Friday, November 12, 2010

Economy & Market Week Ended 11/5/2010

Samuel Brittan had an excellent updated (original in May) article on "The futile attempt to save the eurozone" this week which I did not use in my post "On the Road out of Ireland" on the bubbling credit/liquidity crisis brewing in Ireland.  Using a private, subscriber available only paper published by Capital Economics and written by Christopher Smallwood, Brittan cites Germany's insistence on impossibly severe fiscal policies as reason to wonder if Germany wants the euro to continue and the fiscal tightening of Greece as an example of how to "... dampen the economy and risk creating a vicious cycle of debt and deflation."  Yet, Germany has been the prime beneficiary of the European Monetary Union's creation of exchange rate  and current account trade imbalances.

All of this has Brittan asking if the eurozone member nations might be better off with their own currencies.  While I do not believe it is necessary to abandon the euro, I find the refusal of eurozone member nations to recognize the need for monetary support of individual member nation's internal fiscal policy needs as essentially self-destructive and not salvageable by nominal adjustments alone.  Brittan is not anti-European but Ireland is on the brink of a credit/liquidity crisis.

This weekly report has become increasingly late to publication as I have been repeatedly diverted to the problem in Ireland and writing three posts this week on the subject. 


United States unemployment for October remained unchanged at 9.6% with employment up 151,000 job with a substantial decline in government layoffs/terminations.  This 151,000 job increase just barely keeps up with population growth and at this anemic rate of growth it would take until about 2030 or later to return to ful employment.  The labor participation rate was down to 64.5% from 64.7%.  The employment to population ratio was down to 58.3% from 58.5%.  Involuntary part-time workers were down 318,000 to 9.2 million.  Those unemployed more than 26 weeks  rose to 6,206,000 from 6,123,000 who "still want a job".  The U6 discouraged workers was down to 17.0% from 17.1%, but, if one used the 1994 calculation for discouraged workers, it would be closer to approximately 22%.

Retail sales were mixed, although the media emphasized growth, with soft weather related sales and significant discounting.  There is every appearance that the beginning of the Christmas shopping season is being pushed up from its traditional Friday after Thanksgiving and discounting will be a prime marketing approach.

The U.S. election brought to the forefront the failure of President Obama to clearly, consistently, and forcefully enunciate a domestic policy which focuses on reducing high unemployment.  His post election day news conference showed him at his worst as he rambled and prolonged his answers to questions, because he lacked a central focused message.  His attempts to achieve consensus at the expense of what needs to be done combined with his willingness to accept poor economic advice from discreditable economic advisers, such as Summers, who is leaving, and Geithner, has only sharpened the impression he cares more for the financial elite and little for the hardships and the imposed economic burdens of the financial bailout of the disappearing American middle class.  Austerity will not create jobs and it will dampen the economy even more with further concentration of wealth in the top 1%.  We need productive fiscal programs not pandering to delusional or self-serving politicians spewing misguided and destructive economic propaganda

The toll of unemployment continues with a job gap of 11.8 million jobs down just slightly from September at 11.9 million.  At the best average monthly rate (208,000) of job growth in the 2000's, it would take 12 years
to eliminate the job gap; at the average monthly rate (321,000) from the 1990's, it would take 5 years.  As wages decline, deflation is reinforced.  At the same time, the ratio of household debt to GDP has risen to 95% and the ratio of household liabilities to disposable personal income has risen to 135% which is creating a nation of zombie households.

Mark Thoma posted on a George Evans' paper on economic stagnation in a low interest rate environment in which the proper economic solutions are a sufficiently aggressive fiscal policy (targeted spending) of which fiscal aid to state and local governments has proven to provide quicker economic improvement and tax cuts have proven themselves ineffective unless targeted at liquidity constrained households.  Since these fiscal policies may be politically "undesirable", the Fed would maintain low interest rates in an attempt to increase consumption and start purchasing longer term government bonds, although such monetary policy may not work as it builds negative expectations.  Such approaches all have limitations in achieving timely economic impact.  While not discouraging states from balancing their budgets, the use of federal fiscal spending on productive infrastructure capital projects, which are not constrained by a balanced state budget, on the state and local level may provide a more robust approach to reviving aggregate demand future output growth.  As I have mentioned on several past occasions, China has implemented such a program in the last two years, although some of their projects, such as an empty mega mall and an entirely empty city, have been apparently wasteful.

Krugman demonstrated his position that a higher targeted inflation rate of 4% might possibly resolve unemployment and create an exit from a liquidity trap.  Since thresh holds exist in which too low or too high a rate would not be productive, the amount of inflation needs to be modeled with the level of unemployment to properly achieve full employment without credibility or inflationary problems.

The Fed announced a second quantitative easing (QE2) in which they will buy 600 billion dollars of longer tern U.S. Treasuries at a pace of $75 billion per month.  Some people saw this as slightly higher than expected although others had expected at least a trillion.  The purchases will be in the 2.5 to 10 year range.  This QE2 has already been priced into the market and now the market is speculating that a third will be needed.  This is a switch from the Fed's normal practice of buying short term bonds and reinforces its current inflation target.  There are those market analysts who believe QE2 will do nothing for the economy and, in more extreme views, may cause inflation and the destruction of the currency.  Confirming Krugman's view it reinforces the current inflation target, Bernanke asserted that QE2 will not spark unwanted inflation.  The St. Louis Fed, whose president, James Bullard, believes continued low interest rates are potentially deflationary, has published a small article on the benefits and costs of low interest rates. Yves Smith has characterized Bernanke as disengaged from reality and QE2 is nothing more than deceptive window dressing and goes on to cite El-Erian of Pimco, who says QE2 has risky adverse consequences and does nothing to resolve the need for meaningful structural reforms.  QE2 risks stoking inflation in emerging countries and putting pressure on their currencies and creating disruptive capital inflows.  In fact, emerging countries and countries preparing to attend the G20 meeting in South Korea have denounced the QE2 as a threat requiring protective responses.  On Friday, Hoenig, Kansas City Fed President, renewed his call for higher interest rates now to avoid higher future inflation from pumping liquidity into the market.

Meanwhile, the Fed continues to be viewed as raining money on financial corporations, doing nothing about unemployment, and continuing a policy which is promoting slow growth squeezing out savers and destroying retirees as middle America is left exposed and vulnerable to flap in the wind. Now, the banks have made it clear they intend to defeat the Volcker Rule inhibiting systemically risky and dangerous business activity by using the rule making process to blunt and neuter that portion of the Dodd-Frank Reform.  In the meantime, the mortgage foreclosure fraud participants continue to blow a smoke screen as they steam away from any factual discussions of the fraudulent documents, fraudulent submissions to the courts, and fraudulent process of the mortgage business and foreclosure process.  Flaws in some $50 billion of Citigroup moves of mortgages to mortgage-backed securities show it to be vulnerable to lawsuits and put-backs.  J. P. Morgan has received requests for files on $8.1 billion in mortgage loans which may be candidates for buybacks.  Six large U.S. banks are estimated to have additional exposure to $31 billion in buybacks over the already recognized $12.4 billion in losses.

Nobel Prize winning economist George Akerlof has argued that prosecution of criminal fraud is necessary for the economy to have a sustained recovery and Joseph Stiglitz agreed that a failure to enforce a equitable judicial code would result in indentured servitude.  Stiglitz is adamant in "Justice for Some" that the "rule of law" is under substantial attack in the mortgage mess with a denial of property rights, a bankruptcy process that takes rather than repairs, and a legal process that is turning justice for all into justice for those who can afford it.  As laws on campaign financing by corporations and non-profit lobbying groups, which do not have to disclose funding sources, we have seen the U. S. Chamber of Commerce become the lobbyist and conduit of campaign contributions from the international financial elite.  If you have money, you have power, while always true, is inconsistent with a free republican democracy.

The FDIC has sued executives of a failed Illinois bank to recover as much as $2 billion in losses, because they issued $11.8 million in dividends and incentive payments while masking problems in commercial real estate loans with new loans for $8.5 million of losses failing to preserve capital and provide sufficient reserves.

The attack on consumer friendly regulation in the securities and financial services business is hitting high gear with SIFMA arguing that commission based accounts are more cost effective and the "flawed" fiduciary standard would cost investors money.  These arguments all assume lumping financial salespeople with fiduciary advisers just as they are now and the objection is against disclosure and actual legal fiduciary responsibility.  Others are all upset that FINRA is contemplating an ADV like form requiring disclosure to clients from brokers of conflicts of interest and limitations of duty to the client; all of which is seen as overkill in providing information by the salespeople.  The ICI dislikes the SEC proposal to limit 12(b)1 fees, which requires a distinction between a continuing sales charge and a "marketing and service fee" and which the provider would have the choice of constructing within limits, as potentially increasing cost to the consumer.

John Hussman, in his weekly commentary on Monday the 1st, said "... greater risk does not imply greater reward if the risks investors take are overvalued and inefficient ones."  Using his forward operating earnings methodology, the ten projected return on the S&P 500 is 4.69% annually.  With the S&P 500 dividend yield at 1.96%, the ten year projection on a dividend based model would be only 2.30% annually.  On quantitative easing, Hussman believe the original QE had little effect on real GDP or inflation and what kicked the can down the road was not the QE but the guarantee of Fannie and Freddie debts and the suppression of fair and accurate financial disclosure via the FASB suspension of mark-to-market rules.  He still believes the market is overvalued, overbought, and over-bullish with a shift to neutral on not yet rising yield pressures.  He believes we have not yet cleared the recent months of economic concerns, but the economic data has been better than expected but still mixed enough to not be decisive.  The recent GDP report with 2% growth had 70% of that growth represented by inventory growth with final sales at only .6% annual gain.  The ECRI Weekly Leading Index improved to <6.5> from <11.0> in July but the same index improved from <10.8> in March 2008 to <5.9> in May 2008.  Short term activity has been reasonably quiet and modestly positive, but it is taking place over a more fragile economic structure than observers appreciate.

Market Report: 4 banks failed = 143; unofficial problem bank list = 894

                    DOW/Volume                                              NASDAQ/Volume
Mon           6.13/ down 7.3%                                            <2.57>/ down 9.9%
Tue           64.10/ down 4.8%                                           28.68/ down .1%
Wed         26.41/ up 20.6%                                                6.75/ up 4.0%
Thu          219.71/ up 23.3%                                             37.07/ up 25.5%
Fri               9.24/ down 8.6%                                            1.64/ down 15.5%

TOTAL    325.59                                                             71.57

Mon: Oil up $1.52 to $82.95; Dollar stronger but mixed against the pound; volatile price day ending flat; mixed economic reports.

Tue: Oil up 95 cents to 83.90; Dollar stronger but mixed against the euro; low volume on market hopes on election and Fed QE; Nasdaq flirted with April high again.

Wed: Oil up 79 cents to 84.69; Dollar weaker but mixed against the yen; new 2010 high for Nasdaq - best since June 2008; oil supplies were up 1.9 million barrels, gas was down 2.7 million barrels, and distillate was down 3.6 million barrels; oil was affected in part by French refinery strikes and Canadian Irving St. John  refinery maintenance.

Thu: Oil up 1.80 to 86.69; Dollar weaker; world wide stock rally on QE2 but gold and bond prices went up on inflation fears; weekly jobless claims were up 20,000 to 457,000, 4 week moving average was up 2000 to 456,000, and continuing claims were down 42,000 to 4.340,000.

Fri: Oil up 36 cents to 86.85; Dollar stronger; market turned positive at end and gold ended at $1397.40.

United States:

ECRI Weekly Leading Index was unchanged at <6.5>.

U.S. consumer spending was up .2% September (.5% in August); core PCE for 12 months was up 1.2% (lowest since September 2001); core inflation September was flat (.1 August); personal income was down .1% and disposable income was down .2%

ISM manufacturing activity was up to 56.9 October from 54.4; new orders were up to 58.9 from 51.1.

AMBAC indicated it will not pay interest on bonds as it was unable to raise capital as an alternative to Chapter 11 bankruptcy.


Pfizer Q3 missed revenue expectations by $500 million on weaker overseas sales and generic competition.

1.47 million Americans have been out of work 99 weeks or longer as of September.

Fannie Mae posted $4.1 billion Q3 loss and will be asking for $100 million more aid.

ADP private employer survey for October was up 43,000 jobs.

U.S. manufacturing new orders were up 2.1% September; ex-transportation they were up .4%; non-defense capital goods orders were down .2% (up 5.1% August).

ISM service sector was up to 54.3 from 53.2.

GM sales were up 3.5% October.

Fed plans to spend $600 billion in QE2 by the middle of next year at $75 billion per month on longer term U.S. Treasury purchases.

SEC banned brokers from allowing clients access to direct exchange trading with broker access codes without pre-trade risk controls.

In GM's IPO (seeking $13 billion), U.S. will reduce its 61% stake to 41-43% by selling at least $365 million in shares at $26-29.  Why not wait to sell?

Ford sales were up 19% October; GM sales were up 13%; Chrysler sales were up 37%; Toyota sales were down 4%.

U.S. productivity Q3 was up 1.9% (it was down 1.8% Q2); labor costs were down .1%.

Bernanke said QE low interest rates will not stoke inflation.

President Obama backtracked and indicated he may consider extension of Bush tax cuts for all income levels.

Fed may release guidelines allowing "well capitalized" banks to raise dividends.


AIG Q3 loss is $2.4 billion on asset sale losses and mixed insurance business results; operating income was up 47% to $1.07 billion.

Bank lobbyists hope to blunt the Volcker Rule during the implementation process; Representative Bacchus has warned Secretary Geithner to be careful and not be rigid.

In response to investor claims, including the New York Federal Reserve, that Bank of America should buy back mortgages improperly made, Bank of America said the lawsuit would speed up the foreclosure process and force it to evict homeowners and the losses on the mortgages sold were the result of the economic downturn and not from any underlying problem with how the mortgages were sold to investors.

Pending home sales index was down 1.8% September.

Sear will be open on Thanksgiving Day for the first time in 85 years.

Consumer credit was up $2.1 billion September in the first gain since January; August was revised down to <$4.9villion>; revolving credit (credit cards) was down $8.3 billion in the 25th straight month drop.

Berkshire Hathaway operating profit was up 28% to $1692 per share but net profit was down 8% to $2.99 billion with losses on derivatives (derivatives portfolio is about $60 billion).

REO (real estate owned) inventory for Fannie, Freddie, and FHA through Q3 is up 24% from Q2 and up 92% vs year ago.

International:

ECB has refused to release files on how the prior Greek government used derivatives to hide debt.

The Bank of Japan held interest rates at .1% and held off on further monetary policy easing, although it said it intended to buy index linked ETFs, AA or higher rated REITs, and government bonds.

The Reserve Bank of Australia raised its interest rate 25 bps to 4.75% in what some economists thought unnecessary. The Australian dollar shot up in response.  Controversy stormed up when the Commonwealth Bank of Australia, the country's largest home lender, raised its variable mortgage rate 45 bps to 7.81% in the face of profits indicating costs had risen 15%.  Analysts subsequently pointed out that nearly 50% of homeowners are suffering mortgage stress deep in the mortgage belt, but the act has cause a political firestorm

China PMI (Purchasing Managers Index) was up to 54.7 October from 53.8, which was more than expected, to a six month high; total new orders were up to 58.2 from 56.3; export new orders were down to 52.6 from 52.8.

China ordered banks to charge more interest to first time home buyers by halving the interest rate discount from 30% to 15%.

South Korea exports were up 29.9% October vs year ago; imports were up 22.4%; CPI was 4.1%, which is a 20 month high.


Distressed loans in Spanish banking system reached 102.5 billion euro in August at 5.6% of all loans, which is the highest proportion since 1996.  Some banks, including BBVA, are selling branches and then leasing them back in order to book short term gain and conceal mortgage losses.

Spanish unemployment statistics, in the complete survey, show unemployment did not drop to 19.79% by the end of September but rose to 20.8% from 20.5%.

India's Central Bank raised its interest rate for the 6th time --- repurchase rate to 6.25% and reverse repurchase rate to 5.25% --- in order to slow inflation and protect purchasing power of the poor.

BP profit was down 67% to $1.79 billion Q3 but Q2 had been <$17.2 billion>.

China's five year plan may create large changes, but a Central Bank governor said progress towards current account convertability and global yuan will be gradual.

French and Spanish car sales were down in October with the end of economic incentives.

Markit eurozone PMI was up to 54.6 October from 53.7 with Germany, France, and Italy up, Spain and Ireland struggling, and Greece declining.

German Economic Minister, Bruederle, expressed concern U.S. is trying to stimulate by injecting liquidity and using monetary policy to influence the dollar's exchange rate.

Asian and European markets liked the Fed QE move; both saw it as a willingness to support economic recovery.  How long will that view last?

China is considering setting up reserve of 10 metals, including rare earth; China has 95% of the global market in rare earths.

Canada block BHP's bid for Potash Corp as not in the national interest.

Portugal broke political gridlock and voted an austerity budget to reduce the deficit at 7.3% of GDP to 4.6% next year.

China auto sales were down in September to 1.27 million units but up 27% vs year ago.

Toyota Q2 profit more than quadrupled to $1.2 billion but missed views; sales were up 6%, but it revised down its annual forecast to $4.3 billion on lower U.S. sales.

CDS (credit default swaps) for Ireland, Greece, and Portugal were at their highest levels at the end of the week since September 2009; Spanish CDS were also up.



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