A few months ago, I complained about the Fed use of its own "money" to buy its own debt. My rule of not betting against the Fed was true for a short period of time: the 30 year treasury bonds rallied.
Since then, macroeconomic dynamics have worked its way to make an even truer "truism" true (awkward triple use of the same word intended):
If it's too good to be true, then it probably is.
Below are two articles explaining the shift in interest rates. Consumers might see mortgage rates rise.
This trend might continue, and the result will be higher mortgage rates. Mr. Market has an immune system and is reacting to the free-spending grand experiment of Keynesian economic theory.
In Mauldin's newsletter entitled "The Paradox of Deficits," Mauldin analyzes the problem of running deficits. He describes the macroeconomic trading between the US and Asia over the past few decades, how the US debt will have difficulty being sold, and the expectation for higher taxes for the years ahead. A discussion of the weakness in European banks and the weak real estate market in Spain was discussed but excluded in my excerpts. Please read his original newsletter if you are interested in the latter topics. My comments are below.
Source: John Mauldin, Best-Selling author and recognized financial expert, is also editor of the free Thoughts From the Frontline that goes to over 1 million readers each week. For more information on John or his FREE weekly economic letter go to: http://www.frontlinethoughts.com/learnmore
Total US debt is $11.3 trillion and rising rapidly. The Obama Administration projects that to rise another $1.85 trillion in 2009 (13% of GDP) and yet another $1.4 trillion in 2010
Congressional Budget Office (CBO) projects $10 trillion in additional debt from 2010 through 2019. Just last January the 2009 deficit was estimated at "only" $1.2 trillion.
Mauldin notes that the CBO then projects GDP growth of 50% over 10 years, higher revenue (through higher income tax), and higher unemployment (8.9%). This is contradictory. How can there be GDP growth when unemployment is still rising, even using a 0.1% projection?
About De-leveraging:
"The world is deleveraging. Debt is being drawn down. Securitization of various types of debt has seriously slowed. Banks are cutting back on lending. Home prices are dropping all over the world. Commercial real estate is rolling over, and banks all over the world are exposed. "Recession turns malls into ghost towns" is the headline in today's Wall Street Journal. Personal savings are rising and retail sales are flat to down. Unemployment is rising.
All this should be massively deflationary. Interest rates should be falling or at least not rising. But a funny thing is happening. In the past two months, the yield on the ten-year bond has risen by 1%. It has moved 0.38% or almost "4 big handles" in just two weeks.
The Paradox of Deficits
Call it the Paradox of Deficits. We have been running a large trade deficit in the US for years, because the people (China, Japan, and the Middle East) who wanted to sell us "stuff" were kind enough to turn around and invest the money in our bonds. This in turn created Greenspan's conundrum, as it helped keep down US (and global) interest rates. Combine that with a massive increase in leverage, a few bubbles, and we now arrive at a true crisis.
Deficits are not necessarily a bad thing if kept in check and restraint is shown. But everyone cannot run deficits at the same time. If we don't buy $700 billion in goods, then that money cannot be recycled back to our debt. It is that simple.
(Sidebar: And now, China and Brazil are moving to do their trades in their own currencies rather than dollars. Very smart on their part.)
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Long before we get to 2015, let alone 2019, I think the bond markets will have called a halt to $1 trillion deficits. There will be a real crisis. The deficits will not be funded at anywhere close to an interest rate that will not break the budget. Taxes will get raised beyond what they were in the Clinton years. And Obama's budget makes some very optimistic judgments about how much will be saved in medical costs, as if no one has tried to rein in medical costs before. The crisis may come much sooner if his universal health-care bill is passed as proposed without offsetting cuts somewhere else.
Watch the bond market.Rates should be going down, not up. The bond market is telling us the deficit simply can't be financed down the road. Now, maybe a few cool heads in the Democratic Party will prevail in the US Senate and the deficits will be brought under control. (The Republicans have so far seemed as clueless as they are impotent.) We could (theoretically) run $400 billion deficits for a very long time, as GDP would be growing somewhat faster.
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I am increasingly inclined to think that as the world comes out of its current malaise – and it will – US investors should think more globally with their investment portfolios. That is something we will explore over the coming year. But that's enough for today.
Comments:
US Bonds took a big dive last week and this may be explained by trading partners settling the balance using their own currency. This is why the US dollar dropped over 10% from its peak in March. The stock market rally is also creating greater confidence for investors to divest itself from US assets/currency. The long-term question is whether growing GDP through a deficit year after year is sustainable or not. Between March and May 2009, the stock market focussed on the "growing" aspect of this paradox. Over the next few weeks and months, I suspect that economic fundamentals will act like gravity for the stock market if the information continues to support Mauldin's points.
Below are notes taken from John Mauldin's Newsletter. My comments are included.
About Bank Earnings Q1 (April 2009):
Of course US banks made good money in Q1. The environment created for them is the equivalent of the US government reducing the cost of goods to zero for its embattled car manufacturers and then going on to buy - courtesy of the US tax payer - a couple of million cars that nobody really needs. Even Detroit would make money given those conditions!
Comments: Mauldin notes that all of this "free" (tax-paid) government money is being trapped in the banking sector. This means that the "multiplier" will not be at work and that inflation is not as likely as many think. Look out for downward pressure on gold. Bear Market Rally:
It will take longer than 18 months to unwind the excesses of the past 25 years
15 largest banks which between them have shrunk their balance sheets by about $3,600 billion so far in this crisis, will shed another $2,000 billion in 2009. If you do not share my pessimism, please take a quick look at chart 3 below. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off with total household debt now at 96% of GDP vs. 47% in 1982.
Comments: It will become clear soon that the March - May rally was a necessary one because too many companies were trading at far too low a valuation. Many companies have capitalized their balance sheets by selling shares or debt. Shareholders who bought these issues will feel the pain as the market trades closer to economic fundamentals (down). I am most cautious in the financial, commercial real estate, and the automotive sector. I believe that GM bond holders will be wiped out. The company will likely go bankrupt but the market has already priced this in. On Mortgage loans:
Delinquencies related to Alt-A and adjustable rate mortgages have taken off, and prime and jumbo loans are only now starting to suffer.
Matt Blackman wrote about the market Yin and Yang in his weekly newsletter. Important sections in bold. Market participants keep asking two questions. "Is the market going to keep rallying" and "Is it time to take profits?" Some are even trying to predict where the market will be longer-term (say beyond this summer).
The market has rallied about 35% from the March bottom. The market is still about 43% from its high reached in 2007. With these figures, I turn to charts.
I am spending less time using technical charts to estimate short-term prices. However, if investors who bought at the peak want to break even (or reduce their losses), then 1000-1200 on the S&P 500 might be a good area for investors to sell. Those who bought at the bottom might want to sell at current levels. They might use charts to lock in profits with the S&P somewhere between approximately 850 - 930.
As discussed last week, this is a double-sided market. On one side there are corrective forces at work to bring valuations of numerous asset classes back down to earth after years of ‘bubblenomics’ driven by cheap money and highly stimulative monetary policy. On the other side, the tremendous amount of liquidity being that continues to be pumped into economies around the world in attempts to lessen the pain and reflate the bubbles.
One lesson the Presidential Cycle teaches us is the almost unbounded efforts in which governments employ to get re-elected and the subsequent impact those stimulative efforts have had on markets. Bears cannot afford to ignore this undeniable fact – at no time in history has the amount of cash currently being pumped into the economy been greater and the cost of money lower. This is bound to have a stimulative impact on stocks. And based on the latest news out of Washington, the generous programs being offered seem to continue without end (see the latest program outlined in the “Treasury Offers Incentives” article below.) But in spite of this generosity, foreclosures hit another new high last month and the number of U.S. homes with mortgages worth more a increased to 20.4 million or 22% of the total residential properties (houses, condos and co-ops) of 93 million homes.
Until earnings begin to recover in earnest and consumers begin to spend with confidence, any rally from here will be difficult at best. The question is, is the government prepared to continue to spend taxpayer dollars until then and if so, how big will the bill get in the meantime?
The words "Green Shooting" have popped up in media in recent weeks. This catch phrase is used to describe the idea that there are signs the economy is reviving. Does hope spring eternal?
The rally is two solid months old, but as I wrote numerous times, it is based on less bad news (for jobs and housing), on companies beating already lowered expectations, and on enthusiasm for a brighter future. Yesterday, consumer spending figures were released. In April, sales declined 0.4%. March sales declined by a revised 1.3%. Foreclosure notices increased 32%.
It would appear that there is a greater likelihood that the stock market will at least begin a steady decline, because the rally was based on hope and emotion instead of unchanging economic and social behavioural facts:
The average svings rate in the U.S. will continue to rise
Unemployment will remain steady or rise
Foreclosures will likely increase (there are stories that foreclosures were stalled due to government policy, not due to economics)
Commercial real estate remains a significant concern
Bank-held mortgages will remain a concern (ARM's, etc.)
Capacity is still in excess and will need to shrink.
Another thing to watch carefully is the price of commodity prices, especially and copper and oil. The word "de-coupling" is reaching the headlines quite often. The premise of de-coupling is that China's economy is separate from world economies, and therefore China will grow/expand/consume whilst the world does not.
I believe that this is a silly idea.
China's production of goods that consume raw materials depends on other countries making those orders. What is true, however, is that China is one of the largest savers in the world. The country has a lot of money. Its government is spending right now. This will raise the price of raw materials (this is happening now, although much of the gains is due to market enthusiasm for a global recovery as early as Q4/09).
The bigger question is not China's spending. It is what China intends to do with its holdings in US debt. Investors will need to monitor the relative currency strength of China against the US dollar. This will be an indicator for whether China is spending to reduce its position in the US, or if indeed its economy is strengthening, independent of all other countries.
"All five startups demonstrated the capacity to generate revenue from a unique and appealing solution capability."
"Each of the five startups is focused on a new, innovative solution that meets a compelling business requirement that will benefit financial institutions. The future upside for these five startups will depend on the execution of their business plans."
Canada reported a net increase of 10,000 jobs. Amazing? Not really, unfortunately. Many of the unemployed workers decided to be their own boss and to work for themselves.
Conclusion:
Headline numbers tell us that things are less bad, but let us look deeper. Let us look at U6. U6 includes part-time workers who want to be full time. That figure is 15.8%.
U6 "The comprehensive unemployment rate which is referred to as U6 and includes part time workers that want full time jobs and discouraged workers that have stopped looking but will take a job if offered, rose to 15.8% from 15.6% and 9.2% in April 2008."
Half-Truth is not enough: Other comments for last week
1. Why is WFC, and banks for that matter, rising on the belief that all is well based on an easy stress test? Bank stocks are up. Banks are selling shares to raise capital, using expensive high p/e shares (WFC). The bank is essentially improving balance sheets at the expense of the sucker investor. Show me actual improving earnings. Then I'll buy WFC.
2. China is a net saver. It has net cash. It is no longer buying and funding the U.S. in its spending spree. It might say it is, or it might do so to reduce its exposure to US assets. Whatever media says, China is not a net consumer. 10-year and 30-year Treasuries will essentially fall further than current levels.
3. USD may collapse, finally...but where is the money going to go? Another currency? Probably not. Gold? Maybe. Silver? Maybe. What about oil? Have small positions in all of those areas to hedge against the USD.
4. Inflation is a greater likelihood again at least in the short term, because energy prices are rising. You often hear of CPI ex-energy. Well, energy is still a big cost for companies and consumers...well at least the ones who still have a job and need to commute.
5. One abating decline in job losses does not make a trend. Watch price levels but do price in an economy but estimate total unemployment ~10% for the US. That equates to an additional 1M - 1.5M jobs lost. The bank stress test used 9.5% unemployment.
6. Commercial real estate is the next problem on the horizon that has not been priced into the market. Read up on it.
Approximately 491,000 jobs were lost in the private sector. The markets expected a fall of 645,000.
2. LIBOR spreads are now under 1%. When Lehman collapsed last year, the spread was over 4%. Teck Corporation was able to raise over $4B from the debt markets (albeit the yield on the debt is around 10%). Last month many thought Teck would collapse under its existing debt obligations.
3. The "Stress Test" was leaked to the markets. How convenient. The "leak" is preparing the markets to price in and accept that Bank of America will need $34B. Citi will need around $5B. Wells Fargo will need 15B (didn't Buffett champion this company?). Full results come tomorrow, but as Warren Buffett said, the test will not have much meaning or value.
Analysis and Conclusions: Market "pros" will continue to cheer on the rally, the recovery, the recovery by end of year, "less worse" unemployment, and a "bottom." The latest earnings reports have all exceeded lowered forecasts. The lowered earnings forecasts were reasons the stock market fell two months ago. Beating the lowered expectations would conversely justify a rise in the stock market.
A rising market does not in itself justify a return to "good times." I has, however, very quickly fueled a mini-bubble for specific sectors, namely the resource sector. Teck Corporation did not improve fundamentally overnight. It is still in heavy debt due to expensive acquisitions. Its survival depends on rising commodity prices. The same can be said for the energy sector.
In effect, it is possible that a mini-bubble may emerge in oil/energy. Excess money in the system needs to flow somewhere. This is assuming that money is indeed in excess in our economic system. If the banking sector is not recovering, then money will be "stuck" in the same (subprime, etc.) debt that is a drag in the economy.
This is the tug-of-war that must be closely monitored.
A user on kaChing.com brought this clip to my attention:
Investors need to keep adapting to the changing winds. This is not to be interpreted as a promotion of day trading, swing trading, or momentum trading. It simply means that if the economy is truly improving, then adjust a portfolio accordingly, in small steps.
NAR’s Pending Home Sale Index rose 1.1% from March 2008. The less significant Pending Home Sales (monthly gains) were also positive, rising 3.2% from February to March 2009
Most of the gains came in the regions with the highest foreclosures: The South and West gained, while the NorthEast and Midwest fell
Analysis: Show me 3 months of stronger or improving home sales. Show me a rising monthly improvement in this sector and I will be convinced. Still, DOW @ ~8400 and S&P > (over) 875 are significant levels. Needless to say, SRS has traded significantly downward this past month.
Unemployment figures will also be released this Friday. It is best to place great emphasis on these figures.
