Saturday, January 30, 2010

Business Daily - China Crisis

How well is the Chinese economy really doing? The latest figures show the economy grew at nearly nine per cent last year. The International Monetary Fund has forecast that this year's growth will be ten per cent. And there has been a chorus of predictions that China will soon overtake Japan as the world's second biggest economy.

But there are also fears that the red-hot property and share markets are gigantic speculative bubbles. Money from the great rise in bank lending has fed these markets. The government has moved to slow lending. But some investors believe that China is heading for a fall.

One of the most powerful of those is Jim Chanos, the legendary New York investor from Kynikos Associates. He built his fortune by foreseeing the collapse of Enron, and various troubles at other corporations. His method is called short-selling; he bets that companies' strategies will fail. He warned about the looming credit crisis back in April 2007.

Now he tells Lesley Curwen he is concerned about the overheating of the Chinese property market, and the consequences for commodities if the bubble bursts.

Business Daily on China Crisis with Jim Chanos
Broadcast on:
BBC World Service, 8:32am Wednesday 27th January 2010

Reflection Series: Niall Ferguson at Carnegie Council

"Chimerica is a fantasy country that I dreamt up a couple of years ago. It's the economy you get when you add together China plus America. Chimerica has been, in many ways, the key to the way in which the world economy has worked in the past ten years," says Niall Ferguson.
This Carnegie Council event took place on November 20, 2008. For the full video, audio, and transcript, go to

Roubini speaks on recovery in Davos

The economist says he sees a weak U-shaped recovery around the world. He forecasts the divergence in the second half of the year: the developed economies will do worse and the emerging markets will do better

Davos: Economists say keep stimulus

Two of the world's leading economists - Professor Joseph Stiglitz from Columbia University and Professor Kenneth Rogoff, from Harvard -- discuss the prospects for 2010.

Schwarzman Warns of Tighter Credit Amid Bank Bashing

Jan. 28 (Bloomberg) -- Stephen Schwarzman, chief executive officer of Blackstone Group LP, talks with Bloomberg's Erik Schatzker about the risk of banks restricting credit. They speak in Davos, Switzerland, at the World Economic Forum.

The U.S. markets are in a major correction

For the foreseeable future, the market is a roulette wheel. Until the dust clears that is, until market participants figure out the direction of the economy -- this is a good time to be in cash (and non-cyclicals like biotech).

I note with some small degree of vindication that the S&P 500 finished last week at the same level as it was when I called a market top in October, 2009. Perhaps all I really missed was a needle peak that has now evaporated faster than President Obamas high public opinion rating.

As for why the market has turned bearish, Obama has certainly been doing his part. This last week he could have truly ushered in some real change on his economic team. Imagine him announcing that he was replacing his easy money, ultra-Keynesian, babes in the woods triad of Summers-Geithner- Bernanke with the Dream Team of John Taylor at the Federal Reserve, Paul Volcker at Treasury, and Martin Feldstein as top White House economic advisor. That would have truly turned this country around in one single day. (Note, by the way, that I didnt even mention Christina Romer and Jared Bernstein. These two White House accoutrement are truly Lilliputians at a time when we need Big Bold Thinkers.)

That said, the economic headwinds we face transcend anyone at the helm. Yes, we had a big GDP number. But few believe it wont be revised downward, and even if it is big, it does bring closer the day of reckoning when the Fed must confront its bloated balance sheet and the White House must confront its ballooning deficits.

Sure, the markets could take off again next week despite this gloom. But the bigger point here for traders and investors is that the bullish trend has been broken and the days of making easy money like March 2009 to June 2009 have been replaced by more cautious times.

Peter Navarro, The Well-Timed Strategy and Coming China Wars, January 30, 2010

Friday, January 29, 2010

George Soros: Obama’s plans are premature

George Soros has welcomed US President Obama’s plans to limit the size of financial institutions in the US but has warned that the timing of their implementation maybe premature.
George Soros: Obama’s plans are premature

The investor made the comments at a meeting at the World Economic Forum in Davos.

Mr Soros said that he was “very supportive” of the proposals to tax the banking industry to reclaim tax payer money used to bail out ailing institutions during the global economic crisis.

However, he stated that the implementation of the levy should be delayed until banks and companies are more financially stable.

Obama’s plans will affect financial institutions with over $50,000 worth of assets and are expected to raise as much as $90 billion over the next ten years.

The reforms also include preventing commercial banks from investing in private equity firms or hedge funds.

However, this new rule may mean “some banks will spin off their investment banks and they will be very substantial and they will be too big to fail,” Mr Soros warned.

The hedge fund investor also criticised those bankers opposing the reforms, describing them as “tone deaf”.

According to Soros, the global crisis was the result of a “super bubble” created by the banking system and built up from 25 years worth of smaller bubbles.

By Jim Ottewill (January 29, 2010)

City expert says double-dip recession a “strong reality”, despite the Sentance’s reassurances

Sterling reached a five month high against a broadly weaker euro today, hitting a day high of €1.1625 this afternoon.

Mounting worries about sovereign credit risk within the euro zone have undermined the euro, as tumbling Greek government bonds highlighted the market’s concerns over their ability to pay back its soaring deficit.

Mark Bolsom, Head of the UK Trading Desk at Travelex, the FX Payments Specialist, comments, “Sterling was also bolstered by Bank of England MPC member Andrew Sentance’s bullish comments yesterday. The markets took comfort in his apparent assurances that Quantitative Easing will not be extended past its current level of £200 billion.

Bolsom continues, “Despite Sentance’s comments, I still think a double-dip recession is a strong reality and shouldn’t be rejected. It is an undeniable fact that both the government and Bank of England have pumped in unprecedented levels of stimulus into the economy and it has grown only marginally.

“And because of our huge deficit, we expect a real tightening of fiscal policy after the general election. The situation stands to get far worse when stimulus is withdrawn – we can see already that retail sales are already slumping now VAT has returned to its former level. The real question is what will happen to growth after the stimulus is withdrawn? I wouldn’t go as far to say return to recession is inevitable, but I would say it is a strong possibility.”

With regards to a broadly weaker euro, Bolsom commented, “Most Euro zone states will be pleased with a weaker euro as it helps their competitiveness in foreign markets. Certainly, Head of the European Central Bank, President Trichet, has been vociferous in calling for a stronger dollar against the euro.”

(City press release, January 28, 2010)

David Rosenberg: The Houdini Recovery

The growth bulls are out in full force today [01/29/2010 early morning ] in the aftermath of the headline 5.7% QoQ annualized print on fourth quarter GDP growth in the U.S. We offer a slightly different perspective.

First, the report was dominated by a huge inventory adjustment — not the onset of a new inventory cycle, but a transitory realignment of stocks to sales.

Second, it was a tad strange to have had inventories contribute half to the GDP tally, and at the same time see import growth cut in half last quarter. Normally, inventory adds are at least partly fuelled by purchases of foreign-made inputs. Not this time.

Third, if you believe the GDP data — remember, there are more revisions to come — then you de facto must be of the view that productivity growth is soaring at over a 6% annual rate. No doubt productivity is rising — just look at the never-ending slate of layoff announcements. But we came off a cycle with no technological advance and no capital deepening, so it is hard to believe that productivity at this time is growing at a pace that is four times the historical norm. Sorry, but we're not buyers of that view.

Fourth, while the Chicago PMI and the revision to the University of Michigan consumer sentiment index also served up positive surprises, the “hard” data in terms of housing starts, home sales and consumer spending suggest that there is little, if any, momentum heading into early 2010. Moreover, the prospect that we see a discernible slowing in the pace of economic activity this quarter and a relapse in the second quarter is non trivial, in my view — by then, today's flashy headline will be a distant memory.

(by David Rosenberg, January 29, 2010)

Goldman Sees Russia ‘Correction’ as Stock Funds Exit

Russian stocks risk a “temporary correction” as commodity prices fall on concern China will increase interest rates, Goldman Sachs Group Inc. said.

“We see this as no more than a temporary correction, yet we would recommend tactically to diversify with a more defensive exposure,” strategists led by Moscow-based Sergei Arsenyev wrote in a research report. Russia is unlikely to outperform in the “very short term,” he wrote.

Russia’s Micex Index has retreated 5.5 percent from its 2010 high on Jan. 19 as crude oil prices sank 6.4 percent. Investors are concerned that interest-rate increases by China will restrain a recovery in the world’s fastest-expanding major economy that helped spur a surge in global equities since March including in Russia, the world’s largest energy exporter.

Russian equity funds posted their first net outflows in 12 weeks as investors withdrew $608.5 million from emerging markets on concern the global recovery will slow, research company EPFR Global said. Net outflows from Russia were $87 million for the week ended Jan. 27.

“We believe the outflow of cash from Russian assets might lead to additional pressure on the market and exacerbate the downward correction,” Mark Robinson, head of equity research at UniCredit SpA in London, said in a report dated today.

The Micex advanced 0.2 percent, reversing an earlier decline, to 1,408.10 at 4:39 p.m. in Moscow. The Micex level is equivalent to 8.7 times analysts’ 2010 earnings estimates for its traded companies, the lowest among major equity markets in developing countries, according to data compiled by Bloomberg.

‘Cheap’ Valuations

Russia is still the most attractive emerging market in the “medium term” given “cheap” valuations and the potential for the central bank to lower borrowing costs over the next 12 months, Goldman’s Arsenyev wrote.

OAO Rosneft, Russia’s largest oil company, was added to Goldman’s “focus sell” list for central and east Europe, the Middle East and Africa, according to the report dated yesterday, which cited the potential elimination of tax breaks in eastern Siberia. Rosneft shares fell as much as 1.9 percent and last traded 0.9 percent lower.

Telkom South Africa Ltd. was included in the “focus buy” list to boost holdings of so-called defensive companies with less reliance on economic growth.

“We are concerned about short-term headwinds for emerging markets,” Arsenyev wrote. “Our key concern is potential China tightening and its negative impact on short-term commodities prices.”

(Bloomberg, January 29, 2010)

Bill Gross' "The Ring Of Fire"

In his latest commentary entitled "The Ring of Fire" Bill Gross focuses on how investors should invest in 'less levered countries'. In terms of identifying such countries, Gross says to look for a growing consumer sector, low national debt levels, a savings oriented economy, and high reserves. He advises investors to find countries like Brazil and China, but ones that are less bubble-prone. Specifically, he points out to avoid the UK as their high debt coupled with possible currency devaluation presents high risk. Among countries that are already developed, Gross favors Canada and Germany.

Bill Gross February 2010 Commentary -

Thursday, January 28, 2010

Soros: Chinese Stocks Are Overheating

Billionaire investor George Soros said China’s stock market is “overheating” and policy makers should seek to temper its gains.

“Right now, the Chinese market is overheating and they have to slow it down,” Soros said in an interview with Bloomberg Television today at the World Economic Forum’s annual meeting in Davos, Switzerland. “It remains to be seen how successful they are.”

After surging 80 percent in 2009, China’s benchmark Shanghai Composite Index has fallen this year as the government reins in credit growth to avoid asset bubbles and slow the world’s fastest-growing major economy.

The founder of the $25 billion hedge-fund firm Soros Fund Management LLC said there is “no attractive alternative” to the dollar, noting the U.K. is in “worse shape” than the U.S. and the euro has its “own problems.”

Soros repeated that the yuan is undervalued and allowing it to strengthen would be a “very appropriate thing” for the Chinese government to do. “If they don’t do it, there will be increasing pressure from the United States,” he said.

His concern about the value of Chinese stocks reflects the results of this month’s poll of investors and analysts who are Bloomberg subscribers, which showed 62 percent of respondents view China as a bubble. Three out of 10 investors said the country posed the greatest downside risk, ranking it the second- riskiest market behind the European Union.

Greek Deficit Woes

Greece will tackle the EU’s largest budget deficit without leaving the 16-nation euro area, Soros said. “I’m actually confident they will make it,” he said, adding that the alternative of quitting the single-currency bloc would be more painful than paring the debt.

Soros said the world economy remains at risk of a double- dip recession, citing any premature reversal of economic stimulus by policy makers as a trigger for a renewed slump. “It might dip again if you withdraw the stimulus too soon,” he said.

The investor who made $1 billion selling the British pound in 1992 urged policy makers to coordinate their regulation of finance or risk a splintering of markets.

“If we fail to do that, the global markets are going to break up,” Soros said. “Unless you have these common rules, each country is going to protect itself.”

(Bloomberg, January 28, 2010)

IMF Global Financial Stability Report

Systemic risks have continued to subside as economic fundamentals have improved and substantial public support remains in place. Despite improvements, financial stability remains fragile in many advanced countries and some hard-hit emerging market countries. A top priority is to improve the health of these banking systems so as to ensure the credit channel is normalized. The transfer of financial risks to sovereign balance sheets and the higher public debt levels also add to financial stability risks and complicate the exit process. Capital inflows into some emerging market countries are beginning to raise concerns about asset price and exchange rate pressures. Policymakers in these countries may need to exit earlier from their supportive policies to contain financial stability risks. For all countries, the goal is to exit from the extraordinary public interventions to a global financial system that is safer, but retains the dynamism needed to support sustainable growth.

Financial markets have recovered strongly since their troughs, spurred on by improving economic fundamentals and sustained policy support (see the World Economic Outlook Update, January 2010). Risk appetite has returned, equity markets have improved, and capital markets have re-opened. As a result, prices across a wide range of assets have rebounded sharply off their historic lows, as the worst fears of investors about a collapse in economic and financial activity have not materialized.

These favorable developments have resulted in an overall reduction in systemic risks. Overall credit and market risks have fallen, reflecting a more favorable economic outlook and a reduction in macroeconomic risks, together with support from accommodative monetary and financial conditions. Emerging market risks have also fallen. Prevailing easier monetary and financial conditions, while helpful, also point to future challenges that will need to be managed carefully.

Even with overall improvement, however, the repair of the financial system is far from complete, and financial stability remains fragile. There are still pressing challenges from the crisis. At the same time, new risks are emerging as a result of the extraordinary support provided by the policy measures that have been implemented. Indeed, unprecedented policy support has come at the cost of a significant increase of risk to sovereign balance sheets and a consequent increase in sovereign debt burdens that raise risks for financial stability in the future. Simultaneously, some major emerging market economies already have rebounded strongly, raising initial concerns about upward pressure on both asset prices and exchange rates. As a result, the timing, sequencing, and execution of exits to a newly reformed financial system will require policymakers’ deft handling.

Banks and Credit

The first major challenge is to restore the health of the banking system and of credit provision more generally. For this it is necessary that the deleveraging process under way in the banking system remains orderly and does not require such large adjustments that they undermine the recovery. The process of absorbing the credit losses is still under way, supported by ongoing capital raising. Our estimates of expected writedowns will be updated in the April 2010 GFSR; the recovery in securities prices on banks’ balance sheets suggests the estimate would be somewhat lower than estimated previously if recalculated at the present time.

Looking forward, even though some bank capital has been raised, substantial additional capital may be needed to support the recovery of credit and sustain economic growth under expected new Basel capital adequacy standards, which appear to be converging to the markets’ norms that were the basis of the October 2009 GFSR’s calculations of remaining capital needs.

Credit losses arising from commercial real estate exposures are expected to increase substantially. The expected writedowns are concentrated in countries that experienced the largest run-ups in prices and subsequent corrections and are in line with our previous estimates.

Banks not only face the task of raising more capital, but also need to address potential funding shortfalls. As noted in the October 2009 GFSR, there is a wall of maturities looming ahead through 2011–13. This bunching of financing needs is a legacy of shortening maturities during the crisis. A future retrenchment in confidence therefore could severely weaken banks’ ability to roll over this debt.

A more imminent concern is the withdrawal of special central bank liquidity facilities and government guarantees for bank debt. While the use of both types of programs has fallen as money and funding markets have stabilized, some banks remain more dependent than others on such support. Unless the weaknesses in these banks are addressed in conjunction with the withdrawal of funding support measures, there is the risk of renewed bank distress and overall loss of confidence that could have systemic implications.

Bank credit growth has yet to recover in mature markets, despite the recent improvement in the economic outlook . Bank lending officer surveys show that lending conditions continue to tighten in the euro area and the United States, though the extent of tightening has moderated substantially. Although credit supply factors play a role, presently weak credit demand appears to be the main factor in constraining overall lending activity.

Bank credit growth is continuing to contract as the credit cycle turns. Even though the cycle trough is approaching, the prospects for a strong rebound are highly uncertain. Nonbank sources of credit such as corporate bond issuance have picked up strongly, but in many cases are not large enough to offset the decline in bank lending and have, for the most part, been used for refinancing outstanding debt. The improving economic outlook will bolster both the demand for credit and banks’ willingness to lend, but as banks continue to deal with capital and funding challenges, their capacity to lend may become a more binding constraint. Uncertainty about the future regulatory framework may also weigh on bank lending decisions.

A combination of continued bank writedowns, funding and capital pressures, and weak credit growth are expected to limit future bank profitability. This highlights the need for more decisive steps to promote bank restructuring in order to ensure that banks have sufficient margins to weather future shocks and to generate additional capital buffers.

Emerging Market Inflows

While bank flows to emerging markets have yet to recover, the rebound in portfolio inflows has supported a rally in emerging market assets, particularly equities, and to a lesser extent real estate. Concerns have been raised that these inflows can lead to asset price bubbles and put upward pressure on exchange rates. This can complicate the implementation of monetary and exchange rate policies, especially in those countries with less flexible exchange rate regimes.

These inflows are being driven by a variety of factors. The initial surge in inflows in the second quarter of last year appears to have been the result of push factors, that is, changes in the desires of investors. There was a sharp renewal in risk appetite that benefited all risky assets. Investors shifted from safe havens in search of yield, given low interest rates in advanced countries. This can be seen from the decline of the dollar and treasury bond prices, and outflows from money market funds. But since the second quarter, inflows have been sustained by pull factors, namely the better growth prospects for emerging markets, particularly in Asia and Latin America. Expectations of exchange rate appreciation in these regions also have encouraged new inflows.

The rise in asset prices cannot yet be considered excessive and widespread, although there are some countries and markets where pressures have increased significantly. Property price inflation is within historical norms, with a few localized exceptions.

Further, outside of China, credit growth in many emerging markets has yet to recover appreciably. This suggests that leverage is not yet a key driver of the rise in asset prices. That said, policymakers cannot afford to be complacent about inflows and asset inflation. As recoveries take hold, the liquidity generated by inflows could fuel an excessive expansion in credit and unsustainable asset price increases.

Sovereigns Under Pressure

Financial market participants are increasingly focusing on fiscal stability issues among advanced economies. Concerns over sustainability and political uncertainties have led to a widening of credit default swap spreads for the United Kingdom and Japan in recent weeks. Other European issuers, most notably Greece, have come under more pronounced pressure after their ratings were downgraded or as uncertainty has persisted over their fiscal imbalances and consolidation plans.

Our projections of the net supply of public sector debt show a substantial increase in issuance relative to the long-run average over the next two to three years. This increase in deficits and public debt imposes some important challenges for policymakers and risks for financial stability.

At a minimum, there is a risk that the public debt issuance in the coming years could crowd out private sector credit growth, gradually raising interest rates for private borrowers and putting a drag on the economic recovery. This could occur as private demand for credit recovers and as banks are still constrained in their ability to extend credit, particularly as financial support measures are being unwound. A more serious risk is from a rapid increase in interest rates on public debt. Such a rapid run-up in rates and a steepening of the yield curve could have negative effects on a wide variety of financial institutions and on the recovery as sovereign debt is repriced. Finally, there is the risk of a substantial loss in investor confidence in some sovereign issuers, with negative implications for economic growth and credit performance in the affected countries. While this may be a localized problem, there is the risk of wider spillovers to other countries and markets and a negative shock to confidence.

Policy Priorities

Policymakers now face a difficult balancing act in judging the timing, pace, and sequencing of exit policies, both from the monetary and financial policies, as well as starting implementation of a medium term strategy for fiscal consolidation and debt reduction. Withdrawing policy support prematurely would leaves the financial system vulnerable to a re-intensification of pressures (such as in countries with weak recoveries and remaining financial vulnerabilities), while belated withdrawal could potentially ignite inflationary pressures and sow the seeds for future crises (such as in countries with risks of financial excesses and overheating).

In the near term, policies should be focused on securing financial stability, which remains fragile, to ensure that the recovery is maintained and that there is no recurrence of the negative feedback between the real economy and the financial sector. In those economies where financial vulnerabilities persist, efforts should continue to clean up bank balance sheets, ensure smooth rollover of funding, and restructure weak banks.

In those emerging market countries that are recovering rapidly, the policy priorities remain to address capital inflows through macroeconomic policies, including through greater exchange rate flexibility, and prudential measures.

Over the medium term, policies should be aimed at entrenching financial stability, which will underpin strong, sustained and balanced global growth. Public sector risks will need to be reduced through credible fiscal consolidation, while risks emanating from private financial activities should be addressed by the adoption of a new regulatory framework.

The Financial System of the Future

Overall, the exit from the extraordinary support measures implemented in the crisis must be to a financial system that is safer as well as sufficiently dynamic and innovative to support sustainable growth. Achieving this correct balance between safety and dynamism will not be easy.

Several aspects of implementation require special attention. Policymakers should be mindful of the costs associated with uncertainty about future regulation, as this may hinder financial institutions’ plans regarding their business lines and credit provision. But they should also avoid the risks associated with too-rapid deployment of new regulations without proper overall impact studies. It also continues to be vitally important that differences in international implementation of the new regulatory framework are minimized to avoid an uneven playing field and regulatory arbitrage that could compromise financial stability.

For regulatory reform to be successful, micro- and macro-prudential regulations will have to complement one another and help to effectively mitigate systemic risks. Only then can the financial system properly do its job—to intermediate flows from savers to borrowers in ways that enhance sustainable economic growth and financial stability.

To view the Figures please follow the source at
Global Financial Stability Report. GFSR Market Update

(IMF, January 26, 2010)

Monday, January 25, 2010

Pimco's Bill Gross Sees 2010 as Year of Reckoning

Not only does Pimco managing director Bill Gross oversee the world's biggest bond fund, his views often sway markets. In a late December interview with TIME's John Curran, Gross pointed to the second half of 2010 as a period when investors large and small will reckon with a new reality of poor economic growth and a Federal Reserve that is hard-pressed to offer much help.

Where do you see the economy going over the next six to 12 months?
The economy should be relatively strong in the first half of 2010, then weaken in the second half. That's not to say we'll return to recession, but we'll see weakness as opposed to a continuation of what will probably be a decent first half.

What will make the first half of 2010 so good?
The first half will be dominated by government stimulus and by inventory accumulation or a lack of [inventory] liquidation among businesses. I expect nothing from consumer [spending] and nothing really from housing or really any of the standard cyclical leading sectors. It's hard to put a number on GDP growth rates, but let's say 4% in the first half and then 2% in the second half, which would basically call for some additional help. (See TIME's 2009 Person of the Year: Federal Reserve Chairman Ben Bernanke.)

You're talking about a second shot of federal stimulus?
Yes. Something else is probably needed if the [government's] thrust is really reducing unemployment below double digits and renormalizing the economy. (See questions and answers about retirement.)

What does this say about the Federal Reserve's hopes to start pulling its added liquidity out of the markets, either by raising short-term rates or just getting out of buying bonds, which has been keeping long rates low?
I think the Fed's statements suggest that they really want to exit in some fashion from the buying program. The first step in that direction, logically, would be to stop buying, and our sense is that they're at least going to try that. But based on our forecasts for the second half of the year, they may have to reinitiate it, and that will be difficult to do once they stop because it then becomes a political hot potato.

All that said, I think they'll stop buying mortgage-agency securities, and the trillion-and-a-half-dollar check that's been written over the past nine to 12 months basically disappears. It's significant from the standpoint of interest rates and interest-rate spreads in certain sectors. And I would even go so far as to say it might be a mistake. (See the best business deals of 2009.)

Because they might have to restart the buying program later?
Yes. I think the Fed wonders about this as well. But you have to understand that the Fed's probably under political pressure — such as the hearings for new regulation of the Fed, the growing public unease about the supersized Fed balance sheet, etc. The Fed's expanded balance sheet is not something that I consider to be a problem, but I think the market does — and so the Fed will probably be working in the direction of pulling some of the liquidity out of the marketplace. They won't sell — it's a near impossibility to unload what they've purchased over past 12 months. But they'll at least stop buying. (See the worst business deals of 2009.)

Won't that put upward pressure on interest rates?
I think it will. I mean, the mortgage market would be your first place to look, in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth — we think about half a percentage point on rates, but we don't know.

But secondly, there's a ripple effect. Just speaking about Pimco's general portfolio strategy, we've sold our agency mortgage securities, Fannie and Freddie, in the billions to the willing check of the Fed. They're buying a trillion dollars of them, or have over the past nine to 12 months, and so we sold them a lot of ours. Now, what did we do with the money? We bought Treasuries, we bought corporate bonds, and so the bond markets in general have benefited, as have stocks, because this available money effectively flows through the capital markets. So it's a trillion-and-a-half-dollar check that won't be there as the Fed withdraws from the market. How that affects the markets, I just don't know. I'm not eagerly anticipating the answer, but I think it holds some surprises in 2010 — not just in mortgage securities but stocks as well. We could miss the money, put it that way.

(from Time, January 5, 2010)

Sunday, January 24, 2010

David Rosenberg's Outlook For 2010

To his credit--and, if the bullish consensus is right, his doom--David Rosenberg is sticking by his guns.

Below, from Gluskin Sheff's "Breakfast With Dave", is Dave's outlook for 2010.


The credit collapse and the accompanying deflation and overcapacity are going to
drive the economy and financial markets in 2010. We have said repeatedly that
this recession is really a depression because the recessions of the post-WWII
experience were merely small backward steps in an inventory cycle but in the
context of expanding credit. Whereas now, we are in a prolonged period of credit
contraction, especially as it relates to households and small businesses (as we
highlighted in our small business sentiment write-up yesterday).

In addition, we have characterized the rally in the economy and global equity
markets appropriately as a bear market rally from the March lows, influenced by
the heavy hand of government intervention and stimulus. But in classic Bob
Farrell form, 2010 may well be seen as the year in which we witness the inevitable
drawn out decline that is typical of secular bear markets. There may be some risk
in industrial commodities if global growth underperforms, but the soft
commodities, such as agriculture, may outperform in the same way that consumer
staple equities should outperform cyclicals in an environment where economic
growth disappoints the consensus view. Gold is operating on its own particular set
of global supply and demand curves and should be an outperformer as well,
especially when the next down-leg in the U.S. dollar occurs. We are not alone in
espousing this view — have a look at Why Consumers Are Likely to Keep on Saving
on page C1 of today’s WSJ.

The defining characteristic of this asset deflation and credit contraction has been
the implosion of the largest balance sheet in the world — the U.S. household
sector. Even with the bear market rally in equities and the tenuous recovery in
housing in 2009, the reality is that household net worth has contracted nearly
20% over the past year-and-a-half, or an epic $12 trillion of lost net worth, a
degree of trauma we have never seen before.

As households begin to assess the shock and what it means for their retirement
needs, the impact of this shocking loss of wealth on consumer spending patterns
in the future is likely going to be very significant. Frugality is the new fashion and
likely to stay that way for years as attitudes toward discretionary spending,
homeownership and credit undergo a secular shift towards prudence and

While hedge funds and short-coverings have been the major sources of buying
power for the equity market this year, what has really impressed me is what the
general public has been doing with their savings, which is to allocate more
towards fixed-income strategies. Looking at the U.S. household balance sheet,
what I see on the asset side is a 25% weighting towards equities, a 30%
weighting towards real estate and there is obviously a lot in cash and deposits,
life insurance reserves and consumer durables, but the weighting in fixed-
income securities is less than 7%. So my contention is that this is the part of the
asset mix that will expand the most in the next five to 10 years and I am
constructive on income strategies.

What also makes this cycle entirely different from all the other ones experienced
in the post-WWII era is that this is the first consumer recession we have
witnessed where the median age of the baby boom population is 52 going on
53. The last time we had a consumer recession in the early 1990s, the boomer
population was in their early 30s and they were still expanding their balance
sheets. The last time we had a bubble burst in 2001 they were in their early
40s. Now they are in their early 50s, the first of the boomers are in their early
60s, and we are talking about a critical mass of 78 million people who have
driven everything in the economy and capital markets over the last five decades.
This cohort realize that they may never fully recoup their lost net worth, and yet
they will probably live another 20 or 30 years.

So, what is happening, which is at the same time fascinating and disturbing, is that
the only part of the population actually seeing any job growth in this recession are
people over the age of 55. Everyone else can’t get a job or are losing jobs — there
is a youth unemployment crisis in the United States of epic proportions and a
record number of Americans have been out of work for longer than six months in
part because the “aging but not aged” crowd is not retiring as early as they used
to. My contention is that many retirees who took themselves out of the workforce
because they believed that their net worth would provide for them sufficiently in
their golden years are redoing their calculations and coming back to the workforce
to make up for their lost wealth. They are seeking income in the labour market,
not because they want to but because they have to in order to satisfy their
retirement lifestyles.

So, instead of being tempted into capital appreciation equity strategies, for every
dollar that the household sector has allocated to these funds since the March
lows, over $10 dollars has flowed into income funds — bonds, hybrids, dividends
and the like; the areas of the investment sphere that we have been recommending
this year. We can understand that there are concerns over inflation, but the
history of post-bubble credit collapses is that even with massive policy reflation,
deflation pressures can dominate for years — this was certainly the case in the
U.S.A. and Canada in the 1930s, and again in Japan from the 1990s until today.
Income strategies in both cases worked well with minimal volatility.

Of course, all the talk right now is about reflation and all the efforts from the
central banks to create inflation, but the facts on the ground show that the
inflation rate for both consumers and producers has turned negative for the first
time in six decades. Perhaps inflation is a consensus forecast but deflation is the
present day reality and often lingers for years following a busted asset and credit
bubble of the magnitude we have endured over the past two years. So, to protect
the portfolio in this deflationary landscape, a pervasive focus on capital
preservation and income orientation, whether that be in bonds, hybrids, or a focus
on consistent dividend growth and dividend yield would seem to be in order.

Be that as it may, what has also become crystal clear is the attitude that the U.S.
government has taken over the beleaguered U.S. dollar, which can only be
described as benign neglect. After all, 2010 is a mid-term election year in the U.S.
and the Administration will do everything it can to squeeze every last possible
basis point out of GDP growth and to prevent the unemployment rate, the most
emotionally-charged statistic of them all, from reaching new highs.
The decisions to give 57 million social security recipients another $250 and to
not only extend the first-time homebuyer tax credit but to expand the subsidy to
higher-income trade-up buyers smacks of populist economic policies that will
stop at nothing to generate growth, even with the budget deficit-to-GDP ratio is
already at a record of over 10%. While I still believe that a sustainable return to
inflation is a long ways away, there is little doubt that we will see continuous
efforts at policy reflation, which means that the U.S. money supply is going to
continue to expand rapidly, which in turn is positive for commodities, which are
after all priced in U.S. dollars.

On top of all that, it does appear from a volume demand perspective, that the
secular growth dynamics in Asia, China and India in particular, have reasserted
themselves and this part of the world is the marginal buyer of commodities. This is
the key reason why the Canadian stock market, given its resource exposure, has
continued to do very well in comparison to the United States, especially when the
positive trend in the Canadian dollar
enters the equation, and I expect this
outperformance to continue.

Typical of a post-bubble credit collapse, I see the range of outcomes in the
financial markets and the economy to be extremely wide. But one conclusion I
think we can agree on in this light is the need to maintain defensive strategies and
minimize volatility and downside risks as well as to focus on where the secular
fundamentals are positive such as in fixed-income and in equity sectors that lever
off the commodity sector, under the proviso that the “experts” are correct on this
particular forecast — that China and India remain the global growth leaders.

With that in mind, we were encouraged to see this on page B1 of today’s NYT —
Cutting Back? Not in China: Rising Incomes Make it Easier to Splurge. As Dennis
Gartman pointed out yesterday, there was a time (1820) when the U.S.A. was 2%
of global GDP and Asia was 33%. That is tough for a lot of folks to swallow but
maybe we will see in our lifetime a period when the Chinese economy does
surpass the size of the U.S.A. (with 1.3 billion people, four times the U.S.
population that actually seems quite likely).

After all, for the first time ever, China is going to be buying more vehicles than
Americans will this year (then again, 20% of the Chinese aren’t exactly three-car
families either) — 12.8 million units in China compared to 10.3 million in the U.S.
And it’s not even fair to compare appliances any more either with consumption in
China now up to 185 million (we are talking about washers, dryers, refrigerators,
etc) versus an expected 137 million in the American market.

In Q3, Chinese consumers bought more computers (7.2 million) than the U.S.A.
too (6.6 million). So while China is indeed still export-dependant and relies
heavily on government infrastructure projects, there may be something to be
said, at the margin, that consumer demand is also becoming an important
contributor to its economic growth. Now keep in mind that most of this stuff is
made in China and not in the U.S.A., so this is more of a commodity-input story
than it is a U.S. export story.

China’s strategy of deploying its surpluses in assets around the world is quite a
bit different than what Japan did with its surpluses in the 1980s. China is not
into golf courses or movie studios as much as in gaining ownership of global
resources in the ground. At last count, the country has signed trade deals with
Africa to the tune of $60 billion (heck, that’s only 8% of the size of TARP, which
is now going to be diverted towards a government-led job creation program in
the U.S.A.). Have a look at the nifty article on the topic on page 11 of the FT —
Africa Builds as Beijing Scrambles to Invest.

Marc Faber's 2010 Outlook

“Money printing doesn’t create wealth”
The future isn’t rosy for the U.S. in 2010. Marc Faber expects 2010 to be much more difficult after a 2009 stock run from its March lows. One of the biggest, if not the biggest, concern for Dr. Faber is the national debt and its interest rates which will potentially go up in the next 5 years. Also on Marc Faber concerns are credit bubbles in China and Dubai along with rising stock prices in certain emerging markets.

Marc Faber Agrees with Jim Chanos on China Bubble

Google founders to cut stake by selling $5.5 billion in stock. Sales would cut Brin, Page's voting power at Internet giant to less than 50%

Google Inc. co-founders Sergey Brin and Larry Page, who still own nearly one-fifth of the Internet giant, disclosed Friday that they intend to significantly reduce their stake by selling roughly $5.5 billion worth of stock over five years.

The sales are significant, because they would effectively eliminate Brin and Page's control of their company by cutting their collective voting power below 50%. Still, the 48% voting power that the co-founders' would retain following the sales nonetheless constitutes a formidable position of influence.

In a regulatory filing with the Securities & Exchange Commission, Brin and Page, who started Google /quotes/comstock/15*!goog/quotes/nls/goog (GOOG 550.01, -32.97, -5.66%) as graduate students at Stanford University, disclosed that under a five-year "diversification plan" adopted in November, they'll be selling 5 million shares each.

Brin and Page currently own roughly 57.7 million shares of common stock in Google, or about 18% of its outstanding capital stock. Their diversification plan is intended "to allow Larry and Sergey to sell a portion of their Google stock over time as part of their respective long-term strategies for individual asset diversification and liquidity," according to the regulatory filing.

At Google's closing stock price of $550.01 on Friday, the co-founders' sale of stock would result in proceeds of roughly $2.75 billion each.

Brin and Page have maintained significant ownership stakes in Google, while also relying on a dual-class stock structure at the company that currently grants them about 59% of the voting power of the company's outstanding capital stock.

After their planned five years of stock sales, their voting power would be reduced to roughly 48%, according to the regulatory filing.

Google shares dipped $6.47 to $545.25 in after-hours trading.

The search giant's stock price has been on a wild ride over the past two years, veering toward $250 in late 2008, before mounting a steady recovery throughout 2009.

Early last year, Google took the unusual step of In a regulatory filing with the Securities & Exchange Commission, Brin and Page, who started Google /quotes/comstock/15*!goog/quotes/nls/goog (GOOG 550.01, -32.97, -5.66%) as graduate students at Stanford University, disclosed that under a five-year "diversification plan" adopted in November, they'll be selling 5 million shares each.

Brin and Page currently own roughly 57.7 million shares of common stock in Google, or about 18% of its outstanding capital stock. Their diversification plan is intended "to allow Larry and Sergey to sell a portion of their Google stock over time as part of their respective long-term strategies for individual asset diversification and liquidity," according to the regulatory filing.

At Google's closing stock price of $550.01 on Friday, the co-founders' sale of stock would result in proceeds of roughly $2.75 billion each.

Brin and Page have maintained significant ownership stakes in Google, while also relying on a dual-class stock structure at the company that currently grants them about 59% of the voting power of the company's outstanding capital stock.

After their planned five years of stock sales, their voting power would be reduced to roughly 48%, according to the regulatory filing.

Google shares dipped $6.47 to $545.25 in after-hours trading.

The search giant's stock price has been on a wild ride over the past two years, veering toward $250 in late 2008, before mounting a steady recovery throughout 2009.

Early last year, Google took the unusual step of resetting stock options for employees at lower prices, making it easier for them to cash in on their equity. for employees at lower prices, making it easier for them to cash in on their equity.

(from MarketWatch, January 22, 2010)

Saturday, January 23, 2010

Damien Cleusix's thoughts on Commodities

"Global growth (China tightening could take the upper hand given investors obsession with the story…) will be the referee with regard to the timing as continued robust growth could mask some of those dynamics for some time but ultimately we will have a correction to be remembered...Observers have focused too much on what happened to financial markets to explain the rapid slowdown we witnessed in 2008-early 2009... our contention is that even without it, we would probably have a "commodity price too high" induced mild recession..."

Full pdf here

First_Quarter_2010_GTAA_Commodities.pdf1.67 MB

"Inflate or die"

"Inflate or die." That's been the story for years. But today if you continue to inflate you're dealing with a global market and powerful creditors. Our number one creditor is China. China holds a staggering $2.3 trillion in reserves, 70% of which are US securities. China is looking at US money creation (inflation), and wondering what to do about it. Here's an idea - why doesn't China buy up the US with China's ever-growing hoard of US dollars? Wait, maybe they're doing it - this year, for the first time in history, China spent more buying US assets than the US spent buying Chinese assets. Ah well, as one jokester put it, it's going to be tough when Chinese families have American house-boys.

Below is the dire picture from the viewpoint of Austrian economics.

The Austrian Monetary Theory of the Trade Cycle offers a political-economic explanation of why an economy's debt-to-GDP ratio may rise over time. Output gains fall short of the government-sponsored circulation credit growth rate. With this in mind, it might be insightful to briefly recall the so-called "debt dynamics."

If an economy's debt-to-Gross Domestic Product (GDP) ratio is allowed to rise further and further, interest rates must keep declining so that borrowers do not default on their debt. In the short-run, lower rates might prevent widespread bankruptcy. However, a policy of pushing interest rates down would by no means offer a solution to the underlying problem.

In fact, an artificial lowering of interest rates through the central bank would represent the very process that Austrians consider a perpetuation of the fateful expansion of circulation credit that must end in a collapse of the monetary system.

Russell's Comment - For the sake of argument, let's say the Austrians are correct, and in the future we face a collapse of the monetary system. What then? If the current monetary system collapses, nobody will know what any currency is worth. In that event, I'd want to be 100% in gold. The reason is - as the monetary system moves ever-closer to collapse (distrust), people will turn to the one currency that has been trusted and hoarded since Biblical times, and, of course, I'm referring to gold.

If your nation's currency is losing purchasing power and is being devalued, how much is gold worth in terms of your currency? The answer is, in that case, the price of gold is open-ended in your currency, since you will pay any amount in your fading currency to obtain money of unchallenged value. What's a life-saver worth to a drowning man? Answer - It's worth everything he owns.

Comments - There's no question about it, the stock averages are pushing higher. In view of that, there are two questions that might be asked. (1) Take the move at face value. Is the market correctly discounting better times ahead? I believe this is the widely-held view. The market's function is to discount. Therefore, the market is now discounting better times ahead.

But what if we are experiencing a bear market advance? Following the 1929 market crash, which ended in November 1929, a huge rally occurred. By April 27, 1930, the rally had recovered over 50% of the ground lost during the 1929 crash. Many investors bought the '29-'30 rally on the thesis that "the worst is over" and that better times lie ahead. Many thought it a resumption of the bull market.

(2) The great counter-trend rally ended in April 1930 at 294 in the Dow. Following the rally, the market turned down and the Great Depression began. The lesson - rallies in bear markets don't necessarily reflect good times ahead. And that's about where we are now.

When life is a puzzle, I like to go back to fundamentals. The most basic of fundamentals (Dow Theory) is that the market runs from extremes of overvaluation (where I believe it is now) to extremes of undervaluation, a place where it has not been since the early 1980s.

And the question is - are we now on the long winding path to extreme undervaluation? I really think that's what's happening now. And I ask myself, how does this help us with positioning ourselves for the coming years?

First, if equities are headed (over time) toward undervaluation, I don't want to be loaded with common stocks. I'm not a trader so holding stocks, even top-grade blue chips, is not the way I want to go.

As for money instruments (bonds, notes, bills), I think as the dollar sinks over time, interest rates (now abnormally low) will head higher. That leaves out bonds as an investment as far as I'm concerned. Besides, if I hold a bond yielding 4%, and over the next year the dollar drops 5%, I'm out money, and I'm out purchasing power.

So where does that leave me? It leaves me holding as much in the way of precious metals (particularly gold) as I'm comfortable with. So half of all my liquid assets are in gold. But I don't want to put all my liquid assets in gold, because in investing nothing is guaranteed. The other half of my liquid assets I'm going to leave in dollars, because that will give me time to think, and hopefully, over the next six months to a year the situation will clarify.

This may be the time to repeat an old Russell aphorism. "In a primary bear market, everyone loses, and the winner is the one who loses the least."

A final thought. As I read my voluminous daily and weekly material, it occurs to me that most investors and most analysts are viewing the current situation as a "bothersome, temporary patch" that should, within a few years, give way to normalcy, and I'm talking about the "old normal." In other words, after a year or so "this too shall pass" and stocks should be heading higher again as they usually do once we return to the good old normal days.

I think almost everybody's on that side of the boat. But it's not going to happen. That's the Warren Buffett optimistic view, "Don't sell America short. Stocks go up over the long haul."

I believe too many people are on the optimistic side of the boat. The boat is about to list the other way. The unexpected trend would be a long journey towards deleveraging, devaluation and deflation, all leading to an even more recession or depression.

You say "it can't happen here." Maybe so, but I'm not playing it that way. In the investment business anything can happen, and it's been almost three decades since we've experienced a great bear market bottom, during which stocks sell at extreme undervaluation. As far as I know, there's never been a period this long without the appearance of a great bear market bottom.

(from, January 23, 2010)

Saturday, January 2, 2010

Bruce Krusting's "US Treasury - Deep Thinking?"

I was down in Washington on a business trip. That ended at four and I headed for a bar. I found a spot between Pennsylvania and Kentucky Avenues. Nice place. Two barkeeps, me and another guy who looked like he had been drinking gin for the past few hours. Quiet, just the way I like it.

Sure enough, at five the place fills up. It’s a young crowd. Good looking. Well dressed. This looked like an Ivy League group. I was thinking that they could be DOJ, possibly IRS (they looked too happy, but who knows). They could have been Treasury folks; the headquarters is not far off. Anyway, they had two drinks gossiped for and hour and left. I stayed.

At one point I happened to look under the now empty stool next to me. Some folded up papers. Being the nosey S.O.B. that I am, I picked them up and took a look. Bingo!

I am just guessing, but these initials could stand for Geithner, Volker, Summers, Goolsbee and Romer. Of course they could stand for anything. I will leave it to you to draw any conclusions that might be appropriate after a look at this. Judging from the notes that were taken, this must have been an interesting meeting. I am using the Scribd format so you can enlarge this. Enjoy!

Found Memo

If you haven’t as yet, take a look at the ‘labels for this post’. Life is a comedy. We’re all a part of it.
(from Bruce Krasting's blog, December 21, 2009)

Friday, January 1, 2010

Treasures - 2009 Receipts By Source Categories

Taxed to death -

Of Mountains And Molehills…

As we move into the new year and 2010 forecast after forecast hits the Street, invariably the “mountain of money on the sidelines” argument is being put forth by more than a good number of Street seers and pundits as a rationale for bullishness on financial assets, and equities specifically. We’ve heard this same argument again and again for decades now. Invariably these seers and pundits are referring to money market fund balances in their so-called analysis. Don’t get us wrong, over the last few decades we have seen record money market fund balances be created. But the fact is that if you go back to the early 1980’s and move forward, there has virtually never been a down year for money fund balances straight through to 2002. Point-to-point from 2002 through 2006, money fund balances experienced no growth. But you also know that during this exact period, we experienced both a cyclical bull market in equities and a coincident multi-generational residential real estate bubble of incredible proportion. It’s no wonder money fund balances did not grow as it‘s simply not often that we get a double barreled asset class movement as was the case from ‘02 through ‘06. But off to the races with growth in 2007 and beyond has once again been seen in money funds until just recently, punctuated by the safety trade movement of last year and early this. Of course once Bernanke and friends moved the Fed Funds rate to academic zero, dragging money fund rates with it, mom and pop investors have dutifully moved into bond funds in record amounts. Just as the Fed wanted, but ultimately to investor’s detriment when generational low interest rates are no more. The point is that the theoretical “mountain” of money has been on a path of growth for three decades now. The mountain simply grows ever higher and analysts again and again point to it in each cycle as a rationale for yet ever higher financial asset prices (of course completely disregarding the issue of valuation in the investment decision making process using this logic). As we see it, if the mountain of money argument held significant water, we would never have experienced two instances in the same decade where the equity market was cut in half. The so-called mountain of money in money funds should have cushioned such an extreme historical outcome…but they did not.

The fact is that money funds have grown in popularity with a broad constituency of “players” as the decades have evolved. Conservative folks that two or three decades ago would only put their money in banks “found” the sometimes higher yielding money fund complex and shifted investment exposure. But for many former CD buyers who moved to funds, it’s a good bet that money is never destined for equities. The corporate crowd found the fund complex long ago in terms of parking short term cash/working capital assets, etc. as money funds fit the bill - yield, liquid and often safety (govt. funds). You get the picture. The growth in multiple constituencies in money fund owners means there is a ton of money in the fund complex that is never destined for equities. But the analytical community treats money funds as if their owners were homogenous. They are not and that says to us generically pointing to money fund balances and suggesting it is fodder for equities is very poor analysis at best, and disingenuous at worst.

Anyway, we promise the remainder of this discussion will be long on graphics and short on commentary as the pictures tell the story. As opposed to looking at the money fund complex generically and drawing conclusions about fuel for potential equity investment, we’d rather take an analysis of “cash” by investor constituency. Just who are buyers of equities? Households, institutional investors, corporations (buy backs), etc. We want to look at them. Where are levels of cash by constituency relative to current market values? Relative to historical context?

One last quick comment before pushing off from shore. In terms of institutional cash levels, this week the Investment Company Institute reported equity and bond fund cash levels. Near 3.8% at present, equity fund complex cash rests at a level last seen in October of 2007. Relative to total historical context (data going back to the 1970’s) it’s a low number both in relative and absolute terms. The low in October of 2007 was 3.48%. Not quite a mountain at the moment, no?

Although we just got through telling you that we wanted to focus on constituencies, per se, we'll quickly start with a look at the macro. What you see below is the analytical "mountain of money" argument the Street conveniently uses. It’s money fund balances as a percentage of the market value of equities. Again, so you know where this data came from, we’ve used the Fed’s own Flow of Funds numbers for equity values and money fund values also as reported by the Fed. It’s no wonder many a seer and strategist is so bullish, no?

Increasingly money fund balances have spiked in equity market corrections, the spike just becoming larger with each bear market (early 1990’s, 2000 and over the past few years) episode. But we need to remember that with the recent spike in fund balances, many folks were simply seeking the apparent safety of government asset protection, clearly regardless of nominal yield concerns. And that continues to this day. Let’s face it, how does one get close to a zero yield on 3 month T-bills unless safety was still a primary concern for at least a fair amount of investors? So we see the recent spike in fund balances and the ratio of money funds to equity values very much being driven by a run to safety from all asset classes over the October 2007-March 2009 period. That does not mean it will all flow back into equities. Not by a long shot.

Another meaningful macro in our minds is very simple - M2 relative to the value of the equity market. See the recent spike? That’s both equities declining and our friends at the Fed juicing the liquidity (and their balance sheet, of course). But despite both of these anomalistic sets of circumstances, this ratio currently rests below its half century average of 75%.

Um, where’s that mountain of money again?


It has been many a moon since we have looked at some of this data, so a quick definitional comment. You may remember that when we have historically calculated household “cash”, per se, we’ve included every bank account, CD, money fund, and every single household bond holding (corporate, Treasury. Agency, muni, etc.). We stretch the strict definition of cash a good bit, but we are essentially trying to give the cash argument all the benefit of the doubt possible. Forget money funds, we’re essentially assuming in this view of life that households would also be willing to liquidate all of their bond holdings (despite record current inflows to bond funds) in a heartbeat to theoretically plow into equities. And what we get as a historical ratio using this methodology is as follows.

We currently rest at approximately a 65% ratio when the average for the entire period for which we have data is 105%. Not exactly a mountain, but a very strong contender for a molehill. Over the last two years (since YE 2007) the combo of household cash and bond holdings is almost flat. The recent spike in the ratio seen above from under 50% to over 70% was driven by the decline in equity values, NOT a major increase in household cash/liquidity/bond holdings.

And why no spike in household cash in absolute dollars as of late? Simple. The household balance sheet deleveraging cycle, which is still in its early stages. Households are paying down and defaulting on debt in addition to increasing savings. We know by looking at the inflows to equity funds this year the numbers are negative, as there has been a net outflow. Flows into ETF’s have been very positive, but on a net basis we believe it’s fair to say the public has not been piling back into equities, despite the near meteoric rise off of the March lows to this point. Although it may sound a bit melodramatic, in an environment like the present where labor market conditions are unsettled at best, wage growth is zero to minimal and household balance sheets remain “offsides”, so to speak, in terms of existing liabilities relative to a big decline in assets, it’s only a natural that households husband liquidity. And even if households are unable to raise significant cash (liquidity), they at least forgo spending what cash resources they have. We believe this thought process is actually playing out as represented by the chart below. We’re looking at household cash relative to total household assets. Remember the broad definition we have brought to the term “cash”. Again, the recent big spike is due specifically to household asset value deterioration (financial assets and RE).

Interesting, no? Clearly from the late 1940’s to the early 1990’s, this ratio was incredibly stable within a roughly 2% point band. This band of experience was broken to the downside in the early 1990’s, reaching its nadir at the top of the residential real estate and equity market cycle a few years back, but has recently returned to that forty year band of experience with the decline in equity and housing values. Does this really represent households raising significant cash balances? Of course not. It’s the drop in the asset side of the balance sheet that has driven the reversion to the mean journey. Does this represent a return to some type of normalcy (although we hate that word)? For now let’s just call it a change back to what was traditional household asset allocation historically. So implicitly analysts are suggesting perhaps households will allocate precious liquidity resources of the moment back to equities? That seems to be the argument. Personally, we just don’t buy it given total household balance sheet circumstances playing out in the here and now. But that’s our opinion.


You know from our coverage over the years that corporations have been meaningful buyers of equities. Of course this activity is caught up in both buyback and cash driven M&A activity. First, you may be familiar with the fact that recent corporate insider selling has been literally swamping buy activity. Personally, corporate insiders seem anything but bullish as we’ve seen recent weekly experience of 30:1 sell to buy ratios, or more depending on the week. But how are they treating corporate cash? If equities are in the bargain bin, shouldn’t buyback activity logically be off the charts? In a period where top line growth is clearly a struggle, doesn’t buyback and M&A activi

ty make sense in terms of trying to advance the bottom line ball past the next first down markers? One would think so. Unless, of course, one is part of the current corporate sector. The following is simply an update of a chart we have shown you in the past. In the bottom clip we chronicle US corporate equity issuance and buyback activity stretching back three and one half decades. Just look at what has happened so far this year. And as we describe in the chart, this activity DOES NOT include the financial sector (who have been prolific equity issuers this year).

Of course the top clip of the chart chronicles the same equity issuance or retirement, but this time alongside is the rhythm of corporate debt issuance or pay down. Up until literally the last quarter 2009 marked the first year in many a moon where on an aggregate basis, corporations have issued both equity and debt. They are raising cash, per se, as opposed to spending it. It was just in the third quarter that corporate debt in aggregate began to contract for the current cycle.

And this is very much dramatic change in terms of corporate influence relative to the size of the equity market itself historically. You can see this in the next graphic depiction the historical magnitude of net equity retired by the corporate sector over time as a percentage of total equity market value. At market highs in 2007, corporations retired 3% of the total value of the equity market. Talk about a meaningful price support mechanism. Too bad they could not have waited just a few years when a lot of these equities could have been purchased at the 50% off sale, right? Admittedly, a meaningful portion of this prior period equity retirement is also attributable to the mini mania in private equity at the time.

As we see it, for now corporations are husbanding liquidity much as appears to be the case with US households. All one has to do is look at the current dynamics of corporate cash flow to get a sense for what we are talking about in terms of corporations acting to protect liquidity. Below is yet another chart courtesy of the historical Fed FOF data. Here we are looking at corporate internal funds generation less capital expenditures. A close proxy to net corporate cash flow? Yes, close enough to get the point across. The issue here is that corporations are not spending on cap-ex. No surprise at all as we have been chronicling this fact all year long whether looking at business surveys or the raw numbers in non-defense and non-aircraft corporate spending. Again, logical. Corporations would be spending if they saw investment opportunities that would exceed the cost of capital. The message is they don't. And wildly enough for the many, the cost of debt capital is near generational lows. That's a loud message.

Without trying to reach for melodrama, we’ve never seen anything like the above. On a hopefully positive note, does this tell us pent up demand for corporate capital spending will be a reality somewhere in the period ahead? 2010? We think so, but we’ll just have to take it one step at a time as for now the corporate purse strings are largely closed for both cap spending and equity buybacks. Quite the opposite is occurring as we are seeing net equity issuance.

A final view of life in terms of “cash” at the corporate level lies below. This go around we’re looking at the longer term ratio of cash at the corporate level as a percent of the total value of the equity market. The long term average rests at 68% and we’re current sitting at 82%, comfortably above that average. But one more time, the change in this ratio over the last few years is a result of equities declining in value. The increase in the actual nominal dollar level of corporate cash since year end 2007 is an overwhelming 2.1%. Peanuts. Remember, we are including corporate fixed income holdings/assets as cash.

Okay, there you have it. You get the picture at this point. The “mountain of money” argument is certainly not completely without some merit, it’s just it seems clearly not to be the big bull argument the Street makes it out to be. Although these are our personal opinions, some of the constituents of equity buyers that are households and corporations are not sitting on “mountains of money”. Moreover, they are showing us directly in the data they are not in the spending mood, whether for capital expenditures, retail sales (currently resting at 2005 levels, as we have been chronicling), or equities. And in the bigger picture of broad money in the system that is M2, the numbers just are not that impressive relative to historical context. What does all of this tell us? There simply does not seem to be huge “pent up demand” for equities that would be funded by existing cash balances among many constituencies of equity buyers. That’s the message. And what does this mean to the near term equity market outlook? To us it means more of a structural support that would be money potentially headed to equities simply isn’t realistic. And as we see life, this says Fed/Government sponsored liquidity has been and continues to be the most important structural support. That and institutional momentum. As we move into the new year it‘s simply this that we follow. Simple enough? A gloomy view of life? We’re simply searching for realism and trying our best to implicitly ask the age old question, "who's the next buyer?"

(from ZeroHedge, December 31, 2009)