicenter of the market quake. Franco-Belgium bank Dexia was down 22% at one point. Deutsche Bank (DB) was down more than 6% in Frankfurt after announcing it would miss its profit target for the current year.  American banks have not avoided the carnage affecting financial stocks elsewhere; just take a look at Bank of America (BAC) and Morgan Stanley (MS), both trading at two-year lows.

While the behavior of banking stocks makes it clear that a credit crisis is taking place, falling commodity prices clearly indicate that the global economy is turning down. Copper prices fell as low as $3.01 a pound early Tuesday. Copper sold for well over $4.00 at its high in February and dropped sharply throughout September. Oil is also indicating weakness, with WTI crude closing at $77.61 on Monday. It traded as low as the $75 range on Tuesday. Oil is heading into a period of seasonal weakness and this is likely to exaggerate any price drops. Next strong support is around $70 a barrel.

Money continues to move into safe haven treasuries. The 10-year yield was as low as 1.725 before selling began in the bond market. The U.S. dollar index traded just under 80 at its high. The euro, which moves opposite to the dollar, hit a low of 1.31.62 Tuesday. Further weakness should be expected until there is some resolution to the debt crises in the EU.

 In bear markets, the bigger trend is down, but this is frequently accompanied by huge volatility. This is what has taken place since August and until there is a good reason that the trend should change, investors should expect that prices will be moving lower.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

A Terrible Third Quarter Will Be Followed by a Bad Fourth

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The third quarter of 2011 had the biggest drop and most volatility for stocks since 2008.  The fourth quarter may not be much better since the cause of the problem is a new credit crisis and an emerging global recession. Both will continue to be a drag on the market.

Except for small cap stocks, the U.S. markets did somewhat better than many overseas markets during the quarter. The Hang Seng in Hong Kong was down 25.7%, the CAC-40 in France fell 25.6% and the DAX in Germany dropped 25.0%. Only the Russell 2000 in the U.S. was lower by a comparable amount, falling 24.1% from its May 31st close. These indices are all in deep bear territory. Not much better was the Bovespa in Brazil. It lost 19.0% in the third quarter. The Brazilian market peaked in November 2010 and it too is in a bear market.

While the bigger cap U.S. indices weren't down as much, they were severely damaged nevertheless. The S&P 500 was lower by 15.9%, the Nasdaq by 14.8% and the Dow industrials by 13.2%. This was just the drop during the quarter. U.S. stocks in general peaked on May 2nd. From its high back then to its low in the third quarter, the S&P 500 dropped 19.6%. A bear market is defined as a loss of 20%.

Volatility returned to the markets with a vengeance in the third quarter. The VIX index reached a high of 48.00, not much below its peak in the 2000 to 2002 mega-bear, but well off its Credit Crisis peak around 90. Mini-crashes returned to the market, with both the Nasdaq and Russell 2000 experiencing drops equal to or greater than 5% on three different days.  There were four consecutive days in August when the Dow was up or down by 400 points or more. A volatile market is prone to selling and  markets usually need to calm down before they can bottom.

Just as was the case during the Credit Crisis year of 2008, only two major assets were up in the third quarter — treasuries and gold. The 10-year hit an all-time low yield of 1.71% (bond prices go up when yields fall). This was well below the previous low that took place because of the Great Depression in the 1930s. While the price of gold fell by 15% at the end of the quarter, it rallied from the beginning until its peak on September 6th. It wound up rising 5.8% (as measured by GLD) from its closing price on May 31st. Its companion precious metal, silver, had a quarterly drop of 23.1%.

There is no reason to think that the market will bottom until problems in Europe come to some stable resolution. Greece admitted over the weekend that it would not be meeting the budget targets that were part of the terms of the first bailout. Global markets are once again selling off, as if this was somehow surprising news — Greece has misrepresented its financial number repeatedly, it would only be surprising if they turned out to be accurate. Greece may still get its next tranche of bailout money, since the EU has shown over and over again that its standards for the currency union are meaningless. Eventually though Greece will default because too much bailout money will be needed to keep it afloat. Even at that point, Spain and Italy will have to be reckoned with.

The other issue facing the markets is a global economic downturn. While a case can be made that the post-Credit Crisis economy never got out of recession (the unemployment rate and consumer confidence remained at recession levels for instance), the important question is whether or not economic activity is declining now. Last week, even the ECRI (Economic Cycle Research Institute) admitted the U.S. economy was heading down. Since a credit crisis can make an economic decline much worse, this doesn't bode well for the markets in the upcoming months.
Disclosure: None 

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.