Archive for January, 2010

Buck For President

January 28, 2010 Leave a comment

“If I am to speak for ten minutes, I need a week for preparation; if fifteen minutes, three days; if half an hour, two days; if an hour, I am ready now” – Woodrow Wilson

President Wilson didn’t say what would happen if he spoke for one hour and nineteen minutes besides, as President Obama did last night, but I am pretty sure that (following the curve) it would have risked a tear in the space-time continuum, with the preparation happening after the speech itself. And perhaps Wilson was on to something, because the President did ad-lib some lines very tellingly. My favorite was when he was explaining why the “spending freeze” won’t take effect until 2011, rather than this year, and said “I know that some in my own party will argue that we cannot address the deficit or freeze government spending when so many are still hurting. I agree, which is why this freeze will not take effect until next year, when the economy is stronger.” After groans from the Republican side of the aisle Mr. Obama, visibly  irritated, ad-libbed in a lecturing tone, “…that’s how budgeting works.”

This brought howls of laughter from Republicans and even some Democrats – the first time I can remember a non-laugh line getting a laugh. The Chamber seemed to understand that this really is how the President thinks budgeting works – we “budget” when we have enough money to buy what we want and have some left over. And that’s funny. And scary.

The SOTU reinforced what the People, and Wall Street too (some of them are people, anyway), have come to understand. This Administration is at home with soaring rhetoric and populist messages; but it is adrift completely when it comes to economics. They just don’t understand how it works.

The Address didn’t reroute anybody’s opinion of what is going on down there in DC. We had groans of objection. We had unorchestrated laughter at things that shouldn’t have been funny. We even saw a Supreme Court Justice (Alito) scowl and mouth “That’s not true” to the President. Things are getting scrappy right now in just the place we need calm, even-handed leadership, and as I said before it’s clear we’re not getting our money’s worth out of … well, the money that’s being spent to buck up the economy. The crummy SOTU, I believe, is why stocks were down overnight.

Initial Claims today were surprisingly weak, falling only 8k to 470,000 from an adjusted 478,000. The prior week, California had reported an increase of 44,000 claims as they were “clearing [the] claims backlog” (the weekly news release contains, with a one-week lag, the explanation by state of increases or decreases that are unusual); perhaps that is continuing this week or perhaps there is something more to it.

If this sort of volatility in the Claims number had happened in late December or early January, it would be easier to dismiss since the seasonal adjustments are truly massive around the turn of the year. By late January, those seasonal adjustments are ebbing and the numbers are more reliable. There are still huge error bars, and it may be that “Furlough Fridays” in California just pushed the period of uncertainty forward. However, even if it is the case that these numbers are overstated a little because of that effect, it implies that the prior numbers had been understated by an equivalent amount, and the implication is much the same: the employment trajectory has not been improving quite as much as we thought.

But the surprisingly high Claims number did in fact outweigh a core Durable Goods release that was stronger than expected. Moreover, stocks were under pressure early today and reached new lows for the year intraday. But here’s where trading gets hard. 10-year note futures, with all that, did little and closed up a tick and a half in lethargic action. Could it be because the “spending freeze” doesn’t kick in for another year, implying that the mountain of Treasuries being shoveled on the market is going to continue to grow?

I don’t think that movements in stocks or bonds or the dollar had anything to do with Bernanke’s confirmation finally passing the Senate. The Congress has been throwing brickbats at Geithner for his role in the AIG debacle, and roundly criticizing Bernanke quite fairly for exceeding his authority as Fed Chairman and possibly creating problems greater than those which he was fixing, and they couldn’t get rid of either of those guys. Is it any wonder that people are worried whether our leaders can do anything at all? (On the plus side, I have four more years to write my sequel to Maestro, My Ass!)

For now, the dollar is strong-ish thanks to Greece. But if our currency unit can lead, then perhaps we should elect it to public office.

Tomorrow, there are several economic reports worth watching. The Employment Cost Index (ECI) is useful because it is the broadest measure of labor costs although it is reported only quarterly and with a significant lag. It was last at a feeble +1.5% year-on-year, and the consensus call is for a print of +0.4% to keep the year-on-year number unchanged. I don’t know if there is anything this figure could do right now to cause the market to move, because inflation is perceived as not an immediate threat. But the forecasts are based on the Keynesian assumption that inflation is caused by a lack of slack in the economy, and as long as Aggregate Demand is well south of the economy’s potential inflation isn’t a risk. However – and Goldman Sachs had a good piece on this topic out this week that I need to read in more detail – given the amount of slack in the economy inflation should, if Keynes is right, have fallen much further. (Keynes, of course, isn’t right, but he is popular.) Anyhow, if wages tick up at all with Unemployment at 10% then someone needs to dig up Keynes and ask him how that can happen. (Note to readers: please no one dig up Keynes).

The advance GDP report doesn’t usually excite me much – it’s all about Q4, which we know will show a strong print thanks to tax rebates on housing, etc. Look at the C+I+G+(X-M) breakdown. How much of the growth (Consensus: +4.5% annualized) is due to government spending? I am more interested in the report from Chicago Purchasing Managers (Consensus: 57.0 from 60.0), which last month jumped to a multi-year high. The number is volatile, and won’t tell us a ton, but it’s worth a look.

It will also be worth a look to see how stocks behave following Microsoft’s blowout numbers tonight. I thought we had the makings of a rip-roaring short-covering rally as bears got run over by Bill Gates, but at this hour S&P futures are up a whopping 0.20.

Categories: Uncategorized

Keynes vs Hayek Rap

January 28, 2010 Leave a comment

This is really a terrific video – by that I mean both that “the production values are good” and that “the explanations are outstanding.”

The entire world has spent the last couple of years wrestling with the practical results of the debate between Keynesian prescriptions and Austrian ones (the latter associated with Hayek’s views). This rap video is a wonderful summary of the theories and counterarguments.

Categories: Economy


January 27, 2010 Leave a comment

There are two clear perversions that are sullying the housing sales data currently. First, there is the tax credit for first-time home buyers (that morphed into a credit for any home buyer, and will probably eventually become a tax credit for anyone regardless of whether they bought a house at all. But I digress). This clearly should stimulate sales, albeit at the cost of future sales since obviously the tax break isn’t likely to increase the aggregate number of houses that people buy (one per customer, usually) nor the frequency with which people move.

The other effect is the “distressed property overhang” consisting of people who want a higher price to sell, people who would sell at current prices if the bank were to approve a “short sale” and release them from the balance of the mortgage, and bank REO (“real estate owned”) that is liquidated when the bank is able to find a market and willing to take a hit writing down the asset.

But the “distressed property overhang” obviously only affects existing homes. I suppose there are some ‘distressed new housing developments’ out there, but the mortgage defaults happened only on homes which are now “existing homes.”

Today, the pace of New Home Sales declined to something near last year’s lows, while Monday’s Existing Home Sales data retraced some but still was pretty strong (see Chart, source Bloomberg):

Appears that the tax break didn't do much

It looks to me as if the factor that was working on both of these, the tax break, is to blame for the road-bump in NHS, but the spike in EHS is due to the distressed-seller effect.

That’s not bad news. It shows that some of the overhang is starting to clear. But it means we should look to New Home Sales as a better measure of the natural pace of property turnover right now, and the 342K pace we had last month would have been the second-lowest recorded since at least 1963 (there was one print 338K in 1981) if we hadn’t had a few even-lower prints last year. Housing is still very sick, regardless of how Existing Home Sales are turning over.

Speaking of perversions, the President will speak tonight on the new definition of the phrase “spending freeze.” It is a political masterstroke. By calling a spending freeze after the budget deficit exploded, the Administration can set the “fiscal responsibility” bar at a certain level simply by defining it with such words, and then easily clear that bar. What is more, it will make the Republicans look like they want to crash the economy when they call for spending “cuts” from this bloated level. And Paul Krugman is calling (here) this a “betrayal of everything Obama’s supporters thought they were working for” and saying that “Obama has embraced and validated the Republican world-view.” I guess Obama’s supporters were working to make government spending 100% of GDP and the Republicans are satisfied with what, 50%?

With any luck, someone will point out that a spending freeze two years ago would have been a lot more impressive.

Notice I didn’t say anything about the Fed meeting today. That’s because nothing important happened.

Tomorrow, Initial Claims (Consensus: 450k, as economists pray the spike to 482k was mostly a perversion due to weather) will be joined on the tape by Durable Goods (Consensus: +2.0%, +0.5% ex-transportation). Ordinarily, Durables would have a better chance of moving the market but if ‘Claims surprises on the upside by very much it will give bonds a nice boost and pressure stocks. Investors are already nervous about the housing data, the turmoil in Europe, and tighter policy in China. Each additional piece of data that is weak, even a little, will tend to make them more nervous.

(P.S…How many hits do you think this blog will get just by using the word “perversions?”)

Categories: Economy

Jobs Hard To Fathom

January 26, 2010 Leave a comment

It’s growing clear that the mo-mo traders who have pressed stocks so high are beginning to be concerned about the ebbing of the momentum. Although that has nothing to do with fundamentals, it is something to watch when the technicals and fundamentals begin to align. We likely have a correction coming, although I expect it will be a brief one.

I don’t know if it will be enough to push rates much lower than they are, however. There are too many valid concerns about the possibility of inflation, dollar weakness, sovereign downgrade (concern about default would be invalid, but the ratings agencies never let logic get in the way of a ratings decision so the concern about a downgrade isn’t crazy), the Fed starting to hint about raising short rates “some day,” etcetera. Unless stocks take a really bad belly-flop, I suspect 10y Govvies stay in their broad range around 3.50%, plus or minus 20bps.

I will follow yesterday’s very long post with a brief one today, but I do want to note one oddity today: CNBC, which yesterday reported that 6% of companies so far have beaten EPS estimates and 65% have beaten revenue estimates, reported today that among S&P 500 companies that have reported so far, 80% have beaten EPS estimates. Are large caps doing so much better than small caps? I would think there is some difference, since the large caps have access to credit at good (sometimes absurd) levels while mid- and small-caps often have no access to credit at all…but that big a spread makes me think that CNBC just messed up the numbers. It isn’t like they spend a lot of time fact-checking (neither do I, apparently…but then, I’m not a journalist. I think it’s fair to assume that a media outlet checked their own facts, but maybe that’s not true any more).

Today’s economic data were mixed, with Consumer Confidence up a little bit. The key employment indicator, the proportion of respondents saying “Jobs Are Hard To Get,” remains very high (see Chart). While the indicator is no longer climbing, that does not necessarily mean that the Unemployment Rate will cease rising – there is, after all, some cap on “Jobs Hard To Get.”

No real improvement in "Jobs Hard To Get"

Tomorrow, New Home Sales are expected to rise to 368K from 355K last month. New Home Sales have been curiously languishing despite hefty government incentives to buy. It would be a good sign if they began to move higher.

The Fed also meets tomorrow. I am not one of those people who expects a dramatic change in the statement any time soon, or a specific signal that they are considering hiking rates. The economy is a long way from being able to handle higher rates. It would be a classic error for the Fed to suggest otherwise at this point, and whatever Bernanke is, he’s a good enough student of history not to make this error. The Desk can try and begin removing accommodation whenever it likes, without the FOMC making a public statement about it. That is the way I think the Committee will eventually dip their toes into the tighter-policy waters – but the time is quite distant, I think.

Categories: Uncategorized

“I Am Become Debt, Destroyer Of Worlds”

January 25, 2010 8 comments

The stock market bounced back today, but in a fairly unconvincing fashion (if you ask me). After a couple of waterfall-decline sorts of days, a bounce was due and expected, but a reasonably small advance with a fairly small range during the day doesn’t speak volumes about investor confidence.

However, it supports my belief that the slide late last week isn’t (yet) the beginning of a slide into oblivion. Also supporting that point, Greece managed to sell €8 billion bonds quite easily today. I don’t really understand why it was so easy. I suppose there is a deep reservoir of people who don’t want to see a European sovereign go bust – for example, other Europeans – but it isn’t as if that 8 billion will carry Greece forever. They are in dire straits, and as I’ve pointed out here before they can’t print money and that fact is what makes a default possible. I do believe this could be the beginning of the end for the Euro, but I don’t think that end is imminent. Institutions have selfish memes and tend to protect themselves vigorously. In this case, I suspect that other European central banks, big European investors, European corporate entities…they all have a very strong vested interest in holding the Euro together, and they will do so as long as it is possible. And it will be possible for a while.

The Existing Home Sales data today showed a massive retracement of the government-induced spike over the last couple of months, but the 5.45mm-unit pace (well below expectations) was still not too bad. It’s a weak market, but a functioning one. Humorously, Deutsche Bank’s economist argued that the fall might imply that there isn’t much “desirable supply” left out there. Joe Lavorgna is a funny guy…a shortage in the housing market? Economists don’t usually make me giggle, but that made me giggle.

The stock and bond markets didn’t meaningfully react even to the big miss in Existing Home Sales, which points up the importance of always keeping in mind the size of the error bar on the estimate. No one has a clue what the natural run rate of Existing Home Sales is right now, and the data is such a mess that you can’t reject any null hypothesis so…move along!

An interesting factoid that I saw on CNBC today: of companies announcing Q4 earnings so far, 9% have beaten earnings-per-share (EPS) estimates, but 65% have beaten revenue estimates. What does that mean? I think it means that margins have been lower than analysts expected (although there’s a statistical caveat, because the number of misses may or may not correlate to the size of the miss), which means that they’re buying business through lower prices or, on the other hand, are holding prices down while input costs rise. One is a disinflationary spin and one is an inflationary spin. The data suggest the latter, as inflation-other-than-housing has been percolating some, but wage growth (a big input) hasn’t exactly been robust either. I’ll call it a tie on that evidence (with respect to inflation implications), but either way tightening margins are a sign of economic weakness.

But my bigger worry is that some sharper near-term imbalances are brewing. Economic weakness we can work through, if the basic capital markets and economic structures are left in place and government doesn’t take too much of the productive capacity of the country (these assumptions are somewhat in doubt these days, but let’s look past that). What worries me in the reasonably short-term is that there are some big imbalances that are following on the heels of the imbalances that just blew up…and those just about cracked the edifice of Western civilization.

All of these imbalances are of our own making, but none has been created as fast as this one. I will do my best to explain it, and I hope that somewhere my logic falls down and someone can correct me.

When the government runs a deficit, where does it get the money so that its expenditures can exceed its revenues? It borrows, from essentially two places: domestic savers and foreign savers. In recent years, domestic savings have been low, and the government has financed its deficits more and more with money lured from foreign investors who hold dollars. Because the only reason these folks hold dollars is because we are buying more stuff from them than they are buying from us, we have a trade deficit. If domestic savings is stable, then over time the budget deficit and the trade deficit must equal; but a better way to think of this is that budget deficit = (trade deficit plus domestic savings).

This is why folks talk about the “twin deficits,” trade and budget. Large deficits can only be financed entirely from within if there is substantial domestic savings, but we have been discouraging savings for a couple of decades now. The graphic relationship is sloppy, partly because we’re not great at measuring these values and partly because domestic savings ebbs and flows, but you can see that the larger trade deficit in recent decades seems to be at least of similar magnitude as the budget deficit (Source:

This was a much better chart until 2009.

Well zowie…those last few points are interesting, are they not? The government is running an epic deficit, as we all know, but the trade deficit has been improving. How is that possible? It is possible because domestic savings has been growing by trillions of dollars over the last year.

Now, you might say “that’s great news!” except that it isn’t great news at all. The largest part of that “savings” is the money that the Fed has printed by buying Treasuries, agencies, and other collateral. This is where the rise in the money base (see chart below) is showing up.

All that money IS going somewhere. It's buying Treasuries.

A 1.4 trillion-dollar jump in the money base? Where did I just see a number like that?

That’s right: the improvement in the trade deficit, despite the huge budget deficit, comes almost entirely because the Fed has provided the needed savings with its checkbook. But now here’s the problem. The Fed declares that they are not going to keep doing that, which means that (a) they’re lying, or (b) there is going to be a massive improvement in the deficit of $1.4 trillion or so, soon, or (c) the trade deficit is going to start looking really, really, really bad, pretty soon.

Any guesses for (a), (b), or (c)?

Assuming that the Fed isn’t lying, and assuming that the federal government isn’t going to find fiscal Jesus and slash a couple trillion from the deficit (as I’ve noted though, if they just don’t have any emergencies this year the deficit ought to improve a few hundred billion), then the trade deficit is going to start to look ugly. Epic ugly. Medusa-ugly.

And this leads to the worry – if the trade deficit explodes, then two other things are going to happen, although how much of each I can’t even guess: (I) protectionist sentiment is going to become very shrill, and fall on the ears of a President who is looking to burnish his populist creds, and (II) the dollar is going to be beaten like a red-headed stepchild (being a red-headed stepchild, I use that simile grudgingly).

Others – Warren Buffet is one – have publicly toted up the numbers and observed that it’s hard to figure out how we finance such deficits unless most of it comes from overseas. To entice such largesse, the currency unit will need to be cheaper, and rates will have to be higher.

This is my worry – not a global meltdown, but a U.S.-specific meltdown. Higher rates, higher inflation, lower equities, and a lot of volatility. And it may happen quickly, when it happens.

When might this happen? Putting dates on nightmare scenarios is ordinarily a useless chore. It is usually far better to merely be alert to possibilities and to move quickly when the rock looks like it’s toppling. But in this case, there is a particular time period I am especially concerned about: the end of March (as in, about two months from now).

The Fed is gradually reducing its purchases of MBS, with the intention of ending those purchases…in March. Also, Japanese year-end is in March, and lest we forget the Japanese represent some 20% of the foreign ownership of Treasuries. There is a reason that seasonals for the bond market are weak in the spring. If we can skate past April 1 without something serious happening, then I will breathe a sigh of relief and go back to balanced-rock-watching. But in the meantime, I sleep fitfully.

Categories: Good One

The Big One? This Isn’t It. Yet.

January 24, 2010 Leave a comment

I don’t really think the 3-day, 5% fall in equity markets this week was prelude to “the big one,” but I think it is very interesting that we are still nervous about “the big one.”

I think the cause of this latest downdraft is pretty clear, and it isn’t immediately clear to me that it’s over. The Administration’s attack on Wall Street is going to end up being far more costly for the nation than the Bush Administration’s prosecution of the war on Iraq, not just in the short run where whatever stock market wealth is lost can be recouped but in the long run where the cost is measured in higher costs of trading, less-efficient distribution of capital, concomitantly higher costs of that capital, and (as a result) slower long-term growth. If you want to turn a deep recession into a depression, the first thing I would try would be extremely tight money – and the Fed has really done a great job of avoiding that repeat of Depression I. The second thing I would try is tearing apart the capital markets structures that connect borrowers with lenders and investors with inventors.

So there’s nothing particularly mysterious about this selloff. Explanations on Friday included repeated rumors that the data Greece provided to join the ECB had been doctored (which rumor turned out to be true when over the weekend ECB President Jean-Claude Trichet stated as much), but that trireme has sailed…who cares how Greece got into the ECB? The question is whether they’re going to be kicked out. Another proffered explanation was the notion that Chairman Bernanke’s confirmation by the Senate for a second term as Fed chief was in trouble. I certainly can’t see why that would be bearish, given what he has brought to the office!

So I don’t think the 5% decline means the end of the world is nigh. Having said that, one precondition for the end of the world has been met: Abby Cohen is bullish.

But the re-developing crisis is global. The one I worry about is U.S.-specific, and we are not out of the woods there. I will talk about my fears tomorrow.

Speaking of Monday, the data on tap is Existing Home Sales, which has been one of the more confusing series recently. A spike over the last few months, to6.54mm units, is likely the product of both tax incentives and the release of some stranded properties onto a finally-functioning housing market. (I wrote about the spike last month here.) Consensus estimates call for a retreat to 6.0mm units (annualized pace), which is still pretty robust and sounds to me a lot like a wild guess.

Categories: Uncategorized

You Want Some Of This?

January 21, 2010 Leave a comment

Obama is the kind of guy who, if he was pulled over for drunk driving, would vow to drive faster so that he wasn’t on the roads as long.

The President’s speech today about bank proprietary trading operations – specifically, his desire that “no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit” – marks another overreach, another attempt to turn messy, capitalist enterprises into state-run utilities (see also: autos, student loans, health care). And this comes only a couple of days after his policies were repudiated by the very people who managed to see Ted Kennedy as sufficiently moderate to return to the Senate year after year.

The idea is also half-baked. It is an attempt to re-create Glass-Steagall, a Depression-era law (actually two laws, according to Wikipedia) that prevented commercial banks from owning investment banks. The problem is that the financial system isn’t as clean and simple now as it was then. Declaring that banks can no longer take proprietary positions will remove them from “trading” altogether, since an important part of the market-making function lies in the converting of certain risks (say, outright duration risk that I get when WAMCO hits me with $200mm long bonds) into other risks (for example, I might sell 10y notes instead of 30y notes to hedge that position, if doing so allows me to unwind the position at an eventual profit). If banks cannot do this – and it clearly is the taking of proprietary risk – then they can have no function as market-makers since my response if I am hit with $200mm long bonds is to … try and hit someone else with $200mm long bonds. That works if it is $1mm. It doesn’t work if it is $200mm.

So banks will become pure lending institutions, except burdened by a heavy taxation structure and regulatory oversight. It isn’t clear if they would be able to “ride the yield curve” by borrowing short and lending long, since that of course is a proprietary position and involves risk. Lending spreads will increase, and lending volumes will fall, in exactly the opposite way that Glass-Steagall’s repeal in 1999 contributed to narrower lending spreads and increased lending volumes.

Banks will have to spin out their “investment bank” arms, where the “proprietary risks” are kept. But these firms will face greater oversight and more-expensive capital, since they don’t have deposit bases to lean on (profits from commercial banking being more stable, they tend to lower the overall cost of capital that the capital-intensive side of the business, prop trading, faces). The result will be lower trading volumes and wider bid/offer spreads, in exactly opposite the way that the repeal of Glass-Steagall in 1999 led to increased liquidity and narrower bid/offer spreads.

And this will lead to lower asset prices. The level of asset prices embodies the value of liquidity – assets with lower liquidity trade at discounts (examples include closed-end mutual funds and limited partnership interests). Ergo, government actions which tend to lower liquidity will also tend to lower asset prices.

Investors know this viscerally, which is why the stock market today did exactly what it should have done in a circumstance where these ideas might become law unless grownups intervene (n.b., grownups are in short supply on Capitol Hill): they plummeted. Stocks ended the day at the lowest level of the year, down nearly 2% on the day. Yes, the market was and is overvalued…but isn’t it amazing that the President managed to take the one thing working in his favor over the last year, the rising stock market, and put it into jeopardy? He is making the mistake that Clinton carefully avoided during his two terms: you might think that only fat cats own stocks, but that’s no longer true. We are all investors now, and you’re ticking us off.

President Obama clearly views a populist rant as his best remaining idea, and this is part and parcel of that rant. In announcing this plan, the President said “If these people want a fight, it’s a fight I’m ready to have.” Really? Okay, tough guy. You’re on. I think that all employees at primary dealers ought to take their Fed-mandated one-or-two-week vacations…in unison. Go on strike, collectively. See what happens with Treasury auctions then. I hope TreasuryDirect is up to the challenge.

Somewhere along the line, President Obama and his previously-sane advisor Paul Volcker seem to have forgotten that Wall Street actually serves a function. They don’t seem to realize that it is competition of smart, profit-maximizing folks which has driven liquidity to ridiculous highs and spreads to ridiculous lows. Remove those folks (or cause them to give up and leave the industry), and replace them with bureaucrats who are neither smart nor profit-maximizing, and all of society suffers.

This is not to say that these bright folks labor merely to help the little guy. Of course not! To paraphrase Adam Smith, it is not from the benevolence of the NASDAQ market-makers or hedge-fund traders that we expect penny-wide spreads, but from their regard for their own self-interest.

Needless to say, in addition to the fact that economic indicators seem to be stalling in their improvement (although it is somewhat hard to tell when the BLS blames holiday short-staffing for today’s jump in Initial Claims and the concomitant understatement of them for the last few weeks) the actions of the Administration and Congress is becoming increasingly hostile to the economy and to investors. While bonds have their usual seasonal weakness to deal with, it seems dangerous to be positioning that way at the moment. We didn’t get the break to higher yields that I expected, yet. I would not be exceptionally long duration at this point, but crawling back into the low-risk shell is probably warranted until it becomes clear that this volatility isn’t blossoming into something more. It isn’t as if stocks are so cheap that one need fear missing a lot of upside!

On a completely different note: I am so far enjoying writing this commentary (again). Please reward me by passing the URL ( on to your friends and neighbors who may find it illuminating. It doesn’t cost anything to sign up! And I am also enjoying the comments that are being posted in response. Keep them coming.

Categories: Uncategorized

It Tolls For Thee, Warren

January 20, 2010 Leave a comment

Well, perhaps yesterday’s stock market rally wasn’t all about the race for the Senate after all – today, with the Republican having still won the seat in Massachusetts, stocks began the day on the skids. The proximate cause this time reportedly were the moves to tighten monetary policy in China, but it wasn’t exactly a surprise as the regime has been signaling it for several days at least. (And anyway, if you’re investing on the basis of what you’re hearing from China – and I include their official statistics in that – then God bless you and good luck. I would prefer to throw dice in a casino myself. Blindfolded. The odds that I’ll get a fair report of the outcome is better, and anyway at least I can be pretty sure the game itself is fair.)

There is, though, something odd going on. I am not sure what it is, but look at the following 5-day intraday chart of the S&P 500 index (Source: Bloomberg):

I think I saw this ride at Coney Island!

Notice anything odd? The pattern looks closer to an EKG output than a random walk. A sharp rally, slowing down (but still strong) on the 13th and 14th; a sharp open lower on the 15th and a slide to the lows; a bounce, followed slightly more than 2 hours later with a second slide; and a steady recovery.

It’s usually foolhardy to try and read anything into stock market wiggles, but this is a little creepy. It makes me wonder whether there is some systematic portfolio liquidation going on at the higher levels. Since most market liquidity is found early and late in the day, rather than in the middle, it is a more compelling picture than if the sharp downtrade was happening around lunchtime every day.

But enough of that. It’s time to turn to the defense of freedom.

Funny story in the news today: Warren Buffett complained about the new bank levy being proposed by the Obama Administration on banks (here is the story on Bloomberg), which the Administration says is necessary to make sure that “every dime” of the TARP money is repaid (and those who have already paid theirs back…should keep paying!). Why is that funny? Well, when the talk went around, about a year ago, about having a pay czar who would be in charge of limiting Wall Street bonuses, the silence from the “buy side” (institutional investors like Buffett, Bill Gross at PIMCO, etc) was positively deafening. At that point, the opinion of the well-respected Oracle of Omaha would have been helpful, and it made sense: Gross and Buffett need Wall Street, and they need it to thrive. Mr. Buffett is fond of pointing out that an investor should always ask himself whether he would be comfortable with the stocks he owns if the stock market shut down for a year – but I suspect he doesn’t really want to try that experiment. That goes double-ditto for Gross, who doesn’t even pretend to be buy-and-hold.

And now, Warren, you’re asking for whom the bell tolls? It tolls for thee, Warren…it tolls for thee!

Honestly, anyone who is surprised that the notion of limiting banker pay by fiat somehow morphed into a tax on bonuses and into other ways of taxing the bejeezus out of healthier firms to support the weaker ones just hasn’t been paying attention. The latter was eminently foreseeable given the attempt at the former, because they are part of the same philosophy: the wealthy should give money to the poor (and if they don’t, we’ll help them do the right thing). Here’s another quote for you, Warren: “All that is necessary for the triumph of evil is that good men do nothing.” You did nothing last March, when you were needed. On behalf of all Americans who might some day need a sound, liquid and efficient banking system: thanks.

Of course, the punishments for the banks don’t stop there. Obama tomorrow is going to propose new rules on proprietary (“prop”) trading, limiting their size and complexity, according to Bloomberg. The delicious quote in the story:

“We’ve got a financial regulatory system that is completely inadequate to control the excessive risks and irresponsible behavior of financial players all around the world,” Obama said in an interview with ABC News broadcast tonight.

Therefore, the clever reasoning goes, rather than improve the financial regulatory system so as to be able to evaluate and control the “excessive” risks, we must stop all of those who are trying to make money in “complex” ways. (Note to the Bloomberg reporters: checkers qualifies as complex to a banking regulator.) And the trees are all kept equal. By hatchet, axe, and saw.

Categories: Uncategorized

Wake Me After PPI…Or Don’t

January 19, 2010 Leave a comment

After the equity futures market closed the morning session fairly close to unchanged, the cash market launched higher at the open, maintained those gains throughout the day, and moved to new yearly highs on the close. What was the cause of the sudden move?

…Could it be because Citigroup reported a $7.6 billion loss? Analysts tried to spin this positively: most of the loss was the cost of paying back TARP money. But even after that, the bank managed a 6-cent-per-share loss in a period of record earnings for other banks. Oh, and the loss was only that small because Citi had lower loan-loss provisions…even though delinquencies and bankruptcies, by all indications, are still rising. In any event, I don’t know that we ought to take that much pleasure in the performance of a company that paid back cheap funds with expensive funds so that they can pay executives more. And the market didn’t, when all was said and done, with C basically reversing Friday’s loss.

…So maybe the broader market rallied because it is Tuesday, following a nice weekend with pleasant weather; moreover, the market had already declined for one consecutive day, so the correction must be over. Possible, but it turns out that the answer is probably that…

…Unbelievably, the market is reacting violently to the very possibility that a Republican might win Ted Kennedy’s seat in the Senate. This would have a big effect, some believe, on the probability that the health care bill passes (that is, making it less likely). And sure enough, with the S&P up 1.25%, the NYSE Healthcare Index was +1.99%. This idea has some legs, but it still doesn’t understand why non-healthcare stocks rallied unless…

…Unless the market is growing disenchanted with the movement towards bigger and more expensive government. This is big news, if true – in my mind, much bigger than the news that Republicans are winning on a generic ballot by 9% according to Rasmussen. Polls change, and can easily be moved by near-term events. Republicans would be courting disaster to treat the current mood of the nation as something that can be milked until November. However, a movement in the market is something else entirely. If the stock market starts to decline every time the Democrats gain, and rallies every time the Republicans gain, then the Dems will have to beat two opponents – because they sure don’t have much of a chance if stocks are plunging. They’d have to gain an edge in the polls while mollifying the investing public (and these are very different groups!).

This is something to watch over the next nine months!

There wasn’t much else to watch today, though. Tomorrow, the economic data includes Housing Starts (Consensus: 575k vs 574k last month) and PPI (Consensus: unch/+0.1 ex-food-and-energy versus +1.8%/+0.5% last month). I don’t really pay attention to PPI, and there are many reasons for this. One reason, though, I am not sure I have ever mentioned before and it’s this: producer heterogeneity.

That’s a nice little phrase, no? But here is what I mean. Consumers are fairly homogeneous, meaning that we all consume generally the same things. We consume shelter, medical care, education, transportation, apparel, and so on. We consume them in different proportions, but the difference between the “10th percentile” and the “90th percentile” in consumption patterns isn’t as great as you might think. One way or the other, almost everybody consumes shelter, after all.

On the other hand, there are huge differences in what “producers” consume. A producer of farm equipment has a basket of input goods, and therefore Producer Prices, that is extremely different from the producer of tax returns, which is different from the inputs used by a producer of donuts, and so on. Therefore, while an accelerating CPI has a very clear implication for each and every one of us, an accelerating PPI means very different things depending on what stuff you as a producer are using. The only thing I care about in PPI, and usually not enough to actually go figure it out, is the uniformity of advance. If all inputs are advancing in price, that probably means something for the likely pass-through (but even then, causality is difficult to determine). Accordingly…I don’t usually care about PPI.

Gosh, I hope something else interesting happens tomorrow!

This just in: as I prepare to hit ‘Publish’ on this post, I see that the Senatorial seat was won by the Republican, by around 5%. In this age of recounts, that barely even counts as being close. A truly shocking result! And it will be interesting to see how the market, and political theater, unfolds from here. So maybe things will be interesting after all.

Categories: Uncategorized

The Smoke Is There, But No Fire Yet

January 17, 2010 2 comments

The economic data released on Friday was another mixed bag, continuing to show a recovery from the recession’s depths but not yet thrilling us with the breadth and strength of said recovery. As I noted on Thursday, though, my focus is on CPI.

The print was right on the market’s expectations for a rise in core CPI of +0.1%, but of course that was slightly above my expectations. I am very sensitive at the moment to deviations of inflation above my expectations, since the dynamics of the number create an unsettling stand-off between the rising and falling components of CPI to produce the illusion of stable inflation.

I have shown Core-CPI-ex-Housing before and you will hear me chirp on that again. But I want to show the issue with a little more detail. It is normally the case that some subcomponents of inflation are rising faster than others; what is abnormal is that in this case the subcomponent that is holding core down is just so darn large.

Looking at the eight CPI major groups (Housing, Medical Care, Transportation, Apparel, Food & Beverages, Education & Communication, Recreation, and Other), we can say that 58% of that group is rising slower than core inflation on  year-on-year basis; on average, this group is rising at +0.5% held down by Housing (which is nearly half of core inflation) at +0.1% year-on-year, ex-energy. Incidentally, I’m approximating these numbers – to actually subtract energy from many of these subcomponents you have to dig down into the strata further than I had the time for.

The other 42% is going up faster than the average, of course, by an average of 3.4%. So far, this seems to confirm the general sogginess of the inflation data: core is heading lower, and most of the index is heading lower. The numbers are summarized in the table below

Approx Core Y/Y change Approx Weight in Core
Housing 0.1% 49.4%
Transportation 4.9% 16.0%
Medical Care 3.4% 8.3%
Educ, comm 2.4% 8.2%
Recreation -0.4% 7.4%
Apparel 1.9% 4.8%
Other good,services 8.0% 4.4%
Food & bev 0.8% 1.5%

Here’s the thing, which is the same thing I’ve said before but you can see it here more viscerally perhaps: if you remove housing from core inflation, then about 73% of what’s left is rising 2.4% or faster. There is a really good reason to think that housing should be treated as something a bit unusual in this cycle, and without housing we have what appears to be an inflation problem.

We know about the Medical Care and Education inflation increases and we hear about them every day it seems (funny story, by the way: Education would seem to have nothing to do with Communication, unless you happen to major in communications while at college. But if you separate those two series you get the cost of communication going always lower, while the cost of education goes always higher, for decades. So combining them has the effect of hiding two major trends. I have no idea why these two are combined in one Major Group). But I wonder if we should be concerned about the Transportation part.

Transportation includes car prices (both new and used), and as we know the auto manufacturers have been in dire straits for a while. Why are these prices actually rising, in the midst of a huge recession? Cash-for-clunkers might be expected to help hold up auto prices by artificially stimulating demand, and by junking the perfectly good “clunkers” it might also have kept used car prices higher than they otherwise would be. But…really? Car companies actually have pricing power? See the chart below (Source: BLS), which shows the seasonally-adjusted price series for “New and Used Motor Vehicles”. Car prices have been rising since early 2009, long before C-f-C became a reality:

Why Do Almost-Bankrupt Companies Have Pricing Power?

Airline fares, too – also part of Transportation inflation – are recovering but in this case it looks like just a resumption of the previous work airlines had done to restore pricing power after the recession in the early part of the decade. Capacity is down, so load factors are up, and that gives airlines some pricing power. They briefly relinquished this when the global financial crisis hit, but prices are rising again as they had previously been.

Airlines Have Worked Hard To Earn This Pricing Power

The airline fares increase doesn’t bother me, as a worrywart on inflation, because it’s been well-earned. Airlines ought to have pricing power, because they have rationalized their cost-revenue models and aren’t flying big empty jets all the time. For a change, airlines have decided to make some money on less volume rather than no money on more volume. But autos are more worrisome.

Inflation is what happens when prices generally start to rise as too much money chases too few goods, thus cheapening the value of that money in terms of goods. When the stock of money is increasing, prices don’t need a reason to go up. Firms don’t need to cultivate business models that live on the right part of the demand curve – as a vendor in inflationary times, you raise the price and people pay the higher price. This is not supposed to be happening in a recession.

As I said, Cash-for-Clunkers may well be part of the story there. But it isn’t only autos, and only Transportation, where we see inflation percolating. And that’s the concern.

There is an interesting correlation among the groups that are inflating the most, however. Medical Care, Education, and now Transportation…can you spot it? What fundamental force is different in those sectors of the economy compared to, say, Apparel and Recreation?

Approx Core Y/Y change Approx Weight in Core
Housing 0.1% 48.9%
Transportation 4.9% 15.8%
Medical Care 3.4% 8.2%
Educ, comm 2.4% 8.1%
Recreation -0.4% 7.3%
Apparel 1.9% 4.8%
Other good,services 8.0% 4.4%
Food & bev 0.8% 1.5%
Categories: Uncategorized
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