Dubai, the Canary in the Coal Mine?

November 28, 2009

The S&P500 dipped 0.4% last week, notching two consecutive weeks of small drops.  Volume was very light due to the Thanksgiving holiday.  But the VIX (or fear) index jumped 12%, most of which occurred on the last day of the week when the markets sold off strongly on the news coming out of Dubai.

The economic data were mixed.  Existing home sales rose, but most of the rise was explained by the government’s home buyer tax credit program.  Third quarter GDP was revised down, from an initial 3.5% to 2.8%.  Consumer confidence rose slightly.  More troubling, durable goods fell; they were expected to rise.  Personal incomes rose 0.2%, as expected, and personal spending rose more than expected.  This raises the question of how much the government transfer payments are propping up incomes and spending, because these payments cannot continue–to this degree–indefinitely. 

The technicals are continuing to suggest that the rolling tops are sputtering, on a daily basis.  The 1,100 level has been extremely difficult to break through for over a month.  The uptrend, on the weekly charts, is still holding, but the force of the prior upward movements is getting weaker.  The monthly, two-year, downtrend is still in tact. 

Why did Dubai’s looming default scare credit and equity markets around the world, to such a great degree?

On the surface, the problem does not seem to warrant a huge response.  While Dubai owes its banks over $50 billion, much of this credit exposure is spread among dozens of banks and other lenders globally.  And after the financial events of 2007 and 2008, one would think–reasonably–that much of the Dubai credit exposure has been conservatively hedged.

But what if these hedges don’t hold up?  What if these hedges far exceed the amount of debt actually outstanding in Dubai?  What if firms such as AIG sold this insurance to these lenders?  If these sellers of insurance are forced to make good on their credit default swaps, what happens if they fail to pay up?

This leads to the ultimate risk.  What if the final backers of the debt in states such as Dubai (or what if the final backers of the insurance sold against the default of debt in states such as Dubai) are sovereign nations who fail to make good on this debt?  In other words, what if the government backstops around the world fail to hold?

Let’s remember that our problems began in 2007 with a credit (or liquidity) crunch stemming from sub-prime loans that went bad in the US.  This crunch expanded in 2008 to a global financial (solvency) crisis that exploded when most banks around the world lost access to funding and began to teeter.  But these banks were saved from falling by backstops from governments, governments that relied on massive amounts of borrowed (and printed) funds to prevent the collapse of not only the financial system but also the general economy.  Think of the U.S. saving Fannie Mae, AIG and Citigroup.  In Europe, think of the U.K. saving RBS and HBOS.

So here’s the great fear stemming from the Dubai crisis–what happens if the global credit markets begin to question the ability of governments to honor their backstops, especially when these governments themselves are in debt up to their eyeballs? 

If confidence in governments wanes, who’s going to bailout the governments?  God?

The Bank for the Central Banks Gets It. The Fed, Not So Much.

November 22, 2009

The S&P500 slipped ever so slightly (0.2%) last week on light volume.  The VIX (or fear) index also slipped for the week.  Volume was light.  Now, more than ever over the last seven months, the market is stalling in the face of doubts about the strength of the economic recovery.

The economic data were mostly weaker than expected.  While retail sales were stronger than projected, retail sales ex-autos were much weaker than expected.  The Empire State Mfg survey came in well below expectations.  Industrial production also disappointed; it rose only 0.1%, not the 0.4% economists had projected.  PPI and CPI did not raise any red flags.  PPI (producer prices) were weaker at the monthly core level and the and the annual headline level.  Housing starts and permits were a huge miss.  Starts, for example, were projected to rise to 600,000.  Instead, the fell to 529,000.  Also in housing, the Mortgage Bankers Association announced that 14% of all mortgages (Q309) were either in delinquency or foreclosure, the highest level of distress ever recorded by this group.  Initial claims were still above 500,000, and the leading indicators rose, but less than expected.

The technicals, on a daily basis, are suggesting that the S&P is struggling to move higher.  The 1,100 level has provided strong resistance on several occasions over the last two months.  The weekly charts are also very toppy and pointing to a pullback.  The probability of a pullback seems very high; the magnitude of such a pullback is less clear.  The monthly charts are still confirming a long-term downtrend, the two-year old bear market that began on late 2007.

The Bank of International Settlements (BIS), located in Switzerland, is often called the central bank for central banks.  A leading economist from the BIS commented, in a piece written in the Telegraph, on the causes of a major financial crisis.

And no, the BIS did not blame the sub-prime crisis in the U.S.  Instead, the BIS pointed the finger to the US Federal Reserve for allowing massive credit bubbles to be blown.  For example, “How could such a huge shadow banking system emerge without provoking clear statements of official concern?”  Also, “The fundamental cause of today’s emerging problems was excessive and imprudent credit growth over a long period.  Policy interest rates in the advanced industrial countries have been unusually low.”  And, “Should governments feel it necessary to take direct actions to alleviate debt burdens, it is crucial that they understand one thing beforehand.  If asset prices are unrealistically high, they must fall.  If savings rates are unrealistically low, they must rise.  If debts cannot be serviced, they must be written off.”

Finally, “To deny this through the use of gimmicks and palliatives will only make things worse in the end.”

When was this article published?  June 2008, well before the global equity and credit markets crashed. 

Not only was this warning highly accurate in forecasting a crisis, but it suggests that the U.S. Federal Reserve–today–is pursuing the wrong strategy to fix the problem.

What’s the Fed and our government doing instead?  Propping up asset prices with new bubbles; changing accounting rules to allow big banks to hid bad debts; encouraging consumers and business to increase spending and borrowing (think Cash for Clunkers and New Home Buyer Tax Credits).

It hasn’t worked in Japan for the last fifteen years.  It won’t work in the U.S. today.



11%, 12%, 13% and Counting

November 14, 2009

The S&P500 pushed 2.3% higher last week, on no meaningful news.  The volume dropped yet again, suggesting that the price rise did not have a lot of conviction behind it.  The VIX (or fear index) barely budged, also suggesting that the price increase may not hold.

While there wasn’t much economic data released last week, most of it was negative.  Initial jobless claims dipped to 502,000 but remain stubbornly above the 500,000 for almost a year now.  The Treasury announced that it incurred a deficit of $176 billion for the month of October, the worst deficit on record.  Government receipts fell 18% yoy to $135 billion.  So the deficit was a staggering 130% of receipts!   The September trade deficit came in worse than expected and worse than the August deficit.  Finally, consumer sentiment fell to 66.0, far lower than the projected increase to 71.0.

Technically, the daily charts are suggesting a rise that might be sputtering.  The weekly charts are also forming a long-term topping formation that began several months ago.  Prices have been rising but numerous technical indicators are diverging bearishly;  these indicators turn down, as they are doing now, ahead of an actual price downturn.

Almost two weeks ago, the nation’s unemployment rate rose to 10.2%, the highest level since April 1983.  But the mainstream media and the purveyors of green shoots propaganda keep drilling into our heads that this is OK.  No need to worry because unemployment “always lags” in a recovery from a recession.  And since GDP has just turned the corner with a positive 3.5% third quarter, then the unemployment rate should start to go down over the next quarter or two–this being the lag.

But what if it doesn’t go down?  What if it goes up–a lot?

David Rosenberg, from Glusking Sheff, lays out the highly likely scenario where economic stability will cause job losses to grind to a halt.  That’s good news.  But the bad news is that employers will not start hiring for many years.  As formerly discouraged people (currently not counted as unemployed) re-enter the labor force to look for jobs, they will get counted as unemployed, driving the unemployment rate higher.

Why won’t they get re-hired immediately?  Mr. Rosenberg explains that employers will first boost the workweek for existing employees; but simply returning to pre-recession workweek levels would be the equivalent of hiring two million people.  Next, employers will reduce furloughs, turning part-time workers into full-time workers; this will also be the same as hiring millions of additional workers.

So employers will not need to touch the vast pool of unemployed folks, or the 100,000+ of typical monthly entrants to the work force, for a long time, perhaps years.

How high can unemployment rise?  Mr. Rosenberg thinks 11% is nearly a certainty and that the final level will reach 12% to 13%. 

If this is a normal lag, or nothing to worry about, then we’d better call our doctors and stock up on some OxyContin.  If we can’t avoid the impending damage, we might as well try to numb the pain.

10.2% and Counting

November 7, 2009

The S&P500 rebounded 3.2% last week but on lower volume, suggesting that the buying was not done with strong conviction.  While the VIX (or fear) index fell during the week, its gradual turn to the upside–which began in the summer–is still in effect.

The economic data were mixed to weak.  ISM Manufacturing came in better than expected; ISM Non-Manufacturing was worse.  Factory orders were slightly lower than consensus estimates.  Initial jobless claims were 512,ooo (better than expected), but the claims from the prior week were revised lower.  The big news was non-farm payrolls, which disappointed.  The unemployment (U-3) rate soared past 9.8% from the prior month all the way to 10.2%, which was much worse than predicted.  190,000 jobs were lost compared to the expected loss of 175,000.  The average workweek stayed at a record low of 33.0 hours; it was expected to rise.   Finally, consumer credit fell almost $15 billion, 50% more than the consensus estimate.

Technically, the rebound in the S&P is bumping up against the downtrend established over the previous two weeks.  The weekly charts are still toppy–last week’s price range set a lower low and a lower high (when compared to the prior week), despite the 3.2% rise.   The monthly bear market downtrend is still holding.

How bad was last week’s unemployment picture?

The headline rate, 10.2%, was the highest level reached in this country since April 1983, over 26 years ago.  The highest level reached during the 1980’s recession was 10.8%.  We’re not very far away from breaching this level.

People who’ve been unemployed for over 27 weeks (ie. the long-term unemployed whose old job is likely gone forever) rose to 3.6% of the civilian workforce.  This this a record high for this measure; records began in 1948.  So, the plight of the long-term unemployed is the worst it’s been since the Great Depression.

But here’s the scariest statistic, one that did get front page coverage in the New York Times.   The broadest measure of unemployment (the one that includes folks who are so discouraged that they’ve given up looking, and those who can’t find similar work and resort to taking lower-paying survival jobs that don’t fully use their skills) is called U-6. 

This spiked to 17.5%.

In his New York Times piece, David Leonhardt pointed out that this is the highest level since the Great Depression.  More than one out of six workers were unemployed or underemployed last month.  And by the way, this is worse than the highs reached in the recession of the 1980’s.

And he reminded readers that this measure too will most likely keep deteriorating well into 2010.

But isn’t unemployment the classic “lagging” indicator, the message that most of the media pundits and government officials endlessly try to shove into the public’s mind? 

Not always.  In most inventory based, inflation control recessions, yes unemployment lagged the recovery, and then came roaring back when the private sector economy reignited.

But this is a balance sheet recession caused by excessive debt levels that finally started imploding.  In these types of recessions, unemployment does NOT lag the economic rebound.  It creates a negative feedback loop that puts downward pressure on an economy that has not even begun to rebound organically (ie. without government created demand).

We last saw this in the Great Depression in the 1930’s, and in Japan today–where the economy has just entered its third decade of stagnation.

In other words, today’s high (and climbing) level of joblessness could only make things worse for the economy.

Red Alert?

November 1, 2009

The S&P500 dropped 4% last week.  More disturbingly, many signs point to the possibility that the equity markets could be in for more declines.  One sign was volume.  Volume rose on the four down days; it fell on the one day when prices rose.  This suggests that there’s more force on the sell side.  Also, VIX (or the fear index) went ballistic, especially on the fifth and most violent selling day.  This suggests that the owners of stocks are willing to pay a lot for insurance (in the form of options) against potential losses.  What are stockholders so afraid of?

The macro data was mixed to weak.  Consumer confidence fell sharply, when it was expected to rise.  Durable goods orders rose, but far less than predicted.  New home sales fell; they were expected to rise, specifically because of the $8,000 federal tax credit for new home buyers.  GDP for the third quarter came in at 3.5%–better than expected, but perhaps not as good as it looks.  Initial claims, at 530,000 were worse than expected.  Personal income was unchanged; personal spending fell 0.5%.  Chicago PMI was better than expected.

Technically, the daily charts are bearish; numerous indicators are flashing caution signs and warning of further selling potential.  The weekly charts are still overbought and showing signs of turning down; despite the last two weeks of declines, the weekly uptrend has not been decisively broken.  The monthly charts are still preserving the two-year bear market–the down trendline that began in October 2007 has not been violated.

Why was the 3.5% rise in the Q3 GDP report not quite as strong as it looked?

A slew of analysts jumped all over the slightly better than forecast results, which did manage to push equity prices up on the day of the release.  David Rosenberg points out that Cash for Clunkers provided 1.7% of the 3.5% rise.  And the government’s other stimulus spending (including the housing tax credit) provided for most of the rest. 

The result?

Real organic GDP did not grow at all in the third quarter according to Rosenberg.

In other words, the Green Shoots propaganda campaign has essentially been a lie.  The U.S. economy is not growing on its own.  And without 4% (or so) growth, most economists can confidently conclude that unemployment will keep on rising. 

So what happens if the government’s attempts to prime the pump don’t work?  What happens if the economy resumes falling when government life support gets withdrawn?

Exactly–it’s not looking very good. 

Perhaps this was one of the reasons that the markets sold off again on Friday.  Perhaps this will mark the time when the markets regain a healthy dose of skepticism. 

Perhaps this is the time to sound the alarm.