Below is another great article from John Mauldin via his weekly newsletter.

John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to:http://www.frontlinethoughts.com/learnmore

From ghoulies and ghosties
And long-leggedy beasties
And things that go bump in the night,
Good Lord, deliver us!

–Old Scottish Prayer

Where the Wild Things Are is a beloved children’s book and now a beautiful movie. But in the investment world there are really scary wild things lurking about in the hidden recesses of the economic landscape. Today we look at one of the unintended consequences of the Federal Reserve’s low interest rate policy.

For quite some time, I have been arguing that we are faced with no good choices, not just in the US but in the entire "developed" world. I see a low-growth, Muddle Through world over the next years (with a double-dip recession just to liven things up). However, that does not mean that we will lack for volatility. Things could get volatile rather quickly. Let’s quickly set the background.

It Is Not Just Japan

Let’s look at today’s interest rate picture. Yesterday, we had the bizarre occurrence of banks actually paying the government to hold their cash. Three-month treasuries yield a miniscule 0.01% in interest. If you opt to buy a one-year bill you get all of 0.26%. You can see the entire spectrum below.

Look at the graph of the yield curve below. It is as steep as we have seen it in a long time. But that is almost the point. Banks are essentially getting free money. If you are a banker and can’t make money in this environment, you need to quit and find meaningful employment.

And that is part of the rationale that the Fed espouses with its low interest rate regime. Not only does it allow banks to repair their balance sheets, it also encourages investors to put money into riskier assets in order to get some return on their investments. Over $260 billion has gone into bond funds this year, and just $2.6 billion into stock funds. However, you have to balance that with the fact that some $400 billion has left money market funds paying less than 0.2%. So there is some movement to capture yield.

But is it just banks that are getting cheap money? And is encouraging investors to find riskier assets a sound policy? Maybe not.

The Euro-Yen Cross and the Dollar Carry Trade

I wrote a great deal in the past few years about the strong correlation of the euro-yen cross to stock markets all over the world in general. (The euro-yen cross is the exchange rate of the euro and the Japanese yen.) This was a proxy for the Japanese carry trade. The stock markets of the world rose and fell in synchronization with the yen versus the euro.

A currency carry trade is a strategy in which an investor sells a certain currency with a relatively low interest rate and uses the funds to purchase a different currency yielding a higher interest rate. A trader using this strategy attempts to capture the difference between the rates, which can often be substantial, depending on the amount of leverage used.

The Japanese drove their rates down to essentially zero in the 1990s. By early 2007, it was estimated that the yen carry trade was over $1 trillion. But when the world credit crisis hit, the world wanted dollars. They paid back the yen and bought dollars, driving the yen higher and killing the yen carry trade. Who wants to borrow in a currency that continues to rise, even if the costs are low? And often, large leverage was used, so small movements in the currency could destroy outsized amounts of capital.

But now, there are some who are beginning to ask whether there is a dollar carry trade. In the last nine months, the correlation between the dollar and the stock market has gone to about 90%. If the dollar rises, the stock markets and other risk assets tend to fall, and vice-versa. It would appear that investors and funds are borrowing cheap dollars on a short-term basis and investing in all sorts of risk assets. Not only have stock markets risen, but so have high-yield bonds, commodities, and so on.

We have seen the steepest rise in US stock markets coming out of a recession since the end of the last world war. The market is "discounting" a 5% GDP next year and a profit rebound beyond anything in past experience. Depending on the quarter, operating earnings are expected to rise by anywhere from 30-40%. P/E ratios are back at 23, well above the 17 we saw in the summer of 2007 (I am using 4^th quarter 2009 estimates so as to not have to take into account the disastrous 4^th quarter of last year.)

Worrying about a dollar carry trade is not just a preoccupation of my friends Nouriel Roubini or David Rosenberg or Frank Veneroso. Look as this story from Bloomberg:

"China’s Liu Says U.S. Rates Cause Dollar Speculation

"Nov. 15 (Bloomberg) — The decline of the dollar and decisions in the U.S. not to raise interest rates have caused "huge" speculation in foreign exchange trading and seriously affected global asset prices, said Liu Mingkang, chairman of the China Banking Regulatory Commission."

"The continuous depreciation in the dollar, and the U.S. government’s indication, that in order to resume growth and maintain public confidence, it basically won’t raise interest rates for the coming 12 to 18 months, has led to massive dollar arbitrage speculation," he told reporters in Beijing today at the International Finance Forum.

"Liu said this has ’seriously affected global asset prices, fuelled speculation in stock and property markets, and created new, real and insurmountable risks to the recovery of the global economy, especially emerging-market economies.’

"His view echoes that of Donald Tsang, the chief executive of Hong Kong, who said the Federal Reserve’s policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis."

"’I'm scared and leaders should look out,’ Tsang said in Singapore Nov. 13. ‘America is doing exactly what Japan did last time,’ he said, adding that Japan’s zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown."

It is not just China. Brazil has moved to impose a tax (or tariff) on investment money coming into the country on a shorter-term basis, as they are worried about both a bubble in their markets and in their currency. Russia is openly considering similar policies.

I have been doing a lot of speaking in the last month. In almost every speech, I warn of the significant imbalance in the dollar. I walk to the very end of the stage to help illustrate that the world now has on a massive ABD trade. By that I mean Anything But Dollars. Everyone is now on the same side of the boat. They have borrowed dollars to buy other risk assets, assuming that the dollar, like the yen in the glory days of the yen carry trade, will continue to fall. Dollar bears are everywhere.

Explanations abound for why the dollar is a trash currency. It is Fed policy, or the Obama administration’s willingness to run massive deficits, or the trade deficit or our health-care policy or (pick any number of issues). But I wonder.

Global trade collapsed last year and well into this year. Global trade was essentially done in dollars. If global trade is down 20% or more, then there is less need for companies in various countries to hold dollars and more need for local currency because of the crisis. Thus, after a rush to safety in the credit crisis, there is a rational selling of dollars by business.

Look at the above chart. Notice that the dollar is roughly where it was 20 years ago. And notice the recent jump during the credit crisis. We are not even back to where we were before the crisis.

What happens if world trade picks back up, as it appears to be doing? Admittedly, it is not a robust recovery as yet, but it is rising. That means more need for dollars. And dollars which are being borrowed (and probably leveraged!) on the assumption the dollar will continue to fall.

And I agree that, over time, the case for the dollar is not as good as I would like. But in the meantime, we could have one very vicious dollar rally, which would take equity markets down worldwide, along with other risk assets. Why? Because it would be a major short squeeze.

Barron’s just did a survey. It revealed that the bullish sentiment on stocks is quite high and almost everyone hates US treasuries (graph courtesy of David Rosenberg of Gluskin, Sheff)

Whenever sentiment gets too strong in one way or the other, it is usually setting up the markets for a rally in the despised asset. Mr. Market like to do whatever he can to cause the most pain to the largest number of people.

I am not predicting a near-term crash or imminent precipitous bear, although in this environment anything can happen. I am merely noting that there is an imbalance in the system. The longer this imbalance goes on, the more likely it is that it will end in tears. And the irony is that a recovering world economy could be the catalyst.

The Wild Things? They may be hiding in a portfolio near you. Just food for thought. Stay nimble.

Source

Where the Wild Things Are – John Mauldin

Related posts:

• Chart of the day: Aussie – Yen cross
• Is the U.S. dollar carry trade replacing the one in Japanese yen?
• Japan’s easy money policy was the trigger for the tech wreck
• Mea culpa on the need for a new currency
• The dollar is rising against floating currencies

Below is a CNBC video with Meredith Whitney in which she joins Nouriel Roubini on the doom and gloom parade.  Over the summer, both Whitney and Roubini were fairly optimistic. In June I said:

Think of the consensus forecast as an anchor which restricts the outlook of any individual forecaster afraid of failing unconventionally.

In Roubini’s case – and this logic also applies to media darlings like Meredith Whitney – it does NOT pay to up the ante.  What Faber is saying is that they have already benefitted from the bold and unconventional contrarian market call they initially made.  There is little payoff and much risk from continuing on that path.

To wit, Whitney upgraded Goldman Sachs to a buy and by July she almost sounded bullish. But, things are vastly different now. The banking index is up some 136 percent, with many stocks doubling and tripling. Some are up nine times. This is way over the top.

In her interview with Maria Bartiromo, Whitney gives ample reason to expect significant headwinds in the financial services industry and the economy more generally. While I am less certain that we are presently seeing a secular move to consumer deleveraging yet as evidenced by recent retail sales and current account deficit numbers, there is no doubt that credit lines to small businesses and consumers have been cut as Whitney details. 

I have also been getting much gloomier about the prospect of a sustainable recovery as a result.

With fiscal belt-tightening on the agenda at states and municipalities and, now, federally, I expect a double dip in 2011 – a view Whitney shares.

The key question in financial services?

Maria Bartiromo: Do you think that the sector is adequately capitalized today?

Meredith Whitney: No way.

Maria Bartiromo: No way?

Meredith Whitney: No way.

She is bearish on bank stocks generally. As for relative value trades, Whitney says the trade was large cap banks over regionals until now. However, she says now is the time to reduce weight in large cap banks as the outperformance due to government backstops may be about to disappear.

A lot more in the video below. The interview with Whitney runs 11:47.

Related posts:

• Bill Miller and Meredith Whitney: The Bull and the Bear
• Meredith Whitney: “I would diversify out of financials here”
• Meredith Whitney seems onboard with the fake recovery
• Meredith Whitney: more bearish than ever, but…
• Is Meredith Whitney bullish now?

Just arrived in my inbox:

If you want to know what market momentum is all about, here you have it. Get in now to profit.

Sources

Bill Gross Calls High-Yield Corporate Debt `Overvalued’: Video (video here) – Bloomberg

Related posts:

• The market is moving. You should be too.
• Selling the good news does not a bull market make
• Richard Bernstein: Once a huge market bear, now a bull
• Jeremy Grantham: The market is 25% overvalued; 15% correction coming
• U.S. pre-market trading suggests a major selloff

Christopher Wood, the well-noted market strategist at CLSA and writer of the classic Japan crash warning book “The Bubble Economy,” is now warning of a market correction in the West.  According to CNBC India, Wood believes that the markets’ extreme upward move is increasing the chances of a major correction.

Wood is still cautious. He says there is some initial indication of a technical breakdown in the US. "The US market will be vulnerable early next year the US market. If it becomes clear, after this inventory cycle, that consumption, employment is not really recovering, then the market will go down. You will then get renewed stimulus in the US and measures trying to generate growth. The key variable in the West is government policy." CLSA’s best case scenario is 1,200 on the S&P 500 by year-end, he added.

I agree with Wood that underlying economic demand may indeed be weak and all we may be seeing is an inventory and stimulus induced cyclical upturn (see my July post “ISM: Is this the mother of all inventory corrections?”). Of course, the worry is about the employment cycle not turning up before these measures’ positive effect wears off.  This is the question for 2010. If this happens, we get  a double dip and a huge market-sell off. Even if the employment situation starts to improve slowly while stimulus and the inventory cycle recede, this will lead to a muddle-through scenario, again inducing a correction. This is the heart of Van Hoisington and Lacy Hunt’s call about partial recoveries and stock market weakness.

For those of you who want to believe and want to load up on junk, there’s a clap for that too, via bear turned bull Richard Bernstein:

Richard Bernstein of Richard Bernstein Capital Management is a lot more bullish. "Right now, there is a blurring between the secular issues and the cyclical ones. There are people, including me, who are concerned about the secular issues, but we can’t ignore the fact that the economy is getting better, employment is improving. When that happens you will see a cyclical rebound."

Just in September, Bernstein was saying America “practically invites another catastrophe.” What happened to that guy? He better be right on his bullish turn or he is going to have a lot of egg all over his face.

Source

Chances of a deeper correction are rising: Chris Wood – CNBC TV18 India

Related posts:

• Whitney Tilson: "A pullback of some sort is likely"
• Richard Bernstein: Once a huge market bear, now a bull
• Bill Gross: Sell equities and buy Treasuries
• Marc Faber: “Monetary policy in the United States will stay expansionary”
• Partial recovery will mean new lows for stocks

Here’s another bullet point in our ongoing tally of reflation indicators. It’s the return of risk in the form of start-up hedge funds (John Meriwether included).

From the FT:

Hedge fund launches are growing in size and number after months of subdued activity in the wake of the collapse of Lehman Brothers last year.

The revival of fund start-ups is one of the clearest signs yet that the $1,400bn global hedge fund industry is starting to return to better times.

London-based Tyrus Capital on Monday became the largest fund to launch so far this year. According to people close to the company, investors placed about $800m with it before the cut-off for initial subscriptions closed. The fund is expected to raise a further $300m before the end of the year.

Theleme Partners, set up by Patrick Degorce, the co-founder of The Children’s Investment Fund, also launched on Monday with an estimated $200m under management. In the US, Greenwich-based Pia Capital, set up by ex-Moore Capital trader Christopher Pia, launched with an estimated $300m under management in June.

Related posts:

• Hedge Fund Panic
• Hedge Funds: the bell tolls for Ospraie
• Hedge funds collapsing
• Corporate defaults mean more hedge fund blow-ups
• John Meriwether is back, risk must be too

This is a guest post from our newest contributor, Charles D. Bull.

Greetings Writedowners,

Ed has gone to bed already. This is Charles D. Bull speaking.

You know, my wife told me yesterday that the local shopping area already has the Christmas tree up and is all geared up to drum up holiday season sales.  Shoppers were out, the sun was shining and the place was really looking pretty, she said. It warmed my heart. I was so excited for the holidays. I couldn’t wait.

Then, I wake up this morning and along comes this guy, what’s his name, David Rosenberg — with his tales of doom and gloom like the Grinch who stole Christmas. Forget about Nouriel Roubini, this guy makes him look like Mary Poppins.

Check this out:

BULL RUN MAY BE REVERSING
The S&P 500 is riding a four-day losing streak. And while we have seen these corrections turn around before during this massive bear market rally that started last March, the difference this time is that the uptrend line from the lows has been violated across a fairly broad front, including the S&P 500, Nasdaq and the Russell 2000. When trend lines get violated, and when this happens on high volume, it usually, though not always, signals something big.
So many people are deluding themselves that we have some sort of durable recovery on our hands and yet consumer confidence, at 47.7 in October, is unbelievable — the lowest this every got in the 2001 recession, which included the 9-11 terrorist attacks, was 84.9. Think about that for a second. If the equity market is catching on to the view that we could be in for some slowing in the data, then a significant correction after a 60% surge is very likely. This is a time to be raising cash if you haven’t done so already — valuation, technicals, fund flows and fundamentals at this juncture are all near-term obstacles.

In terms of valuation, we said yesterday that the P/E ratio on the S&P 500 on a normalized 10-year basis is 20x and the long-turn norm is 16x. Just to go back to the norm, let alone compress to a level commensurate with an unusually high level of economic and financial uncertainty, would suggest that we would see the S&P correct down towards 875.

ONLY ECONOMISTS SEE THE RECESSION AS BEING OVER
The man on the street sees it a little differently, perhaps less enthused by the fact that a lower rate of inventory destocking is arithmetically underpinning GDP growth at this time. Put simply, a Wall Street Journal/NBC News poll just found that 58% of the public believe the economic recession still has a ways to go — and that is up from 52% in September and means that the private investor, unlike the hedge fund manager, is not interested in adding risk to the portfolio even after a 60% surge in the equity market.

Only 29% of those polled believe the economy has hit bottom — imagine having that psychology with nearly zero interest rates, a bloated Fed balance sheet and unprecedented fiscal deficits (poll was taken from October 23-25). Nearly two in three (64%) said the rally in the stock market (still a bear market rally — not the onset of a new bull market) has not swayed their view (or ours for that matter). There is going to be some very tough slogging ahead as far as the economy is concerned.

OK. Enough already. I think Dave needs to take a few happy pills.  Dave, did you see that rally today? Dow up 200. S&P up 23. Now, that’s what a bull market rally looks like, my friends: stocks way up, bonds way down, lower dollar, lower gold prices.  That’s what I’m talking about!

As for you shorts out there, you’re probably grabbing your ankles, crying “thank you, sir. May I have another?” Serves you right. In the ‘real’ America, we’re doing just fine, thank you.

Stop listening to those clowns Ed Harrison and Marshall Auerback, writing here about depressions and pulling the rug from under our trusted banks. Earth to Ed: we are going into a V-shaped r-e-c-o-v-e-r-y, not depression. Our banks need to be bigger, not smaller. And, um, Eddie, take off the blinders. I don’t know if you noticed it, but we just printed 3.5% on GDP. So, me, I AM popping the cork on the Moet. In fact, I’m sipping it right now.

I don’t know what Ed and Marshall are smoking, but don’t pass it around.

See, I’m an optimist. I knew we would pull out of this one. My motto? Remember, there’s always a bull market somewhere. You just need to know where to look.

You’ve probably been sitting there wondering, "What is The Secret?" I’ll tell you, it’s called positive thinking.

Anyway, I’m sure you pessimists are going to try to bring me down in the comments: aitrader, Lavrenti, kbob, Vangel, you know I’m talking to you – you too Wadsworth. I can take it. As my boy Nails would say, “I love it, baby… Pile it on, bro.”

Charlie has left the building.

Charles D. Bull is a pseudonym. He has been loosed on this site to post purely for your amusement… and ridicule.

Related posts:

• Rosenberg: Market rally is just multiple expansion
• Overbought?
• An amazing market rally. What’s next?
• Rosenberg thinks U.S. market may Test March lows
• Back to the future: Rosenberg says it’s like the crisis never happened

Jeremy Grantham is out with his much anticipated Quarterly Letter and it’s a good one. “Just Deserts and Markets Being Silly Again” is a cutting, snarling, and sarcastic rejection of the prevailing V-shaped recovery bull market view.  But Grantham is far from ultra-bearish, giving a more nuanced and realistic assessment for the medium and longer-term.

He starts his letter with sarcastic allusion to Obama’s Nobel Prize, titling the section “Just Deserts.”

I can’t tell you how surprised, even embarrassed I was to get the Nobel Prize in chemistry. Yes, I had passed the dreaded chemistry A-level for 18-year-olds back in England in 1958. But did they realize it was my third attempt? And, yes, I will take this honor as encouragement to do some serious thinking on the topic. I will also invest the award to help save the planet. Perhaps that was really the Nobel Committee’s sneaky motive, since there are regrettably no green awards yet. Still, all in all, it didn’t seem deserved. And then it occurred to me. Isn’t that the point these days: that rewards do not at all reflect our just deserts? Let’s review some of the more obvious examples.

But, he is just warming up, as he goes on to heap vitriol on 13 groups he feels are equally undeserving of rewards in a scathing condemnation of status quo ante in the economic and financial establishment.

They are:

1. Ben Bernanke
2. Larry Summers and Tim Geithner
3. Mortgage Brokers
4. Homebuilders
5. Over-spenders and under-savers
6. Too-big-to-fail banks
7. Over-bonused financial types
8. Overpaid large company CEOs
9. Stock holders of overleveraged Corporations
10. The U.S. Auto Industry
11. Over-vehicled America
12. Stock options
13. And, of course, Sir Alan Greenspan

This letter is a polemic against the financial elites of a ferocity the likes of which I have never seen from a major fund manager. I see it as a must-read.

As for the markets, he is not all doom and gloom.  But the point that certainly jumped out at me was this:

Corporate ex-financials profit margins remain above average and, if I am right about the coming seven lean years, we will soon enough look back nostalgically at such high profits. Price/earnings ratios, adjusted for even normal margins, are also significantly above fair value after the rally. Fair value on the S&P is now about 860 (fair value has declined steadily as the accounting smoke clears from the wreckage and there are still, perhaps, some smoldering embers). This places today’s market (October 19) at almost 25% overpriced, and on a seven-year horizon would move our normal forecast of 5.7% real down by more than 3% a year.

Translation: the market is so overvalued now that you should expect pretty meager long-term returns in equities.  Does that mean a crash is right around the corner? Not necessarily – but a brutal correction is probably in the offing. Grantham says:

I would still guess (a well-informed guess, I hope) that before next year is out, the market will drop painfully from current levels. “Painfully” is arbitrarily deemed by me to start at -15%. My guess, though, is that the U.S. market will drop below fair value, which is a 22% decline (from the S&P 500 level of 1098 on October 19). 

Unlike the really tough bears, though, I see no need for a new low. I think the history books will be happy enough with the 666 of last February.

The bottom line here is this: the market is significantly overvalued at present levels because of a technical rally super-charged by stimulus. This necessarily means lower returns over a longer-term horizon. The possibility of a major correction is high.

Update: the full letter with a lot more detail, market history and asset allocation recommendations is now linked below instead of embedded due to copyright restrictions.

One other thing: a GMO representative reminded me you that can register with their site and subscribe to the letter and receive it automatically as well.

Source

Jeremy Grantham’s 3Q 2009 letter – GMO website

(the link to the GMO splash page above will guide you to registration in order to view the letter – and to subscribe to future letters)

Related posts:

• More bullishness from Jeremy Grantham
• Jeremy Grantham: “Pull the trigger”
• Jeremy Grantham: “Keep telling yourself… you’re a long-term investor”
• Jeremy Grantham: “Many shares priced for… economic collapse”
• Jeremy Grantham: Overheating in China, speculative rallies and fair value

Richard Bernstein has done a huge reversal in the last few months from touting low-risk stocks to high-beta ones. He has gone from a preference for consumer staples to one for consumer cyclicals (XLY). And he has gone from lugubrious doubter of a sustainable recovery to an almost V-shaped optimism. 

What is remarkable about the transformation is the dichotomy between his views and his former Merrill Lynch colleague David Rosenberg’s. The two were tied at the hip at Merrill, producing research that was out of step with the bullish consensus yet painstakingly substantiated.

Just five months ago, back in May, I caught Bernstein on Bloomberg and he was questioning whether we would get any recovery at all.  I wrote then:

Richard Bernstein asks a very good question in a wide-ranging interview with Bloomberg.  Now that the so-called green shoots are dominating the news coverage and the S&P 500 is up a massive 34% from its March lows, one might think we are due for a pretty Robust V-shaped recovery.  Is that what the future holds?

Bernstein doesn’t think so.  He thinks the recovery will be more muted than most people think.  For this recovery to have any legs Bernstein believes we need to move away from the “credit-induced” dynamic of the previous 5 to 15 years.  This necessarily means that financials will not be leaders in a sustainable bull market because we will have a lot less leverage in the system. This also means that the core earnings power in the sector is a lot less than people think. Bernstein thinks the financial sector has gotten way ahead of itself – a view I am beginning to share after today’s junk rally.

Bernstein went on to say that there was still huge overcapacity in financial services and that we needed to shed this capacity if we wanted to see a good return on investments in the sector. At the time, I was more bullish on the financial sector (although I also worried expectations were getting ahead of themselves; I am now bearish). I saw upside because the overcapacity coupled with low interest rates was an invitation to seek risk, a view that has been borne out in recent months.

As to the bailouts and the government plan, Bernstein believes that the government is attempting to keep the excess capacity in the financial sector alive.  His basic point is that bubbles create overcapacity (think tech stocks).  This is the case in finance.  The sector must shrink.  In my own, there are only two ways a sector in over-capacity can perform.  They can have poor earnings (Bernstein’s first point) or they can seek heavy risk taking and reach for yield.

Just as I am switching the other way, so too is Bernstein.  Witness the latest Bernstein appearance on CNBC last week.

It seems even the most bearish market mavens can’t fight the bullish momentum in this stock market. Wait until you find out who’s now a buyer of stocks.

Richard Bernstein, the former Merrill Lynch chief investment strategist, and one of the biggest bears we know is changing his tune.

People like me have underestimated the rebound, Bernstein says. What’s made him a believer?

You might remember the last time Bernstein was on Fast Money he told the traders – at the foundation of the stock market and the recovery is  jobs. The market can’t sustain itself unless people are brining home the bacon.

And although the unemployment rate continues to rise Bernstein is more focused on initial jobless claims which he and many others consider a leading indicator. And that number has started to decline.

In fact, when they were reported last week new jobless claims dropped to the lowest level since January. And that trend combined with low inflation likely means Americans will regain their appetite for spending.

Another way of saying that is – the economy is slowly getting better. “if you believe in the recovery this is the prime time to be a value investor.”

Bernstein added that one wants to load up on risk now if one believes in the recovery. Junky names are the best as they have more leverage to a rebound.  This is certainly the play right now (but I think it has more to do with interest rates than recovery). I had seen Bernstein saying exactly this last month, but he was not yet confident that the jobs picture had turned. Apparently, he is now and recommends going all-in, a recommendation I would view with skepticism.

Related posts:

• Bernstein: What kind of recovery are we going to get?
• Wood warns of correction, says “key variable in the West is government policy”
• David Rosenberg and Richard Bernstein to leave BOA
• Are the markets set for a pullback?
• Bill Gross: Sell equities and buy Treasuries

In today’s morning with Dave article, Gluskin Sheff’s Chief Economist and Strategist says the macro environment makes it look like 2007 all over again – as if the crisis never happened.

It’s like 2008 and early 2009 never happened. Hong Kong’s Hang Seng index just hit a 14-month high as the island benefits from Chinese growth, U.S, interest rates and competitively supercharged currency link. In fact, the entire MSCI Asia-Pac index added 1.0% today, with broad-based gains and taking the index to its highest level since September 1, 2008.

The VIX index, at 21.49, is back to where it was on September 3, 2008, when most economists didn’t even know we were knee deep in recession, strategists believed we were only in for a mild correction and the Fed still thought it was fighting a liquidity battle as opposed to a credit contraction. In fact, to show just how complacent the market is now regarding that dirty, but now forgotten four letter word called “risk”, the VIX index is flirting near levels we saw back in October 2007, when the S&P 500 was just coming off its all-time high of 1,565 and market pundits were dreaming up new ways to redefine ‘global liquidity’.

Meanwhile, the DXY (USD index) is still recovering a bit but still on very shaky ground (Japan reiterated that it will not intervene in the FX market) and the commodity complex is bid with copper enjoying a nice session yesterday (though off a tad this morning) and oil heading for $80/bbl. It is amazing that the surge in oil prices and the challenge to the economic outlook isn’t making front page news, but it is arguably very tough to push Dow 10,000 off the front pages of the morning papers. The market seems to like Apple’s earnings — my kids sure love its products — and Texas Instrument’s too with futures up and the tech sector on a big roll right now — the Nasdaq is up 38% so far for the year!

Corporate bond spreads have continued to tighten (even in the face of a massive supply boom, a record $1 trillion of new U.S. issuance has hit the market this year) and the “undervaluation gap” in this once-very-cheap sector has now closed given that it is de facto discounting 2.5% U.S. economic growth in the coming year (equities now are close to 5% — not far off from what they were pricing back at the October 2007 peak). Question that still must be asked is that if we are into some big reflationary trade here, why are U.S. Treasuries not getting absolutely smoked? In the last couple of sessions, they have rallied (10-year T-note yield at 3.38%) and being led lower by real rates, which is generally not consistent with pro-growth cyclical beta performance.

It’s what’s called reflation!  And it will end in a very bad way.

More here.

Related posts:

• Rosenberg: The Grinch who stole Christmas
• Rosenberg: Market rally is just multiple expansion
• One on One with David Rosenberg, Chief North American Economist at Merrill Lynch
• UK real wages falling
• Rosenberg: Still a bear market rally

You have probably heard a lot of chatter from the media about a newfound thrift amongst American consumers.

The general take is that Americans, faced with lost incomes and wealth and burdened by record levels of debt, have moved away from the asset-based consumption models of yore. Instead of using the 401(k) or the house to do one’s savings, Americans are now saving the old-fashioned way by cutting spending and stashing money away in bank accounts.  The commonly-held belief is that we are witnessing a secular change away from excess consumption toward thrift in the household sector.

Not true.

If you haven’t noticed, asset markets in the United States are all rising: stock prices, bond prices, house prices, even gold prices and commodity prices. This certainly is not lost on the mutual fund industry.  And it is not lost on American households either.  The savings rate has declined to 3.0% after briefly hitting an 11-year high of 5.9% in May.  Welcome back to the asset-based economy.

(click on image to enlarge)

In the charts above, the left side shows how savings levels spiked up in response to the recession and credit crisis. The right side shows a fall off in the savings rate since May, just after the jobless claims numbers first began to recede.

A few factoids about the savings rate:

• Savings rates averaged 9% through 1982. They were consistently above 7% through 1992. Since then, savings rates have collapsed. From Jan 1969 to November 1997 (comprising all monthly data since record-keeping began), the 10-year average savings rate was higher in every single month than the 5.9% savings rate achieved in May 2009.
• Measuring the 12-month average savings rate, savings troughed in America at an all-time low of 1.4% in April 2008.
• Average savings has since increased monthly to the present 3.9%.
• The monthly savings rate peaked in May 2009 at 5.9%.  It declined every month to August, hitting 3.0% in August.

What should be evident from the charts above is that the collapse in savings coincided with the secular bull markets in bonds and equities and with a secular build-up of debt (see “Household debt as an indicator of secular bull and bear markets”).

My takeaway from the data during this past downturn is that American households are not necessarily saving more. As asset prices have risen, a return to the asset-based economic model seems to be taking hold. Let’s look to future personal income data from the BEA to confirm if this trend holds.

If so, the feedback between asset price increases, collateral for bank lending, increased consumption and economic growth could be more powerful than is commonly assumed. This is what could drive a multi-year recovery… that is until the next debt- and asset bubble-induced downturn ends this brief nirvana.

Related posts:

• Do the personal income data demonstrate unbalanced reflation?
• Chart of the day: Savings Rate
• US personal income data for September shows pullback
• Household debt as an indicator of secular bull and bear markets
• Stephen Roach: Americans’ abandonment of overconsumption is a good thing

That was the title of an e-mail I received from my bank today. Here is what the e-mail looked like:

This is what happens when markets go up. I don’t recall getting anything like this when the market was tanking. Obviously, there are a lot of people depending on you to invest in order to put food on the table.

I wonder if this is a contrarian indicator though.

Related posts:

• The wisdom of crowds, the precision of models and going contrarian
• Marc Faber makes bullish comments on Bloomberg
• Regional banks: Zions falls
• Selling the good news does not a bull market make
• An amazing market rally. What’s next?

In my last post, I presented you with a bunch of data on debt levels broken down by sector of the economy (see “A brief look at the Asset-Based Economy at economic turns”).  I found it interesting that a secular pattern seemed to be at play when looking at the household debt charts.

Notice the three areas boxed in red on the chart to the right.

The chart measures the differential between the year-on-year change in household debt and nominal GDP.

The three areas show three distinct periods of household debt accumulation.

1. 1951-1966. The first shows household debt changes generally outstripping nominal GDP by a wide but decreasing margin. This period coincided with a secular bull market in equities.
2. 1966-1982. This second period is more volatile, but with the overall numbers lower.  In general, debt was accumulated less rapidly compared to the growth in nominal GDP. And when recession hit in 1970, 1974 and 1980, it induced a retrenchment (at least relative to nominal GDP growth). This period coincided with a secular bear market in shares.
3. 1982-?. This last period shows an enormous increase in debt growth relative to GDP growth during the 1980s followed by minor retrenchment after the 1990-91 recession and strangely also in 1997 (could this be a butterfly effect to the Asian Crisis?). But after that it was off to the races right through the 2001 recession until mid-2007.  This period coincided with a secular bull market in equities.

The pattern seems to indicate that there is a relationship between debt build-up in the household sector and stock prices.  The build-up in debt relative to nominal GDP troughed in Q3 2008 at -0.4%. As of Q2 2009, the number was +1.2%.

I see this as evidence of the so-called Wealth Effect. The data suggest that the secular bear market may not have begun in 1998 or 2000 as I have generally believed. And they also suggest that, despite the recent rise in shares, a new secular bear market may have just started in 2007. I will be curious to see what the data look like for the second-half of 2009.

Source

Z1 Data Series – Federal Reserve

Related posts:

• Americans are not increasing savings
• A brief look at the Asset-Based Economy at economic turns
• Chart of the day: household debt vs. savings
• Consumer credit falls 4.4% from year ago levels
• Data on past consumer deleveraging during recessions

Following up on my “Sell equities” post, I want to highlight a factoid from today’s David Rosenberg’s Breakfast with Dave distribution.

Never before has the S&P 500 rallied 60% from a low in such a short time frame as six months. And never before have we seen the S&P 500 rally 60% over an interval in which there were 2.5 million job losses. What is normal is that we see more than two million jobs being created during a rally as large as this.

In fact, what is normal is for the market to rally 20% from the trough to the time the recession ends. By the time we are up 60%, the economy is typically well into the third year of recovery; we are not usually engaged in a debate as to what month the recession ended. In other words, we are witnessing a market event that is outside the distribution curve.

I had been pretty bullish in March and April.  But almost immediately, this rally just went straight up in a moon-shot kind of way that makes someone like me who is more oriented toward fundamentals a bit nervous. After months of wondering how long this thing could last, I’ve finally said sell.

I’m not saying that the rally can’t continue (after a correction).  That depends in part on the economy and reflation. What I am saying is that a two- or three-sigma move should have you asking yourself a lot of questions. And since this is a two- or three-sigma move to the upside, you should be taking profits, not chasing that last dollar.

The video below from 7 Sep with Cazenove’s Robin Griffiths gives one the bigger picture.  Going into treasuries is a flight to safety. Going into gold is the same. Notice that Griffiths dispels the notion that Gold is an inflation hedge alone.  In reality, it is a paper money hedge and its rise represents a fiat currency rejection as much as a portend of inflation.

Source

Breakfast with Dave, 18 Sep 2009 (PDF) – David Rosenberg, Gluskin Sheff

Related posts:

• Rosenberg thinks U.S. market may Test March lows
• Sell equities
• Overbought?
• Rosenberg: Market rally is just multiple expansion
• Rosenberg: Still a bear market rally

In late August, I wrote a post called “Getting bearish again” in which I said that the bear market rally I had anticipated back in March was long in the tooth.  At the time, I mentioned 1026 on the S&P 500 as a sell signal.  With the S&P 500 now well over 1060 and gains of well over 50% from those March lows, it’s definitely time to sell.

And when I say sell, I’m not talking about going overweight bonds or commodities by putting additional new money disproportionately in other asset classes – which is what you should have been doing in August.  I am talking about lightening up on equities and selling existing positions. 

Now, if you missed the rally, I’m sorry but, now is not the time to get in. And if you have been there from the start, remember, bulls make money, bears make money but pigs get slaughtered.

David Rosenberg sums up the logic.

The S&P 500 is now up more than 60% from the lows, which is truly amazing and kudos to those who called it. But the question is whether the fundamentals will ever catch up to this level of valuation — usually after a 60% rally, we are fully entrenched in the next business cycle. Never before have we seen the stock market rise so much off a low over such a short time period, and usually at this state, the economy has already created over one million new jobs — during this extremely flashy move, the U.S. has shed 2.5 million jobs (as may as were lost in the entire 2001 recession).

Do you really think there’s huge upside here? After a 60% run to the upside?  Laszlo Birinyi does and sees 1200 before year end. I’d rather sit this one out. The downside is a lot greater at these levels than the upside. I would say lighten up on risk all around. High quality over low quality. Low beta over high. Consumer staples over discretionary.

But, if you are not going to run with the liquidity-seeking-return crowd and chase high beta and low quality stocks or high yield bonds, where do you put funds?  After all, Bernanke and company have made sure cash is trash by lowering rates to zero. 

Here are three ideas.

Government Bonds

Has anyone noticed the yield on treasuries?  It’s falling. For example, a month before Labor Day on 7 Aug the 30-year yielded 4.61, the 10-year was yielding 3.89 and the 5-year got you 2.84 (see 2009 data here).  Today, we are looking at 4.18, 3.40 and 2.38 (data here).

Meanwhile the dollar is getting crushed – approaching parity with the Swiss Franc. Everyone is shouting “recovery, recovery,” as if that’s the reason that the U.S. Dollar is falling. So then, why are government bond yields exploding to the downside even while the U.S. government budget deficit spirals upward?  It doesn’t sound like the bond market is expecting a very robust recovery. Pimco, the world’s largest bond fund, is already in this trade. They have been loading up on treasuries of late – bringing them to their highest relative weight in 5 years.

Gold (or platinum)

As I see it, the U.S. is likely to use the U.S dollar as an escape hatch for a very intractable debt problem.  That is dollar bearish, but not necessarily bearish for U.S.-based treasury investors.  A scenario in which the Dollar tanks and there is a flight to safety in Treasuries is also one in which Gold could outperform at the same time. And Gold has also been surging as well, last trading well over $1000 at $1015.  If you like precious metals as a hedge against a dollar run, then platinum is a good bet as well as it has outperformed gold.

Out of the money puts

If you think this cyclical bull market (aka bear market rally) has legs like Laszlo Birinyi does, why not do a Taleb Black Swan trade via out of the money puts on Spiders (SPX) or QQQQs or some other broad market ETF?  This would be a hedge – and that’s all. The benefit of such a trade is that you don’t have to sell outright. And it is de minimis in cost right now. The VIX, a broader market volatility index, is at a one-year low. So, this insurance bet will cost you less.  But, the decrease in the VIX should also be treated as a contrarian indicator.

Sources

Breakfast with Dave, 17 Sep 2009 – David Rosenberg, Gluskin Sheff

Update: I just noticed that Barry Ritholtz has a post out discussing why he thinks markets can and will go higher. See his comments here.  He makes valid points  – based more on technicals than fundamentals.  On a fundamental basis, the market is overvalued. To the degree you hold Barry’s view that the rally will continue because of liquidity, then you would want to employ the Black Swan strategy I mentioned as a hedge against downside risk.

Related posts:

• Bill Gross: Sell equities and buy Treasuries
• Way too much risk in the equity market
• Treasurys are getting killed again
• Kass: Bearish on equities
• Marc Faber: "I don’t think that you’ll see gold below $1,000 per ounce probably ever"

So we started September in an ugly way. With the markets down 2% across the board, and oil and bond yields also falling.  Forgive me for thinking this is a bad sign, but selling on good news doesn’t sound very bullish.

  And the ISM data definitely was bullish. Production 61.9 – Yay! New orders 64.9 – Hurrah! What’s not to like? But the Dow was down 185 points – Boo!  What gives? 

Well, for one, bank shares were decimated (see the sea of red in the chart to the right?). But, there’s more to it than that; Wal-mart was the only stock to rise in the Dow. For the S&P, we had breadth of 16-1 for decliners to advancers.  This was a broad-based selloff – and one that took place with the backdrop of positive economic data from manufacturing and housing.

To me, that is a very worrying sign. Now, obviously I expect a market correction (see posts here and here). But, I neither expect nor want a crash (I do think this is a possibility, however, given how far stocks have run without a correction).

It is now September, the month of market jitters,  and the financial services industry is headed back from their long slumber.  Things get serious in September. Let’s hope they don’t get too serious or Paul Tudor Jones is looking like a financial prophet yet again.

Related posts:

• Wood warns of correction, says “key variable in the West is government policy”
• Are the markets set for a pullback?
• Richard Bernstein: Once a huge market bear, now a bull
• Major selloff coming?
• Jeremy Grantham: The market is 25% overvalued; 15% correction coming

Jeremy Grantham is out again with a very important investment strategy piece entitled “Boring Fair Price!”  He leads off by talking about how markets went from extremely overvalued a year ago to cheap back to a state which he considers fair value.  But, he sees the recent rally as a speculative rally which is a response to the savage beating markets took late last year and this past Winter.

Waiting for Markets to be Silly Again A year is certainly a long time in markets, and so is a quarter. A year ago, equities globally – and everything else for that matter – were very overpriced, particularly if they were risky. A quarter ago, in mid March, prices everywhere were cheap. Now they have all – or almost all – converged for a few unusual moments at fair value. A year ago, it was very easy to know what to be: a risk avoider. It was not so easy reinvesting when terrified, but most of us knew that we should have been doing more. But today? It’s difficult to be inspired at fair value. Since early March, the market has had the type of strong speculative rally that often follows extreme declines. The danger of a breathtaking rally is that it leaves those few investors who raised considerable cash waiting for a pullback and psychologically invested in the case for a new bear market leg. This was covered in our mid- March posting, “Reinvesting When Terrified.”…

I tried to make the point that such a rally had absolutely nothing to do with the logic. of long-term fundamentals, but was merely a response to great stimulus and great implied promises. Well, this time once again, enough risk takers were found to get the job done, and the market rose to 950, with presumably at least a decent shot (say, 50/50) at rising over 1000 in the next two to three quarters.

This is my tack as well as I explained in a June post Market manipulation, short-covering rallies and cyclical bulls.  Just because the fundamentals do not support a rally, doesn’t mean it can’t happen. Momentum, stimulus, moral hazard, technicals, you name it – they can all be factors causing a market to bounce significantly despite poor fundamentals.  And these speculative moves can certainly continue for much longer than a fundamental bear with a short position can withstand.  But, now it is looking like the market may have surged beyond what is even sustainable in the short-run.  What to do?  Grantham gives his perspective.  I have linked some of the points he makes to previous posts of mine that make the same arguments.

Plan C: What to do if the Market Overruns

Given our view that we are in for seven lean years in which the market will be looking for an excuse to be cheap, we recommend taking some risk units off the table, including becoming underweight in equities – between 1000 and 1100 on the S&P, if it gets there this year. Around 880 you should continue to move slowly to fair value, twiddle your thumbs, and wait to see what happens. Boring! Otherwise, it is time to focus on the lesser issues: which types of equities are cheaper or more expensive than the market. This leads us back once again to the bet on quality stocks.

The Quality Bet

The easy winner of the cheapest equity sub-category contest is still high quality U.S. blue chips. They were really trashed on a relative basis by the second quarter rally in junk. I understand a rally in junk after the record decline, but this was excessive and based apparently on unrealistic hopes for a strong, sustained economic recovery. Such a recovery seems most unlikely, whereas a temporary, weaker recovery appeared very likely three months ago as the substantial size of the stimulus package was revealed. The latter scenario still seems probable. Our original estimate for the timing of some economic recovery to occur late this year or early next year still stands. Without an unexpectedly strong improvement in the economy, it is hard to see high quality stocks losing much more ground, given their extreme value gap over junky stocks – more than an 11 percentage point spread per year on our seven-year forecast!

My synopsis: expect a weak recovery of uneven quality late this year or early next year.  That means you want to be overweight value and not reach for yield or risk as these asset classes are overvalued on a relative basis.  This is the same advice from Richard Bernstein, the astute market strategist formerly at Merrill Lynch.  Now when looking across global equities for shares to buy, emerging markets come to mind.  And Grantham is generally pretty bullish here.  However, a key note of caution comes on China.

My colleague, Edward Chancellor, strongly suspects that the Chinese economy is dangerously unbalanced and very likely to come unhinged in the next few quarters, surprising the pants off investors. On the other hand, the strong longer-term case that I outlined in “The Emerging Emerging Bubble” 15 months ago seems intact. I suggested then that emerging equities would sell within five years or so at a distinct P/E premium to celebrate their obviously superior GDP growth compared with that of an aging developed world. Emerging market equities are already selling at a modest premium to EAFE and the higher quality half of the U.S. equity market. Being pro-emerging yet anti-China is a dilemma for us; we are working to resolve it. Meanwhile, emerging equities, like most risky asset components, are moderately overpriced. We in asset allocation may, however, push our luck in emerging – particularly ex-China emerging – using inertia to reduce our current modest overweight. If we do this, it will be out of respect for the high probability that emerging equities will sustain and increase their overpriced level relative to the rest of the world.

Translation: Emerging markets have rallied way too much.  China is looking dangerous in particular.  However, we are holding positions ex China and not yet selling as these markets still may outperform.

Bottom line for me: this is NOT a bull market, and as such asset allocation decisions are fraught with risk. Running with a buy and hold strategy in this environment may not be the best strategy. Grantham has a ton more to say and it is a very good read.  I do suggest you read the entirety of his piece, which is linked below as well as being available here.

Jgletter All 2q09

Source

GMO Quarterly Letter July 2009 (PDF) – Jeremy Grantham

Related posts:

• More bullishness from Jeremy Grantham
• The mega Jeremy Grantham interview on how durable the rally will be
• Jeremy Grantham: The market is 25% overvalued; 15% correction coming
• Jeremy Grantham: “Keep telling yourself… you’re a long-term investor”
• Market manipulation, short-covering rallies and cyclical bulls

This is an astonishing video in China with Hugh Hendry, the money manager who is bearish on China who I profiled earlier this month.  In it, he shows us building after building after building – all of them massive and all of them empty.  And you see yet dozens of others still in construction in the background. Who is going to pay for all of this stuff?

Breathtaking.  Hat tip Ravin.

Related posts:

• Hugh Hendry: “China is Santa Claus”
• China’s empty city: the emperor really has no clothes
• Huge property bubble in China
• Stephen Roach sees a W-shaped recovery for China
• China is now America’s largest creditor

On numerous occasions you will have heard me use the term ‘monetizing debt’ to describe what happens when the central bank creates money out of thin air in order to increase reserves in the banking system. The central bank is certainly increasing the monetary base in this regard, but are they really monetizing the debt being issued by the federal government?  Let’s examine the issue to find out.

Fiscal and Monetary Authority

The crux of the issue here is whether the US or the UK central governments can deficit spend to their hearts’ content in order to prop up their respective domestic economies and whether this spending will be financed by printing money at the central bank.

In both cases, a small budget deficit in good times has turned into monstrous deficit reaching double digits in percentage terms. Moreover, the two countries have a monetary authority (the central bank) and a fiscal authority/backer of legal tender (central government) which is at the same level.  This is not true in, say, Spain, where the ECB and the Spanish central government are at different levels.

So what happens then?

Printing money

Let’s first turn to the central bank.  The central bank, looking to increase bank reserves in the system, buys assets (usually federal government debt) with previously non-existent money that it electronically prints out of thin air. This money printing is known as quantitative easing or QE. QE increases bank reserves in the system when the seller of the assets deposits the new funds at her bank and the bank then holds some of these funds in reserve at the central bank as it is mandated to do.

The hope is that the seller’s bank will then go out and lend the non-mandated funds, thus increasing credit in the system.  However, what has generally happened is that the bank has deposited these funds at the central bank as excess reserves without lending it out, receiving only the base rate of interest for doing so – almost zero.

The reason excess reserves are piling up in the UK and the US has as much to do with the demand for credit as it does with the impairment of banks’ balance sheets.  Banks are under-capitalized on a mark-to-market basis, and are, therefore fearful of making new loans when they need to increase their capital base.  But, companies and individual, fearful of their enormous debt burdens in a world of asset price deflation, show no demand for credit.  The lack of credit and the build-up of excess reserves is, therefore, due to constraints on both the supply and demand sides of the credit process.

But, this is a situation which cannot continue ad infinitum because those reserves are assets on the bank’s balance sheet earning near zero interest.  That means the bank’s profitability is lower than it would be had it lent out those funds or purchased assets with those reserves.  Right now, that is acceptable because banks are earning a lot of cash due to high interest spreads, but eventually, these excess reserves are going to become painfully unprofitable.

So, eventually, the bank will be forced to buy some treasuries in order to increase profitability. Obviously, treasuries would be the asset class of choice for financial institutions fearful of making loans while their capital base is impaired. This makes those lenders wiling buyers of federal government debt and financiers of the burgeoning supply of the government’s spending spree.  In essence, the central bank has caused the private sector to prefer bonds over reserves by pushing the overnight rate to zero. That is what is meant by monetizing debt.

Whether the seller is domestic or foreign, the net effect is the same in increasing reserves unless a foreign seller converts the money into a foreign currency without eventual re-conversion back into the domestic currency.  In this case, QE has actually increased reserves in the foreign baking system instead.

By the way, monetizing debt is a central issue in the debate over Federal Reserve independence.  Because the Federal Reserve has been acting in concert with the executive branch since the credit crisis began, many are beginning to question its quasi-fiscal role in supporting the wider financial system with bailouts, subsidized borrowing, guarantees and liquidity. Add in the QE and a ballooning Fed balance sheet as the central government deficit spends and you have an organization that seems to be acting on behalf of the executive branch.

Is this inflationary?

It all depends on net private savings as to whether this stokes inflation in the short-term. The reason that the Federal Government is deficit spending to begin with has to do with the loss of consumption in the private sector due to increased deleveraging and savings.  In the U.S., we have seen the savings rate rise from negative territory (i.e. saving nothing and spending even more by drawing down accumulated wealth) to almost 7% in a few years’ time.  This behavorial change is a positive for America as it is a recognition of the excess consumption that an asset-based economy created. It puts America in a much better position on its current account and helps to reduce debt from unsustainable levels.

But, it is also responsible for much of the decline in the US economy.  So, to prevent a deflationary spiral, the federal government has stepped in to fill the void.  But, if the increase in net government spending (with the improvement in the current account balance) is less than the increase in net private consumption (both via individuals through lower consumption and companies through reduced capital spending), then the net effect of the spending will not be inflationary.  In that case, the net consumption of individuals, businesses and government (C + I + G +(EX-IM) for you economics fans) is lower than it was before the negative consumption shock.

Over the longer-term, the money printing is problematic.  When demand for borrowing is restored, the extra reserves in the system will be lent out. Moreover, the excess reserves can always be invested in higher yielding assets by the banks in order to increase profitability. Therefore, this sequence will engender rises in either asset or consumer prices, depending on how much excess capacity is in the system.  This is why it is imperative that the Fed outline how it plans to withdraw all of the excess liquidity it created when it expanded its balance sheet by twofold.

And since capacity utilization is incredibly low right now, my bet is on asset price inflation rather than consumer price inflation. So when Marc Faber says don’t underestimate the power of printing money, this is what he means.  That is how and why an asset bubble can inflate even in the face of poor fundamentals and why the present bear market rally can sustain itself longer than one might think.  Eventually, all of this comes to an end and the fundamentals re-assert themselves. When that is, is the $23.7 trillion question.

Related posts:

• Connecting Fed cuts with credit writedowns and quantitative easing
• Quantitative easing: printing money like mad to ward off deflation
• Chart of the day: Excess Reserves
• China warns that the west’s quantitative easing is inflationary
• Don’t underestimate the power of printing money, part 2

Marc Faber was quoted in June as saying he expects a major move in financial markets, but is unclear which directions markets will turn.  His statements suggest to me he could be advising clients to go long volatility in anticipation of market turbulence.  This would usually be accomplished by buying options in high beta assets which one believes are underpriced.

Moneycontrol.com reports.

Investment Guru Marc Faber said he sees a huge breakout from the narrow trading range soon. “I think the summer is shaping up nicely. The grave is out, we had a huge rally. We now have a narrow trading range but we will get a big breakout.” He added that the S&P could hit 970-1020.

“I have turned kind of neutral recently because I think we are at that trading range. The big move, a huge move is coming in the dollar, bonds and in equities. But I am not yet sure clearly on what side it will be.”

However, today CNBC is reporting that Faber remains a long-term bear irrespective of his short-term views. An article on their site called “Ultimate Crisis Is Still Coming: Marc Faber” says:

We haven’t seen the last of the crisis despite all talk about green shoots, and the surge in markets was caused by nothing more than the excess liquidity coming from central banks, Marc Faber, author of the Gloom, Boom and Doom Report, told CNBC Friday.

"If you pump money into the system and you create large fiscal deficits, you create volatility," Faber said.

"We’ve seen an intermediate low in March, we’ll rally for a year or so or maybe 18 months… the ultimate crisis will happen much later, and the ultimate crisis would clean the system," he added.

Asked when this would be, he said he could not forecast a precise timing: "it may be 5 years time, 10 years time, but that’s not the last crisis."

Translation: Don’t underestimate the power of printing money. This combined with government intervention into the market will most definitely keep markets from crashing over the near term. In fact, markets may rise for a longer period than bears now expect. The real question is what will be the likely longer-term implications of this money printing.

In my view, it distorts price signals, causing people to lever up, reach for yield and take on more risk.  Whether those bets pay off is now largely determined by how successful government actions are in arresting deflationary forces over the short-term.  That makes this market extremely difficult to call and also extremely volatile, hence Faber’s talk about a big move in either direction.

On other fronts, I see Faber as a bit extreme. Always the small government-minded Libertarian, he goes on to suggest firing half of government employees in the world as a solution.  He says, “Why does California have these problems? It’s not that there are too many teachers in California but the education department is very bloated.”

Whether you agree or not, he is always entertaining.

The video of Marc Faber’s more bullish statement from June is below.

Source

Mkt to break out either way, stay on sideline… – Moneycontrol.com

Related posts:

• Marc Faber on CNBC: bearish on oil and India
• Marc Faber says avoid financials and buy gold
• Marc Faber: “it’s very tough for a forecaster who was ultra-bearish to stay bearish”
• Marc Faber: Dr. Doom goes bullish
• Marc Faber: “Monetary policy in the United States will stay expansionary”

I just read a CNBC story which fails to mention CNBC’s involvement in the apparently erroneous report that Nouriel Roubini has suddenly become more bullish. Is this omission justified? 

The controversy centers on statements Roubini made regarding the timing of a technical recovery in the United States.  Yesterday, it was reported on CNBC and elsewhere that Roubini had made a ‘change’ to his market view and was essentially more bullish on the U.S. economy.  Many market participants believe this was a major factor in the rise in shares yesterday.

However, Roubini issued a statement after markets closed repudiating the view that he had changed his view on the U.S. economy at all (see statement here).  And since that time, many in the financial blogosphere have taken CNBC in particular to task for its role in spreading the belief that Roubini’s economic outlook was more favorable.

• CNBC Report on Roubini; Denninger Response – Barry Ritholtz
• CNBC: You Owe America An Apology – Karl Denninger
• Roubini: "My Views Were Taken Out Of Context." – Zero Hedge
• Denninger accuses CNBC of falsely goosing market on Roubini’s back – Credit Writedowns
• Roubini Denies He Said "Recession Will Be Over This Year," Despite Bullish Media Reports Otherwise – Yves Smith

Clearly, this story struck a nerve in the blogosphere.  Now, CNBC has acknowledged the original thesis that Roubini is a bull was false. But, the media outlet apparently does not see itself as culpable for their part in this.  Below is part of a story they ran on their website.  Notice the parts I have highlighted in bold.

Several business news outlets, picking up on a report initially from Reuters, earlier Thursday cited Roubini as saying that the worst of the economic financial crisis may be over.

The New York University professor was quoted by Reuters as saying that the economy would emerge from the recession toward the end of 2009.

Reports of his comments helped trigger a late rally in the stock market.

Roubini added late Thursday that he sees no economic growth before the end of 2009.

So, I guess Reuters is to blame?  I see this exchange on CNBC in the video below as part and parcel of this story.

You tell me: Is it Reuters or CNBC here?

Note: Reuters has now amended its story to reflect the new non-bullish story line. The original story is nowhere on the web.

Sources

RPT-UPDATE 2-Worst behind us but more stimulus needed-Roubini – Reuters

Roubini: Views on Economy Unchanged Despite Reports – CNBC

Related posts:

• Denninger accuses CNBC of falsely goosing market on Roubini’s back
• Richard Bernstein: Once a huge market bear, now a bull
• Nouriel Roubini: we are in recession
• Meredith Whitney: “I haven’t been this bearish in a year”
• Marc Faber: “I am 100% sure that the U.S. will go into hyperinflation”

Here is a clip from the Daily Show with Jon Stewart that highlights Lenny Dykstra, the former baseball player turned financial guru.  To my mind, it really puts the bubble years into perspective.

By the way, I am a Boston Red Sox fan. And, in 1986, when the hated New York Mets beat us in the World Series, I was living with two Mets fans. Needless to say, I got a lot of stick, so Lenny Dykstra is not one of my favorite ball players.

Related posts:

• Fred Hickey: Gold starts secular bull, tech ends secular bear
• Rosenberg: The Grinch who stole Christmas
• GM drops to 53-year low
• The new Star Trek film is here
• Marc Faber: “The feds poured the gasoline and lit the match. Now they’ve joined the fire department

Just when I was wondering where Meredith Whitney had gone, she’s back.  But she has a whole new tone to her.  In this interview on CNBC, she says she is expecting a monster number from Goldman (GS) tomorrow morning, in 2010 and in 2011. She is well above the street on Goldman. She even uses the word ‘cheap’ when referring to the stock.  Is Meredith Whitney a bull now? Have a listen – she also talks about other names and sees Bank of America (BAC) as the one to watch.  I like her reference to ‘junk in the trunk’ when talking about JPMorgan Chase (JPM) in the 2nd video below.

Her comments seem a far cry from the bearish Meredith Whitney of yore.  What happened to that woman?  Maybe she read my post “Marc Faber: “it’s very tough for a forecaster who was ultra-bearish to stay bearish.”

For a view of what Whitney sounded like just a few months ago, see my May post “Meredith Whitney seems onboard with the fake recovery” or my April post “Meredith Whitney: Regardless of stress tests, banks will still need more capital.” She sounds very different today and is singing a tune I first got onboard with in April (“Wells profit forecast is a clear bullish sign”).  But, given the huge run up in shares, I do question how much more upside there is to bank shares now despite what are likely to be very good earnings.  Let’s see how Goldman’s earnings and shares do and that should be a good test.

You will notice that in the first video she suggests that the disappearance of the likes of Lehman and Bear are good for the surviving behemoths (which increases banking concentration, a point I just made).

UPDATE 1230ET: Whitney makes a point regarding loan modifications that I first made on May 26th (“How refinancing helps the likes of Bank of America and Wells Fargo”) i.e. that the big banks are getting a HUGE incentive to do refis and this will goose their earnings short-term in three ways: a. they get a refinancing fee that goes straight to current income. b. they get an incentive fee due to rules the government made on May 21st, the subject of my May 26th post. c. the banks get to at least delay writedowns because past due mortgages become current and this will decrease their loan loss provisions over the short-term.  Nevertheless, home mortgage default recidivism means that re-default likelihood is high and that the writedowns will eventually have to be taken.  Whitney seems to be saying this makes banks a good trading play, not a good holding play.

Related posts:

• Meredith Whitney: “I haven’t been this bearish in a year”
• Bill Miller and Meredith Whitney: The Bull and the Bear
• On Meredith Whitney’s Goldman downgrade
• Meredith Whitney seems onboard with the fake recovery
• Meredith Whitney: more bearish than ever, but…

David Rosenberg is out with a bearish piece on equities today (I hop that doesn’t surprise you).  He sees the market as still overvalued at these levels. The key, he say is that most of the rally has been built on multiple expansion and not earnings growth. Here is what he says (emphasis added)

We heard at the market lows in March 2009 that the stock market had sunk to Armageddon levels. We have often thought about that because we can certainly understand that at the 2.0% lows on the 10-year Treasury note yield, we had gone to a place we had not seen in over five decades. Also, with Baa spreads north of 600bps, we could see that corporate bonds had moved to levels not seen in seven decades as well.

But this notion that we had moved to Armageddon lows in equities does not seem to hold water. After all, the forward P/E multiple on the S&P 500 at the lows was 11.7x. That was not a multi-decade low or some massive standard-deviation figure — we were actually lower than that at the October 1990 lows when the multiple was 10.5x and frankly, coming off the 1987 collapse, the forward P/E had compressed to 9.8x. As it now stands, the multiple is back very close to where it was at the October 2007 market high, when the multiple had expanded to 15.0x. The range on the forward P/E over the last quarter-century is between 9.8x and 21.8x (excluding the tech bubble), so at 14.5x currently, it is hardly the case that this market can be viewed as a bargain.

On a trailing earnings basis, the P/E multiple has actually widened, from 17.0x at the lows to 23.3x currently, a huge multiple expansion. At this stage of the 2003 recovery, the multiple hardly expanded at all, earnings were driving the rebound; coming off the October 1990 lows, the multiple expansion four months into the rally was closer to 2x and the powerful surge in the post-1982 recovery saw a 3x multiple point expansion at this juncture — not 6x!

Back in November 2007, just as the recession was about to take hold, John Mauldin commented that 80% of the stock price appreciation in the 1980s and 1990s bull market came from multiple expansion (also see his May 2006 piece with research from Jeremy Grantham on this).  So, obviously, multiple expansion is part and parcel of the psychology of secular bull markets.  However, Rosenberg’s piece reveals that all secular bull markets in the U.S. for which data is available have started from price-earnings multiples that are much lower than we are seeing at present.  Translation: this is not a secular bull market.

What we have seen since March is a bear market rally, nothing more.

Source

Multiple-Led Market May Meander – David Rosenberg

Related posts:

• Kass: Bearish on equities
• Rosenberg: Still a bear market rally
• Rosenberg thinks U.S. market may Test March lows
• Getting bearish again
• Overbought?

This morning, stock markets are down in Asia and Europe.  And Futures show a likely decline in the U.S.

What’s happening?  I think we are seeing the March rally hitting the wall as the technical recovery everyone is anticipating looks to come later and to be less robust. As a result, commodities are selling off horribly.  Crude has traded under $65 and is down over 3%.

For me, Alcoa’s Wednesday report will give a good sign of how robust the economy is as basic material stocks should do well in an upturn.  In a post in late May Consumers ‘do believe in the green shoot story’, I indicated that June and early July would be key for this overbought market.

Let’s remember that confidence does not translate into consumption, especially as most of the uptick here was in consumer expectations.  Nevertheless, this has grabbed the market’s attention and U.S. stocks are up well over 2% as I write this.  If you were wondering whether the powerful market rally from March has legs, this should come as proof that it does.  The S&P 500 is now above its 20-day average trendline again.

I should caution that an uptick in expectations of this magnitude has a dark side.  If the economic data disappoint in June, we could see a sharp selloff.  That makes the June data and the early July earnings reports very crucial data points.

And I still believe this is true.  The June economic data was not nearly as good as market experts expected and the market has sold off as a result.  he employment data last week was truly dreadful.  If we get poor earnings here in July, this bear market rally is going to get cut down to size.

Key sectors to watch are financials and basic materials.

Sources

Commodity Futures – Bloomberg
CNN Money Pre-Market Data – CNN Money

Related posts:

• Dow 4,000 still in the cards?
• Kass: Bearish on equities
• Rosenberg: Market rally is just multiple expansion
• Are the markets set for a pullback?
• Getting bearish again

As If you didn’t know this already, the wall of money being funnelled through Chinese banks is creating a massive speculative bubble in shares.  The Telegraph reports:

Under orders from the government, China’s banks have flooded the economy with new credit this year, advancing more money in the first six months than the total for 2008.

It is the biggest wave of money since the People’s Republic of China was founded in 1949. The loans are part of a stimulus package to spur domestic investment and consumption and help the economy through the financial crisis.

However, a significant proportion has been diverted into shares and property, with the Shanghai Stock Exchange rising 60pc since January.

Several economists believe a large part of the government’s 4 trillion yuan state aid package has also failed to reach the "real" economy.

Wei Jianing, an economist at the Development Research Center of the State Council, said 20pc of the new bank loans had reached the stock market, and 30pc had been invested in property.

According to the Chinese state media, Wei said the huge flow of money could fuel further asset bubbles. However, he was careful to note that this was not yet the view of the State Council, China’s ministerial cabinet.

“When funds are circulating and swelling inside the financial system, instead of servicing the real economy, we see this as a sign of bubble formation,” said Wei. “Now the rapidly circulating funds can easily boost the stock market and produce new financial bubbles, and lift real estate prices as well.”

Related posts:

• Chinese officials warn banks about reckless lending
• Treasurys are in a bubble
• Is the U.S. stock market close to bottoming?
• China cutting overcapacity
• China is now on the same bubble path as Japan post-1987 crash