Month: May 2014

Authored by David Hay, CIO of Evergreen Gavekal,

“We’ve gone back into this kind of a foie-gras bubble environment. We’re all being force-fed risk assets. It’s an unpleasant experience when you’re playing goose to the central bank farmer.” -James Montier, strategist at elite money manager, GMO

 

“Unless countries come together to take the right kind of policy measures, we could be facing years of slow and subpar growth.” -Christine Lagarde, IMF Chief

Same time, this year. Almost everyone has heard the saying, “Fool me once, shame on you. Fool me twice, shame on me.” But what about, “Fool me four times”? It has been widely touted over each of the past four years that the global economy was about to achieve “sustainable acceleration,” “return to trend growth,” and “escape velocity,” or whatever other feel-good sound bite you care to use.

Unsurprisingly, those who have been wearing the economic “beer goggles” in recent years have tended to be the architects of, or apologists for, prevailing policies—a set of supposedly growth-stimulating measures so extreme that they might have caused John Maynard Keynes to blush. Yet, each year since 2010, the reality has been more of the same: Economic activity is moving as fast as the glacier on Mount Rainier.

2014, of course, was supposed to be different, especially in the US, where hopes have been running high for America to perform its typical role as the planet’s growth dynamo. This was believed to be the breakout year and, since it is still early, it could be. Undoubtedly, inclement weather has chilled activity in much of the country and, with spring in the air, a pickup seems probable. (It is ironic, though, that Europe’s latest sluggishness is being blamed by some on a mild winter that has restrained utility output and energy consumption.)

As expressed in last week’s EVA, the US has been growth-challenged for nearly 15 years. Europe has also experienced a recurring growth shortfall since the new millennium began, and in Japan the malaise is approaching a quarter of a century. Even emerging markets, which not long ago were supposed to keep the planet on a healthy expansion trajectory, have been looking like the Denver Broncos in the Super Bowl.

Additionally, inflation has been doing a vanishing act. Japan, as we all know, has been engaged in hand-to-hand combat with deflation for the past twenty years. Now that battle seems to be spreading to Europe, causing even inflation-phobic Germany to suddenly make noises about extreme counter-measures. And while deflation fears in the US are negligible, at least for now, overcapacity abroad and plunging foreign currencies have recently led to falling import prices even here.

If you think back to widely-held views of a few years ago, this is the precise opposite of what was supposed to happen, given the ultra-easy monetary policies by most of the world’s dominant central banks. Among the pessimistic back then, there was considerable hyperventilation about hyperinflation. For the optimists, rapid growth was just around the corner. But, despite zero or near-zero interest rates, countless trillions in deficit spending in most leading countries, and massive money creation in the US and Japan, inflation and growth remain largely MIA.

For true believers in the efficacy of the classic Keynesian remedies of incontinent fiscal and monetary policies, it is, and probably always will be, just a matter of time—no matter how many years go by. But, for the rest of us, it might be time to wonder if this isn’t the economic version of waiting for Godot. In case you don’t know, Godot was a no-show (as Mark Twain once wrote, “History doesn’t repeat, but it does rhyme!”).

A most unvirtuous circle. Veteran EVA readers know that for many years we have expressed the view that the missing link for both the inflation-paranoids and the growth-hopers was money velocity. As the rate at which money circulates through the economy crashed, it has become virtually impossible to trigger either a “normal” inflation rate or recovery (yes, I realize that “normal” is just a setting on your dryer but you get the idea). Figure 1 on the next page vividly illustrates that velocity has been declining and continues merrily on its downward path—a trend that is anything but normal. (However, as you will read later, this may be poised to change.)

Regular readers also won’t be surprised to learn that GaveKal’s co-founder, Charles Gave, has done some of the more groundbreaking and controversial work on this topic. Several months ago, we discussed his theory that velocity should be split in two: One part measuring what he calls “financial velocity,” and another that tracks “economic velocity.”

His key point, one we believe to be very valid, is that when central banks are bombarding the system with trillions of synthetic money, and anchoring interest rates close to zero, financial assets go bonkers. Money flows into the capital markets (like stocks) rather than capital assets (like new factories); hence, the result is high frequency financial velocity and low frequency economic velocity.

Since capital expenditures are essential for long-term economic vitality, the net result is bubbly financial markets—at least for awhile—and an underachieving economy. As you may have noticed, this is essentially the scenario that has played out over the last five years, and particularly the last two or three when QEs have been in full force. In fact, this has largely been the case for the last fifteen years. Accordingly, inflation has shown up primarily in asset, not consumer, prices.

You may be wondering why this has been the case. Why is it that the two favorite acronyms of leading central bankers, QE (quantitative easing, commonly known as money printing) and ZIRP (zero interest rate policy) have failed to bring home the economic mail? One of the better answers I’ve seen comes from this simple chart GaveKal included in a recent presentation.

Basically, this illustrates that when interest rates are artificially low, companies that normally should fail due to excessive leverage and inferior profitability, linger aimlessly around (the zombie effect), luring earnings and returns away from healthy firms. Thus, capitalism’s essential function of creative destruction is inhibited, resulting in overall stagnation.

Additionally, very low interest rates encourage companies to leverage up and buy back their own stock (or buy out competitors) rather than invest in new plant and equipment (i.e., capital spending), per Charles’ theory. One of the two drivers of growth (along with population increases) is productivity, and it withers without capital investments. Thus, it should be no surprise that productivity has also been anemic in recent years, as discussed in last week’s EVA.

While this chart describes what has played out in Japan since their gargantuan asset price crash occurred over twenty-five years ago, it has also unfolded to a large degree in the US after our own home-grown (literally) bubble went kaput six years ago. The daisy-chain shown above may also be a prime reason why US workers have seen their share of the proverbial pie get cut down to super-model size (i.e., a tiny sliver). As you can see below, this trend has been in place since the early 1970s, but it accelerated after 2000, when we first began to see excessively easy Fed policies (first to combat the tech bubble bust and then the housing meltdown).

Similarly, it could be just a coincidence that real household earnings peaked around 2000, when the Fed went into extreme “stimulation” mode (with a brief hiatus from 2005 to 2007), and have been in a bear market ever since.

It could be, but much like Sherlock Holmes, we’re not big believers in coincidences.

Have we gone “ex-“ cap ex? One of the more interesting views we see from time to time comes from Paradarch Advisors in their provocatively titled, Sex, Drugs, and Debt (who knew those three were connected!?!). In their most recent missive, they included some commentary that I thought was so good I should just relay it as is:

“The entire edifice of the 2009-2013 economic recovery has been built upon the foundation of wealth effects, i.e., higher stock prices. This was precisely the intent of the recovery’s bearded architect. The wealth created has certainly been enormous: Since bottom ticking 666 on March 6, 2009, the S&P 500 is now up roughly 208%. But like all spectacular bubbles, behind all of that newly created paper wealth stands a mountain of debt.

 

Since the beginning of 2009, total outstanding US corporate debt has increased by $3.376 trillion to a total of $9.766 trillion at year-end 2013. Of that $3.376 trillion increase in net issuance, nearly 87% has been used to fund share buybacks and dividend payments. In other words, the last five years have been one massive, market-wide leveraged buyout/dividend recapitalization.”

Paradarch further notes:

“This situation has the potential to devolve into something extraordinarily dangerous…very little of the post-recovery corporate debt issuance has gone into either the building or purchase of productive assets, meaning a deeper long-term economic contraction is more likely whenever the (bear market) comes. The current situation seems perversely worse than the housing bubble, because at least after that iteration of the credit mania we were left with something tangible (i.e., cheaper houses).“

Lest you think this is an off-the-wall, renegade view, the iconic Jeremy Grantham was just interviewed in Fortune, where he echoed this same sentiment. Given that Mr. Grantham previously issued early warnings on both the tech-wreck and the housing-hosing, it’s wise to heed his words. (By the way, he feels the S&P 500 could rise another 25% before reprising those earlier obliterations.)

As with Charles Gave and Paradarch, Grantham wants to know where all of the long-term investing has gone, per this line from his Fortune interview: “The theory is that lower interest rates are supposed to spur capital spending, right? Then why is capital spending so weak at this stage of the cycle?” As you can see from the chart below, it’s hard to argue that over the last 15 years that we’ve been adequately investing in productive assets.

Could it be that by letting ourselves get caught up in a series of bubbles we’ve been engaging in a societal version of what the Austrian school of economics calls malinvestment? If the answer is yes, we should all be doing some serious thinking about future implications.

The Fatted Goose. Returning to this EVA’s opening theme about the close-but-never-quite-here-recovery, there are some very bright people who believe that we are on the cusp of the real deal. In at least one way, we think they may be right. There does seem to be growing evidence, as previously relayed in recent EVAs, that the labor market is tightening for the best workers. Yet, this raises another nettlesome question.

If the tens of millions of unemployed aren’t truly employable, is the Fed making a huge mistake by trying to force the jobless rate down from here? There is already evidence of wages rising in many sectors of the economy. It just may be that most of the workers companies want to hire are already on the job. Thus, as the Fed continues its long-running rendition of The Big Easy, it is also elevating the risk of creating the next asset bubble (and we would agree with Paradarch and Grantham that they already have) with little benefit to employment. If this logic is right, the Fed is basically trying to force a round peg into a square hole (or stuffing even more fat-soaked corn into an already gagging bird).

An EVA prediction from last summer and fall was that this would be the year of the taper. That is turning out to be the case, and it is likely to continue barring some catastrophe. But that doesn’t mean the Fed is inclined to alter its Zero Interest Rate Policy. In fact, Janet Yellen went out of her way earlier this week to assure markets that it won’t zap ZIRP anytime soon. The stock market predictably celebrated, but should those of us who would like to see America finally return to its former 3% growth rate feel the same way?

If the past 15 years in Europe and the US, and the last twenty-five in Japan, are any guide, the answer is a resounding no. The odds are high that our economy will remain burdened by growth-inhibiting monetary policies. In addition, it will continue to be negatively impacted by various other impediments, including a populace that is increasingly under-employed, an unwieldy and inscrutable tax code, a Rube Goldberg-like healthcare system, an increasingly ossified infrastructure, and a regulatory apparatus that congests the lungs of our economy, small businesses.

Consequently, the still-dominant consensus view that America’s economy is poised to single-handedly yank the world out of its lethargy is likely to be disappointed once again. We say this realizing there is some evidence that loan and money supply growth in the US are decisively turning up. This is a development we will watch very closely as it would almost certainly lead to money velocity acceleration in fairly short order. If so, the Fed won’t just need to tap the brakes but slam them on, and put out the drag chute as well.

While many would welcome a surge in velocity, we don’t think financial markets should be among the celebrants. They’ve benefited mightily from the paradigm of collapsing money turnover and constant liquidity injections. Even though sharply higher interest rates, at least on the shorter-term end, are what the economy needs to return to some kind of normal capitalism—and capital formation—weaning the stock market off of casino capitalism promises to be anything but pain-free. But did any responsible adult really believe there would be no pay-back for all these years of the Fed’s force-fed gains? If you do, you probably also believe foie gras grows on trees.

via Zero Hedge http://ift.tt/1jmQmSk Tyler Durden

Here is what Bloomberg’ survey sees as consensus for tomorrow’s key data:

• Nonfarm payrolls: +218,000
• Private payrolls: +215,000
• Unemployment Rate: 6.6%
• Avg Hourly Earnings: 0.2% MoM, 2.1% YoY
• Avg Weekly Hours: 34.5

 

Weather is the biggest factor, as Goldman notes…

We forecast a 220k increase in nonfarm payrolls in April, a touch stronger than the consensus estimate of 215k.

 

We expect private payrolls increased 215k (vs. consensus 215k).

 

Payroll gains now stand just shy of 200k for February and March and look poised to come in stronger in April. Notably, the employment components of all ten of the major business surveys released so far rose in April, in every case to a level consistent with increased employment. In addition, jobless claims reached a new post-recession low just prior to the April reference week, and continued normalization of weather conditions in April from a still-chilly March could provide a modest additional boost. We also think it is likely that the April report will include substantial positive back-revisions, as has tended to be the case historically.

Arguing for a stronger report:

The employment components of all ten major business surveys available so far improved in April. Among manufacturing surveys, gains were seen in the ISM manufacturing index (+3.6pt to 54.7), the Chicago PMI (+7.8pt to 57.8), and the Philly (+5.2pt to 6.9), Empire (+2.3pt to 8.2), Richmond (+4pt to 4), Kansas City (+3pt to 3), and Dallas (+4.7pt to 19.7) Fed surveys. While the ISM nonmanufacturing index is not yet available, the employment components of the New York Fed’s service sector (+4.5pt to 6.2) and the Richmond Fed’s service sector survey (+10pt to 6) both improved.

 

Weather conditions finally returned to seasonal norms in April. Much of the bounce-back from the unseasonably cold and snowy winter was already apparent in the March data. In particular, weekly hours rebounded strongly from disruptions caused by major snowstorms in the previous months. However, measured as the deviation from normal, March was the most unseasonably cold month of the winter, suggesting that some additional room remains for a further weather boost in April.

 

The four-week moving average of initial claims for unemployment benefits reached a new post-recession low during the April reference week, declining 18k from the March reference week. However, the Labor Department has cautioned in recent weeks that seasonal adjustment of weekly claims is challenging around the Easter holiday and spring break from schools.

 

Private job gains reported by ADP rose to 220k in April from an initially-reported March gain of 192k. That said, we attach only limited weight to the ADP report because its initial print has yet to prove itself as a reliable indicator of payroll job growth as measured by the Labor Department.

Both new and total online job ads rose modestly in April. While the series tends to be quite volatile and is a forward-looking rather than coincident indicator, it has printed at a decent level over the last few months.

Arguing for a weaker report

The labor differential?the difference in the percentage of respondents in the Conference Board’s consumer confidence survey describing jobs as plentiful vs. hard to get?worsened by 2pt to -19.6 in April from an upwardly-revised March base. The index has shown a fairly steady recovery since late 2011, but has stalled in recent months.

Neutral indicators

Announced layoffs were up on a seasonally-adjusted basis in April, but only modestly, according to Challenger, Gray, and Christmas. The heaviest job cuts in April were seen in the retail and financial sectors. However, job cuts in the health care sector declined from March, suggesting at most a modest impact from layoffs of temporary workers at the end of the sign-up period for health insurance under the Affordable Care Act.

We expect that the unemployment rate declined to 6.6% in April (vs. consensus 6.6%) from an unrounded 6.71% in March. Despite strong employment gains in the household survey this year, the unemployment rate has held steady since December as a result of a 0.4pp increase in labor force participation. As we noted last week, the unemployment rate has recently fallen more quickly and the participation rate has increased more quickly among workers with lower education levels over the last few months.

Average hourly earnings (AHE) are likely to be in focus on Friday following several months of heightened attention to wage growth and labor market slack.

We expect an increase of 0.2% in April (vs. consensus 0.2%).

 

AHE for all workers were flat in March, likely reflecting the reversal of weather distortions that boosted the gain in February, and rose 2.1% over the past year. Even at this low growth rate, AHE have been rising more quickly than other wage measures. Wednesday’s Employment Cost Index showed compensation growth of just 0.3% in Q1 (1.8% year-on-year) and wage & salary growth of just 0.25% in Q1 (1.7% year-on-year), and compensation per hour in the nonfarm business sector rose just 0.3% year-on-year as of 2013Q4.

And here are a smorgasboard of optimistic and pessimistic “economists” perspectives:

UBS’s Sam Coffin: 150,000 — “Our forecast reflects a small boost from a residual weather-related rebound and some continued improvement in underlying trends, with a counterweight from unfavorable calendar effects… Within payrolls, incremental strength is likely in manufacturing, retail trade, and information industry payrolls—all of which had slowed, on balance, in recent months. The decline in jobless claims over the past month has been consistent with some labor market improvement.   We do see some drag from calendar effects. The gap between the March and April payroll surveys was four weeks. A four-week gap has been associated with below- trend April payrolls in 12 of the last 15 instances (and more recently in 4 of the last 5 instances). We put the downward bias for this month at about 20k and otherwise would have estimated April payrolls at 200k.”

High Frequency Economics’ Jim O’Sullivan: 185,000 — “…but we are allowing for the recurring pattern of payrolls being under-reported initially, only to be revised up later. Nor are we counting on any additional catch-up for weather effects. The household survey series on the number of people with a job but not at work because of bad weather was back to its normal level in March after being unusually high in February.”

Citi’s Peter D’Antonio: 225,000 — “We expect another solid gain in payroll employment in April, as the labor market normalizes from the weather distorted readings in December and January. By our estimates, this should be the last reading influenced by winter weather. At this point, we think the trend is still about 180K per month, but we do expect that the running rate will pick up this year toward 200K. Note 1: We can’t rule out that the tail end of the payroll rebound occurs through revisions, rather than a big rise in April. Last month, the headline gain was smaller than we expected, but upward revisions to earlier months made up the difference.”

Deutsche Bank’s Joe LaVorgna 240,000 — “…claims data showed a new cyclical low for the employment survey period. This is a very positive sign for the labor market that is also being confirmed by the growth in employee tax withholding receipts.”

Barclays’ Dean Maki: 250,000 — “Both initial and continuing jobless claims have fallen significantly in April, suggesting a more robust pace of job growth than in recent months. We also believe more normal weather conditions than those prevailing earlier in the year will support job creation in April.”

Morgan Stanley’s Ted Wieseman: 250,000 — “Since the weather started to become less severe in mid-February, jobless claims have shown a big improvement that accelerated in the first half of April, pointing to a significantly reduced pace of firings recently. The 4-week average of initial claims fell to 312,000 in the survey week for the April employment report from 329,500 in March, and 336,500 in February, a seven-year low and very strong level historically. With layoffs declining, as long as hiring rates have at least held steady, net job growth has accelerated. We look for a temporary pickup to a pace moderately above the pre-winter trend near 200,000, reflecting some catch up reversal of winter drags.”

via Zero Hedge http://ift.tt/1pUqy59 Tyler Durden

Submitted by Ralph Dillon of Global Financial Data,

If you don’t like how things work in a free market, just change the rules and financial engineer whatever the results of which you like to achieve. And so, since 1995 we have been going from boom to bust from one bubble to the next as we try to navigate the financial markets that have been turned into a circus act.
 
You want to securitize home loans and dump them on the public? Package Collateralized Mortgage Obligations with AAA ratings. The masses cant afford a mortgage? No worries, have the Federal Government back and guarantee loans from Freddie and Fannie and simply change the underwriting rules so they can. Want to move the equity markets considerably higher? Start cutting interest rates to as close to zero as you can and force investors into equities.
 
In order to fully grasp what has been done here, you have to take a look at what is currently going on. Last year in 2013, it is estimated that 60% of the homes purchased were purchased with cash. In contrast, since 1988 only 6% of the homes purchased were purchased with cash. Additionally, studies have shown that historically US homeowners typically finance 50-60% of the purchase price of a home. At the peak of the real estate bubble in 2008, some folks were purchasing homes with no money down and financing 100% of the purchase price. Even more staggering, are all the diffent types of loans that have been created to accommodate the appetite of Wall Street and the securitization of them. And finally, 75% of the loans written since 1988 have been conventional loans. That too has been re-engineered, at the peak in 2008, we had more flavors of loans than there are ice creams. Adjustable Loans, Interest Rate Only Loans and Jumbo Loans to name a few that can and did accommodate anyone who wanted to purchase a new home regardless of income and credit rating. It didn’t matter if you couldn’t afford it.
 
But why was this all done? Politicians will argue equality, Wall Street would argue modern global financialization and I would argue a way to get and stay elected.

 
All of this creative financial engineering started in 1995 when the rules governing underwriting mortgages for home ownership were changed. The idea being, that everyone should be able to own a home and share in the American dream.  With declining mortgage rates and very accomodative underwriting standards, home ownership exploded over 10 years. An expansion that has never been seen before as the chart below depicts. Look at the declining mortgage rates and what happened to home ownership in 1995 courtesy of these new underwriting standards.
 

And what does the financial engineering that was being done on Wall Street look like on home ownership when you overlay it with the S&P 500? As you can see by the chart below, the financial engineers had accomplished what they sought. To create a wealth effect and economic expansion that we too have never experienced before. Exactly in 1995.

And finally, what effect did the financial engineering to the US 10yr Bond have on the equity markets? Here is a look back to 1791. But look what was done again in 1995 to the 10yr and the S&P 500. The financial engineers drove interest rates to historic lows with perpetual easing in order to move the equity market. Results are where we are today. Historic low yields and an equity market at all time highs. Exactly what the financial engineers sought out to do. 
 

via Zero Hedge http://ift.tt/PVl4qb Tyler Durden

By: Chris Tell at http://ift.tt/146186R

Our good friend “Kuppy” aka Harris Kupperman, hedge fund prodigy, occasional writer at Adventures in Capitalism and Chairman of Mongolia Growth Group (YAK:V), our favoured means of playing the Mongolian Real estate boom, recently visited that bastion of chronic political ideology gone wrong – Cuba.

He has written no less than 4 fantastic articles on his travels there and over the next week we’ll share them with you. I’m sure you’ll enjoy them as much as we have.

——–

It all started as I was grabbing coffee with a close friend of mine. After a very successful, but exhausting year in Mongolia, I was looking for a holiday location where I could unwind. The prerequisites were that there be limited phone or internet access to avoid roping me back into work. I wanted a place that I could truly escape to and that business could not find me. I was worried that it would take some far-away land to achieve this goal—an African safari—or some deserted Pacific island. I had already spent the morning spinning the globe around on Google Earth—nothing piqued my interest.

 

 

Then my friend suggested the obvious; “How about Cuba—the forbidden fruit of American travelers? Your cell phone won’t work, the internet is impossible to access and business won’t come and find you—heck, business cannot even legally exist in Cuba.”

“…But won’t that take months to get the visas in order? I need to leave immediately as I’m due in Mongolia, during the first week in January,” I replied.

“Don’t worry. I’ll get your visas sorted out. Let’s just say that I know people… (wink, wink) Besides, I’ve been there many times in the past decade. It’s finally starting to wake up and shake off communism. You need to see it now, so that you have perspective on it in a year or three when Americans can start investing there.”

 

48 hours later, my girlfriend and I were on a plane to Cuba with a visa for the “purposes of attending worship services…to interact with the people of Cuba…to the purpose of friendship and worship.” Those of you, who know me well, will appreciate the irony and incongruity of me getting a visa to do missionary work—then again, the last half century of Cuban history is full of incongruent ironies.

 

 

Having lived in Miami for the past decade, I have met plenty of Cubans and heard the disheartening tales of Cuba and the Castro brothers. I expected to find the world’s largest tropical gulag. Instead, I found a cheerful country, full of warm friendly people, some of whom seem to genuinely admire the government—despite its arcane rules and habitual dysfunction. I also found many who were illegally saving their money in US Dollars and plotting their escape from Cuba.

 

I expected to find an island mired in misery with chronic scarcity of basic goods. Instead, I found a place that was remarkably devoid of extreme poverty—a true anomaly in Latin America. Given the inevitable failings of a purely socialist state, I expected much worse. If you remove the top few percent of wealthy Argentines, the average Cuban is roughly on par with the average Argentine in terms of standard of living and Cuba’s infrastructure is a good deal ahead of Argentina’s—something I certainly did not expect to find.

 

 

I expected that men in green army uniforms would harass us as we went about life—typical of military dictatorships with a suspicion of America (we have spent the last half century trying to topple the government). Instead, the police presence was less than that of Manhattan and the military is effectively out of sight. The only government representatives that we met were in Museums—they were both helpful and amazingly patient as I fumbled for words in Spanish.

In many ways, it was an island of contrasts and unexpected surprises. My friend with the visas, was also correct, Cuba is beginning to open up and transition to a market economy. While there is no business to be done by Americans (yet), I spent my week in Cuba trying to cut the Gordian Knot of misconceptions, misinformation and failed economic plans that have characterized Cuba’s last half century of economic dysfunction. I expected to see another failed socialist state, impossible to revive—a Zimbabwe off the coast of Florida. Instead, I was both surprised and impressed by the country and its potential as a future investment destination.

 

Over the next few pieces, I will take you through my week in Cuba—the misconceptions, the obvious failings and occasional successes of state-planned socialism. This collage of stories was the result of dozens of conversations with ordinary people that I met during my vacation—hotel employees, barkeepers, waiters and especially taxi drivers (who tend to have the best pulse on the economy in every transitioning economy). These people ranged from life-long communist ideologues to those who truly despised the government; however, the majority of the people I met, were simply divorced from politics, frustrated with socialism, but appreciative of the occasional benefits that it brought. I stayed true to my mission of escapism. I did not speak with any senior government officials and I did not engage in any business. Rather, I ate, drank and travelled myself ragged, through dozens of cities and over a thousand kilometers of back roads. Let’s just say, that I’m not the type of vacationer who sits on the beach…

Bienvenido a Cuba!!!

Photos by Mili Martinez

——–

Watch out for part II next week.

– Chris  

“Cuba may be the only place in the world where you can be yourself and more than yourself at the same time.” – Pedro Juan Gutiérrez

via Zero Hedge http://ift.tt/1fyeXVk Capitalist Exploits

There has been much discussion in the past year(s) whether the Fed has inflated (the final) bubble. Sadly, most of it has been misguided. To get some “guided” analysis of what is easily the most important market topic of the day, we go to GMO’s Jeremy Grantham and his latest quarterly letter covering just this: “Looking for Bubbles.“

First the background:

What is a bubble? Seventeen years ago in 1997, when GMO was already fighting what was to become the biggest equity bubble in U.S. history, we realized that we needed to define bubbles. By mid-1997 the price earnings ratio on the S&P 500 was drawing level to the peaks of 1929 and 1965 – around 21 times earnings – and we had the difficult task of trying to persuade institutional investors that times were pretty dangerous. We wanted to prove that most bubbles had ended badly. In 1997, the data we had seemed to show that all bubbles, major bubbles anyway, had ended very badly: all 28 major bubbles we identified had eventually retreated all the way back to the original trend that had existed prior to each bubble, a very tough standard indeed.

Then, the bullish case, or in other words, what is the maximum the S&P can stretch further, before it all comes crashing down:

So now, to get to the nub, what about today? Well, statistically, Exhibit 3 reveals that we are far off the pace still on both of the two most reliable indicators of value: Tobin’s Q (price to replacement cost) and Shiller P/E (current price to the last 10 years of inflation-adjusted earnings). Both were only about a 1.4-sigma event at the end of March. (This is admittedly because the hurdle has been increased by the recent remarkable Greenspan bubbles of 2000 and a generally overpriced last 16 years.) To get to 2-sigma in our current congenitally overstimulated world would take a move in the S&P 500 to 2,250. And you can guess the next question we should look at: how likely is such a level this time? And this in turn brings me once again to take a look at the driving force behind the recent clutch of bubbles: the Greenspan Put, perhaps better described these days as the “Greenspan-Bernanke-Yellen Put,” because they have all three rowed the same boat so happily and enthusiastically for so many years.

 

 

… purist value managers may try to block out the siren call because they don’t wish to be tempted, and some may hear it and do nothing because the gains are never certain and the lack of prudence is painfully obvious in the end. Yet long-term value managers are outnumbered by momentum managers – always were and probably always will be – and momentum managers have no such qualms. Why this time, then, would they not play the game with even more enthusiasm, at least enough to drive the market to its 2-sigma level of 2,250 and perhaps a fair bit beyond? And although nothing is certain in the market, this is exactly what I  believe will happen.

But what if we are already well past the point of no return? Enter Hussman:

Out there in the wilds of the internet along with our free quarterly letter, which always feels like a long painful delivery, there is an equally free letter from John Hussman, who turns out to have the same work ethic as Alexey Stakhanov, that hero of the Soviet Union known for his massive and routine production over quota. Hussman, can you believe, produces a long and well-researched quarterly letter each week! Deplorable. Surely (he says enviously), he must be a workaholic and obviously unlike some of us less industrious types can have no life at all. But I will say this: he grinds some good data. He therefore makes a good representative of the analytical group, all value diehards who believe the market’s demise is imminent. And the data is comprehensive enough that I admit it worries me. Clearly he and the others may be right. Exhibit 7 reproduces – with his kind permission – his version of all of the value measures he deems important. They indicate an overpricing for the U.S. markets that ranges from 75% overpriced to 125% at the end of March. All of the measures have a history of being predictive – much more so than, say, Yellen’s reprehensible choice of current price as a multiple of next year’s estimated earnings. (Either she’s painfully ill-informed or, most implausibly, not too smart, in which case sooner or later we’re scr*w*d, or she knows this measure is a third-rate prediction of true value and is cynically using it to tout the market, in which case we’re doubly scr*w*d! But at least that latter reason would be an ideal proof of her buying into her predecessors’ Put, in case we had any doubt.)

 

 

But back to value and Hussman. Not surprisingly, GMO very much agrees with the spirit of this data, but our preferred measure for our 7-Year Forecast has the market slightly less overvalued at 65%. (Although, interestingly, at 2,250 – our 2-sigma target – it would be about 100% overpriced.) Our estimate allows for a very modest improvement in trend line profitability and an even more modest allowance for a slightly higher P/E as a response to probable lower equilibrium interest rates. Still our estimate of overpricing is pretty close to his.

 

Exhibit 8 shows an equally disturbing Hussman exhibit in which he has collated very bad things that happen to markets. His exhibit suggests that whenever this large collection of troublesome predictions line up like they have recently there has been a very serious and fairly immediate market decline. While I have no quarrel with the eventual outcome and recognize that possibly the bear market’s time may have come, particularly in light of recent market declines (April 13, 2014), I still think it’s less likely than my suggestion of a substantial and quite lengthy last hurrah.

 

Which brings us to the punchline: Grantham’s “Best Guesses for the Next Two Years”:

With the repeated caveat that prudent investors should invest exclusively or nearly exclusively on a multi-year value forecast, my guesses are:

 

1) That this year should continue to be difficult with the February 1 to October 1 period being just as likely to be down as up, perhaps a little more so.

 

2) But after October 1, the market is likely to be strong, especially through April and by then or in the following 18 months up to the next election (or, horrible possibility, even longer) will have rallied past 2,250, perhaps by a decent margin.

 

3) And then around the election or soon after, the market bubble will burst, as bubbles always do, and will revert to its trend value, around half of its peak or worse, depending on what new ammunition the Fed can dig up.

 

Conclusion and Summary

 

The bull market may come to an end any time, indeed as I write it may already have happened. It could be derailed by disappointing global growth, profits sagging as deficits are cut, a Russian miscalculation, or, perhaps most dangerous and likely, an extreme Chinese slowdown. But I believe it probably (i.e., over 50%) will not end for at least a year or two and probably not before it reaches a level in excess of 2,250 on the S&P 500. Prudent long-term value investors will of course treat all of the above as attempted entertainment (although I believe all statistically accurate) and be prepared once again to prove their discipline and man-hoods (people-hoods) by taking it on the chin.

 

I am not saying that this time is different (attention Edward Chancellor). I am sure it will end badly. But given this regime of the Federal Reserve and given the levels of excess at other market peaks, I think it would be different to end this bull market just yet

via Zero Hedge http://ift.tt/1nO0yXi Tyler Durden

Days after acting Defense Minister Mykhailo Koval warned “the Armed Forces are not ready for this,” Ukraine has announced the return of military conscription. After Mr Turchynov admitted his security forces were ‘helpless’ to quash the pro-Moscow insurgency that has tightened its grip on the increasingly chaotic east of the country, Koval believes “if there were conscripts in military units, then the situation might be different.” Of course, this is exactly what the IMF ‘demanded’ as yet more cities in the East fall to pro-Russian separatists. We can only imagine how pro-Russian 20-23 year old men will feel when they get their call-up papers to fight… against themselves.

 

As NRCU reports,

The Armed Forces of Ukraine could return military conscription, acting Defense Minister Mykhailo Koval has stated. “The army will be professional – this is the future of the Armed Forces. But now the Armed Forces are not ready for this. Therefore we might have to return 21-23-years-old men for a while, and they will serve the state,” he told reporters in Kyiv on April 26.

According to Koval, the reckless policy of transition to contract service showed its negative sides, in particular, in Crimea. “If there were conscripts in military units, then the situation might be different,” the minister said.In addition, the minister said the Armed Forces of Ukraine have not created a good base for training and life-support of contract soldiers.

And then today, The Daily Mail confirms…

Embattled Ukraine today announced it was bringing back conscription as a mob of some 300 pro-Russian militants seized control of the prosecutor’s office in Donetsk after overrunning police.

Coming on the heels of this…

But Mr Turchynov admitted his security forces were ‘helpless’ to quash the pro-Moscow insurgency that has tightened its grip on the increasingly chaotic east of the country.

And the previous details of the conscription plan…

The Ukrainian parliament has adopted a resolution recommending that acting President Oleksandr Turchynov resume mandatory drafting of conscripts into the country’s army.

The resolution “on additional measures for strengthening Ukraine’s defense capability in connection with Russia’s aggression against Ukraine” was adopted on April 17.

Kyiv announced the last mandatory drafting of conscripts into the Ukrainian Army in October, saying that by the end of 2014 the Ukrainian armed forces would be comprised of professional soldiers only.

Ukraine — which currently has the fifth-largest army in Europe, with 180,000 soldiers — planned to decrease the total to 122,000 soldiers by 2017.

According to the old law, all male citizens between the ages of 18 and 27 must serve for one year in the national army or for 18 months in the Ukrainian Navy.

via Zero Hedge http://ift.tt/1nNYgrc Tyler Durden

File under “Government Health Care”…

Health officials are investigating what may have sickened over 100 people who attended a conference where more than 1,300 food safety experts had gathered.

 

No one at the Food Safety Summit held April 8-10 in Baltimore was hospitalized, according to health officials, and most people reported cases of diarrhea.

 

Alvina K. Chu, who is leading the Maryland Department of Health’s investigation, said Tuesday that officials haven’t yet determined what caused people to get sick. It’s not yet clear if the illness was transmitted by food or from person to person, she said.

 

The Baltimore City Health Department received complaints of nausea and diarrhea from four people one week after the conference. After the illnesses were reported, city health officials inspected the convention center after and its in-house catering company, Centerplate, on April 16, and issued a violation for condensation dripping from an ice machine, according to city health department spokesman Michael Swartzberg.

 

City health officials found no violations during the most recent regularly scheduled inspection of the convention center on Feb. 27.

 

The state health department sent a survey to summit attendees on April 17. About 400 responded, with more than 100 people reporting symptoms. Health officials said there have been no reported hospitalizations or deaths.

 

Rita Foumia, corporate strategy director for BNP Media, which hosts the summit, said nothing like this has happened in the summit’s 16-year history.

Source: AP

via Zero Hedge http://ift.tt/1i3jQA1 Tyler Durden

While everyone is by now fully aware just how dependent Europe is on Russia’s energy supplies (and most are aware of the “nonsense” that the US will fill any gap if Russia steps up its actions – which Barroso said wouldn’t happen because “Russia has self-interest not to play the energy card”) but few are truly aware of the scale of contagious debt-driven defaults that could occur if the US (and a reluctant Europe) decide to undertake more aggressive economic sanctions, which, as Germany’s Europe minister stated today, “are on the table.” As the following chart of Europe’s domestic bank exposure to Russia show, Roth’s warning that Russia’s retaliation could mean “anything is possible,” is a major problem for the Germans, Italians, and most of all – The French.

Germany is nervous…

• *ECONOMIC SANCTIONS `ON THE TABLE’; RUSSIA COULD RETALIATE: ROTH
• *GERMANY’S ROTH SAYS `ANYTHING IS POSSIBLE’ IN UKRAINE CRISIS

Because they know what happens if this house of cards falls down…

As The Council for Foreign Relations notes, in the fourth quarter of last year, with tensions rising between Russia and the West over Ukraine, U.S., German, UK, and Swedish banks aggressively dialed down their credit exposures in Russia… but levels remain huge…

But as the graphic above shows, French banks, which have by far the highest exposures to Russia, barely touched theirs.  At $50 billion, this exposure is not far off the $70 billion exposure they had to Greece in 2010.  At that time, they took advantage of the European Central Bank’s generous Securities Market Programme (SMP) to fob off Greek bonds, effectively mutualizing their Greek exposures across the Eurozone.  No such program will be available for Russian debt. 

 

And much of France’s Russia exposure is illiquid, such as Société Générale’s ownership of Rosbank, Russia’s 9th largest bank by net-asset value ($22 billion).

 

With the Obama Administration and the European Union threatening to dial up sanctions on Russia, is it time for U.S. money market funds and others to start worrying about their French bank exposures?

The bottom line – it’s all well and good to let the people starve, freeze, or stagnate amid a lack of energy supplies… but start fucking our banking exposure and Russian sanctions just got real

via Zero Hedge http://ift.tt/R5kg3c Tyler Durden