Archive for June, 2009
Probably. Of course the market knows about America’s troubles and some of them are priced in. Currency traders would also remind me that currencies are priced relatively to each other: we speak of yen per dollar, or dollars per euro. So if you are bearish on the dollar you can’t just prove that the dollar is weak. You need to show why it is weaker than the alternatives as well.
Before doing that I will concede the obvious: other countries also have troubles. We are in recession, and so is just about everyone else. Our Federal Reserve is printing ridiculous amounts of money, but other central banks are too. Our government runs a large fiscal deficit, but again, other countries do too. Our banking system is weak, but the Brits and the Eurozone have nothing to write home about here either.
So if other countries are hurting too, why should the dollar stay weak? I have four reasons, but they boil down to one. We are no longer acting as if we can carry the burden that goes with the privilege of owning the world’s reserve currency.
First, we are unique in the large current account deficit we run. That is, we import more than we export, we have been doing this in size, and we will seemingly continue to do until other countries stop taking our dollars in exchange for goods. We were lucky earlier this year in that a lower oil price reduced our oil import bill, but oil’s price has doubled off the bottom since then. So, even though Americans buy less imported “stuff” than we used to, we can’t consider the problem solved. As long as we import more goods than we export, we have to make up the difference by selling dollar denominated securities –usually Treasury bonds– to foreigners. So in this way America continues to increase the supply of Treasury IOUs without regard to the world’s demand for them.
Which leads us to reason number two: there is a large overhang of dollars held reluctantly in foreign portfolios. This site’s readers know that, but the point is, portfolio overhang is unique to the dollar, as opposed to other currencies. There is no other currency held in such size by people who would likely dump it if they had their druthers.
Plenty of people try to tell us that this overhang is “not a problem.” They say that the world is used to running on dollars. Governments, banks and corporations are used to doing dollar based transactions, they tell us. Moreover, no other currency can match the deep and liquid market that Treasurys afford. Even though the Eurozone is a huge economic bloc, Eurobonds issued by Italy, for example, are not the same as Danish or German government bonds. So everyone agrees that a complete transition to a new currency regime would take time, but is that truly a reason for doing nothing? It may be that today the dollar is the best place to park wealth, but sooner or later the countries with wealthy central banks will find a way to put their money where they want to. If we don’t make the dollar more attractive, foreigners will eventually take their money elsewhere. It’s that simple.
Our press also lulls itself into complacency regarding large dollar holders such as the Chinese. It would be hard for China to sell in size, dollar bulls say. The market couldn’t absorb that selling, the dollar would crash, and the Chinese would themselves wipe out the value of their own dollar holdings, bulls argue.
On the other hand, others worry that China may reduce its dollar buying going forward. Therefore these days when the Treasury holds an auction to sell more Treasury debt, traders await the results with baited breath to see how easily the market absorbed the supply — and how many foreigners bought. Furthermore the WSJ reports that the Treasury recently rejiggered its statistics so as to make foreign buying look heavier than it really is (h/t, Trader Mark). Treasury now reports some customers of primary dealers as “indirect” bidders, the closely watched category that also includes international purchasers. What a disgrace, that America is so dependent on other countries, and that we lie about it to ourselves rather than face the problem.
As an aside, China is seemingly having a grand old time showing us who controls the dollar’s trade in the currency markets. On June 26 officials at the People’s Bank of China said that they wanted a new, supranational currency to replace the dollar as reserve currency, Bloomberg reported. Dollar Index futures, which trade based on a weighted average of major tradable currencies, gapped down 55 basis points — a considerable move — to open at 80.12 on the CME the following morning. On the 28th Central Bank governor Zhou Xioachuan said that his country’s reserve policy remains “stable.” The dollar index shot up enough to close the gap of the previous day during overnight trade, though it gave up most of those gains before the Chicago open. Are the Chinese placing trades so as to profit from the statements they make thereafter? I have no idea but the prospect must tempt them.
Third on my list of problems unique to the dollar is this: America’s strategic rivals act as if they see an opportunity to weaken us by attacking the dollar’s privileged status. Rusisia’s Vladimir Putin has made noises about replacing the dollar for years. If Russia can take the dollar down, that would make it harder for the US to finance its 800 or foreign military bases, and give Russia freer rein in Eastern Europe, South Asia, and the Middle East. Similarly, China has never liked the military power that the US projects into the Pacific. So on this score some of China’s geopolitical objectives may coincide with Russia’s.
Also on our list of geopolitical considerations: in yet another chapter in the troubled history of Iran-US relations, Iran quit accepting dollars for oil in 2007. Might other oil exporters follow suit? Or might they simply accept other currencies in addition to dollars when they sell oil? The latter policy would reduce demand for dollars while still allowing us to pay for imported oil in dollars. There have always been countries that want to see America humbled but I don’t think these attacks on the dollar would have got traction if our rivals were not holding large stacks of dollars they might like to sell if they could. No other major power is in debt to its rivals like we are.
My fourth reason for ongoing dollar weakness: we don’t have a strategy for maintaining the dollar. We just keep hoping that China and our other trading partners will continue to do what suits us. That’s irrational. Other countries that hold dollars will act in their own interest. We should figure out what that is likely to be and prepare accordingly.
Instead, the Fed and the Treasury focus on economic stimulus and bailing out weak banks. The US keeps spending and printing money as if it grew on trees. Nor does President Obama talk about retooling our stance as importer from the world. And so the situation drifts. Sooner or later our government will learn what every trader knows: Hope is not a strategy.
Disclosure: Long FXY, may buy UDN on pullbacks.
What an ugly day. No one was spared today. The only winners today were the inverse funds and the VXX.
The financials were the leaders down today as the Dow dropped 200 points and closed at its low of the day and the SPX lost 3% to drop 28.19 points as well as closing back under it’s critical 200ma. But nearly every group participated in the downside. The BKX dropped nearly 7%. The exchange stocks got hit with CME down 24 pts andICE down nearly 10 points. Energy stocks were not far behind with most being down anywhere from 5-9% as oil sold off $2.49 to close at $67.06. Oils and oil service stocks were not the only losers as the coals and solars got hit also, with most the major coal related stocks down in excess of 10%. Solar stocks were right there with them with FSLR dropping a whopping 11+ points.
Not to be spared, other glamour stocks such as RIMM, -$4.67 and BIDU, -$19.58 shared in the joy as Techs came under fire after staging a nice rally over the past few months. AAPL was the best performer, only dropping a couple of points.
The carnage started during the night as gold, which has been weak, started dropping about 3am before finally recovering some to close at 922ish. But gold was simply a reflection of the entire commodity trade. Everything and anything commodity related was hit. Potash, the golden child of the commodity stocks, after staging a huge rally from the 50 range back to 120 the past few months has now dropped 30 points in the past week.
So where to from here? As you can see, though we’re oversold on some of the short term indicators, we’re not really close to any major support area until we get down to the 880 area.
Although the S&P has stalled out for the moment it had quite a rebound from the March 9 bottom. And until June 12 or so the market shrugged off bad news quite regularly. It’s easy enough to understand a rebound from a panic low, but are we really in a new secular bull market? The recent Forbes article, “The Real Suckers are in Cash” tries to prove that case, but comes up short.
Forbes’s case: the March 9 bottom was THE bottom, the recent stock market strength tells us that that the end of the recession “is plainly in sight.” Housing is bottoming, autos are bottoming, commodities are booming, credit markets are healing, and stock earnings yields provide ample competition for bonds. It looks so good that the cash on the sidelines will have to come in, mostly to stocks but maybe also to commodities, which can keep going as the economy rebounds or if inflation expectations rise.
Regarding their case for rapid economic recovery the Forbes article contains at least one outright misstatement: “The U.S. manufacturing Institute for Supply Management Index (ISM) rose to 42.8%S in May, which usually signals that gross domestic product is expanding rather than faltering.” No, it usually doesn’t. According the ISM, readings lower than 50 on the Index signal contraction. Forbes reporter Robert Lenzner should know this. I think Lenzner meant to tell us that GDP was contracting at a decreasing rate, but that’s not what he wrote. Furthermore, the Index measures activity in the manufacturing sector rather than GDP as a whole. While expansion in manufacturing would be good news for the economy, our shrunken manufacturing sector accounts for only about 20% of total US economic activity.
Increased home construction traditionally helps boost a recovering economy. Since residential construction is not recovering yet, Lenzner reaches for the bright side and notes April’s 6.7% jump in pending home sales when compared with April 2008, as measured by the National Association of Realtors (NAR) Index. There is less to this one than meets the eye. Even though pending sales are up home prices continue to fall, according to economists at BMO, who seem to have provided Lenzner with much of his data. In other words, the housing market shows falling prices on higher volume— not exactly a healthy market yet. In addition NAR says that April’s strong data may reflect a desire to get home purchases consummated by November in order to qualify for the the $8,000 first time home buyers’ tax credit. Therefore NAR implies that current data may reflect a boost in current sales at the expense of future sales.
Moreover, as of now, most of the sub prime loans with that originally came with introductory teaser rates have already reset — but the alt-A schedule of loan resets is about to pick up steam. Alt-A loans are supposedly of higher quality than subprime, but more likely to default than prime loans. When these loans reset, many homeowners in higher price brackets, who often got alt-A loans, will be squeezed as the sub primers were, forcing some to default and place more distressed inventory onto the market. Increasing unemployment is forcing more prime mortgage borrowers to default as well. Housing isn’t just “in the tank” as Lenzner says, it continues to deteriorate. Finally I find it odd that Lenzner actually missed the one positive sounding data point in April’s housing numbers, an increase of spending on improvement of existing residences of 8.9% year on year as reported by the Census Bureau.
Another industry that often helps lead us out of recession is automobiles, and Forbes correctly notes that auto sales improved in May by about 100,000 vehicles over April to the best performance of the year. Is this a big deal? Too early to tell, in my view. Sales are down year on year, as one would expect, and they remain anemic, below a seasonal adjusted annual rate of 10 million. No doubt auto sales could rebound off their lows, but what concerns me is the consumption pattern going forward. Does anyone expect the average middle class homeowner to finance a second or third car from a home equity loan (as was often the case in California and Florida?). As I understand it, the industry was geared to produce 16 million units annually before the recession hit; in his March CNBC interview Warren Buffett forecast that 13 million would be the new normal rate going forward, but felt he had to argue with those who forecast that rate rather than 11 million. The difference between 16 million and 13 million: the people who have lost their jobs so far in Detroit’s bankruptcies, and perhaps more to come, especially if the 11 million number should become accurate.
Still… a rebound to 13 million would be great news. And… much more of that rebound will have to come from savings, not borrowing, because consumers are tapped out and forced to raise their savings rates. They certainly have less home equity to borrow against, too. My verdict: an auto sales rebound should happen, eventually, but a strong rebound is not something to bank on heavily any time soon. I expect consumers, especially those with secure jobs or who need cars to get to work, to replace cars that need replacing, but less frivolous consumption, especially financed by imprudent borrowing, will be less common than in previous cycles. New employment will have to come from a new industry in this recovery, maybe from green technology if we are lucky, but that too will take time.
Lenzner asserts that the recent increases in commodity prices imply that the economy ” is about to turn the corner,” presumably because higher commodity prices signal industrial raw materials demand. That’s a hard case to prove because, not only is the US manufacturing sector continuing to contract, as noted above, but our trade partners such as China, Germany, and Japan, are contracting too since their exports to the US are down year on year. Forbes does not tell us, who is making more of what? I suspect, few companies are actually making much more of anything: as London based portfolio manager and financial blogger Macro Man writes, China has been buying commodities heavily but putting them into storage rather than using them in manufacturing. The Chinese business magazine Caijin (h/t, Naked Capitalism) adds descriptive color to Macro Man’s charts and statistics. Caijin notes that China has increased bank lending by six trillion yuan since year-end 2008, and that many of these loans have gone into commodities speculation. Caijin’s writer Andy Xie fears this margin financed commodity buying could come to a bad end. Having said that, I am bullish on commodities longterm, though they may have gotten ahead of themselves here. I agree with Lenzner, that commodities could rise over time with inflationary expectations.
Forbes also states that there is a large repository of cash sitting on the sidelines that is feeling left behind. Lenzner even says that this sum equals half the market cap of the S&P500. It’s hard to analyze this statement fully, since Lenzner does not name his source. However, veteran money flow analyst Charles Biderman of Market Trimtabs told CNBC on June 18 (h/t, Zero Hedge) that sideline cash is nearly spent. Based on his funds flow analysis, Biderman rates the market a sell and is in fact short banks, consumer discretionary, and retail stocks among others. He stated that companies are selling stock “as fast as they can.” According to Biderman, 7 of the 8 times when, by his measures, companies have have sold large amounts of new stock to the public while company insider trading activity is simultaneously bearish, the market has subsequently declined.
Although Lenzner thinks the ability of the credit and equity markets to absorb new supply is positive, and that has certainly been true up to a point, one might also remember the old Wall Street adage, “When the ducks quack, feed ’em.” Wall Street can only sell stock when markets have been strong, but the new supply soaks up at least some of the available buying power.
Speaking of funds flows, Forbes (along with many others) claims that compression in key short rates and spreads (such as LIBOR and the TED spread) proves that the money markets have healed. As stated two weeks ago, I believe these spreads are now misleading indicators. No one knows just how high these rates would be, absent the trillions of dollars that the Fed has lent under its new, extraordinary programs such as TAF, TSLF, PDCF, and so on. In addition, we have Treasury’s explicit guarantee of money market funds, and its de facto guarantee on all liabilities of major banks. One suspects that without these programs, money market rates would be significantly higher. Of course the right thing to do would be to use these guarantees as a temporary shield to forestall panic while the FDIC shut down insolvent institutions and forced banks to mark tradable assets to market. Until that is done, we effectively have a nationalized money market whose indicators tell us how much confidence lenders have in the US government, rather than how much confidence they have in institutions that stand on their own.
Forbes puts a great deal of store in the comparison of earnings yields with bond yields, in effect relying on the “fed model” to show that stocks are cheap. For those of you who need a refresher, the fed model compares earnings yields to bond yields and says in effect that when earnings yields on stocks are greater than bond yields, investors buy stocks. Given the earnings estimates Lenzner is apparently using, he says that the yield on bonds provides stocks with room to move to 9,000 or even 10,000 by summer’s end. I would make three points here.
First of all, the “fed model”relationship is not set in stone. Up until the late Fifties, investors demanded a higher yield on stocks than on bonds, to compensate for the inherent uncertainty that stocks provide. Later, in the Sixties, investors became more willing to pay up for the growth prospects that stocks also provide, and Lenzner seems to assume this behavior will continue. Could the relationship between stock and bond yields shift again? Value investors, at least, have talked about that in the past year. Second, I have never liked the fed model with bond yields below 5% or so. Like it or not, if you use the fed model then you are forecasting P/E ratios in excess of 20. That may be reasonable in a stable environment with great growth prospects, but it would be hard to argue that we are back in Nirvana now.
Thirdly, Lenzner’s argument says that we can dismiss inflation concerns for the next 2-3 years, and so we need not worry that bond yields will rise and provide more competition for stocks. I would actually agree with the first part — inflation feels tame for now in this environment. The Fed’s extraordinary programs have replaced vaporized assets on bank balance sheets rather than increase the money supply as much as might appear, and banks are not eager to lend out the money they have. That keeps demand for goods, and hence inflation, low. The real trouble as I see it, is the increasing supply of bonds to finance the government’s fiscal deficit. Seemingly every week the bond market faces an an auction with trepidation. Is this really the time to buy stocks because you are confident that bond yields will stay low? I have trouble with that.
Of course Forbes covers itself by listing the usual worries: increasing unemployment, decreasing consumer spending, inflationary expectations. Fair enough. But when I read through the Forbes case, I just don’t see a cogent reason to buy stocks here. And to go higher, we need, not just holders who keep holding, but also, new buyers to push the price up.
It looks like the euphoria has finally started to wear off the past several days as continuing unfavorable fundamental data has started to catch up with our counter trend rally. All the talk of green shoots, upon closer examination, turns out to be just wild onions. Though we are short term slightly oversold after the past several days and could see a relatively small bounce over the next few days, many are starting to look at the market with a little more jaundiced outlook after a strong three month rally.
The fact that some stocks were able to beat their greatly revised outlooks during earnings season is behind us now. Though there is still a lot of money sitting on the sidelines and I’m sure nervous about missing any further upside moves, I believe the awareness is slowly sinking in that the hangover from the SEC’s neglect and the Feds multi-year loose money binge for the greater part of this decade, has not even really begun to subside. Have another bloody mary and make it a double this time. It’s got to feel better at some point. So the realization is, or at least should be, sinking in that there’s probably no rush.
Though a technical trader by trade, I’m a fundamentalist atheart and the fundamentals are nowhere close to giving me a warm and fuzzy feeling. The Fed continues to paint themselves into a corner. At what point do they cry uncle. Trillions spent in bailouts have done little if any to reduce the pain for the overwhelming amount of the so called ‘middle class’ citizenry. Mortgage rates have started back up, though for all practical purposes are still at multi-year lows. Hundreds of thousands have been laid off in just the financial sectors, the primary beneficiaries of the government largess. Seventy million plus baby boomers are looking at a whole new meaning to the word ‘retirement’ due to the decimation of their retirement funds and of course their favorite backstop, their home equity which has been vaporized. And of course, several new studies released this past week show that we’re still not at the bottom in housing yet. This doesn’t count probably hundreds of thousands of people sitting on homes trying to weather the storm who will promptly put their homes on the market at the first glimmer of a rebound, much as a novice trader will do who didn’t keep his stop and watch his stock fall 50% will sell at the first little bounce trying to preserve some equity.
Despite the Feds continuing spending, the average consumer remains ravaged. What token tax credits and/or cuts given are now being sucked up by basic necessities like food, credit card rates approaching 30% and now fuel prices which have increased nearly $1 per gallon in the past several months. For the average family, the fuel price increase alone will suck up $1000 year. The recent drop in the dollar will only increase inflationary pressures. Let’s not even talk about how much extra the upward move in interest rates will cost our government, uh, that be you and I.
It seems to me that our government’s whole attack on our problems have been to stimulate consumer spending, in other words, more of the same that got us into this situation. Has anyone besides me ever stopped to think that maybe all of us in the baby boomer generation, besides being spent out, just don’t want anymore ‘stuff’. I mean think about it, in our 30s and early 40s many of us were on a buying binge. Remember all the T-shirts with “He with the most toys wins”. Now in my 50’s I’ve got way too much ‘stuff’. We’ve had our Mcmansions. I don’t need or want anything else. In fact wish I could easily get rid of a lot of the ‘stuff’ I have already. The older we get, the more we realize that none or at least very littleof it, matters and it’s a chore keeping it up ar storing it. Plus many of us in this generation are now faced with taking care of elderly parents and relatives. Ferrari’s and Lexus’s don’t handle hospital and nursing home parking lots well. The net result is that probably 70% of the purchasing power that still remains in this country could care less about buying more ‘stuff’ that our government believes will save our economy. Frugal is the newest hip word.
The absolute worse thing about the whole situation is the legacy we’re leaving our children. I think in the recent downturn, many of the older ones have seen some of the pitfalls and are more frugal than we were at their age. But they’re now facing decades of paying for our mistakes withhigher taxes for their lifetimes because our healthcare and retirement systems were so mismanaged and misallocated.
Reading a report from Tom Dyson of the Stansberry group yesterday, Tom, who likes to visit rail yards and even occasionally hop a train, to get a feel for economic conditions reports that rail traffic remains anemic and there are thousands of railcars sitting, rusting in storage. So no early signs of pickup from that perspective. So for those of you who missed the rally, I say sit back and relax, you’ll get another shot, unfortunately maybe at even better prices.
The Federal Reserve and the Treasury did what they had to do to stop the money market panic of 2008. Since then many commentators have taken comfort from indicators that in normal times would point to healthier credit markets: falling TED spreads, falling LIBOR, tighter A2/P2 spreads, etc.
To which I reply: not so fast. Without the continuing, massive, and unprecedented government interventions in the credit markets, one suspects that these spreads would zoom again. We do not have a self sustaining recovery in the credit markets, because the government refuses to address banking system’s longterm problems. So in the meantime, the Fed and the Treasury are essentially painting the tape. Yes, Virginia, even credit spread numbers can be made to lie.
Last year’s panic is over, to be sure. We’ve even seen tightening in longer term junk bond rates when compared with Treasurys of similar maturities. But would anyone buy debt from a major bank without Treasury guarantees? Does anyone think for a minute that commercial paper rates would stay so low without Fed purchases of commercial paper (or more precisely, backstopping SPVs that purchase commercial paper)?And given the Fed’s T-bond purchases, does anyone think that the free market now sets rates on longer Treasurys? These questions answer themselves, don’t they?
Here’s another reason why the falling rate graphs don’t tell the whole story: even with Fed support, the commercial paper market is shrinking. Total outstandings have dropped to $1.248 trillion, the lowest level since 2001. Is that because companies can’t get funding, or because they don’t dare to borrow? Probably some of both. The big banks don’t dare lend as much as they used to because the recession continues to produce increasing losses on residential and commercial real estate loans, credit cards, and toxic securities they can’t sell. Money market funds learned in 2007 that they actually have to do their own credit analysis before they buy anything that the Treasury does not guarantee, so they are pickier than they used to be. And why would corporations borrow more, when the profits of the S&P500 companies are down 90% year over year?
We are in trouble now partly because businesses and consumers couldn’t service pre-recession debt loads. Intelligent government policy would cushion the worst fallout from the inevitable deleveraging that is taking place, rather than try to keep total credit outstanding at June 2007 levels. But rather than tell us the truth, the government seems to be trying to encourage borrowing at prior levels in order to finance consumption we can no longer afford. This they do by keeping rates artificially low and by keeping weak institutions on life support.
While the Fed seemingly likes low commercial paper rates, making short term loans to private business (which is what the Fed does when it backstops facilities that buy commercial paper) is not normally thought of as part of the Fed’s mission. This was an unprecedented step last October, though arguably necessary to prevent a recurrence of the September panic. The Fed, however, doesn’t appear to be getting itself out of this business. Money market funds and banks are usual buyers for commercial paper, and if we repaired the financial system properly, they might do more of that business again.
Speaking of repairing the financial system: this year the FDIC has closed a small insolvent bank almost every week but somehow we don’t want to close the big banks that would seem to be troubled — banks like Bank of America, (BAC), Capital One Financial (COF), Citigroup (C), JP Morgan (JPM), and Wells Fargo (WFC). This does not make sense. I understand, some people are afraid that if the FDIC takes over big weak banks, the government would have to own them, or parts of them, for years while selling off the bad assets. After all, the FDIC needed seven years to wind up the business of Continental Illinois after it failed in 1984, and that rescue might eventually look like a walk in the park compared to fixing a complex institution like Citigroup.
On the other hand, the longer taxpayers continue to support these banks, the weaker these banks get, and the more we will have to pay later. Given the declines we’ve seen in corporate profits, businesses are laying off 600,000 employees a month in order to cut costs commensurately. Need we say that does not bode well for banks who lend to consumers? Banks that lend to companies who sell to shrinking businesses may not make out so well either.
Meanwhile, if the FDIC simply got on with the job, private investors and other banks would purchase pieces of the weak banks, new lending capacity would be created, and real confidence restored. Surviving financial institutions would find private funding without government guarantees, and there would be less need for government intervention in the credit markets.
In 1933 the government closed the insolvent banks but thereafter people believed in the surviving institutions’ solvency and were comfortable lending to them. On a smaller scale (relative to the economy, at least) the FDIC cleaned up the bad S&Ls in the early 1990s by closing them down and selling the impaired assets, which worked out pretty well in the end. Until the government helps to re-create a financial system that private business can believe in, the government will have to keep supporting the financial system with extraordinary actions by the Treasury and the Fed. And it will presumably do so until reality forces policymakers to change — either through horrendous bank credit losses that even the new accounting rules can’t hide, or when the bad dream of a failed Treasury auction actually comes true.