News and views from Rosie and others

David Rosenberg on musical chairs:

So let’s get the story correct. We are still in the midst of a credit collapse where there is simply too much debt and debt service globally relative to worldwide income. The fact that we had a year-long respite does not alter this view. It was a respite that was induced by what is now an apparent unsustainable pace of bailout and fiscal stimulus in practically every country on the planet, not just the United States. What has happened was that governments bailed out the banks and massively stimulated the economy but because the revenue cupboard was bare, in part due to the savage effects of the global recession, public sector debt loads exploded at all levels of government, and to varying degrees, in every jurisdiction.

But someone had to buy these government bonds, and who else, but the very same banks that the governments rescued! And, they had a super-steep yield curve to generate profits from this bond-buying activity. Talk about a symbiotic relationship.

Not only that, but because of global bank capital rules, these financial institutions were not compelled to put any new capital into reserve against these government bonds because of their investment-grade status from the ratings agencies, when in fact, very few countries actually deserve the ratings they have when one assesses structural deficit ratios, debt/GDP ratios and interest costs/revenue ratios appropriately. Now, ironically, the governments, having saved the banks, only to then rely on the banks to fund their bloated deficits, are now in a situation where their banks need help again because of the eroding quality of the government debt on these bank balance sheets. Talk about a dangerous game of musical chairs.

Rosie on the downward US GDP revision, the lacklustre recovery in domestic demand, and the stock market:

The equity market may have only figured this out, but outside of inventories, the U.S. economy is barely growing and is actually stagnant in real per capita terms. We are not sure how an 80% rally off the lows could have ever been considered by anyone as being consistent with such an anemic recovery in the real economy. And, if you are wondering how on earth the yield on the 10-year Treasury note can possibly be anywhere remotely close to 3%, it is because that is exactly where the trend in nominal GDP is — and we are well past the peak of all the government stimulus efforts.

and D.R. again, this time from a couple of days ago, on stock market valuations:

CAN WE EXPECT A 30-40% CORRECTION?
There have only been two other times when the stock market ran parabolically up from a low in barely over a year, as was the case this time around (+80% from March 2009 to April 2010): the 112% surge from June 1, 1932 to September 7, 1932; and the 116% runup from March 2, 1933 to July 18, 1933. In the first case, we had a 40% correction and in the second, the correction was 34%. So, we are talking here about the prospect of a pretty hefty reversal in the S&P 500 that could very easily take the index down to as low as 850, if the history of these types of givebacks is any indication.

The problem for Mr. Market is that it went into this latest Europe-induced ordeal with an excessively bullish GDP growth outlook for the U.S.A. – at the April highs, we would argue that a GDP growth rate of 6% was effectively being discounted. How nutty is that?

In the aftermath of the correction, the equity market is now pricing in a growth rate closer to 3.5% — the fact that earnings have been rising while the market has been correcting has helped cut the degree of overvaluation in half, to a 0.5 standard deviation from 1.0 just over a month ago on a Shiller normalized P/E ratio basis. But the ECRI leading economic index is actually foreshadowing a deceleration in real GDP growth, to 1.5% in the second half of the year from the 3.75% average pace since the recession technically appeared to have ended around mid-2009. The S&P 500 level that would be consistent with that sort of pace would be closer to 850 than the current level of 1,074. In other words, there is still more air to come out of the balloon.

also worth reading:

Don't Mess with Aunt Minnie. John Hussman.

the combination of unfavorable valuations and collapsing market internals is a sharp warning to examine risk exposures carefully here...if you've got an overvalued
market which then loses technical support, the outcome can be extremely negative, because technical investors are prompted to sell, but fundamental investors have weak sponsorship at that point, so large price declines are required to induce the fundamental investors to absorb the supply

Hussman also quotes Richard Russell:

"If I read the stock market correctly, it's telling me that there is a surprise ahead, and that surprise will be a reversal to the downside for the economy, plus a collection of other troubles." Speaking in reference to one of his key measures of market internals, he observes "In 50 years, this is the most decisive top I can ever remember... the damage and cost of this reversal will run into the trillions."

and on Europe, Hussman says:

in a situation where the probable amounts repaid by borrowers cannot meet the required debt service on the bonds (or mortgages), one has two choices: either savage the innocents in order to defend the bondholders (and create new government debt or print money to do so), or restructure the debt. For Euro-area countries, the stronger member countries (which are already running fiscal deficits) are being asked to run even larger fiscal deficits to bail out the weaker members. This itself would undermine the Euro. The alternative bailout is for the ECB to effectively print the money, which has the same effect of undermining the Euro by levying an eventual "inflation tax" on the holders of Euro-denominated assets.

Fiscal Crises and Imperial Collapses: Historical Perspective on Current Predicaments. Niall Ferguson, via Peterson Institute for International Economics.

Easy Money, Hard Truths. David Einhorn, NYT.

Hugh Hendry Slams Economist Jeffrey Sachs: I Would Recommend You Stop Going Skiing And Panic. Clusterstock.

Geithner on "Sustaining the Unsustainable"; Bill Gross, Robert Mundell say Sovereign Default Likely Inevitable. Michael Shedlock.
includes this gem: Geithner quoted saying:

"European leaders face the difficult challenge of trying to restore sustainability to an unsustainable system."
Yes Tim, that challenge would indeed be "difficult", in fact, impossible by definition.

IMF Economist Argues Home Prices Still Have Far To Fall. WSJ.

Whitney Tilson's T2 Partners Unveils Latest Mega-Case Against Housing And The Homebuilders. Business Insider.
The entire multi-trillion dollar mortgage market has been nationalized, and yet even that has failed to keep home prices from sliding. Foreclosures are still near record highs, despite the best government efforts to stall and delay the foreclosure process. The mortgage mod program is accomplishing next to nothing, and even when mods are done, it does more harm than good, as recidivism is high --- i.e. even after mods, most end up in foreclosure anyhow. All the government has managed to accomplish is to create this massive overhang of properties that must one day be foreclosed on and brought to market. In the end the banks are going to have to write off all these losses in their mortgage holdings.

Email from Canada: Its Different Up Here -- It Really Is! Michael Shedlock.

Conventional Madness. Paul Krugman, NYT.
discusses, with contempt, the OECD's recommendation that the Fed should be hiking rates this year --- even with unemployment high --- and projected by the OECD to remain high for the next couple of years --- and inflation low --- and projected to remain low for the next couple of years --- so the Fed should hike WHY exactly? to slow the recovery?

Crying Fire! Fire! In Noah’s Flood. Krugman again.

The Realities and Relevance of Japan's Great Recession. Adam Posen, BoE MPC.
topic: what does it mean for an economy to ‘turn Japanese’ and what determines whether it will?

and, finally, just a reminder:
The Aftermath of Financial Crises. Reinhart and Rogoff, Univ of Maryland and Harvard, respectively.
yes, recovery from financial crises is almost always protracted and difficult