Sunday, August 30, 2009

It's a train

(Richard Arms developed the TRIN, or Arms index, as a contrarian indicator to detect overbought and oversold levels in the market. Because of its calculation method, the TRIN has an inverse relationship with the market. Generally, a rising TRIN is bearish and a falling TRIN is bullish.{} -AM)

By Brett Steenbarger
Seeking Alpha
August 29

A few readers have asked this question, noting recent low TRIN values. (TRIN is also known as the ARMS Index). Of course, what this means is that a high proportion of daily trading volume has been concentrated in rising stocks.

But is TRIN low?

To address this, I looked at the median 20-day TRIN values going back to 2000. I used the median because the TRIN ratio is constructed in such a way that you can get much larger readings above 1.0 than below. With the median, I wanted to capture whether the average day was showing greater concentration of volume to the winning or losing stocks.

Guess what? The current 20-day median TRIN is the lowest value we've seen since 2000 at around .75.

I'm not exactly sure what to make of that.

What I can tell you with certainty is that two of the past historical occasions in which we've had 20-day price highs and ultra low median 20-day TRIN readings have been March 2000 and late May/early June, 2007. Both corresponded more or less to bull market peaks.

Saturday, August 29, 2009

Consumption junction

Published: August 28, 2009
New York Times via Across the Curve blog

AUSTIN, Tex. — Even as evidence mounts that the Great Recession has finally released its chokehold on the American economy, experts worry that the recovery may be weak, stymied by consumers’ reluctance to spend.

Given that consumer spending has in recent years accounted for 70 percent of the nation’s economic activity, a marginal shrinking could significantly depress demand for goods and services, discouraging businesses from hiring more workers. (The economy is the consumer stupid!-AM)

Millions of Americans spent years tapping credit cards, stock portfolios and once-rising home values to spend in excess of their incomes and now lack the wherewithal to carry on. Those who still have the means feel pressure to conserve, fearful about layoffs, the stock market and real estate prices.

“We’re at an inflection point with respect to the American consumer,” said Mark Zandi, chief economist at Moody’s Economy .com, who correctly forecast a dip in spending heading into the recession, and who provided data supporting sustained weakness.

Lower-income households can’t borrow, and higher-income households no longer feel wealthy,” Mr. Zandi added. “There’s still a lot of debt out there. It throws a pall over the potential for a strong recovery. The economy is going to struggle.”

In recent weeks, spending has risen slightly because of exuberant car buying, fueled by the cash-for-clunkers program. On Friday, the Commerce Department said spending rose 0.2 percent in July from the previous month. But most economists see this activity as short-lived, pointing out that incomes did not rise. Some suggest the recession has endured so long and spread pain so broadly that it has seeped into the culture, downgrading expectations, clouding assumptions about the future and eroding the impulse to buy.

The Great Depression imbued American life with an enduring spirit of thrift. The current recession has perhaps proven wrenching enough to alter consumer tastes, putting value in vogue.

Households must increasingly depend upon paychecks to finance spending, a reality that seems likely to curb consumption: Unemployment stands at 9.4 percent and is expected to climb higher. Working hours have been slashed even for those with jobs.

Economists subscribe to a so-called wealth effect: as households amass wealth, they tend to expand their spending over the following year, typically by 3 to 5 percent of the increase.

Between 2003 and 2007 — prime years of the housing boom — the net worth of an American household expanded to about $540,000, from about $400,000, according to an analysis of federal data by Moody’s

Now, the wealth effect is working in reverse: by the first three months of this year, household net worth had dropped to $421,000.

“Not only have people lost money, but they don’t expect as much appreciation in the money they have, and that should affect consumption,” said Andrew Tilton, an economist at Goldman Sachs. “This is a cultural shift going on. People will save more.”

Watch the rats

From Jesse:

"Investors Intelligence's latest survey of advisory services showed an impressive 51% bullish and a meager 19% bearish...the spread hasn't been that wide since November 2007." Alan Abelson, Barrons, Aug. 29, 2009

Next week we move into September, the riskiest month of the year for financial markets, with the federals escalating preparations for a flu pandemic, while Congress considers legislation providing a 'kill switch' on the Internet for President Obama to use in the event of 'an emergency.' There are widespread rumours of a bank holiday lasting one week after a market meltdown begins in the US, during which the banks would be restructured.

Risky times indeed, and those in the best position to know what is happening behind the scenes are hitting the exits in record numbers right now.

As TrimTabs reports , insider selling is reaching record levels, even as more speculators borrow to go long stocks. There are some obvious bubbles already formed in certain insolvent financial stocks like AIG, with disinformation rampant in the Wall Street demimonde.

The Obama Economics and Regulatory Team, in conjunction with the Federal Reserve, have accomplished no serious reform of the financial system.

And the bear says ...

(Posted over 100 days, and 100 S&P points, ago by Corey Rosenbloom of AfraidToTrade blog, it was the most bearish scenario given Elliot wave analysis -AM):

This count implies that Primary Wave 3 completed on the March Lows, and that a triangle formed for the fractal Wave 4 of Primary 3 (an interesting interpretation) and that we’re currently perhaps in Wave A up of an ABC Wave 4 that could take us up to 1,100 or even higher. However, it is ‘bearish’ because it assumes the Bear Market has many more months to complete (perhaps mid-2010 or later) and that the final target will be lower (perhaps 550 - 600).

We're more miserable than we think we are

(Get people to ask the wrong questions you don't have to worry about their answers.

At some point though doesn't it become who you going to believe me or your lyin' eyes? -AM

By Marcus Baram
08-26-09 12:48 AM
Huffington Post

Things are still pretty miserable for millions of Americans, according to the latest update of Huffington Post's Real Misery Index.

The index for July 2009 was 29.2, a slight decrease from June's 29.9, the highest number in the 25 years analyzed by the Huffington Post. (Second derivative, buy buy buy. -AM)

Compared to June, the rate of inflation declined slightly, with smaller year-over-year increases in prices for food and medical care. But that good news was offset by other factors such as a rise in food stamp recipients and continuing home equity delinquencies.

To formulate our index, which provides a better snapshot of the economy than the often-criticized misery index (inflation added to unemployment), we used a more accurate unemployment statistic (the U6 formulation), with the inflation rate for three essentials (food and beverages, gas, medical costs), and year-over-year percent changes in credit card delinquencies, housing prices, food stamp participation, and home equity loan deficiencies. We gave equal weight to the broad unemployment numbers and the combination of the other seven metrics (with housing prices having an inverse relationship to the index). Thus, we added the broad unemployment U6 statistic (note: the current U6 was first introduced in 1994 so we used a similar number - the U7 - for the years 1985-1993) to the average of the seven other statistics.

(Can you imagine a world where we actually had officially sanctioned fact-based statistics? -AM)

For the current update, we've included the index for every year going back to 1985, the last year for which all the statistics were available, in a chart and graph.

At this stage in the recession, almost everyone is wondering if the economy has really hit bottom and whether the recovery has truly begun. Last week in a speech to other central bankers, Fed chair Ben Bernanke said "The economic recovery is likely to be relatively slow at first, with unemployment declining only gradually from high levels."

And indeed, most indicators paint a bleak picture: Highest percent of foreclosures in three decades, slower-than-anticipated growth in GDP and the looming double-digit unemployment numbers.

One point of confusion is the recent rise in the Dow, despite the lingering economic malaise. Part of that is due to economic indicators meaning different things on Wall Street and Main Street. For example, rising unemployment may mean layoffs at companies that improve their bottom line.

"Our markets can be ahead of the pace of the recovery," says Art Hogan, director of Global Equity Product at Jefferies & Co. investment bank. "You get a lot of head-scratching from commentators that the market keeps going up but news doesn't correspond to it. It's an order of magnitude. People are looking across the valley and seeing that things could get better."

But for most Americans, the outlook remains gloomy and a vicious cycle continues - as more lose their jobs, more fail to keep up with mortgage payments and some fall into poverty, forced to take public assistance.

(Henry Ford was right when he said he had to pay his employees enough to buy his product. 500,000+ new claims cheered, an incredibly large number if you just stop and consider reality.-AM)

Thursday, August 27, 2009

Anonymity is like a warm blanket

(From the mouth of imaginary characters come the pure unadulterated truth. Sending this to Mom right now.-AM)

Minyanville's Mr. Practical:

There's great debate about inflation versus deflation. Most who are buying stocks aren't doing so because they see good fundamentals, but are doing so because they're worried about inflation. Clearly the Federal Reserve is doing “unconventional” things (perhaps I should use better words such as crazy and irresponsible) which have a lot of people worried about a crashing dollar.

In order to clarify my position, I want to describe to you some mechanics of Federal Reserve operations, the wizardry behind the curtain. I recommend you send this to all of your friends so they can decide for themselves. This is long and tedious, but I think worth it.

The Federal Reserve is a private bank, albeit special. It has shareholders that care about profits and risk. These aren’t normal shareholders, but other banks or the boards of those banks. The Fed was given certain powers by Congress in 1913 to regulate the money supply of the US. That benign-sounding statement has vast implications on capitalism and liberty itself.

Capital can be loosely defined as wealth, unencumbered assets of various forms like cars, buildings, manufacturing plants, and land. Capital is created through productive processes that lower costs, develop new technologies, and raise living standards.

An example of a productive process might be one of specialization. Two farmers grow their own food, make their own clothes and cut down their own firewood. It takes each 15 hours a day to do all this work. They realize one has better land and the other one makes better clothes so they barter to exchange goods. This bartering results in each working only 12 hours a day. One farmer can then take the extra time and sew more clothes and thus barter it with another farmer for more firewood. The extra clothes can be described as “capital” that can be used to raise living standards. Capital can only be created through the production process.

In today’s world, non-liquid wealth in the form of hard assets can be converted into something called money. Money is merely a medium of exchanging hard assets. Money is the liquid form of wealth in only this sense: it is a store of wealth only based on this exchange value. You can’t eat or drink or live in money. Hard assets have a price in dollars to convert them to liquid money.

There's always a defined amount of wealth at any one time in the world, as created by productive processes that increase living standards. This is the real pool of savings. The more production, the more wealth is created. This is a very important statement as you will see later.

Capital can be lent to a borrower. Someone with capital would forgo its use in the present to generate a return. Normally capital is converted to money to be lent. The price of money is an interest rate, how much one charges to use the money.

It makes sense that only those with capital can lend it. Someone can borrow capital from someone else and then lend it to another, but it all starts with the person with capital.

The first red flag is this then: A government, which has no capital of its own, which produces nothing on its own, cannot lend money unless it borrows that capital from another or takes that capital in the form of taxes (but taxpayers must have capital to pay taxes).

The Fed controls interest rates (to a certain extent in normal situations; to a large extent in special situations) to influence the demand and supply of money. Again this innocuous-sounding statement has vast implications. Here is how it works:

There are times in an economy when those with capital don’t want to lend it. It almost always is a time when they see too much risk for too little return.

If we have too many condos in Florida those with capital say I don’t want to lend money to build more condos because there is too high a risk that they won’t sell and I won’t get my money back. So they raise the price of money; they raise the interest rate they charge to compensate for too much risk.

This is how an economy naturally controls itself. It’s called capitalism: the allocation of capital based on risk and return.

When this happens, when an economy has overcapacity, when it has built too many strip malls and lenders restrict the supply of money as a consequence, the economy may temporarily slip into slower growth or even negative growth. But notice this is not a bad thing because the economy is nipping in the bud overcapacity. Why build things if they aren't productive? But the important point is it leaves capital available for a productive process that come along and makes sense to the lender.

Now for several reasons, like political influences, over the last 20 years or so the Fed has taken the stance that any and every recession (caused by lenders raising the price of money) is unacceptable. When lenders (those with capital) want to raise rates, the Fed lowers them to stimulate borrowing and lending by “speculators”: lenders who don’t have their own capital.

Because we already know that lenders with their own capital don’t see productive uses to lend to, by definition the Fed is stimulating lending and borrowing for less productive or even unproductive uses, like building condos when we have too many condos.
How does it do this? It lowers a very special interest rate: the federal funds rate, which is the rate large banks can borrow money from the Fed through the REPO (sale and repurchase agreement) market. The Fed arranges a loan at a lower-than-market rate to a large bank like JP Morgan (JPM). At the lower rate, JP Morgan will earn a higher spread, but assume a higher risk.

There are several reasons why banks have decided to take higher risks over the years. One is simply greed, but this is not enough by itself. Large banks should have been monitored by the Fed for this problem, but apparently they didn't. In fact the Fed implicitly encouraged it by doing nothing and the government explicitly encouraged it through quasi-government entities like Fannie Mae (FNM) and Freddie Mac (FRE), which constantly bought and guaranteed mortgage debt.

So let’s look at an example: JPM decides at an interest rate spread created by the Fed that they're willing to lend money out to build extra condos. They execute a $5 billion repo with the Fed: the Fed makes a credit entry on JPM’s books for $5 billion and JPM delivers t-bills as collateral. The Fed’s balance sheet grows by $5 billion and JPM has $5 billion of fresh “money” on its balance sheet. Where did the Fed get this “money”? Well, from nowhere, it was created out of nothing, out of leverage.

The $5 billion just entered what is called a fractional banking system. A bank only needs to keep a small amount of that REPO as capital and then can lend out the rest.

Before 1987, let’s say, JPM had to keep $0.18 (4.5 x leverage) for every dollar it lends out as capital. Alan Greenspan lowered margin requirements at banks in response to the 1987 crash and never raised them back. So now JPM only had to keep $0.09 as capital (10 times leverage).

Then in the 1990s, derivatives, which offer huge leverage, became the new conduit for liquidity, estimated at creating 80% of all leverage in the system. How do they do that?

A simple example: Let’s say you want to buy a stock. Reg T says you have to put up 50% in cash to buy it. Instead, if you go to your friendly broker he can enter into a performance “swap” with you: if the stock goes up $1 he will pay you $1 and if the stock goes down $1 you pay him. But to do that derivative, which has the exact same economics of owning the stock, he makes you put up only 0.25% -- basically nothing.

In this case, the broker (which in today’s world is a bank) effectively lent money with almost no margin requirement. In the same way interest rate derivatives, which have the same economic risks as loans, are vast on banks’ balance sheets.

The latest estimate of total derivatives worldwide is about $600 trillion. If those derivatives are mismarked by only 1%, that's $6 trillion in potential losses.

So through derivatives, banks and quasi-financial companies like General Electric (GE) were able to achieve leverage levels unheard of. Instead of $0.09 it became $0.03, or 32 times leverage!

JPM as a primary dealer doesn’t lend directly to condo buyers, they lend to regional banks. So JPM has to keep 3%, or $150 million, as capital and then can lend $4.85 billion to a regional bank. In turn that regional bank can lend $ 4.7 billion to another. In this way the original $5 billion in new credit issued by the Fed works its way down through the banking system eventually to consumers and creates $4.85 billion/ (1-0.97) = $162 billion of new credit in the system. In this way the Fed created $4.5 trillion in new credit in 2006 with very little expansion of their own balance sheet.

All that credit fueled the housing boom. All that credit expanded the money supply or liquidity pool vastly by adding huge amounts of consumer/mortgage debt: the money supply grew from $8 trillion in 1987 to $750 trillion in 2006.

Did we have a 100 fold increase in our standard of living? Of course not. So real wealth or capital did not grow even a fraction as much as the amount of money/debt in the system.

I am now going to introduce a new term: moneydebt.

The process I just described is what people refer to as printing money. But notice the Fed is not really printing new dollar bills, they are creating new debt.

This is my definition of inflation: inflating the money supply with debt. When they create new debt (from nothing) they are creating dollars that the debt is denominated in. When you create more dollars you devalue them. When you devalue dollars, prices of things (including stocks) rise because price is how many dollars it takes to buy something.
Because inflating the money supply with debt almost always leads to higher prices, people think of inflation as rising prices.

Moneydebt as a measure of wealth as I referred to earlier is a non-sequitur. The Fed can print (the process I just described) as much as it wants as long as there is a willing borrower and lender. But here is the key: without either, the Fed cannot print high-powered moneydebt.

What happened to the fractional banking system? In mid-2008, when the president went on TV and said we have to bailout the banks, very simply banks were so levered they ran out of treasuries as collateral. They couldn’t lend anymore.

To stop the rapid deflation that was ensuing (deflation is the destruction/reduction in credit; deflation unwinds a massive inflation which is the creation of credit just described), the Fed invented the Troubled Asset Relief Program (TARP): It began accepting other forms of debt stuck on the balance sheets of the banks (such as mortgage debt and their derivatives) as collateral and gave treasuries back to the banks.

This was not printing moneydebt, this was just exchanging bad debt for good debt on the balance sheet of the Fed. This worries its shareholders, but they know where their bread is buttered. They are willing to do this up to a point.

Since then, we have had all types of programs and stimulus. But in my opinion none are highly inflationary (creating vast amounts of moneydebt): You need a fractional banking system to do that.

The Fed has monetized (quantitative easing): It created moneydebt from nothing to buy treasuries in order to keep interest rates lower than the market wants them. In fact, they're doing this as we speak: secretly telling dealers they will buy treasuries after auctions. So far they have monetized (printed dollars) around $250 billion this way.

This is only marginally negative for the dollar because it is not going through the fractional banking system. It is dwarfed by the amount of debt being forfeited/paid back with lots more to come.

The Fed would need to do a tremendous amount of monetization by buying up vast amounts of existing debt for it to devalue the dollar in a great way. The Chinese don’t want to see this and, I believe, have made this very clear to the Fed.
In addition, the Fed’s custody account is swapping agency debt owned by foreign central banks for treasury debt, something they promised to do when they backed FNM and FRE debt.

This could amount eventually to $8 trillion and all the guaranteeing of bank debt could amount to another $15 trillion. In this way, the Fed essentially controls the swap and London Interbank Offered Rate (LIBOR) markets.

But again, this is merely plugging existing holes: the Fed is merely exchanging various forms of moneydebt for other forms. This is what Japan did for a decade. Although egregious, this is not new news.
The Fed is having a great deal of trouble devaluing the dollar because there is just so much debt out there that needs to be supported: There is not enough income being generated by the economy so it is defaulting. This is why the banks are being force fed profits by an artificially steep yield curve, to subsidize future losses on debt write-downs. And this is why they are not lending out the vast reserves created by profits at taxpayer expense.

I still believe there is something like $8 trillion to $12 trillion in debt to be written down. It’s possibly more if the government continues down the path of supporting moneydebt at bad prices.

When moneydebt is destroyed by forfeitures, the dollar is being destroyed. When the dollar is being destroyed it rises in value. When the dollar rises in value relatively prices go down.

This is exactly what the market wants, for prices to go down. When prices go down, real savings/capital is released as the risk for reward dynamics become more favorable. This is exactly what the government doesn't want. They want to subsidize debtors by keeping prices and collateral values high. It’s a fool’s journey.

High Indecision at the Bullisht Corral

Afraid to Trade blog
By Corey Rosenbloom, CMT

I’ve been mentioning over the week that the S&P 500 (and other US Stock Market Indexes) were forming dojis at their upper Bollinger Band lines on the daily charts.

As of Wednesday, we formed the dreaded “Tri-Star Doji” pattern which was last seen at the July 2009 lows prior to the 150 point rally in the S&P 500 into August.

This is a quick mid-day post, so let’s be sure to take a look at how the market closes today for confirmation, but for now, this is a bearish non-confirmation of higher prices as we challenge the upper Bollinger Band on three doji patterns, as well as a negative volume and momentum divergence.

Still no guarantee of a reversal, but odds seem overwhelming to favor a downside move.

(The upper bound looks like 1044 on a M and A top, per Jeff Cooper. My worse case is the A team doesn't have a problem paying no mind to the gap and going to the next Fib level. But the cycles are suggesting no ... we'll see. -AM)

The last bear capitulates

(At this moment,at the oft-heralded 'end of the recession', where housing and employment are showing signs of stabilization, where economies are whispering about 'exit' strategies and the models are showing zero chance of fail... may I humbling request that the last bagholder screw in the light?

The future is so bright I have to short shades. -AM

Posted by Neil Hume on Aug 27 10:29
FT Alphaville

Some burnt fingers round at RBS on Thursday.

In his last note before jetting off to Barbados for his summer vacation, RBS strategist Bob “The Bear” Janjuah told clients that if the S&P 500 closed above 1,022 for four consecutive days he would concede that the lunatics were now running the asylum and close his short position

(Bob you should have kept that QT, they did it to you on purpose. -AM) :

'In order to protect against this fear, that policymakers can’t bring themselves to do the right thing and instead do the short-term thing AGAIN, with no heed to the l-t consequences as a result, then sensible Stop Losses are needed. I will go with the same Stop Loss I set out below on 5th June. So, if the S&P cash index closes ABOVE 1022 for 4 consecutive days, I will be stopped out and it will very likely be the case that policymakers are going the ’shrt-term next bubble’ money illusion/nominal route rather than the longer term route which would be more painful shrt term but which will pave the way for the next 20yr boost to real productivity and real wealth gains.'

After holding firm last night, the S&P has now achieved that goal and it has fallen to Bob’s sidekick Andy Chaytor to close the bear and reluctantly put on a tactical bullish trade - for the next month or so.

(The last bear capitulates. -AM)

Models and bottles

Hoisington Investment Management via Mish

One of the more common beliefs about the operation of the U.S. economy is that a massive increase in the Fed’s balance sheet will automatically lead to a quick and substantial rise in inflation. [However] An inflationary surge of this type must work either through the banking system or through non-bank institutions that act like banks which are often called “shadow banks”. The process toward inflation in both cases is a necessary increasing cycle of borrowing and lending. As of today, that private market mechanism has been acting as a brake on the normal functioning of the monetary engine.

{The demand restoration project is not working yet.-AM)

For example, total commercial bank loans have declined over the past 1, 3, 6, and 9 month intervals. Also, recent readings on bank credit plus commercial paper have registered record rates of decline. The FDIC has closed a record 52 banks thus far this year, and numerous other banks are on life support. The “shadow banks” are in even worse shape. Over 300 mortgage entities have failed, and Fannie Mae and Freddie Mac are in federal receivership. Foreclosures and delinquencies on mortgages are continuing to rise, indicating that the banks and their non-bank competitors face additional pressures to re-trench, not expand. Thus far in this unusual business cycle, excessive debt and falling asset prices have conspired to render the best efforts of the Fed impotent.

(Liquidity trap, using models predicting inflation expectations that are well anchored will result in inflation ... until of course its anchors aweigh, i.e pre 1993 America or the 90s Japan ... what could go wrong? -AM)

The link between Fed actions and the economy is far more indirect and complex than the simple conclusion that Federal asset growth equals inflation. (Credit weasling at the Federales laundromat is a shell game. -AM) The price level and, in fact, real GDP are determined by the intersection of the aggregate demand (AD) and aggregate supply (AS) curves. Or, in economic parlance, for an increase in the Fed’s balance sheet to boost the price level, the following conditions must be met:

1) The money multiplier must be flat or rising;
2) The velocity of money must be flat or rising; and
3) The AS or supply curve must be upward sloping.

The economy and price changes are moving downward because none of these conditions are currently being met; nor, in our judgment, are they likely to be met in the foreseeable future.

Total U.S. debt as a percent of GDP surged to 375% in the first quarter, a new post 1870 record, and well above the 360% average for 2008. Therefore, the economy became more leveraged even as the recession progressed.

An over-leveraged economy is one prone to deflation and stagnant growth. (Thank you, drive through.-AM)

While the Japanese increased leverage for nine years after the bubble highs, neither highly inflated stock and real estate prices nor economic performance could be sustained as debt repayment became more burdensome.

In several years, real GDP may be no higher than its current levels. However, since the population will continue to grow, per capita GDP will decline; thus, the standard of living will diminish as unemployment rises. These conditions will produce a deflationary environment similar to the Japanese condition.

Presently the 10-year yield in Japan stands at 1.3%. Ultimately, our yield level may be similar to that of the Japanese.

(Paging Dr. Rosie. -AM)

(And of course the hyperinflationary argument is that the Federales will blow out the doors in an effort to make reality fit the models. Models and bottles. -AM)

The bottom line is that private debt-based growth is simply not possible, whereas any "growth" we do experience will be as a result of incremental government borrowing and spending, most of which will be in the form of war spending, bailouts, and social service transfers at very low GDP multiplier.

Wednesday, August 26, 2009

At no time do my hands leave my arms

Sunday, August 2, 2009

Since the start of 2009 and continuing through the month of May, private investors sold $364 billion dollars worth of US assets, while central banks purchased $50 billion dollars worth. (TIC report)

During this past business week (July 27th - 31st, 2009), the US Treasury auctioned off more than $243 billion worth of various Treasury bills and bonds. "Indirect bidders," assumed to be mainly central banks, took an astonishing 39% of the total, or nearly $95 billion worth.

Wait a minute, thought we just talked about how the TIC report said that foreign central banks have only bought $50 billion in total US paper assets through May - and now they are said to be buying $95 billion during a single week in July alone?

Something is not adding up here.

To understand what, and to get to the essence of the shell game, we need to visit one more source of information - something called the Federal Reserve Custody Account.

It turns out that when China's central bank (or any other foreign central bank) decides to buy either US agency or Treasury bonds, they do not walk up to some window somewhere, hand over a pile of cash, and then take some nice looking bonds home with them in a suitcase.

Instead, what happens is that the Federal Reserve actually holds the bonds (or rather an electronic entry representing the bonds) in a special account for these various central banks. This is called the "Custody Account" and it holds US debt 'in custody' for various central banks. Think of it as a magnificently vast brokerage/checking account, run by the Federal Reserve for central banks, and you'll have the right image.

The custody account currently stands at $2.787 trillion (with a "t") dollars. It has increased by over $430 billion the past 12 months and by more than $275 billion in 2009 alone (through July 29). These are truly shocking numbers, and they tell us that foreign central banks have been accumulating US debt instruments throughout the crisis.

There has been absolutely no deflection in the growth of the custody account as a consequence of the financial crisis, bottoming trade, or the local needs of the countries involved. It's almost as if the custody account is completely disconnected from the world around it. We might wonder what sorts of distortions are created by having such a massive monetary spigot aimed from several central banks towards a single country. We also might question just how sustainable such an arrangement really is.

Despite everything that's been going on, the custody account is on track to grow by the largest dollar amount on record this year, nearly $500 billion dollars (if the current pace continues). Where is all this money coming from and for how much longer?

The TIC report only shows $50 billion in foreign bank inflows for 2009, while the custody account grew by $277 billion.

How is it possible for the TIC report to show smaller inflows than growth in the custody account? One explanation is that the custody account, at some $2.7 trillion dollars, is accumulating a lot of interest. If those interest payments are not "sent home" and remain in the account, then the account will grow by enough to more or less explain the difference. For example, the $135 billion difference shown above could be generated by a 5% return to the custody account, which is not an unthinkable rate of interest for that account.

In this game, Central Bank A prints up a bunch of money and buys the debt of Country B. Then the central bank of Country B prints up a bunch of money and buys the debt of Country A.

When we dig into the custody account data, we find that the total picture is hiding something quite extraordinary. Even as the total custody account has been growing steadily and faithfully, the composition of that account has been changing dramatically.

Here we note that agency bonds peaked in October of 2008 at nearly a trillion dollars but have declined by $178 billion since then. Treasuries, on the other hand, have increased by over $500 billion over that same span of time. A half a trillion dollars! If you were wondering how the US bond auctions have managed to go so smoothly, here's part of your answer.

What is going on here? How is it possible that central banks are buying so many Treasury bonds, at the fastest rate of accumulation on record?

It would appear that foreign central banks have been swapping agency bonds for Treasury bonds, but that's not how the markets work. First, they would have to sell those bonds, before they could use the proceeds to buy government debt. So to whom did they sell those Agency bonds in order to afford the Treasury bonds?

Here we might recall that the Federal Reserve has been buying agency bonds by the hundreds of billions.

These are the three critical points to remember :

The US government has record amounts of Treasuries to sell.

Foreign central banks, which have a big pile of agency bonds in their custody account, would like to help but want to keep things somewhat under the radar to avoid scaring the debt markets.

The Federal Reserve does not want to be seen directly buying US government debt at auctions (and in fact is not permitted to, but many rules have been 'bent' worse during this crisis), because that could upset the whole illusion that there is unlimited demand for US government paper, but it also desperately wants to avoid a failed auction.

For various reasons, the Federal Reserve cannot just up and start buying all the Treasury paper that becomes available in record amounts, week after week, month after month.

Instead,it uses this three-step shell game to hide what it is doing under a layer of complexity:

Shell #1: Foreign central banks sell agency debt out of the custody account.

Shell #2: The Federal Reserve buys those agency bonds with money created out of thin air.

Shell #3: Foreign central banks use that very same money to buy Treasuries at the next government auction.

Looks like more ponies

Posted by Stacy-Marie Ishmael on Aug 26 16:59.
FT Alphaville

Back in April, the Federal Reserve released the methodology for its stress-testing (scratch that, IQ testing-AM) of the major US financial institutions. The Fed’s models included a “baseline” scenario for economic conditions in the US and a “stressed” scenario:

The baseline assessment averages the projections published by Consensus Forecasts, the Blue Chip survey, and the Survey of Professional Forecasters. It assumes a 2.0% GDP decline in 2009 and a 2.1% GDP gain in 2010, unemployment reaching 8.4% in 2009 and 8.8% in 2010, and house prices falling 14% in 2009 and 4% in 2010.

Supervisors also compiled a more “severe but plausible” scenario, which assumes a 3.3% GDP decline in 2009 and 0.5% GDP gain in 2010, unemployment at 8.9% in 2009 and 10.3% in 2010 and house prices down 22% in 2009 and 7% in 2010.

And as Bank of America Merill Lynch analyst Hans Mikkelsen noted on Wednesday, reality is fast catching up with even the more adverse scenario:

The Congressional Budget Office (CBO) and the White House (Office of Management and Budget) issued updated budgets with large deficits for the coming years.

In terms of underlying economic assumptions both now expect unemployment rates consistent with the more adverse stress scenario of 8.9% in 2009 and 10.3% in 2010 used in the Fed’s bank stress tests concluded as recently as early May.

The future's so bright I've got to short shades

Quantifiable Edges blog via Seeking Alpha
by Rob Hanna
August 26

Some extreme readings are appearing in a few Worden Bros. indicators that look at stocks relative to their 200 day moving averages. One is T2107, which simply looks at the percentage of stocks trading above their 200ma. The other is T2109, which looks at the percentage of stocks trading at least 1 standard deviation above their 200ma. Both indicators are near all time highs (dating back to 1986). In fact, the only period of time in which these indicators registered higher readings was in the beginning of 2004. Above is a chart of T2107 which illustrates this.

Paging Dr. Faber Dr. Grant Dr. Faber

Dennis P. Lockhart
President and Chief Executive Officer
Federal Reserve Bank of Atlanta
August 26

The views I will express today are mine alone and do not necessarily reflect those of my colleagues on the Federal Open Market Committee (FOMC).

...As regards inflation, with continuing economic weakness and financial uncertainty, firms have very little pricing power. Headline inflation has fallen in part because of lower oil prices compared with a year ago. Core measures of inflation excluding food and energy costs also have been drifting lower. Looking ahead, I expect inflation will remain contained. (Until it isn't in a big way.-AM)

With respect to growth, my forecast envisions a return to positive but subdued gross domestic product (GDP) growth over the medium term weighed down by significant adjustments to our economy. Some of these adjustments are transitional in the sense that they impede the usual forces of recovery. Among these are the rewiring of the financial sector and the need for households to save more to repair their balance sheets.

Some of these adjustments, however, are more "structural" in nature. By this, I mean that the economy that emerges from this recession may not fully resemble the prerecession economy. In my view, it is unlikely that we will see a return of jobs lost in certain sectors, such as manufacturing. In a similar vein, the recession has been so deep in construction that a reallocation of workers is likely to happen—even if not permanent. I'll discuss manufacturing and construction a bit more in a moment.

This recession has had a severe impact on employment in various ways: jobs, furloughs, and number of hours worked. For example, the average manufacturing workweek has fallen below 40 hours for the first time since 1983. And the number of workers employed part-time for economic reasons has increased more in this recession than in any since the Bureau of Labor Statistics (BLS) started tracking that information.

If one considers the people who would like a job but have stopped looking—so-called discouraged workers—and those who are working fewer hours than they want, the unemployment rate would move from the official 9.4 percent to 16 percent.

The higher share of part-time employment arguably gives employers a means to increase work hours without adding to the overall number of full-time workers. Businesses seem inclined to defer hiring and focus on productivity until a sustained pick-up in top-line demand is beyond doubt.

Firms always have incentives to improve efficiency and keep a lid on costs—including labor costs. The last two recoveries have involved unusually long periods of GDP growth accomplished through productivity gains instead of employment growth. At this point, there is scant evidence that the coming recovery will break that pattern.

( Controlling the means of production by controlling the meaning of production. -AM)

If my prognosis for the broad economy is correct, the pace of job restoration and growth through the medium term will be frustratingly slow. So, what can be done to address the prospect of high unemployment and underemployment? (Jobless recovery is an oxymoron. -AM)

Further fiscal stimulus has been mentioned, but the full effects of the first stimulus package are not yet clear, and the concern over adding to the federal deficit and the resulting national debt is warranted.

The FOMC has stated its intention to keep the policy interest rate low for an extended period. I agree that this approach is needed. This policy stance should encourage more business activity and facilitate more hiring.

No policy is certain to improve outcomes, and no policy is without risks. The challenge my colleagues and I face is navigating between the risk that early removal of monetary stimulus snuffs out the recovery and the risk that protracted monetary accommodation stokes inflation expectations that could ultimately fuel unwelcome inflationary pressures. (Paging Dr. Faber, Dr. Grant, Dr. Faber. -AM)

Tuesday, August 25, 2009

And now for something completely different

Via Minyanville

Anchors aweigh my friend ...

Stand Models out to sea
Fight our battle cry
We’ll never change our course
So vicious foe steer shy.

SF Fed via King Report:

The worsening global recession has heightened concerns that the United States and other economies could enter a sustained period of deflation, as did Japan in the 1990s and the United States during the Great Depression. Indeed, a popular version of the well-known Phillips curve model of inflation predicts that we are on the cusp of a deflationary spiral in which prices will fall at ever-increasing rates over the next several years. A sizable and persistent deflation would likely worsen already very difficult global economic and financial problems. Macroeconomic forecasters, however, generally view such a dire outcome as highly unlikely. The most recent Survey of Professional Forecasters (SPF) puts only a 1-in-20 chance of core price deflation this year or in 2010. Are we on the brink of years of deflation, or are the professional forecasters right? This Economic Letter examines the risk of deflation in the United States by reviewing the evidence from past episodes of deflation and inflation.

The Phillips Curve and the risk of a deflationary spiral

A useful framework for examining the behavior of inflation and the risk of deflation is provided by the Phillips curve model. This theory posits that the inflation rate depends positively on the expected rate of inflation and negatively on the degree of slack in the economy, as measured, for example, by the difference of the unemployment rate from its equilibrium level. For this discussion, it is useful to distinguish between two variants of the Phillips curve model that differ in how expectations are formed. In the first, "unanchored" Phillips curve model, expected inflation rates are assumed to depend primarily on past inflation rates. That is, people expect inflation in the future to be about what it was in the recent past, say the past year or two. In this case, inflation expectations are said to be "unanchored," in that they move around with actual inflation like a boat being pulled to and fro by the waves. As discussed below, this model does a good job of describing inflation in the United States for much of the postwar period and is therefore a popular model of inflation in the United States.

If inflation expectations are unanchored, then a severe recession can lead to a deflationary spiral. The logic is as follows: In the early stage of recession, the emergence of slack causes the inflation rate to dip. The resulting lower inflation rate prompts people to reduce their future inflation expectations. Continued economic slack causes the inflation rate to fall still further. If the recession is severe and long enough, this process eventually will cause prices to fall and then spiral lower and lower, resulting in ever-faster deflation rates. The deflation rate stabilizes only when slack is eliminated. And inflation turns positive again only after a sustained period of tight labor markets.

The second model is one where inflation expectations are "well anchored" in the sense that they are consistent with the goals and policies of the central bank. In this case, even in a severe recession, people expect the central bank to take policy actions (It is of course at all times just a confindence game. -AM) that will restore a positive rate of inflation, and this expectation acts as a magnet pulling prices up. Although deflation will occur if the extent of slack is sufficiently large, a deflationary spiral only develops in the direst circumstances in which monetary policy is incapable of righting the economy (see Reifschneider and Williams 2000).

These two versions of the Phillips curve model--one in which inflation expectations are well anchored and the other in which they are not--have very different implications for the likelihood, severity, and duration of deflation. In the end, which version better describes the behavior of inflation is an empirical question. To answer it, we turn to evidence from history.

The Great Depression

The natural starting point for a discussion of deflation is the U.S. Great Depression of the 1930s. The duration and magnitude of the declines in economic activity and prices during the Depression were astounding. Between 1929 and 1933, real gross domestic product per capita plummeted by nearly 30% and the unemployment rate soared from about 3% to over 25%. The consumer price index (CPI) plunged by nearly 25%, with the rate of deflation exceeding 10% in 1932.

A striking pattern during the Depression and the decade leading up to it was a strong and stable negative relationship between the price level and the unemployment rate. The CPI and the unemployment rate were relatively stable during the 1920s. But, during the first four years of the Depression, the CPI plunged as the unemployment rate soared. That prices fell during the early part of the Depression is consistent with either version of the Phillips curve model of inflation. What is surprising is that the CPI then rose steadily from 1934 through 1937, despite the unemployment rate averaging over 18% during that period.

(Inflationistas will be correct in the long term, but its' from a much lower level methinks. -AM)

Analysis of the relationship between prices and unemployment during the 1920s and the Depression indicates that the inflation rate was closely linked to the change in the unemployment rate, rather than the level of the unemployment rate. That is, when unemployment was rising, prices fell, and when unemployment was falling, prices rose. This finding indicates that inflation did not fall into a deflationary spiral as would be expected if inflation expectations were not well anchored. Instead, deflation lasted only while the economy was getting worse and turned to positive inflation once the unemployment rate stabilized.

What explains this relationship between prices and unemployment? As discussed by Ball (2000), the behavior of inflation depends critically on monetary policy and the ways that policy affects inflation expectations. The United States was following the gold standard at the onset of the Depression, a policy that produces a relatively stable price level over long periods. After falling 25% in the early part of the Depression, prices were well below their "normal" level of the past. One interpretation of the outbreak of positive inflation between 1934 and 1937 was that people expected that prices would eventually rise again from abnormally low levels, and this expectation helped push the inflation rate into positive territory, despite the very high unemployment rate.

Japan's lost decade

Inflation dynamics today are likely to be very different than they were during the 1920s and 1930s. Among other reasons, the United States and other countries no longer adhere to the gold standard. Instead, they generally follow policies aimed at maintaining low, positive inflation rates rather than stable price levels.(Don't you love it when they just come on out and say how they redistribute wealth from the renters to the owners?-AM)

Japan provides recent evidence of what can cause sustained deflation. Core consumer price inflation in Japan averaged a little over 2% during the 1980s and the first half of the 1990s. Following the bursting of the Japanese housing and stock market bubbles, the economy tumbled into a lengthy recession, with the unemployment rate rising to nearly 5-1/2%, about three percentage points above its prior long-run average. Nine straight years of core CPI deflation followed. The anomalous spike in the inflation rate in 1997 resulted from an increase in the value-added tax that boosted consumer prices that year. Interestingly, despite the relatively high rates of unemployment in Japan during the past 10 years, a downward deflationary spiral did not ensue. Statistical analysis confirms that inflation in Japan is not described well by the unanchored Phillips curve model. Instead, inflation expectations appear to have been reasonably well anchored despite the prolonged period of deflation and high unemployment.

The here and now

The deflationary episodes in the United States during the Depression and more recently in Japan do not follow the pattern of a deflationary spiral predicted by the unanchored Phillips curve model (see Akerlof and Yellen (2006) for related evidence from other countries). We now turn to evidence from the United States during the postwar period. Unlike the two deflationary episodes described above, this model does a good job of describing the relationship between U.S. inflation and unemployment over the past 50 years.

In the current recession, this model predicts that, with unemployment remaining very high, core inflation will fall steadily over this year and next, with deflation occurring in 2010. This forecast uses the most recent SPF unemployment projection and a Phillips curve model based on the historical relationship between inflation and unemployment from 1961 to 2008. The SPF forecast is for the unemployment rate to rise to 9% early next year and then edge down during the remainder of 2010. According to this model, the high degree of slack in labor markets pushes the core personal consumption expenditures price index (PCEPI) inflation rate down from 1.9% in 2008 to 0.3% in 2009, and down further to a deflation rate of 0.8% in 2010. Based on this forecast and the historical average of core PCE inflation forecast errors reported in Reifschneider and Tulip (2007), the estimated probability of deflation is about 30% for 2009 and 85% for 2010.

(Holy suck the liquidity right out of the flippin room inflationistas! -AM)

This forecast is based on the "average" behavior of inflation over the past five decades, which includes both periods when inflation expectations were reasonably well anchored, such as the past two decades, as well as periods when they clearly were not, such as the late 1960s and the 1970s (see Orphanides and Williams 2005). As discussed by Williams (2006), the behavior of inflation over the past 15 years differs markedly from that in the preceding quarter century. A Phillips curve model estimate using data since 1993 is consistent with well-anchored inflation expectations and precludes the emergence of a deflationary spiral. Indeed, over the past 16 years, the U.S. inflation rate is negatively related to the change in the unemployment rate, rather than its level, similar to the pattern seen in the data from the 1920s and 1930s (see Gorodnichenko and Shapiro (2007) for related evidence).

The forecast from this model, again using the SPF forecast for unemployment, shows core PCE price inflation slowing to 1.1% this year, but then rising to 1.6% in 2010. The estimated probability of deflation based on this forecast is about 3% in each year.

(Models and bottles babe. Vuja de non! -AM)

This inflation forecast is nearly identical to the SPF forecast of 1.1 and 1.5% inflation in 2009 and 2010, respectively, and the estimated probability of deflation from the model forecast is roughly in line with those reported by SPF forecasters.

Evidently, professional forecasters view the experience of the recent past as more relevant for forecasting than that from the more distant past.

Forecasters appear to be convinced that the Federal Reserve would not be content with sustained deflation and would take policy actions to restore a positive rate of inflation. This contrasts with the 1970s, when forecasters were concerned that the Fed would tolerate high rates of inflation.

This analysis highlights the central roles of economic slack and inflation expectations in the risk of deflation over the next several years.

The evidence indicates that a substantial increase in slack can lead to deflation, but the depth and duration of the deflation depends on how well anchored inflation expectations are. Two policy implications can be drawn from this and other research on deflation. First, a central bank should take appropriate actions to stem the emergence of substantial slack in the economy and thereby reduce the risk of deflation. Second, it should clearly communicate its commitment to low positive rates of inflation. An example of such communication is the Federal Open Market Committee's recently released long-run inflation forecasts. Such words, backed by appropriate actions, reinforce the anchoring of inflation expectations and reduce the chances of a deflationary spiral.

John C. Williams
Executive Vice President and Director of Research

Yanks bung them rats and mice.

(Why does the MSM foreign press present the most cogent analysis of our cooking? -AM)

By Edward Hadas
Published: 11:53AM BST 24 Aug 2009

In a speech to the global conference of central bankers at Jackson Hole, Wyoming, the leading member of the profession blamed investors for the crisis and praised - would you believe it? - central bankers for their response.

The Bernanke narrative starts by glossing over a big mistake. Last year's meeting occurred weeks before the collapse of Lehman Brothers, which precipitated the biggest financial collapse in close to a century. Bernanke casually excuses this blindness, saying "we could not fully appreciate" what was coming a few weeks later.

As far as he is concerned, the reason things got so bad so fast was that investors freaked out. The crisis showed "some features of a classic panic".

This characterisation of the crisis conveniently lets forecasters off the hook. Mood swings, after all, are unpredictable.For Bernanke, central bankers were the heroes. In the face of irrational hordes, they offered liquidity and a host of innovative policies, ensuring that financial panic did not lead to a new Great Depression. In Bernanke's word, "the outcome could have been decidedly worse".

His assessment isn't exactly wrong. But as a historical record it is incomplete and far too generous to central bankers.

One reason the Fed and its peers did not anticipate the financial blaze is that they misunderstood the system's chemistry. Their own boom-time policies were an incendiary cocktail. A full account of the crisis would lay blame on interest rates kept too low for too long, poor supervision of lending and an excessively indulgent attitude towards financial innovation.

Those who spread kerosene should not take too much credit for putting out fires. The past errors suggest Bernanke is premature in praising the central bankers' decisive response. With ultra-low policy rates and extensive market support, central banks have entered unknown territory.

Bad results - high inflation, a feeble recovery or even another financial crisis - could yet trigger another of Bernanke's "panics"

Beast in the East or China Anstalt

(Pick your poison...either is hemlock. My lens for the market is that news does break with the cycles and that the worst is at the bottom - as opposed to best at the top. Market action at or around October 11 or November 15th might coincide with some serious newsdays.

I keep seeing a hard sell into October 11th, a crazy flippin' rally into November 15th and a rollover. But who knows? -AM
August 25th

Aside from timing "exit strategies" as the economy strengthens, what worries central bankers? According to one, a fear behind the scenes at Jackson Hole, Wyo., was the state of Eastern Europe. His view: A "very severe problem" there could drag down a large European bank, "becoming a problem for everyone."

Monday, August 24, 2009

Hanging on the house

(Top 10% of US earners represent about 23% in consumption. They are cracking. The middle is frozen, Walmart and Kohl's are not speaking about a new normal because they like the Pimpco blog. -AM)

Calculated Risk:

This graph shows the delinquency and in foreclosure rates for all prime loans.

Prime loans account for all 78% of all loans.

Back in the 2000 to 2006 period, 45% of those delinquencies cured. Now, according to Fitch, only 6.6% cure - and a large percentage of those "cures" are modifications - and there is a large redefault rate on those loans.

Step aside and let this bear walk through

(Shortin' and snortin' since S&P 1015, position won't be done until S&P 1120 if we get there. The best trade is the one where you wish after the fact that you would have put more down. -AM)

Jeff Cooper:

Interestingly the last move down into the low in March after the first attempt at a turn up on March 4th was 57 S&P points.

From what looked like the first attempt to turn down last Monday, a similar 57 point move off the 978 is 1035/1036 S&P.

In my experience these first 'octaves' in price often prove to be notes worth watching.

Fool me once...

S&P April 15, 2008

We wrote in our last report card that we don't believe conditions in the credit markets of industrial economies will revert to the status quo ante, but we believe the spillover effects to emerging markets will be contained.

S&P August 24, 2009

The credit cycle looks set to enter its next phase, typified by the end of a recession.

Donaudampfschiffahrtsgesellschaftskapitän preparing for River Styx

(The ferryman Charon is in modern times commonly believed to have transported the souls of the newly dead across this river into the underworld, where will Merkel transport the souls of the newly unemployed after the lipstick is rubbed off? -AM)

Financial Times
By Daniel Schäfer in Frankfurt and Richard Milne in,London
Published: August 24 2009 03:00

Germany faces a potential wave of corporate restructurings, some of its top managers say, because companies have deferred job cuts to help ensure the re-election of a business-friendly government at next month's federal elections.

Senior managers and institutional investors say there has been an implicit "pact" not to announce big job cuts ahead of the September 27 ballot.

"Germany is currently protected from change. But after the elections it's normal that the messages will change," Hakan Samuelsson, chief executive of Man, the German truck and engineering group, told the Financial Times.

Business fears that a left-leaning government would increase the burden on companies.

Henning Gebhardt, head of equities at DWS, the German institutional investor, said: "There has been a tacit agreement not to slash jobs, which will be dissolved after the elections."

(A German trading partner recently told me that he has noticed several changes lately : 1) Not as many big cars on highways most new purchases seem to be for smaller and cheaper vehicles ; 2) Almost obsessive focus on economy and finance ... dominates small talk; 3) A general malaise on the big picture but satisfaction on ones' current situation with more focus on simple pleasures ... summarized by a 'could be worse' attitude... is that todays' optimism?

Appears to me that soon it will be worse. -AM

Financial Times
By James Wilson in Frankfurt
Published: August 24 2009 03:00

Several of Germany's biggest public sector banks are likely to reveal steep rises in loan loss provisions this week even as optimism grows that the country is pulling out of its economic crisis.

Rising provisions for bad loans are likely to depress the profits ... for the second quarter and put in doubt the speed of recovery in the Landesbank sector, which analysts highlight as the most troubled part of Germany's banking system.

Many analysts have warned that the worst could be yet to come for the country's corporate and banking sectors, as companies' working capital becomes scarce and corporate downgrades mean banks have to set aside more capital to cover losses.

"These potentially high loan losses mainly reflect the speed and depth of Germany's worst [post-second world war] recession," S&P said. "We consider there to be a high risk that domestic corporate and private insolvencies will rise to new post-unification highs, potentially in 2010."

If in birds, we'll need a plan, its Superflu

Two Chilean poultry farms are under quarantine after swine flu was detected in turkeys, the first case of the virus being found in birds, the nation's health ministry and US health officials said yesterday.

Scientists are concerned the virus may combine with the H5N1 bird flu virus, making a more dangerous and easily transmitted strain.

Avian flu has killed more than half the humans who caught it.

Initial tests found the birds do not have avian flu.

It has estimated that as many as 2 billion people could become infected over the next two years with swine flu - nearly a third of the world's population.

Free market capitalism sat on a wall

... and all the JackHolies are trying to put it back together again with the same glue that knocked it off the wall. -AM)

Rosie via the King Report

As for those who believe that the housing market is stabilizing should have a read of the article Improving Home Sales Belie Market Reality on the front page of the Money & Investing section of the WSJ. The reality is that sales and pricing are currently being distorted by the wave of all-cash deals by investors who are looking to rent out foreclosed units and this wave of competing supply for the apartment market is dragging down rents — a critical driver of the inflation rate — for the first time in 17 years.

According to a survey conducted by the National Association of Realtors, 36% of all sales now involve “nondistressed” properties. And, the article titled Souring Prime Loans Compound Mortgage Woes in today’s WSJ is also worth a read for anyone who believes we are going to see anything closely resembling a normal recovery, and assumes, of course, that the usually wrong consensus is correct that this downturn is completely over and done with. Fully 12.2% of mortgages in 2Q were either in the foreclosure process or in arrears, up from 12.1% in 1Q and 9.0% a year ago.

Saturday, August 22, 2009

Feds' dead baby, Feds' dead.

To understand Wall Street is to understand goldfish

h/t Eelkat

Goldfish will eat just about everything that fits in their mouths.

Goldfish eat their eggs and their young.

Goldfish eat any dead goldfish floating in the tank.

and a very big goldfish will eat a very small goldfish as well.

Interview with W.D. Gann

(Mr. Gann comes to us via

New Stock Trend Detector
A review of the 1929-1932 panic and the 1932-1935 bull market
Published in 1935
by William D. Gann -AM

Anonymous Monetarist :Mr. Gann thank you for resurrecting yourself for this conversation. You were a finance trader who developed the technical analysis tool known as Gann angles. How would you summarize your philosophy?

'Thanks nice to be here. Well I would summarize my philosophy as suggesting future stock movements can be forecast by a study of past history and past movements. By knowing the time when the greatest advances have taken place and the times when the greatest panics and declines have occurred and the time periods to watch for major and minor changes in trend, you can detect what to expect in the future. Advances and bull markets will come in the future and panics will come in the future, just as they have in the past. It is important to study the time that has elapsed between bottoms and tops and the greatest duration of any bull campaign as well as the greatest duration of any panic or decline.'

What have your studies determined?

'The culmination of the bull market in September 1929 was really the result of a long trend business cycle which began in August, 1896 and continued for 33 years, with each campaign in the market making higher prices, which showed that the long-term trend was up. The Bryn Silver Panic August 1896 low of the Dow-Jones Averages at 29 was the end of a panicky decline that marked the beginning of the McKinley boom which lasted several years'

'The lows in this uptrend were:April 1897 at 40 and one half; October&November of 1903 at 42 and one half; Nov 1907 and June 1913 which both saw 53; December 1914 touched 53 and a half; and then December 1917 and 1920 which both bottomed at 66.'

'The August 1921 low of 64 was still a good sign of support in this uptrend, for it did not violate previous lows by 3 points, roughly 5%, thus indicating that a bull market would follow. From this August low followed the greatest bull market in the history of the United States, culminating at 386 in September 1929.'

Greater than 1992-2000?

'Yes, actually your recent run from 1982 to 2000 was a bit larger in price gain than 1896-1929..and of course in less than half the time. However the 8 year bull in the 20s that ended on September 3, 1929 increased price by a factor of 6 while your 8 year run from 1992 to 2000 increased prices less than 4 times.On September 3, 1929 when the final top was reached the Industrial Averages made 386 which was approximately 13 times higher in price than the Bryn Silver Panic Low.' '

'After the greatest bull market in history, the greatest bear market in history must follow... my philosophy is that one must look back in order to determine how long the bear campaign might run. Going back over all the records, we find that the greatest bear market had lasted not more than 43 months and the smallest had been as short as 12 months. Some of them had culminated around 27 months,30 months,34 months and in extreme declines,anywhere from 36 to 43 months. You handed me cue cards describing the research since the Great Depression but I can't read your writing...'

13 recessions since 1929 lasted on average 10 months. The longest,the Great Depression, lasted 44 months. The third longest(1973-1975, 1981-1982) each lasted 16 months, and we're in the second longest and counting. How would you then compare our outcome given yours?

'On July 8, 1932, the Dow Jones Averages made a low at 40 and 1/5. This was equal to the April 1897 low and was successfully tested. Several bear market lows were tested and broken on that campaign. In fact we can track a general uptrend of higher lows from this April 1897 and July 1932 low up through the May 2000 highs. This current bear market campaign with highs in March of 2000 and May of 2007 (2007 higher closing but lower intraday) has broken past support similar to our crash in 1929 and subsequent rally. The key will be to see what support holds. So far, the 2002 S&P 500 low of 768 obviously did not hold.'

Thank you William.

Friday, August 21, 2009

The Demand Restoration Project is not working yet


What one does is not included in the outcome of what one does?

(And at no time do my hands leave my arms.-AM)

'The world has been through the most severe financial crisis since the Great Depression. As severe as the economic impact has been, however, the outcome could have been decidedly worse. The global downturn could have been extraordinarily deep and protracted...we averted the imminent collapse of the global financial system, an outcome that seemed all too possible to the finance ministers and central bankers.' -Ben Bernanke

Someday this War is Going to End Goldie

"Oddly enough, the Rolling Stone article tapped into something. I saw it as gonzo, over-the-top writing that some people might find fun to read. I was shocked that others saw it as being supporting evidence that Goldman Sachs (GS) had burned down the Reichstag, shot the Archduke Ferdinand and fired on Fort Sumter." - Lloyd Blankfein

Either this market is dead or my watch has stopped.

Wednesday, August 19, 2009

No worries, move along please ...

(Aug -Sept 1929 :But news of the great increases in broker's loans each week brought periodic sharp drops to the market and general apprehension...-AM)

Posted by FT Alphaville on Aug 19 17:51.

Gavan Nolan of Markit wrote this CDS report:

European credit indices widened for the sixth consecutive session today following another sharp drop in Chinese equities. The Markit iTraxx Europe was at 102.75bp, an improvement from earlier in the day but still over 2bp (2.2%) wider than yesterday’s close. The Markit iTraxx HiVol was again lagging behind at 195bp (+9.5bp, 5%), while the Markit iTraxx Crossover was at 646.5bp (11bp, 1.8%).

All three indices underperformed equities, which recovered after a sluggish start.

Economic depression cannot be cured by legislative action or executive pronouncement

Seeking alpha via Some Assembly Required
By One Eyed Guide
August 18, 2009

Over time, the stock market reflects the earnings of the individual companies, so an understanding of the likely direction of the market can be had by looking at earning trends and how the market reacts to them during recessions.

The first chart above shows selected S&P500 annualized data from Robert Shiller’s Irrational Exuberance site which goes all the way back to 1871. Shown are the 2 relevant market declines from the top to the final bottom: The 1929 drop which was the last deflationary pullback and the 2000 drop which is most similar to what the Bulls say is about to happen today. It’s easy to see that both Indexes followed the declines in earning.

S&P is nice enough to provide estimates of future operating earnings at their site so let’s use this to see what is likely to happen (note this data is quarterly instead of monthly which makes the charts jagged and shifts the market tops).

The second chart above compares the current decline which started in the second quarter 2007 with the decline that started in the first quarter 2000. S&P earnings estimates are used for the third quarter 2009 on.

In 2000-2003, the market declined 29% after earnings bottomed in the fourth quarter 2001. If we assume that the bottom in earnings will occur in the third quarter 2009 as the S&P currently estimates, we can expect a similar decline from today down to approximately 650.

The current earnings decline is much greater than that of the 2000 pullback, 59% versus 28%, but the absolute bottom in earnings is similar, $38.38 versus $38.85, so a bottom similar to 2002 of around 800 might be projected. Note that the S&P estimates assume a V shaped recovery in earnings that is much steeper than what occurred in 2001-2002. This is contrary to what most economists are predicting, so if you’re a conservative forecaster, the 650 would be no better than your mid-point estimate of the market bottom. Your forecast of how low the market may go is dependent on how bad you think the current economy is and when corporate profits will recover.

Obviously, we don’t know where the market will bottom but a sharp pullback from current levels is almost certain to occur. Testing the old low appears a certainty while going below it is likely if corporate profits decline more than current estimates. Unfortunately, analysts have been overestimating earnings for the last two years.

(Difference between top-down earning estimates and bottom-up earning estimates is that, with bottom-up, 'tis your arse in the air. -AM)

Watch me make this recovery disappear

Wednesday August 19, 2009 – Issue 3574
The King Report

By Bill King

The financial media’s ineptness was illustrated yesterday when most heralded the slight increase in housing starts as a sign the economy has turned – even though the metric was worse than expected! We have brayed since the housing bubble that housing starts are NOT a sign of economic strength when they exceed sales and the US consumer is losing jobs and income. We asserted that housing starts in excess of demand are a sign of easy credit and illustrate the concept of Austrian Economics. July Housing starts are 581k. June New Home Sales are 384k; 388k is expected for July. ~200k houses will be added to inventory. Is this a sign of recovery or a sign of excess credit and supply? Jobs, income, credit, bankruptcies, NODs, foreclosures, inventory and organic housing sales are the key factors in the economy and a housing recovery. Housing starts are now irrelevant unless the workers building the houses are buying the houses. (Pay the man Shirley. -AM)Mark Hanson notes a negative for housing that few, if any analysts, have mentioned. Due to the decline in jobs and income and “without exotic financing, buyers can’t reach out of their affordability bands like they could from 2002-2007. Investors won’t reach out of their rental return band in order to chase a bid. This dynamic has isolated millions of houses above the median income/rent ratios in cities across the nation and will lead to significant house price compression.”