Of course, other PIIGS (Portugal, Ireland, Italy, Greece, Spain) should soon be observed approaching the EU with hat in hand.
I'm adding to my short position around these levels as indexes approach resistance.
position in SPX
Wednesday, June 29, 2011
Greece Bailout
Greece is now set to receive a new tranche of bailout funds. More money being passed to a broke country in order to stave off default... Stocks have been lifting on the news.
Of course, other PIIGS (Portugal, Ireland, Italy, Greece, Spain) should soon be observed approaching the EU with hat in hand.
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I'm adding to my short position around these levels as indexes approach resistance.
position in SPX
Of course, other PIIGS (Portugal, Ireland, Italy, Greece, Spain) should soon be observed approaching the EU with hat in hand.
I'm adding to my short position around these levels as indexes approach resistance.
position in SPX
Questioning the Usefulness of GDP Measures
Most of us have come to accept the validity of GDP as a given. This article questions the usefulness of national output measures.
Arguments against GDP are not new. As the author notes, Mises was on the case years ago. GDP is hardly a measure of 'economic health' as many believe. One need only look at the components of GDP to understand why:
GDP = C + I + G + (X - M)
C = private consumption
I = gross private investment
G = government spending
X = exports
M = imports
As measured, GDP is largely a measure of consumption. In the spirit of 'what gets measured gets managed,' policymakers will likely intervene in markets in order to goose the numbers in their favor.
Interestingly enough, as noted by the author, GDP measurement didn't come about until the 1930s, when New Deal bureaucrats sought a measurement on which they could focus the public's attention on the need for planning to maintain national economic health.
A better argument can be made that long term economic health depends on savings and capital accumulation. Focus on a consumption oriented measure of national output like the one above is more likely to result in capital consumption in order to 'make the number.'
The decline in savings and rise of debt suggest that this is precisely what is going on.
Arguments against GDP are not new. As the author notes, Mises was on the case years ago. GDP is hardly a measure of 'economic health' as many believe. One need only look at the components of GDP to understand why:
GDP = C + I + G + (X - M)
C = private consumption
I = gross private investment
G = government spending
X = exports
M = imports
As measured, GDP is largely a measure of consumption. In the spirit of 'what gets measured gets managed,' policymakers will likely intervene in markets in order to goose the numbers in their favor.
Interestingly enough, as noted by the author, GDP measurement didn't come about until the 1930s, when New Deal bureaucrats sought a measurement on which they could focus the public's attention on the need for planning to maintain national economic health.
A better argument can be made that long term economic health depends on savings and capital accumulation. Focus on a consumption oriented measure of national output like the one above is more likely to result in capital consumption in order to 'make the number.'
The decline in savings and rise of debt suggest that this is precisely what is going on.
Friday, June 24, 2011
The Correlation of Contagion
Interesting discussion by Conor Sen on the set-up for a EU-based contagion now vs the housing/credit market contagion we experienced in 2008.
An important difference, he notes, is that in 2008 there was leverage across the board. Debt was piled high on consumer, corporate, and government balance sheets. He suggest that since then, corporate balance sheets have improved dramatically making them more capable of withstanding a credit event.
He does not discuss the changes in consumer and government balance sheets. Consumer balanced sheets have improved marginally as individuals begin to save and pay down debt. But governments have levered up as risk has shifted from private to public hands over the past few years. Systemic leverage has gone up.
The similarities between then and now include the persistent run-up in risk spreads despite interventionary efforts to put down problems. For example, sovereign yields of Greek, Spanish, and Italian sovereign bonds have been rising over the past year or so in the face of ECB interventions. Similar to 2008, Conor notes, stock markets have been basically chugging higher, basically ignoring problems in the credit markets.
The other similarity is interlinked and leveraged exposure to smoldering credit problems. Some institutions are long sovereign debt while others are short sovereign credit default swaps in a complex, levered manner that is difficult to figure out. The exposure reaches the US, including risk to cash assets. Approximately 40% of domestic prime money market funds are parked in unsecured European bank debt.
You would think domestic institutions would have sold off their Euro exposure by now in order to manage risk. Well, it so happens that in 2008-2009 we changed the accounting rules so that institutions could mark distressed securities as 'held to maturity' rather than having to market them to market in the 'assets for sale' category. Marking them to market would have meant lower values. When you're highly leveraged as banks are, lower values to balance sheet assets drive you toward insolvency. By designating securities as 'held to maturity,' institutions only need to recognize losses if cash flow issues drive them to sell.
It was this fun with numbers, extend-and-pretend approach that helped stave off a more severe decline two years ago. Consequences of that manipulation may now be coming home to roost, however.
Should an institution elect to sell 'held to maturity' securities before they mature, the accounting rules require that other assets in the 'held to maturity' category must be moved back to the 'held for sale' bucket, meaning that they must be marked to market once again.
Because marking them to market would require significant write-downs and threaten solvency, Conor suggests that institutions are 'not going to sell sovereign debt until they can't.' (nicely put) The important consequence of this is that banks seeking to reduce risk will instead sell correlated assets. This means that they might sell anything from corporate bonds to stocks in order to avoid a margin call or outright failure.
This is what a 'contagion' is about. Investors selling anything that isn't nailed down in order to stay solvent. Contagions cannot occur without leverage, or debt. The more debt that's in the system, the higher the chance that a deleveraging contagion will occur at some point.
As we noted above, while debt has been shifted around, the overall systemic leverage is high. The potential for contagion, thus, is also high.
position in SPX
Wednesday, June 22, 2011
Fudging the CPI Numbers
As part of the federal budget talks, there is a proposal on the table to alter the way that the consumer price index (CPI) is calculated. Essentially, the proposed method would try to take into account the fact that consumers often trade down (e.g., go from steak to hamburger) when prices rise.
If passed, the alteration would make the 'headline' inflation number smaller.
Why is this on the table as part of the budget debate? Because a smaller inflation number would lower federal payouts (such as social security) that include cost of living adjustments. Viola! An instant $200 billion in budget savings.
This would not be the first time that the CPI has been dumbed down. There have been multiple changes to the methodology over the past couple of decades. The weird (criminal?) thing is that when the goverment changes the method, they do not go back and alter the historical series. Those looking at historical CPI data are not comparing apples to apples (the same is true for unemployment, GDP, and other measures). If we were measuring the CPI the same way as in 1980, the headline inflation number would be nearly triple the currently reported level.
How such a practice is viewed as legitimate and is tolerated is beyond me. If I had tried to manage measurement systems like this during my industry days, then I would surely have been fired.
Make sure you understand the dynamic here. The federal government is printing money, which undermines the value of the dollar. Government officials are then supressing the metric that is supposed to reflect the dollar's value, effectively under-reporting reporting the inflationary consequences of their activities.
If passed, the alteration would make the 'headline' inflation number smaller.
Why is this on the table as part of the budget debate? Because a smaller inflation number would lower federal payouts (such as social security) that include cost of living adjustments. Viola! An instant $200 billion in budget savings.
This would not be the first time that the CPI has been dumbed down. There have been multiple changes to the methodology over the past couple of decades. The weird (criminal?) thing is that when the goverment changes the method, they do not go back and alter the historical series. Those looking at historical CPI data are not comparing apples to apples (the same is true for unemployment, GDP, and other measures). If we were measuring the CPI the same way as in 1980, the headline inflation number would be nearly triple the currently reported level.
How such a practice is viewed as legitimate and is tolerated is beyond me. If I had tried to manage measurement systems like this during my industry days, then I would surely have been fired.
Make sure you understand the dynamic here. The federal government is printing money, which undermines the value of the dollar. Government officials are then supressing the metric that is supposed to reflect the dollar's value, effectively under-reporting reporting the inflationary consequences of their activities.
Tuesday, June 21, 2011
US Money Market Exposure in Europe
Learned via Bill Fleckenstein today that Jim Grant, in his most recent newsletter, has observed that US money market funds have substantial fractions of their assets invested in European bank debt. Many money fund managers have been extending themselves abroad in search of yield, given the Fed's suppression of short rates to essentially zero.
The five largest domestic money market funds (three at Fidelity, one at Vanguard, one at Blackrock) with about $400 billion under management have about 45% of their assets in Euro bank paper.
If a credit crisis commences in Europe on the back of sovereign debt probs, then the spectre is raised that collapsing Euro bank paper could pressure net asset values of US money market funds to the point where they could 'break the buck' (fall below the $1 unit value). This occured to a small degree two years ago here in the US.
The implication is that US investors should make sure that they understand the nature of their cash holdings. Some funds may be FDIC insured. Current insurance amount, which was raised during the recent credit crisis, is $250,000 per depositor per insured bank.
For cash holdings that exceed the insurance limit or that are not covered, then the strategy should be locating the safest principal preserving vehicle possible. For those who are capable, this might mean parking cash in 1 to 3 month T-bills. They yield next to nothing but likely reflect the surest bet on preservation of principal.
Some believe that the US government would intervene should US money market funds begin to feel stress. Based on history, that may be a good bet. It is also one of the reasons why moral hazard is so high among bank depositors. As a class, depositors are largely clueless of the issues discussed here since they figure that the government has their back.
The five largest domestic money market funds (three at Fidelity, one at Vanguard, one at Blackrock) with about $400 billion under management have about 45% of their assets in Euro bank paper.
If a credit crisis commences in Europe on the back of sovereign debt probs, then the spectre is raised that collapsing Euro bank paper could pressure net asset values of US money market funds to the point where they could 'break the buck' (fall below the $1 unit value). This occured to a small degree two years ago here in the US.
The implication is that US investors should make sure that they understand the nature of their cash holdings. Some funds may be FDIC insured. Current insurance amount, which was raised during the recent credit crisis, is $250,000 per depositor per insured bank.
For cash holdings that exceed the insurance limit or that are not covered, then the strategy should be locating the safest principal preserving vehicle possible. For those who are capable, this might mean parking cash in 1 to 3 month T-bills. They yield next to nothing but likely reflect the surest bet on preservation of principal.
Some believe that the US government would intervene should US money market funds begin to feel stress. Based on history, that may be a good bet. It is also one of the reasons why moral hazard is so high among bank depositors. As a class, depositors are largely clueless of the issues discussed here since they figure that the government has their back.
Thursday, June 16, 2011
Election Cycle Analog
In the summer of 2007, stock markets showed early warning signs that something was going on in the credit markets. Led by the banks, we had a few big down days in July/Aug.
I happened to be in NYC at the time and recall that, while there was some palpable concern among traders, many viewed the bearish action as a minor, necessary correction to relieve overbought conditions in what had been a strong multi-year uptrend. A stroll thru Midtown certainly did not suggest that luxurious lifestyles had taken much of a hit yet. Excess was still visible everywhere.
One rationale offered by the bulls was that it was the year before an election year, and that the Bush/GOP political machine would pull out all stops to keep markets from falling. After the summer swoon, markets indeed reversed higher. In fact, the S&P 500 (SPX) notched a marginal all time high in early fall.
After that, however, things came unglued. For most of the following 18 months, stocks cratered alongside the credit markets, lopping more than 50% off the value of the SPX.
It is safe to say that maneuvers employed by politicians to keep things 'contained' (and they used that word alot) were not very effective.
So here we are four years later. Markets softened back in March and then ralled to marginal highs for the move off the early 2009 lows. Prices have given back more than 7%. From a macro standpoint, we have the end of QE2, data suggesting a softening domestic economy, a sovereign debt crisis in Europe, and stress cracks in the Chinese machine. As a whole, this constitutes a big stinking mass of bear fodder that could/should propel markets much lower.
Yet, similar to four years ago, many have been trotting out the year-before-the-election-year rationale once again. Obama can see his poll numbers sliding w/ the weaking economic picture, the thinking goes. He and his political machine will therefore pull out all stops to keep things afloat into next year's election.
I have no doubt that many political stops will be pulled--some perhaps more extreme than we've seen already (and that's saying something). Whether those stops will 'stop' the bleeding is another question entirely, as our analog four years ago suggests.
Can't shake the sense that all the king's horses and all the king's men will once again prove ineffective in parrying the corrective forces of markets seeking balance.
position in SPX
I happened to be in NYC at the time and recall that, while there was some palpable concern among traders, many viewed the bearish action as a minor, necessary correction to relieve overbought conditions in what had been a strong multi-year uptrend. A stroll thru Midtown certainly did not suggest that luxurious lifestyles had taken much of a hit yet. Excess was still visible everywhere.
One rationale offered by the bulls was that it was the year before an election year, and that the Bush/GOP political machine would pull out all stops to keep markets from falling. After the summer swoon, markets indeed reversed higher. In fact, the S&P 500 (SPX) notched a marginal all time high in early fall.
After that, however, things came unglued. For most of the following 18 months, stocks cratered alongside the credit markets, lopping more than 50% off the value of the SPX.
It is safe to say that maneuvers employed by politicians to keep things 'contained' (and they used that word alot) were not very effective.
So here we are four years later. Markets softened back in March and then ralled to marginal highs for the move off the early 2009 lows. Prices have given back more than 7%. From a macro standpoint, we have the end of QE2, data suggesting a softening domestic economy, a sovereign debt crisis in Europe, and stress cracks in the Chinese machine. As a whole, this constitutes a big stinking mass of bear fodder that could/should propel markets much lower.
Yet, similar to four years ago, many have been trotting out the year-before-the-election-year rationale once again. Obama can see his poll numbers sliding w/ the weaking economic picture, the thinking goes. He and his political machine will therefore pull out all stops to keep things afloat into next year's election.
I have no doubt that many political stops will be pulled--some perhaps more extreme than we've seen already (and that's saying something). Whether those stops will 'stop' the bleeding is another question entirely, as our analog four years ago suggests.
Can't shake the sense that all the king's horses and all the king's men will once again prove ineffective in parrying the corrective forces of markets seeking balance.
position in SPX
Wednesday, June 15, 2011
The Default Option
When you have borrowed more than your income will allow you to comfortably pay back, you face three choices. One is to borrow even more, assuming that creditors are stilling willing to lend to you. A secone choice is to lower your standard of living so that you can allocate more of your income to debt service. The third choice is to default on your loan.
In the first case, you are merely kicking the can down the road while facing larger payback obligations. In the second case, your standard of living falls. In the third case, the creditor's standard of living falls. In all cases, there is likely to be a drag on economic progress. In fact, collective standard of living will probably fall.
These choices now confront much of the world. Greece is a microcosm of the situation. The people of Greece have borrowed extensively to elevate their standard of living far beyond that which income from productive effort would permit. The Greeks want to borrow even more to sustain their condition. Unfortunately, the bond market no longer believes that the Greek condition is indeed sustainable and has effectively shut the country off from further credit.
To frame it in terms that we in the US might currently relate to, Greece would like to 'raise its debt ceiling.' Unfortunately, lenders refuse to offer any more loans.
As such, the first choice elaborated above is unavailable to Greece.
The Greeks do not appear to want to lower their living standards, as demonstrated once again yesterday by yesterday's riots. The second choice therefore seems unlikely either.
Quite appropriately, by default (!) this leaves the third choice: default.
no positions
In the first case, you are merely kicking the can down the road while facing larger payback obligations. In the second case, your standard of living falls. In the third case, the creditor's standard of living falls. In all cases, there is likely to be a drag on economic progress. In fact, collective standard of living will probably fall.
These choices now confront much of the world. Greece is a microcosm of the situation. The people of Greece have borrowed extensively to elevate their standard of living far beyond that which income from productive effort would permit. The Greeks want to borrow even more to sustain their condition. Unfortunately, the bond market no longer believes that the Greek condition is indeed sustainable and has effectively shut the country off from further credit.
To frame it in terms that we in the US might currently relate to, Greece would like to 'raise its debt ceiling.' Unfortunately, lenders refuse to offer any more loans.
As such, the first choice elaborated above is unavailable to Greece.
The Greeks do not appear to want to lower their living standards, as demonstrated once again yesterday by yesterday's riots. The second choice therefore seems unlikely either.
Quite appropriately, by default (!) this leaves the third choice: default.
no positions
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