Short Term Update

ISM New Orders and Leverage Indicator

I also watch the new orders component of the ISM which leads the overall ISM. It has dropped to 53 falling from 58 recently. Below 50 may show up for the August report with the overall ISM falling below 50 for September.

"The equity market will though crumble like the house of cards it is, when the nationwide [US] manufacturing ISM slides below 50 into recession territory in coming months."

See this link: Albert Edwards SocGen 

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A good leverage indicator is the dispersion of stock performance or how many stocks rise and fall together. A stable market would be 50% say where half of the stocks are rising and half falling. From pragcap.com:

CBOE Implied Correlation Index Hits New Record

by Brett on August 25, 2010

The CBOE Implied Correlation index has hit a new record – and this is usually bearish. From ZeroHedge:

The CBOE Implied Correlation index has just hit another historic plateau, touching on 85 earlier in the day, which means that all those who believe relative value can still be found are about to be carted off. Aside from the fact that the current level of JCJ would be the highest closing level in history, the intraday high of 84.50 is a very troubling indicator, which once again confirms that stocks continue to trade not on fundamentals, and probably not on technicals, but on ever increasing amount of leverage applied to some indication of beta. Essentially, market participants are likely levered to the gills like never before and betting it all on another daily Hail Mary. Another way of looking at the reading, as we have pointed out previously, is that stock dispersion: the most critical indicator of a healthy market, is at 15%!

I’m with Tyler here – this is trouble. We’ve been repeating over and over that traditional diversification is unlikely to help out much when the markets roll over again. Why own a portfolio of stocks that drop 50%, when a single one would do the same trick?

For what it’s worth, this surpasses a 23-year record of 83% correlation that was set just before – wait for it – the 1987 crash.

Will the Stimulus 2011 Be Saved?

Investing is all about getting ahead of the curve. What will 2011 look like?

Before too long, calls for stimulus will be answered in early 2011. The only question for stimulus 2 is how much will be saved and how much will be spent. At this time, consumers are also paying down their mortgages with cash-in refinances and rebuilding equity. If most of stimulus 2 is saved, stimulus 3 will be put on the table. As mentioned before, make no mistake that there is plenty of capital at the government's disposal. Consequently, they will spend. Perhaps not more than a 3 $T deficit but certainly another 1-2 $T deficit is possible.

In the near term as far as long term bond yields, net QE was initiated in October 2008 while bonds peaked in December 2008. Hence, the earliest near term peak would be November 2010. Like 2008, a rebound may occur after the election in November. I will be watching for this. The watch for the economic upturn and spending to resume will continue in 2011.

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Small Investors Shift To Bonds 

At this time the only bond bubble is in junk bonds and emerging market bonds. Look for the bond spreads to widen. 'Flight to Quality' within bonds will commence when the stock market starts falling decisively.

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Housing Drives New Recession 

Of course housing is key. Contrary to what one hears about real estate it can be a long term trap. Because it is illiquid, people hold on and on...even banks. The price continues to drop year after year as with Japan dragging the economy down with it preventing a sustained recovery.

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From Rosenberg Aug 23, 2010:

NO BUBBLE IN BONDS

Not only did Paul Krugman really nail it on the head in his column in last Friday’s

NYT, but The Economist also weighed in — see A Bull Market in Pessimism on

page 59. The last paragraph just about said it all:

“None of this [note: apparent overvaluation], however, may be enough for investors to start bailing out of bonds. With economic growth painfully slow throughout the rich world it will be a long time before the threat of deflation can be written off. Central banks are not only likely to keep their policy rates on hold for the foreseeable future, they may, for good measure, buy more bonds themselves. Low yields could be here for a good while yet.”

Indeed, look at the long, long-term chart of the long bond and see what it did

after the last depression endured in the 1930s. Indeed, it touched the 2%

threshold, which is exactly where it should be on a ‘normal’ yield curve basis if

the Fed does in fact, as we expect, hold the funds rate near zero for the next

several years.

Americans and Foreigners Buy US Treasuries / GDP To Contract Q3

Americans number 1 buyers of US Treasuries as predicted...

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From Mauldin quoting Rosenberg...

And just to show that I am really the optimist in the room, let's turn to my good friend David Rosenberg, writing this morning under the following headline:

"U.S. RECESSION NEVER ENDED; GDP TO CONTRACT IN Q3

"Our suspicions have been confirmed - the recession never ended. Macroeconomic Advisers produces a monthly U.S. real GDP series and it shows that the peak was in April, as we expected, with both May and June down 0.4% in the worst back-to-back performance since the economy was crying Uncle! back in the depths of despair in September-October 2008. The quarterly data show that Q2 stands at a +1.1% annual rate (so look for a steep downward revision for last quarter) and the 'build in' for Q3 is -1.5% at an annual rate. Depending on the data flow through the July-September period, it looks like we could see a -0.5% to -1% annualized pace for the current quarter. Most economists have cut their forecasts but are still in a +2.5% to +3.5% range. What is truly amazing is that despite all the fiscal, monetary, and bailout stimulus, the level of real economy activity, as per the M.A. monthly data, is still 2.5% below the prior peak. To put this fact into context, the entire peak-to-trough contraction in the 2001 recession was 1.3%! That is incredible.

"Interestingly, and dovetailing nicely with our deflation theme, nominal GDP fell 0.3% in May and by 0.4% in June. This is a key reason why Treasury yields are melting."

Politicians are going to be greeted with a GDP number for the third quarter, right before the elections. Will it be negative like Rosie thinks? I am not sure, but in any event it will not be good. Structural unemployment will still be over 10% and deficits will be high.

Look at the following graph from my friends at The Liscio Report. Unemployment and continuing claims have started to rise again. This is not what happens in V-shaped recoveries, gentle reader. The ONLY reason the headline unemployment number has dropped a little is that the Labor Department has dropped so many people from the labor force. Again, if you have not looked for a job for four weeks, they do not count you as unemployed. If you use the labor-force number from just last April, unemployment is 10.5%. Brutal. Who doesn't know too many people without jobs?

But it is not just rising unemployment claims. Yesterday's Phillie Fed report was just awful. Buried in the details was the fact that the hours-worked index is collapsing, consistent with previews to past recessions. Very worrisome. (From my favorite slicer and dicer of data, Greg Weldon: www.weldononline.com)

Bottom line? It is going to be a tough environment for the next 6-8 years. That is just what happens when you have a deleveraging / balance sheet / deflationary / end of the Debt Supercycle recession. It is what it is, and no amount of wishing or finger pointing can change the facts.

Let me take a moment and offer some sympathy to President Obama. This recession/slow period is not his fault. Obamacare? A now-trillion-dollar stimulus? Those he owns. But the recession/credit crisis would have happened if McCain had been elected.

Deleveraging will continue

In response to article Austerity vs Deficit Spending in pragcap.com, Austerity vs Deficit  I argue that deleveraging will continue. Consumers are now cash-in refinancing their homes to pay down debt. This situation ultimately will not be good for Wall Street.

The Fed will do some QE (of course not effective) in order to appear to do something. Some QE will not lead to inflation. Markets rebounded after 2008 due to consumer spending not QE. QE merely contained mortgage rates from going higher. Now all rates are falling rendering QE ineffective.

Congress will continue to spend with new stimulus which over time will become more effective for employment. This will cause CPI to rise from time to time but not to any significant level above 3% for example. Mostly the slow economy will bias it towards deflation. Over the coming years inflation will vary between -3% and +2% until deleveraging runs its course. As the markets oscillate, capital will be ground down and reduced. Each rebound will be smaller than the last.

When CPI shows an uptrend in this period, the gold market will respond but it is simply a story hedge funds do to sell their product. As deflationary pressures resume, signs of deflation will cause hedge funds to dump their gold funds.

Eventually, deleveraging will unburden households enough to start spending. Government will be able to increase taxes or reduce spending and the government debt will be paid down over time.

Economic Upturn and Downturn

I have plotted the consumer metrics institute daily growth index using a 31 day and 183 day moving average updated to Aug 13, 2010.

When the 183 dma crosses 100 to the downside, the stock market falls shortly thereafter, and crossing above 100 in early March 2009 meant growth and rising stock market. The recent crossover in late March also corresponded to a recent high in stocks. Note also an early indicator in Dec 2008 when the 31 dma crossed 100 to the upside and the 183 dma showed an uptrend. Similarly, April 2008 showed a crossing of the 31 dma to the downside coupled with a downtrend in the 183 dma.

The 31 dma shows a record low at this time..

 

Hoenig Comments and Stimulus 2011

Quote from Hoenig:

that policy makers shouldn't be beholden to "volatile monthly data" nor should "market participants... direct policy."

"Of course the market wants zero rates to continue indefinitely," Hoenig said in prepared remarks during a speech in Lincoln, Neb. "They are earning a guaranteed return on free money from the Fed by lending it back to the government through securities purchases."

Meanwhile, the Fed's zero interest-rate policy "is as likely to be a negative as a positive in that it brings its own unintended consequences and uncertainty." Getting rid of Wall Street's guaranteed source of profit -- borrowing from the central bank and investing that in treasuries -- "tells the market that it must again accept risks and lend if it wishes to earn a return," Hoenig said.

Hoenig said megabanks, "even after their poor performance during this last crisis, remain financially and politically powerful institutions."

"It gives me pause, for example, that after the recent devastating experience of the global banking crisis, regulatory authorities are already backing off initial attempts to strengthen international capital requirements for these largest banks and financial firms," Hoenig said. Capital is the money banks keep to guard against losses.

While Hoenig's policies won't be adopted, he does influence policy through the board's compromise positions. For example, his pressure was instrumental in stopping QE in March and currently in rolling MBS into treasuries. While Hoenig would want a reduction in the Fed balance sheet they compromised by maintaining the balance sheet and rolling out of mortgage bonds into treasuries. So no new net QE. QE is a mirage anyway because consumers were already spending in October 2008 before QE even started or the stimulus in March 2009. The stimulus maintained that spending however until May 2010. This time the social mood of the consumer is worse and unlikely to respond without significant stimulus. The response may be delayed until middle 2011.

Nevertheless, the Congress does appear more stingy when GDP is positive. By Q3 or Q4 of 2010 GDP will turn negative and the Congress will lose its nerve. I can even for see 15% to 18% deficits next year and another false recovery lasting 1-1.5y. The issue with deficits is not inflation but rather available capital.

With a mere fraction of world capital (25T in Equity and 80T in Bonds), the Congress could spend another 10T over the next 5-10 years. Bid/cover ratios on treasury auctions confirm this as well.

Three Stimulus / BullandBearWise / BE yield

Monetary Trends 

See adjusted monetary base, domestic nonfinancial debt, and money market mutual fund shares. You can see in these charts QE (monetary base), Fiscal Stimulus (federal dom nonfinan debt), and money markets to drive the equity market. All 3 stimuli are 'off' and have turned to lower growth or contraction. Savings are also growing at a good clip.

Fiscal stimulus growth is declining...

Savings are up and money market contraction is starting to turn which is bad for equities.

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Bull and Bear Wise chart has turned (the 200 day moving average points down) as well as the index breaking the moving average decisively...

Bull and Bear Wise 

Chart as of August 11...

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Break even yield is opposite to TLT. BE yield predicts future inflation.

BE yield 

Helicopters Can Only Come from Congress

From Mish about inflation...

QE not inflationary 

QE can lower interest rates inducing consumers to spend because of lower rates and perhaps borrow. These behaviors are dependent on their social mood which - unfortunately for Bernanke- is to save more and consume less.

I do believe that even a Republican Congress and Democratic President can compromise on new tax cuts and infrastructure spending next year in March. The question is how big and how effective it will be at stimulating the economy.

The stimulus will not necessarily be inflationary as the momentum in the economy is to conserve. The stimulus can cushion and prevent a bigger negative however.

Mish:

Inflation Threat is Congress Not the Fed

The real inflation threat in the US is not the Fed. I think the Fed is pretty much powerless here. If quantitative easing seems to work, it will be temporary, just as happened in Japan.

Many people have emailed me stating that the Fed will give away money. No the Fed won't.

The Fed cannot throw money out of helicopters or give money away. Such talk is nonsense. However, Congress can give money away.

Here are the pertinent questions:

1. How likely is that?

2. Enough to cause a serious bout of inflation?

The answer to #1 is straightforward enough: It is certain. Indeed, Congress has reluctantly agreed to toss another $26 billion at states to "save jobs". The idea is foolhardy of course. One of the big problems cities and states face is public unions and public union salaries.

Those problems wrecked Greece and in my opinion have virtually bankrupted many major cities and states. Yet, here we are making another policy error, attempting to keep union wages intact and a defined benefit pension scheme alive, both of which desperately needs to be tossed in the gutter permanently.

The more important question is #2. Most think yes. I think no.

For starters the next Congress is going to be a lot more conservative than this one. Already we have seen unemployment benefits delayed for week. Money for the states came out of another pocket so the deficit did not go up.

However, a major reason a massive helicopter drop is not coming in spite of what everyone seems to think, is neither the Fed nor banks wants one! The Fed does not want hyperinflation as it will end the game. Banks do not want hyperinflation for the same reason.

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See article from pragmatic capitalism on QE explaining that it's simply an asset swap...

Some investors prefer to call it “money printing” or “stimulative monetary policy”. Both are misleading and the latter is particularly misleading in the current market environment. First of all, the Fed doesn’t actually “print” anything when it initiates its QE policy. The Fed simply electronically swaps an asset with the private sector. In most cases it swaps deposits with an interest bearing asset. They’re not “printing money” or dropping money from helicopters as many economists and pundits would have you believe. It is merely an asset swap.

QE non-event

OECD monthly indicators turn negative in June...

OECD June Indicators Turn Negative 

Deflation Searches

Deflation searches at google are increasing...

 

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I took the prices paid index on the ISM and calculated the quarterly change in prices. Manufacturing ISM prices paid shows a continued quarterly decrease...

In addition, I calculated ISM new orders rate of change year over year...

 

ECRI 13 week on track for recession

The ECRI change on a 13 week basis still in record territory...

 

This is also echoed by the consumer metrics institute bad July numbers...