Friday, September 23, 2011

What a Week!

Although S&P500 tested the 1,120 level, it ended the week well above it at 1,136.43. We note that this was a pretty bad week with the S&P500 taking a dump and finishing the week down 6.5%.

The equity market actually had a better week than the commodity markets as the Fed disappointed everyone with its announcement on Wednesday. As we touched on it before, gold did slide back down and it appears it is well on its way to fill the gap that we talked about a few weeks back. The approx. 155 support level for GLD is still there, but if we don't see at least some upward movement early next week, this falling knife could pick up speed and not ease until it hits around 150. GVZ, the gold volatility index, shot up nearly 22% today and closed at new 12-month high of 39.17. Even with such pullback, which we expected, GLD is up 15%+ YTD, compared with S&P500’s near 10% slide. At 150, GLD would still be up around 9% YTD. Of course, that is nothing compared with betting on volatility, which, based on VIX, has had a 140%+ YTD return.

S&P500 did not break below its 1,120 support level, which is good news at least for the time being. We believe the risk of going below that remains as long as S&P500 doesn't 'settle' around 1,150 - 1,160. This index has been trading erratically between 1,120 and 1,220 since early August. And it has not created a base anywhere within that range during those near two months. So, although we are slowly getting our feet wet again when S&P500 dips below 1,150 (by continuing to long non-cyclical sectors and slowly getting into a few cyclical ones), we remain cautious. If it breaks through that 1,120 support level, then we would be more aggressive in longing more cyclical sectors (ETFs) and high quality companies within those sectors.

As usual, some market moving data is due to come out next week - new home sales (Aug.), Case/Shiller home price index (Jul.), Consumer Confidence (Sept.), durable goods orders (Aug.), weekly initial claims, personal income & PCE (Aug.), Chicago PMI (Sept.) and the University of Michigan/Thomson Reuters consumer sentiment (Sept.). We expect the PCE price index to surprise on the upside. It will also help explain why the Fed chose the 'Operation Twist' and why it is divided internally when it comes to printing more money. In addition, new home sales could disappoint, especially after seeing just how foreclosures, investments and all-cash transactions drove the better than expected existing home sales. Lastly, growth in personal income during Aug. was likely negative, and if so, it would disappoint as the market expects no change. When companies are not hiring, they are also not increasing wages; and August was certainly a month that many companies, individuals and lawmakers would rather forget.

Thursday, September 22, 2011

Did Bernie Disappoint?

We are amazed that it took the Fed so long to realize that the economic and financial issues we are facing are not mere temporary shocks.  And it was such realization by the Fed and its inclusion in the official statement yesterday that sent the markets down.  Based on where the futures are right now, the equity markets will likely be down today also. 

The Fed said “recent indicators point to continuing weakness in overall labor market conditions, and the unemployment rate remains elevated,” and it sees "significant downside risks to the economic outlook, including strains in global financial markets."  The Fed has realized that the psychological approach to turning around the economy will no longer work.  Consumers will likely not jump up and consume as soon as they see the equity market bounce back up; and companies won't hire.  While the Fed claims that helping the state of employment and controlling inflation are its two main objectives, it has obviously ignored the first one.  And we think its announcement yesterday was an indication that it saw the risk of losing control of the second objective in the short-term increase significantly.

Simply put, the Fed's policy goal is to make long-term borrowing more attractive for businesses and consumers by buying $400bil worth of long-term US debt until June '12.  This may bring down long-term borrowing costs which the Fed believes will help drive more borrowing by businesses and consumers; hopefully based on long-term objectives such as increasing capex and adding human capital (possibly), and purchasing homes.  The impact of this type of money printing won't be felt in the economy until sometime. 

So, without a 'quickie' in store for the equity market (unlike old times), gold retreated further and it appears it might continue to do so today.  The same support levels that we touched on a while back remain for GLD.  If it gets below 170 (or around $1,760 for gold), then it can soon test low 160's (or $1,650), assuming the Fed won't make 'politically correct' statements in the near future.  In addition, the gold volatility index (GVZ) has remained at historically high levels.  The Fed's move has made the dollar the least worse, which also won't help gold; and we note that it was not expected as the market wanted to see more of an outright short-term money printing and dollar-devaluing policy.  With regards to the S&P500, if it goes below 1,150, which appears to be likely, then YTD lows of around 1,120 could be re-tested.  We've seen so much volatility, that the market appears to be 'consistently' volatile.

Lastly, to make things worse, initial weekly claims came in above expectations, 423K vs 418K.  In addition, the previous week's figures were upped by 4K.  Continuing claims declined, but we note that many other factors may have driven this, including many unemployed running out of their unemployment benefits (regular, extended and emergency).

Wednesday, September 21, 2011

Existing Home Sales Up Nicely

Existing home sales came in at a seasonally-adjusted 5.03MM rate, easily beating the Street's 4.70MM estimates; up 7.7% from July and 18.6% Y/Y.  Lower prices, which were 5.1% below last year were likely the driver of such growth.  However, we remain pessimistic regarding the real-estate market (as we have for a few years) as majority of the growth were for homes priced between $100K and $250K.  In addition, a sizable chunk of the sales, 22%, were investors; all-cash buyers were 29%, up from last year's 28%.  First-time buyers represented 32% of the purchases in August, unchanged sequentially and up from last year's 31%.  Inventory remained at high levels historically, although it did dip to an 8.5 months supply from 9.5 in July.  Maybe those builders with surprising number of building permits are beginning to see some indications of demand pickup.  However, we note that it is still a bad market (or shall we say buyer's market ... for the buyers with the income, savings and cash) with prices being pressured, combined with unemployment at high levels, continuing deleveraging per household, no growth in wages and lack of savings, it is tough to think of the August data as a trend and assume it will continue.  If we do see another blip, then a lot of properties may be dumped onto the market as investors made up more than one-fifth of purchases made in August and they may just want to get them off their hands.  And let's not forget continuing foreclosures.  We always hope for the best but take the worst into account. 

Refinancing Drives Up MBA Mortgage Index Slightly

The MBA Mortgage index went up 0.6% last week. Refi's edged up 2.2% while demand of loans for home buying went down 4.7%. We'll see how the existing homes sales figures turn out later this morning.

Tuesday, September 20, 2011

Gold above $1,800 and Builders Building without Much Demand

Looks like today, the Fed's index finger of its market-helping hand was seen; and that gesture brought the Fed back to the front pages. The equity market gave back nearly all of its morning gains and decided to wait for the Fed's rate decision which is expected tomorrow. But as we anticipated, with the Fed in the headlines on the front pages, gold reacted pretty well and got back over $1,800 again. We think it will still remain volatile and might retreat back again (for reasons mentioned before), unless the Fed bluntly states that further monetary easing is coming along. We note that the Fed is the best political org that this country has to offer. In addition, for this latest upturn to gain some momentum, gold will likely have to cross $1,820 - $1,825 first. With regards to GLD, that comparable level would be around 179 - 180.

Regarding economic news, housing starts data were disappointing. 571K for August represented 5% and 5.8% sequential and Y/Y declines, respectively. Building permits were slightly better than expected and up 3.2% and 7.8% sequentially and Y/Y, respectively. We've been asking this for a couple of years - do we really need more homes built? Shouldn't we get rid of all the inventory (incl. foreclosures or shadow inventory) first? Will aggressive buidling put the builders in the same situation it did after 2007? Besides a few areas where the higher income people live, real estate markets have remained very weak. We have not yet seen strong indications of growth in demand. And for this reason, we wonder why the government and the market want to see more construction, from which some jobs may be created but will not last long.

Tomorrow (Wed.), in addition to the Fed's rate decision, we'll get the latest on the MBA Mortgage index and August's exisiting home sales, which might provide some initial color regarding whether or not the increase in building permits was good news or not. The Street expects August home sales to come in at a 4.7MM seasonally-adjusted annual rate.

Friday, September 16, 2011

More Manufacturing Data and Consumer Sentiment

First, we thought we must provide a summary of the Philadelphia's Fed business outlook survey, which we did not include in yesterday's lone post.

The survey was disappointing, similar to Empire State's. It came in at -17.5 versus a -10.0 consensus. More businesses upped their employee count which was positive, but was offset by pretty much no change in average employee workweek. In addition, surprisingly, more businesses said their inventory levels were higher.

As was with the Empire State's, the forward looking survey was more positive. More businesses expect more new orders and shipments. However, at the same time, they expect a dip in inventories, which tells us uncertainty remains going past the next six months for these manufacturers; and the increase in number of employees and average employee workweek (as indicated in the forward survey) will likely be temporary.

Now ... how are the consumers feeling? Well, that's what University of Michigan (with that great win against Notre Dame last week) and Thomson/Reuters tell us with their survey of consumers. The preliminary results for the month of Sept. (released this morning) were better than expected; 57.8 versus a 56.3 consensus. This was also up from August's 55.7. Although this represents some improvement, we must note that it is significantly below last year's 66.6 preliminary reading.  Consumers may be thinking that the glass is half full, but is it?

Thursday, September 15, 2011

Economic Indicators Update and Some Thoughts to Think About ...

Given that some what we consider as important economic indicators came out, we thought to post our thoughts on them.

No indication of much improvement in the state of employment as initial unemployment claims (seasonally adjusted) for last week were 428K, significantly higher than the Street's 410K estimate and up from the previous week's 411K and . We note that the previous week's figure was adjusted higher by 3K.

On the pricing front, it appears higher prices continue to be passed on to the consumers. CPI came in up 0.4%, higher than the 0.2% expectation. Core CPI was in-line with expectations. However, we note that oil has remained around the $85 - $90 levels. As mentioned before, expectations of further monetary easing policies will likely push commodities higher or limit their downside even on weak economic data. This won't help contain inflation during a pretty much flat economic growth period.

Empire State manufacturing survey results were also disappointing. Overall, it declined to -8.82 from -7.72, not only indicating contraction at a higher rate but also much lower than the Street's -4.0 expectation. New orders dipped slightly as compared to last month. Shipments plummeted. Inventories declined, which could indicate at least some improvement in the coming months. Prices increased, both paid and received. As expected, the index for number of employees dipped to contraction levels (below zero) and to make things worse, the average employee workweek was unchanged and remained negative. The forward looking part of the survey was a bit more positive, although still nothing to write home about. We think we're likely to see some inventory replenishment, but the upside for that will be short-lived. Although most components of the forward looking survey showed some improvement, both the number of employees and average employee workweek indexes declined, which we believe may offset the positive side of the forward looking survey.

According to our great Fed, industrial production increased 0.2%, 20bps higher than the estimates on the Street. Of course, the great Fed did reduce its previously released figures for April, May and June. Capacity utilization was in-line with expectations at 77.4%, which as we've said before remains below growth period average of 80% - 85%.

Based on most of this data, it appears that the state of employment will not improve much.

In terms of the equity market, well, the higher chances of the great Fed (and other central banks) coming to the rescue, as mentioned before, more than offset negative economic news. Last week's volatility pretty much met our expectations. The S&P 500 dipped below its 1,175 - 1,180 support levels; again, the possibility of a QE3 kept it from testing its YTD lows. We must say it did hit the 1,136 level intra-day on 9/13, but then the Chinese came to the rescue as rumors that China would help out Italy brought smiles to everyone's faces.

Gold has been taking a breather (mentioned in Aug) as the dollar, even given further upcoming monetary easing, has become the best of the worst. This is especially true given the troubles that Euro faces and doubts regarding continuing high growth rates in emerging markets. And as the Euro story remains on the front pages, gold might retreat further. In addition, gold, or the GLD ETF, hasn't necessarily filled the gap created when it shot up to $1,900 (or around 186 for GLD) pretty much straight from $1,600 (or around 157 for GLD) in a very short period of time. Once the Fed's QE3 comes back to the front pages, we'll likely see gold gain some strength.

Lastly, we’d like to offer some things to think about. Can Greece really recover and avoid defaulting? If not, does this continuing support from ECB increase the risk of the contagion effect? Can the developed economies and markets continue to ‘kick the can down the road’? Will there be a QE4 after what appears to be a more likely QE3? And will the bickering between the White House and Congress (and within Congress) over another increase in debt limit be as exciting as the most recent one? This is based on the assumption that the new jobs plan will pass, which will likely force the lawmakers to raise the debt limit again. We’re thinking about these, as we’d always like to think that we are thinking.

Sunday, September 4, 2011

Wikileaks Discloses The Reason(s) Behind China's Shadow Gold Buying Spree

A pretty interesting perspective provided on based on info from Wikileaks ...

"Wondering why gold at $1850 is cheap, or why gold at double that price will also be cheap, or frankly at any price? Because, as the following leaked cable explains, gold is, to China at least, nothing but the opportunity cost of destroying the dollar's reserve status." ...

Friday, September 2, 2011

Help Wanted!

We thought the employment numbers may come in below expectations, but a big fat zero for non-farm payroll (NFP) employment was a surprise. Given Bernanke's promise, we didn't think the market would react this negatively if the NFP figure was non-negative, but then again, a zero is nothing to write home about. We note that the bad news was made worse as the NFP numbers for June and July were revised down significantly. June's figure went down to 20K net jobs added from 46K, and July was revised down to 85K from 117K. This may help further explain the market's early reaction to the job numbers.

Most private NFP figures were either unchanged or increased in August, resulting in a net 17K for the month. Manufacturing declined slightly by 3K, while information technology dropped by 48K, of which 45K was due to the VZ strike. However, even if we add the VZ number to private NFP, the resulting 62K would still be well below the 100K Street consensus.

Government NFP declined 17K, slightly less than the 25K estimate.

We also noticed somewhat of a bad combination - lower average workweek for private NFP employees and only a 1.9% increase in average hourly earnings during the last 12 months. Lower workweek indicates lower demand for production and/or services. In addition, the hourly earnings growth trails the 12-month inflation which is above 2% currently. These two basically are not very good news for the job market and overall consumption.

In terms of the market, after crossing 1,200 and reaching around 1,220 earlier this week, given what seems to be a pull-back today, 1,250 for S&P 500 doesn't appear realistic.  The next support level is around 1,175 - 1,180.  If the market goes below that level, with Bernanke's promise, we're not sure if it will really test the YTD lows of 1,115 - 1,120 from now until end of Sept.  Then again, as mentioned before, because QE2 did not stimulate the economy, doubts regarding effectiveness of QE3 may override a possible short-term boost it may give to the equity market. 

Lastly, we thought to comment on a recent report that President Obama "pulled back proposed new national smog standards".  He basically told the EPA ... you-know-what.  This is surprising given Obama's image as a liberal.  Then again, he is a politician and the elections are ONLY about 14 months away.  We don't have an opinion on the right or left, or on the smog standards and/or their impacts on the economy, government spending, etc.  However, we must say that politicians of all kinds (with maybe one or two exceptions) will do or say anything to get elected.  Of course, everyone already knows this.

Thursday, September 1, 2011

Still have Faith in the Fed?

Today, initial claims were slightly higher than expectations, 409.00K versus 407.00K estimate. The smoothed out 4-week moving average increased by 1,750 to 410.25K. Although continuing claims fell, as we had expected, they did not fall below expectations. Continuing claims for week of Aug. 20 stood at 3.735MM, down 18K from the previous week.

ISM came in above expectations as we had assumed yesterday. 50.6 was slightly higher than our estimate and above the 48.5 consensus. There was no revision to the July figure. Also, as we expected, we saw contraction (below 50.0) in production, new orders and backlog. Although employment was below the previous month, it remained above 50.0. 

Other economic indicators released included July construction spending and Q2 productivity levels and unit labor costs. All of those figures came in worse than expected. Although the construction data was for July, most stocks in the industrial goods sector and construction industry reacted very negatively to the news. We note that there may be a bounce, a temporary bounce, in construction, mainly due to the Irene hurricane.  Also, although this was for Q2, we note that lower productivity and rising labor costs are not good news for the jobs market.

The Fed-driven rally did not continue today, even though the ISM headline figure was better than expected. This could be a sign that anticipation of further monetary easing was mostly priced in. And it could pave the way for a volatile market tomorrow (Fri. 9/2), which is the big labor data day, going into the official Labor Day weekend.  We note that some of that volatility could be discounted due to the upcoming job market speech by President Obama next week.

In terms of tomorrow's payroll numbers, we do not have an estimate. We must note that although the employment indexes for most manufacturing data were not at contraction levels, initial claims and ADP data did indicate that the official employment numbers may come in below expectations. As mentioned earlier in the week, as long as the payroll numbers are not significantly worse than expectations, stocks will likely remain flat or could go up in anticipation of a Fed move. An upward move became a bit more likely after today's decline. But again, overall, we are not really sure where those employment numbers will fall.

Wednesday, August 31, 2011

Another Day Filled with Economic Data and Political You-Know-What

Well, we did see volatility, even within the volatility index. At one point VIX was down more than 8%, but somewhat recovered by the end of the day closing down only 3.9%, while the equity market (S&P 500) closed up 0.5%. So some option play with VIX or VIX ETFs likely paid off.

Economic indicators were mixed, but the two important ones came in below expectations.

ADP was at 91K, below the 100K consensus. In addition, it revised its July numbers down by 5K. While Challenger job cuts for August were slightly lower than July's 16-month high, they were still up 47% from Aug. '10.

So, again, the labor market is not recovering fast enough. However, as we mentioned earlier, the Fed's helping hand more than offsets these not so impressive numbers. By the way, with the election being only 13 months away, President Obama will try to provide some color on how he is planning to address the dismal job market by having a speech during prime time next week. We'll see what Bernanke, Axelrod, Emanuel, Geithner, Krueger and the rest of his buddies advised him to say.

The MBA (Mortgage Bankers Association) Mortgage index for last week declined another 9.6% from the week before. The decline was mostly due to a drop in refinance applications. Home purchase applications went up only 0.9% (non-seasonally adjusted was actually down 1.3%), even though the average 30-yr fixed rate went down to 4.32% from 4.39%. According to MBA, "purchase volume remained near 15-year lows."

July factory orders were above expectations, but that was mainly due to recovery from the supply-chain shock. Also, that was for July.

Surprisingly, Chicago PMI for August was at 56.5, well above the 53.0 estimates; and that good news, which we think was due mainly to the recovery in motor vehicles, helped keep the equity market in positive territory. We note that nearly all important components declined, including production, new orders, and order backlogs. One good sign was that the employment part increased slightly, but that may not continue.

Two additional important figures will be released tomorrow - initial weekly claims and ISM. We think initial weekly claims will be in-line with the 407K consensus. Continuing claims will likely decline as many have not found new jobs and their unemployment benefits are running out. Don’t be surprised if you see headlines highlighting the decline in continuing claims as positive.

Regarding ISM, the news may not be as bad as the market expects. We must say that unless it is significantly below the 48.5 consensus, given the Fed's very visible hand, a miss on the ISM number won't have a significant negative impact on the market. Given that the Fed hasn't been able to help the economy recover much, it is trying (and will continue to) to create more 'positive thinking', hoping it will help everyone work harder and get the economy going. We love the psychological monetary strategy!

Our own estimate of around 49 - 50 is based on what we have seen from regional surveys conducted by the Feds and what we saw this morning from Chicago. After 'playing around' with the numbers, our estimates ranged from approx. 48 to 51. Production will likely be low, along with new orders and backlogs, but given that employment decisions are not made on the spot nor can be changed that quickly, similar to what we saw in the Chicago figures, the employment component of the ISM might be slightly higher than July.

Tuesday, August 30, 2011

What Could Explain Today?

Interesting that after we saw S&P 500 shoot up 2.8% on Monday, on very light volume, we did not see at least a small sell off today.

Let's see if any of the economic indicators could explain this.

Personal income came in below expectations, while spending exceeded estimates. Initially, some might think that higher spending is positive. We disagree, especially when you combine the higher spending with lower income and higher credit during a period of slow economic growth, weak labor market and rising core CPI and PCE index. We must mention that those economic numbers were for the month of July.

Let's look at June pending home sales figures. They came in at -1.3%, 10bps (or 1/10 of one percent) better than expected. This may indicate that a seasonally adjusted rebound in the housing market for 2H '11 is off to a pretty slow start. Although this was for June, it is somewhat of a forward indicator.

The June Case/Shiller home price index (20 cities) was 4.52% lower than last year. This was 18bps better than expected. Then again, May's numbers were revised lower by 8bps, so let's say 10bps better than expected. Overall, not much of a positive surprise. We do note that the report stated certain regions did show improvement; we actually pointed this out in one of our August 11 posts.

Then we saw the miserable consumer confidence data which came in at 44.5 for August; significantly below the 52.0 consensus and July's 59.2. This is self-explanatory.

So, with overall economic numbers not being positive, especially the recent ones, what explains the lack of at least some profit-taking today after Monday's near 3% rise in S&P 500?  And the answer is: the greatest, the best and least questioned insurance coverage provided by the Fed. Yes, as mentioned before, they have created a win-win situation, at least for now. Even one of the three Fed dissenters, Kocherlakota, said he might now support a QE3. This may tell you that he is realizing the situation may be worse than expected, even after the Fed's last two meetings in August.  He may be thinking that it could get so bad that the risk of inflation can be ignored and further monetary easing can be implemented. 

Tomorrow's ADP and Challenger employment figures will provide more color going into Friday's 'official' employment numbers. Although the market was up slightly today, VIX was also up, approx. 2%. So there is a chance of a siginficant move up or down in VIX and VIX ETFs during the next couple of days, from which one may be able to benefit by trading VIX (or VIX ETF) options.

Summary of August FOMC Minutes

In case you may not have read the FOMC minutes (released this afternoon) or read all the headlines in early August, we thought a summary of those minutes might be useful. Full detail is available on the Fed's website.  We note that we have cited most of what is discussed below in our previous posts, going back to 2010.

Staff Review of Economic Situation
  • Pace of recovery remains slow; recovery during 1H '11 "quite sluggish"
    • Weak labor market
    • High initial claims
    • Lower labor force participation
  • Recession worse than initially thought
  • Expect stable long-run inflation
  • Not much change in manufacturing
    • Excl. motor vehicles production, other output posted "only a modest increase."
    • Flat capacity utilization
    • Indications of "only small gains in production in the coming months."
  • Q2 consumer spending pretty much flat
    • Auto sales rebounded in June
    • Nominal wages up in Q2 but offset by higher prices
    • Decline in consumer confidence
  • "Housing market remained depressed"
    • Prices trended lower
    • Not much new construction due to high current inventory and weak demand
  • Business spending up, driven mostly by spending on high-tech equipment
    • Orders for non-defense (excl. aircraft) were up
    • Investments in non-residential stablized at low levels
    • Besides in motor vehicles, inventories aligned with sales
  • Federal spending up, driven by defense spending; state & local spending down
  • Real exports exceeded real imports in Q2
  • Not much change in CPI and PCE index as downward pressure on food and energy offset by rise in core prices --> meaning inflation continued to increase
  • Nominal hourly compensation up in Q2 more than productivity in non-farm business; driving up unit labor costs --> could create more pressure on the labor market
  • Slowdown in international growth

Review of the Financial Situation
  • Equity market's reaction to the end of QE2, weak economic reports, S&P downgrade, and troubles in Europe
  • Improvement in business credit quality during Q2
  • Weak commercial real estate markets, but delinquency and vacancy rates decreased slightly
  • Improvement in consumer credit markets
  • Core commercial bank loans flat in June and July (slowdown in lending to businesses offset by more loans to households)
  • Lending standards eased, except for residential real estate loans. Standards remained "between moderate to relatively tight" compared with standards since 2005.

Staff Economic Outlook
  • Lowered real GDP growth estimates for 2H '11, 2012 and additional years down the road; but expect overall positive growth, but the labor market to remain weak through 2012
  • Expect short-term bounce in economic growth driven by easing of the Japan-related supply chain disruption
  • Upped inflation expectations, but expect lower energy and food prices, easing inflationary pressure; "expect prices to rise at a subdued pace in 2012."

Participants' View on Current Conditions and Economic Outlook
  • Overall weaker than expected conditions driven only partially by temporary factors; "underlying strength of the economic recovery remained uncertain".
  • Long-term unemployment can impact skills and ability to find jobs
  • Not much of a match between the unemployed and available jobs
  • Extended unemployment benefits has likely kept some out of the labor force, lowering the labor force participation rate
  • Lower labor force participation rates likely a driver of slightly improved unemployment rate, rather than improvement in overall employment.
  • Lack of business confidence impacting hiring decisions
  • Some expect inflation to decline due to weak labor and product markets, lack of much wage growth, and not much pricing power.
  • Some noted that core inflation has moved up
  • Lower than expected consumer spending driven by lack of confidence, not much wage growth, balance sheet clean-up, and declining home prices.
  • Some see downside risk to recovery, but no contraction (or recession)
  • Economy and markets may be vulnerable to adverse shocks
  • Most agreed that they would use any/all tools necessary to help the economy grow, but some said that more stimulus won't make much of a difference except that it increases risk of too much inflation.
  • As basically a compromise, they agreed to keep rates low until at least mid-2013.
  • Discussed setting similar short-term objectives for the unemployment rate, but did not do it
  • Hinted that basically, if necessary, the Fed would take additional steps at the end of Sept.
  • All members except for Fisher, Kocherlakota and Plosser agreed with the decision.


Monday, August 29, 2011

Upcoming Data This Week

Let's start with employment. DOL's figures will be released on Friday and we can already discount the estimates which currently stand at 75K and 111K for non-farm and private non-farm payrolls. Weight given to the always questionable unemployment rate should be basically zero, so let's not think too much about the expected 10bps decline for the August figure. The market already expects lower numbers given the initial claims for the month (partially driven by the Verizon strike), the fiasco on Capitol Hill and the White House, the S&P downgrade and continuing rise in core PPI and CPI. For this reason, unless the payroll figures are below -15k, we don't think the market will react too badly towards the numbers. We note that Bernanke basically hinted that if the state of the economy gets worse, the Fed will come to the rescue.

We will likely see some volatility leading up to Friday's important employment numbers as the ADP and Challenger figures will be released on Wednesday before the open. Although those are highly correlated historically with DOL's employment data, there have been months where the two sets of data have gone basically in opposite directions. If the ADP figures come in much worse than expected (Aug. consensus is 100K), then depending on how significantly the market reacts, there could be a trading opportunity going into Friday's numbers.

Other data scheduled to be released this week include weekly initial jobless claims, Conference Board's consumer confidence (Aug.), ISM (Aug.), and the Chicago PMI (Aug.). ISM and the Chicago PMI will also likely provide more color on Friday’s employment numbers.

June pending home sales and home prices (Case/Shiller index) will also be released this week. Although we are way past June, those figures will impact a few related sectors, especially given the fact that President Obama has begun discussing other ways to help the housing market. The worse those figures are, the more they may increase the chances of Obama's begging to be successful, which could be positive for stocks in those sectors, at least in the short-term.

We note that other economic data for June and July will also be released this week. No matter if they are better or worse than expectations, we believe the market will forget about them after an initial and very short-term reaction.

Winner, Winner! Chicken Dinner!

Winner, winner; chicken dinner! That could be what many were saying before calling it a day on an up-day Friday, packing and heading out of town in order to avoid hurricane Irene. Yes, combined with the worse than expected news regarding initial claims, Q2 GDP and consumer confidence, Bernanke's assurance that it will basically do anything (if still necessary) by the end of Sept. pushed the S&P 500 up 1.51% for the day, and helped end the week up 4.74%. The market is basically looking at that assurance as an 'insurance' (with an invisible premium), especially if economic news worsen.

Regarding the speech out of Jackson Hole, we briefly reviewed what Bernanke discussed. Below are a few things that stood out.

"In the broader economy, manufacturing production in the United States has risen nearly 15 percent since its trough, driven substantially by growth in exports." Of course, this is expected especially when recovering from a "trough".

"Temporary factors, including the effects of the run-up in commodity prices on consumer and business budgets and the effect of the Japanese disaster on global supply chains and production, were part of the reason for the weak performance of the economy in the first half of 2011; accordingly, growth in the second half looks likely to improve as their influence recedes." If the run-up in commodity prices is considered as temporary, then we could say that the recovery can also be considered temporary. The somewhat of a slowdown that we have seen in the emerging markets, along with disappointments at home have driven commodities down. Add to that the artificially low interest rates and devaluation of the dollar (thanks to Mr. Bernanke), and the commodities will react twice as much to an appreciation in the equity and economic markets. So expect the commodities to jump again if the Fed comes to the rescue at the end of Sept.

"Historically, recessions have typically sowed the seeds of their own recoveries as reduced spending on investment, housing, and consumer durables generates pent-up demand. Improving income prospects and balance sheets also make households and businesses more creditworthy, and financial institutions become more willing to lend. Normally, these developments create a virtuous circle of rising incomes and profits, more supportive financial and credit conditions, and lower uncertainty, allowing the process of recovery to develop momentum." Such rate of growth and recovery cannot be maintained if the state of employment, balance sheets and the housing market remain weak. That is what has basically taken place. That initial injection of liquidity may have been necessary, but by keeping the rates so artificially low for such a long time, the Fed has taken away any incentive for people to save, and has 'forced' many to take unnecessary risks. By the way, Bernanke did say that we need incentives to save in order to have economic growth for the long-term.

"Households will continue to strengthen their balance sheets, a process that will be sped up considerably if the recovery accelerates but that will move forward in any case. Businesses will continue to invest in new capital, adopt new technologies, and build on the productivity gains of the past several years." We shall just ask - Mr. Bernanke, is it the chicken or the egg? Is it the cleanup of the balance sheet that makes the recovery faster or is it a faster recovery that helps clean up the balance sheets? By the way, basically putting a ceiling on interest rates will not help speed up the balance sheet clean-up process; making that “move forward in any case” a very slow move.

Wednesday, August 24, 2011

Ron Paul Leaps Past Bachmann in Latest Poll

One of our readers provided us with the link to the story below.  It appears that even though Ron Paul is ignored in the mass media, he isn't ignored by potential voters.  It is interesting that his ideas that were once considered as too extreme or fanatic are now gradually being viewed more as mainstream.  We are not taking any political positions here; just thought that this is some useful info.


By John Thorpe
Wednesday, August 24, 2011
Ignored by the media and dismissed by the Republican Party in general, liberty-minded Congressman Ron Paul leaped into third place today in the Gallup Presidential Nomination preference poll. Paul jumped over Michele Bachmann, the Tea Party darling/lunatic, relegating her to fourth-place in the current poll. Here's how the numbers shake out today.

  • Rick Perry, Texas Governor: 29%
  • Mitt Romney, former Massachusetts Governor: 17%
  • Ron Paul, Texas Congressman: 13%
  • Michele Bachmann, Minnesota Congresswoman: 10%

That's right. Ron Paul jumped into third place...and the media continues to ignore his candidacy. I can't explain it as anything other than outright bias against the man and his ideas.

One thing to take away from the poll is that it only includes current, declared candidates. It does not, for example, include potential candidates Donald Trump, Sarah Palin, Chris Christie, Rudolph Giuliani, or George Pataki - all of whom have made noise about possibly jumping into the race at a later date.

One of them could possibly be very successful following a later-entrant strategy. As of today, a full 17% of respondents indicated "no preference" in their vote.

Think about that for a minute. "None of the above" essentially takes second place right now, ahead of everyone but Rick Perry - and even Republicans aren't crazy enough to nominate Rick Perry. This means one thing: there is room for either one of the marginalized candidates (like Ron Paul) to gain a lot of support, or a new candidate to emerge and become an instant challenger.

Given his three percent jump in the polls (despite the entrance of former Democrat and popular Texas governor Rick Perry into the race) shows that Ron Paul's numbers are steady and rising. Are we witnessing the promised Ron Paul revolution, or has the Texas congressman maxed out his voter numbers? I suppose the analysis depends on who you ask.

Certainly experts are beginning to see the benefits of signing on to Team Ron Paul. The Ron Paul 2012 Presidential Campaign announced today that constitutional and international law expert Bruce Fein will join the campaign as senior advisor on legal matters.

"Bruce Fein's participation adds to our campaign's already intellectual heft, enabling us to more broadly engage the conversation about constitutionality, civil liberties and the dangers to national security of an increasingly interventionist foreign policy," said Ron Paul 2012 Campaign Chairman Jesse Benton.

According to the Ron Paul for President Website (, Mr. Fein served as associate deputy attorney and general counsel to the Federal Communications Commission under President Ronald Reagan. He served as Research Director for Republicans on the Joint Congressional Committee on Covert Arms Sales to Iran, and on the American Bar Associations Committee on Presidential Signing Statements. He has been a Visiting Fellow for Constitutional Studies at the Heritage Foundation and an adjunct scholar at American Enterprise Institute. He has advised numerous countries on constitutional reform, including South Africa, Hungary and Russia.

Apparently the American people are starting to take notice, too. According to the most recent Rasmussen survey of likely voters, Ron Paul is a mere one point behind President Obama in a head-to-head matchup - a better result than any of the other GOP contenders received.

This is despite the media blackout around Ron Paul's campaign, and despite the media's insistence that Ron Paul can't beat Obama. This poll suggests he can.

If you're interested in the Ron Paul campaign, and tired of the general media ignoring the campaign, stay tuned to and/or specifically, find my personal story page here.

If you want to volunteer for his campaign, you can find his website here.

You can reach the author by email or on twitter @johndthorpe.

Will Bernie come to the rescue?

We believe that after yesterday's big bounce in the equity market, a potential QE3 may be partially priced in. If that is the case, then the question is - would the equity market go down on the news (on which Bernanke may provide a hint later this week)?

The answer is yes and no; a usual Street response! Yes, if upcoming economic figures are in-line and do not disappoint too much. However, what many may consider as unusual (but we have seen it before) is that very bad economic news (below expectations) would actually help the equity market as it could increase the chances the Fed will go into fifth gear and initiate QE3. If this occurs, then there could be further upside in the short to medium term.

Today's July durable goods orders came in better than expected. While this may provide a more positive perspective on the economy (with which we disagree), it could increase chances of the Fed staying put and not creating QE3, which we believe may mean that QE3 could be priced in. However, this is not yet clear as Q2 GDP, consumer confidence, and weekly initial jobless claims will be released later this week. In addition, various market moving employment indicators are scheduled to be released next week. We also note that the MBA Mortgage Index released today disappointed, but then again we assume everyone has accepted the double-dip in the housing market.

Basically, this year is somewhat similar to last year - the equity markets benefit if the economy is in much worse shape than expected as it will 'force' the Fed to meddle again; and the equity markets will benefit if the state of the economy is not as bad as the market currently indicates. We note that these benefits will be good only for the short to medium term, similar to last year.

Technically, gradual run up towards and past 1,200 would likely lead to 1,250 - 1,275.  But if the upcoming economic indicators disappoint before we get more color from Bernanke, then breaking below 1,120 could be next which could drive it down as much as another 100+ to 1,000.  Right now, with the uncertainty surrounding Bernanke's decision, the economic status of Europe, some slowdown in the emerging markets and the political upheaval right here at home markets are basically ignoring fundamentals.

Lastly, gold is taking a breather (and may be breathing pretty heavily) as we suggested before. Technically, it is close to breaking through its support level, which we believe is $1,760. If that takes place, then its next support level would be around $1,600. If Bernanke installs another QE, then we could again see gold rise along with the equity market possibly driven by risk of higher inflation. We note that gold did move along with S&P 500 after QE2 was announced. The movements in the two were correlated until pretty much the official end of QE2, end of Jun. ‘11. We wouldn’t recommend getting in until another support level is maintained or more certainty regarding Bernanke’s QE3, if any. By the way, VIX is down nearly 25% since it hit its YTD closing high of 48.00 on August 8th.  Volatility would likely return after Bernanke's speech and leading up to next Friday's (9/2) key employment numbers. 

Thursday, August 18, 2011

Cold as Ice ...

We're not sure if this market tumble will continue, but it appears that it will take a lot more than just political BS and Bernanke/Geithner tag team to at least reduce volatility in the market.  This might seem a bit silly, but for some reason, we started singing "Cold as Ice" after seeing the CPI and initial claims figures this morning.  Never forget the music of the 70's and 80's :).  

And as if the US isn't facing enough problems at home, the 'healer', President Obama, has called for the resignation of Syria's Assad.  We note that we're not necessarily picking on the current President, as that 'healing power' has been used and abused by many Presidents before Obama.  Then again, that 'healing power' has been created and provided by those great lobbying groups that basically buy up their preferred policies out there in Washington, D.C.   We fear that the same groups might be making the pitch that wars drive economic growth (for the aggressors, of course) and create jobs.  They're probably saying, "Mr. President, you'd be killing two birds with one stone - be more aggressive for 'our' benefit in the Middle East, and if you get into another military 'engagement', it'll actually be beneficial for you and the US economy."  Hopefully we're wrong about that.  


Saturday, August 13, 2011

Has FDIC created a new 'moral hazard'?

The discussion in the podcast (above) pretty much tells us that bank regulations are going too far in telling banks how to manage their portfolios. It cites a good example, Main Street Bank.  This small bank in Kingwood, TX is changing its business model mainly for one reason - too much regulation. As mentioned in the WSJ earlier this week, Main Street gave up the benefits of its deposits being insured by the FDIC; it is no longer a 'bank'.

The FDIC is basically discounting banks' incentives to manage their own risks. Most banks, with the FDIC deposit insurance, now have the incentive to hold more securitized assets and take other types of risks. But the smaller banks that are just fine with a portfolio of 90%+ small business loans (which are not usually securitized), are getting pressured and fined by the 'standards' that FDIC is enforcing, which are not necessarily applicable to those banks.

The capital standards that are being enforced are pushing banks to favor certain types of assets. Main Street Bank has basically said that it is not interested in deposits nor securitized assets. For this reason, it feels it can do better without the protection and bullying provided by the FDIC (sounds very similar to what the old-timer mafia bosses used to do). Hey, FDIC, 'say hello to da new moral hazard friend!' :)

Main Street will continue to lend to qualified individuals and small businesses. This actually helps increase productivity and growth. Its capital is in the form of equity (provided by other parties) rather than deposits. More detail regarding Main Street's decision is in this article - Fed Up: A Texas Bank Is Calling It Quits. The podcast is very interesting.

Friday, August 12, 2011

The Morality of Capitalism

A short discussion on the morality of what everyone is preaching.  I found it pretty interesting.  I actually saw Tom Palmer, the interviewee, speak at Cato a few weeks ago in Annapolis, MD.  He and his Cato colleagues provided some very educational presentations.

Wages vs. Prices

In response to one of our 'members' (actually, the only member we have!) question/comments regarding wages, we put together some charts (below) describing changes in wages and prices over the last 5+ years, including the last recession.  We decided to use the PCE price index as the great Fed uses this to get an idea about inflation.  We note that the wages data exclude government (state, local and federal) wages.


As displayed above, it is pretty clear that the core CPI (which excludes food & energy) has been creeping up a bit since late last year. Also, it appears that wages started becoming a bit more volatile after Q1 '10.

The chart above displays the behavior of wages and a variety of inflation measurements, including the one that the Fed uses, PCE price index. It shows how wages have remained pretty much flat when compared to CPI and PCE price index. Lastly, growth in both core CPI and PCE price index caught up and passed growth in wages. As we saw in the monthly chart, these indicators are pretty volatile, so although overall prices will likely drift down a bit given the latest downturn in energy prices, it may take some time before the core CPI and PCE lose their upward momentum.

Thursday, August 11, 2011

It's been almost a year!

We realize that we haven't published since Aug. '10. Late Wednesday night (and early Thursday morning) we thought we might as well share our thoughts. We weren't just sitting on our you-know-what during the last 12 months. We have been trying to enlighten ourselves by studying financial engineering at University of Michigan. We loved the academic environment so much that we decided to pursue another graduate degree, master of applied economics. Whether we'll realize substantial return on these investments remains to be seen.

Until then, we thought it may be time to review what we had mentioned up to last year.

First, let's start with a simple comparison that we made last year. The table below is self-explanatory. We note that yes, the recent volatility of and semi-correction within the equity market have certainly helped. But even before the latest equity market's dip, gold was and remains ... golden.

Here is some additional data: S&P 500 is down 6.2% during the last ten years, while VIX is up 104.5%.

Second, after reviewing most of our posts, we realized that we were pessimistic when it came to the state of employment; not just ours, but also that of the rest of the country. Well, the picture hasn't improved much since last year.

The 'official' July '10 unemployment rate of 9.5% was only slightly higher than last month's 9.1% rate. July’s U-6 unemployment rate which includes PT workers and the “marginally attached” employed, came in at 16.1%, down about 70bps from the year before. Many, including us, question the methodology used in calculating the official unemployment rate. So let's look at the non-farm payroll figures. Jan. ‘08’s annualized total non-farm count was 137.996MM; last July’s annualized figure was 131.190MM. The private figures for the same periods were 115.610MM and 109.156MM, respectively. We must highlight the fact that 1.258MM and 1.805MM non-farm and private jobs have been added during the last 12 months. However, those figures have been far below expectations.

What about wages? One of the potential impacts of monetary easing that we continued to highlight was that although it may inflate asset prices ('artificially' in our opinion), it will not "trickle down" (as one of our former Presidents used to say) to most Americans in form of cash (higher wages) or jobs. Well, it hasn't trickled down. With inflated asset prices, companies went on a shopping spree for a while, which actually led to more payroll cuts. We discussed most of this in a bit more detail in CEOs Explain Why They're Not Hiring Despite Cash, Rising Profit. In addition to lack of enough job and wage growth, unemployment benefits for many are expiring and many states have not only ended extended unemployment benefits, but have also actually cut the 'default' 26-week benefits.

We also continued to use what we view as leading indicators of the state of employment, weekly initial claims and monthly capacity utilization, to support our belief that the equity market was too far ahead of the economy and the state of employment (thanks to monetary easing). Initial claims disappointed more times than not, and capacity utilization has remained well below the 80.4% average of 1972 - 2010.

Third, we had some doubts regarding the housing market. It appears that we were on the right track. Many housing numbers indicate that we either already have or are well on our way to hitting a double-dip. June’s annualized existing home sales data was 8.8% below last year’s data. Inventory also didn’t look great as the months’ supply went up 4.4% sequentially and 6.7% Y/Y. Other data and charts providing more color on the real-estate market are provided below.

We must say that some regions have seen signs of recovery, but then again, Washington, D.C.; Santa Monica, CA (including Brentwood); San Francisco, CA; Manhattan, NY; Bethesda, MD and other similar regions were not hit nearly as hard as many other areas. We'll take a political risk here and say that the 'rich' areas recovered somewhat and the other areas got hit again; not much is trickling down. One last thing regarding housing - it is obvious that lower rates are not bringing the buyers out of the woodwork. The MBA Mortgage Index has been increasing but mainly driven by refi's and not purchases. So much for that incentive that the government provided to induce people to buy homes.

What has been the benefits of all of this monetary easing (third of which is likely around the corner)? In our opinion, nothing much besides a short-term 'high' for the equity market and some 'artificial turf' instead of the good 'ol 'green shoots' that Bernanke kept talking about. And now the market is getting some turf burns. While the rally of the stock market may have benefited a few, that was just it, only a few.

We are not being political or ideological. We simply believe that the politicians' yearning for power, which translates into thinking about getting re-elected 24/7, combined with the Street's hangover from the stock and housing market bubbles, drove them to push through short-term quick fixes, while ignoring the long-term negative impacts. Many should be familiar with this phrase these days - 'kicking the can down the road.'

And we are referring to nearly all politicians out there on Capitol Hill and in the White House, and in the Treasury and the Fed. Lower interest rates created some liquidity which was desperately needed, but the Fed should know when to say when. We mentioned this a couple of years ago - "What we are looking for is a combination of deleveraging, higher savings rates followed by stabilization in unemployment, all of which represent a slow recovery" - hasn't yet taken place. The deleveraging basically slowed down or stopped when the job and housing markets refused to show recovery. June’s consumer credit ballooned to $15.5bil, nearly 3x the previous month. On top of that, consumer confidence has been declining gradually during the last few months. We still wonder why the government and the Fed wanted to see consumers jump on the back of those credit cards again? After the return of some liquidity, we believe rates should have inched up a bit to induce consumers to save, which in turn would create 'organic' capital for banks to utilize in order to resume lending to qualified individuals and small businesses. Of course this takes a couple of years and that is just too much time for the politicians. They need to continue to provide those quick fixes to keep their voters happy for the time being. It’s pretty disappointing.

In terms of what we would do now, well, that is tough to say. Gold, or the GLD ETF, has treated us well, but we may see a small correction in the short-term given how quickly and significantly the Gold Volatility Index (GVZ) has shot up. We note that the two are somewhat negatively correlated. For this reason, given that GVZ more than doubled during the last month, we believe the GLD upsurge may take a breather. However, we remain bullish on gold for the long-run given that a QE3 is becoming more likely (who could have imagined this!). With regards to the S&P 500, besides a few dead-cat bounces (one which may take place on Thursday as the stock market futures are up at the time that we are writing this piece), we don't think it will recover until it bottoms out which we believe is around the 1,100 level; and is not too far below from where it closed on Wednesday (8/10). Buying some OTM puts on the VIX (Oct. or Nov.) is becoming more and more attractive; then again, the upside for the VIX may be unlimited. But we think that by late Oct. or early Nov. the deficit-reduction 'super-duper' committee will likely tell the markets what they want to hear. If not, the Fed will come to the rescue, which could push the market up in the short-term, pushing VIX down. We note that although VIX has hit new 52-week highs and surpassed the 2010 high, it would have to nearly double to match its 'performance' of 2008.

Given the increasing chances of another recession, sector rotation may be a good move (what a bright idea! :) ). XLP and XLU are attractive ETFs representing the consumer staples and utility sectors, respectively. While these sectors may not bounce back as significantly as some other sectors, their downside risk is also lower than the other sectors. Overall, we’d recommend highly liquid large-cap stocks with strong balance sheets, low betas and high dividend yields. Believe it or not, investment decisions based on fundamentals may pay off. We must say that although the S&P may look attractive from a P/E valuation standpoint, the majority of earnings estimates have not yet been adjusted to account for lower GDP growth (if any) in the 2nd half of CY ’11.  Lastly, although a dead-cat bounce might seem certain on Thursday, we note that the market does react to the initial claims results.  The consensus for that indicator (seasonally adjusted) is 409K, which means the non-adjusted figure has to be around 360K or approx. 20K higher than the prior week.