Wednesday, November 3, 2010

Economy & Market Week Ended 10/29/2010

The Q3 United States GDP was estimated this week at 2.0% of which inventory added 1.44% compared to .82% in Q2.  Without the inventory build up, Q3 would have been barely positive.  Personal consumption was 2.6% (2.2% in Q2).  This shows a slower trend growth and a generally weak (Consumer Metrics Institute October 29 commentary) and long recovery.

The unemployment rate for everyone 55-64 has more than doubled.  I have been maintaining for some time that unemployment for this age group could be a permanent condition.  At the very least it means not working at the same pay at one's full ability level.  This is a huge loss of productive talent which has nothing to do with appropriate skills for the marketplace.  It has to do with age discrimination and filling the positions with younger workers who will cost less and theoretically stay with the job longer.  At the same time the highest unemployment is among the 20-24 year old college educated who will, as a consequence of unemployment at this early stage of their careers, suffer a life long possibility of lower earnings.  This recession has the distinct possibility of creating a very negative social divide magnifying the wage inequality and wealth inequality problems which directly threaten our republican democracy and the sustainability of a market economy as opposed to a feudal corporate economy.  Every 34th wage earner in 2008 went through 2009 not earning a single dollar.   In 2009 dollars total wages have fallen $5.9 trillion.  Average wages and median wages are down and the number of idle workers grew by 6 million in 2009 with real unemployment, including discouraged workers, at 22%.  At the same time, while the number of Americans making $50 million or more fell from 131 in 2008 to 74, the average wage increased from $91.2 million in 2008 to $518.8 million in 2009 or almost $10 million per week.  Those 74 people made as much as the lowest paid 19 million workers who comprise one in every eight workers.

Econbrowser had an interesting piece on demand shocks in trade and how they manifested themselves in different countries with Japan and China showing distinct deviations from the mean, which would indicate there were alternative reasons which were not consistent with Germany and the Untied States.  It makes you wonder where all the increasing exports in the world are expected to go. The line that caught my attention was "The finding that demand shocks working through the composition of trade ... explained the bulk of the drop and recovery in trade suggests the stronger the rebound in GDP, the faster the recovery in trade in proportionate terms."  This is exactly what we are not seeing in the present recession/recovery.  The GDP is not growing fast enough to reduce unemployment and the government is not exercising fiscal policy to reduce unemployment and everyone is surprised that consumers are not spending.  Consumer spending is not going to bring recovery if unemployment remains high.  A weak dollar is not going to sufficiently drive exports when it also appreciates foreign currencies and inflation in other countries.  To lay this problem on the door step of China is disingenuous.  China has internal problems, and perhaps more complicated problems, just as the Untied State, the eurozone, Japan, and Germany have internal economic problems which must be addressed internally.  The failure of these countries and others to not address their economic problems which have a global economic impact only aggravates the tension among those who would rather blame than act.  The G20 and the PR show on currency accords and trade collapsed before the delegate departed the airport.  The failure of the G20 to address and resolve the different trade and capital needs of emerging and developed countries, foreign currency reserves, current trade imbalances, and the vastly different saving and borrowing needs of emerging and developed countries is a failure to acknowledge the differences and the necessity of each country to implement different internal fiscal policies.  It is not a global chess board which can be mended by duck tape.  It is also not resolvable by including emerging nations currencies in a new reserve currency basket.  Emerging nations do not want their currencies to be a reserve currency.  For instance, there is presently no way the Chinese renminbi can be accumulated by foreigners who are not allowed to have renminbi accounts.  It will take China a very long time to reduce its current accounts surplus and develop a deficit.  Given its internal problem of cheap capital which transfers income from households and reduces household consumption, it would be very politically and economically difficult for China to rebalance internally in the short time that a fast appreciating renminbi would demand.  It is more likely that China's capital outflows could be matched by foreign capital inflows in the form of investments, which would require a gross change in the form of ownership and governance in China.  That is an unrealistic expectation, particularly, when the Untied States refuses to deploy the fiscal policy necessary to reduce high unemployment and kick start GDP growth.

Quantitative easing (QE) is designed to lower long term interest rates, but The Pragmatic Capitalist argues that it fails historically to do so and the attempt actually increases asset prices without any underlying change in fundamental value.  QE is merely an asset swap with little real impact on the economy.  In fact, historically the market has collapsed following the end of each of the last three major QE programs.  Models and Agents cites a 2003 Eggertsson and Woodford paper and argues that its conclusion that QE is redundant and the optimal policy should be price level targeting historically based rule will not work, because the rule lacks credibility since its implementation is only a verbal intention and, consequently, only a bluff.  She wants to call a spade a spade and call the purchases "debt monetization", because the only true way, in her opinion, to boost aggregate demand at this stage is to implement a fiscal operation whose goal is to protect productive capacity and assist companies and households in their deleveraging efforts.  In such an operation, the role of the Fed would be to provide the financing.  Econbrowser believes the market has already priced in a trillion dollar QE and that the QE is being justified by the Fed as a means of combating negative real interest rates, which mean people can get a positive real return by stuffing money under a mattress, in disinflationary, deflationary times.  The Fed can help but it cannot solve the zero lower bound problem with QE and one should keep an eye on commodity prices and real rates.  A fiscal stimulus would not only target the creation of jobs now but also assisting the states and local governments who are under revenue pressures and have been reducing employees to the extent that government layoffs and terminations exceed growth in private hiring.  This could be partially accomplished by the Fed and Treasury buying state and local municipal bonds.

In a recent paper on the correlation of bonds and stocks, it found "...the changing risks of nominal bonds are related to the changing relationship between inflation and economic growth."  If the stock-bond correlation implies investors believe government bonds are a hedge against the possibility of deflation and low growth, while at the same time, despite being uncertain about the direction of inflation over the next five years, believing any increase in inflation will likely be accompanied by growth, making it less painful for their portfolios,  then bonds should carry a negative inflation risk premium and higher prices.  The question becomes whether investors are correct.  Another question is the study assumed the CAPM (Capital Asset Pricing Model) use of the stock market as a proxy for the economy, but CAPM also assumes an efficient market which is not substantiated by modern experience and more modern economic/finance models.  Consequently, in my opinion, the determination of a bond bubble could be lagging information and/or a divergence from the mean.  The use of a negative or positive trend based on the assumption of an efficient market is not enough information to make an investor decision.

When talking about the current high unemployment, low interest rate, slow growth economy and the use of quantitative easing and fiscal stimulus, political gridlock and austerity policies become all the more destructive.

In John Hussman's weekly commentary from Monday the 25th, he provides a different analysis of a liquidity trap and the inevitable failure of QE through his dislike of "unproductive" fiscal spending and the invocation of the velocity of money.  Yet, he manages to end up with the proper conclusions that QE will not induce businesses and households to spend when their gut tells them to save save save and that fiscal spending targeted at economically productive targets is useful.  Of more interest is his references to the work of Nathaniel Mass whose work involved the application of microeconomic methods to macroeconomics.  Hussman still finds the market overvalued, overbought, and overbullish with a negative trend and high risk profile which could result in a sharp downturn after a string of new highs, 2-3 day pullbacks followed by sharp recoveries.

Consumer Metrics Institute, in their October 25 commentary, shows that the current contraction has surpassed the recent "Great Recession" in length and there is no end in sight.

Wells Fargo is refiling 55.000 foreclosures, because they have found no faults with them.  This drew the immediate objection of the Ohio Attorney General, who said the quick turnaround of Wells Fargo does not speak well of the review process.  Attorney General Cordray followed with letter to several banks indicating it was not proper or sufficient to just replace false court document with new, "fixed" documents.  Of additional concern in the mortgage mess is the exposure of home builders who originated $205 billion in loans and may now face $1 billion or more in put backs.  Pulte, Hovnanian, DR Horton, and Lennar may have the most risk.

Treasury concealed $40 billion in tax payer losses on the AIG bailout, according to the Inspector General of TARP.  Treasury refused to correct the report after information was sent by the Inspector General to Treasury.  Representative Issa indicated he thought the report was misleading and, if it had been issued by a private company, it would have been subject to a SEC investigation.  At the same time Treasury has thumbed its nose at the Bloomberg FOIA request for information on Citi guarantees, which is information at least two years old.  Bloomberg has won in court, but Treasury has a history of stringing these FOIA TARP related requests out.  In this vein, it is relevant that Washington's Blog had a post on how fraud contributed to the Great Depression.

The CFTC has found repeated attempts to influence and control the price of silver in the markets.  This is a subject we have commented on in the past.  It remains to be seen if the CFTC will do anything about their findings.  Here is the complete CFTC statement.

Protests in France against an increase of the retirement age to 62 failed as the measure became law.  The retirement age is a big issue in many countries, particularly those in which have an aging population with a low birth rate.  Retirement ages are all over the map from as low as 45.  Most discussion of increasing retirement ages never touches on age discrimination in job seeking and the work place or the productive value of experience and knowledgeable workers; it is all about the cost of retirement.

Market Report  No banks failed this week == 139 (140 last year); Unofficial Problem bank list = 894

                               DOW/Volume                                           NASDAQ/Volume
                       31.49/ up 30.7%                                           11.46/ up 7.4%
                          5.41/ down 4.1%                                          6.44/ up 9.3%
                      <43.18>/ up 5.9% distribution day                     5.97/ up 7.0%

                      <12.33>/ down 1.4%                                        4.11/ sown .2%
                           4.54/ up 2.7%                                                .04/ up 2.7%

Total               <14.07>                                                        28.02

Mon: Oil up 87 cents to $82.52; Dollar weaker; chemicals offset financials; highest close since April 29th but still closed near session lows.

Tue: Oil up 3 cents to 82.55; Dollar stronger but mixed against the pound; highest close since April 26 on low volume and struggle during day.

Wed: Oil down 61 cents to 81.94; Dollar stronger; markets pummeled by worries over Fed easing but pared losses at end; oil supplies were up 5 million barrels; gas supplies were down 4.4 million barrels; distillate supplies were down 1.6 million barrels.

Thu: Oil up 24 cents to 82.18; Dollar weaker; market could not make up its mind with several economic reports due Friday; weekly jobless claims were down 21,000 to 434,000 (lowest since July); 4 week moving average was down 5500 to 453,250, and continuing claims were down 122,000 to 4,356,000 (but number of workers with exhausted benefits is increasing).

Fri: Oil down 75 cents to 81.45; Dollar weaker; market ended flat at end of higher volume day despite mediocre GDP report; trade below average for 6th day i row on NYSE -- what will happen after next week's election and Fed meeting?

United States:

Bernanke (Fed) said regulators are reviewing foreclosure practices of large financial institutions and will publish a report next month.

Freddie Mac says foreclosure pipeline is slowing down (8 months --- 2 months longer than normal).

In the last two months, the U.S. dollar was effectively devalued 14% by the market.

Chicago Fed economic activity index was down to <.33> September from <.32> ; national activity was down to <.58> from <.49>.

Core Logic August housing prices were down in 78 of 100 metro areas.

NAR existing home sales were up 10% September to 4.53 million (19.1% vs year ago) but inventory is 10.7 months, which is down 1.9% September but up 8.9% vs year ago.

Case-Schiller 20 City house prices index (3 month average) was up 1.7 vs August 2009 (slower) with 15 reporting lower prices.

Dallas Fed manufacturing activity showed production up to 6.9 from 4.0 (2nd month up); new orders were down to <4.3> from <3.0> (5th month); finished inventory was down to <12.5> from 1.0; prices paid for raw materials was up to 29.9 from 24.4 (15th month); prices received for finished goods was down to <3.5> from .5.

Volcker said inflation is not the problem and will not be the problem for several years; no possibility of deflation.

Berkshire Hathway is disputing SEC claims that their Q2 should have written down $1.9 billion in losses from Kraft, US Bancorp, and other firms; contends the losses are temporary and expected to rebound.

Bank write-offs of credit card uncollectibles were up to 10.03% August from 9.45%; 30 day past due was down to 4.7% n a small decline.

Ford Q3 EPS were up 48 cents per share ex items (expected 38 cents); sales were up 6% ex Volvo which was sold; paid $2 billion in debt and $3.6 billion to retirees health trust.

September new home sales were up to an annual rate of 307,000 from 288,000 with months of supply down to 8.0 from 8.6; still weakest September on record.

Mortgage defaults Q3 were up 18.9% from prior quarter but down 25.5% vs Q3 2009.

Philadelphia Fed State Coincident Index for September increased in 24 states, down in 14 states, and unchanged in 12 states; this shows sluggish recovery.

U.S. durable goods orders in September were up 3.3%; exclude transportation and orders were down .8%; exclude defense orders were up 2.9%; shipment were down .4% for 2nd month; inventory was up .5% for 9th month.  Capital goods new orders, non-defense, were up 8.6%; inventory was up 1.3%.

On Wednesday cotton prices were the highest since the U. S. Civil War.

Hedge funds have been advised by law firms specialists and MBS traders at a conference that the coming wave of MBS put backs will cost banks at least %97 billion.

Freddie Mac 90 day delinquencies were down to 3.89% from 3.83%.

P&G Q1 EPS were down 4% to $1.02 per share (expected $1); sales were up 2% but below views; expects Q2 to suffer from higher commodities prices and marketing costs.

Kansas City Fed manufacturing survey showed continued moderate expansion.  Increased activity was reports by 10 down from 14; new orders were up to 16 from 9 firms.

GM is preparing for an IPO; it will repay $2.1 billion to Treasury and make payments to pension and retiree health plan ($2.8 billion); after IPO it will pay $4 billion cash and $2 billion common stock to treasury and buy back preferred at a 2% premium.  It has an agreement with ten large banks for a five year, $5 billion credit facility for backup liquidity.

Institute of Supply management (ISM) Chicago PMI (Purchasing Manager's Index) was up to 60.6 from 60.4; new orders were up to 65.0 from 61.4.

Reuters survey of 80 economists project GDP in 2011 will only be 2.4%.

ECRI Weekly Leading Index was up to <6.5> from <6.9> the prior week.

Hoenig (Kansas City Fed) said there are real risks to QE; it is "very dangerous", hazardous bet which could set in motion a boom-bust cycle.

Dudley (New York Fed) said the Fed cannot wave a magic wand but can provide essential support for the long bumpy road.

U. S.Treasury Auctions:

2 yr Treasury, $35 billion, yield .40%, bid to cover 3.46, foreign 39.98%, direct 15.9%.

5 yr treasury, $35 billion, yield 1.33% (1.26% last month), bid to cover 2.82, foreign 39.5%, direct 11.7% (highest since May).


UBS Q3 was a massive miss 50% below consensus due to investment bank and wealth management results; fixed income plunged due to "negative debt valuation adjustment".

Japanese exports were up 14.4% September (slowest gain this year).

Ireland will attempt to cut $21 billion form their annual budget in 4 years; deficit set to hit 32% of GDP on the bank bailouts which favored management and bond holders at the expense of the public.

Portugal budget talks have collapsed Wednesday on political gridlock.

The French lower house voted for the Senate bill on pension reform and the bill goes to President Sarkozy.

Greece is experiencing lower than expected tax revenue growth after austerity tax hikes.

Japan cut its GDP estimate to 2.1% from 2.6% and sees 1.8% for next year down from 1.9%.

China says it will cut its trade surplus by encouraging consumer spending.

Eurzone October inflation was up 1.9% (1.8% September).

French refinery workers returned to their jobs on Friday ending the strike.

Japanese factory output was down 1.9% in the 4th straight monthly decline; consumer prices fell for the 19th month vs year ago.

A weak U. S. dollar, which will result from any new Fed QE, will hurt Europe more than it will help the U.S.

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