January 30

2011 Investment Strategies: 9 Buys, 9 Sells. Gary Shilling.

Pavlov's bulls. Jeremy Grantham's quarterly letter.

A potent brew for a tall glass of regret. Alan Hartley, Morningstar.

further commented on by Mish at:
Market participants learn the wrong lesson from Bernanke; conflicts of interest in stay the course advice.

A bubble in complacency. John Mauldin.
discusses GDP #s, imports, inventories and how the rise in oil prices affected all that

Similar discussion at Pragmatic Capitalism in Really Nominal GDP.

Also at PragCap, Is QE really working? cites Richard Koo.

January 24

Do we really have a balance sheet recession? David Beckworth.

The age of de-leveraging. Jason Leach.

How I learnt to stop worrying and love The Bank. Steve Keen.

How will they prop up stocks after QE? An answer? Bruce Krasting.

The Fed can’t go bankrupt. Anymore. FT Alphaville.

More evidence of undercapitalization/insolvency of major banks. Yves Smith.

National debt = great recession 2.0. Dian Chu.

Spain's bank nationalization and the euro zone crisis. Ed Harrison.

The real cost of Chinese NPLs. Michael Pettis.

China vs. inflation: a love-30 match so far. Dian Chu.

Beijing most likely will come to grip very soon that eventually somebody got to pay somewhere, and there’s just no way around it, and that the time has come for some decisive actions with a combination of more aggressive monetary, fiscal and regulatory measures to show it really means business.

For example, instead of the symbolic two 25-bps interest rate hikes in Oct. and Dec., Beijing probably will do an immediate 50-bps rate hike by early February and another 50 bps in early March to blunt the start of the typical yearly run-up of crude oil, and other commodities. Then, depending on the market reaction and new economic data, more hikes could be implemented later on in the year. Fiscal policies such as taxes, and financial regulations and restrictions on speculative activities could be necessary.

Meanwhile, the expectation of a Yuan appreciation is keeping liquidity swimming. So, perhaps China would do just the opposite, as suggested by Andy Xie, a currency depreciation, which would lead to a capital outflow forcing interest rates up. There [are]many more things that China has to do to get the inflation situation under control, which most likely will send shock waves throughout global markets.

Social Unrest Could Make or Break A Party: Nmbers may be rigged or "smoothed out", but can't fool the regular Chinese Joe's and the smart money.

China's runaway chariot. Charles Smith.

SocGen crafts strategy for China hard-landing. Ambrose Evans-Pritchard.

Record Food Prices Causing Africa Riots Stoking U.S. Farm Economy. Bloomberg.

Inflation: not here, not now. John Taylor.


other fare:
of amusement: Gartman investment SAT score 410.

January 20

Consumers and the Economy, Part II: Household Debt and the Weak U.S. Recovery. FRBSF.

The U.S. economic recovery has been weak, especially in employment growth. A microeconomic analysis of U.S. counties shows that this weakness is closely related to elevated levels of household debt accumulated during the housing boom. Counties where household debt grew moderately from 2002 to 2006 have seen a moderation of employment losses and a robust recovery in durable consumption and residential investment. By contrast, counties that experienced large increases in household debt during the boom have been mired in a severe recessionary environment even after the official end of the recession.

Quarterly Review and Outlook. Van Hoisington and Lacy Hunt.

We see seven main impediments to economic progress in 2011 that will slow real GDP expansion to the 1.5%-2.5% range. First, fiscal policy actions are neutral for 2011. Second, state and local sectors will continue to be a drag on the economy and labor markets in 2011. Third, Quantitative Easing round 2 (QE2) will likely produce only a slight economic benefit as the Fed continues to encourage additional leverage in an already over-indebted economy. Fourth, while consumers boosted economic growth in the second half of 2010 by sharply reducing their personal saving rate, such actions are not sustainable. Fifth, expanding inventory investment, the main driver of economic growth since the end of the recession in mid-2009, will be absent in 2011. Sixth, housing will continue to be a persistent drag on growth. Seventh, external economic conditions are likely to retard U.S. exports....

In spite of the adverse psychological reaction to the QE2, long Treasury bond yields dropped to 4.3% at the end of 2010, down 30 basis points from the close of 2009, producing a total return of slightly more than 10% for a portfolio of long Treasury and zero coupon bonds. The problematic economic environment and its depressive effect on inflation suggests long Treasury bond yields could easily decrease another 30 basis points in 2011, which would produce another double-digit rate of return for a similar portfolio. The probabilities of even lower yields are significant.

One step forward in the Euro zone? Claus Vistesen.

The system has reached the stage that a bankrupt sovereign state is issuing debt to buy bonds in a vehicle that is tasked with buying debt from a bankrupt Sovereign state that is no longer able to go to market. Folks this is reaching the level of a Monty Python skit.

This brings up a serious question not seen answered in the public yet.Who is ultimately responsible for the bonds that the rescue fund is going to be selling as AAA investments? Whose AAA balance sheet is guarantying these bonds that will be sold to investors like Japan?

EMU policies are pushing Southern Europe into systemic political crisis. Ambrose Evans-Pritchard.

Let us assume for the sake of argument that Europe succeeds in containing the immediate EMU debt crisis, with help from Asia, and that Germany’s fractious coalition actually agrees to a bail-out fund big enough to make any difference. What does this achieve, other than allowing banks to buy time by offloading liabilities onto European and Chinese taxpayers?

Is core Europe heading for a hard landing? Michael Darda.


Europe's Gordian Knot. Scott Minerd, Guggenheim Investment.


America has ‘reached the point of no return,’ Reagan budget director warns. Raw Story.

Stockman, who described himself as a libertarian during a recent interview with Reason.tv, told Raw Story that the economy got into this mess because of the public and private sectors' addiction to "guns and butter Keynesianism," an economic policy that amounts to a Ponzi scheme that has ballooned since 1990.

"If we see what's going on carefully, we've reached the final unmasking of the Keynesian illusion, that Keynesianism is really nothing but borrowing, stealing from the future to induce consumption today," he said. "There are no multipliers. Every one of these programs we've had from 'cash for clunkers' to housing purchase credits have disappeared as soon as they expired and simple shifted activities in time by a few months."

Stockman explained that before 1980, it took about $1.50 of new borrowing -- public or private -- to generate $1 of GDP growth. By the mid-1990s, it was $2.50 or $3 of borrowing for a $1 of GDP growth. By 2007, before the big collapse and meltdown finally came, $7 of public and private debt was added to the national balance sheet in order to get $1 of GDP growth.

"When you get to the point of $7 of borrowing to get $1 of income, you're obviously on an unsustainable path and pretty close to hitting the wall, which more or less we have," he said.

"So the addicts in Washington are now unfortunately terrified to stop all this borrowing whether it's for guns or butter for fear of the economy will collapse.... That's why we're just at the beginning of solving this massive financial collapse we had in 2008 and not in the process of healthy recovery as some of the pals in the White House or on Capitol Hill or on Wall Street would have you believe."

We cannot support ever-rising debt. Andrew Smithers.


Hedge funds bet China is a bubble close to bursting. Telegraph.


I like Ike: A powerful warning ignored. Jeremy Grantham.


I have been wrong -- I've been too bullish: Albert Edwards.

Sovereign debt crisis -- can it happen here? Soc Gen, via zero hedge.


Sustainable Credit Report 2011. World Economic Forum, via zerohedge.
finds that while global credit stock doubled from $57 trillion to $109 trillion in just 10 years (from 2000 to 2010), it will need to double again to $210 trillion by 2020 in order to provide the necessary credit-driven growth for world GDP to retain its current growth rate


The Financial Crisis: Will It Lead to America's Decline? FORA.TV.
Niall Ferguson, David Gergen, Mort Zuckerman.

January 16

QOTD:

"We are shaped by our thoughts; we become what we think. When the mind is pure, joy follows like a shadow that never leaves." ~ Buddha

The great food crisis of 2011. Foreign Policy.

La Nina as black swan; energy, food prices and Chinese economy among casualties. Yves Smith.

How many Senators does it take to screw a taxpayer. Jim Quinn, on stupidity of using corn for ethanol and impact on food prices


other fare:
Darkness on the edge of the universe. Brian Greene, NYT.

January 12

"Illusory Prosperity" - Ludwig von Mises on Monetary Policy. John Hussman.


Hussman: The Anti-Tepper Makes an Apology (kind of). The Reformed Broker.

The manager's January 10th commentary reads as part admission of wrongheadedness, part bitter cartoon villain fist-shaking (you'll see!) and part doubling down on his bear case thesis. He admits that it's his job to generate returns in all environments but then pulls the fiduciary card to excuse his excess caution. Oh yeah, he also basically calls us all idiots. I guess we'll have to make do with only our profits as consolation for the insult.

Bearish John Hussman Is Sounding Like Someone Desperate To Keep His Clients. Clusterstock.


The market is a heartless beast. Pragmatic Capitalism.

The equity market is priced based on future profit expectations that are often right, but more often than not prove to be wrong. As we saw in 2007 those expectations were high, investors believed economic downturn would be thwarted and the environment ultimately surprised substantially to the downside. As the waterfall decline ensued we experienced the inverse reaction in 2009. Markets and expectations overshot to the downside. Expectations for profit growth became far too low and classic mean reversion ensued. As the economy stabilized in 2009 the economy remained stagnant at best. But the economy’s loss had become corporate America’s gain. The massive cost cuts made these corporations lean and mean. Corporate America’s diverse revenue stream kicked in as the global economy strengthened and leveraged up these lean balance sheets. Despite persistent weakness in the US economy profits continued to rebound through 2009 & 2010 even as US unemployment continued to climb. That heartless bitch did not care about the unemployed, stagnant wages or l-shaped recoveries. She cared only for the bottom line and the bottom line was robust – particularly when compared to expectations....

If I have made one mistake in recent years it has been focusing on what should be good for an economy (job growth, fair markets, organic growth, etc) as opposed to what the market desires (higher profits no matter how they come).... Ultimately, the purpose of research is to generate investment profits.  Connecting the dots between this research and actionable ideas is vital to success.  If you allow the emotion of a macro outlook to infect your work your results will suffer.   Remember, the market is not the economy.

Which country prints more and runs bigger government deficits: Canada or the US? Rebecca Wilder at Angry Bear.

Is inflation about to burst the Chinese bubble? naked capitalism.

China's lending quota? Michael Pettis.

would I have taken seriously a quota on new lending? Not really. It seems to me that if Beijing wants GDP growth in 2011 to come in at the expected 9%, the amount of new investment in China – which is determined in large part by the banking system – is really not something they can decide today. It is going to be whatever it needs to be given developments in household consumption growth and the trade surplus.


This is why I argued a few weeks ago that at whatever level the new loan quota was set, I was not going to think of it as constraining new lending in any way. Either the loan quota would be adjusted (upwards, almost inevitably) or more new lending would occur outside the banks’ balance sheets, as it did in 2009 and 2010.

Investment this year I suspect is going to be extremely high, as high as in 2009 and 2010, because it is only with very high levels of investment that we are likely to manage GDP growth rates high enough to keep Beijing happy. So my guess is that 2011 will be yet another year in this increasingly strained investment-driven party. Chinese GDP growth will continue to be the envy of the world, while those of us who worry about the sustainability and quality of the growth will worry more than ever.

Economic forecasting delusions. FT Alphaville.

So economists who tend to predict near the consensus are, by definition, unlikely to anticipate extreme events, while those who correctly predict the occasional Black Swan tend to get everything else wrong... Generally we agree with the standard defence that it’s not the forecast part of forecasts that matters, but rather their underlying information and logical coherence. And indeed, sometimes these are extremely helpful regardless of the outcome.

January 10

Rosenberg says that Q1 US GDP may come out as high as at a 4% annualized rate. But...

What is important is what happens in the second and third quarter when we see the U.S. economy hitting an important air pocket. In Q2, there is a loss of fiscal support at the margin. Moreover, we will be deeper into this renewed leg of the downturn of home prices, with negative implications for the household wealth effect, confidence, and spending. We will be seeing the peak impact from the runup in energy prices too. The inventory cycle has pretty well run its course as well (it was responsible for half of the GDP growth in 2010). It would also likely be prudent to assume that some risk aversion will resurface from the renewal of European debt concerns in March after the Irish elections (if the opposition party wins, expect the EU deal to be renegotiated and the debt to be restructured, and if that happens, look for other countries to follow suit). Of course, we have the debt-ceiling issue to contend with in March-April and the GOP are dangling $100 billion of spending cuts in front of the White House in order to get a deal done. This is not last year’s lame duck Congress. And this doesn’t add to uncertainty and possible disappointment in the second and third quarter?

The long road ahead. Paul Krugman.
notes that economy has to grow at least 2.5% per year just to keep unemployment from rising, and concludes:

suppose that from here on out we average 4.5 percent growth, which is way above any forecast I’ve seen. Even at that rate, unemployment would be close to 8 percent at the end of 2012

three viewpoints on the economy

first, the conventional cyclical interpretation by most economists who view the credit crunch-inspired recession as little different than typical post-war recessions:
Glory days: another good year in 2011? Liz Ann Sonders, Charles Schwab.

This reacceleration has inspired an uptick in GDP forecasts both for the fourth quarter of 2010 and the full year of 2011. There are numerous reasons for this increased optimism, including:

• Taxes are not going higher, while the bill also includes a payroll tax reduction and immediate and full expensing for business investment.
• Leading indicators have reaccelerated and manufacturing is expanding at a seven-month-high pace.
• Initial unemployment claims have significantly broken out to the downside.
• Credit conditions are improving markedly for both consumer and commercial loans.
• Real consumer spending is back in expansion mode, having surpassed its 2007 high (ahead of GDP doing the same).
• Earnings growth remains high and steady, keeping valuations reasonable.
• Core inflation remains contained.
• Merger-and-acquisition activity is picking up sharply, especially among technology and energy companies.
• Long-term yields are up, but short-term rates are low and steady; lending support to the economically important steep yield curve.
• QE2 is having success boosting asset prices and should offset some of the recent drag on the savings rate while boosting household net worth and confidence.  
• The election cycle greatly favors the pre-election year (2011), with an average annual gain of over 17% for the S&P 500 index and no down years since 1945.

second, a secular perspective influenced by debt dynamics, which leads to the conclusion that sustained economic growth will be illusory if not well-nigh impossible:
Why the world is financially doomed. Charles Hugh Smith.

1. When money is dear and difficult to borrow, then productivity and capital accumulation are encouraged, speculation, malinvestment and debt-based consumption are discouraged.
2. When money is "free" (zero-interest rate policy) and liquidity is unlimited, then the opposite conditions hold: speculation in risk assets, malinvestment and debt-based consumption are all encouraged, and productivity and capital accumulation are heavily discouraged.
3. When debts exceed the value of the underlying assets, the only way out of the Tyranny of Debt is to write off the debt on both the borrower and lender's balance sheets, wiping out their capital via liquidation and bankruptcy.
4. The "extend and pretend" policy pursued by all major nations is simply transferring the impaired debt from private hands to the taxpayers (public debt), crippling the economy with higher taxes and higher debt service.
5. The Central State's "extend and pretend" policy requires heavy borrowing every year to prop up the status quo, pushing the Central State (or equivalent, i.e. the Eurozone) in an inescapable double-bind: either continue increasing public debt and cripple the economy with high taxes and high public-debt servicing costs, or let the financial status quo of "profits are private, losses are public" implode.

third, a sociological, structural/institutional perspective, which implies that though corporate profits and therefore stock markets may still have reason to do okay, they are doing so via multinationalist policies which come at the expense of domestic economic prospects:
Corporate America: paving a downward economic slide. Harold Meyerson, WaPo.

Our economic woes, then, are not simply cyclical or structural. They are also - chiefly - institutional, the consequence of U.S. corporate behavior that has plunged us into a downward cycle of underinvestment, underemployment and under-consumption.

other items of concern, in addition to those above, to contrast with Sonders' points:
- high oil and gas prices tax on consumer (undoing benefit of reduced payroll taxes)
- ditto for food price inflation
- persistently low inflation / disinflation
- steep yield curve helps banks but hurts savers (low short-term rates reduce household interest income) and hurts those in debt trying to refinance
- US housing prices in decline since July persists as more foreclosures come on stream (having been stalled in autumn due to fraud-closure and robo-signing scams and then due to holidays) and shadow inventory adds to existing excess supply
- revival of uptrend in residential mortgage delinquencies as Option ARM and Alt-A resets trend up from May through November, with residential mortgage rates now higher than they were in the fall
- delinquencies on commercial mortgage backed securities hit a record high in December
- potential political gridlock due to typical political dynamics but also to deficit hysterics
- what happens to QE come June: more? less? is a wildcard for both economy and markets
- policies of artificially boosting asset prices to induce a wealth effect to induce increased consumption are unsustainable and have historically worked for a time.... only until they failed miserably with a bust
- equity valuations based on reliable historical metrics, Shiller PE and Q-ratio, are very high
- forward earnings estimates' extrapolation of recent earnings growth implies expansion of profit margins from already very high levels, in contrast to historical very regular pattern of reversion to mean of profits/GDP
- markets not just over-valued but over-bullish and over-bought in period of rising yields
- high corporate cash balances not only mask high corporate debt burdens (cash is high in large part because debt issuance has been high) but indicate that companies are not willing to make investments in expansion of productive capacity
- state and local government retrenchment and possible defaults
- sovereign credit risk in Europe
- refinancing risk for both European banks and governments in spring
- risk of Chinese credit and housing and malinvestment bubbles popping due to government measures to cool inflation


Risk trades will test investors through 2011. Stacy Williams, Head of FX Quantitative Strategy at HSBC, in the FT.

[The risk-on / risk-off trading pattern] reflects the great uncertainty in the outlook for the global economy in the coming years. A world where stable growth returns and government indebtedness is brought under control is very different to one where growth falters and sovereign debt problems escalate. Markets are struggling to correctly price in these very different outcomes. Feelings of optimism and pessimism oscillate nervously within the markets and the prices of a whole range of assets move up and down with them.... Only when talk of quantitative easing, sovereign risk, and deflation starts to fade will we see any change. It would be optimistic to imagine this happening within the next eighteen months.

Baltic Dry and the risk trade. Bruce Krasting.
of the 3 things weighing on the BDI now, Australian floods leaving ships idle, new ships having come on service in last 18 months so no shortage of ships, and China's previously very aggressive pace of accumulating raw materials has slowed in last 60 days:

"China trumps everything. It's not just shipping rates; all the froth in the commodities market is at risk."

This is of course just one mans opinion. Who knows, maybe China will ramp up its infrastructure development again sometime soon. But given that they are going hell bent for leather in the opposite direction to cool an overheated economy I would suggest that a revival of their build-out program is the least likely thing we might see.

There are two basic trades. The Growth Trade and the No Growth Trade. In many areas of the markets (stocks, commodities, currencies and to some extent bonds) the Growth Trade is fully priced in at the moment. When (if) more evidence of a China slowdown comes out it is possible that a fair bit of “air” will have to be released. Nothing like that is in today's 'print'.

other fare, first 3 serious, then 1 hilarious:

Twelve virtues of rationality. Eliezer Yudkowsky.

The first virtue is curiosity. A burning itch to know is higher than a solemn vow to pursue truth.... The third virtue is lightness. Let the winds of evidence blow you about as though you are a leaf, with no direction of your own. Beware lest you fight a rearguard retreat against the evidence, grudgingly conceding each foot of ground only when forced

Peak oil and the changing climate. The Nation, featuring Bill McKibben, Noam Chomsky, Dmitri Orlov, James Kunstler, Nicole Foss, Richard Heinberg.

Population 7 billion. By 2045 global population is projected to reach nine billion. Can the planet take the strain? National Geographic.


Dave Barry's Year in Review. Washington Post.

January 3

Albert Edwards, SocGen bear, takes a bite out of China. Guardian.

Edwards is thus sticking to two eye-catching predictions. Stock markets will revisit their March 2009 lows (3512 for the FTSE 100). And, despite the hints in recent months of a return of inflation, gilt yields will fall below 2% (from 3.5% today) as deflationary forces reassert themselves. Oh, and for good measure, prepare for the hard landing in China and the crash in commodity prices.

In Edwards' view, China is a "freak economy"; its investment-to-GDP ratio is off the scale in terms of size and endurance. "In development history, Korea is the only one that got close. It then collapsed. China is basing a growth model on the most unstable part of GDP. The Chinese authorities have recognised this and are trying to steer the economy over to consumption – which is fine, but it will take a long time."

The danger, he suggests, is that China has produced such strong growth for such a long time that investors assume the process will last indefinitely. "There is too much confidence in the lack of volatility."....

He and his colleagues (at the French bank Société Générale) have been the top-rated analysts in the "global strategy" category for seven consecutive years, despite being too quick out of the blocks with some of their predictions. "Often the call is right but it is early and the clients know that,"

As his final research piece of 2010 put it: "I've been doing this job long enough to recognise when the markets are entering a new phase of madness that leaves me scratching my head with bemusement. The notion that we are back in a sustainable economic recovery is as ludicrous as it was in 2005-07. But investors are backon the dance floor, waltzing their way towards the next, inevitable implosion, [which] yet again they will no doubt claim in retrospect was totally unpredictable!"

Setup and resolution. John Hussman.

We enter 2011 at a point where investors have pushed risk assets to a speculative extreme, on the belief that the Fed has provided a "backstop" against losses. While there's no assurance that we won't see a further extension of this over the short-term, we've found more often than not that speculative setups in the financial markets are followed by a striking degree of subsequent resolution in the opposite direction....

I still believe that existing post-war data was not representative of what we were observing in 2008-2009, and that significant problems were papered-over instead of resolved. But in hindsight, I was wrong to expect investors to share that assessment. The aversion of investors to risk has vanished, so every concern about risk has been unrewarding. Thanks to a tripling of the Fed's balance sheet, a suspension of fair-market disclosure by major financial companies, and an ongoing Federal deficit of more than 10% of GDP, the economy appears to be slowly recovering, and investors care little about the dangers of the policies that produced that outcome. Though my concerns about other major risks have generally been well placed, to this point, risk aversion has been a mistake....

the stock market remained characterized by an overvalued, overbought, overbullish, rising-yields condition that has historically produced poor average market returns, and consistently so across historical time frames. However, this condition is also associated with what I've called "unpleasant skew" - the most probable market movement is actually a small advance to marginal new highs, but the right tail is truncated and the left tail is fat, meaning that there is a lower than normal likelihood of large gains, and a much larger than normal potential for sharp and abrupt market losses....

The upshot is that there is little historical basis at present to expect positive returns as compensation for accepting risk in stocks, bonds, or precious metals. This will change, possibly soon, but the result of the recent speculative run is that risk premiums have been compressed to levels that have historically been inadequate to compensate for risk.

addendum to Hussman's valuation evaluations of small-caps vs large-caps and the Nasdaq vs SP500:
since 1900, the Q-ratio has only been higher than its current level of 1.14 during one period: 1997-2001