Links, July 19

"The issue which has swept down the centuries and which will have to be fought sooner or later is the People versus the Banks."

Lord Acton (the same man who said "Power tends to corrupt, and absolute power corrupts absolutely")

The US banking recovery is a sham. David Stevenson, MoneyWeek.

JPMorgan's recent quarterly profits... have now climbed right back to 2007's high point. That's nothing short of amazing. And it's more than enough to get bank bulls quite excited again.

But hang on a minute. Maybe there's a con trick being played here.

For one thing, JP Morgan hasn't achieved any 'real' growth. The bank's revenues actually fell by 8%. Investment banking and fixed-income trading results both dropped.

So where did all the money come from?

Well, the bank only turned in such a 'good' result because it slashed its "provision for credit losses" by two thirds, from $9.7bn to $3.4bn. In other words, all (and more) of JP Morgan's latest profit was due to the bank making a much lower allowance for bad debts – loans that could go sour because the debtors can't repay to the bank the money they've borrowed.

also comments on FASB 157, which allows banks to book profits due to the deterioration in its bonds' prices --- i.e. the company still owes the face value of its outstanding debt, but it can pretend it owes less because its bonds' market values have fallen, and this, apparently, constitutes "profits"

A generation of overoptimistic equity analysts. McKinsey Quarterly.

equity analysts have been overoptimistic for the past quarter century: on average, their earnings-growth estimates—ranging from 10 to 12 percent annually, compared with actual growth of 6 percent—were almost 100 percent too high

Don't take the bait. John Hussman.

Important metrics of economic activity are slowing rapidly. Notably, the ECRI weekly leading index slipped last week to a growth rate of -9.8%. While the index itself was reported as unchanged, this was because of a downward revision to the prior week's reading to 120.6 from the originally reported 121.5. The previous week's WLI growth rate was revised to -9.1% from the originally reported -8.3% rate. Meanwhile, the Philadelphia Fed Survey dropped to 5.1 from 8.0 in June, while the Empire State Manufacturing Index slipped to 5.1 from 20.1. The Conference Board reported that spending plans for autos, homes, and major appliances within the next six months all dropped sharply. These figures are now at or below the worst levels of the recent economic downturn, and are two standard deviations below their respective norms - something you don't observe during economic expansions....

The U.S. economy continues to face the predictable effects of credit obligations that quite simply exceed the cash flows available to service them, coupled with the predictable shift away from the consumption patterns that produced these obligations....

Investors who allow Wall Street to convince them that stocks are generationally cheap at current levels are like trout - biting down on the enticing but illusory bait of operating earnings, unaware of the hook buried inside.

I continue to urge investors to have wide skepticism for valuation metrics built on forward operating earnings and other measures that implicitly require U.S. profit margins to sustain levels about 50% above their historical norms indefinitely. Forward operating earnings are Wall Street's estimates of next year's earnings, omitting a whole range of actual charges such as loan losses, bad investments, restructuring charges, and the like. The ratio of forward operating earnings to S&P 500 revenues is now higher than it has ever been. Based on historical data, the profit margin assumptions built into forward operating earnings are well beyond two standard deviations above the long-run norm. This is largely because... forward operating earnings are heavily determined by extrapolating the most recent year-over-year growth rate for earnings. In the current instance, this is likely to overshoot reality, and in any event, has little to do with the long-term cash flows that investors can actually expect to receive over time.

comments from David Rosenberg:

The growth rate on the ECRI leading index did it again! It sank further into negative terrain, now at -9.8% during the week ending July 9, down from -9.1% the prior week. This was the tenth deterioration in a row and the growth index is now negative for six straight weeks. We have never failed to have a recession with the ECRI at current levels but there is also inherent volatility in the index that requires acknowledgment. Our reckoning is that in the past few weeks, the index has gone from pricing in even-odds of a double-dip to two-in-three odds. It may take a while, but Mr. Market will figure it out before long.

All we hear from in the mainstream economics community is that double-dip recessions are out of the question because they are “extremely rare” events. The double-dip deniers say that this only happened in 1982 because of the renewed sharp tightening by the Fed (as if we aren’t going to see a sharp fiscal withdrawal this time around to take its place). What is it that these economists and strategists don’t see?

These “extremely rare” events have been the norm for the past 24 months: negative nominal GDP growth; negative operating earnings; a massive contraction in credit; a 30% slide in home prices (these same economists — Bernanke too — were telling everyone that home prices never deflate over a 12-month time span ... but they did this time!); a record-high duration of unemployment.

The past 24 months have given us a lifetime of “extremely rare” events...

Relying on indicators that have been useful in previous post-WW2 recessions is like comparing the statistics of U.S. football teams versus the statistics of Australian football teams. They may be called the same thing but they are different sports. The economy is one sick puppy and we are seeing first hand now what it looks like once the crutch of government support is taken away.

GMO Quarterly Letter. Jeremy Grantham.

Hoisington Quarterly Review and Outlook. Van Hoisington and Lacy Hunt.

Stress-testing Europe's banks won't stave off a deflationary vortex. Ambrose Evans-Pritchard, Telegraph.

Euroland's authorities are inflicting a triple shock of fiscal, monetary, and currency tightening on a broken economy. They are doing so in a region where industrial output is still 14pc below its peak, where growth barely scraped above zero over the winter "recovery", and where youth unemployment is at 40pc in Spain, 35pc in Slovakia, 29pc in Italy, and 26pc in Ireland.

They seem unaware that China is slowing and the US is tipping into a second leg of the Long Slump. Last week's collapse in America's ECRI leading indicator to -9.8 marks the end of the V-shaped rebound. If this means what it normally means - recession within three months - Europe must take immediate action to prevent being drawn into a deflationary vortex. Spiralling public debt precludes further Keynesian spending, so this must come from central bank stimulus. Tight fiscal policy offset by ultra-loose money is the only option for Europe, the US, and Japan....

The US Conference Board's indicator is not yet flashing a red alert, but that is because it gives weight to "yield curve inversion", where long rates fall below short rates. This indicator is meaningless in a Japan-style bust where policy rates are zero.

BP link of the day:

What if he's right? James Howard Kunstler, Clusterfuck Nation.

Matt Simmons has been around the oil business for forty years. His knowledge is deep and comprehensive. From the beginning of the BP Macondo blowout incident in April, he's taken the far out position that the well-bore is fatally compromised and that BP has been consistently lying about their operations to stop the flow of oil. Perhaps most radically, Simmons claims that an oil "gusher" is pouring into the Gulf some distance from the drilling site itself....

Simmons's current warning about the situation focuses on the gigantic "lake" of crude oil that is pooling under great pressure 4000 to 5000 feet down in the "basement" of the Gulf's waters. More particularly, he is concerned that a tropical storm will bring this oil up - as tropical storms and hurricanes usually do with deeper cold water - and with it clouds of methane gas that will move toward the Gulf shore and kill a lot of people.