Love Trade Cools as Central Banks’ Gold Demand Heats Up

Sunday, August 19th, 2012

Love Trade Cools as Central Banks’ Gold Demand Heats Up

By Frank Holmes, CEO and Chief Investment Officer, U.S. Global Investors

The two largest gold buyers in the world that largely drive the Love Trade, China and India, underwhelmed the metals market with their subdued demand for the yellow metal during the second quarter of this year.

According to the World Gold Council’s (WGC) quarterly Gold Demand Trends report, total demand was 990 tons, which was about 7 percent lower compared to the second quarter of 2011. When you break down demand and look at the jewelry sector, you can see that Chindia remains about 50 percent of the world’s total gold demand. However, this quarter’s jewelry demand of a little more than 400 tons makes it one of the weakest periods in two years.

Total bar and coin demand was also weak in China and India compared with the rest of the world.

As we discussed earlier this year, India has been facing a number of economic challenges, resulting in a dramatic decrease of 30 percent in jewelry demand for the country over the second quarter compared to this time last year. The country’s “unsupportive environment” for gold included a slowing GDP growth, record high gold prices because of its currency, rising domestic inflation, high interest rates, and fears of a poor monsoon season, says the WGC.

China’s gold demand has been affected by a slowing economy as well as a “lack of clear direction in the gold price,” says the WGC. However, during the WGC’s conference call, Managing Director of Investment Marcus Grubb said it would be wrong to think that China is entering a period of extended weakness. If you look at Chinese demand for gold over the first half of 2012, the level was 410 tons—about the level that it was this time last year over the same period.

As we enter the Love Season for gold, we’ll look for any indications from government policies that might spur the continuation of the long-standing tradition of gold buying for weddings and Diwali in India, along with gold gifts for weddings and births that take place in China during this auspicious Year of the Dragon.

Although the Love Trade is on ice for the period, a relatively new gold buyer has been warming up to gold.

The official sector continued its gold buying spree this quarter. The WGC reported that central bank purchases hit a record high since the official sector became gold buyers three years ago. According to Mr. Grubb, if this trend continues over the remainder of 2012, central banks will be entering a “new territory” of gold buying that has not been seen since the early 1960s and since the end of the Bretton Woods System in 1971.

According to the firm’s quarter-end data, official sector institutions purchased 158 tons of gold in the second quarter—or about 16 percent of the quarter’s total gold demand. During the first half of 2012, central banks have acquired 254 tons of the metal, which is about 25 percent higher than the same period last year, says WGC.

Central banks from developing markets led the buying trend once again. The WGC says Kazakhstan indicated that it is “targeting an allocation to gold of 15 percent of its foreign exchange reserves” and one way it plans to build up its allocation is to purchase “the country’s entire domestic production over the next two to three years.”

Other emerging countries with central banks increasing their allocations to gold include Mexico, the Philippines, Russia, Turkey and Ukraine. According to Mr. Grubb, central banks have been motivated to add gold mainly as a currency hedge. Central banks want to increase their weightings in reserve asset portfolios and diversify away their dependence on U.S. dollars—and possibly the euro. There’s also a belief that sovereign debt is no longer considered to be a “risk-free” asset, says the WGC.

During his quarterly conference call, Mr. Grubb elaborated on this up-and-coming trend that we’ve been watching take place over the past 12 to 18 months. He believes gold is being “reintegrated into the fabric of the financial system” as a use of collateral. Mr. Grubb noted how “many exchanges are making gold eligible, with a haircut somewhere between sovereign debt and equities, as a collateral asset in all kinds of financial transactions.” The CME Group in the U.S. has already accepted gold as collateral, and just today, the European clearing house, the CME Clearing Europe, announced that gold bullion is now considered an “eligible collateral type.”

When it comes to collateral and capital requirements, “gold is being brought back into the fold as an important asset,” says Mr. Grubb.

Strike While Gold’s Not Hot?

There’s been a lot of discussion from market pundits wondering where gold is heading. I say investors should use math to their advantage. Similar to card counting strategies used by blackjack players, count historical trends to discover inflection points.

Gold appears to be at one of those inflection points right now. Using the last 10 years of data, if you plot the 12-month rolling return, you can see that gold has reached an extreme low, registering a -2 sigma.

The last time gold reached this point was in August 2008. You can see below the yellow metal’s significant climb after hitting that standard deviation low.

Just recently, the gold price has moved above its 50-day and 100-day moving averages, which is another indication of potential strength for the metal and an additional reason to believe that gold may be an attractive entry point.

I’ll be talking about gold and natural resources at the Chicago Hard Assets Investment Conference on September 21.  If you’d like to learn more about attending the free event and when I’ll be speaking, send me a note at editor@usfunds.com.

Tags: Central Banks, Chief Investment Officer, Chinese Demand, Domestic Inflation, Dramatic Decrease, Economic Challenges, Frank Holmes, GDP Growth, Gold Buyers, Gold Demand Trends, Gold Price, Gold Prices, Government Policies, Grubb, High Interest Rates, India, Metals Market, Monsoon Season, Russia, Trade China, U S Global Investors, World Gold Council
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Eric Sprott: Investment Outlook (August 2012)

Saturday, August 11th, 2012

From Eric Sprott & Etienne Bordeleau

The Solution…is the Problem, Part II

When we wrote Part I of this paper in June 2009, the total U.S. public debt was just north of $10 trillion. Since then, that figure has increased by more than 50% to almost $16 trillion, thanks largely to unprecedented levels of government intervention.

Once the exclusive domain of central bankers and policy makers, acronyms such as QE, LTRO, SMP, TWIST, TARP, TALF have found their way into the mainstream. With the aim of providing stimulus to the economy, central planners of all stripes have both increased spending and reduced taxes in most rich countries. But do these fiscal and monetary measures really increase economic activity or do they have other perverse effects?

In today’s overleveraged world, greater deficits and government spending, financed by an expansion of public debt and the monetary base (“the printing press”), are not the answer to our economic woes. In fact, these policies have been proven to have a negative impact on growth.

While it hasn’t received much attention in recent years, a wide body of economic theory suggests that government policies and their size relative to the total economy can have a significant detrimental impact on economic growth. A recent paper from the Stockholm Research Institute of Industrial Economics compiles evidence from numerous empirical studies and finds that, for rich countries, there is overwhelming evidence of a negative relationship between a large government (either through taxes and/or spending as a share of GDP) and economic growth.¹ All else being equal, countries where government plays a large role in the economy tend to experience lower GDP growth.

Of course, correlation does not imply causation. While the literature is not definitive on causation, it still provides strong evidence that more taxes and government spending as a share of GDP (except for productive investments such as education) is associated with lower growth.

One exception to these findings is the experience of Scandinavian countries. They have both high taxes and high government spending as a share of GDP but have experienced relatively rapid growth over the past 20 years. However, a significant share of their spending goes to education, which has been found to foster growth. They also counterbalance the large role of the state with very liberal, pro-market reforms and low levels of public debt.²

Debt overhang and economic growth

Even if one believes that temporary Keynesian-type fiscal stimulus, in the form of tax breaks and increased government spending, can spur growth in the short-term, these actions inevitably lead to larger deficits and higher government debt (see July 2010 Markets at a Glance, “Fooled By Stimulus”). As Figures 1 and 2 below show, the U.S. Federal Government deficit and debt levels are already at their highest levels since the end of World War II and the scope of future stimulus appears to be rather limited. According to our projections (which assume there will be no fiscal cliff), the U.S. federal debt will increase significantly as the deficit remains sustained and elevated. For many European countries the situation is even worse.

FIGURE 1: U.S. DEFICIT AS A SHARE OF GDP

FIGURE 2: U.S. DEBT-TO-GDP*

Source: The White House: Office of Management and Budget (OMB) and Sprott Calculations
*For reasons discussed in May 2009 Markets at a Glance The Solution … is the Problem, Part 1, we show total federal debt subject to the debt ceiling.

High levels of debt, or debt overhangs, cause more problems. Recent work by Carmen Reinhart and Kenneth Rogoff (Harvard University) demonstrates that banking crises are strongly associated with large increases in government indebtedness, long periods of unemployment and, ultimately, some form of default. They identify a threshold of 90% debt-to-GDP as the trigger to a debt crisis.³ As shown in Figure 2, the U.S. has already passed that threshold.

The historical evidence shows that countries with large governments and high levels of debt have on average, achieved lower economic growth. Given the already high level of debt and deficits in most developed countries, it is doubtful that increased fiscal stimulus will really help the recovery. It’s clear that debt is the problem and the solution does not lie in piling on even more of it. The current debt situation, coupled with the increasing lack of transparency of politically motivated regulations and interventions, leaves little room for a healthy deleveraging of our economies. Here is what central planners have in mind.

Debt overhang resolution and implications for the future

Througout history, high debt-to-GDP ratios have been resolved through five channels:⁴

1. Economic growth
2. Austerity
3. Defaults
4. Sudden bursts of inflation
5. Steady financial repression and inflation

Clearly, number one and two are not working right now and, in some European countries, are actually negatively reinforcing each other. The U.S. is facing its homegrown fiscal cliff and political polarization makes its resolution doubtful. Number three seems politically unacceptable for rich, developed nations, which see default as the realm of developing countries. Sudden bursts of inflation are hard to contain and work only so many times as investors, assuming a normal bond market, demand higher interest rates to compensate for inflation risk. Moreover, with interest rates already, at zero it seems that we are left with number five: steady financial repression and inflation. This terminology was first introduced in the early 1970s by Edward Shaw and Ronald McKinnon, both from Stanford University.⁵

They define financial repression as:

• Explicit or indirect caps or ceilings on interest rates
• The creation and maintenance of a captive domestic audience (i.e.: forced holdings of government debt by financial institutions and pension funds)
• Direct ownership of financial institutions and/or entry restriction in the financial industry (i.e.: China, India)

We are clearly living through a period of financial repression. The symptoms include:

• Artificially low interest rates in most of the G20 countries and commitments to keep them low for long periods of time combined with inflation, which results in negative real interest rates
• Large expansion of central banks’ balance sheets through the purchase of government bonds
• Basel III liquidity rules which force banks to hold more government debt on their balance sheets⁶,
• Newly nationalized banks in many countries (UK, Ireland, Spain, etc.), which have drastically increased their holdings of government debt
• and it will bet worse…

Figure 3 below shows that financial repression can be observed within the holdings of U.S. financial institutions and pension funds, which have steadily increased their holdings of U.S. Treasuries since 2009.

FIGURE 3: HOLDINGS OF U.S. TREASURY SECURITIES BY DOMESTIC FINANCIAL INSTITUTIONS

Source: Federal Reserve Flow of Funds

It’s clear that governments are preparing for more. A key component to erasing government debt through inflation is extending the duration (maturity) of one’s outstanding bonds. In a normal bond market, negative real interest rates make it difficult to roll over short-term debt at low borrowing rates (although financial repression and captive financial institutions certainly help to keep rates lower than they normally would be). Due to this tendency for short-term rates to rise with inflation, however, it is in the best interests of highly-indebted countries to issue the majority of their bonds at the long end of the yield curve. As Figure 4 shows, the US Treasury is proactively planning to increase the maturity of its outstanding debt (green line) in order to maximize its benefit from inflation erosion. In other words, they are capitalizing on the current flight to safety to set the stage for further financial repression down the road. The same is true for the U.K., which benefits from one of the longest weighted-average maturity of debt in the developed world. For Eurozone countries to do away with their current debt overhang they will either have to default (the least preferred option for political reasons) or use the good old combination of steady inflation and financial repression (feared by the Germans and the ECB central planners).

FIGURE 4: U.S. TREASURY WEIGHTED AVERAGE MATURITY OF MARKETABLE DEBT

Source: U.S. Treasury Office of Debt Management, Fiscal Year 2012 Q1 Report

Conclusion

On both sides of the Atlantic, the largest contributors to the current crisis are excessive debt and spending. We are now at a point where additional government stimulus measures will have negligible, if not detrimental effects on the economy and long-term growth. Debt has to be reduced, not increased by more deficits. Central planners have demonstrated that they don’t have the discipline to implement the Keynesian model of surplus in good times in order to finance deficits in bad times. We have now reached the limit of indebtedness and need to muddle through a painful but necessary deleveraging.

The politically favoured option of financial repression and negative real interest rates has important implications. Negative real interest rates are basically a thinly disguised tax on savers and a subsidy to profligate borrowers. By definition, taxes distort incentives and, as discussed earlier, discourage savings. Also, financial institutions, which are traditionally supposed to funnel savings towards productive investments, are restrained from doing so because a large share of their balance sheets is encumbered by government securities. The same is true for pension funds, which instead of holding corporate paper or shares, now hold an ever growing share of public debt. Pensioners, who are also savers, get hurt in the process.

The current misconception that our economic salvation lies with more stimulus is both treacherous and self-defeating. As long as we continue down this path, the “solution” will continue to be the problem. There is no miracle cure to our current woes and recent proposals by central planners risk worsening the economic outlook for decades to come.

Footnotes:

1 Bergh, A., Henrekson, M. (2011): “Government Size and Growth: A Survey and Interpretation of the Evidence”, Research Institute of Industrial Economics, IFN Working Paper No. 858, April 2011.

2 Bergh, A., Karlsson, M., (2010): “Government Size and Growth: Accounting for Economic Freedom and Globalization”, Public Choice 142 (1–2): 195–213.

3 Reinhart, C., Rogoff, K. (2010): “From Financial Crash to Debt Crisis”, National Bureau of Economic Research, NBER Working Paper #15795, March 2010. Reinhart, C., Rogoff, K. (2011): “A Decade of Debt”, National Bureau of Economic Research, NBER Working Paper #16827, February 2011. Reinhart, C., (2012): “A Series of Unfortunate Events: Common Sequencing Patterns in Financial Crises”, National Bureau of Economic Research ,NBER Working Paper #17941, March 2012.

4 Reinhart, C., Sbrancia, B. (2011): “The Liquidation of Government Debt”, Bank of International Settlements – Monetary and Economic Department, BIS Working Paper #363, November 2011. Reinhart, C., Reinhart, V., Rogoff, K. (2012): “Debt Overhangs: Past and Present”, National Bureau of Economic Research ,NBER Working Paper #18015, April 2012.

5 McKinnon, R., (1973): “Money and Capital in Economic Development”, Washington DC: Brookings Institute. Shaw, E., (1973): “Financial Deepening in Economic Development”, New York: Oxford University Press.

6 Bordeleau, E., Graham, C., (2010): “The Impact of Liquidity on Bank Profitability”, Bank of Canada Working Paper, WP#2010-38, December 2010.

Tags: Central Planners, Detrimental Impact, Economic Theory, Economic Woes, Empirical Studies, Eric Sprott, GDP Growth, Government Intervention, government spending, India, Industrial Economics, Investment Outlook, Monetary Base, Monetary Measures, Negative Relationship, Overwhelming Evidence, Perverse Effects, Productive Investments, Public Debt, Rich Countries, Sprott, Unprecedented Levels
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Rosenberg On The Pending Trade Shock and Q4′s GDP Growth Outlook

Wednesday, August 8th, 2012

It would appear that the dilemma of the world exporting more than it imports (that we initially pointed out here) is starting to come to a head in reality with a negative export trade shock. As Gluskin Sheff’s David Rosenberg notes, since the recovery began three years ago, over 70% of the real GDP growth we have seen was concentrated in export volumes and inventory investment; and recent data from the ISM (here and here) points to a dramatic slowdown in both. Compounding this weakness is the fact that the remaining growth was from Capex – which is now likely to slow given the weakening trend in corporate profits – and will more than offset any nascent turnaround in the housing sector – if that is to be believed. The consumer has all but stalled and adding up all these effects and there is a high probability of a 0% GDP growth print as early as Q4.

Macro Risks Squarely To The Downside

I think that there may be a time, before too long, when we will walk into the office to find that the US prints a negative GDP reading on the back of a negative export trade shock that does not appear to be in any forecast – let alone consensus.

Look at the pattern of ISM export orders:

• April: 59.0
• May: 53.5
• June: 47.5
• July: 46.5

That is called a pattern. And this is a level that coincided with the prior two recession. As the chart below vividly illustrates, there is a significant 81% correlation between annual growth in total US exports and the ISM new orders index (with a four month lag). So either the market has already priced this in or it is going to end up coming as a very big surprise. We are already seeing the lagged effects of the spreading and deepening European recession hit Asian trade-flows: Korean exports sagged 4.1% in July after a 3.7% slide in June and are down 9% on a YoY basis. Industrial production there edged lower by 0.4% as well last month – I like to look at Korea since it is a real global ‘play’ on the economic cycle.

There is likely going to be another surprise, which is inventory destocking. How do I know that? Because the share of ISM industries polled in July reported that customer inventories were excessively high soared to 33% in July from 11% a year ago (because this metric is not seasonally adjusted it can only be assessed year-on-year), the highest ever for any July in the historical database.

Add to that what is happening to order books – the share of the manufacturers reporting expanded orders sank to 17% in July from 50% a year ago and again – the worst July showing on record.

The food price situation is another major wild card, especially since whatever relief we enjoyed from lower gasoline prices is now behind us. At a 14% share of the consumer spending pie, only shelter is more important than food. And when you go back to the last food cost surge, in the first quarter of 2011 when the grocery bill soared at a punishing 10% annual rate, real GDP growth slowed to a 0.0% annual rate that quarter, which arguably was the big surprise of the year (up until the dent downgrade, that is).

In the final analysis, since the ‘recovery’ began three years ago, over 70% of real GDP growth we have seen was concentrated in these two areas: export volumes and inventory investment. The rest was in capex which is now likely to slow along with the weakening trend in corporate profits, more than offsetting the nascent turnaround in the housing sector. Also keep in mind that the consumer has stalled.

Tally all these effects up and you are looking at the prospects of 0% growth as early as Q4.

Tags: Asian Trade, Capex, Corporate Profits, Correlation, Dalio, David Rosenberg, Downside, Dramatic Slowdown, Export Orders, Export Trade, Export Volumes, GDP, GDP Growth, Gluskin Sheff, Growth Outlook, Inventory Investment, Ism, Korean Exports, Real Gdp, Recession, S David
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Note to Bond King: Check Your Math

Tuesday, August 7th, 2012

by Seth J. Masters, AllianceBernstein

August 6, 2012

The Wall Street Journal published an article on August 1 headlined: “Bill Gross: Equities are Dead.” In fairness to Gross, what he actually wrote in his August “Investment Outlook” was, “the cult of equities is dying.” We agree with most of Gross’s argument—but not with his unsupported forecast of extremely low  stock returns.

Let’s take a look at Gross’s claims:

1) Gross notes that bonds have outperformed stocks for the last 10, 20 and 30 years. With long US Treasuries currently yielding 2.7%, it is unlikely that bonds will replicate the performance of decades past.

We agree. That is why stocks are attractive today relative to bonds. Bonds—having outperformed—are now unusually expensive and have low expected returns going forward. By contrast, stocks—having performed poorly—are cheaper than normal and are likely to significantly outperform bonds over the next 10 years.

2) Gross argues that US stocks can’t maintain their 6.6% average annualized real return over the last 100 years. The 6.6% real equity return was 3% higher than real GDP growth, with shareholders gaining at the expense of labor and government. Labor and government must demand some recompense for wealth creation, and GDP growth itself must slow due to deleveraging.

We agree. We are now in a lower return environment. The question is, how low? Let’s concede that stocks will grow in line with real GDP. Over the long haul, real GDP growth primarily reflects population (growing a little over 1%) and productivity (growing just above 2%). That would give us a projected real equity return of maybe 3%—less than half the historical 6.6% rate.

3) Gross asserts that stocks will have a nominal return of 4%.

This is where Gross’s math gets fuzzy. Why this sudden switch to nominal instead of real returns? Does Gross expect that US population will shrink, productivity gains will disappear, and inflation will remain quiescent forever? That is what needs to happen for long-term nominal GDP growth to be as low as 4%. The scenario is possible, but hardly likely. Just assuming that inflation runs at a relatively tame 3% with below-normal real GDP growth of another 3%, we’d have nominal equity returns of 6% or so. That looks quite attractive when you get just 2.7% for holding long bonds to maturity.

In our recently published paper “The Case for the 20,000 Dow,” we show that with reasonable assumptions we can get returns in the 6% to 7% range and that the Dow hits that target in five to 10 years. We will also lay out our argument in an upcoming blog post.

Most investors today are very concerned about equity volatility, and for good reason. But there is another risk that should concern investors: the risk that their investments will not keep up with inflation and meet their goals. As investors balance short-term market risk against the long-run risk of falling short of their objectives, we think an appropriate allocation to equities continues to improve the likelihood for success.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.

Seth J. Masters is Chief Investment Officer of Asset Allocation and Defined Contribution Investments at AllianceBernstein and Chief Investment Officer of Bernstein Global Wealth Management, a unit of AllianceBernstein.

Tags: Alliancebernstein, August 1, Bill Gross, Bonds, Equity Return, Fairness, GDP, GDP Growth, Government Labor, inflation, Investment Outlook, Productivity Gains, Real Gdp, Recompense, Seth, Stock Returns, Treasuries, Wall Street Journal, Wealth Creation
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Emerging Markets Radar (July 30, 2012)

Sunday, July 29th, 2012

Emerging Markets Radar (July 30, 2012)

Strengths

• The HSBC China July Flash PMI improved to 49.5 versus 48.2 in June, though it is still below 50. The manufacturing sub-index moved above 50, suggesting de-stocking pressure is lessened.
• The Nanjing local government announced supportive measures to provide an easy mortgage facility for first-time home buyers who participate in the city’s Provident Housing Fund. Although the central government has been making stern talks to continue to curb the housing market, its differentiated housing policy will stay and first-time home buyers will be supported by better mortgage rates.
• The Shangsha local government initiated Rmb 829 billion investments in 195 projects. This may show the ability of China to support economic growth. These projects are positive to commodity and machinery producers.
• Singapore industrial production jumped 7.6 percent in June, rising far more than the estimate of 2.8 percent growth. Increased pharmaceutical output countered a decline in electronic shipments.
• The Philippine central bank surprised the market by cutting its interest rate by 25 basis points to a record low 3.75 percent. The Philippines also reported a budget deficit of $278 million in June, mainly to improve the country’s infrastructure.

Weaknesses

• The Bank of Thailand, the central bank, kept its benchmark rate unchanged at 3 percent, but revised GDP growth down from 6 percent to 5.7 percent for 2012 due to collateral impact from external factors. Thailand’s industrial production dropped 9.6 percent, and exports fell 2.5 percent in June.
• Hong Kong June trade growth missed expectations. Exports were down 4 percent year-over-year and imports were down 2.9 percent.
• Korea’s second quarter GDP expanded 2.4 percent, growing at the slowest pace in almost three years, below the median estimate for a 2.5 percent gain.

Opportunities

• Turkey and some other high-yielding emerging market countries (such as Russia) may find themselves the beneficiaries of Japanese investor interest previously directed at Brazil. Barclays estimates that potential portfolio flows to Turkey from Japan could reach $5 to 6 billion per year, or the equivalent of 0.8 percent of GDP.

• Philippine infrastructure investment has become a policy priority. In his “State of the Nation Address,” Philippine President Aquino stated “a large portion of our job generation strategy is building sufficient infrastructures,” focusing on airport, rail, and toll roads that would be built, upgraded and/or privatized. The market expects the policy to benefit companies specializing in construction materials and engineering, public utility, and property developers.

Threats

• China was exporting steel at the highest levels in two years last month. Its shipments abroad rose to 8.7 percent of domestic output, the highest proportion since July 2010, indicating soft domestic demand.
• The “whatever it takes” pledge from ECB president Mario Draghi in reference to saving the euro could come with conditions attached. RGE expects the ECB to restrict any assistance to Spain alone, given that Spain signed a memorandum of understanding.

Tags: Bank Of Thailand, Basis Points, Benchmark Rate, Budget Deficit, Easy Mortgage, Emerging Market Countries, External Factors, First Time Home, First Time Home Buyers, Gain Opportunities, GDP Growth, Housing Fund, Machinery Producers, Median Estimate, Mortgage Rates, Provident, Quarter Gdp, S Industrial, Supportive Measures, Time Home Buyers
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David Rosenberg On A Modern Day Depression Vs Dow 20,000

Wednesday, July 25th, 2012

 
From David Rosenberg of Gluskin Sheff

The challenge ahead is one of expectations. I think we win be fortunate to see any GDP growth at all for Q3, and yet the consensus is at +2.2%. The consensus is at +97k on July non-farm payrolls whereas the claims data point to sub-80k. Among the analysts, hope springs eternal that expected revenue growth of +2.6% in Q4 will be enough to generate a +12.1% expansion in bottom-line performance.

To meet that profit forecast, even more cost-cutting will have to come our way (no sooner do we say that than we see this article on page 61 of the WSJ: Steelmaker Presses for 26% Pay Cut). This may be encouraging for profits, but will also come at the expense of labour income, and with that, a sluggish consumer. Concerns over the fiscal cliff have already led to a renewed uptrend in the personal savings rate. The worst drought in the U.S. in a half-century are sending food costs sharply higher, which will severely pinch discretionary outlays, and whatever respite there had been of late from relief at the gas pumps has come to an end (have a look at Price Check: Drought May Hit Grocery Tabs, also on page 61 of the weekend WSJ). Survey after survey shows a sharp turndown in hiring plans as well.

This is looking more and more like a modem-day depression. After all, last month alone, 85,000 Americans signed on for Social Security disability cheques, which exceeded the 80,000 net new jobs that were created: and a record 46 million Americans or 14.8% of the population (also a record) are in the Food Stamp program (participation averaged 7.9% from 1970 to 2000, by way of contrast) — enrollment has risen an average of over 400,000 per month over the past four years. A record share of 41% pay zero national incomes tax as well (58 million), a share that has doubled over the past two decades. Increasingly, the U.S. is following in the footsteps of Europe of becoming a nation of dependants.

Meanwhile, policy stimulus, whether traditional or non-conventional, are still falling well short of generating self-sustaining economic growth. Some investors see this deflationary trendline because it is they that have helped drive the S&P Dividend Aristocrats index (contains large-caps that have consistently raised their payouts over the past 25 years) up 10.5% in the past month and actually touched a new all-time high last week. The likes of Kraft, Wal-Mart, Verizon, Johnson & Johnson, Pfizer and Merck all managed to reach 52-week highs as well. So even in this tough macro and market environment, there are ways to put money to work — in areas of the market that generate a reliable dividend stream for investors and produce a product that people need, not what they want.

Investors must not only screen for earnings visibility, non-cyclicality, dividend payout potential, strong management and high quality balance sheets with a manageable debt maturity calendar, but also for fully-funded pension plans. The S&P 500 space, right now, contains 338 defined-benefit plans, with aggregate obligations of $1.68 trillion but assets of just $1.32 billion, for an unprecedented underfunded liability of $355 billion. So you know the record cash-stash on corporate balance sheets that are often cited as a prime reason to be bullish on Corporate America the real issue is the extent to which shoring up depleted pension funds will compete with stock buybacks and dividend growth in the future. One thing is for sure — a reversion back to the old defined-contribution pensions is clearly coming back into focus as company after company seek out ways to reduce their contribution rates.

DOW 20,000?

Well, this is perfect.

It is amazing how many pundits still believe in stocks for the long run. See The Long-Term Argument for Dow 20,000 on page 6 of the Sunday NYT Money & Business section. Shades of Jeremy Siegel.

So what are we left to conclude?

Last week, we saw the VIX index touch 15. The Investors’ Intelligence survey showed there to still be two bulls for every bear in the realm of market newsletters. The put-call ratio had fallen through 1:1 after a 20% decline since early June. The bottom-up consensus of equity analysts see global profit growth of 13.5% for 2013, which is more than a double from the 6.3% projection for this year. The S&P 500 is currently trading much closer to the top end of its year-long 1.100-1,400 band than the low end. And now we see headlines of Dow 20,000 (whatever happened to the other 15,000 points Dr. Siegel promised 13 years ago)? Where exactly is there any sign of capitulation beyond, say, the mutual fund flows data which are illustrating even to the most casual observer that what we are witnessing on this front is little more than a demographic-driven rebalancing of the baby boomer asset mix as the investment lifecycle continues along a secular shift towards capital and cash-flow preservation themes.

The bottom line is that from the spring of 2009 to the spring of 2011, the stock mark doubled, and it doubled principally because of a wild short-covering rally in the financials which were priced for insolvency at the lows. It was a classic 1933-1936 bounce that never saw a new high and never foreshadowed better times ahead. The Great Depression ended nearly a decade later and the next secular bull market did not begin until 1954. And from what history teaches us, secular bear phases do not typically end with headlines about Dow 20,000 but rather with contrarian news like The Death of Equities on the front cover of BusinessWeek back in 1979 (or Awash in Oil on the front cover of the Economist back in 1999, when crude prices were turning in their secular lows).

* * *

Of course, for the laugh track, here again is James Altucher from June of 2011, predicting Dow 20,000 as recently as a month ago.

Tags: Bottom Line Performance, Consumer Concerns, David Rosenberg, Discretionary Outlays, Food Costs, Food Stamp Program, Gas Pumps, GDP Growth, Gluskin Sheff, Labour Income, National Incomes, Non Farm Payrolls, Personal Savings Rate, Program Participation, Record Share, Social Security Disability, Steelmaker, Turndown, Uptrend, Wsj
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China’s Rebalancing Has Begun

Saturday, July 21st, 2012

Michael Pettis at China Financial Markets has some interesting comments via email regarding much needed China rebalancing and a timeframe for a possible Spain exit from euro.

Pettis On Spain Exit …

How will Spanish households react to a default on preferred shares and subordinated bonds, or even a very public discussion about the possibility of such a default?　 I don’t know, but I assume that it will speed up deposit withdrawals from the banking system even more.　 For that reason it continues to be a very good idea to keep an eye on Target 2 balances.　 These serve as a pretty good proxy, I think, for the behavior of depositors.

Things are evolving in Spain exactly as we would expect them to evolve according to the sovereign-debt-crisis handbook.　 Unless we get real fiscal union in Europe, or Germany leaves the euro, or Germany stimulates its economy into running a very large trade deficit, or the euro depreciates by 15-20% against the dollar in the next year – all very unlikely, I think – I really see no reason to doubt that Spain will leave the euro and restructure its debt within the next few years.

Mish Comments on Target 2

Target 2 stands for Trans-European Automated Real-time Gross Settlement System. It is a reflection of capital flight from the “Club-Med” countries in Southern Europe (Greece, Spain, and Italy) to banks in Northern Europe.

Please see Target2 and the ELA (Emergency Liquidity Assistance) program; Reader From Europe Asks “Can You Please Explain Target2?” for a more compete description.

There is much misinformation floating around on how Target 2 works, what Germany’s liabilities are, so please click on the above link if you are interested in target 2 balances.

The following chart from PIMCO article TARGET2: A Channel for Europe’s Capital Flight shows the capital flight through March. The problem has accelerated since then, because of fears in Spain and Italy.

Pettis On China Price Deflation…

China’s official GDP growth rate has fallen sharply – on Friday Beijing announced that GDP growth for the second quarter of 2012 was a lower-than-expected 7.6% year on year, the lowest level since 2009 and well below the 8.1% generated in the first quarter. This implies of course that quarterly growth is substantially below 7.6%.　 Industrial production was also much lower than expected, at 9.5% year on year.

In fact China’s real GDP growth may have been even lower than the official numbers.　 This is certainly what electricity consumption numbers, which have been flat, imply, and there have been rumors all year of businesses being advised by local governments to exaggerate their revenue growth numbers in order to provide a better picture of the economy. 　Some economists are arguing that flat electricity consumption is consistent with 7.6% GDP growth because of pressure on Chinese businesses to improve energy efficiency, but this is a little hard to believe.　 That “pressure” has been there almost as long as I have been in China (over ten years) and it would be startling if only now did it have an impact, especially with such a huge impact occurring so suddenly.

Adding to the slow economic growth, the country may be tipping into deflation.　 Last Monday the National Bureau of Statistics released the following inflation data:

In June, the consumer price index (CPI) went up by 2.2 percent year-on-year. The prices grew by 2.2 percent in cities areas and 2.0 percent in rural areas. The food prices went up by 3.8 percent, while the non-food prices increased by 1.4 percent. The prices of consumer goods went up by 2.3 percent and the prices of services grew by 1.9 percent. In the first half of this year, the overall consumer prices were up by 3.3 percent over the same period of previous year.

In June, the month-on-month change of consumer prices was down by 0.6 percent, prices in cities and rural went down by 0.6 and 0.5 percent respectively. The food prices dropped by 1.6 percent, the non-food prices kept at the same level (the amount of change was 0). The prices of consumer goods decreased by 0.9 percent, and the prices of services increased by 0.3 percent.

My very smart former PKU student Chen Long, who follows monetary conditions in China as closely as anyone else I know tells me:

The most interesting thing is that even if CPI remains stable month-on-month, it will turn negative year-on-year in January 2013.　 And if it continues to decline month-on-month at current rates, we could see negative year-on-year CPI as early as August/September.

Unlike some other analysts, in other words, I am not concerned about deflation persisting for long unless the PBoC cuts interest rates much more sharply than any of us expect.　 I know this may sound strange – most analysts believe that cutting interest rates will actually reignite CPI inflation – but remember that the relationship between inflation and interest rates in China is, as I have discussed many times before, not at all like the relationship between the two in the US.　 It works in the opposite way because of the very different structure of Chinese debt and consumption.

Pettis On China Rebalancing…

After many failed attempts, over the past six months we may be seeing for the first time the beginning of China’s urgently needed economic rebalancing, in which China reduces its overreliance on investment in favor of consumption.

Regular readers of my newsletter may be surprised to see me say this.　 For the past four or five years analysts have been earnestly assuring us that the rebalancing process had finally begun, and I had always insisted that it couldn’t have begun yet.

Why?　 Because as I understand it rebalancing is almost arithmetically impossible under conditions of high GDP growth rates and low real interest rates.　 Once the real numbers came in, it always turned out that in fact imbalances had gotten worse, not better.　 Typically many of those too-eager analysts have resorted to insisting that the consumption data are wrong, although even if they are right this does not confirm that rebalancing had taken place since errors in reporting consumption have always been there.

But this time seems different.　 Now for the first time I think maybe the long-awaited Chinese rebalancing may have finally started.

Of course the process will not be easy. With China’s consumption share of GDP at barely more than half the global average, and with the highest investment rate in the world, rebalancing will require determined effort.

How to rebalance

The key to raising the consumption share of growth, as I have discussed many times, is to get household income to rise from its unprecedentedly low share of GDP.　 This requires that among other things China increase wages, revalue the renminbi and, most importantly, reduce the enormous financial repression tax that households implicitly pay to borrowers in the form of artificially low interest rates.

Forcing up the real interest rate is the most important step Beijing can take to redress the domestic imbalances and to reduce wasteful spending.

And this seems to be happening.　 [Yet] Beijing has reduced interest rates twice this year, and reluctant policymakers are under intense pressure to reduce them further.　 [However] The students in my central bank seminar at PKU tell me that there are new rumors about the way the cuts were implemented.　 “Usually it is the PBoC that submits a proposal of rates cut to the State Council,” one of them wrote me recently, “but this time (July 5th) it was the State Council who handed down to the PBoC the decision to cut rates, so that the PBoC was not fully aware of the rates cut before July 5th.”

If my student is right (and this class has an impressive track record), this suggests that monetary easing is being driven by political considerations, not economic ones, which of course isn’t at all a surprise.　 But even with the rate cuts, perhaps demanded by the State Council, with inflation falling much more quickly than interest rates the real return for household depositors has soared in recent months, as has the real cost of borrowing.　 China, in other words, is finally repairing one of its worst distortions.

China bulls, late to understand the unhealthy implications of the distortions that generated so much growth in the past, have finally recognized how urgent the rebalancing is, but they still fail to understand that this cannot happen at high growth rates.　 The problem is mainly one of arithmetic.　 China’s investment growth rate must fall for many years before the household income share of GDP is high enough for consumption to replace investment as the engine of rapid growth.

As China rebalances, in other words, we would expect sharply slowing growth and rapidly rising real interest rates, which is exactly what we are seeing.　 Rather than panicking and demanding that Beijing reverse the process, we should be relieved that Beijing is finally resolving its problems.

As an aside, we need to make two adjustments to the trade surplus in order to understand what is really going on within the balance of payments.　 First, one of the causes of last month’s weak imports has been a sharp decline in commodity purchases.　 I have many times argued that commodity stockpiling artificially lowers China’s trade surplus by converting what should be classified as a capital account outflow into a current account inflow.　 If China is now destocking, then China’s real trade surplus is actually lower than the posted numbers.

Second, we know that wealthy Chinese businessmen have been disinvesting and taking money out of the country at a rising pace since the beginning of 2010.　 One of the ways they can do so, without running afoul of capital restrictions, is by illegally under- or over-invoicing exports and imports.　 This should cause exports to seem lower than they actually are and imports to seem higher.　 The net effect is to reduce the real trade surplus.

Since these two processes, commodity de-stocking and flight capital, work in opposite ways to affect the trade account, it is hard to tell whether China’s real trade surplus is lower or higher than the reported surplus.　 But once de-stocking stops, we should remember that the trade numbers probably conceal capital outflows.

How does all this affect the world?　 In the short term rebalancing may increase the amount of global demand absorbed by China, but over the longer term it should reduce it.　 Rebalancing will inevitably result in falling prices for hard commodities, and so will hurt countries like Australia and Brazil that have gotten fat on Chinese overinvestment. 　Rising Chinese consumption demand over the long term and lower commodity prices, however, are positive for global growth overall, and especially for net commodity importers.　 Slower growth in China, it turns out, is not necessarily bad for the world.　 The key is the evolution of the trade surplus.

There is much more in his email that I wanted to use, but I stretched the bounds of fair use already.

Those wishing to see more can follow Michael Pettis on his blog China Financial Markets which I consider one of the very few “must read” sites.

The above report should appear on his blog shortly, with more details. Thanks Michael!

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: Banking System, Capital Flight, China Gdp, China Price, Club Med, Debt Crisis, Deflation, Depositors, GDP Growth, Gross Settlement, Michael Pettis, Northern Europe, Preferred Shares, Rebalancing, Settlement System, Southern Europe, Sovereign Debt, Subordinated Bonds, Target 2, Trade Deficit
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The Economy and Bond Market Radar (July 23, 2012)

Saturday, July 21st, 2012

The Economy and Bond Market Radar (July 23, 2012)

Treasury yields headed modestly lower again this week. Retail sales were much weaker than expected. Inflation and manufacturing data were more or less in line with expectations, while housing data was mixed. By Friday, European financial concerns had resurfaced as Spanish 10-year bond yields spiked above 7 percent and hit new highs. Spain indicated its recession will likely continue into next year. U.S. treasuries remain a safe haven for global investors, pushing yields lower this week.

Strengths

• Industrial production rose 0.4 percent, ahead of expectations and a bright spot in an otherwise lackluster week for economic data.
• Real estate lending in China jumped 20 percent year-over-year in the second quarter and already shows Chinese policy-makers are taking aggressive action to combat the ongoing global slowdown.
• Housing starts rose 6.9 percent in June and the National Association of Home Builders confidence index had its biggest increase since September 2002.

Weaknesses

• Retail sales fell 0.5 percent and have now fallen for three months in a row, which bodes very poorly for second-quarter GDP growth.
• The Conference Board’s Leading Index fell 0.3 percent in June, also indicating lackluster growth.
• Auto sales in the European Union fell 2.8 percent in June for the ninth consecutive monthly drop.

Opportunity

• With growth tepid, the Federal Reserve will not only remain accommodative, it may increase accommodation in the next few months.

Threat

• Europe remains a wildcard with the markets shifting focus on a weekly basis.

Tags: Aggressive Action, Auto Sales, Bond Market, Bond Yields, Chinese Policy, Confidence Index, Economic Data, Financial Concerns, GDP Growth, Global Investors, Global Slowdown, Housing Starts, Market Radar, National Association Of Home Builders, New Highs, Quarter Gdp, Safe Haven, Shifting Focus, Treasuries, Treasury Yields
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Emerging Markets Radar (July 16, 2012)

Saturday, July 14th, 2012

Emerging Markets Radar (July 16, 2012)

Strengths

• China’s second quarter GDP was up 7.6 percent, in line with the market expectation of 7.7 percent. Asia markets were up after the data release. Fixed asset investment growth accelerated on stronger infrastructure, increasing 20.4 percent year-over-year for the first half of the year versus the forecast of 20 percent. Consumption was stable, rising 13.7 percent in June, slightly down from 13.8 percent in May, but better than the estimated 13.4 percent. Clearly, China is growing at a slower speed, which makes it possible for the government to stimulate with easing monetary and fiscal policies.
• China’s June new loans were RMB 919.8 billion versus the estimate of 880 billion, but short-term lending is still high at about 50 percent. Household lending was 30 percent, which explains why housing sales went up 41 percent in June.
• Korea unexpectedly cut its benchmark interest rate by 25 basis points to 3 percent.
• For the China Region Fund we find that the current market is offering plenty of investment opportunities of growth at a reasonable price (GARP) in the China region. The Fund’s portfolio currently has an average dividend yield of 3.4 percent with average revenue growth at 25 percent.

Weaknesses

• China’s June industrial production was up 9.5 percent, lower than the estimate of 9.8 percent, but just slightly down from 9.6 percent in May. The growth of industrial production was still restrained by enterprises’ destocking and deleveraging, which has negative implication for the economic growth. As a leading indicator to China’s GDP growth, power output is in decline, flat in June, compared to 2.7 percent year-over-year growth in May.

Opportunities

Acceleration in Chinese Bank Lending Should Help Sustain Property Transaction Recovery

• After two interest rate cuts, China housing transactions have increased as home buyers can borrow at lower rate. In the meantime, the People’s Bank of China, the central bank, has encouraged banks to lend to first-time home buyers. The increased new loans in June are a positive sign that new loans are back on an upside trend.

Threats

• Although China’s June economic numbers are showing a steady economic growth, the trend can be on the downside, which makes the market believe the Chinese government will continue to spend to backstop growth weakness.

Tags: Asia Markets, Asset Investment, Bank Of China, Basis Points, Benchmark Interest Rate, China Region, Chinese Bank, Current Market, Dividend Yield, Emerging Markets, Fiscal Policies, Garp, GDP Growth, Housing Sales, Implication, Investment Growth, Investment Opportunities, Leading Indicator, Property Transaction, Quarter Gdp
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Case for US and Global Recession Right Here, Right Now; Recognizing the Limits of Madness; Permabears?

Wednesday, July 11th, 2012

There is a big difference between making a claim the economy is in recession from a claim the economy is headed for one.

Case for a Global Recession

I think the entire global economy is in recession and said so on July 6, 2012 in Plunging New Orders Suggest Global Recession Has Arrived

However, we need to define the term “recession”

Contrary to popular myth, recession does not mean two consecutive quarters of economic contraction. Rather, two consecutive quarters of economic contraction is a sufficient, but not necessary condition.

In the US, the NBER is the official designator of recession start and end points. Many recessions have started with GDP still growing.

The “Conditions for Global Recession” are even looser. “The International Monetary Fund (IMF) considers a global recession as a period where gross domestic product (GDP) growth is at 3% or less. In addition to that, the IMF looks at declines in real per-capita world GDP along with several global macroeconomic factors before confirming a global recession.”

Given current conditions are what one would expect from outright stagnation (if not worse), I am confident a global recession has begun.

What About a US Recession?

On June 21, I gave 12 Reasons US Recession Has Arrived (Or Will Shortly).

Tipping the Balance to Now (Not Shortly)

• The Third Consecutive Weak Payroll Report
• The pending Global Collapse In Auto Sales
• Plunge in China Import Growth (For discussion see China Import Growth Plunges, Trade Surplus Hits 3-Year High; Will US Response Be Protectionism? Is China Headed For a Deflationary Shock?)

That is enough for me. And I am not the only one to feel that way.

ECRI’s Achuthan: “I Think We’re in a Recession Already”

Link if video does not play: ECRI’s Achuthan Says U.S. Economy Is in Recession

Partial Transcript of Video

Achuthan on whether he can reaffirm his recession call from last year:

“Yeah…I think a lot of people forget what our call was. What we said back in December was that the most likely start date for the recession would be in Q1 and if not then, by the middle of 2012. I’m here to reaffirm that. I think we’re in a recession. I think we’re in a recession already. As I said back there, it is very rare that you know you’re going into recession when you’re going into recession. It often takes some big hit on top of the head. In the last recession, it took Lehman to wake people up and the recession before, it took 9/11.”

Those are exactly the kinds of things that irritate me about the ECRI. The fact of the matter is Achuthan was calling for a recession in September, not December, and not June.

For details, please see my September 30, 2011 post ECRI Calls Recession Based on “Contagion in Forward Indicators”; Just How Timely is the Call?

Tom Keen: “Single Sentence, why recession now”
ECRI’s Lakshman Achuthan: “Contagion in Forward-Looking Indicators”

That link clearly shows I thought a recession was imminent as well. Those are the facts. It is silly to try and hide them.

Yet, in December (after economic data firmed), Achuthan moved the date forward to June, wanting another 6 months to be proven correct.

My question in September “Just How Timely is the Call?” was a good one. The ECRI has been both very early and very late. Far from the perfect track record they claim.

That my friends is the nature of making predictions. No one is perfect, not me, not Achuthan, not anyone, and it is very foolish to pretend otherwise.

Actually, I have no problem at all with Achuthan moving the date forward. Conditions change. My problem, is revisionist history that makes it appear as if a recession call in September was a recession call for June (made in December).

All this nonsense goes away the moment Achuthan admits the ECRI does not have a perfect track record.

That said, I think Achuthan is now correct. However, I thought so in September. So be it. I was wrong. The solution when you were wrong is easy, simply say you were wrong.

The Other Extreme “Recession is Not Imminent”

Please consider the other extreme, Recession is Not Imminent by Dwaine van Vuuren.

Among the bearish voices I most respect is John Hussman, whose work I read regularly. He is thorough and quantitatively rigorous. Whenever I am convinced there will be no recession, I temper my enthusiasm by re-reading his articles to make sure I maintain a balanced view. One day he will be right and I will be wrong, but at least I won’t be blindsided.

But the data don’t show catastrophe. Looking at the Leading SuperIndex, we are a bit worse off than last summer and the summer before that. We just put in a leading SuperIndex peak on April 13 (10 days after the SP-500 peak) that is lower than the prior two peaks. This slowdown, if not checked in time, may well be the one that pushes us into recession. But even that worst-case scenario is still three to four months away, according to the SuperIndex recession-path projections in our regular weekly report.

Emphasis in italics added.

I disagree. The global data is an outright catastrophe. Moreover, the jobs reports in the US and the US ISM manufacturing numbers are  a catastrophe as well.

I am amused by van Vuuren’s statement “at least I won’t be blindsided”. I suggest he already is.

“We Have Reached the Point that Delineates an Expansion from a New Recession”

John Hussman asks What if the Fed Throws a QE3 and Nobody Comes?

With regard to the economy, I noted two weeks ago that the leading evidence pointed to a further weakening in employment, with an abrupt dropoff in industrial production and new orders.

Mike Shedlock reviews the litany of awful figures we’ve seen since then, focusing on the new orders component of global purchasing managers indices: U.S. manufacturing new orders and export orders plunging from expansion to contraction, Eurozone new export orders plunging (only orders from Greece fell at a faster rate than those of Germany), and an accelerating decline in new orders in both China and Japan.

Recall that the NBER often looks for “a well-defined peak or trough in real sales or industrial production” to help determine the specific peak or trough date of an expansion or recession. From that standpoint, the sharp and abrupt decline we’re seeing in new orders is a short-leading precursor of output. As the chart below of global output suggests, I continue to believe that we have reached the point that delineates an expansion from a new recession.

On the employment front, Friday’s disappointing report of 80,000 jobs created in June may be looked on longingly within a few months, as we continue to expect the employment figures to turn negative shortly. That said, it remains important to focus on the joint action of numerous data points, rather than choosing a single figure as an acid test. I noted last week in Enter, the Blindside Recession, GDP and employment figures are subject to substantial revision.

Lakshman Achuthan at ECRI has observed the first real-time negative GDP print is often seen two quarters after a recession starts. Earlier data is often subsequently revised negative. As for the June employment figures, the internals provided by the household survey were more dismal than the headline number. The net source of job growth was the 16-19 year-old cohort (even after seasonal adjustment that corrects for normal summer hiring). Employment among workers over 20 years of age actually fell, with a 136,000 plunge in the 25-54 year-old cohort offset by gains in the number of workers over the age of 55. Among those counted as employed, 277,000 workers shifted to the classification “Part-time for economic reasons: slack work or business conditions.”

Permabears?

Hussman has been labeled a “permabear”. So have I. So has Dave Rosenberg. So have many others. It only seems that way. The reality is Hussman, I, and Rosenberg were bullish at the March 2009 bottom.

However, the market shot up so far, so fast, that valuations became quickly stretched.

I cannot speak for the others, but I surely underestimated the effect of global coordinated liquidity move by central bankers virtually everywhere (US, EU, UK, China, Australia, Canada, etc.).

The result was we had a 10-year stock market rally in three years. Those patting themselves on the back for their “no recession” call were correct only because of  a massive coordinated liquidity pump by central bankers worldwide.

Unless the “no recession” callers specifically counted on that, then they were lucky with their forecast.

What about now?

What if the Fed Throws a QE3 and Nobody Comes?
What if stock market valuations reach typical bear market valuations?
What if a recession is really at hand?

I do not believe the Fed is in control. Such ideas are a myth.

If the Fed could prevent recession we would never have them. Yet we do, don’t we?

The fact of the matter is Fed tail-chasing policies combined with fractional reserve lending and moral-hazard bailouts have amplified the crest and trough  of every boom and bust.

Deep Problems

Hussman comments …

Our economic problems run far deeper than what can be healed by more reckless bubble-blowing by the Federal Reserve. At the center of global economic turmoil is a mountain of bad debt that was extended on easy terms by weakly regulated lenders with a government safety net. Global leaders have done all they can to protect the lenders at the expense of the public – to make good on the bond contracts of mismanaged financial institutions by breaking the social contracts with their own citizens. The limit of this unprincipled madness is being reached.

The way out is to restructure bad debt instead of rescuing it. Particularly in Europe, this will require numerous financial institutions to go into receivership, where stock will be wiped out, unsecured bonds will experience losses, senior bondholders will get a haircut on the value of their obligations, and loan balances will be written down. Bank depositors, meanwhile, will not lose a dime, except in countries where the sovereign is also at risk of default. Even there, depositors will probably not lose any more than they would if they held sovereign debt directly. In the U.S., the pressing need continues to be mortgage restructuring, and an emerging recession is likely to bring that issue back to the forefront, as roughly one-third of U.S. mortgages exceed the value of the home itself

Recognizing the Limits of Madness

I agree. The key statement is “The limit of this unprincipled madness is being reached.”

The problem is not only recognizing the limits of “unprincipled madness” but also recognizing the market’s willingness to play along. It always lasts longer than one thinks possible.

At the end of the line, every possible person is sucked into belief current conditions can go on forever. We saw that in the 2000 dot-com bubble, the housing bubble, the commercial real estate bubble that followed the housing bubble, and we see it now in the “Fed is omnipotent belief bubble”.

The only reason we have escaped recession so far is the amazing effort central bankers and global governments have put forth to avoid what needs to be done. Congratulations to those who recognized this condition in advance.

However, no credit can be given to those with the misguided belief such policies and efforts will last perpetually. The end of the line always comes.

No Decoupling

There was no decoupling in 2008 and there will be no reverse decoupling now. For further discussion please see Will the US Economy Continue to Decouple From the Rest of the World?

Recession Has Begun

In this case, the data speaks for itself. We are at the end of the line. The recession is not coming, it is not down the road, it is not likely, it is not at even at-hand.

Rather, the recession has begun. Fiscal stimulus from Congress is not coming and no amount of QE is going to stop it.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

Tags: China Import, Consecutive Quarters, Current Conditions, Economic Contraction, GDP Growth, Global Collapse, Global Economy, Global Recession, Hussman, Import Growth, International Monetary Fund, International Monetary Fund Imf, Macroeconomic Factors, Nber, Necessary Condition, Partial Transcript, Payroll Report, Protectionism, Recessions, Trade Surplus, World Gdp
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