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Tuesday, June 30, 2009


the german conundrum

it seems as though everyone has a good idea as to what has to happen in order to rectify global imbalances that have their headwaters in trade. east asia, germany and japan were supposed to seamlessly transition to high-wage consumer economies; the united states was supposed to learn to double or more the share of its economy dedicated to export; international capital flows would balance, and all would be well. so transparent was the need that legions of observers ridiculed the agents who did otherwise in the 1930s, dismissing protectionism as the folly of idiots who knew less than we do.

but on the way to recovery a strange thing happened: we rediscovered why protectionism ruled the rebalancing of the early 1930s, and it turns out it isn't because all our grandfathers' economists and politicians were morons. tradermark of fund my mutual fund highlights the deep difficulty that germany is having in transitioning into being the new california.

Germany, in the grip of a massive export slump, firmly believes it has no alternative to export-led growth. But there is an alternative -- the country just doesn't have the stomach for the changes it would require.

There are three ways that Germany, the world's fourth-largest economy, could respond.

One is to sit tight and wait until global trade recovers. That's what Chancellor Angela Merkel's government and much of corporate Germany plan to do. In their view, this recession is an almighty cyclical hiccup, but Germany's economy is fundamentally sound.

right, "cyclical hiccup".

A second option is to increase domestic consumption, and labor unions say it's high time. Export competitiveness has come at the expense of consumer spending, they argue, because German companies have browbeaten workers into forgoing pay raises for years.

except that what is happening is that wages are having to normalize across the same borders that capital and production are crossing with ease in the age of globalization. the deflationary pressure on real wages throughout the west is inexorable, and the only way to put an end to the arbitrage is to -- yep -- raise protective barriers such as tariffs and capital controls.

The third option would be to foster entrepreneurship in new sectors, to supplement Germany's traditional strengths in cars and engineering. ... But genuinely diversifying Germany's economy would require an overhaul of the country's universities, banking and capital markets, bureaucracy, taxes and welfare state, labor market and immigration laws, say economists. That's unlikely to happen soon. The nation is tired of reforms, after years of controversial changes to cut budget deficits and long-term unemployment.

everyone always says "innovate" -- but it just isn't that simple, is it?

the german conundrum is also the conundrum of japan, the other high-wage mercantile export powerhouse. but more importantly it highlights the massive structural and cultural adjustments that must be made in the global economy in order to correct the imbalances we've grown so used to. such structural and cultural changes take years to effect and are expensive in frictional costs.

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"it seems as though everyone has a good idea as to what has to happen in order to rectify global imbalances that have their headwaters in trade. east asia, germany and japan were supposed to seamlessly transition to high-wage consumer economies"

I posted this on Credit Writedowns and Gold Versus Paper on China and it could apply to other export based economies too:

"China cares for its interests primarily. If protectionism and mercantilism is in its interests, it will adopt those policies even if it harms other nations. I suppose a key macroeconomic theme (as described here) is the hallowing out of the Western middle class in countries that have an Anglo-Saxon labor market. This is caused by stagnant wages from competing against immigrants, third world labor, and technology. Increasing consumption during the bubble years was not provided by increased earning power, but by the accumulation of debt.

One can make money from globalization by importing goods made in countries with cheap labor to countries where firms still retain significant pricing power. Globalization in the long run seems to undermine the earning power of the Western middle class.

Furthermore, profits from globalization come from intertemporal discount rates that gravitate towards short-term consumption over long-term saving (it is basically the argument presented here) in wealthy current account deficit nations. Given the gravitation towards savings in those nations, it is unlikely that the current form of globalization will be significantly profitable, and this is one reason why I expect interest rates to fall.

So could multinationals rely on China? Of course, there are a lot of workers in China and that would serve to depress domestic wages (and consumption) despite their enormous savings. Chinese protectionism would destroy the thesis that Chinese consumption would help lead the global economy to recovery. I do not think China could replace the Western middle class."

I am an emerging market bear, and I am skeptical of the transition away from export dependency to domestic demand. Even if Chinese domestic demand will drive its growth, I wonder whether the state will allow investors to profit from its economic growth. China has protectionist policies, so it would not allow other nations and investors who operation outside of China to benefit from its growth

BTW, do you count yourself among the contrarian debt deflationists, or are you a "contrarian" inflationista? I think your blog has a deflationist bias towards it.

Regarding other issues, I am interested in your thoughts about the financial crisis and religion. From your previous posts (years ago), it seems that you are a Roman Catholic. Despite being an atheist, I do respect your thoughts as I did like your blog entry about how nihilistic individualism preverted Christianity (religion as entertainment was probably its name).

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case-shiller double dip?

so thinks ivy zelman, per the WSJ.

Prices at the mid-to-high end are falling as job loss and the worsening economy have iced demand for higher-priced “move-up” homes. Also, tougher financing conditions have made it harder to get mortgages for “jumbo” loans on more expensive homes, and delinquencies are rising among jumbo borrowers, which could lead to an even greater oversupply of homes.

Independent housing analyst Ivy Zelman notes that such a “double dip” in the index in the second half of 2009 could materialize because the Case-Shiller index is value-weighted, which means that repeat sales of higher priced homes figure have an outsized impact. ...

Mid-to-high end home price declines could generate some mixed signals over the coming months. If prices fall low enough to attract new buyers, that could generate more sales of higher-priced homes that lead to increases in median prices. But those median price gains won’t necessarily mean that housing is out of the woods.

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confidence fail?

pragmatic capitalist:

Consumer confidence came in much lower than expected at 49.3 versus expectations of 57. This decline represents the schism between the green shoots theorists and the real economy. Consumers simply aren’t recovering as high gas prices persist, wage deflation sets in and job losses mount.

this is a disappointment which, at least so far this morning, has sent an overbought market reeling a little bit. but i'm not entirely sure that it should be read as a negative.

i've noted before that likely the meaningful measure is the differential between future expectations and present situation. this measure is at its wide going back to 1993 (not shown, but jim stack has run this back to 1967). while the aggregate confidence number tends to fall throughout a recession and lag the stock market, a sharp rise to meaningfully positive readings accompanied the 2003 stock market lows, and ordinarily lead the end of a recession.

but there is a potential sticking point. while the future expectations component is now well off the floor and touched 71.5 last month, that is approximately the level reached at the floor in 2002-3 -- in other words, 70 is still a damned sour outlook.

using economagic one can see that trough expectations in late 1990 were as low as 55; in 1980 as low as 50; december 1973 touched 45. that's some excellent context for the recent unbelievable readings in expectations, which -- after breaking records in october 2008 at 35.7 -- absolutely fell down the stairs to an all-time low of 27.3 in february 2009.

the $64,000 question is whether such low readings of expectations demonstrate a systemic shock that will simply take longer to recover from. it may be worth noting that, in each of these earlier instances of extremely low readings of expectations, the recession tended to drag on -- 1980 was prelude to the infamous double-dip that didn't resolve until the end of 1982, and it took until the middle of 1975 to emerge from the big recession of the seventies.

what's more, most jaundiced observers would tell you that, whereas present situation is something of a coincident indication of the employment picture, the expectations index is in large part a reflection of recent equity market performance. it is highly likely that we are seeing a jump in expectations now mostly because the market has rallied. if that rally craps out, as anticipated by several savvy observers? chances are the effect on expectations would be devastating. one can note, for example, that the december 1973 nadir was followed by a bounce in expectations that ran up to around 90 in the summer of 1974; this coincides exactly with a bear market rally similar in duration to what we've experienced recently -- the dow industrials rallied from 53.65 on christmas eve 1973, off nearly (-25%) from the highs, to 58.22 in mid-march 1974 and holding in the 54 area through summer. but as the market then collapsed back to 35 into october 1974, so did expectations -- pegged back down to 50 in october and december of 1974.

in any case, i'd wait to see how expectations behave on a correction of the big march-june equity upswing. it's hard to imagine lower lows in expectations, given how very low the recent readings were. but there are plenty of bank failures ahead, more house price deterioration and perhaps even some nasty turbulence in global credit markets provoked by events in europe. as was illustrated by a shockingly poor first quarter GDP reading for the UK, it's perhaps harder to stimulate one's way out of this manner of economic trouble than it commonly believed.

UPDATE: zero hedge with an excellent correlation chart matching the S&P to the consumer confidence headline number -- which incidentally verifies how confidence tends to be led around by the stock market -- and notes a divergence.

The last time we got a -2.42 standard deviation between confidence and the market, things got real ugly, real fast.

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Monday, June 29, 2009


second derivative deterioration?

the story of recent weeks on the economic front has been one of green shoots and second derivative improvements. perceived changes in the rate of economic collapse have been taken as an excuse for equity to make a fabulous charge off the lows, aided by a systemic short squeeze and probably no small amount of bleedover from federal reserve bank excess reserve expansion (conspiratorially organized or no, it makes little difference).

the story has thusfar had few exposed flaws and discontinuities -- after all, the pace of collapse in 4q08 and 1q09 stood to be mitigated by fiscal stimulus and an effective financial system backstop. however, the second derivative improvement isn't actual economic improvement, and one wonders when expectations of an actual recovery could begin to be disappointed.

and now -- via john hempton -- perhaps a leading indication that one of the most intractable of all american economic and financial problems, that being housing, is again accelerating to the downside.

I have been firmly in the “second derivative is good” camp for some time. Green shoots were few and far between – but the economy no longer appeared to be in free-fall. ...

The data I considered most persuasive was the delinquency data at Fannie and Freddie. It gets worse every month, but until the last data point it was getting worse at a decreasing rate (especially if you adjusted for the foreclosure moratoriums they implemented).

Today I am more worried. My favourite data point (rate of increase of Freddie Mac delinquency) has deteriorated – especially in their insured portfolio. Its not sharp deterioration – and it is possible – even likely – that Freddie Mac will have end credit losses considerably lower than the bears anticipate. But as a second derivative bull I am feeling just that little bit less certain.

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deconstructing LEI, revisited

james hamilton of econbrowser dissects the leading economic indicators in a fashion similar to what i did recently, with similar results, and as david rosenberg has.

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Friday, June 26, 2009


revisiting the net international investment position

via john jansen, the comments of JPM on the NIIP.

brad setser also visits the topic in his typically insightful style.

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the impending end of the bear market rally

fund my mutual fund links to a CNBC interview with paul desmond of the venerable lowry report. i'm a subscriber of his excellent letter, and let me tell you their indications are even more dour than this clip conveys -- and how much more dour can you get than the last thirty seconds? the report weekly commentary today was loaded with expectation of an impending retest and fail of the march lows, given the stubborn refusal of selling pressure to abate -- it's trended sideways from march -- or of buying power to expand, particularly in june as it has really collapsed in apparent anticipation of the end of the bear market rally.

desmond's letter has been brilliant throughout, and on the strength of the lowry analysis, particularly under these circumstances, i'd feel safe betting the farm against the market. (indeed my current short position, installed around S&P 925, couldn't be bigger.) it's quite hard to find anyone talking about new lows -- the current presumption is of nascent economic recovery and at worst a mild pullback on the way to a much improved earnings background, never mind any systemic concerns. i suspect that's all going to seem quite foolish with a bit of retrospect.

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I agree. My short positions are between SP 910-930, I am also starting to buy the Vix. Saying this I am still heavily in Cash, as these bear market rallies can be really stupid. Should the SPX get into the 1000's then I'll go all in on the short side.

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Are you short via the ETFs? SDS? TZA has been good to me recently.

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i've got some stops set to limit the damage if things head north, paul, as i agree there could be a push higher which would represent a better entry point.

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stimulus or unrest

marshall auerback on fiscal stimulus and government deficit financing:

What President Obama, Fed Chairman Bernanke, and Treasury Secretary Geithner must say is that until the government deficit spending and the improvement in the trade balance exceeds desired net private sector saving, we can create all the money we want - it simply will not be enough to driver final product prices higher unless and until we succeed in restoring aggregate demand to sufficiently high credible levels where a self-sustaining economic recovery can take place.

and as for mopping it up when that glorious day comes, read paul mcculley:

I’m perplexed that so many pundits put so much emphasis on the importance of the Fed soaking up excess reserves, as if it is a necessary condition for hiking the Fed funds rate. It is not. To be sure, it used to be, before the Fed had the legal authority to pay interest on reserves, which Congress granted last fall. Before then, the only way the Fed could achieve a meaningfully positive Fed funds rate target was to constrain the supply of reserves relative to the banking system’s demand for reserves, essentially required reserves. ...

It is ... simply wrong to get wrapped around the axle about the amount of excess reserves in the system. The Fed now has the ability to hike the Fed funds rate, despite a huge reservoir of excess reserves, because it now has the legal ability to pay interest on those reserves.

and so, continues auerback:

The key is building a political case for the stimulus. This means getting people around a common objective where everybody is perceived to be benefiting and that the sacrifices are being borne fairly. This was clearly the situation in WWII when the budget deficit as a percentage of GDP got as high as 30.3% of GDP, yet nobody complained about the “sustainability” of government expenditures. The upshot was that by 1946, the GDP per capita was 25 percent higher than it had been in the last peace years before the War. GDP per capita continued to grow during the Marshall Plan years. Despite giving away two percent of U.S. GDP, American residents (and taxpayers) experienced a higher standard of living each year. And nobody spoke about us running out of money.

By contrast, the current bonanza for banks is neither economically efficient, nor politically sustainable.

What is driving the change in portfolio preference shifts is not only a misguided paradigm, but also an inability for the Obama administration to make a sensible, coherent case in what they are doing and why they are doing it. Their actions, in fact, seem to suggest that everything is ad hoc and that they are operating out of their depth, in effect continuing the same policies of the Bush/Paulson period, but on a much greater scale. ...

In the meantime, beyond automatic stabilizers, the door appears to be shutting to further active fiscal ease. I wonder if the stage is already being set for tax hikes, as rumors of a federal VAT (value added tax) have been floating around of late. Add this to rising commodity prices and interest rates, and the profile of any recovery may become increasingly in question, a la 1937-8. Add to that additional bank write-offs, further credit contraction and a minimalist welfare system which leaves nothing in the way of social cohesion, and the prospects for major social upheaval look dangerously likely. What is missing is a vision of a new growth path for the US. If a public backlash is to be marshalled to something more than retribution, that needs to come to the fore. Once you get beyond the pothole and school patching, what industries can be pushed forward through public seed capital or public private partnerships? The economist Hy Minsky pointed out a better way to solve both the liquidity and the income problem, while also providing full employment: by channeling government expenditure through an employer-of-last-resort program.

The current crisis could have been mitigated if increased household consumption had been financed through wage increases and if financial institutions had used their earnings to augment bank capital rather than employee bonuses.

The current system has failed because it was built on an incentive system that did just the opposite.

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A review of FASB statement 166 may clarify the banks current predicament.

I grant that it is nice to assume a certain nefariousness on the part of the banks, (lord knows they seem to deserve it) but I suspect the new rules regarding their use of SPE's and securitization has them worried that if they appease congress and the general public now with increased lending, they may have a steep price to pay come 1Q 2010.

Of course that can change at the whim of congress now as we saw with marking to market rules.

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Yes, it would have been better if household consumption had been financed through wage increases--but it wasn't and won't be. If the stimulus is not effective because the banks aren't lending, why not just start handing out cold hard cash to the citizenry? For all this talk about how awful deflation is and how important it is to inflate no one seems to want to discuss how to really cause inflation--hand out dollars to all and sundry, with the promise of more down the road. You want a weak currency, I can do that. . .

Of could it be that there is something worse than deflation? :>)

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recession road trip

christina davidson of the atlantic takes a page from kerouac. the results are being posted here.



how fiscal stimulus is supposed to work

this morning saw the bureau of economic analysis release of personal income and outlays, where may income spiked higher for a gain of 1.4% atop an upwardly-revised 0.7% in april.

Personal income in May surged far more than expected but it was nearly all related to temporary fiscal stimulus. ... Personal income posted huge 1.4 percent gain in May, following a 0.7 percent boost in the month before. The rise in the latest month topped the market projection for a 0.4 percent increase. The advance in personal income was led by one-time payments under the American Recovery and Reinvestment Act of 2009. However, the wages and salaries component slipped 0.1 percent after an increase of 0.1 percent in April. Consumer spending actually made a moderate comeback with a 0.3 percent gain after no change the month before. The May spending boost matched market expectations.

the boost in income facilitated a massive increase in personal savings, ie household balance sheet repair.

Spending growth has been lagging income growth as indicated by large spike in the personal saving rate to 6.9 percent in May from 5.6 percent in April and 4.3 percent in March. Consumers are being cautious with the one-time payments from a special Social Security based stimulus package (which is not being funded from the Social Security trust fund). However, the additional income will likely help consumption in coming months.

now, all we have to do is keep this up until private sector debt falls from its current dizzying heights of ~300% of GDP back down to ~100%. right. easy. anyway, i don't think it's the negative news some might see it as.

one can follow along at as we incrementally socialize our thirty-year debt disaster by ramping up government outlays which become private sector income and thereby savings -- of the near $575bn approved by congress in the american recovery and reinvestment act of 2009, some $152bn has been obligated thusfar and $52bn spent (on its way to $119bn by year-end).

photo borrowed from christina davidson of the atlantic.

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Thursday, June 25, 2009


the fed and commercial paper

following on earlier comments -- via ft alphaville:

Of course, a lot of this is down to alternative facilities, like the Commercial Paper Funding Facility, provided by the Fed. Companies are issuing directly to the Fed’s SPV instead of traditional counterparties like money market funds. This is especially the case since Fed terms allow issuers to finance the repurchase of outstanding commercial paper by selling new paper to the SPV. ...

Last week, the overall market shrank by $27.7 billion. Over the past 3 months, the commercial paper market has seen dramatic contractions. Demand for funds from companies has dropped, while the Federal Deposit Insurance Corp. program guaranteeing longer-term debt has provided some companies with a viable funding alternative. The bulk of the shrinkage this week is in the asset-backed portion of the market. It saw a decline of $21.3 billion this week, after a decline of $22.2 billion last week. The Fed set up the Commercial Paper Funding Facility in October to extend short-term financing to U.S. companies that had been shut out of the commercial paper market. Later Thursday, the bank will release data on how much it holds in its program.

The only thing is, the Fed’s June report on the uptake of its credit and liquidity programs contradicts the above line. It described a decline in the use of its Commercial Paper Funding Facility thus:

Recent Developments • A significant portion of maturing paper in the CPFF over recent weeks has not been rolled over. • Improvements in market conditions may have allowed some borrowers to obtain financing from private investors in the commercial paper market or from other sources.

So what does it mean if companies are not tapping either the market or the Fed for short-term liquidity?

Dow Jones suggests the shrinking economy has translated into fewer spending needs and lower overheads. But that would be extremely effective cost-cutting by companies. We, on the other hand, presume a shrinking economy can seriously hinder cashflow due to invoice payment delays, upping the need for accessibility to short-term cash.

i think the answer is that the vehicles which were financed by commercial paper -- which prominently include mortgage, auto and credit card financing -- are being wound down to the detriment of outstanding consumer credit in advance of being forced back onto bank balance sheets. see alphaville on meredith whitney:

Record credit card losses are pushing big US banks to come to the rescue of off-balance sheet vehicles they use to transform hundreds of billions of dollars in consumer loans into securities sold to investors. The support provided by Citigroup, Bank of America, JPMorgan Chase and American Express underscores how the deteriorating health of the US consumer is opening new fronts in the financial crisis.

this would in part explain why early consumer results for june have been so poor. a fearful combination of bank anticipation of funding problems and consumer balance sheet repair.

alea linked to dean popplewell's forex blog today, where he provided this commentary on yesterday's FOMC comments:

Bernanke and Co. came and delivered what was expected. No real surprises, the FOMC communiqué was probably more on the hawkish side (how else will they influence the most important variable-the consumer). Positives, policy members believe that businesses have pared inventories to levels better ‘aligned with sales’. Inventories have been the scourge of this recession. Any drawdown of stocks must be seen as a positive! On the inflation front, they mention commodity prices, however, the feeling is they are not that concerned (bang goes the exit strategy!). One note, they said that will ‘make adjustments to credit and liquidity programs as warranted’. Analysts interpret this as an indication that they might raise the rate on TAF and perhaps the discount rate to encourage further wind down of these programs which could be the 1st-step for an exit strategy.

and further on durable goods, which were yesterday's upside surprise:

The May data still leave the 3-month annualized growth rate for core-orders at -13.5% vs. 1st Q decline of -44%. Analysts note that a flat June reading would push 2nd Q growth into positive territory. Digging deeper, core-shipments were down -24% over the last 3-months. For the naysayers, firstly, the upbeat headline may be driven by foreign orders rather than domestic strength. Proof may be seen in May’s ISM manufacturing index foreign orders component which posted some improvement. Secondly, markets continue to deal with ‘rabid’ volatility off of a very low order mark and of course this will exaggerate any series of data. Thirdly, the durable goods inventory-to-sales ratio now stands at its highest level in nearly 2-decades (manufactures are bullish on the future-but it’s the consumer we are concerned about) and finally, not for any bull to enjoy, aircraft orders are a huge headline factor in the report and could easily reversed next month!

the fed is hinting at an intention to get its alphabet soup under control if not off the balance sheet -- large banks are anticipating having to fund a new flight of failed consumer-credit SPVs, even as they furiously retract -- and the consumer is so weak that even the huge drawdown in durable goods orders and shipments has left inventory-to-sales at record levels, with predictable effect upon retailers. this is very scary indeed, pointing directly to an aggravated two-part credit crunch and i think perhaps a more difficult second-half path ahead than is generally being discounted.

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Some good points, Gaius. The US government (and others) have been good at pumping out more spending, but it's not clear if it's doing anything other than delaying a collapse in asset prices--do you follow how much the federal withholding taxes are down Y-O-Y (about 9% this quarter)? Part of this is because the federal government isn't really very good at spending new money(seriously).
The stimulus would be much more effective if it just gave everyone $10,000 (or forewent 10% of taxes, if you prefer).

We can, of course, keep extending and pretending, but this too has its cost. High RE and other asset prices have the effect of stifling new business and enterprises that would create jobs and exports. The inability to take losses will strangle growth and encourage middle-class people to search out "safe" employment--which now means either health care, education, or government. The problem is that none of these areas produce anything that the rest of the world needs (or, in the case of prescription drugs, is willing to pay for).

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initial claims jump

calculated risk on a mildly surprising uptick in initial claims to 627,000, from previous period with upward revision of 612,000.

My view is the most useful number in the weekly claims report is the number of seasonally adjusted initial claims (with a 4-week moving average because it is so noisy). This has declined from the peak of 10 weeks ago, but is still very high. This suggests that the peak of job losses might be behind us, but also that there are still significant job losses occurring. We will probably see monthly job losses reported by the BLS until the weekly initial claims numbers declines close to 400 thousand.

ed harrison has noted that the seasonal adjustment may obscure the turn in claims, however, so looking at the unadjusted number provided by the department of labor

The advance number of actual initial claims under state programs, unadjusted, totaled 566,586 in the week ending June 20, an increase of 8,548 from the previous week. There were 358,159 initial claims in the comparable week in 2008.

here's the fed chart (link is updated; snapshot at left is through last week only). the trend in both adjusted and unadjusted is still clearly indicating a slow dissipation of the unemployment cycle -- but a pessimist will want to keep an eye on the unadjusted claims low point in the may 30 report of 500,383. this june 20 report is some 13% higher that that reading. obviously there is considerable volatility in the series and no real conclusion can be drawn -- but the low reading in a normal year comes in august. (2008 was clearly not a normal year.) if unadjusted claims continue to rise -- or even stay level -- it implies a strengthening employment problem.

more from harrison today
. note that both he and CR are discounting possible improvements in continuing claims, noting that even extended benefits are running out for many former workers and thereby reducing the count without reflecting any improvement in hiring.

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We all know where that chart is going....the spike points in the general direction.

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Wednesday, June 24, 2009


CRE: "pretend and extend"

via david bodamer at clusterstock:

Aside from the discussions of government policy, there was a consensus that banks largely are trying to delay the days of reckoning when they will have to recognize losses and writedowns by extending loans as much as they can. The phrase “pretend and extend” came up more than once, as in, banks are pretending that borrowers can pay off their loans and therefore granting extensions to them. However, no one thinks that can go on forever. As Barone described the process with dealing with troubled borrowers, “Banks are granting extensions at low rates and hoping the economy recovers quickly enough to get the loans performing. But things have gotten worse instead of better.” Lynn agreed that banks “are playing for time” and waiting for a value floor. But right now no one really knows what commercial real estate values are because the volume of investment sales transactions is too low to truly draw conclusions. All anyone knows is that cap rates are much higher than they were at the peak of the market in 2007–perhaps as much as 300 to 350 basis points. But by not foreclosing on troubled loans, all this process is doing is keeping values of commercial mortgages at “unsustainable levels.” At some point, the losses need to be realized. So panelists expected the long awaited boom in distress to materialize in 2010.

there is a hell of a lot of pain coming.

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downside skew

via bloomberg:

Downside skew, which gauges the relative cost of buying insurance against a slide in stocks, is now higher than it was when the Standard & Poor’s 500 Index dropped to a 12-year low on March 9. That indicates a “relatively high chance of downside moves,” the brokerage wrote in a report dated yesterday. ...

“The sharp move higher in risky assets off the early March lows had pushed hedging to the back burner,” a team of analysts led by New York-based Sivan Mahadevan wrote. “Downside skew has risen recently, implying that the probability of large negative moves is actually somewhat higher.” ...

The difference between the cost of put options to hedge against a 30 percent drop in equities and the cost of options to protect against a 10 percent decline is now at its highest since February, the brokerage said. The spread, which is one way of measuring so-called skew, is now higher than it was when the S&P 500 dropped to its lows in March.

“The fact that skew has ticked up in the recent past suggests to us that derivatives users seem to agree that tail risks are still present,” the analysts wrote.

that probably goes hand-in-hand with this report from fortune:

A key market measure of the health of the biggest global financial institutions has deteriorated this month, after showing sharp improvement in April and May.

The price of betting that big banks will default on their debt -- made via derivatives known as credit default swaps -- has risen 17% in June, according to data from New York-based Credit Derivatives Research.

The uptick in wagers against banks such as Bank of America (BAC, Fortune 500), Goldman Sachs (GS, Fortune 500) and Morgan Stanley (MS, Fortune 500) comes as the spring's scorching stock market rally peters out and doubts about the health of the global economy and the banking sector re-emerge.

UPDATE: adam warner with more on put skew:

Now again, let's take this as accurate, the highest skew since March. And I would agree that signals demand for OTM puts (I mean that's the definition of why skew would lift).

But let's think about it for a sec. The author and the team of analysts assume the probability of a negative move has increased. Because someone is buying puts? Isn't that actually bullish on a contrarian basis? Why do we assume it's smart money buying and not incorrectly nervous money? Why can't this just be a relatively sensible and innocuous "insurance" buy against a good quarter?

Bottom line as my friend Don Fishback will always remind me is, we just don't know the answer to any of these questions. All we know is put demand increased, which without any other wisp of info is actually bullish.

And as long as we're on the subject, the chart here shows a ratio of the VIX to the VXO. The VIX incorporates every near and/or 2nd nearest month strike in it's calculation until it hits two with no bids. So thus it picks up lots of ATM puts and incorporates skew in it's formula. The VXO just takes a few near money strikes (and is OEX as opposed to VIX, which looks at SPX). Theoretically, this ratio should hit a high when skew is most pronounced. Yet it troughed in March. Which seems to make little sense.

Not sure I have a point there, just a related observation.

adam's contextual observations are as always as informative as his subject matter. i'm going to track this VIX:VXO "skew ratio" chart in my header links.

looking at the skewness on a more granular level -- adam's right to point out that skew peaked early in 2009, in fact ahead of the majority of the big bear move into the march lows. the peak reading came mid-january; the peak of the 20ema came first week february. the rebound uptrend off the november lows had peaked in first week january.

moving back to the fall into the november lows, a similar pattern emerges -- while the reaction off the october low peaked on the first day of november, skew ratio peaked in last week october and 20ema mid-november. this wasn't much of a trading signal.

back again to the great crash of 2008 into october -- the peak skew ratio read came a couple days into may and 20ema first week may, whereas the high in the SPX registered mid-may.

now, this is just another indicator of course and has to be contextualized. but there is also a clear correlation between skew extrema and price extrema, and often there is some divergence around turning points. this is at least worth watching, and i'll add it to my daily screens as well to get some feel for it over coming months.

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may durable goods +1.8%

via the commerce department and bloomberg:

New Orders

New orders for manufactured durable goods in May increased $2.8 billion or 1.8 percent to $163.9 billion, the U.S. Census Bureau announced today. This was the third increase in the last four months and followed a 1.8 percent April increase. Excluding transportation, new orders increased 1.1 percent. Excluding defense, new orders also increased 1.4 percent.


Shipments of manufactured durable goods in May, down ten consecutive months, decreased $3.6 billion or 2.1 percent to $169.9 billion. This was the longest streak of consecutive monthly decreases since the series was first published on a NAICS basis in 1992 and followed a 0.5 percent April decrease.

Unfilled Orders

Unfilled orders for manufactured durable goods in May, down eight consecutive months, decreased $2.0 billion or 0.3 percent to $747.5 billion. This followed a 1.1 percent April decrease.


Inventories of manufactured durable goods in May, down five consecutive months, decreased $2.5 billion or 0.8 percent to $323.3 billion. This followed a 1.1 percent April decrease.

so unfilled orders and shipments are still on long losing streaks, with backward revisions down, while orders jumped.

Bookings for non-defense capital goods excluding aircraft, a proxy for future business investment, jumped 4.8 percent, the most since September 2004. Shipments of those items, used in calculating gross domestic product, rose 0.3 percent after dropping 2.7 percent.

not sure you can make a green shoot out of that, but it is at least some further evidence of a well-established moderation in the rate of contraction. it confirms earlier ISM readings that ed harrison took as evidence of a nascent expansion, and will certainly improve the condition of the "real economy" components of the LEI.

anecdotal questions over order quality remain

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Durable Goods OR Planes, Planes and More Planes?

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Tuesday, June 23, 2009


more retail sales

via zero hedge and pragmatic capitalist:

[T]oday's horrendous Johnson Redbook Index numbers were curiously not noted anywhere.

These are not good numbers for green shoot theorists and likely mean the U.S. consumer is even weaker than many suspect. June retail sales are shaping up to be a real disaster.

UPDATE: it shows in the freight too -- there's no economic rebound here.

UPDATE: nor is there recovery in japan's may exports.

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Rail Freight Traffic maybe rebounding... maybe...

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Monday, June 22, 2009


news from 1930

via paul kedrosky -- fascinating. from this past week in the wall street journal 79 years ago:

“This is America. Piffling talkers would turn back the calendar to the nineties and destroy the economic progress of thirty years. Vicious rumors spread for selfish purposes; flippant predictions of a five-year slump in business; wholesale demands for the cutting of wages are unworthy of American intelligence. Credit is super-abundant. Business is no worse than three months ago. Twelve months of declining volume is behind us. Many adjustments have been all but completed. Engineering and marketing brains are as fertile as ever. Problems there have always been. To proclaim their insurmountability is childish.”

AFL President William Green meets with President Hoover, says he believes the employment situation is beginning to improve.

Record low 2 1/2% New York Fed rediscount rate indicates to businesses that very easy credit is here to stay for a while. Reserve expected to be cautious about raising rates until it's clear business upturn is here to stay. Rates have been lowered from 6% last August.

“Stocks down, money down, wheat down, rubber down, copper down, silver down, silk down, gasoline down, steel prices down” - but don't forget, “what goes down must come up.”

Economists feel the current situation in commodity markets is starting to look like a bottom; a combination of underproduction and easy credit at low rates should work as usual to correct conditions.

Industrial and financial sectors of the US economy are set up for high levels of production and consumption; the current depression puts buyers in control and they are holding off for lower prices. When consumers start spending again this will be reflected early in stock prices.

“A Turn of the Tide Near” ... “It cannot be imagined that the wholesale failures and interest defaults characteristic of earlier depressions will now be repeated. Confidence in our banking system wholly precludes the money panics of former eras.”

Head of a sizable New York investment trust says the current conditions of very easy credit and poor business have always been a buying opportunity in the past. Absolutely confident that any list of good stocks will have good gains by end of 1931 and probably show a profit by end of 1930. Cautions that current market technicals don't look that good and further declines may occur first.

Market students have been encouraged by the general gloom for the past two weeks. This contrasts with the “new era” thinking of last summer when no end was seen to the rise in stock prices and margin debt was hitting a record every week. History says the current gloom is just as mistaken as last summer's unjustified optimism. Historically there has been no case in this country since 1900 when business failed to turn upward the year following a depression.

dear god -- lock, stock and barrel, it could have been taken from yesterday's journal. and the further you read, the more apparent that is.

the symmetry is astounding -- testament to just what a terrific extent 'news' is not actually much to do with the reporting of reality and rather is instead the perpetuation of necessary human mythologies. dumbfounding. shocking. deeply frightening.



god help the people of iran. i don't think i shall soon forget, as a dad of two daughters, the harrowing footage of another dad's teenage girl -- whose name is said to have been neda agha soltan -- slaughtered as an innocent bystander martyred to history by a coward's bullet.

her terrifying death mask has quickly become the single iconic and transcendent image of the struggle to upend the power-mad and now transparent tyranny that clings so desperately onto the ship of state in iran. i am no advocate of violent revolt under any conditions, and i deeply respect the need of political and religious institution as necessary buttresses for social coherence. the people of iran have indeed been remarkable in their eschewing of violence and their devotion to the founding ideals of both their government and their religion, seeking as far as i can tell not a revolution but a reform. indeed it would seem to be impossible to support a figure such as nir hossein mousavi as a revolutionary; as a reformist, however, he is altogether passable.

the current government of iran, if it can again be made legitmate in the eyes of its citizenry, must give these proud people more than a jackboot to the face. the failure to convincingly re-elect bellicose populist mahmoud ahmadinejad -- and the rather transparent resort to fraud (now openly acknowledged by the government's guardian council) in the absence of support -- should have been handled much more responsibly by the conservative power structure that surrounds the heretofore intensely respected ayatollah khameini and the revolutionary guard. that it was not is indicative of their unfitness, a point not lost on the people in the streets of tehran and other iranian cities. what is more, the response of repression and open violence against otherwise peaceful masses through the instrument of the basij, playing the role of a brownshirt militia and the likely source of the sniper's bullet that murdered neda, has very likely permanently delegitimized the leadership of not only ahmadinejad but his sponsor khameini. even if the urban masses are beaten off the streets, civil unrest and insurgency will likely become a permanent feature of iran under khameini -- forcing a further devolution of what was once a stable grand bargain with reasonable latitude between the reactionary islamists who elevated conservative clerics to leadership and the urbane denizens of the great cities of persia into an incessant and debilitating cycle of political violence and police-state repression.

one has to hope, in the aftermath of this brutal response, that the institutions of the nation of iran are allowed to work to restore legitimacy by removing from power those who would in such nihilistic fashion resort to the machiavellianism of openly violent and amoral subjection. here the hopes of many fall on ayatollah rafsanjani, who -- in spite of the clear threat presented to his family by khameini's allies -- has similarly not abdicated his institutional role but instead appears to have thrown himself into the task of turning the gears of the machinery of institution. may god speed him in his task.

UPDATE: douglas muir of fistful of euros is not optimistic about a change of leadership atop the institutions of iran, on the basis of his earlier general analysis.

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the bank cash pile

i drew this up a couple weeks ago, but it is still quite salient.

via zero hedge -- david rosenberg on CNBC highlights the $1tn in accumulated cash assets on the systemic bank balance sheet as a potential sink for treasuries to finance government issuance.

this is a point in need of exploration. i've often alluded to richard koo, who would i think be first to tell you that such idle cash locked in banks is exactly the cash government should be borrowing.

so why aren't they? instead, it appears that long-end treasury yields are rising, steepening the yield curve in the face of a massive issuance schedule, while banks earn less than you might think from net interest margin.

well, the answer to some extent is that they are buying treasuries, as seen in the fed's h.8 report. but it would seem that, as was noted by the other talking head, the banks are simply not buying 10s and 30s, instead favoring the shorter durations. it is a commonplace that policy rates will be low for a long time, and that leaves the banks a surer risk-adjusted profit in buying, say, the three-year and waiting as the duration shortens and yield declines. this has been used to explain why treasury auctions for the middle of the curve have done rather better than those for the long end.

i further wonder, if i might think aloud for a moment, if the reason isn't that some banks are wary of funding long-duration treasury (or any other) investment profitably at yields too narrow to their cost of funding. as i've started to repeat as a mantra ad nauseum, american banks are heavily reliant on wholesale funding -- and wholesale funding can be expensive.

LIBOR is under 1% now and fed funds even less, if you have unpledged collateral and access to the window. but not very long ago LIBOR was 5%, and it is not entirely self-evident that such conditions cannot return in a reprise of the credit crunch. moreover, the financial times points out that not all banks can fund very near LIBOR.

[A]nalysts and bankers warn that Libor rates may not be telling the full story.

That is because there are wide differences between the rates at which individual banks can borrow. The biggest institutions are able to fund themselves at around Libor levels while smaller institutions have to pay, in some cases, more than 100 basis points above Libor. This is explained by continuing counterparty risk in what remains an uncertain economic environment.

That contrasts with the situation before the credit crisis when institutions paid similar rates to borrow.

Meyrick Chapman, fixed income strategist at UBS, says: “We should not build up our hopes that the fall in Libor is such a positive sign for the markets. We have a very tiered market, where many smaller banks are still having to pay relatively high rates to borrow.”

Lena Komileva, head of market economics at Tullett Prebon, adds: “What we are seeing is a huge difference in the price of borrowing for individual banks. There is a higher proportion of banks paying above Libor.”

is it possible that the banks are factoring a contingency where wholesale funding becomes much more expensive while long-duration treasury bonds do not rally -- or yields even rise from current levels, compelling banks to liquidate at a loss? in comparison to riding the duration of a three-year down to zero, it is a riskier trade.

perhaps most importantly in the bigger picture, however, banks are very probably faced in the intermediate term with weening themselves off a large measure of their wholesale funding through a combination of deposit growth and balance sheet reduction, a commitment at odds with growing the investment portfolio on the asset side. though now funded with the aid of the federal reserve, there has been a lot of discussion of 'exit strategies' to imply that central bank aid may not be indefinitely durable -- meaning that, sooner or later, the banks must cover their own assets. and that could be a big job -- in a domestically-chartered system with $8.6tn in assets, just $5.8tn is funded by nontransactional deposits, leaving a $2.8tn potential funding gap.

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As you know I'm a believer in the "banks buying treasuries" perspective... however in the short term they are just as likely to misjudge the macro outlook as anyone else and put money on reflation/inflation. Even PIMCO seems to be talking about buying TIPS and avoiding regular treasuries for fear of inflation! (Of course perhaps they are just trying to talk down prices).

"banks are very probably faced in the intermediate term with weening themselves off a large measure of their wholesale funding through a combination of deposit growth and balance sheet reduction, a commitment at odds with growing the investment portfolio on the asset side."

I agree that expensive liabilities seem likely to get paid down with available cash, shrinking balance sheets... But as I discussed in my previous writeup I linked regarding this, this leaves those repaid funding providers with available cash assets to invest (instead of wholesale deposits), and with aggregate private assets contracting, these funders seem as likely to buy treasuries on net as the banks would have been, IMO.

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hbl -- i'm pondering your point...

for example -- bank A uses cash to pay down an interbank funding liability to bank B. bank B does likewise to bank C. bank C does again to bank D. the same cash has eradicated three times its value in leverage -- and i have to imagine the multiplier is larger than that. the cash asset can be exchanged for treasuries, but the reduction in systemic balance sheet capacity before it is is a multiple of the cash.

as the current account imbalance narrows, i think it will really only once wholesale funding is reduced to much lower levels that cash can actually start to pile up in banks' investment portfolios (provided it cannot be lent).

fwiw -- it also has to be noted that much of the 'cash' on a corporate or financial balance sheet is really 'cash equivalents' and in fact already holding t-bills -- in other words, already funding the government to some extent. using the cash equivalents to buy t-bonds would mean selling t-bills in many cases.

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Regarding your bank A -> bank D deleveraging scenario, I agree with these mechanics... I hadn't argued that shrinking balance sheets would magnify purchasing power (and therefore potential treasury demand), I simply argued that such purchasing power is preserved whether or not each individual firm chooses to pay down liabilities (i.e., bank D has the same purchasing power bank A had). The key related point is that if public debt issuance does not grow faster than private debt contraction, all that is happening at a system-wide level is substitution of public debt for private debt, and public debt supply should see sufficient demand. [Of course Japan's public debt has grown much faster than private debt has shrunk, yet their JGB yields have declined regardless, so clearly other factors matter also, I'm just touching on the core point as I see it.]

On cash already being supportive of treasury issuance via t-bills -- I agree! (It's also a point I made here). Which is why I see the current run-up in yields as not driven by supply/demand inbalance (the latest flow of funds shows reduction in private lending slightly exceeding increase in public borrowing) or even expensive marginal cost of funds (since the phenonmenon has been global), but instead primarily reflation/inflation expectations. So for me the key question is simply whether reflation/inflation can succeed this time around before significant further deleveraging. The odds seem against it but maybe I'll be surprised.

P.S. Your blog has been better than ever in recent months. I can't figure out why it isn't better known (at least evidenced via links from other blogs I read).

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Sunday, June 21, 2009


rosenberg on LEI

via pragmatic capitalist -- david rosenberg reflecting some of my concerns about the state of leading economic indicators.

[W]hat is really interesting is that the actual economic variables have not contributed one iota to this two-month very exciting bulge in the leading index. In fact, if you did a composite of the five economic components — building permits, hours worked, real core capital goods orders, real consumer goods orders, and jobless claims, they collectively were -0.05% last month. Go figure.

So what we have is an LEI that is being fuelled by a stock market rebound from egregious oversold lows (which may now be over now), a narrowing in credit spreads from Armageddon levels, and survey data/diffusion indices. It is tough to believe that the recession is indeed over at a time when hours worked, which feeds directly into GDP, is still making new lows.

When recessions do end, what’s normal is for the financial and survey segments of the LEI to be joined by the hard economic components in the ‘plus’ column. In fact, as we saw in November 2001 at the trough, usually the sum of the contribution from the economic segments comes to 40bps, not -5bps as was the case today.

Not only that, but it would help the cause of the growth bulls if the index of coincident indicators was to make a bottom, but alas, it fell 0.2% MoM in May. Of course, this is far off the much larger negative readings earlier this year when the U.S. economy was in freefall, but back in 2001 the worst number we ever saw (excluding 9/11) was -0.2% and the range in the early 1990s downturn was -0.1% to -0.4%, so to say that the recession has somehow come to a close when the coincident indicator is declining 0.2% seems a little off base. As for what it will take to no longer take the LEI with a grain of salt, we have to see the diffusion index of strength do a lot better than 70% and we have to see the economic components do much better.

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house prices and unemployment

via calculated risk, both the national correlation and the chicago-specific.

Although there are periods when there is no relationship between the unemployment rate and house prices, this graph suggests that house prices will not bottom (in real terms) until the unemployment rate peaks (or later, especially since the current bubble dwarfs those previous housing bubbles). And it is unlikely that the unemployment rate will peak for some time ...

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what is shadow banking?

via james kwak highlighting this rortybomb piece, this excellent paper by gary gorton, also usefully summarized by ezra klein.


Friday, June 19, 2009


corporate spreads

excellent chart from david rosenberg via pragmatic capitalist.

i look at that 611 bps peak and think of jim welsh. but rosenberg thinks there's more recession protection priced in at this level than we are likely to need, making investment grade corporates a buy.

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Just noticed you had asked on an old Econbrowser comment thread where I get my data for Chicago area home sales.

I use the interface that the Chicago Sun-Times provides for a database of recorded home sales, which presumably is compiled by some entity from the county records.

Because the entry-point Sun-Times web page itself is a clumsy interface, I cobbled together a quick-and-dirty html page that provides an easier way to execute the same cgi script get requests.

For example:

As I still see the same advertising and this is not an "automated web scraper" or "bot", I feel this does not violate their terms of use. If you would like a copy of that html, you can email me using the address you would construct by Googling the value of the mathematical constant "e" and inserting that between "jm" and "".

Your blog looks interesting.
I'm going to add it to my bookmarks.

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Greetings from Strasbourg, France.

I like your moniker and blog, good info...and taste in wine I see :)

Tonight I sample some rather nice Rosado.



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I thought the post made some good points on web scrapers, For simple stuff i use python to get or simplify data, data extraction can be a time consuming process but for larger projects like documents, the web, or files i tried "website scraper" which worked great, they build quick custom screen scrapers, web scrapers, and data parsing programs

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seasonality of volatility

via bill luby at vix and more:

we're in the well, so to speak.

UPDATE: via zero hedge -- i track this volatility curve in this link at the top of this page. this was one of the warnings of august 2008 that amounted to a prelude to disaster.

at least in the recent past, when the cash VIX has approached 80% of its forward futures, a turn down has been in the cards.

hoo boy, and did it ever. while there needn't be a monster collapse ahead and in fact the forward spread could widen still more, this degree of divergence has preceded several moves in excess of (-10%) in the S&P.

current snapshot at left. moreover, the volatility screen i mentioned in that august 2008 post also gave warning on the VXN in late may (may 27 to be exact) and on both may 22 and june 15 on the VIX.

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the state of marginal systemic funding

i've added a sidebar link to the slosh report, which monitors treasury open market operations (TOMO), TIO and TAF management operations done by the federal reserve. this is one way one might gauge the fed management of bank liquidity. as one can readily see, after ramping up liquidity into the march lows in equities, the fed began withdrawing support from the market. while this amounted only to taking back the first quarter surge until mid-may, the fed has since may 21 overseen a fairly dramatic reduction in this liquidity profile -- most of it a reduction in the TAF.

while the S&P 500 peaked in early june, its may 20 high was 924.60 -- and, whether by causation or coincidence, it is trading at 924.90 as i write.

pragmatic capitalist further highlights the ongoing crash in another important source of marginal systemic funding, the commercial paper market.

The deceleration in commercial paper has had a very high correlation with economic activity in the last two years. The recent cliff dive in commercial paper represents how weak near-term business activity has been across the economy. I would expect to see a substantial acceleration in the ABCP market before we see any sharp acceleration in economic activity. As of now, the commercial paper market is nothing more than a sure sign that the so called “recovery” is beyond weak and is perhaps even weaker than many “green shoot” theorists assume. A double dip recession is looking more and more possible as we move into the second half of the year….

pragcap ties this move to a reduces need for working capital in industry, but i'm not so sure. i discussed this some last month. while non-financial paper -- the kind that amounts to flotation for working capital -- is indeed declining at a punishing rate and has continued to do so (latest figures here), the vast majority of the collapse in CP has been the unwinding of the off-balance sheet financing vehicles which were at the heart of the shadow banking system. asset-backed commercial paper has vaporized down from a seasonally-adjusted $717bn at the open of 2009 to $503bn through june 17, a (-29%) collapse. from its 2007 peak of nearly $1200bn, this is a spectacular unwind and exactly what is meant by the run on the shadow financial system that, per james kwak, has been a source of some debate recently. over this is, to my understanding, largely a function of the relentless unwinding of special-purpose vehicles (SIVs and conduits) which were funded by ABCP. the size of the unwind since the last two weeks, ending june 10 and 17, is particularly notable -- $54.7bn in total.

further, financial paper has been vanishing at a remarkable rate as well -- from $569bn at year open to $441bn today, down (-22%).

that's not to say there's no meat to pragcap's argument. domestic non-financial CP has deteriorated just as rapidly, from $202bn at 2009 open to $153bn today, a (-24%) drop. though much of this non-financial paper may have been in fact quasi-financial (thinking particularly about GE here) i think he's right to say:

While the market rallied a bit in the after hours market on this news I believe the market is overlooking a much larger problem. While it is a good sign that companies aren’t reaching out for short-term government funding it is also alarming that commercial paper issuance continues to fall off a cliff.

the reduction of dependence on short-term and fed-intermediated funding is a necessary part of the correction that must take place in the american financial and corporate system. but no one should pretend that these banks and companies are now healthy, aggressive and levering up using private finance. a massive amount of equity issuance combined with balance sheet downsizing/deleveraging is the underlying dynamic, and however necessary that is not a symptom of rude health -- nor is it a positive for equities.

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Thanks for this good information...
accounting services

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Thursday, June 18, 2009


conviction sell?

here might be a good test of whether i'm a tell or a contra tell.

the fedex earnings report was, as ed harrison points out, a colossal disappointment for anyone who wants to think there's a nascent booming recovery afoot. there's been plenty of data to question the "green shoots" meme, a term i think soon enough to be consigned to the dustbin of history. but not much of it has been as high in profile as a 10% revenue miss from the world's bellwether courier and shipper. the fedex number changes that.

still, further economic recovery is not a necessary precondition for a further massive rally if the conditions of the marketplace are right. stock index technical weakness from overbought levels beginning in may put me short the S&P earlier this month, and that condition has begun resolving itself over the last few days. the question is whether equities will continue to correct, reflecting a slower but continuing economic contraction -- or even anticipating further deterioration.

acknowledging that money doesn't move into or out of a secondary market, this has more to do with the balance sheet capacity and financing costs of large market participants which allow them to leverage into equities versus the flow of primary supply (or contraction thereof through buybacks). on this, two points:

the sharp rise in treasury yields has more than offset spread tightening in long-maturity corporate debt instruments. i suspect this is a problem for industrial finance more than bank borrowing, which is mostly pegged to LIBOR or fed funds. threats to LIBOR exist, but none have yet materialized. so while -- as noted yesterday by hugh hendry -- rising yields could choke off economic recovery by raising the cost of finance for industry and households, the effect on equity balance sheet financing is questionable.

but it has been noted that banks and other equity market participants are broadly deleveraging, as reliance on systemic wholesale funding -- a product of a massive current account deficit, once intermediated privately, now only possible with the intermediation of the fed -- is gradually unwound. this is i think a major longer-term negative for equities.

the question of primary supply is something else again. pragmatic capitalist with a potentially important outlook update from trimtabs, ned davis and the venerable richard russell.

Prior to May, according to TrimTabs Investment Research, the highest level of share issuance in a given month was $38 billion. May blew that record out of the water, with a monthly total of $64 billion.

Furthermore, that blistering pace has continued during the first two weeks of June, according to TrimTabs.

How bad an omen is this corporate eagerness to offer its shares to the investing public? Looking back through recent history, TrimTabs found that there have been just 12 months since 1998 in which total new corporate offerings totaled at least $30 billion. The average return for the S&P 500 index over the 90 days following those months was a loss of 4%.

Dissecting the data further, TrimTabs next focused on those months in which not only did total corporate issuance exceed $30 billion, but also those in which total corporate share purchases were less. The S&P 500’s average 90-day return following those months was a loss of 7%.

This more-narrowly-defined subset applies to today, unfortunately. According to TrimTabs, corporate new offerings since the beginning of May have been nearly five times greater than corporate purchases.

The recent surge in the supply of shares has also caught the attention of Ned Davis, the eponymous head of Ned Davis Research. He has found through his research that it is optimal not to focus on monthly totals but instead on a rolling 13-week window. On this basis, according to Davis, recent corporate issuance has been exceeded historically only by two other occasions — early 2000 and early 2008.

Those were “not great times to buy stocks,” Davis notes dryly

Davis also draws an even more ominous parallel to the recent corporate rush to sell stock: “This high level of [recent] supply is one of the key characteristics of the monster rally in November 1929 - April 1930.”

From April 1930 through the low in July 1932, of course, the Dow Jones Industrial Average fell by 86%.

For the record, I should point out that Davis, despite these ominous portents, remains cautiously bullish for the short-term, since many of his other indicators suggest that this rally has further to run.

But TrimTabs is quite bearish, recommending that clients be 50% short U.S. equities. “Stock prices are going to fall hard,” they predict.

the rally of the last twelve weeks was often disparaged as a government-orchestrated short-squeeze and pump operation that would get the banks into a position where they could plausibly issue equity to improve their capital position (and wean them off government funding). this they have in fact done, regardless of how you view that characterization. and the titanic flood of equity supply into a market where corporate buybacks are more or less dead means that primary supply has grown significantly over the last six weeks.

in an environment of generally deleveraging market participants, including those participants who underwrote those massive equity floats and may still be placing shares, one has to imagine that -- regardless of rates -- on net the pressure will be on stocks to price to meet the systemic balance sheet capacity to hold them. this is less a function of the cash assets in the system than the liability-side funding of the system. though declines in equity prices may not proceed via a straight line -- in fact, they almost certainly won't -- the funding structure of equity holders, including banks, insurers and hedge funds, remains under pressure.

UPDATE: via zero hedge -- CNBC interviews charles biderman of trimtabs.

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Wednesday, June 17, 2009


1931, again

via zero hedge -- hugh hendry of eclectica capital revisits an oft-revisited year.

I keep thinking that it would be ironic if history were to show that US policy makers were right to fear the prospects of a $54 trillion debt deflation and that they should have been more ambitious in their monetary expansion. The bond vigilantes believe that the double dip deflation of the 1930s will ensure that the Fed will be slow to raise interest rates this time around. But what if the economy stalls because the credit markets are premature in tightening monetary policy for them?

I am beginning to sense another paradoxical twist. What if the Fed is right and Angela Merkel, Zhou Xiaochuan, Warren Buffet and James Grant are wrong? And that contrary to their inclinations the American authorities are forced to moderate their monetary expansion in order not to undermine the confidence of the international community. Whilst at the same time the bond market pushes long rates higher.

Under such a scenario the debt reduction efforts of the private sector would usurp the government’s attempts at stimulus; the economy would falter once more. Back in 1931 the same thing happened. Bond prices dropped and yields rose to the level that had prevailed for the previous ten years; a feeble economy lapsed back into a deflationary spiral. Perhaps if this were to happen again, and we were once more confronted by a truly dire economic outcome, then it is conceivable that the authorities could gain the vital legitimacy necessary to engage in an unquestionably large monetary response which finally purges the system of deflation. That is when I would choose to let rip on buying commodities and cheap equities.

The key is the economy’s sensitivity to bond yields. Russell Napier argues that it would require ten-year yields of 6pc (vs. 4pc today) to knock the economy and stock market from their perch and reassert the deflationary trend. But he bases his assertion on observations taken since the early 1960s. My quibble is that today’s leverage is unprecedented and prices are falling. May’s American CPI is forecast to contract by 0.9pc YoY; they fell in April. We never had falling prices in the 1960s, 70s, 80s or 90s. I therefore maintain that it is feasible that some unquantifiable but certainly lower nominal rate could choke the economy.

Regardless, it is my contention that many are investing in risk once more almost oblivious to the notion that a heavily indebted economy is confronted by a very real tightening of monetary policy. It is not inconceivable that the macro compass could swing violently towards deflation and wrong foot them again.

hendry highlights the current similarity to this time in 2008, when bonds were being savaged, the dollar battered, oil skyrocketing and fed futures pointed to rate hikes. revisiting the comments of those days is unnerving. hendry's view of the bond market doing the job that the fed directly undertook in 1931 and tightening money drastically to bolster the dollar and choke off perceived inflation -- something it can be said to have done this time last year as well, in advance of the greatest equity crash since 1987, or indeed perhaps since 1929. while that kind of apocalypse is a very low probability, a deflationary spiral isn't given the relative lightness of fiscal stimulus to date.

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A very interesting interview with Paul Samuelson.

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buy china

ambrose evans-pritchard on what might be perceived as an egregious act of economic nationalism.

The Chinese elite no doubt feel provoked by what they call the “poison” of the US `Buy American’ clause, but the Obama White House managed to tone down the worst excesses of Capitol Hill and in any case the Chinese version is more restrictive.

It bans the purchase of foreign equipment for investment projects unless a special exemption is obtained. The measures apply to European goods, even though EU states have not imposed any such “Buy Europe” clause of their own. EU producers of wind turbines have already been excluded from a $5bn wind project, whether or not they have factories in China. ...

China’s action is extremely disturbing. It confirms what we have long feared, that the Chinese government is sufficiently worried about rising unemployment to adopt suicidal measures. Nor does this episode instill confidence in the `China recovery story’.

While exports fell 26pc in April, imports were down by almost as much. There is no real rebalancing under way from external to internal demand. China is still running a massive surplus. It is flooding the world with excess goods, and exporting deflation. This is untenable. At some point, the West will react.

evans-pritchard might be allowing hyperbole to get the better of him. how such a provision might work in practice will be far more important than how it was drafted. faced with joblessness at home, the government of china is likely to say a lot of things to placate their masses. but that is a long way from adopting "suicidal measures".

it is to be hoped that the highly destabilizing imbalances in the current account currently promoted by china's mercantilist dollar peg are resolved in time. one also hopes, however, for that resolution not to involve a debilitating trade war, rather preferring a gradual adjustment in the dollar-renminbi cross.

either way, this will add fuel for china growth skeptics, among whom you can number myself and (as always) socgen's albert edwards, via zero hedge.

I continue to be extremely sceptical and see recent events as part of a 1930s-like, long march to revulsion. Talking about long marches, nowhere in the world fills me with more scepticism than the Chinese economic recovery. The continued enthusiasm for all things China reminds me so much of the way investors were almost totally blind to the fact the US growth miracle was built on sand. China could be the biggest disappointment yet.

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The rulers of China have been constantly mis-characterized as communist.

What they are is the perfect mafia.
Sopranos writ large.

Those they rule over are free to make as much money as they can as long as they follow the mafia's orders, and give a little taste of the action.

The other poor saps pay tribute and are promised work to keep them from torches and pitchforks.

If the poor don't find work and complain they disappear.

If the rich or powerful get caught publicly embarrassing the bosses, they get a very public disappearance.

Not many complain now but the numbers will soon overwhelm the foot soldiers and lieutenants. Dissent is easy to manage when times are good.

That is all that China is.

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They seem to do a better job of running their economy than the dimwits in Washington D.C. and the Fed do here.

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CPI following PPI

following on yesterday's comments about the producer price index -- the consumer price index today came in as a deflation scare number as well -- seasonally adjusted CPI-U YoY all items change is (-1.3%).

This is the largest decline since April 1950 and is due mainly to a 27.3 percent decline in the energy index.

the somewhat-controversial owners equivalent rent metric -- which accounts for 24.4% of CPI -- is up strongly in may and 2.1% year-over-year. this doesn't comport very well with data and anecdotes describing falling rents around the country. this drew the attention of calculated risk, who notes that OER is the result of a survey question, whereas actual REIT rent-receipt data suggests rents are flat year-over-year. furthermore, the leading index of apartment tightness suggests that further deflation of rents and OER is likely. so the deflationary impulse may be underestimated somewhat in CPI at the moment.

UPDATE: a correction from CR.

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the complexity of iran

events in iran following last week's hotly contested election between incumbent mahmoud ahmadinejad and veteran reformist mir-hossain mousavi have taken on an altogether too familiar hue -- green, to be exact. it isn't the color that heightened my suspicions (green is just fine) but the color-theme in general. this is of course one of the characteristics of a by-the-book fomented "revolution" as articulated by gene sharp and so eagerly pressed with mixed results in the post-soviet baltics, serbia, georgia, ukraine, lebanon, kyrzygstan and elsewhere by both the clinton and (more aggressively) the neoconservative-heavy bush administration directing and funding a network of ostensibly non-governmental organizations, including USAID and freedom house. the obama administration, it must be said, has done a far better job of managing whatever involvement in the fray they are responsible for than john mccain -- who, if he believes what he is saying, is just a doddering impolitic old twit -- or, if he doesn't believe it, is as cunning as daniel pipes without being as honest -- wants them to. that does not, however, mean they are not involved.

how prominently do the thought and principles of gene sharp figure in a third world power structure's understanding of american foreign policy? watch this surreal iranian government propaganda piece from february 2008 -- sharp's digital alter-ego sits in the white house with then-republican-presidential-nominee john mccain and george soros. i sincerely doubt sharp (interviewed here by in 2007) is a "CIA agent" -- but the CIA has certainly applied his outline to regime change, which is the nugget of truth that makes this bit of disturbing propaganda just plausible enough to be believed by those inclined to believe it.

but in truth one cannot know. it could well be that the lessons sharp first articulated have now -- as testament to the power of mass political nonviolent protest -- disseminated into the fabric of civil disorder such that anyone organizing and funding (and it generally takes much of both to foment the kind of protests being seen in iran over the last few days) mass non-violent protest practices the principles on some level.

and there is further the fact that iran is a huge, variate, proud, wonderfully complex society that is simply not as easily given over to the kind of externally-managed revolt that pushed leadership changes and redrew cultural alliances in aforementioned smaller countries. regardless of how interested the united states may be, this is clearly not all about the heavy hand of the united states -- something that i don't think could be fairly said in, say, lebanon or georgia. trita parsi, writing in time and though clearly biased, gives as much indication of that as might be packed into a few paragraphs.

as the grassroots populist agitator ahmadinejad, the moderate political careerist mousavi, the deeply conservative armed forces and more-diverse-than-westerners-think clerical leadership feel the ground shift beneath them and realign accordingly, the speed and intricacy of political and social developments will be well beyond the scope of my ability to analyze -- indeed perhaps beyond the scope of most any outsider, however expert.

it will remain important, however, to attempt to step beyond the sphere of western thought to gain what insight is possible to obtain. al-jazeera is a welcome voice. today's column by mark levine is an example.

A lot depends on what the elite thinks is actually happening on the ground, and why the alleged fraud unfolded as it did.

Do the issues motivating the current protests ultimately derive from people's anger at perceived fraud and not having their votes counted? Or do they, as seems increasingly clear, reflect a much deeper level of anger at, and even opposition to, the nature and governing ideology and practises of the Iranian political system?

Equally important, if there was systematic fraud, was it perpetrated as a collective decision of a senior leadership unwilling to accept the cultural, political and economic liberalisation a Mousavi government would initiate, or, as University of Michigan professor Juan Cole and others have argued, did it owe to a sudden fit of pique by Supreme Leader Ayatollah Ali Khamenei?

His well-known personal antipathy to Mir Hossein Mousavi could have made the imminent prospect of his long-time political rival's victory so distasteful that he could not bring himself to sanction Mousavi's victory, leading to a hastily arranged fraud - many ballot boxes were allegedly never even opened before the official tabulation was announced - even as other parts of the leadership were laying the groundwork for a public announcement of Ahmadinejad's defeat.

What seems evident as the crisis deepens is that Ayatollah Khamenei, who most commentators have long assumed holds near absolute power in the country as Supreme Leader, is in a weaker position than previously believed. The collective religious and military leadership, along with the Revolutionary Guard, will likely have a lot of input into determining what course the government takes.

And it is certainly questionable whether these factions have shared core interests during this crisis, as the Revolutionary Guard - from whose ranks President Ahmadinejad emerged - is both culturally more conservative and economically more populist than much of the political and religious leadership.

The religious establishment is itself split into hard-line, moderate and more progressive factions, each of whose members are tied to factions within the economic, political and security elite, producing a complex and potentially volatile set of competing and contradictory loyalties and interests. ...

Ahmadinejad's and Khamenei's decisions in the coming days will be telling.

If the official tally was in fact broadly accurate, then they will likely be more willing to agree not just to a recount, but even to a run-off election, if that is what it takes to pacify the angry protesters.

Indeed, a second Ahmadinejad win would severely weaken reformist forces and increase the system's legitimacy.

More generally, regardless of whether there was significant fraud the power elite could decide collectively that the protests are not motivated by broader concerns and thus do not threaten the stability of the system.

This could also lead them to agree to a broad recount or run-off, even at the risk of a Mousavi win, and it is worth mentioning here that Mousavi is no liberal; the "core values" of Khomenei's revolution - to which he advocates a return - are well within the mainstream of Iran's clerical culture.

Alternatively, if the protests do not lose steam in the coming days, the leadership could decide that the opposition is too broad and deeply rooted to attempt to crush it.

In this case, it would have little choice but to cave in to the protesters' demands or face losing its legitimacy in the eyes of the broader Iranian public, particularly if large numbers of protesters are arrested, injured or killed.

The greatest degree of uncertainty surrounds a scenario in which the power elite both concludes that the mass protests reflect deep-seated discontent by a large segment of the population, yet at the same time believes it has a narrow window of opportunity to deal with this situation forcibly before losing control to the rapidly encroaching street politics.

In this case, Iran could quickly approach a Tiananmen moment, in which the Iranian government calculates that crushing the pro-reform opposition will give it time to push the reformers back in the closet for the foreseeable future, and push the cosmopolitan liberal-cultural elite who have the ability to leave, to do so.

The problem is that Iran can't follow China's path.

It is true that if oil prices continue rising, they will produce enough revenue for the government to keep the poor and working classes happy, or at least quiescent.

But what allowed the Communist party in China to maintain its hegemony rather than merely dominance over Chinese society was its willingness to liberalise culturally at the same time as it closed down politically.

Cultural liberalisation became the safety valve that allowed the emerging generation of Chinese citizens to accept the continued power of the Communist party.

Needless to say, no such safety valve exists in the Islamic Republic, where a cultural perestroika is precisely what Ahmadinejad and his supporters in the leadership and among the people want to prevent.

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Tuesday, June 16, 2009


current account imbalances create financial crises

shades of richard duncan -- via brad setser, the work of florence pisani and anton brender, "globalized finance and its collapse".

They recognize that the current crisis could not have happened in the absence of an accumulation of credit risk by private financial intermediaries (big banks, broker-dealers and the “vehicles” that operated in the shadows) in the US and Europe. But they also recognize that the accumulation of credit risk by private financial intermediaries would not have been possible if emerging market governments hadn’t been so willing to accumulate exchange rate risk.

They consequently highlight the impossibility of assigning blame for the current crisis solely to the financial sector (and their regulators) in the west or the central banks of the east. Both ultimately were responsible, just in slightly different ways.

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california bailout rejected

and so begins the slow dance. via calculated risk:

Concern has grown inside the White House in recent weeks as California's fiscal condition has worsened, leading to high-level administration meetings. But federal officials are worried that a bailout of California would set off a cascade of demands from other states. ...

After a series of meetings, Treasury Secretary Timothy F. Geithner, top White House economists Lawrence Summers and Christina Romer, and other senior officials have decided that California could hold on a little longer and should get its budget in order rather than rely on a federal bailout.

the trouble is that denying the bailout is not a tenable position to hold for a government interested in managing aggregate demand. this charade will go on for some time, i expect, but can only really end with a large transfer of money to the state of california -- and a similarly large transfer of political power to washington.

the trick to preventing a lineup of states at the door of the treasury will be making the conditions of a bailout so punitive for the existing state power structure that all the other states will try anything before conceding to a federal rescue. but california and some others will not be dissuaded. if i recall correctly, abraham lincoln settled a great deal regarding the nature and limitations of the political independence of states vis-a-vis the union back in the 1860s. i imagine we'll be revisiting some of those lessons in due course, and perhaps rewriting some.

i am a great admirer of the balanced federal system as originally conceived, but the united states has been consolidating an imperial power structure for more than a century now under which the states have migrated from being the centers of real power to semi-autonomous legal jurisdictions to clownish junior administrative zones within a whole, providing little more than minor leagues in furtherance of the development of the political and legal classes. as dependent as they are on federal funding, and about to become much more so, i would not be entirely surprised if the remnants of state-level political power were severely circumscribed as the crisis progresses.

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Now that is one of the best pieces you've and I agree on this one.

My own Washington State may not be far behind.

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