Did the Fed Flinch?

September 26, 2009

The S&P500 slid 2.2% last week on not so heavy volume.  The VIX (or fear index) jumped 7% extending its slow motion move upward over the last six weeks.

What made the slide more puzzling was the lack of any awfully bad data.  It was weak, as usual, but weak data over the past several months had not prevented equities from rising.  The leading indicators index was slightly weaker than expected, but it did move up nevertheless.  Initial jobless claims, at 530,000, were slightly lower than predicted.  Existing and new home sales were both lower than expected and slightly lower than in the prior month.  Durable goods orders fell; they were expected to rise.  Consumer sentiment was stronger than consensus estimates.

Technically, the S&P500 weakened on a daily chart, but it still maintained its uptrend on a weekly basis.  On the monthly long-term charts, the downtrend is still in tact, although price levels are now just about to bump into this down trend line.

So if the economic data wasn’t the core reason for the drop in the S&P, then what was?

Apparently, the Fed’s comments–not the official committee statement, but an Op-Ed piece by Fed Governor Kevin Warsh–gave the markets something to worry about.

If the Fed’s $1.5 trillion quantitative easing program has helped fuel the rise in the capital markets, then any signs that the Fed might withdraw this program, faster and more forcefully than expected, could bring the party to an abrupt end.

And it seems like Mr. Warsh hinted that the Fed might pull the punchbowl faster and more violently than the markets had anticipated.   In his words, “policy likely will need to begin normalization before it is obvious that it is necessary, possibly with greater force than is customary”. 

Ouch–for the capital markets!

But this could be a sign that the Fed is starting to worry that the world’s holders of dollar securities might reject the Fed’s massive dollar printing program, a program that monetizes debt issued by the Treasury and housing agencies.

As discussed in prior posts, such a rejection could lead to a dollar and funding crisis, which in turn could lead to total systemic collapse of the U.S. financial-economic-political complex. 

Barron’s this week featured a piece on the growing likelihood of a Japanese debt default.  What was once unthinkable is now being presented as uncomfortably probable.  And this in a nation 1) whose huge sovereign debt borrowing is almost exclusively financed by its own citizens, and 2) that exports more than it imports, thereby extracting wealth from the international economy.

The U.S. on the other hand, borrows about half its debt from foreign nations, on a short term basis.  And the U.S. consistently imports more than it exports, thereby taking on even more debt from the international economy to finance this balance of trade deficit.

If the sun is setting on Japan, is America approaching the edge of another cliff without even realizing it? 

Let’s hope the Fed continues to flinch.

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Who’s Buying Equities?

September 19, 2009

The S&P500 continued to march upward, posting an increase of 2.5% for the week.  The VIX, or fear, index failed to confirm the rise in prices; instead it is continuing its gradual turn up suggesting that traders are still nervous.

The economic data for the week were mixed, with most of the improvements easily explained by government support programs.  Retail sales jumped up 2.7%, but most of the increase was due to the government cash for clunkers program, which has ended.  Core producer prices and consumer prices were up modestly higher month-over-month, as expected.  Industrial production and capacity utilization–both still dismally low on a year-over-year basis–came in slightly stronger from the prior month.  Again, these were pushed up by the government auto credit.  Housing starts were slightly below expectations, but improving over the last few months because of the government’s $8,000 home purchase credit.  This is set to expire at the end of November.  Initial claims came in at 545,000 still stuck at a disturbingly high level.

Technically, the equity market is extremely overbought–and overbought at levels not seen very frequently. 

So what’s driving the stocks higher? 

David Rosenberg, of Gluskin Sheff and formerly with Merrill Lynch, recently asked the same questions, and this is what he had to say.

Is it the private client?  Nope.  Stock funds are losing funds while bond funds are enjoying inflows.

Is it the corporate insider?  Nope.  Insiders have been dumping shares at ratios last seen in October 2007.  In fact, last week the ratio of sellers to buyers approached 80 to 1.

Is it corporate buybacks?  Nope.  Per Standard & Poor’s, stock repurchases were down 72% from a year ago.  At $24 billion in Q2, this is the lowest level in recorded history.

David did suggest who might be buying:  computers trading with each other, short sellers closing out their losing positions, and some portfolio managers desperately trying to make up for last year’s disastrous losses.

The other possibility?  Our government, of course.  Paling in comparison to the few $ billion spent on clunkers and first time home buyers is the Fed’s quantitative easing program.

How large is it?  Between straight treasuries, agency debt and agency mortgage backed securities, the Fed has committed to printing and spending over $1.5 trillion. 

Given that consumers are losing income and credit to spend on buying goods and services, and given that corporations are still cutting capital expenditures, corporate buybacks and dividends, much of these Fed purchases are spilling into the markets–into stocks and bonds and commodities.

And when did quantitative easing begin?  Mid March, almost exactly when stocks began their meteoric rise.

In the 1990’s, the Fed’s easy money policy helped fuel the tech bubble.  In the early 2000’s, the Fed’s easy money blew the housing bubble to enormous proportions.  Today, the Fed is busy blowing another bubble, the last bubble–if this one ends badly, the U.S. dollar and the U.S. government debt market could implode.

Charles Ponzi would be proud.


Honey, I Shrunk the Credit Cards

September 12, 2009

The S&P500 pushed higher 2.6% last week, on light volume, partly due to the holiday shortened week.  Volatility eased, but also in part because many traders were on vacation. 

The economic reports were light.  The Treasury sold another chunk of debt, but we’ll need to wait a few weeks to learn how much of it (and other older Treasury debt) the Fed purchased.  Initial claims came in at 550,000.  Continuing claims remained above 6 million.  The U.S. trade deficit widened slightly, primarily due to the increased cost of importing oil.  Consumer sentiment rose, but consumer credit shrank.

Technically the S&P500 remains heavily overbought on the daily charts.  It’s also toppy on the weekly charts.  But it remains in a mildly sloping downtrend that began in December 2007.

Consumer credit fell off a cliff in July–down $21.6 billion from the prior month.  To put this in perspective, the consensus estimate for this change was only $4 billion.  And it was more than double the prior month’s drop of $10 billion.  Worst of all, July’s drop was the largest monthly contraction in consumer credit since 1943, when naturally consumer credit (and spending) fell as the economy shifted resources to fight World War II.

And credit is contracting because of two reasons that will not go away anytime soon: 1) Banks are cutting down credit limits, hiking interest rates and fees, and even shutting down customer accounts entirely. 2) Consumers are themselves refusing to take on more debt; instead, they’re paying it down.

Why does all this matter?

Since the U.S. economy depends on consumers for 70% of its total activity, the implosion in consumer credit points to a large reduction in consumer spending, a reduction that is gaining momentum.  

And this is a reduction that appears to be both large in magnitude and long-lasting in duration.  In other words, America’s consumer is changing.  This data suggests that our love affair with consumption may finally be over.  Frugality is making its way back into our culture.

This is great news in the long run–we save more; we invest more for the future.

But this is absolutely terrible news in the short run, especially for the folks who are forecasting a strong V-shaped recovery in the economy.  In virtually every recovery after WWII, the consumer led the way.  The consumer, starting with modest debt loads, took on more debt and helped to power sharp recoveries in GDP growth.

But when the consumer–today–is saddled with near record levels of debt and desperately trying to pay it down, there is no way he, or she, can propel economic growth. 

The repercussions? 

At today’s price levels, the U.S. equity market is discounting a 4% growth rate in the economy going forward.    I’ll take the under on this one.


Machine Guns?

September 6, 2009

The S&P500 slipped 1.2% last week, the last week before Labor Day.  VIX (the fear index) continued to march higher, up 2% for the week.  Volume was strong on the three days when prices fell and weak on the two days when prices rose.  The S&P500, according to Standard & Poor’s data, closed the month of August priced at a 191 P/E ratio, using as-reported, trailing four quarter’s earnings, or a 27 P/E ratio, using as-reported, projected earnings for 2010.

Economic data were mixed.  On the positive side, Chicago PMI and ISM Manufacturing came in better than expected, but both benefited from recent inventory restocking orders that my not be sustainable in terms of final consumer demand.  On the negative side, auto sales disappointed–despite a $3 billion federal Cash for Clunkers giveaway designed to boost auto sales.  Factory orders were up less than projected. Initial claims came in at 570,000 and continuing claims rose to 6.23 million, even as more unemployed people lost their benefits.  The unemployment rate spiked to 9.7%.  Non-farm payrolls fell by 216,000.  And the broader unemployment rate (including involuntary part-time workers and discouraged seekers) rose to a new high (since record keeping began) of 16.8%.

The technicals point to a topping and and possible breakdown in the daily charts.  The weekly charts are still in an uptrend, and last week can be viewed as a pullback.  The long-term bear market is still in effect.

Barron’s conducts a semi-annual round-table discussion with about a dozen leading money managers and strategists from across the globe.  As elite investment managers responsible for hundreds of billions of dollars, these folks are highly respected and closely followed. 

One manager, Marc Faber, conducted an interview on Australian television last week.  In it, he was asked to comment on the health of the major equities markets, the major national economies, and the so-called recovery.

His conclusions were startling.

In the short-term, the U.S. government’s fiscal and monetary stimuli will stabilize the economy.  The economy will technically recover (ie. GDP will show positive numbers) and equity markets will probably rise.

In the long-term, he quite confidently concludes that the U.S. government will go bankrupt.  And the entire system will collapse–in about five years.

Faber quite logically concludes that our government will not have the political will to curtail its stimulus programs.  So the U.S. will continue to spend and print dollars until the rest of the world (its creditors) forces it to stop.

When that happens, the U.S. will suffer from the mother of all busts–a total economic meltdown, with political and social consequences.

What to do?  Become self-sufficient, warns Faber.  Buy a farm and a gun.  Better yet, buy a machine gun.

Is Faber a quack?  He’s a long-term thinker, strategist and investor who predicted last year’s financial crisis with uncanny accuracy.  He can’t (and doesn’t pretend to be able to) predict the precise timing of this next crisis. 

But it doesn’t take a genius IQ, an PhD in economics, or 40 years of market experience to justifiably worry about the sustainability of Washington’s fiscal and monetary programs.  There IS a limit to national borrowing and there IS a limit to the amount of additional money that can be printed–even with the benefit of having the world’s premier reserve currency.

Unless these programs and policies change, the question is not IF, but simply WHEN, the U.S. will fall into the abyss.