Category: zerohedge

The traditionally quiet period for markets in December is turning out to be not-so-quiet, thanks to a key meeting of the U.S. Federal Reserve starting December 17. The meeting will decide on whether a reduction in quantitative easing (QE) is necessary. Consequently, every economic data point up to the meeting is being analysed and over-analysed. But it does appear that the Fed seems committed to so-called tapering at some point soon and the odds are 50:50 that it’ll pull the trigger in December.

A few weeks ago, I was asked for my 2014 global outlook by a large precious metals website and I told the editor that while tapering will be a key theme, Japan is likely to prove equally important if not more so. The editor was taken aback by this and I can understand why. But let me explain…

The Fed has been flagging tapering for some time and markets appear to have gotten used to the fact that it’ll happen soon. In May, when Bernanke first hinted of tapering, markets freaked out as they assumed a rise in interest rates would come simultaneously. Since then, the Fed has been at pains to say that interest rates will stay low for several years to come while a wind down in QE occurs. Markets appear to have bought this line. They may continue to buy the line through 2014 and even 2015.

While the U.S. cuts back on stimulus, Japan is likely to move in the opposite direction, increasing its own stimulus very soon. That’ll be on top of Japan’s existing QE which is the equivalent of 3x that of the U.S. when compared to GDP. The reason for even more QE is that the grand experiment known as Abenomics, almost one year old, has been a failure. It hasn’t lifted key components such as core inflation, wages or business spending.

Increased Japanese QE will mean a lower yen, potentially much lower. If right, that’ll have significant consequences. Among other things, it’ll increase the risks of exporting rivals fighting back by depreciating their own currencies and embracing a currency/trade war. Second, it’s likely to raise the ire of exporting competitor, China, and raise already high tensions in the South China Sea. If more stimulus fails to lift the Japanese economy, Abe will be desperate to maintain his credibility and a fight with China could just suit his ends. Hence why Japan matters. Perhaps more than tapering.

To taper or not to taper?

It may be the time when the Fed stops with all the flirting and finally starts to cut bond purchases. Bond whiz, Bill Gross of Pimco, suggests there’s a 50:50 chance, or even greater, of tapering this month. And he’s probably right given the many hints from the Fed that it’s ready to go down that path. If tapering does occur, markets will be assessing the potential time frame for a full wind-down of QE and the economic targets set by the Fed for that to happen.

To understand the potential consequences of tapering, let’s do a quick recap of what QE is and what it’s been trying to achieve. The Fed has put in place two key policies since the financial crisis:

1. Lower short-term interest rates towards zero.
2. Implement QE, involving the purchase of longer term bonds.

The Fed and other central banks have done this to achieve several ends:

• Suppress bond yields and thereby interest rates (check).
• Buying the bonds from banks and other institutions who can use that money to lend out and therefore stimulate the economy (hasn’t happened).
• The printed money also helping banks to repair their balance sheets, devastated by 2008 (check, at least in the U.S.)
• Keeping short-term rates near zero means pitiful bank deposit rates and tempting depositors into higher yielding but higher risk investments (check).
• Rising asset prices inducing the wealth effect, where people feel wealthier and start to spend again (minimal success, but let’s wait and see).
• Keeping interest rates below GDP rates, thereby reducing the developed world’s large debt to GDP ratios (slow progress given sluggish GDP).

The Fed is now contemplating tapering as it sees a recovering economy and is worried about QE’s stimulatory effects on asset prices. Tapering involves cutting back on the purchase of long-term bonds while keeping short-term interest rates near zero.

In essence, the Fed is saying: “Look everyone, we’re going to keep short-term interest rates near zero for a very long time. We’re resolute with this and hoping that cutting back on the buying of long-term bonds won’t lead to a spike in long-term bond yields. Please, market, cooperate with us in achieving this aim.”

The Fed knows markets largely control the long-term bond. It can’t afford to lose control of the bond market as higher long-term bond yields would result in increased mortgage rates and rising government interest expenses. That outcome would be a disaster as consumers and governments simply wouldn’t be able to cope with even a small spike in rates. And any hoped-for economic recovery would be over.

Key risks to the tapering strategy include a stronger-than-expected economic recovery or higher future inflation expectations, and the Fed moving too late to raise short-term rates. Alternatively, an economic recovery doesn’t take place and more QE is needed to maintain current growth. Here, the Fed would lose immense credibility and may eventually lose control of the bond market as investors start to demand higher yields on government debt.

But these risks may not be short-term story if investors believe that tapering and rising rates don’t go hand-in-hand.

Increased Japanese QE coming soon

On December 16 last year, Shinzo Abe came to power and promised the most audacious economic reforms in Japan since the 1930s in order to arrest a 23-year deflationary slump. Almost a year on, the reforms now known as Abenomics can be judged a failure. This failure may soon result in policies which could have a greater impact on markets in 2014 than the much talked about taper.

Initially Abenomics involved a strategy with the so-called three arrows. The first arrow was a dramatic expansion in the central bank’s balance sheet to lift inflation to a 2% target rate. The second arrow involved a temporary fiscal support program. While the third was structural reform to the economy.

The first arrow came with much fanfare and resulted in a large depreciation of the yen. Yen devaluation wasn’t a stated aim but was certainly a target given a lower currency is needed to lift inflation. The big problem is that inflation has risen for the wrong reasons via higher import costs. Core inflation is flat as wages have barely moved.

The second arrow was implemented while the third arrow largely hasn’t been fired. The market has been disappointed with the latter as it knows economic reform is needed for stronger and sustainable growth. Abe has resisted change on this front given the entrenched interests against reform.

A fourth arrow has been fired, though, in the form of an increased consumption tax. The tax will increase from 5% to 8% in April next year. This is necessary to raise government revenues given Japan’s unsustainable budgetary position where government debt is 20x government revenues. The problem is that the tax will depress spending and cut GDP growth by an estimated 2% next year. To partially compensate for this, Abe has promised corporate tax relief and infrastructure spending of 5 trillion yen, equivalent to 1% of GDP. In other words, more stimulus to partially offset the impact from rising taxes.

Given the failure of Abenomics to lift core inflation or wages, you can soon expect even more stimulus on top of the 290 trillion yen already planned between now and end-2014. And this is likely to result in a much weaker yen, for the following reasons:

• To reach a targeted 2% annual inflation rate requires the yen to depreciate by around 15% per year. That translates into a +115 yen/dollar rate by the end of next year.
• If U.S. tapering occurs, that will widen the yield differentials between U.S. and Japanese bonds even further. Those yield differentials currently point to fair value of 115-120 yen/dollar rate.

• More QE should result in more money heading offshore and a subsequent weakening of the yen.

If a much lower yen is on the cards, it’ll have the following consequences:

• Japan will export even more deflation to the world when it least needs it. By this I mean that a lower yen allows Japanese exporters to price their products more competitively vis-vis other exporters. This would raise already heightened global deflationary risks.
• It’ll put other exporting powerhouses, such as Germany, China and South Korea, in a less competitive position, increasing the odds of a backlash via currency war. The yen at 115 or 120/dollar would change the ballgame and increase the risks of this occurring.
• Any currency war risks a trade war. Historically, trade wars reduce global trade, sometimes significantly.
• Putting China in a weakened exporting position will possibly increase tensions in the South China Sea. Tensions are already high and a lower yen won’t help the cause.
• You don’t have to have a wild imagination to see that if Japan’s experiment doesn’t help lift inflation and the economy, a desperate, nationalist Prime Minister may just be more inclined to take the fight up to China.

The above analysis could well turn out to be incorrect. Perhaps Japan holds off on stimulus. Or it increases QE but combines it with meaningful structural reform.

Maybe. Whichever way Asia Confidential looks at it though, a substantially lower yen would seem to be something you can almost take to the bank. And the implications of that being the case are worth thinking about as we head into 2014.

This post was originally published at Asia Confidential:
http://asiaconf.com/2013/12/07/japan-matters-more-than-taper/

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/9hanJXvIzMQ/story01.htm Asia Confidential

Authored by Yannos Papantoniou (Greece's Economy & Finance Minister 1994 to 2001), originally posted at Project Syndicate,

As the eurozone debt crisis has steadily widened the divide between Europe’s stronger northern economies and the weaker, more debt-laden economies in the south (with France a kind of no man’s land economy in between), one question is on everyone’s mind: Can Europe’s monetary union – indeed, the European Union itself – survive?

While the eurozone’s northern members enjoy low borrowing costs and stable growth, its southern members face high borrowing costs, recession, and deep cuts in incomes and social spending. They have also suffered substantial output losses, and have far higher unemployment rates than their northern counterparts. Unemployment in the eurozone as a whole averages about 12%, compared to more than 25% in Spain and Greece (where youth unemployment now stands at 60%). Indeed, while aggregate per capita income in the eurozone remains at 2007 levels, Greece has been pushed back to 2000 levels, and Italy today finds itself somewhere in 1997.

Europe’s southern economies owe their deteriorating circumstances largely to excessive austerity and the absence of measures to compensate for demand losses. Currency devaluation – which would boost the competitiveness of domestic industry by lowering export prices – obviously is not an option in a monetary union.

But Europe’s stronger economies have resisted pressure to undertake more expansionary fiscal policies, which would lift demand for its weaker economies’ exports. The European Central Bank did not follow the lead of other advanced-country central banks, such as the US Federal Reserve, in pursuing a more aggressive monetary policy to cut borrowing costs. And no financing has been offered for public-investment projects in the southern countries.

Moreover, fiscal and financial measures aimed at strengthening eurozone governance have been inadequate to restore confidence in the euro. And Europe’s troubled economies have been slow to undertake structural reforms; improvements in competitiveness reflect wage and salary cuts, rather than productivity gains.

While these policies – or lack thereof – have impeded recovery in the southern countries, they have yielded reasonable growth and very low unemployment rates for the northern economies. In fact, by maintaining large trade surpluses, Germany is exporting unemployment and recession to its weaker neighbors.

As Europe’s north-south divide widens, so will interest-rate differentials; as a result, conducting a single monetary policy will become increasingly difficult. In the recession-afflicted south, continued fiscal consolidation will demand new austerity measures – a prospect that citizens will reject. Such impasses will lead to social tension and political crisis, or to new requests for financial assistance, which the northern countries are certain to resist. Either way, financial and political instability could lead to the common currency’s collapse.

As long as the eurozone establishes a kind of wary equilibrium, with the weaker economies stabilizing at low growth rates, current policies are unlikely to change. Incremental intergovernmental solutions will continue to prevail, and Europe’s economy will soldier on, steadily losing ground to the US and emerging economies like China and India.

For now, Germany is satisfied with the status quo, enjoying stable growth and retaining control over domestic economic policy, while the ECB’s limited powers and strict mandate to maintain price stability ease fears of inflation.

But how will Germany react when the north-south divide becomes large enough to threaten the euro’s survival? The answer depends on how Germans perceive their long-term interests, and on the choices of Chancellor Angela Merkel. Her recent election to a third term offers room for bolder policy choices, while forcing her to focus more on her legacy – specifically, whether she wishes to be associated with the euro’s collapse or with its revival.

Two outcomes now seem possible. One scenario is that the economic and political crisis in the southern countries spreads, inciting fears in Germany that the country faces a long-term threat. This could drive Germany to withdraw from the eurozone and form a smaller currency union with other northern countries.

The second possibility is that the crisis remains relatively contained, leading Germany to pursue closer economic and fiscal union. This would entail the mutualization of some national debt and the transfer of economic-policy sovereignty to supranational European institutions.

Of course, such a move would carry considerable political costs in Germany, where many taxpayers recoil at the notion of assuming the debts of the fiscally profligate southern countries, without considering how much Germany would benefit from a stable and dynamic monetary union. But a new grand coalition between Merkel and the Social Democrats could be sufficient to make this shift possible.

Even so, there could be victims. Indeed, the continued failure of smaller countries like Greece and Cyprus to fulfill their commitments reinforces the impression that they will forever be dependent on financial assistance. The exit of one or two of these “undisciplined” countries could be a requirement for the German public to agree to such a policy shift.

Europe’s north-south divide has become a time bomb lying at the foundations of the currency union. Defusing it will require less austerity, more demand stimulus, greater investment support, deeper reforms, and meaningful progress toward economic and political union. One hopes that modest recovery in the south, aided by strong German leadership in the north, will steer Europe in the right direction.
 

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/hMPbVa-PN4w/story01.htm Tyler Durden

Authored by Yannos Papantoniou (Greece's Economy & Finance Minister 1994 to 2001), originally posted at Project Syndicate,

As the eurozone debt crisis has steadily widened the divide between Europe’s stronger northern economies and the weaker, more debt-laden economies in the south (with France a kind of no man’s land economy in between), one question is on everyone’s mind: Can Europe’s monetary union – indeed, the European Union itself – survive?

While the eurozone’s northern members enjoy low borrowing costs and stable growth, its southern members face high borrowing costs, recession, and deep cuts in incomes and social spending. They have also suffered substantial output losses, and have far higher unemployment rates than their northern counterparts. Unemployment in the eurozone as a whole averages about 12%, compared to more than 25% in Spain and Greece (where youth unemployment now stands at 60%). Indeed, while aggregate per capita income in the eurozone remains at 2007 levels, Greece has been pushed back to 2000 levels, and Italy today finds itself somewhere in 1997.

Europe’s southern economies owe their deteriorating circumstances largely to excessive austerity and the absence of measures to compensate for demand losses. Currency devaluation – which would boost the competitiveness of domestic industry by lowering export prices – obviously is not an option in a monetary union.

But Europe’s stronger economies have resisted pressure to undertake more expansionary fiscal policies, which would lift demand for its weaker economies’ exports. The European Central Bank did not follow the lead of other advanced-country central banks, such as the US Federal Reserve, in pursuing a more aggressive monetary policy to cut borrowing costs. And no financing has been offered for public-investment projects in the southern countries.

Moreover, fiscal and financial measures aimed at strengthening eurozone governance have been inadequate to restore confidence in the euro. And Europe’s troubled economies have been slow to undertake structural reforms; improvements in competitiveness reflect wage and salary cuts, rather than productivity gains.

While these policies – or lack thereof – have impeded recovery in the southern countries, they have yielded reasonable growth and very low unemployment rates for the northern economies. In fact, by maintaining large trade surpluses, Germany is exporting unemployment and recession to its weaker neighbors.

As Europe’s north-south divide widens, so will interest-rate differentials; as a result, conducting a single monetary policy will become increasingly difficult. In the recession-afflicted south, continued fiscal consolidation will demand new austerity measures – a prospect that citizens will reject. Such impasses will lead to social tension and political crisis, or to new requests for financial assistance, which the northern countries are certain to resist. Either way, financial and political instability could lead to the common currency’s collapse.

As long as the eurozone establishes a kind of wary equilibrium, with the weaker economies stabilizing at low growth rates, current policies are unlikely to change. Incremental intergovernmental solutions will continue to prevail, and Europe’s economy will soldier on, steadily losing ground to the US and emerging economies like China and India.

For now, Germany is satisfied with the status quo, enjoying stable growth and retaining control over domestic economic policy, while the ECB’s limited powers and strict mandate to maintain price stability ease fears of inflation.

But how will Germany react when the north-south divide becomes large enough to threaten the euro’s survival? The answer depends on how Germans perceive their long-term interests, and on the choices of Chancellor Angela Merkel. Her recent election to a third term offers room for bolder policy choices, while forcing her to focus more on her legacy – specifically, whether she wishes to be associated with the euro’s collapse or with its revival.

Two outcomes now seem possible. One scenario is that the economic and political crisis in the southern countries spreads, inciting fears in Germany that the country faces a long-term threat. This could drive Germany to withdraw from the eurozone and form a smaller currency union with other northern countries.

The second possibility is that the crisis remains relatively contained, leading Germany to pursue closer economic and fiscal union. This would entail the mutualization of some national debt and the transfer of economic-policy sovereignty to supranational European institutions.

Of course, such a move would carry considerable political costs in Germany, where many taxpayers recoil at the notion of assuming the debts of the fiscally profligate southern countries, without considering how much Germany would benefit from a stable and dynamic monetary union. But a new grand coalition between Merkel and the Social Democrats could be sufficient to make this shift possible.

Even so, there could be victims. Indeed, the continued failure of smaller countries like Greece and Cyprus to fulfill their commitments reinforces the impression that they will forever be dependent on financial assistance. The exit of one or two of these “undisciplined” countries could be a requirement for the German public to agree to such a policy shift.

Europe’s north-south divide has become a time bomb lying at the foundations of the currency union. Defusing it will require less austerity, more demand stimulus, greater investment support, deeper reforms, and meaningful progress toward economic and political union. One hopes that modest recovery in the south, aided by strong German leadership in the north, will steer Europe in the right direction.
 

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/hMPbVa-PN4w/story01.htm Tyler Durden

By EconMatters  

 

 

 

© EconMatters All Rights Reserved | Facebook | Twitter | Post Alert | Kindle

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/jM0QFUeQD3Q/story01.htm EconMatters

It was inevitable that a few short days after Wall Street lovingly embraced Bitcoin as their own, with analysts from Bank of America, Citigroup and others, not to mention the clueless momentum-chasing, peanut gallery vocally flip-flopping on the “currency” after hating it at $200 only to love it at $1200 that Bitcoin… would promptly crash. And crash it did: overnight, following previously reported news that China’s Baidu would follow the PBOC in halting acceptance of Bitcoin payment, Bitcoin tumbled from a recent high of $1155 to an almost electronically destined “half-off” touching $576 hours ago, exactly 50% lower, on very heave volume, before a dead cat bounce levitated the currency back to the $800 range, where it may or may not stay much longer, especially if all those who jumped on the bandwagon at over $1000 on “get rich quick” hopes and dreams, only to see massive losses in their P&Ls decide they have had enough.

Which incidentally, like gold, is to be expected when one treats what is explicitly as a currency on its own merits in a world of dying fiat – with the appropriate much required patience – instead of as an asset, with delusions of grandure that some greater fool will pay more for it tomorrow than it is worth today. Sadly, in a world of HFT trading, patience is perhaps the most valuable commodity.

As for Bitcoin, while the bubble may or may not have burst, and is for now kept together with the help of the Winklevoss bros bid, all it would take is for another very vocal institutiona rejection be it in China or domestically, where its “honeypot” features are no longer of use to the Fed or other authorities, for the euphoria to disappear as quickly as it came…

Two day chart, showing the epic move from $1155 to $576 in hours:

And longer term chart showing the overnight action in its full glory:

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/BenzOEWh3fs/story01.htm Tyler Durden

Contrary to what many, including ourselves thought, the expected divergence of monetary policy between the Federal Reserve tapering on one hand, and the European Central Bank (and Bank of Japan) which likely to have to provide more monetary support next year on the other hand, has not spurred a US dollar rally against European currencies.  There is little reason to expect this to change, from a technical point of view.

 

That said, the dollar’s losses have not been broad based.  Sterling and euro (and the Swiss franc and Danish krone) are where the greenback’s losses have been concentrated.  In part, the market appears to be taking the Fed’s guidance seriously.  Tapering is not tightening.   The premium the US offers over Germany on 2-year money has been nearly halved over the past week to 9 bp.  The nearly 20 bp discount of the US compared to the UK is near the largest since late 2011.

 

Yet, when it comes to the yen, it does not appear that interest rate differentials were the key driver. Normally, we find the exchange rate is more sensitive to long-term rate differentials.   The US 10-year rate premium over Japan widen to new multi-year highs of almost 224 bp on December 5, even as the dollar was recording six-day lows against the yen.  We suspect the pullback in Japanese equities (~4.5% fall Dec 3-5) was a more significant factor.  The combination of the bounce in the dollar against the yen after the US employment data, the rally in US shares, and the strong close in the Nikkei, warns that last week’s gap, found 15579 and 15661 will likely be tested early in the week ahead (pre-weekend close 15300) . 

 

This suggests that the dollar  will have another run at JPY103.75, high set in late May.  Support has been established near in the JPY101.65-80 area. 

 

The dollar’s weakness against the European currencies does not appear exhausted.   The only cautionary note from technical indicators is that the euro and Swiss franc are at the top of their Bollinger Bands, which are set +/- 2 standard deviations from the 20-day moving average.  Although the returns (changes) in currency prices are not normally distributed, a break of the bands may still be seen as reflecting  a stretched market.     This should encourage buying on the next pullback. 

 

The next technical target for the euro is $1.3800-30.   A similar level for the dollar against the Swiss franc is found just below CHF0.8900.  There is little chart-based support below there before CHF0.8500. 

 

The US Dollar Index, which is heavily weighted toward the complex of European currencies,  tested the 80.30 area which represents a 50% retracement of the rally from late October through the first part of November.  The next retracement objective is near 79.90.  A break of this area could signal a move to the year’s recorded in February just below 79.00. 

 

Sterling has been a bit disappointing after rising to new two-year highs at the start of last week near $1.6440, it has under-performed, but the advance does not seem to be over.    Support is seen near $1.6260, which correspond to the Oct highs.   We target the $1.6600-$1.6750 on the next leg up.   That said, the recent highs in sterling were not confirmed by the RSI or the MACDs. 

 

We have been frustrated by the Australian dollar.  Last week, we suggested the Aussie was set to bounce.   The bounce was muted and the Aussie fell to lows since early Sept before the US jobs data.  It subsequently rallied and finished the North American session above the previous day’s high, setting up a potential key reversal.  Initial resistance is seen near $0.9140 and then $0.9200. 

 

The US dollar extended its recent gains against the Canadian dollar to the CAD1.07 level.  It was tested Wed-Fri last week and the greenback failed to close above it even once. The technical indicators are not suggesting an important high is in place, but a break of CAD1.06 will likely spur a bout of profit-taking. 

 

The US dollar began last week by extending its gains against the Mexican peso.  It reached almost MXN13.27 on Dec 3 before reversing lower and finished the week near 3-week lows, having tested the MXN12.90 area.  Technical indicators warn of potential of additional dollar weakness in the period ahead that could extend to MXN12.80 or a bit lower. 

 

Observations on speculative positioning in selected currency futures at the CME:

 

1.  The mixed spot performance of the dollar is reflected in the speculative positions in the currency futures. On a net basis, speculators are long the euro, sterling, Swiss franc, and Mexican peso.  They are short yen and the Australian and Canadian dollars.   This is almost the opposite of earlier this year, though the speculative market was short yen then too.

 

2.  Gross long currency positions were generally added to, except in the yen and Mexican peso.  Almost a quarter of the peso longs were squeezed out (10.9k contracts), but in the three sessions after the reporting period ended, the peso has come back strongly.  Gross short currency positions were more mixed, but the larger adjustments came from adding to shorts (especially the Canadian dollar, 17.2k contracts and Australian dollar 13.8k contracts).

 

3.  Gross sterling longs saw the biggest increase, 17k contracts.  The gross long sterling position is the largest of the currency futures we track.  At 18.4k contracts it is nearly twice as large as the second place euros (9.3k contracts).

 

4.  At 134.7k contracts, the gross short yen position is at a new five year high.  The gross short Canadian dollar position (41.6k contracts) is the largest in six months.

 

5.  The net euro position swung back to the long side (9.3k contracts) after briefly and shallowly (0.4k contracts) to the short side the previous week.  The net position had been near 72k contracts in early Nov. The shift was more about longs liquidating than new shorts entering.  From Oct 22 through end of November, the gross long position fell 55k contracts, while the gross shorts rose by about 15k contracts in roughly a slightly longer period.  The price action since the reporting period ended suggest this position adjustment was being reversed.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Eu3ffPAFkVg/story01.htm Marc To Market

Submitted by Michael Krieger of Liberty Blitzkrieg blog,

The drone issue is just another topic in which President Barrack Obama has proven himself to be a world-class liar and master of deception. Despite his claims that drone strikes do little damage to civilian populations, in July we discovered that “of the 746 people killed in drone strikes in Pakistan from 2006-2009, an incredible 20% were civilians and 94 (13% of the total) were children.”

I suppose that number just isn’t good enough, because The Pentagon has decided to change the rules of engagement when it comes to drone strikes, now making it easier to target civilians. From The Washington Times:

The Pentagon has loosened its guidelines on avoiding civilian casualties during drone strikes, modifying instructions from requiring military personnel to “ensure” civilians are not targeted to encouraging service members to “avoid targeting” civilians.

Hey cops, how about you “try to avoid” beating the shit out of people and violating their constitutional rights for no reason. Yeah, because that’ll work.

In addition, instructions now tell commanders that collateral damage “must not be excessive” in relation to mission goals, according to Public Intelligence, a nonprofit research group that analyzed the military’s directives on drone strikes.

 

Administration officials say the strikes are legal because the U.S. is at war with al Qaeda and its associates. They also insist there is a wide gap between the government’s civilian casualty count and those of human rights groups.

Right, we are at “war with al Qaeda,” when it is convenient to be at war with them. When it is convenient to be allies with al Qaeda, we will do that too.

Despite Mr. Obama’s pledge for more transparency on drone strikes, the administration “continues to answer legitimate questions and criticisms by saying, ‘We can’t really talk about this,’” said Naureen Shah, advocacy adviser at Amnesty International.

Can’t. Make. This. Stuff. Up.

Full article here.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/vd_pZnDtlig/story01.htm Tyler Durden

The stock market. Source of unknown riches – but not necessarily for investors. So-called "professional" investors offer to manage your money. However, their fees are based on the level of assets managed, not performance. Hence their goal is to maximize assets, not performance, and prey for markets to behave. You will never hear a bad word about stocks from a professional money manager. the by-laws of many mutual funds do not allow the manager to have cash levels above 5% of assets. He has to be invested at least 95% at all times. On one hand, it is probably right to force money managers to concentrate on stock picking, not market timing. On the other hand, this puts the onus of market timing onto the inidiviual investors. Lighthouse's Alex Gloy's excellent presentation below proves finance doesn't have to be complex (people make it complex).

Via Lighthouse Investment Management's Alex Gloy,

The money management industry would like to have their clients' assets indefinitely, through bull- and bear markets. Ride the wave during good times. And simply state that "nobody could have foreseen this", "we don't have a crystal ball" or "it's too late to sell now" in case of a crash.

There must be a better way to invest.

This publication tries to assess the following questions:

1. What kind of return can be reasonably expected from stock market investments? Is that rate
sustainable?
2. What kind of simple tools exist to tell if the stock market is cheap or expensive?
3. Are stock market returns mean-reverting?
4. Are we going to continue to see similar cyclical fluctuations in the future, or are we in the midst of a structural break?

I will try to keep things as simple as possible. Finance doesn't have to be complex (people make it complex). A picture says more than a thousand words – I hope the following charts help.

Performance: How to Visualize It

How do we look at performance?

Above you see the S&P 500 Index since 18711. By looking at the black line (nominal, non-logarithmic scale) you would think there was no point in investing before 1981. That's why you should look at longterm data on a logarithmic scale. The green surface is the real (inflation-adjusted) S&P 500. Should we look at nominal or real returns? What good is a 10% rise in the stock market if inflation runs at 20%? Conventional wisdom has it that inflation is good for stocks. It that true? Compare the chart on the next page:

Performance: Nominal or Real

Look what the inflationary period of the 1980's did to stocks: not much in nominal terms (black line), but devastating in real terms (green surface). From 1973 to 1982, the nominal S&P remained stable (117 versus 118 points). However, in real terms, the index fell from 640 to 286 (-55%). Yes, you would have lost purchasing power, too, if you kept your money in cash. But that is a different question.

For performance measurement, real returns count.

Today, the S&P 500 is around 1,800 compared to 82 (real) in 1871, yielding a real return of 2.2%3. But the S&P 500 is a price index (as opposed to total return), so we must account for dividends (and reinvestment of those). Including dividends, the total real return is around 6.5%. Impressively, this shows how important dividends are (2/3 of total return) in the long run.

We don't live 142 years, so the average total real return from 1871 to 2013 is not so useful for the individual investor. But you can slice those 142 years into periods of 10, 20 and 30 years. Take the returns over those periods and plot their frequency (see above).

You will notice that among all 10-year periods (blue) you had a few with negative returns. When investing over 20-year periods, you would have suffered only one (ending in 1921) with close to zero return. The longer your investment horizon, the closer the returns are clustered around the average, or expected, value. You can see it visually as the distribution of returns gets "slimmer" (green surface) and contains less "outliers".

The more data points we add, the closer the annual returns lie around the same mean (average). This serves as indication that stock market returns are mean-reverting.

Conclusion: It makes little sense to invest in stocks with a time horizon of less than 10 years.

Problems:

1. In 20 years, many different people will have been at the helm of the job as money manager
2. Career risk: most money managers get terminated after a few quarters of unsatisfactory
performance (hence nobody dares to stick his neck out)
3. End-user risk: very few investors would be willing to accept multiple years of disappointing performance (changing strategy mid-term and hence messing up performance)

And here lies the conundrum: almost nobody is investing according to what theory prescribes.

It doesn't help that you can check on the value of your investments every minute via your smart phone.

Do you check every day what your house is worth? No, because, luckily, that is impossible.

It would probably be beneficial for most investors if their investments traded only once a year. The constant availability of pricing information, coupled with swings from one minute to the next add to psychological pressure, leading to mistakes.

Valuation: Price-Earnings

The previous chapter assumes you don't try to time the market (you just invest whenever funds are available and lock them up for at least 20 years). But the stock market rarely trades at fair value. It is either over- or undervalued. What if you could actually determine those valuations? And what do you base valuation on?

In the long run, stocks are driven by earnings:

The problem: company profits are very cyclical. Meaning: in every recession they decline by large amounts, only to recover strongly afterwards.

From 2006 to 2008, for example, real earnings for the S&P 500 declined from $94.70 to $28.50 (-70%).

The price-earnings multiple, or P/E-ratio, rose from 15.7 to 52.7 despite a drop in share prices. Stocks seem expensive when they are not and vice versa.

So Professor Robert Shiller (Yale) came up with a simple solution to smooth out cyclicality: take the average earnings from the last 10 years. Boom and bust should even out.

Valuation: CAPE

The "cyclically-adjusted price-earnings"-ratio (CAPE, or Shiller-P/E) was born.

It actually does a much better job in pointing out when the stock market is "cheap" or "expensive". It also shows the extent of the stock market bubble in 1999/2000.

The average 10-year CAPE-ratio since 1871 is 17 (low: 7 in 1933, high: 42.5 in 2000). Today, we are at 24.6.

 

This puts us pretty far towards the expensive side.

What you do know is the starting CAPE-ratio, and assume a regression to mean (17). With today's CAPE (25), we are facing strong headwinds for returns over the next 10 years. Sliding down the above regression line, the expected annual real return for -8 CAPE points is only around 1%. This does definitely not compensate for the risk associated with stocks. As a result, you should lighten up on stocks.

Gloy goes on to discuss the link between GDP and Profits, War, Inflation, and its effect on all markets.

 

Lighthouse – Equity Market Monitor – 2013-12 by Alexander Gloy

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Ojl8LPf1qTY/story01.htm Tyler Durden

The stock market. Source of unknown riches – but not necessarily for investors. So-called "professional" investors offer to manage your money. However, their fees are based on the level of assets managed, not performance. Hence their goal is to maximize assets, not performance, and prey for markets to behave. You will never hear a bad word about stocks from a professional money manager. the by-laws of many mutual funds do not allow the manager to have cash levels above 5% of assets. He has to be invested at least 95% at all times. On one hand, it is probably right to force money managers to concentrate on stock picking, not market timing. On the other hand, this puts the onus of market timing onto the inidiviual investors. Lighthouse's Alex Gloy's excellent presentation below proves finance doesn't have to be complex (people make it complex).

Via Lighthouse Investment Management's Alex Gloy,

The money management industry would like to have their clients' assets indefinitely, through bull- and bear markets. Ride the wave during good times. And simply state that "nobody could have foreseen this", "we don't have a crystal ball" or "it's too late to sell now" in case of a crash.

There must be a better way to invest.

This publication tries to assess the following questions:

1. What kind of return can be reasonably expected from stock market investments? Is that rate
sustainable?
2. What kind of simple tools exist to tell if the stock market is cheap or expensive?
3. Are stock market returns mean-reverting?
4. Are we going to continue to see similar cyclical fluctuations in the future, or are we in the midst of a structural break?

I will try to keep things as simple as possible. Finance doesn't have to be complex (people make it complex). A picture says more than a thousand words – I hope the following charts help.

Performance: How to Visualize It

How do we look at performance?

Above you see the S&P 500 Index since 18711. By looking at the black line (nominal, non-logarithmic scale) you would think there was no point in investing before 1981. That's why you should look at longterm data on a logarithmic scale. The green surface is the real (inflation-adjusted) S&P 500. Should we look at nominal or real returns? What good is a 10% rise in the stock market if inflation runs at 20%? Conventional wisdom has it that inflation is good for stocks. It that true? Compare the chart on the next page:

Performance: Nominal or Real

Look what the inflationary period of the 1980's did to stocks: not much in nominal terms (black line), but devastating in real terms (green surface). From 1973 to 1982, the nominal S&P remained stable (117 versus 118 points). However, in real terms, the index fell from 640 to 286 (-55%). Yes, you would have lost purchasing power, too, if you kept your money in cash. But that is a different question.

For performance measurement, real returns count.

Today, the S&P 500 is around 1,800 compared to 82 (real) in 1871, yielding a real return of 2.2%3. But the S&P 500 is a price index (as opposed to total return), so we must account for dividends (and reinvestment of those). Including dividends, the total real return is around 6.5%. Impressively, this shows how important dividends are (2/3 of total return) in the long run.

We don't live 142 years, so the average total real return from 1871 to 2013 is not so useful for the individual investor. But you can slice those 142 years into periods of 10, 20 and 30 years. Take the returns over those periods and plot their frequency (see above).

You will notice that among all 10-year periods (blue) you had a few with negative returns. When investing over 20-year periods, you would have suffered only one (ending in 1921) with close to zero return. The longer your investment horizon, the closer the returns are clustered around the average, or expected, value. You can see it visually as the distribution of returns gets "slimmer" (green surface) and contains less "outliers".

The more data points we add, the closer the annual returns lie around the same mean (average). This serves as indication that stock market returns are mean-reverting.

Conclusion: It makes little sense to invest in stocks with a time horizon of less than 10 years.

Problems:

1. In 20 years, many different people will have been at the helm of the job as money manager
2. Career risk: most money managers get terminated after a few quarters of unsatisfactory
performance (hence nobody dares to stick his neck out)
3. End-user risk: very few investors would be willing to accept multiple years of disappointing performance (changing strategy mid-term and hence messing up performance)

And here lies the conundrum: almost nobody is investing according to what theory prescribes.

It doesn't help that you can check on the value of your investments every minute via your smart phone.

Do you check every day what your house is worth? No, because, luckily, that is impossible.

It would probably be beneficial for most investors if their investments traded only once a year. The constant availability of pricing information, coupled with swings from one minute to the next add to psychological pressure, leading to mistakes.

Valuation: Price-Earnings

The previous chapter assumes you don't try to time the market (you just invest whenever funds are available and lock them up for at least 20 years). But the stock market rarely trades at fair value. It is either over- or undervalued. What if you could actually determine those valuations? And what do you base valuation on?

In the long run, stocks are driven by earnings:

The problem: company profits are very cyclical. Meaning: in every recession they decline by large amounts, only to recover strongly afterwards.

From 2006 to 2008, for example, real earnings for the S&P 500 declined from $94.70 to $28.50 (-70%).

The price-earnings multiple, or P/E-ratio, rose from 15.7 to 52.7 despite a drop in share prices. Stocks seem expensive when they are not and vice versa.

So Professor Robert Shiller (Yale) came up with a simple solution to smooth out cyclicality: take the average earnings from the last 10 years. Boom and bust should even out.

Valuation: CAPE

The "cyclically-adjusted price-earnings"-ratio (CAPE, or Shiller-P/E) was born.

It actually does a much better job in pointing out when the stock market is "cheap" or "expensive". It also shows the extent of the stock market bubble in 1999/2000.

The average 10-year CAPE-ratio since 1871 is 17 (low: 7 in 1933, high: 42.5 in 2000). Today, we are at 24.6.

 

This puts us pretty far towards the expensive side.

What you do know is the starting CAPE-ratio, and assume a regression to mean (17). With today's CAPE (25), we are facing strong headwinds for returns over the next 10 years. Sliding down the above regression line, the expected annual real return for -8 CAPE points is only around 1%. This does definitely not compensate for the risk associated with stocks. As a result, you should lighten up on stocks.

Gloy goes on to discuss the link between GDP and Profits, War, Inflation, and its effect on all markets.

 

Lighthouse – Equity Market Monitor – 2013-12 by Alexander Gloy

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/Ojl8LPf1qTY/story01.htm Tyler Durden

Authored by Marc Faber, originally posted at The Daily Reckoning blog,

As a distant but interested observer of history and investment markets I am fascinated how major events that arose from longer-term trends are often explained by short-term causes. The First World War is explained as a consequence of the assassination of Archduke Franz Ferdinand, heir to the Austrian-Hungarian throne; the Depression in the 1930s as a result of the tight monetary policies of the Fed; the Second World War as having been caused by Hitler; and the Vietnam War as a result of the communist threat.

Similarly, the disinflation that followed after 1980 is attributed to Paul Volcker’s tight monetary policies. The 1987 stock market crash is blamed on portfolio insurance. And the Asian Crisis and the stock market crash of 1997 are attributed to foreigners attacking the Thai Baht (Thailand’s currency). A closer analysis of all these events, however, shows that their causes were far more complex and that there was always some “inevitability” at play.

Take the 1987 stock market crash. By the summer of 1987, the stock market had become extremely overbought and a correction was due regardless of how bright the future looked. Between the August 1987 high and the October 1987 low, the Dow Jones declined by 41%. As we all know, the Dow rose for another 20 years, to reach a high of 14,198 in October of 2007.

These swings remind us that we can have huge corrections within longer term trends. The Asian Crisis of 1997-98 is also interesting because it occurred long after Asian macroeconomic fundamentals had begun to deteriorate. Not surprisingly, the eternally optimistic Asian analysts, fund managers , and strategists remained positive about the Asian markets right up until disaster struck in 1997.

But even to the most casual observer it should have been obvious that something wasn’t quite right. The Nikkei Index and the Taiwan stock market had peaked out in 1990 and thereafter trended down or sidewards, while most other stock markets in Asia topped out in 1994. In fact, the Thailand SET Index was already down by 60% from its 1994 high when the Asian financial crisis sent the Thai Baht tumbling by 50% within a few months. That waked the perpetually over-confident bullish analyst and media crowd from their slumber of complacency.

I agree with the late Charles Kindleberger, who commented that “financial crises are associated with the peaks of business cycles”, and that financial crisis “is the culmination of a period of expansion and leads to downturn”. However, I also side with J.R. Hicks, who maintained that “really catastrophic depression” is likely to occur “when there is profound monetary instability — when the rot in the monetary system goes very deep”.

Simply put, a financial crisis doesn’t happen accidentally, but follows after a prolonged period of excesses (expansionary monetary policies and/or fiscal policies leading to excessive credit growth and excessive speculation). The problem lies in timing the onset of the crisis. Usually, as was the case in Asia in the 1990s, macroeconomic conditions deteriorate long before the onset of the crisis. However, expansionary monetary policies and excessive debt growth can extend the life of the business expansion for a very long time.

In the case of Asia, macroeconomic conditions began to deteriorate in 1988 when Asian countries’ trade and current account surpluses turned down. They then went negative in 1990. The economic expansion, however, continued — financed largely by excessive foreign borrowings. As a result, by the late 1990s, dead ahead of the 1997-98 crisis, the Asian bears were being totally discredited by the bullish crowd and their views were largely ignored.

While Asians were not quite so gullible as to believe that “the overall level of debt makes no difference … one person’s liability is another person’s asset” (as Paul Krugman has said), they advanced numerous other arguments in favour of Asia’s continuous economic expansion and to explain why Asia would never experience the kind of “tequila crisis” Mexico had encountered at the end of 1994, when the Mexican Peso collapsed by more than 50% within a few months.

In 1994, the Fed increased the Fed Fund Rate from 3% to nearly 6%. This led to a rout in the bond market. Ten-Year Treasury Note yields rose from less than 5.5% at the end of 1993 to over 8% in November 1994. In turn, the emerging market bond and stock markets collapsed. In 1994, it became obvious that the emerging economies were cooling down and that the world was headed towards a major economic slowdown, or even a recession.

But when President Clinton decided to bail out Mexico, over Congress’s opposition but with the support of Republican leaders Newt Gingrich and Bob Dole, and tapped an obscure Treasury fund to lend Mexico more than$20 billion, the markets stabilized. Loans made by the US Treasury, the International Monetary Fund and the Bank for International Settlements totalled almost $50 billion.

However, the bailout attracted criticism. Former co-chairman of Goldman Sachs, US Treasury Secretary Robert Rubin used funds to bail out Mexican bonds of which Goldman Sachs was an underwriter and in which it owned positions valued at about $5 billion.

At this point I am not interested in discussing the merits or failures of the Mexican bailout of 1994. (Regular readers will know my critical stance on any form of bailout.) However, the consequences of the bailout were that bonds and equities soared. In particular, after 1994, emerging market bonds and loans performed superbly — that is, until the Asian Crisis in 1997. Clearly, the cost to the global economy was in the form of moral hazard because investors were emboldened by the bailout and piled into emerging market credits of even lower quality.

Above, I mentioned that, by 1994, it had become obvious that the emerging economies were cooling down and that the world was headed towards a meaningful economic slowdown or even a recession. But the bailout of Mexico prolonged the economic expansion in emerging economies by making available foreign capital with which to finance their trade and current account deficits. At the same time, it led to a far more serious crisis in Asia in 1997 and in Russia and the U.S. (LTCM) in 1998.

So, the lesson I learned from the Asian Crisis was that it was devastating because, given the natural business cycle, Asia should already have turned down in 1994. But because of the bailout of Mexico, Asia’s expansion was prolonged through the availability of foreign credits.

This debt financing in foreign currencies created a colossal mismatch of assets and liabilities. Assets that served as collateral for loans were in local currencies, whereas liabilities were denominated in foreign currencies. This mismatch exacerbated the Asian Crisis when the currencies began to weaken, because it induced local businesses to convert local currencies into dollars as fast as they could for the purpose of hedging their foreign exchange risks.

In turn, the weakening of the Asian currencies reduced the value of the collateral, because local assets fall in value not only in local currency terms but even more so in US dollar terms. This led locals and foreigners to liquidate their foreign loans, bonds and local equities. So, whereas the Indonesian stock market declined by “only” 65% between its 1997 high and 1998 low, it fell by 92% in US dollar terms because of the collapse of their currency, the Rupiah.

As an aside, the US enjoys a huge advantage b
y having the ability to borrow in US dollars against US dollar assets, which doesn’t lead to a mismatch of assets and liabilities. So, maybe Krugman’s economic painkillers, which provided only temporary relief of the symptoms of economic illness, worked for a while in the case of Mexico, but they created a huge problem for Asia in 1997.

Similarly, the housing bubble that Krugman advocated in 2001 relieved temporarily some of the symptoms of the economic malaise but then led to the vicious 2008 crisis. Therefore, it would appear that, more often than not, bailouts create larger problems down the road, and that the authorities should use them only very rarely and with great caution.

via Zero Hedge http://feedproxy.google.com/~r/zerohedge/feed/~3/1-TG9kZcdMk/story01.htm Tyler Durden