Month: August 2016

Shocked by the inexplicable realization that Americans are stubbornly unwilling to bow down and blindly accept the political and economic views of the educated elites in this country, Harvard Professor Gregory Mankiw recently took to the New York Times to pen an oped where he concluded that the only possible reason for the lack of conformity to his point of view is the stupidity and racism of the electorate.  An article by Adam Button at forexlive, called our attention to the recent oped which he described as a "dazzling display of contempt for the public from a Harvard professor who can't believe that voters aren't listening to the gospel of the economic elites."

Questioning why American's object to increasing globalization, Professor Mankiw pointed to three main conclusions:

"The first is isolationism more broadly. Trade skeptics tend to think, for example, that the United States should stay out of world affairs and avoid getting involved in foreign conflicts.  They are not eager for the United States to work with other nations to solve global problems like hunger and pollution."

 

"The second is nationalism. Trade skeptics tend to think that the United States is culturally superior to other nations. They say the world would be better if people elsewhere were more like Americans."

 

"The third is ethnocentrism. Trade skeptics tend to divide the world into racial and ethnic groups and think that the one they belong to is better than the others. They say their own group is harder working, less wasteful and more trustworthy."

In summary, Professor Mankiw concludes that "…isolationist, nationalist, ethnocentric worldview is related to one’s level of education…the more years of schooling people have, the more likely they are to reject anti-globalization attitudes."  So if we understand Professor Mankiw correctly, we disagree with him because we're stupid, and because we're stupid we're also necessarily racist.  Got it.  

Lest you think that Mr. Mankiw only holds contempt for American dissenters, he points out that the British people are stupid and racist as well:

"…the recent Brexit vote was strongly correlated with education.  Districts with a high percentage of college graduates tended to vote to remain in the European Union, while those with a small percentage tended to vote to leave."

We're happy to note that Mr. Mankiw did find some cause for optimism, noting that populations tend to grow smarter over time.  If we're lucky, hopefully our offspring can all reach the level of enlightenment of Professor Mankiw, though it will probably take another 100-200 years, or so. 

"In the long run, therefore, there is reason for optimism.  As society slowly becomes more educated from generation to generation, the general public’s attitudes toward globalization should move toward the experts.  The short run in which we find ourselves now, however, is another story."

Frankly, we're happy that Professor Mankiw is drawing attention to the infallible intellect of our our ivy league educated economic and political elite.  Given the horrific record of the Fed in recent years, creating bubble after bubble while laying ruin to global economies, we think the Fed could benefit from some smart people like Professor Mankiw.

Janet L. Yellen – Brown University – BA in Economics; Yale University – Ph.D. in Economics

Lael Brainard – Wesleyan University – BA; Harvard University – Ph.D. in Economics

Stanley Fischer – London School of Economic – BS/MS in Economics; MIT – Ph.D. in Economics

Jerome H. Powell – Princeton University – AB in Politics

Daniel K. Tarullo – Georgetown University; Duke University

Wait a minute….

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Submitted by Chris Hamilton via Econimica blog,

In 2010, Social Security (OASDI) unofficially went bankrupt.  For the first time since the enactment of the SS amendments of 1983, annual outlays for the program exceeded receipts (excluding interest credited to the trust funds).  The deficit has grown every year since 2010 and is now up to 8% annually and is projected to be 31% in 2026 and 44% by '46.  The chart below highlights the OASDI annual surplus growth (blue columns) and total surplus (red line).  This chart includes interest payments to the trust funds and thus looks a little better than the unvarnished reality.

For a little perspective, the program pays more than 60 million beneficiaries (almost 1 in 5 Americans), OASDI (Old Age, Survivors, Disability Insurance) represents 25% of all annual federal spending, and for more than half of these beneficiaries these benefits represent their sole or primary source of income.

The good news is since SS's inception in 1935, the program collected $2.9 trillion more than it paid out.  The bad news is that the $2.9 trillion has already been spent.  But by law, Social Security is allowed to pretend that the "trust fund" money is still there and continue paying out full benefits until that fictitious $2.9 trillion is burned through.  To do this, the Treasury will issue another $2.9 trillion over the next 13 years to be sold as marketable debt so it may again be spent (just moving the liability from one side of the ledger, the Intergovernmental, to the other, public marketable).  However, according to the CBO, Social Security will have burnt through the pretend trust fund money (that wasn't there to begin with) by 2029.

Below, the annual OASDI surplus (in red) peaking in 2007, matched against the annual growth of the 25-64yr/old (in blue) and 65+yr/old (grey) populations.  The impact of the collapse of the growth among the working age population and swelling elderly population is plain to see.  And it will get far worse before it eventually gets better. 

From 2017 through 2029, the present 170 million person 25-64yr/old population will grow by just 5 million.  The current 51 million person 65+yr/old population will grow by 22 million.  And it won't get much better after that as the older population keeps swelling with boomers living progressively longer.

Beginning in 2030 benefits will have to be paired up with tax collections according to current law.  By present calculations, this means an initial 29% reduction in benefits.  The reductions will only become larger from there.  The average benefit check in 2016 is $1341/mo, or $16,000/yr.  A 29% reduction on the average payment will be <-$390/mo> and the reductions will keep growing for the rest of our lives.  For couples, this means their initial combined benefit will be $22.850 instead of $32.000.

Americans turning 67 in 2030 will be told that after being mandated to pay their full share of SS taxation throughout their working lifetime, they will not see anything near their full benefits in their latter years.  However, those in retirement now and those retiring between now and 2029 are being paid in full despite the shortfall in revenue.  They will be paid in full until this arbitrary "trust fund" is theoretically drained.

I have no intention of funding, in full, current retirees benefits with my tax dollars only to know I will hit the finish line with a 30%+ reduction that will only worsen over time.  My goal is to pay it forward to my kids and then do my best to never to be a burden to them.  The SS (OASDI) benefits must be cut now to be in line with revenues.  Raise taxes, lower benefits…your choice.  But I'm not about to make the old whole so I can then subsequently see my generation go bankrupt in my latter years.

Conclusion-

1- There was a trust fund, but Executive and Congressional tinkering along the way has seen that is has been entirely spent (artificially and temporarily boosting the economy along the way).  It's gone and issuing more debt in it's place is just asinine.

 

2- With immediate effect, benefits must be cut or taxes raised…you choose.  We can't pretend any longer and attempt to push the consequences out another generation.

Times up. The pain must begin now and must be shared equally by all.

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One month after Goldman strategists downgraded equities to neutral on growth and valuation concerns back in May, the firm turned up the heat on the bearish case with a June report by Christian Mueller-Glissmann, in which the Goldman strategist said that equity drawdown risk “appears elevated” with S&P 500 trading near record high, valuations stretched, lackluster economic growth and yield investors being “forced up the risk curve to equities.” Specifically Goldman warned to prepare for a “major drawdown.”

We, however, were skeptical, and concluded our take on Goldman’s newfound skepticism as follows: “we can’t help but be concerned that the last time Goldman warned about a big drop in the market a month ago, precisely the opposite happened. Will Goldman finally get this one right, or did the firm just say the magic words for the next leg higher in stocks? “

Well, Goldman was right about a brief “drawdown” in stocks just a few weeks later following the Brexit swoon, which however on the back on unprecedented central bank verbal support, resulted in one of the biggest rallies yet, not to mention a historic short squeeze, and indeed led to the next leg higher in stocks, to fresh all time highs to be precise.

So for those who believe that Goldman is just another incarnation of Dennis Gartman and are still bearish, you may want to close out any remaining short positions because moments ago, the same Christian Mueller-Glissman released a new report in which Goldman has gone outright bearish, with a “tactical downgrade to equities for the next 3 months.”

Here is the reasoning behind Goldman’s creeping sense of gloom:

• The rally in risky assets over the past few weeks has continued n and broadened – the S&P 500 has made all-time highs, the VIX has fallen, bonds and ‘safe havens’ started to sell off, and cyclicals have outperformed defensives.
• We think a key driver of the recovery has been a combination of the light positioning into Brexit and the search for yield amid expectations of easing.
• However, given equities remain expensive and earnings growth is poor, in our view equities are now just at the upper end of their ‘fat and flat’ range.
• Our risk appetite indicator is near neutral levels and its positive momentum has faded, suggesting positioning will give less support and we will need better macro fundamentals or stimulus to keep the risk rally going, but market expectations are already dovish and growth pick-up should take time.
• As a result, we downgrade equities tactically to Underweight over 3 months, but remain Neutral over 12 months. We remain Overweight cash and would look for resets lower in equities to add positions.

First off, in its attempt to skim over its most recent erroneous call, Goldman’s global risk appetite indicator “signalled a persistent lack of risk appetite ahead of Brexit (and in general since 2015), with our indicator mostly negative, and a sharp decline post the Brexit vote. The lack of positioning was a key reason why we decided to stay Neutral on equities despite the quick relief rally. Since then, our risk appetite indicator has increased further, indicating a continuation of the risk appetite reversal. We think the negative asymmetry in risky assets is increasing again. A positive level of the risk appetite indicator is not a bearish signal per se – the indicator can remain in positive territory for prolonged periods of time without any risk of drawdowns as long as macro fundamentals remain supportive. However, with our risk appetite indicator now in neutral territory, the market is more vulnerable to growth and policy disappointments, in our view. In addition, its positive momentum has faded and we are back at the levels we saw ahead of the last 3 drawdowns.”

Goldman adds the following:

While the initial risk appetite reversal had both risky and ‘risk-off’ assets rallying alongside each other in a strong search for yield, a more reflationary rally has occurred since July 8, during which bonds and other ‘risk-off’ assets such as gold and the Yen started to sell off, up until Friday. Alongside this, cyclicals and financials outperformed, while low vol stocks underperformed (Exhibit 3). The cyclicals vs. defensives roundtrip, for example, has happened across regions (Exhibit 4) and has been particularly strong in EM and Japan (supported by the financials’ rally after the recent BoJ decision), but we believe a large part of the reversal is now done and without a sustained pick-up in growth, the more pro-cyclical rally is running out of steam.

 

In short, Goldman’s doubling down on a bearish forecast have nothing to do with a change in fundamentals (which have not improved according to the firm) and everything to do with a shift in sentiment and positioning. To wit:

We think this reversal in positioning increases the likelihood of an equity pullback given that our fundamental view has not changed: valuations still appear high and we still expect poor earnings growth across regions. In our view, equities remain in their ‘fat and flat’ range and are now just near the upper end. As a result, we downgrade equities to Underweight in our 3-month asset allocation. Until the growth situation improves, we are not that constructive on equities, particularly after this type of rally and amid continuing concerns about the sustainability of stimulusled growth in China, global policy uncertainty (and in Europe in particular), dovish central bank expectations, and heightened prospects of unknown shocks (e.g. Turkey recently). We remain Overweight credit, which has less negative  asymmetry than equities, in our view.

So, if one believes that Goldman is going to be right this time, how should one trade the coming risk asset swoon? Some ideas from the taxpayer-backed hedge fund:

Cross-asset volatility has reset significantly lower, particularly relative to where recent realised levels are.

We remain Overweight cash over 3 months to benefit from a pick-up in volatility and look for opportunities to re-enter upon pullbacks in equity, as we remain Neutral over 12 months. We think the negative asymmetry for risky assets and for bonds could require more aggressive risk management. We highlight the following cross-asset opportunities:

1. Call-overwriting across indices
2. Short-dated S&P 500 options: Long OTM calls for investors worried about a squeeze higher, long puts for hedges
3. Long-dated Nikkei vol
4. Long gold vol
5. Long MSCI EM puts to hedge positions

Finally some thoughts from Goldman on the underlying macro situation…

Macro surprises have been positive, but from a low bar

 

The recent pro-cyclical tilt of the equity rally might in part be due to expectations of more reflationary central bank polices, but it has also been supported by a better macro backdrop relative to expectations. Our global macro surprise index (MAP) had an increase in July, driven by developed markets (Exhibit 14). And the correlation of equities with macro surprises has been positive, i.e. it’s a ‘good news is good news’ environment as dovish Fed expectations have been anchored. However, the positive macro surprises might in part be due to lowered expectations into and after Brexit. Friday’s US GDP release came in below expectations, primarily owing to a sizeable inventory correction.

 

… and the market’s take on monetary policy, which is at odds with an economy that is supposedly improving:

The current dovish Fed pricing is at odds with current macro trends, the significant easing of financial conditions during the relief rally and our economists’ forecast of above 2% US GDP growth in 2H2016. The repricing of Fed hikes since the beginning of the year has been extreme and now little is priced until 2018 (Exhibit 16). Our economists see a 65% probability of a hike this year (45% for December and 20% for September) post the Fed’s recent meeting as the FOMC indicated nearterm risks to the economic outlook have diminished, although Friday’s US GDP came in below expectations. Bearish rate shocks have put upward pressure onglobal bond yields, which could continue.

In short, Goldman believes the key risk to sentiment, and pricing, is that monetary policy expectations will disappoint.

So far, both the BoE and ECB have been on hold. Our economists expect the BoE to announce a 25 bp cut in the bank rate, Gilts and corporate bond purchases and an extension of the Funding for Lending Scheme. And they expect the ECB to extend its asset purchase programme to the end of 2017 (currently March 2017) at the September meeting, and the key according to which purchases under the PSPP are taking place to be changed from the ECB’s capital key to market capitalisation of debt outstanding. New fiscal easing in Japan is also broadly expected in the near term (see Japan Views: Economic stimulus package upwards of ¥28 tn, but real water component likely only around ¥5 tn over several years, July 27, 2016), but we have concerns that this fails to sustainably boost the market, as has often been the case in the past (see Japan Strategy Views: History Lessons, July 26, 2016). Unless expectations can be met or exceeded, the chances of another drawdown are heightened, in our view.

Taking all this into considerations, Goldman’s latest conclusion is relative simple: sell.

Policy uncertainty is still high post Brexit and has increased further in Europe, the US and China, in our view. In Europe, the Brexit negotiations are likely to take time; in the US, the general election cycle is starting; and in China, concerns have picked up – in fact, our economists have highlighted again a significant pick-up in FX outflows in June amid RMB weakening. Geopolitical risks have also moved again into focus with further terror attacks globally and the attempted military coup in  Turkey on July 15, 2016. With equities at the high end of their range, we think shocks such as these can drive downside from here.

Will Goldman again be wrong?  It’s distinctly possible, in which case we expect the firm to capitulate some time in September, when the S&P is around 2,300 and urging what clients it has left to buy stocks at all time highs. That would clearly market the moment to sell everything. On the other hand, considering Goldman dreadful forecasting record over the past year, it is about time the firm got one reco right, if only purely statistically.  But just to be safe, it may be wisest to wait until Gartman turns “pleasasntly long.”

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