May 31, 2010

About Face! Offshore Drilling Off the Table!

About Face! Offshore Drilling Off the Table!

May 31, 2010

“The problem is the market is not buying this “fix too much debt with more debt” approach. More bailouts are not the answer. Austerity is the answer.”—Jim Bianco,

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -0.56%
SPX: .016%
COMPQ: 1.26%
RUT: 1.90%

The S&P has experienced its biggest correction since the March 9, 2009 bottom, declining roughly 13% from its recent high to touch new lows for the year. We mentioned the mid 1000’s for a level to begin coming back to the market, and the S&P bounced on cue from the those very levels as the market touched down just below 1050 before rebounding slightly to close the week at 1089. This is the first 10% correction since the market bottomed in March 2009, which is not unusual except that it occurred in a single month. Typically 10% corrections don’t occur within a single month, but trace out over multiple months. The severity of the downturn has raised investor concerns about whether this is a normal correction in an upward trending market or something a bit more ominous.

Richard Russell of Dow Theory fame feels the markets are signaling weak economic conditions or even something direr on the horizon. Personally I feel there are many macro concerns, primarily debt, taxes, and entitlement related obligations, but I don’t feel this is the end all correction some are expecting. Comparisons are becoming much more difficult, but there is also a bit more economic activity. This activity is requiring capital, which is no longer being thrown recklessly at risky assets. I continue to believe we are in a range bound market, and referred back to the January 4th note for this quote “For 2010 I expect the market to continue its upward march through the first one-third of the year, with the possibility of a pull-back to consolidate 2009’s gains. A more significant stalling beyond that time frame is highly possible.

Prediction: look for the S&P500 to rise another 8-10% (north of 1200) before settling back in the back 2/3 of the year. Should the Fed be forced (they won’t do it voluntarily) to raise rates, the market could correct back towards fair value, which I peg at 975-1000 (15x $67).”

Earnings look as though they will come in a bit higher than $67, however, with the uncertainty surrounding the macro environment and concerns about a double dip recession, the 15x multiple seems a bit aggressive, so the fair value of 975-1000 stays intact.

The chart below, courtesy of, shows how the Hang Seng (green line) peaked first amongst the major global indexes. The US, Europe, and Japan all rolled over simultaneously after making new post crash highs.

A number of readers have asked how far corporate earnings have bounced. While they haven’t reached the prior peak (2007), the chart below shows that they have bounced to bubble era levels since bottoming in early 2009. Total corporate profits of the S&P 500 are roughly $50 billion or 18% below the peak. The chart below, courtesy, shows inflation adjusted corporate earnings of the S&P 500 since 1935.


Actual Consensus Prior
Existing Home Sales 5.77 mil 5.65 mil 5.36 mil
Case Shiller Home Index 2.4% 3.0% 0.7%
Consumer Confidence 63.3 58.3 57.7
Durable Goods 2.9% 1.5% 0.0%
Durable Goods ex Transports -1.0% 0.7% 4.8%
New Home Sales 504K 425K 439K
GDP-2nd Estimate 3.0% 3.3% 3.2%
GDP Deflator 1.0% 0.9% 0.9%
Initial Claims 4607K 4600K 4656K
Personal Income 0.4% 0.4% 0.4%
Personal Spending 0.0% 0.3% 0.6%
PCE Prices 0.1% 0.1% 0.1%
Chicago PMI 59.7 60.0 63.8
U of Michigan Consumer Sentiment 73.6 73.2 73.3

The Case Shiller home price index posted its sixth consecutive month of soft results in March after peaking in September 2009. The first time home buyers’ credit has expired, meaning the housing market is going to lose another one of its training wheels, the first being the Fed exiting the secondary mortgage market on March 31.

Durable goods orders came in ahead of consensus after a flat March. The core number, ex-transportation, actually declined for the month. Transportation orders for April increased 16.1%, while capital goods increased 7.4% and non-defense orders increased 9.2%. Nondefense/non aircraft capital goods orders declined for the month by 2.4%.

More Trouble for the Rating Agencies
Virtually every bond trader has a Bloomberg terminal on their desktop. Bloomberg has revamped their credit products to include an actual rating system (see chart below). While the credit agencies struggle with fiduciary responsibility concerns, government investigations, and investor skepticism, it appears that they also have a new competitive concern.

Credit Conditions

From LoanConnector:

"With the turmoil in Europe wreaking havoc on the high yield bond market, the week of May 17 saw the second largest spread widening of 2010. Spreads widened 69bp for the week and 33bp on Thursday alone. When Germany unilaterally announced a ban on naked short-selling, a move that could have major ramifications outside of Germany, the markets went wild. The DJIA plummeted 552 points last week, the VIX index, a popular measure of volatility, jumped to 47 Friday morning, and the 10-year Treasury yield dropped to 3.12% at one point last Friday. High yield funds saw an outflow of $378 million, which added onto the previous week's exodus of $1.69 billion, the largest weekly outflow since 2004. Investors are fleeing to safety, and last week saw the lowest weekly high yield bond volume for 2010 to date at $1.30 billion. With spreads on the rise, issuers are waiting for more favorable conditions before testing the markets. Four out of last week's five new issues that priced were LBO deals - transactions that had to close and were therefore not extremely price-sensitive. May has already seen six high yield deals postponed, and this morning's announcement by Allegiant Travel Company upped that number to seven. Many of last week's new issuance traded down, and it is expected that a few more deals will be postponed this week."

California vs. Texas
The Governor of each state was jogging with his dog along a trail. A coyote jumped out and attacked the dog. The respective responses are outlined below.

1. The Governor starts to intervene and then realizes he should stop; the coyote is doing what is natural.
2. Call animal control. Animal control captures coyote and spends $200 testing it for diseases and $500 relocating it.
3. Call Vet. Veterinarian collects dead dog and spends $200 testing it for diseases.
4. Governor goes to hospital and spends $3500 getting checked for diseases from the coyote and getting bite wound bandaged.
5. Running trail gets shut down for 6 months while wildlife services conduct a $100,000 survey to make sure the area is clear of dangerous animals.
6. Governor spends $50,000 and starts a coyote awareness program for people who live in the area.
7. State legislature spends $2 million investigating how to better handle rabies and how to possibly eradicate it.
8. Governors security agent fired for not stopping the attack and letting the Governor try to intervene.
9. Cost $75,000 to train new security agent.
10. PETA protests the relocation of the coyote.

1. The Governor spends $1.23 on a .380 ACP Gold Dot Hollow Point and he and the dog keep jogging.

And we wonder why California is broke?

China’s Inflation Problem
According to the London Telegraph, a rapid expansion of China's money supply strongly suggests that the economy is overheating, said Guo Shuqing, chairman of China Construction Bank, the nation's second-biggest bank. The government's effort to cool off the housing market might be ineffective because property developers are holding so much cash, he said. "Sales are falling but prices are not," Guo said.

Chinese Growth Slowing?
According to Bloomberg, Chinese manufacturing expanded at a slower pace in May, adding to signs that growth may moderate in the world’s third-biggest economy. The Purchasing Managers’ Index fell to 53.9 from 55.7 in April versus a consensus estimate of 54.5.

A government crackdown on property speculation is cooling the economy by damping sales and construction, while Europe’s sovereign-debt crisis could exacerbate a slowdown by cutting demand for exports. China’s policy makers may delay raising benchmark interest rates or letting the Yuan appreciate against the dollar even after the economy grew 11.9% in the first quarter.

India Rocking!
India's gross domestic product increased 8.6% in the first quarter, ahead of consensus and compared to a 6.5% increase in the fourth quarter of 2009.

The Gulf Oil Disaster

The number of times I have been asked about whether British Petroleum (BP) is a good investment at these levels or not is astonishing. The short answer is that I’m not sure, but there are significant unknown factors that need to be examined. The chart below, courtesy of, shows the damage done to the company’s market value since the explosion of the offshore rig.

The questions that need to be answered really center on what is BP’s ultimate liability? There is an obscure drilling law from 1851 that drilling partner Transocean is attempting to use to limit their liability, but it’s applicability may be a reach. Given the current Congress’ willingness to throw anyone under the bus and retroactively change any law they deem to be a roadblock to achieving their goals, I would be a bit wary about placing bets centered on the existing legal limits. An additional question related to the liability is how much BP’s insurance companies are willing or legally obligated to pay? The answer to that one could take years to determine.

The cost of the cleanup will be significant, especially given the leak hasn’t been slowed yet. Additionally, there are unconfirmed estimates that there is a second leak 5-7 miles from the first which is emitting up to 120K barrels of oil per day, well in excess of BP’s estimate of 5K barrels per day. If this is true then the estimates of $10-20 billion will be well short of the actual cleanup costs.

The impact on future drilling will obviously be negative. The Obama administration has already announced they won’t issue any new drilling permits (in spite of new ones actually being issued last week), and many coastal states are rapidly mobilizing to do the same. This will push drillers further offshore into more dangerous and difficult locations.

One question is whether all the environmental concern actually helped cause this disaster. I’m not saying they caused the spill, but instead suggesting that aggressive environmentalist policies have forced oil exploration off of the continental US and into coastal waters, where the drilling environment is much more dangerous and difficult. Had we allowed more on-shore drilling, would it have helped avoid this disaster?

The final point to remember is that access to inexpensive fuel sources, along with superior communication systems dating back to the Revolutionary War, have allowed the US to prosper. Eliminating cheap fuel sources will hamper mobility and transportation, two key components in the success of the US over the past century.

Pension Problems in California

The Wall Street Journal reported this week that for the California Pension system to get fully funded, it will either require massive funding well in excess of the state’s existing tax revenues or the Dow needs to climb to roughly 28,000,000 (from 10.1K as of Friday’s close)!!!

How did we get in this mess? In 1999 then California Governor Gray Davis signed into law a bill that represented the largest issuance of non-voter-approved debt in the state's history. The bill, SB 400, granted billions of dollars in retroactive pension boosts to state employees, allowing retirements as young as age 50 with lifetime pensions of up to 90% of final year salaries. The California Public Employees' Retirement System sold the pension boost to the state legislature by promising that "no increase over current employer contributions is needed for these benefit improvements" and that Calpers would "remain fully funded." They also claimed that enhanced pensions would not cost taxpayers "a dime" because investment bets would cover the expense.

What Calpers failed to disclose, however, was that (1) the state budget was on the hook for shortfalls should actual investment returns fall short of assumed investment returns, (2) those assumed investment returns implicitly projected the Dow Jones would reach roughly 25,000 by 2009 and 28,000,000 by 2099, unrealistic to say the least, (3) shortfalls could turn out to be hundreds of billions of dollars, (4) Calpers's own employees would benefit from the pension increases, and (5) members of Calpers board had received contributions from the public employee unions who would benefit from the legislation. Had such a flagrant case of non-disclosure occurred in the private sector, even a sleepy SEC and US Attorney would have noticed.

Far from being "fully funded" as promised, Calpers has already required $15 billion more from the state budget than projected in 1999 and $3.5 billion is budgeted for this year, a figure that is more than five times the expense projected by the state legislature in its SB 400 analysis. Pensions are crowding out important programs like higher education, parks and health care, and the state will continue to whack away at those programs because the legislature refuses Governor Schwarzenegger's request to repeal SB 400 for new employees!

A recent Stanford University study concluded that California's pension funds are understating liabilities by $400 billion. In response, California's pension funds set up websites and attacked the study as "shoddy" and "faulty."

Cathy Bussewitz of the Associated press reported that “facing massive investment losses, the board of California's giant pension fund voted Tuesday to make the state increase its contributions to employee retirement benefits by $600 million in the coming fiscal year.”

CalPERS, the nation's largest public pension fund, lost $55.2 billion, or a quarter of its value, during the 2008-09 fiscal year.

"The biggest reason why we need increases is the investment losses," said Alan Milligan, interim chief actuary for CalPERS. "Quite frankly, there's more to come.""

Scary stuff indeed!

More Do as I say, Not as I do
Just two days after the WSJ reported that certain members of Congress “made risky bets with their own money that U.S. stocks or bonds would fall during the financial crisis,” it followed up with a story noting that the “Stop Trading on Congressional Knowledge (the ‘STOCK Act’)” continues to languish in Congress. The STOCK Act would prohibit lawmakers from engaging in insider trading based on nonpublic information they learn on the job.

The WSJ’s reminder that Congress currently can’t be held liable for insider trading based on congressional knowledge seemed to come as a surprise to many people. “That’s right! Members of Congress are currently allowed to profit on insider trading!,” Yahoo! Finance reported in an article last week.

In January, U.S. Reps. Louise Slaughter and Brian Baird introduced—for the third time—legislation intended to stop insider trading on Capitol Hill called the “Stop Trading on Congressional Knowledge Act” (the STOCK Act). Slaughter and Baird also introduced similar bills in 2006 and 2007, without success.

Now yet another year has passed, and the STOCK Act has made absolutely no progress. In fact, its minimal support continues to dwindle. As the WSJ notes, when Baird and Slaughter “first proposed the legislation more than four years ago, they were able to persuade just 14 of their colleagues to endorse it. The current version of the bill has fared worse: Only six lawmakers have agreed to support it, and Mr. Baird has announced that he is retiring from Congress at the end of the year.”

Thanks to Al Daniels

More Pension Problems

A Democratic senator is introducing legislation for a bailout of troubled union pension funds. If passed, the bill could put another $165 billion in liabilities on the shoulders of American taxpayers.

The bill, which would put the Pension Benefit Guarantee Corporation behind struggling pensions for union workers, is being introduced by Senator Bob Casey, (D-Pa.), who says it will save jobs and help people.

As FOX Business Network’s Gerri Willis reported Monday, these pensions were in bad shape; as of 2006, well before the market dropped and recession began, only 6% of these funds were doing well.

Although right now taxpayers could possibly be on the hook for $165 billion, the liability could essentially be unlimited because these pensions have to be paid out until the workers die.

It’s hard to say at the moment what the chances are that the bill will pass. A hearing is scheduled Thursday, which will give the public a sense of where political leaders sit on the topic, said Willis.

Just last week President Obama said there would be no more bailouts. Does that include pension funds?

US Lagging in Competitiveness

According to Google and the Associated Press, for the first time since 1993, the U.S. does not hold the top spot in the World Competitiveness Yearbook's rankings. The 2010 yearbook, published by IMD business school, put the U.S. in third place, behind Singapore and Hong Kong.

China IPOs Remain Hot

One area of the market remains hot-Chinese IPOs. China's initial public offerings have seen the best performance in the world this year, according to Bloomberg. During their first month of trading, Chinese IPOs are outperforming the nation's equity indexes by 3300 basis points.

I won’t say that my daily economic notes on Twitter have been an explosive success so far, but I haven’t received any complaints either. I have been consistently sending out the morning economic data via Twitter, and a handful of people have subscribed. I’ll continue doing it unless a better method comes along or people stop caring.

Interestingly, I have found that my weekly notes are being “re-tweeted” by numerous readers. I have to be honest, I’m not sure why someone would re-tweet what another person wrote, but I am curious to find out. If you are one of these “re-tweeters”, please shoot me a note so I can understand the logic and maybe help you in this distribution.

A reader corrected my 1AM typo last week, and it was significant enough I though I’d better include it in this week’s note. When I was discussing the CPI adjustments made in the early 1990’s, I referred to the new pricing method as “hedonistic”, when in fact it is “hedonic”.

Thanks Robert!

Happy Memorial Day to all of our active servicemen and veterans. Thank you for your loyal service which has been instrumental in ensuring we have the freedoms promised to us in our Constitution.

Have a great week.


“Whatever method you use to pick stocks…your ultimate success or failure will depend on our ability to ignore the worries of the world long enough to allow your investments to succeed. It isn’t the head but the stomach that determines the fate of the stockpicker.—Peter Lynch.

May 23, 2010

Credit Crisis Part Deux

Credit Crisis Part Deux

May 24, 2010

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -4.0%
SPX: -4.2%
COMPQ: -5.0%
RUT: -6.4%


The Leading Economic Indicators came in at -0.1% versus consensus of 0.2%. Nondefense capital goods orders were up, while the pace of deliveries and building permits were the largest negative contributors to the decline in LEI.

Money Supply

The chart below, courtesy of the National Inflation Association, shows the growth (red and blue lines) and total (green line) money supply in the US. The growth rate, a 13 week moving average, was an astronomical 100% at the peak of the crisis, and has since pulled back to what appears to be a low double digit rate.

Regardless of how the government tries to cover up inflation (see Inflation below), the end result will be the same. The dollar, and potentially all paper currency, is headed towards Armageddon.

Credit Conditions
The European credit crisis is wreaking havoc on the credit markets. As we showed last week, LIBOR is spiking. Additionally, corporate credit issuance has slowed dramatically and credit spreads are rising, all signs of another brewing credit crisis. Credit-default swaps soared in Europe this week after German Chancellor Angela Merkel implemented a curb on using CDS to speculate on sovereign debt. Rising CDS rates signal investor concern about credit quality.
Spreads on corporate bonds rose to 170bps this week, up from 140bps a month ago. Libor, the rate which banks charge each other for borrowing amongst themselves, rose to the highest level in almost a year to just under 50bps. The LIBOR-OIS spread now sits at 25bps, up from 6bps in March. The rising spread indicates a concern about counterparty risk between lenders. According to Merrill Lynch, the rise in the LIBOR-OIS spread simply signifies reluctance among US banks to lend to European banks.


The dollar has been a beneficiary of the recent problems with the Euro. The chart below, courtesy of reader Bob Rezaee, shows the movement in the dollar since the Euro began experiencing its issues near the end of last year.

The National Inflation Association created this video discussing the impact and under-statement of inflation. I think it is well done, although I feel the part which discusses silver is much too long and too much of a propaganda section.

We have commented extensively about the problems in California, but it appears that Illinois is in even worse shape than the Golden State. According to the Illinois Comptroller, they haven’t paid close to $4.5 billion in bills so far this year. In January the state issued $3.5 billion in pension bonds to pay the state’s obligations to the retirement system.

Could Illinois and California be the US version of the PIIGS?

Concerns over demand and oversupply of oil combined with a surging dollar have pushed the price of West Texas Intermediate under $70 per barrel. The chart below, courtesy, is a five year chart on the commodity.

Alternative Energy
Construction is slated to begin later this year on a 49-megawatt geothermal-energy plant in the U.S. after financing for the project was finalized last week. The $399 million project is being developed by EnergySource. The company plans to pursue as many as four additional geothermal projects, with the next one possibly ready as early as 2013.

Remember about a year ago we compared all the alternative sources of energy, and geothermal was the most economically attractive.


I have written extensively about the hedonistic adjustments made to the CPI measure in 1993. produced the chart below showing the official CPI (orange) and their own estimate of CPI without the hedonistic adjustments. According to the National Inflation Association, the underestimation of CPI over the past two decades has resulted in social security beneficiaries receiving approximately 50% of what they would have received had the measure not been altered.

It makes me wonder how reliant Greenspan was on this meausre when he kept rates artificially low during a 10 year period, and also how close to bankruptcy the Social Security program would be without those adjustments?

Real Estate

According to Jim Welsh, Fannie Mae and Freddie Mac have been taken over by the U.S. government, and the taxpayers will have to make good on their combined losses of at least $400 billion. It’s also worth noting that between 1988 and 2007, Fannie and Freddie made almost $200 million in campaign contributions to Congress. The three largest recipients in the Senate were Christopher Dodd, John Kerry, and Barack Obama.

I mentioned last week that 400 point gains on the Dow typically were bad, and the market reacted as expected with a big drop this week. I’ve closed my QID positions (double short NASDAQ). I discussed a correction taking the S&P 500 to the mid-low 1000’s, and while we aren’t quite there yet, I am going to at least stay off the shorts for now. If we get more negative movement in the credit markets, I may go back in on the short side. I have also been adding to my holdings in high quality, more stable large caps with solid dividends.

Have a great week.


May 16, 2010

A Greek Tragedy

A Greek Tragedy

May 17, 2010

“If healthy economic systems require taxing the responsible and debasing the currency to bail out the profligate, the EU’s rescue package should be a raging success.” --Kevin Duffy

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: 2.31%
SPX: 2.23%
COMPQ: 3.58%
RUT: 6.28%


Volatility has exploded over the past two weeks (see chart below courtesy of Bloomberg) as the markets reacted to an IMF/EU bailout of the PIIGS. The correction of 2:45, which saw the Dow fall by 1000 points in a matter of minutes due to inconsistencies in the circuit breakers amongst the various exchanges, has investors on edge. Rumors of a trading mistake (isn’t it funny how trading mistakes only seem to occur on down days?) have proven to be false and seemingly unlikely.

The market staged an enormous bounce back Monday after the announcement of the big bailout package (also known as ‘Tarp, Part Deux’). David Rosenberg notes that big bounces (400 Dow points or more) typically have occurred during or near the beginning of bear markets. Personally, I have maintained this market has been a cyclical bull in a secular bear market, and right now we may be experiencing either a normal correction or the beginning of a down phase that could take the S&P down to the low 1000’s.

The Euro also staged a one day rally Monday before continuing its retreat (see chart below courtesy The Euro now stands at a four year low, and seems destined to continue falling over the intermediate time frame. Some traders are expecting a short lived bounce due to the crowded short position in the currency. I would use any strength to add to short positions.

The results have been predictable as US Treasuries and the dollar have both rallied given Europe’s problems and a potential slowdown in China (more below). Commodities have recoiled on the strength in the dollar and concerns about demand coming from both Europe and China. Finally, gold has ripped to a new high amidst concerns about not only the Euro, but also most currencies which have been debased in response to the recent financial crises.

From a stock standpoint we have been suggesting staying focused on mid-cycle stocks since the beginning of the year. Doug Cliggott, strategist at CSFB and a very astute market observer, suggested moving to late cycle stocks this week. Doug may be a tad early, but given weakening demand coming from Europe (20% of US exports); the potential for a rate increase in China; and tougher earnings comps in the back half of the year, the burgeoning economic recovery may be peaking this quarter. As a side note, Doug was right on the mark with his market calls heading into the 2000 peak and eventual bear market.

One major area of concern may be liquidity in Europe. The chart below shows the jump in one month LIBOR rates over the past year. Banks across Europe are significant holders of Greek, Portuguese, and Spanish debt. You may recall that spiking LIBOR rates in the middle of 2008 were an outgrowth of the financial crisis, and contributed significantly to the bank liquidity problems at that time.


Actual Consensus Prior
Wholesales Inventories 0.4% 0.5% 0.6%
Continuing Claims 4627K 4570K 4615K
Initial Claims 444K 440K 448K
Export Prices ex-ag 1.4% 0.7%
Import Prices ex-oil 0.5% 0.2%
Retail Sales 0.4% 0.2% 2.1%
Retail Sales ex-Auto 0.4% 0.5% 1.2%
Capacity Utilization 73.7% 73.9% 73.1%
Industrial Production 0.8% 0.8% 0.2%
Michigan Sentiment 73.3 73.5 72.2
Business Inventories 0.4% 0.4% 0.4%

The IMF said this week that this is the first time Asia has led a global recovery while the US and Europe lag. Europe may have destined itself to another decade of slow growth with their most recent bailout package, joining the US as underperforming economies over the next decade due to overly leveraged balance sheets.

Employment rose the most in 4 years last week, but the unemployment rate jumped as more people began looking for jobs. Job gains are still needed to sustain the recovery. Employers increased payrolls by 200,000 workers in April. ISI estimates 750K jobs were created last month, 550K from the government hiring census workers and 200K from the private sector.

March Business Inventories rose by 0.4%, in line with expectations and up for the 5th month in the past 6 after 13 months in a row of declines. Because sales rose 2.3%, the inventory to sales ratio fell to 1.24 months, matching the lowest level on record dating back to 1980. The historically lean inventories is a reflection of business caution to the still uncertain economic environment but also provides a great backdrop for a pick up in production if confidence in the outlook grows and end demand improvements become longer lasting

Oil Spill Good for the Economy

Outside of the obvious environmental disaster, should we be looking at the BP oil spill as a boon to the regional economy? Remember that the rebuilding of the south after Hurricane Katrina was a major boon to the area’s economy.

More on Taxation without Representation

Last week we discussed the UK usuriously taking bonus money while an unnamed US based bank clipped employee bonuses by 7% globally to pay the tax. This week both BofA and Citi announced they would pay $465 million and $400 million respectively due to the UK tax. The UK government had hoped to raise 500 million pounds via the tax, however, it appear that figure may be closer to 2 billion pounds.

I just want to clarify this one. BofA and Citi, among others, operate their businesses so poorly that they require the financial assistance of the American taxpayer, helping to push the country into a recession. Then, after some favorable accounting changes, they begin to pay bonuses again. The UK decides to zing them for their “profitability” for 2 billion pounds.

So the net is that the US taxpayer just subsidized the UK by 2 billion pounds!

Am I missing something here? Don’t they still owe us for helping them a few decades ago when it was apparent they’d be speaking German and doing the goose step?

Demonstrations have been rampant in Greece as the citizenry, primarily government unions, are showing their unhappiness with the plan to cut back on government expenditures in exchange for IMF funding. The protest is aimed at Prime Minster Georgios Papandreou, who was elected in October based on promises to raise wages for public workers and increase stimulus spending. The budget deficit of 14% of GDP is twice the estimate of the prior government and more than 4 times the limit of the EU, tying the Prime Minster’s hands on doling out the goodies.
The surge in the budget gap as the economy contracted fueled investor concern about Greece’s ability to finance the deficit and sent borrowing costs to the highest level since before the start of the Euro in 1999. Papandreou has pledged to lower the shortfall to within the EU limit of 3% of GDP in 2014. With reductions in wages and increases in taxes, the Greek economy is forecast to shrink 4% this year and 2.6% in 2011. Unemployment has risen to 11.3%, a six- year high.

Europe’s Debt Problems

The chart below, courtesy of the NY Times, shows the breadth of the problems facing Europe. In addition to the PIIGS, Britain, Hungary, France and Belgium all have debt levels exceeding EU limits. It’s ironic that the Eastern Block countries, historically unable to issue debt, are now more fiscally sound than their Western neighbors. I’m wondering how much of this Western European debt problem can be traced back to the cost of integration and support of Eastern Europe after the fall of the Berlin Wall?

Identity Theft Gold Mine

Every digital copier since 2002 has been shipped with a hard drive. This means that every document that has been copied on those machines is stored inside. A used machine could have up to 300K stored copies on it. Check out this link to CBS news:

If you have any concern for your financial privacy, this will scare you.

Marge Simpson and Europe

Enough said?

Thanks to the Big Picture.

China’s property market is a bubble looking more and more like the one that preceded it in the US. An estimated 60% of GDP in China comes from construction related activities. James Chanos (who is short Chinese developers and building related materials suppliers) said China is “Dubai times a thousand. They can’t afford to get off this heroin of property development. It’s the only thing keeping the economic growth numbers going.” “China is on a treadmill to hell.”

Property prices in China rose at the fastest pace in almost two years in February even after officials this year re-imposed a tax on homes sold within five years of their purchase to curb speculation and ordered banks to set aside more funds as reserves to cool lending. The boom in China’s real estate has fueled concern that China may face a collapse like that in the US and Dubai.

China’s Reserves
Chanos was also negative on China’s enormous foreign currency reserves, $2.4 trillion, of which nearly $900 billion are US government debt. China’s foreign currency reserves will be “one asset” that can be used to fund a cleanup of the banking system, he said. If that were to occur it could be the end of the 30 year bull market in US Treasuries.

China Part 3

The Chinese market is now down 20%, which qualifies for a bear market. The market has been pressured by concerns about the government raising rates to slow the economy and cool the housing market, rising inflation, and an increase in bank reserve ratios.

Andy Xie on the US Recovery
“I think the current recovery is merely based on government stimulus and low-base effect. And given the amount of stimulus spending, this is not a strong recovery. More importantly, structural problems exposed by the financial crisis were merely covered up, not resolved, by stimulus spending. This is why the recovery is not sustainable.

Since stimulus will eventually lead to inflation, interest rates will have to be raised. That will lead to another dip in the global economy. I expect this second dip in 2012, which means we are en route to a W-shaped economic phenomenon, not a V-shaped recovery.”

People in Glass Houses Just Shouldn’t
An unlikely advisor to Europe regarding their debt problems has emerged- Barack Obama.

I have nothing more to say.

The International Energy Agency scaled back its forecast for growth in global oil demand this year. The revision cut the forecast by 50K barrels a day to 1.62 million. Analysts said the reduction reflects a shaky world economy.

Inflation in Afghanistan?

Bloomberg is reporting that up to one-third of Afghanistan’s poppy harvest this spring has been destroyed by a mysterious disease, according to estimates revealed by the UN, which could hinder the American military offensives this summer in the country’s opium-producing heartland. It seems the Taliban’s public relations strategy against the offensive includes trying to convince local residents that Western troops will destroy their poppy crops, and in recent weeks Afghan farmers have started blaming the American and NATO militaries for spreading the disease. In many places, the blight has wiped out more than half of individual poppy fields.

Besides fueling the propaganda war, the blight might also help the insurgency by forcing prices up. Reduced production is causing prices for fresh opium to soar as much as 60%. The price increase is also raising by hundreds of millions of dollars the value of opium stockpiles held by traffickers and insurgents. The opium trade is believed to provide the Taliban with a large portion of their budget.

Real Estate
Data from the National Association of Realtors indicate that the housing rebound is losing steam and that housing prices in the U.S. might slip into the second part of a double-dip downturn. Core-Logic, a real estate analytics firm, forecast that prices will be 4.2% lower by February. Economists said the next downturn likely would be less severe, in line with our outlook for another 10-15% decline.


With the dollar rising 6% this month and the Euro falling 5% this week, commodities have been hurt while gold and treasuries have risen. The charts below, courtesy of, show the moves in gold, west Texas crude, and the dollar.

As a reminder I am now sending out the morning economic data via Twitter. I’m not saying I won’t forget some mornings, but if you are interested in receiving them, just click on the “Follow Me on Twitter” button on the upper right of the website. It’s easy to join (just requires an email and password), and more importantly it’s easy to unsubscribe.

The market has some tough sledding in front of it. We are advocating a defensive posture, and would use the market weakness to move into stronger, higher quality holdings and away from higher risk, lower quality holdings. There seems to be very few values in the bond market after a 14 month run, and would use any strength or liquidity in that market to take profits.

Have a great week.


“You have the great problem of a potential disintegration of the euro. The essential element of discipline in economic policy and in fiscal policy that was hoped for has so far not been rewarded in some countries.”-Paul Volcker

May 2, 2010

Said the Fed to the People “Speculate and be Prosperous”

Said the Fed to the People “Speculate and be Prosperous”

May 3, 2010

“As hoped and intended the Fed’s outsized accommodation has successfully quashed any impulse to get healthy after the US economy’s credit-induced cardiac arrest.” “The rally in risk is just a sugar high, destined as all sugar highs, to crash.”—Stephanie Pomboy, MacroMavens

Weekly percentage performance for the major indices
Based on last Friday’s official settlement...

INDU: -1.75%
SPX: -2.51%
COMPQ: -2.73%
RUT: -3.41%

This market has been on an absolute tear for a year, and the upwards march over the past three months has been relentless. Low rates, easy money, rebounding investor confidence, and an economy responding to excessive stimulus have allowed the market to race ahead unfettered. Risk appetites have rebounded faster than Zsa Zsa Gabor (for my younger readers, she’s equally famous for being a lousy actress AND having had nine husbands). According to the Group of 20’s finance ministers and central bankers, the time has come to withdraw the stimulus. “We should all elaborate credible exit strategies from extraordinary macroeconomic and financial support measures” they said last week.

While a pullback on the stimulus is needed, it’s doubtful that the US will be the first to tap the breaks. Chairman Bernanke has adopted his predecessor’s view of bubbles, or should I say lack of a view. The Fed once again pledged this week to keep interest rates near zero for “an extended period” even as we now see improvements in the labor market. The Fed appears to be blind, ignorant, or apathetic to bubbles and in fact apparently favors them over the tougher job of correcting the imbalances they create. So the key for investors is to keep the pedal to the metal in the face of increasing risks and wait for the Fed to blink. When they do, look out below!

Raymond James' strategist Jeffrey Saut, who has been accurately bullish the past 12 months, surprised the market with his latest warning “Don't wait for May to go away!” Saut commented “Our increased caution is driven by a number of metrics. To wit, preliminary data suggests last Friday was the first 90% Downside Day since February, our sentiment gauges are back to as bullish as they were in 1987 (read that bearishly), the CBOE equity put/call ratio is at 0.32, for its heaviest "call volume" relative to "put volume" since August of 2000, stocks are the most overbought since the rally began in March 2009, some of the leading stocks are not responding to good news, Thursday was session 34 in the "buying stampede" that began on February 26th (rarely do such skeins last more than 30 sessions), we've gotten that peak-a-boo "look" into the long envisioned target zone of 1200 - 1250, volatility is back to the complacent 2008 levels, and the list goes on.”

In other words, be cautious, this rally is long in the tooth and exhibiting fatique.


Actual Consensus Prior
Case Shiller Index 0.6% 1.1% -0.7%
Consumer Confidence 57.9 53.5 52.3
Continuing Claims 4645K 4625K 4663K
Initial Claims 448K 445K 459K
GDP Adv Q1 3.2% 3.3% 5.6%
Chain Deflator 0.9% 1.0% 0.5%
Employment Cost Index 0.6% 0.5% 0.4%
Chicago PMI 63.8 59.9 58.8
Michigan Sentiment 72.2 71.0 69.5

The initial estimate of first quarter GDP came in just under consensus at 3.2%, fueled by household spending. The combined Q4 and Q1 increase in GDP is the biggest two quarter increase since 2003. Consumer spending increased 3.6% versus a weak 2009 and above consensus, adding 2.55% to GDP. Inventories turned positive for the first time in two years, adding 1.57% to GDP. Construction expenditures in both residential and non-residential fell by double digits. Export growth lagged import growth, negatively impacting GDP. Federal spending increased 1.4% while state and local expenditures declined by 3.8%.

Earlier in the week the FOMC statement confirmed that the Fed plans to keep rates low for some time. “Economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

The S&P/Case-Shiller home price index came in under expectations, an increase of 0.6% versus expectations of a 1.1% increase.


Inflation (and deflation) concerns abound. I am wondering where the dollar might be if the Euro wasn’t puking all over itself and if that would change our short term outlook on inflation?

I would love to hear from all the economists (and amateur economists) who have views on this topic.

More Hidden Taxes in Healthcare Plan
Of the 19 new taxes embedded in the healthcare reform bill, here are a few that are noteworthy. Individuals without coverage will pay $695 per year or 2.5% of their pay in penalties. Additionally, you will be charged $347 per year up to $2250 for children not covered.

How about 3.8% sales tax on home sales? That’s almost $20K on a $500K home.

The CBO estimates that because of the costs, incentives, penalties, and structure of ObamaCare, 8-9 million people will LOSE their employer sponsored healthcare.

I guess when Nancy Pelosi said “we’ll have to pass the bill for you to see what’s in it” she really meant it.

Greece and the Euro

After a tumultuous few weeks, the IMF and European Union announced a $146 billion bailout package for Greece. As is typical for IMF programs, Greece agreed to an austerity program requiring them to make cuts equal to 13% of GDP. Remember that only a week ago there was discussion of this bailout being as low as $59 billion. As we’ve seen in US bailouts (think Bear Stearns, AIG, Lehman, etc), it’s better to be first in line while there’s still capital available. I’d hate to be Spain or Portugal right now.

Last week two year Greek notes were yielding 23% after S&P lowered its rating and warned that investors may only received 30% of their principal if the country restructures. The spread between Greek and German bonds closed the week at 825bps (8.25%). Germany was the last holdout on the aid package, finally approving the bailout plan after recognizing that a Greek default would lead to a collapse of the Euro and potentially both the German and French banking systems. According to The Economist banks from those two countries hold 71% of Greece’s sovereign debt, or just over $100 billion.

Banks in the Eurozone also hold $42 billion in debt issued by Portugal, whose debt was also downgraded by S&P last week. Sovereign-debt risk has become a "major and real threat" to the world's financial system, said Zhou Xiaochuan, China's central bank chief. He said developed countries are the biggest sources of such risk.

The crisis is certainly demonstrating the weakness in the structure of the Euro. Without a single authority over the issuance of debt and fiscal policies there is no way to restrain a member state from behaving irresponsibly. Once again, socialize the losses!

Could this bring down Europe if it continues escalating? Possibly. If so, it will also bring down the US, which is Europe’s largest trading partner (and vice versa).

Pension Problems
I’ve discussed the underfunded pension problem in both corporate America and state/local governments for the past 18 months. Now, according to ISI, it appears that pension funding relief proposals have surfaced recently in the Senate. One example, HR 4213, includes options to fund pension shortfalls over a 15 year period or a "2+7" period (interest only for 2 years then 7 years thereafter).

Will we ever learn that creative accounting only delays and magnifies the problems?

Goldman Hearing
I watched the Goldman Sachs Senate hearing on Tuesday, and three things were quite apparent. First, the Senators had absolutely no idea what they were talking about. They were just looking to make empty political points by launching comments such as “you’re nothing more than a casino pit boss.” Second, Goldman executives obviously have no remorse for hosing their clients, feel like they’re the smartest guys in the house, and are convinced their business model based upon making money in any way possible is justified. Third, the Senate was obviously grandstanding in an effort to gain public support for their financial reform bill.

The hearing makes me wonder if the SEC case isn’t just a stab in the dark effort to generate PR for this same bill, which doesn’t address the biggest problems inherent in our financial system today such as TBTF. "The timing is serendipitous, but it should increase the pressure on Republicans," said Sen. Byron Dorgan, D-N.D.

In spite of the questionable timing of the investigation, the charges are definitely real. Goldman has certainly violated client trust and their fiduciary responsibility, and could be guilty of fraud. A finding of fraud or a systematic breakdown in fiduciary responsibility to their clients would cause a devastating blow to the firm.

Does this Sound Familiar?
“The investigation revealed that National City sold off bad loans to Latin American countries by packing them into securities and selling them to unsuspecting investors, that Wiggin had shorted Chase shares during the crash, profiting from falling prices, and that Mitchell and top officers at National city had helped themselves to $2.4 million in interest-free loans from the bank’s coffers.”

No, this isn’t a quote from a recent Wall Street Journal article, but instead from on written in 1932.

Thanks to Bob Bronson.

More Goldman
Bloomberg reported that the US attorney in Manhattan is investigating Goldman for criminal charges as well. According to Douglas Jensen, a NY based attorney and former deputy chief of the US attorney’s office in NY, “In order to proceed criminally in a case, you need to have very clear evidence of lying, cheating and stealing,”

To me that seems like an awfully low hurdle to clear.

Final Comment on Goldman

Bailing out the UK, Again

Ever since WWII the English have been heavily reliant upon the US, without whose support they would be speaking German right now. Since the new Administration has reordered all of our old relationships, the UK has been feeling a bit insecure and concerned about their status with us. Given their recent fiscal woes, and the high probability the US won’t bail them out, the English have figured out a new way to take money from us.

The UK created a “bonus” tax on banker bonuses above $40K, at the usurious rate of 50%. How did the big US banks respond? By zapping their employees globally, including those in the US, by a whopping 7% to offset the cost of the tax.

Talk about taxation without representation.

Earnings season continued this past week with close to 80% of the S&P 500 beating estimates. The chart below, courtesy of Jim Bianco, shows the historical percentage of companies in the S&P 500 beating estimates since 1992. One thing to note is that 50% of companies beating estimates appear to be the floor. The green, vertical line around the end of 2001 shows when Reg FD was enacted. Note the significant and sustained jump in the number of companies beating estimates from that point forward. This is probably due to the way companies began guiding the street more directly and consistently after Reg FD.

Jim Furey, the proprietor of small cap, independent research firm Furey Partners, just completed some interesting analysis on the most recent earnings season. Jim notes that the 20%+ median earnings increase from Consumer Discretionary stocks lead all major sectors by at least 8%, and the sector’s 1.6% median revenue surprise ranked third behind technology and industrials. He also noted the average consumer stock increased 4.2% in the two days after reporting. Additionally, he notes that Discretionary stocks’ median 35% year over year earnings growth primarily was derived from margin expansion as sales only grew 2%.

Thanks Jim.

According to Bloomberg, oil volatility has stabilized recently as global inventories continue to build. OPEC, which produces 40% of global oil, presently has 6 million barrels a day of excess capacity. Slack demand has resulted in record stockpiles, including US’s 356 million barrels. Additionally, inventories still being held on ships continue to rise. Oil has risen 3% this year in anticipation of increased demand from the global recovery.

Goldman analysts are looking for price spikes in the near future as demand accelerates without corresponding increases in production, wiping out the spare production. OPEC has announced plans to add 12 million barrels per day of capacity over the next five years.

Jeremy Grantham has long been one of my favorite investors and writers. In his most recent missive, he wrote the following regarding low rates:

“Collectively, we forego hundreds of billions of potential interest, but at least we can feel noble because we are helping to restore the financial health of the banks and bankers, who under these conditions could not fail to make a fortune even if brain dead. We are also lucky to have a tiny fraction of our foregone interest returned by the banks as loan repayments with “profit.” Some profit! Oh, for the good old days when we could just settle for a normal market-clearing rate of interest. But that, I suppose, would be wicked capitalism, and we had better get used to bank and speculator-benefiting socialism.”

People in Glass Houses Really Shouldn’t
Former Vice President Al Gore has made millions selling books, videos, and tearing up the speaking circuit on behalf of global warming. A recent article from the Heartland Institute (I’ll admit I don’t know them, but am guessing they’re a rather conservative lot), is taking a shot at Mr. Gore’s apparent hypocrisy.

It seems the former VP recently spent $8 million on an oceanfront property in Montecito, CA. Heartland queries that if he truly believes that global warming will cause ocean levels to rise, why would he park himself right in front of the action?

Additionally, in an apparent about face on his recommendation that “we all need to reduce our ecological footprint”, Mr. Gore’s property is a sprawling 1.5 acres, contains fountains, spas and a pool (BTW-Southern California is suffering from a major water shortage), and has six wood burning fireplaces, which Mr. Gore has previously gored as “carbon-intensive luxuries”.

If the former VP truly believes his own hubris, then this seems like a questionable move.

Status Check
Financial blogger Barry Ritholtz recently posted a 13 point status check on the economy and market. I have reprinted excerpts below:

1. The Economy is recovering; The recession is over: The free fall of 2008-09 is over, and a gradual improvement is seen across the board. Industrial manufacturing, exports, autos, retail sales, durable goods, travel all confirm the economy is “healing.”

2. But, the recovery is “Lumpy”: — Part of the reason some people doubt the recovery story is how unevenly distributed the improvements are. Geographically, much of the country is still soft. In retail, it is pent up demand plus luxury goods. In technology, its mobile devices and consumer products. Financial firms are taking advantage of the steep yield curve and ZIRP to arbitrage profits, as opposed to actually lending. Profits are not evenly distributed either.

3. Government spending is only part of the story: In the midst of the crisis credit froze, the consumer panicked, and business spending looked to be going extinct. Uncle Sam temporarily bridged the gap. But the argument that government spending is the only game in town is overstates the case. Private sector CapEx spending and hiring is improving (albeit slowly). Consumers have come out of their bunkers and are dining out, going to the movies, hitting the malls, traveling.

4. Weak Improvement in Employment: The massive labor under-utilization is one of the two biggest drags on the economy (Real Estate being the other). Near record low hours worked suggest that employers can simply increase hours rather than make new hires. Thus, I do not look for a V-shaped employment recovery — forget about 400-500k NFP data — anytime soon.
There are 15 million unemployed, and 8 million underemployed — it will take a long time for them to be re-absorbed into the economy. The 2001 recession took 47 months to return employment to pre-recession levels. This recession will likely take 65-75 months to achieve that goal — if not longer.

5. Real Estate (Commercial and Residential): We do not believe that residential real estate has found its natural price level yet. It remains over-valued. This is due to artificially low mortgage rates, foreclosure abatements and mortgage mod programs. We are probably 10-15% over valued, when measured by Median Sales price to median Income, Rent vs Ownership Costs, and Home Value as a Percentage of GDP.
Commercial real estate tends to lag residential by 18-24 months. It is still adapting to the downsizing of America, particularly retail. The over-investment in commercial real estate of the past decade will take at least another 5 years to resolve, if not longer.

6. Deflation? Inflation?: Well, as my pal Jeff Saut notes, we definitely have “flation.” Just not the type that everyone fears.
As of today, Deflation is a fact, inflation is an opinion. We are still living in a period of falling prices, heavy discounts, wage deflation, asset depreciation and lack of pricing power. The S&P500 is below levels seen in the 1990s; Wages are flat for a decade.
The risk going forward is that the Fed fails to remove the accommodations in time. But they have Japan as an example of Zirp with no inflation. So long as labor under-utilization is near record levels, they can take their time in tightening.

7. The rest of the world: Europe is a disaster, and is likely to remain that way for a while. Asian economies are doing very well, helping to pull the rest of the world along — but China’s market is at 6 months lows, something few people are discussing. The risk in China’s real estate and stock markets has been mostly ignored,. Commodity regions and emerging markets still have strength.

Market Overview:

1. Cyclical Bull, Secular Bear: The secular bear market collapse of 55% was right in line with other such debacles. The collapse was faster and more furious than typical, but the depth was normal. The snapback is also well within the range of bear market rallies — cyclical bull runs that last 6 to 24 months and range from 25% to 135%.
While it is possible that we are witnessing the start of a new 1982-like Secular bull market, the valuations argue against it. Stocks most likely simply did not get cheap enough — or despised enough — to initiate a multi-decade bull run. My best guess about that bottom is its likely 3-7 years away.

2. Snapback: The 75% bounce over a year seems like a lot — until you put it into the context of a six month 5,000 point collapse. We call that the Armageddon trade — Dow 5000! 3000! We’re going to zero! – was a spasm of panic. It has been mostly unwound the past year.

3. Correction coming (eventually): The cyclical bull tends to end with ~25% correction that lasts about a year. So we are always looking for signs that this run is over. Despite the recent turmoil, we have not found confirmation that the bull run is over — yet.

4. Liquidity: Institutional fund managers seem to be all in (only 3% cash), while Investors are at only median levels of equity exposure. Liquidity is still abundant, free money abides. Money flows for the past few months have gone into US equities — that is a new element — at about $2B per week.

5. Internals: The market technical/internals remain constructive: Breadth and momentum are positive. New 52 week highs are also strong. Earnings are supporting some of the move, as year over year compares are absurdly easy. The uptrend remains in place, and until it is broken we maintain an upside bias.

6. Sentiment: The biggest risk is the unusually high level of bulls. We are not at the sorts of extremes yet that make the contrarian in us scream SELL.

Thanks Barry

Taxing LPs
In case you missed it, the President’s new tax plan for 2010 calls for taxation of carried interest as ordinary income more than doubling what many will pay on taxes from such gains. Here is an excerpt from a related article:

“Executives at buyout, venture-capital and hedge-fund firms will pay an estimated $24 billion more in taxes over nine years if President Barack Obama gets his way. Obama‘s 2010 budget proposal, released today, proposes raising taxes on the managers by treating carried interest, the portion of profits they take from successful investments, as ordinary income instead of capital gains. That change would boost the tax rate, starting in 2011, to 39.6% for most executives from the 15% they now pay. The proposal applies to partnerships that receive a portion of the profits they make for their clients. It will likely reignite a debate begun in 2007 amid the biggest buyout boom in history, when firms including Blackstone Group LP and Och-Ziff Capital Management Group raised their profiles through public stock listings. While the House of Representatives approved the tax change that year, the measure wasn‘t taken up by the Senate.”

I have long joked that Twitter is useful if you want to let people know that you have broccoli stuck between your teeth. Well, I guess I have broccoli stuck between my teeth and want to let you know about it because I started using it this week. I have been a subscriber to a couple of friends’ workout Tweets, but decided to start doing it myself. I am sending out the morning economic data via Twitter. I’m not saying I won’t forget some mornings, but if you are interested in receiving them, just click on the “Follow Me on Twitter” button on the upper right of the website. It’s easy to join (just requires an email and password), and more importantly it’s easy to unsubscribe.

This week features the tail-end of earnings season. Additionally, there is key economic data, including the unemployment rate and non-farm payrolls on Friday. As I finish writing the Asian markets are weak.

I am not sure if I will be publishing next Sunday as its Mother’s Day, and I will be spending the day pampering my wife and mother.

Have a great week.