EconMatters Global

The Stock Market Feels Like 2007 Again

2013-05-16T13:25:00.003-05:00

By Michael Lombardi, MBA for ProfitConfidential

Didn’t the government say the economy is getting better? Why do I question what they’re saying? Because consumer spending is going the wrong way.

Core retail sales declined 0.1% in April—and that’s after they already fell 0.4% in the previous month! (Source: U.S. Census Bureau, May 13, 2013.)

When compared to the first four months of 2012, consumer spending in the U.S. economy declined in the first four months of 2013 at electronics and appliance stores, health and personal care stores, gasoline stations, and general merchandise stores.

And looking forward, consumer spending in the U.S. economy doesn’t appear to look very promising either.

If companies don’t spend or create better-quality/better-paying jobs, can consumer spending really pick up? It’s well documented in these pages: the job creation we have seen since the financial crisis started has been in low-wage-paying sectors.

Keeping all this in mind, with consumer spending still bleak and core retail sales constantly declining, the retailer must be suffering.

But that’s not so!

When you look at the stock market and, more specifically, at the retailers, it appears that consumer spending in the U.S. economy is booming! Consider the chart below of the S&P Retail Index. This index tracks the performance of some of the most well-known retailers in the U.S. economy.

Chart courtesy of www.StockCharts.com

Dear reader, the stock market isn’t portraying the real picture of the U.S. economy. The retail sales number actually shows how consumer spending—the biggest contributor to our gross domestic product (GDP)—is fairing, and those numbers look terrible.

Even with the printing of trillions of dollars of new money via quantitative easing, the Federal Reserve hasn’t been able to do what it originally intended to do—spur economic growth in the U.S. economy. The Fed has made the banks financially stronger and has sent the stock market higher, but the “little guy” really hasn’t been helped.

It’s a vicious cycle that’s not working right now. For consumer spending to pick up, businesses must be willing to spend and invest rather than spending their money buying back their own shares to boost their earnings. Mark my words: this can only go on for so long.

Michael’s Personal Notes:

Something is starting to smell in the bond market…

Since their peak in July of 2012, 30-year U.S. bonds have declined in value—they are down almost six percent. Trading above $153.00 in mid-2012, 30-year U.S. bonds now hover around $144.00, as depicted in the chart below.

Chart courtesy of www.StockCharts.com

Keep in mind that bond investors use U.S. bonds as a benchmark to what kinds of rates other types of bonds, such as corporate bonds, municipal bonds, and junk bonds, should sell at.

For example, if U.S. bonds decline in value, chances are the other types of bonds in the bond market will follow in the same direction. So the yield on 30-year U.S. bonds really matters when it comes to looking at the direction of the overall bond market.

The bond market experienced a significant run-up as the 2008 financial crisis unfolded and investors sought safety. Now, investors have a different type of worry on their hands.

The Federal Reserve, which has become a major buyer of long-term U.S. bonds, buying up to $45.0 billion worth of them a month, is contemplating when it should stop reducing the amount of bonds it purchases each month.

According to data from Investment Company Institute, an association of U.S. investment companies, in the first three months of 2013, long-term bond mutual funds had inflows of $68.9 billion. This was 25% lower than the same period a year ago, when these funds had inflows of $92.08 billion. (Source: Investment Company Institute, May 8, 2013.)

As I have been harping on about in these pages for some time now, caution and capital preservation are hands-down the best strategy for bond investors, as conditions in the overall bond market are changing. A decline in the bond market will hit the most conservative type of investments, like pension funds and insurance companies, which invest heavily in bonds.

I am watching the bond market very closely as the recent decline in bond prices is significant. Bonds are signaling higher interest rates ahead, something very few economists are talking about.

Where the Market Stands; Where It’s Headed:

As I wrote last week, it feels like 2007 all over again. The stock market rises on good news and bad news. Bullishness among investors and stock advisors is near a multiyear high. Corporate profit growth has stalled. The higher this market goes, and it has gone higher than even I thought it would, the bigger the drop will be. The bear market has done a masterful job at convincing investors the stock market is a safe bet again.

What He Said:

“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure – these are the bank stocks I wouldn’t own.” Michael Lombardi in Profit Confidential, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.

About the Author - Michael Lombardi, MBA at Profit Confidential, a daily publication for Lombardi Financial customers. (EconMatters author archive Here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Should You Sell in May and Go Away?

2013-05-16T11:35:00.001-05:00

By Frank Holmes

During the first week of May every year, the maxim, “Sell in May and Go Away,” gets taken out, dusted off and powered up as a reason to sell stocks. The rhyme is more than just a catchy urban legend: June, July, August and September have historically been the weakest months of the year for the S&P 500 Index.

Yet even if seasons trigger certain events, when the snow falls in Minnesota in May, Midwesterners need to throw on their winter gear and roll out snowblowers, not lawnmowers.

Consider this encouraging research: The S&P 500 has been rallying for six months in a row, which has happened 48 times since 1950. Following these six-month winning streaks, stocks have historically continued rising. Sixty percent of the time, the S&P 500 climbed 0.79 percent over the next month; 84 percent of the time, stocks increased 3.50 percent, 7.77 percent and 11.77 percent the next three, six and 12 months following the streak.

In addition, 165,000 jobs were added to payrolls in April, helping the unemployment rate fall to 7.5 percent. This is the lowest level since December 2008.

The news comes days after the Federal Reserve stamped its approval on another month of bond buying, with the added bonus of Ben Bernanke stating that the Fed is “prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation.”

If that’s not enough to validate a continuing bull market, consider the European Central Bank’s exceptional move this week. Mario Draghi cut key interest rates to 0.5 percent, the first time in 10 months, following weaker manufacturing data out of top four largest economies in the eurozone. Germany, France, Italy and Spain all experienced manufacturing contractions.

Our portfolio manager of the Emerging Europe Fund, Tim Steinle, described the ECB’s motivation this way: It’s one thing to punish the periphery; it’s another to weaken the core.

Further Reading: Is This The End of The Commodity Super Cycle?

The S&P 500 has climbed an amazing 12.74 percent through April 30, so if you’re eager to do some investment spring cleaning, you might want to consider areas that have underperformed. For example, take a look at the year-to-date returns by sector, which reveal an interesting pattern. Health care, utilities, consumer staples and consumer discretionary have all climbed more than 15 percent, much more than the market. Meanwhile, companies in the materials, energy and industrials sectors have lagged the overall index.

In recent days, an inflection point seems to have occurred, with these weaker areas of the market gaining strength. We wrote in the Investor Alert last week that cyclical stocks, including health care, consumer staples, utilities and telecommunication, have been lagging the remaining sectors. From the beginning of the earnings season on April 24 through May 3, energy, industrial and materials stocks are nearly the best performing areas of the market.

We believe expectations might have become too lofty for defensive companies and too gloomy for cyclical stocks, so as perceptions toward global growth improve, it won’t take much for energy, industrials and materials to take off.

Spring Clean Your Treasury Portfolio Too

With the Fed’s insistence to keep interest rates low, real interest rates remain negative for investors. For example, a 90-day T-bill yields 0.06 percent and 2-year Treasury yields 0.23 percent, but inflation burns off 1.5 percent.

It’s interesting to note that while low interest rates help keep the government’s debt payments low, these rates hurt seniors living on a fixed income. My friend, Terry Savage writes this week,

“Savers are the big losers in this rigged game. And most domestic savers are seniors and those approaching retirement, who planned to live on the income generated by their savings. Today, that’s simply not possible – unless they are willing to take on a lot more risk.”

The important idea for investors is to adjust to the current conditions. Regardless of the month, if the thermostat shows frigid temperatures, dress accordingly. Likewise for when it’s hot in the summer. What’s important is to stay tuned and make sure your portfolio is dressed accordingly.

About The Author - Frank Holmes is CEO, Chief Investment Officer of U.S. Global Investors, an investment management firm specializing in commodities and emerging markets based in San Antonio, Texas. Frank is also the co-author of The Goldwatcher. (EconMatters author archive here.)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Copper Price and 11 Other Recession Indicators

2013-05-08T16:22:00.001-05:00

By Michael Snyder

There are a dozen significant economic indicators that are warning that the U.S. economy is heading into a recession. The Dow may have soared past the 15,000 mark, but the economic fundamentals are telling an entirely different story. If historical patterns hold up, the economy is heading for a very rocky stretch. For example, the price of copper is called "Dr. Copper" by many economists because it so accurately forecasts the future direction of the U.S. economy.

And so far this year the price of copper is way down. But that is not the only indicator that is worrying economists. Home renovation spending has fallen dramatically, retail spending is crashing in a way not seen since the last recession, manufacturing activity and consumer confidence are both declining, and troubling economic data continues to come pouring out of Asia and Europe. So why do U.S. stocks continue to skyrocket? Will U.S. financial markets be able to continue to be divorced from reality? Unfortunately, as we have seen so many times in the past, when stocks do catch up with reality they tend to do so very rapidly. So you better put on your seatbelts because a crash is coming at some point.

But most average Americans are not that concerned with the performance of the stock market. They just want to be able to go to work, pay the bills and provide for their families. During the last recession, millions of Americans lost their jobs and millions of Americans lost their homes. If we have another major recession, that will happen again. Sadly, it appears that another major recession is quickly approaching.

The following are 12 recession indicators that are flashing red...

#1 The price of copper has traditionally been one of the very best indicators of the future performance of the U.S. economy. The fact that it is down nearly 20 percent so far this year has many analysts extremely concerned...

Copper's downward trend foreshadows a stock market collapse, according to Societe Generale's famously bearish strategist Albert Edwards, who said equity markets will riot "Japan-style."
"Copper is acting exactly as it did when I wrote about the impotence of liquidity in the face of the (then imminent) 2007 recession. Once again it is giving us an early warning that liquidity will not save risk assets: time to get out of equities," Edwards wrote in his latest research note, on Thursday.

#2 Home renovation spending has fallen back to depressingly-low 2010 levels.

#3 As Zero Hedge recently pointed out, U.S. retail spending is repeating a pattern that we have not seen since the last recession...

Retail sales of clothing is growing at the slowest pace since 2010; but while major store sales are about to drop negative YoY for the first time in over 3 years, the utter collapse in general merchandise sales is worse that at the peak of the last recession at -5%. It seems tough to see how a nation with an economy built on 70% consumption is not in a recessionary environment. And while this alone is a dismal signal for the discretionary upside of the US economy/consumer; as Gluskin Sheff's David Rosenberg points out real personal income net of transfer receipts plunged at a stunning 5.8% annual rate in Q1. The other seven times we have seen such a collapse, the economy was either in recession of just coming out of one.

#4 Manufacturing activity all over the country is showing signs of slowing down. In fact, Chicago PMI has dipped below 50 (indicating contraction) for the first time since the last recession.

#5 In April, consumer confidence unexpectedly fell to a nine-month low...

The Thomson Reuters/University of Michigan preliminary index of consumer sentiment declined to 72.3 in April from 78.6 a month earlier. This month’s reading was lower than all 69 estimates in a Bloomberg survey that called for no change from the March number.

#6 NYSE margin debt peaked right before the recession that began in 2002, it peaked right before the financial crisis of 2008, and it is peaking again.

#7 The S&P 500 usually mirrors the performance of Chinese stocks very closely. That is why it is so alarming that Chinese stocks peaked months ago. Will the S&P 500 soon follow?

#8 The economic data coming out of the Chinese economy lately has been mostly terrible...

For starters, China’s recent economic data, as massaged as it is to the upside, is downright awful. China’s PMI numbers were the worst in two years. Staffing levels in the Chinese service sector decreased for the first time since January 2009 (remember that year).
China’s LEI also shows no sign of recovery. If anything, it indicates China is heading towards an economic slowdown on par with that of 2008. And if you account for the rampant debt fueling China’s economy you could easily argue that China is posting 0% GDP growth today.

#9 Things just continue to get even worse over in Europe. Unemployment in both Greece and Spain is now about 27 percent, and the unemployment rate in the eurozone as a whole has just set a brand new all-time record high.

#10 Crude inventories have soared to a record high as demand for energy continues to decline. As I have written about previously, this is a clear sign that economic activity is slowing down.

#11 Casino spending is usually a strong indicator of the overall health of the U.S. economy. That is why it is so noteworthy that casino spending is now back to levels that we have not seen since the last recession.

#12 The impact of the sequester cuts is starting to kick in. According to the Congressional Budget Office, the sequester cuts will cost the U.S. economy about 750,000 jobs this year.

About The Author - Michael Snyder is the founder and editor of The Economic Collapse

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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The Real Unemployment Rate Is Worse Than You Think

2013-05-06T12:51:00.000-05:00

By Louis Basenese at Wall Street Daily

Only in the government’s fantasy land does its math add up.

On Friday, the Labor Department reported that the economy added 165,000 new jobs in April. It also revised February and March data up by a combined 114,000 jobs.

More jobs are obviously a good thing.

However, the misrepresentation comes in when the Labor Department brags that the gains helped push the unemployment rate down 0.1 percentage points from March – and 0.4 percentage points from January – to 7.5%.

Total crap!

That’s not the real unemployment rate. It actually went up in April. And in honor of Myth-Busting Monday, I’m going to prove it…

Never Trust the Government

Not surprisingly, governments like to paint an overly rosy picture whenever possible. And when it comes to reporting the “official” unemployment rate (known as U-3 unemployment), that’s exactly what they do.

Making matters worse, the mainstream press totally goes along with the charade. I’ve read countless headlines touting how the unemployment rate is now down to a four-year low.

Even though, as I mentioned above, the real unemployment rate actually increased in April.

How can that possibly be?

Simple. The government skews the calculation by conveniently excluding three groups of people:

Discouraged: People who have stopped looking for work because they believe that there’s no work available for them.
Marginally attached: People who’d like to work and are physically able, but haven’t looked for work in the last four weeks.
Involuntary part-timers: People who want to work full-time, but can’t find a full-time position.

Sorry. But if people can’t find work – or haven’t looked for work in a few weeks – that doesn’t make them any less unemployed. Just saying.

Now, you might be thinking that the government ignores these people because there aren’t enough in each category to sway the calculations, so the time and resources spent tracking them couldn’t be justified.

Think again.

The numbers are actually staggering…

At the end of April, the tally for discouraged workers stood at 835,000… The total for marginally attached workers reached almost 1.5 million… And the number of involuntary part-timers stood at 7.9 million.

Lo and behold, if we add them back into the calculation, the total number of unemployed Americans almost doubles from 11.7 million to 21.9 million.

Floyd Brown, our Chief Political Analyst over at Capitol Hill Daily, agrees. As he said on Wednesday, “The sinister truth is that we’re being lied to… The actual rate of unemployment is two to three times the Bureau of Labor’s bullsh… I mean statistics.”

And the real unemployment rate currently checks in at 13.9%, not the widely reported 7.5%.

Big difference, huh?

The crazy thing is, the Bureau of Labor Statistics provides the calculation for the real unemployment rate on a monthly basis. It’s referred to as U-6 unemployment.

So it’s not like the journalists and politicians who are peddling the 7.5% figure can use the excuse that they don’t know how to calculate the real number. It’s already done for them.

Bottom line: It’s time for the real unemployment rate to stand up. Any other calculation misrepresents the truth and distorts what’s actually going on in the economy. And now that you know the truth, there’s no more reason for you to be duped by the government, or the media.

Courtesy Louis Basenese at Wall Street Daily (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Chart Du Jour: Commodities Jumping with S&P New All-Time High

2013-05-02T16:03:00.001-05:00

By Tyler Durden of ZeroHedge

Another POMO, another dip bought, another all-time high in the S&P 500 but we are sure there is some disappointment that the '1600' caps have to go back in the closet for one more day. The S&P's best day in over a week was greeted with an almost perfect 'unchanged' for Treasuries and while stocks went out near their highs,Treasuries closed at the low yields of the day (2-3bps lower than the highs). Of course, the 'most shorted' names were smashed higher (at the open and at 1515ET) providing today's ammo.

The USD started weak but Draghi's -ve rates comment sparked a USD surge (up 0.3% on the week) but stocks didn't care. WTI jumped back above $94 with its best day in six months (though little talk from the 'heads' of the removal of the implicit tax?). Gold and Silver also jumped (as did Copper) all ending the day up around 0.75%. Homebuilders banged over 2% higher on the day (as Lumber was limit down at 5 month lows) and while the Dow and S&P closed the previous all-time high, the Trannies remain -1.4% from Tuesday's close.

Stocks recovered yesterday losses very quickly and then went generally sideways on low volume post the European close today (though did make new highs in the meantime)...

WTI Crude saw its biggest jump in six months... closing back at $94

Shorts were trampled at the open and at the 315ET mark...

which dragged the S&P and Dow up to their highs... but not the Trannies...

But sectors tell a different story...

The last time the S&P closed here (Tuesday), 10Y yields were 6bps higher...

and AUDJPY (all JPY carry) disconnected all afternoon...

and US equities totally dislocated from global risk assets today once the US day session opened... (the green line is Capital Context's CONTEXT model - a proxy for cross-asset class risk)

Charts: Bloomberg and Capital Context

Bonus Chart: The last time Consumer Staples stocks were so highly correlated to US Treasuries - bad things happened...

Bonus Bonus Chart: What have global high-quality bonds known for the last 3 months that stocks didn't?

Bonus Bonus Chart: but then again, it's been a good run since the March 2009 lows for all global bonds...

Courtesy Tyler Durden, founder of ZeorHedge (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Is This The End of The Commodity Super Cycle?

2013-05-02T12:35:00.001-05:00

By Frank Holmes

Sometimes following where money is being invested is a solid course of action to gain alpha; other times, a better opportunity lies in going the opposite direction, i.e., thinking contrarian.

Take commodities, energy and materials, which may be the most unappreciated areas of the market these days. According to Bank of America Merrill Lynch’s Global Fund Manager Survey of 250 participants who collectively manage $725 billion, energy, materials and commodities are extremely underowned.

As you can see below, the global asset class positioning during the first week of April compared to historical data shows that energy positions are close to 3 standard deviations below the long-term average. An allocation to materials is more than 2 standard deviations below its long-term average and commodity exposure is close to 2 standard deviations below its historical measure.

click to enlarge

Take note of the timing, though, as it appears that it may make sense to own the most underowned areas of the market. Compare today’s portfolio weightings to the last time fund managers had such a significant underweight in these asset classes. Each bar below indicates whether allocations in energy represented a net overweight or underweight position. Most of the time since 2003, managers maintained an overweight allocation, which means they likely anticipated outperformance in energy companies during this period of time.

However, the last time they had such a big underweight in global energy for this long was at the end of 2008 and the beginning of 2009.

click to enlarge

In materials, there were many more times that managers chose to have an underweight allocation to the sector. But again, the magnitude of today’s allocation decision matches what we saw in the 2008-2009 timeframe.

click to enlarge

A similar picture for commodities reveals this consistent trend. Asset allocation indicating an overweighting in commodities hasn’t been this negative since 2008-2009.

click to enlarge

Given the historical trend in late 2008 and early 2009 when managers were invested in other areas of the market, many likely missed the huge rally in natural resources stocks. From the market bottom on March 9, 2009, the Morgan Stanley Commodity Related Equity Index of commodity stocks grew 156 percent on a cumulative basis over the next two years. This is more than twice the return of the commodities futures index, the Dow Jones-UBS Commodity Index.

click to enlarge

Don’t miss the next potential rally. We believe the commodity supercycle continues, driven by emerging countries experiencing rising urbanization, increasing wealth and healthy GDP growth rates. What’s important for investors to remember is to build a diversified basket of natural resources companies actively managed by professionals who understand the seasonal and cyclical trends of these specialized assets.

Jobless Claims Dropped to 5-year Low, But Don't Get Too Excited Yet

2013-05-02T10:38:00.002-05:00

By James Picerno of The Capital Speculator

Initial jobless claims dropped again last week, slipping to a new five-year low. The news is an upbeat counterpoint to the weak economic numbers released earlier this week. New filings for unemployment benefits retreated to a seasonally adjusted 324,000 for the week through April 27, the lowest since January 2008. It’s been easy to interpret recent data as a sign that the economy’s stumbling again, perhaps fatally, but today’s release looks like a statistical stay of execution, if only for a day.

In fact, history strongly suggests that new recessions don’t begin when jobless claims are dipping to fresh multi-year lows. Anything’s possible in economics, but some things are improbable. Today’s release doesn’t immunize the weak numbers we’ve seen recently, including yesterday’s sluggish pace of payrolls last month via ADP’s estimates. Earlier I also noted that inflation expectations are trending lower as well, perhaps setting us up for macro trouble down the road. Those warning signs are still relevant, of course, but this morning’s claims report tells us that it's still premature to assume that the business cycle is destined for contraction in the near term.

Claims data is notoriously volatile from week to week, of course, but the fact that the four-week average is now in close pursuit of the weekly estimate is an encouraging sign for thinking that today’s update is more than noise. There’s also good news in the chart of the one-year change in the unadjusted data (before seasonal adjustment), as the next chart shows. The ongoing fall in claims each week from year-earlier levels is a robust signal for arguing that the labor market isn’t on the precipice of trouble. No one will confuse the economy's ability to mint jobs as impressive, but it's not yet so weak as to think that another recession is fate in the immediate future.

But what of the other disturbing news from earlier this week, and the sluggish numbers for March for that matter? How are we to square this circle of mixed results? For now, the reasonable view is that we’re knee-deep in another spring slowdown, which for one reason or another has become the norm in recent years. Why that’s been the case needn’t concern us here. Rather, the question is whether the broad picture of economic and financial data tells us that the economy has passed the point of no return? Some analysts are quick to answer “yes,” but a fair reading of the numbers (including today’s jobless claims data) suggests otherwise.

Could that change? Yes, and perhaps soon. But the worst you can say for now is that we’re suffering from a mixed bag of data signals. That may be the precursor to deeper woes, although it could just as easily turn out to be another head fake that leaves the bears running for cover. How will we know which outlook has the upper hand? When a preponderance of the indicators speak loud and clear. The good news is that we’re still well short of that tipping point, as a recent profile of the US economy through March suggests.

What’s the lesson in all of this? A familiar one, namely: The biggest hazard in the art/science of business cycle analysis is the popular sport of rushing to judgment.

About the Author - James Picerno is a veteran financial journalist since the early 1990s at Bloomberg, Dow Jones, etc. before becoming an independent writer/analyst/consultant in 2008. James is also the author of Dynamic Asset Allocation (Bloomberg Financial, 2010) and he writes at The Capital Speculator. (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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Will ASEAN-4 Escape The Middle Income Trap?

2013-05-02T10:32:00.000-05:00

By Anoop Singh (via iMFDirect)

(Versions in 中文 and 日本語)

Emerging economies in Asia have weathered the global financial crisis relatively unscathed and appear to be on track for continued strong growth this year and the next. Perhaps because the region has been doing rather well, policymakers’ concerns have increasingly shifted towards medium-term risks: could growth and fast convergence to living standards in advanced economies—come to an end?

In fact, while the economic performance of emerging economies in Asia remains undoubtedly strong in international comparison, it has already shown signs of gradual weakening.

Both China and India have shown a declining growth trend since the global financial crisis: growth in China has slowed from a rate of over 10 percent in the 2000s to between 8 and 9 percent in the past two years, while growth in India has slowed from around 8 to 6 percent during the same period.

No trend slowdown in Asean-4 economies

There has been no such trend slowdown in ASEAN-4 economies, such as Indonesia, Malaysia, Philippines, and Thailand, but there growth was lower to start with and—with the notable exception of the Philippines—remains significantly below pre-Asian crisis rates.

So what are the risks of a sharper, sustained growth slowdown that would prevent emerging economies in Asia from rising to the high-income levels of advanced economies?

Economic history tells us that as middle-income countries, they are a priori more exposed than their low- or high-income counterparts. Over the past half century, the frequency of abrupt slowdowns lasting for at least a decade has been 1.5 times higher for the former than for the latter. In other words, there is some empirical support for the so-called middle income trap.

But another lesson from economic history is that the middle-income trap can be avoided. In fact, Asia itself is showing us the way: Korea, Singapore, or Taiwan Province of China all graduated from middle income to high-income status in just a few decades.

Minimizing risks of sustained growth slowdown

How can policymakers in the region minimize risks of a sustained growth slowdown? Our recent research shows the following to be especially helpful: good infrastructure, sound economic institutions, open and diversified international trade, as well sound macroeconomic and macro-prudential policies that alleviate booms and busts, all help.

And here is the good news for the middle-income Asian economies I mentioned earlier: on many of these dimensions, they often compare favorably to their counterparts from other regions. But they all have their weak spots.

Compared to others in the region, India, the Philippines, and Thailand are exposed to a larger risk of growth slowdown stemming from subpar infrastructure. Improving economic institutions is a further challenge for India and the Philippines, as well as for China and Indonesia. China’s relative risk factors also relate to its post-crisis increase in investment, while Malaysia’s include its strong capital inflows—both of which have clearly supported growth but also involve potential vulnerabilities.

Demography’s impact

A word on demography. Could emerging economies in Asia get old before they get rich? This issue would warrant another blog, but two points are worth noting.

First, demographic trends are widely heterogeneous across the region. For instance, China, Thailand, and Vietnam will experience a rise in the so-called dependency ratio—the size of the young and old population relative to those of working age—over the next decade, but India and the Philippines will see a decline.

Second, ageing will put a premium on reforms that mobilize untapped pools of labor, not least women, too many of whom remain under-employed or out of the labor force altogether across the region.

Emerging Asia is doing well, but only through unremitting reforms will it be able to fulfill its promise.

Popout

About The Author - iMFdirect is a weblog covering the global economy and policy issues, posted by the International Monetary Fund (IMF) headquartered in Washington D.C., United States. iMFdirect posts content related to the IMF’s work in economics and finance at global or national level, and posts currently highlight the debate over policy responses to the biggest global recession since the Great Depression. The IMF is an organization of 187 countries, working to foster global monetary cooperation, secure financial stability, facilitate international trade, promote high employment and sustainable economic growth, and reduce poverty around the world. (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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When Fed Exits QE: 400% Increase of U.S. Debt Financing Cost

2013-05-01T15:47:00.000-05:00

By Tyler Durden of ZeroHedge

With the Fed now openly warning that there may actually come a time when the 'flow' stops; the most recent Treasury Borrowing Advisory Committee (TBAC) report has some concerning statistics for those change-ridden hopers who see a smooth Fed exit, deficit-reduction, and blue skies ahead. While they are careful not shout 'sell' in a crowded bond market; hidden deep in the 126 page presentation are two charts that bear significant attention. The first shows what TBAC expects (given the market's expectations) to happen to interest rates in the US as the Fed 'exits' its QE program (taper, unwind, hold) - the result, the weighted-average cost of financing for the US government will almost triple from around 1.6% to around 4.3% over the next ten years. But more problematic is that even with CBO's rather conservative estimates of the growth in US debt over the next decade the USD cost of financing will explode from around $205bn (based on TBAC data) to over $855bn. Still convinced the Fed can exit smoothly?

As TBAC warns:

Treasury yields could reprice notably when the market is convinced that policy tightening is imminent

There is a risk that markets may overshoot to higher-than-fair yield levels due to:

Concerns about Fed portfolio unwind
Inadequate interest hedging in certain asset classes
Portfolio rebalancing by retail investors

Annual interest cost on public debt to increase more than 400% (from $205 bn in 2013 to $855 bn in 2023)

Main driver : Increase in WAC from 1.7% to 4.3%
Secondary factor : ~ 65% increase in stock of debt

Given the market's expectations for Fed tapering (or gradual tightening)...

The marginal cost of financing will rise significantly...

but with the sheer size of debt now (and growing), that will balloon the absolute cost of servicing US debt to over $850bn per year...

And just what happens to all those retirees - who need yield - who are being herded into stocks when Treasuries pay over 4.5%? Would seem bullish for bond flows... think Japan...

Charts: TBAC

Where Are The Next BRIC?

2013-05-01T14:51:00.001-05:00

By Michelle Lin at Economy Watch

As the European Union mulls another year of economic stagnation and the United States a year of lacklustre and uncertain economic recovery, will emerging markets take the lead in global economic recovery?

The year 2012 ended on relatively flat note. The United States had the world on its toes as its leaders negotiated a crucial last minute budget deal, narrowly avoiding automatic budget cuts and tax hikes that had the potential to send the world’s largest economy into recession. But even with that out of the way, failure to raise the debt ceiling and, on a large scale, rein in government spending, would keep another generation of Americans trapped in a vicious spiral of unsustainable debt and decline.

From today’s vantage point, we also appreciate the return of credibility in Euromarkets. In 2012, two events helped to secure the region’s and the euro’s stability: The establishment of the European Stability Mechanism, a permanent bailout fund that allows for the direct recapitalisation of banks, thus severing the link between vulnerable sovereigns and weakly capitalised banks; as well as the European Central Bank’s decision to intervene in money markets with its “unlimited” bond purchases.

However, despite the relative calm that markets now enjoy, it is certain that neither global economic growth nor leadership will stem from the West, or any G8 countries for that matter.

In 2011, the eight growth market economies – the BRICs plus MIST, Mexico, Indonesia, South Korea, and Turkey – created close to $3 trillion, more than the United Kingdom in one year. The combined size of these economies is now approximately that of the US economy, with total annual output reaching $16 trillion, about 25 percent of world economic output.

Barring any major contraction, if the “Growth 8” economies expanded by an average of 10 percent, they would add $1.5 trillion to global GDP next year, the equivalent of creating another Greece every 10 weeks, or an economy the size of Spain’s every year.

Are the BRICs Becoming Irrelevant?

But the economic miracle of the BRICs, who collectively hold a large portion of global foreign exchange reserves and make up nearly half of the world’s population, could be coming to an end.

According to the Wall Street Journal, the problem with the BRICs is they tend to promote themselves as an alternative to the G7, often failing to recognise that the economic fates of the BRICs and the G7 are interlocked. “When the U.S. financial crisis spread to Europe, it didn't stop there. The BRICs nations weakened because they lost big export markets and sources of financing and investment.”

Furthermore, while the BRICs accounted for more than half of global growth in the last four years, “only China has the economic heft to make a major difference internationally on its own, and it is just now starting to come out of a slowdown. The other three nations face a variety of economic challenges, ranging from inflation to inadequate foreign investment to labour unrest,” the Journal said.

Similarly, the hope that the BRIC countries would help one another through increased trade, investment and political support hasn't quite materialised. Observers say the BRICs act as much as rivals as allies, and their lack of cohesion adds to their economic problems. Fyodor Lukyanov, an analyst who chairs an influential Kremlin foreign-policy advisory board, told the Journal:

The BRICs is not about the economy. The bloc sees itself as an alternative to the West, but not a confrontational one, like Iran. (The BRICs) have different, sometimes conflicting interests.

Perhaps it was this dreadful realisation that inspired the creation of Goldman Sach’s new rhetorical acronym: MIST – Mexico, Indonesia, South Korea, and Turkey – which are the four biggest markets in the bank’s Next-11 (N-11)* equity fund.

In an interview with Bloomberg last August, chairman of Goldman’s asset management arm Jim O’Neill said he came up with the idea for an N-11 fund as a way to help investors benefit from growth beyond the BRIC nations. Opened in 2011, the N-11 fund climbed 12 percent in 2012, compared with a 1.5 percent gain in Goldman’s corresponding BRIC fund.

With populations that for the most part are younger than the U.S. and Europe and have higher birth rates, fuelling economic expansion, the N-11 nations are emerging from the shadow of the BRICs, where growth is slowing and investors are pulling out funds. In 2011, a net $5.4 billion of investor money flowed out of the BRIC offerings tracked by EPFR Global. An additional $1.3 billion leaked out through the end of August last year.

So when compared with the BRICs, the MISTs appears to have a bit more upside potential, said Larry Shover, chief investment officer of Solutions Funds Group, who added that the total GDP of the MIST countries is less than a quarter of the BRICS – $3 trillion compared with $13 trillion.

“People are recognising that there is still a lot of room for improvement in these economies,” Shover added.

The Asian Tiger Cubs

Meanwhile, on the other side of the world, Asia’s Tiger Cubs – Indonesia, the Philippines, Vietnam and Myanmar – are looking to emulate the economic success of Hong Kong, Singapore, South Korea and Taiwan.

In a special report on emerging markets, MarketWatch said of Indonesia and the Philippines:

With rapidly growing economies and rising incomes, the two countries are home to a large and young labour force, an expanding middle class and have stable, elected governments with policies inspiring investor confidence. They also have sturdy banks and enough foreign-exchange reserves – more than a year’s imports in the Philippines’s case – to rebuff a misguided run on their currencies.

In an economically vibrant Southeast Asia, Indonesia and the Philippines stand out as the region’s “New Tigers” with the potential to leave a bigger imprint on global growth for years to come while the developed world struggles with excess debt and traditional regional heavyweights China and India lose momentum.

Each has also received credit rating upgrades since 2011, with Indonesia now rated investment grade by Moody’s and Fitch. Their stock markets are among the world’s best performing since the end of 2008 –Indonesian shares tripled during the period from beaten-down valuations, and are closely followed by Philippine equities.

On the other hand, for a country once ravaged by war, Vietnam has been one of Asia’s lesser-known economic success stories. Since the introduction of Doi Moi, or Renovation Reforms in 1986, Vietnam has expanded faster than any other Asian economy except China's, posting an average annual per capita GDP growth of 5.3 percent. This growth continued even through the Asian financial crisis in the 1990s and the recent global economic downturn (the economy grew 7 percent per year from 2005 to 2010) – faster than many other Asian economies. Vietnam is expected to grow at a rate of 6 percent this year, according to data from the International Monetary Fund.

But there is no larger growth potential in Southeast Asia other than the opening up of Myanmar. With the upgrading of diplomatic relations, subsequent removal of international sanctions and an influx of foreign aid and investment, foreign businesses are ramping up interest in the long-isolated but potentially lucrative market of Myanmar, whose opportunities abound in raw materials such as gems, timber, rubber and gas, and also in services for a population of 55 million in need of everything from healthcare to telecommunication.

Vinod Chugani, an American-educated Singaporean, said:

I think this is the last virgin market left in the world, the last untapped market. Twelve years ago, when I was in China, I felt the same rush.

*Besides the MIST nations, the N-11 countries include Bangladesh, Egypt, Nigeria, Pakistan, the Philippines, Vietnam and Iran. However, Goldman Sachs does not invest in Iran because it isn’t an open market for foreign investors.

Courtesy Michelle Lin at Economy Watch, (EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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

Syria Intervention: Beyond the Military Power

2013-05-01T12:12:00.000-05:00

By George Friedman at Stratfor Global Intelligence

The civil war in Syria, one of the few lasting legacies of the Arab Spring, has been under way for more than two years. There has been substantial outside intervention in the war. The Iranians in particular, and the Russians to a lesser extent, have supported the Alawites under Bashar al Assad. The Saudis and some of the Gulf States have supported the Sunni insurgents in various ways. The Americans, Europeans and Israelis, however, have for the most part avoided involvement.

Last week the possibility of intervention increased. The Americans and Europeans have had no appetite for intervention after their experiences in Afghanistan, Iraq and Libya. At the same time, they have not wanted to be in a position where intervention was simply ruled out. Therefore, they identified a redline that, if crossed, would force them to reconsider intervention: the use of chemical weapons.

There were two reasons for this particular boundary. The first was that the United States and European states have a systemic aversion to the possession and usage of weapons of mass destruction in other countries. They see this ultimately as a threat to them, particularly if such weapons are in the hands of non-state users. But there was a more particular reason in Syria. No one thought that al Assad was reckless enough to use chemical weapons because they felt that his entire strategy depended on avoiding U.S. and European intervention, and that therefore he would never cross the redline. This was comforting to the Americans and Europeans because it allowed them to appear decisive while avoiding the risk of having to do anything.

However, in recent weeks, first the United Kingdom and France and then Israel and the United States asserted that the al Assad regime had used chemical weapons. No one could point to an incidence of massive deaths in Syria, and the evidence of usage was vague enough that no one was required to act immediately.

In Iraq, it turned out there was not a nuclear program or the clandestine chemical and biological weapons programs that intelligence had indicated. Had there been, the U.S. invasion might have had more international support, but it is doubtful it would have had a better outcome. The United States would have still forced the Sunnis into a desperate position, the Iranians would have still supported Shiite militias and the Kurds would have still tried to use the chaos to build an autonomous Kurdish region. The conflict would have still been fought and its final outcome would not have looked very different from how it does now.

What the United States learned in Iraq, Afghanistan and Libya is that it is relatively easy for a conventional force to destroy a government. It is much harder -- if not impossible -- to use the same force to impose a new type of government. The government that follows might be in some moral sense better than what preceded it -- it is difficult to imagine a more vile regime than Saddam Hussein's -- but the regime that replaces it will first be called chaos, followed by another regime that survives to the extent that it holds the United States at arm's length. Therefore, redline or not, few want to get involved in another intervention pivoting on weapons of mass destruction.

Interventionist Arguments and Illusions

However, there are those who want to intervene for moral reasons. In Syria, there is the same moral issue that there was in Iraq. The existing regime is corrupt and vicious. It should not be forgotten that the al Assad regime conducted a massacre in the city of Hama in 1982 in which tens of thousands of Sunnis were killed for opposing the regime. The regime carried out constant violations of human rights and endless brutality. There was nothing new in this, and the world was able to act fairly indifferent to the events, since it was still possible to create media blackouts in those days. Syria's patron, the Soviet Union, protected it, and challenging the Syrian regime would be a challenge to the Soviet Union. It was a fight that few wanted to wage because the risks were seen as too high.

The situation is different today. Syria's major patron is Iran, which had (until its reversal in Syria) been moving toward a reshaping of the balance of power in the region. Thus, from the point of view of the American right, an intervention is morally required to confront evil regimes. There are those on the left who also want intervention. In the 1980s, the primary concern of the left was the threat of nuclear war, and they saw any intervention as destabilizing a precarious balance. That concern is gone, and advocacy for military intervention to protect human rights is a significant if not universal theme on the left.

The difference between right-wing and left-wing interventionists is the illusions they harbor. In spite of experiences in Afghanistan and Iraq, right-wing interventionists continue to believe that the United States and Europe have the power not only to depose regimes but also to pacify the affected countries and create Western-style democracies. The left believes that there is such a thing as a neutral intervention -- one in which the United States and Europe intervene to end a particular evil, and with that evil gone, the country will now freely select a Western-style constitutional democracy. Where the right-wing interventionists cannot absorb the lessons of Afghanistan and Iraq, the left-wing interventionists cannot absorb the lessons of Libya.

Everyone loved the fall of communism in Eastern Europe. What was not to like? The Evil Empire was collapsing for the right; respect for human rights was universally embraced for the left. But Eastern Europe was occupied by Josef Stalin in 1945 following domination and occupation by Adolf Hitler. Eastern Europeans had never truly embraced either, and for the most part loathed both. The collapse freed them to be what they by nature were. What was lurking under the surface had always been there, suppressed but still the native political culture and aspiration.

That is not what was under the surface in Afghanistan or Iraq. These countries were not Europe and did not want to be. One of the reasons that Hussein was despised was that he was secular -- that he violated fundamental norms of Islam both in his personal life and in the way he governed the country. There were many who benefited from his regime and supported him, but if you lopped off the regime, what was left was a Muslim country wanting to return to its political culture, much as Eastern Europe returned to its.

In Syria, there are two main factions fighting. The al Assad regime is Alawite, a heterodox offshoot of Shi'ism. But its more important characteristic is that it is a secular regime, not guided by either liberal democracy or Islam but with withering roots in secular Arab Socialism. Lop it off and what is left is not another secular movement, this time liberal and democratic, but the underlying Muslim forces that had been suppressed but never eradicated. A New York Times article this week pointed out that there are no organized secular forces in areas held by the Sunni insurgents. The religious forces are in control. In Syria, secularism belonged to the Baath Party and the Alawites, and it was brutal. But get rid of it, and you do not get liberal democracy.

This is what many observers missed in the Arab Spring. They thought that under the surface of the oppressive Hosni Mubarak regime, which was secular and brutal, was a secular liberal democratic force. Such a force was present in Egypt, more than in Syria, Iraq, Afghanistan or Libya, but still did not represent the clear alternative to Mubarak. The alternative -- not as clearly as elsewhere, but still the alternative -- was the Muslim Brotherhood, and no secular alternative was viable without the Egyptian army.

The Difficulties of an Intervention

There are tremendous military challenges to dealing with Syria. Immaculate interventions will not work. A surgical strike on chemical facilities is a nice idea, but the intelligence on locations is never perfect, Syria has an air defense system that cannot be destroyed without substantial civilian casualties, and blowing up buildings containing chemical weapons could release the chemicals before they burn. Sending troops deep into Syria would not be a matter of making a few trips by helicopter. The country is an armed camp, and destroying or seizing stockpiles of chemical weapons is complicated and requires manpower. To destroy the stockpiles, you must first secure ports, airports and roads to get to them, and then you have to defend the roads, of which there are many.

Eradicating chemical weapons from Syria -- assuming that they are all in al Assad's territory -- would require occupying that territory, and the precise outlines of that territory change from day to day. It is also likely, given the dynamism of a civil war, that some chemical weapons would fall into the hands of the Sunni insurgents. There are no airstrikes or surgical raids by special operations troops that would solve the problem. Like Iraq, the United States would have to occupy the country.

If al Assad and the leadership are removed, his followers -- a substantial minority -- will continue to resist, much as the Sunnis did in Iraq. They have gained much from the al Assad regime and, in their minds, they face disaster if the Sunnis win. The Sunnis have much brutality to repay. On the Sunni side, there may be a secular liberal democratic group, but if so it is poorly organized and control is in the hands of Islamists and other more radical Islamists, some with ties to al Qaeda. The civil war will continue unless the United States intervenes on behalf of the Islamists, uses its power to crush the Alawites and hands power to the Islamists. A variant of this happened in Iraq when the United States sought to crush the Sunnis but did not want to give power to the Shia. The result was that everyone turned on the Americans.

That will be the result of a neutral intervention or an intervention designed to create a constitutional democracy. Those who intervene will find themselves trapped between the reality of Syria and the assorted fantasies that occasionally drive U.S. and European foreign policy. No great harm will come in any strategic sense. The United States and Europe have huge populations and enormous wealth. They can, in that sense, afford such interventions. But the United States cannot afford continual defeats as a result of intervening in countries of marginal national interest, where it sets for itself irrational political goals for the war. In some sense, power has to do with perception, and not learning from mistakes undermines power.

Many things are beyond the military power of the United States. Creating constitutional democracies by invasion is one of those things. There will be those who say intervention is to stop the bloodshed, not to impose Western values. Others will say intervention that does not impose Western values is pointless. Both miss the point. You cannot stop a civil war by adding another faction to the war unless that faction brings overwhelming power to bear. The United States has a great deal of power, but not overwhelming power, and overwhelming power's use means overwhelming casualties. And you cannot transform the political culture of a country from the outside unless you are prepared to devastate it as was done with Germany and Japan.

The United States, with its European allies, does not have the force needed to end Syria's bloodshed. If it tried, it would merely be held responsible for the bloodshed without achieving any strategic goal. There are places to go to war, but they should be few and of supreme importance. The bloodshed in Syria is not more important to the United States than it is to the Syrians.

Courtesy Stratfor Global Intelligence (EconMatters author archive here)

American Homeownership Plunges to 18-year Low

2013-04-30T15:52:00.000-05:00

By Tyler Durden of ZeroHedge

When it comes to the US housing market there appear to be three groups of people: those who who have either unlimited cash and/or access to credit, and like the most rabid of bubble-chasing speculators, are perfectly happy to engage in a game of Flip That House for a short-term profit pending the discovery of a greater fool (often times converting the house into rental properties as numerous hedge funds have been doing on cost-free basis courtesy of the government's REO-To-Rent program) - they are the vast minority of speculators; then there are those who currently rent and are opportunistically looking at home prices, willing to dip their toe at the right price - these too are few and far between and mostly represent a function of the natural growth of the US household offset by the availability of jobs; and then there is everyone else. Sadly, it is the "everyone else" that is the vast majority of the US population.

It is this "everyone else" that is once again being forced out of housing due to both the ramping bubble in housing prices making housing affordable primarily to those who buy with the intention of flipping, and due to the lack of available credit to those who actually need it (see sad state of commercial bank loans in the US).

Finally, it is this "everyone else" who comprises the bulk of those who have been kicked out of the American Dream, whose core pillar has always been owning your own home (with or without a massive mortgage attached), not renting.

As the US Census Bureau reported earlier, the US homeownership rates in the first quarter of 2013 dropped by another 0.4% to a fresh 18 years low, or 65% - the lowest since 1995!

That this progressive, ongoing decline in ownership is taking place despite allegedly record home affordability is without doubt the most troubling feature of the economic "recovery" which has forced ever more Americans to shift away from owning and into renting, as can be seen by the next two charts showing the median asking rent and sale prices for vacant rent units and for sale units. While home prices have a long way to go still countrywide (excluding the occasional regional bubble market such as LA and NY), rents are already at record highs, which explains why it is every hedge fund's dream to become a landlord.

However, it is only a matter of time before zero-cost subsidized rental pass thru units owned by hedge funds who can therefore keep the rental asking price as high as they wish, forces out more and more Americans out of the Adjusted American Dream, where renting is the new buying, and leads to ever more people living in the streets.

Although, we are confident, it will be merely a matter of time before this, or some other administration, simply unleashes a "street living tax" - after all, "it is only fair" to apply austerity to hobos next. Because it has worked so well with the billionaires and trillionaires...

Bubble Chart of the Day: Gold, Oil and Tech

2013-04-30T12:19:00.003-05:00

By Frank Holmes

Since gold’s bull run began a decade ago, many people have asked me whether the metal was in a bubble, despite the fact that there were many drivers in place for gold.

Here’s another comparison that answers this classic question.

Research firm Commerzbank’s strategists recently compared the price of gold starting in 2002 to the price of Brent crude oil starting in 1998 and the NASDAQ Composite from 1990. Immediately following each index’s record highs, oil and tech stocks declined sharply. Within nine months, tech stocks had halved in price, while it took only three months for oil to lose half its price, says Commerzbank. You can see the dramatic rise and fall of each index on the chart below.

In contrast to oil and tech, gold has been level-headed over the past decade. Nearly 20 months after its peak, gold has fallen only about 25 percent, and its path remains in line with Brent and the NASDAQ after their bubbles burst.

click to enlarge

In Commerzbank’s opinion, a comparison between the current situation in gold and the former bubbles is superfluous at best.

The Politics of A Congressional Ethanol Study

2013-04-30T12:09:00.000-05:00

By Bruce Krasting

I got a laugh reading this one from the CBO (Link).

The cost of the review of ethanol is a measly $1m. Why has it taken so many years to have this study? More importantly, what happens if this study shows that ethanol is proven to be a dud? Answer:

No later than 30 days after the assessment is completed, EPA would be required to submit a report to the Congress, indicating whether the agency agrees with the study’s findings. The NAS and EPA would have 18 months from the time of enactment to complete the study. Mid-level ethanol blends could not be sold until after EPA issues its assessment report.

A few data points on ethanol:

- 10% of all gasoline sold contains ethanol. That comes to 13 billion gallons of alcohol, $25-30b of cash flow a year.

- The energy content of ethanol is 33% less efficient than gasoline by volume.

- Using E10 (10% ethanol) reduces mileage by 3.3%.

Americans drive 3 Trillion miles a year (incredible). If all of the drivers used blended gas containing 10% ethanol it would mean that the reduced efficiency would cost drivers 100b miles a year, or $350B. The actual losses to drivers is less than that calculation as not all gas consumed has ethanol, but the number that consumers pay as a result of ethanol is well in excess of $50b – serious money.

The politics of ethanol is interesting. The House Bill that would force the review of ethanol comes from Congressman Lamar Smith (R-TX). Lamar is the head of the Committee on Science, Space and Technology (CSST). Smith also represents Texas. Does Congressman Smith have an axe to grind in this story? Sure he does – Texas is oil and refining. Those who produce oil and the refiners who convert it into gasoline have a lot at stake. If ethanol is scrapped, then big oil and big refiners will win big. One can be pretty sure that the ‘results’ of the proposed study are already known. H.R. 875 would not have gotten as far as it has unless guys like Lamar Smith already know the answers on ethanol.

Ethanol is a renewable energy source – so that makes it Green. The Administration, and a fair number of Democratic Senators have IOUs to the Greens. The folks who want ethanol have a very big support base. That support base includes environmentalists, corn growers and ethanol producers – but it doesn’t include consumers.

There are some market related consequences to H.R. 875. Should it pass, it will knock the ethanol producers for a loop, the refiners will see a benefit, and I wouldn’t want to be long corn if this Bill comes into being.

I’m not worried too much about the companies who make ethanol, nor do I think that corn is headed for a tumble. H.R. 875 will never see the light of day. And that is the joke in this story. For a lousy million bucks the answers to this could be available for the public to consider. But the public will never have a chance to see those results. We will continue to burn our food and use inefficient energy supplies for years more to come. Welcome to America and its stupid politics.

About The Author - Bruce Krasting had worked on Wall Street for 25 years--"For 25 years I woke up thinking, "What am I going to do today to make some money in the market". I don't do that any longer. But I miss it." Nowadays, Bruce blogs about his take on financial events at Bruce Krasting. (EconMatters author archive here.)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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

Comparing Bubbles: S&P 500 vs. U.S. Treasuries

2013-04-26T16:01:00.003-05:00

By JW Jones

Today we have a plethora of companies reporting earnings and are moving through the 1^st Quarter earnings season at a rapid pace. Thus far, earnings have been far from exciting and have made the previous 2013 forward earnings estimates laughable.

The only way we get to the proposed valuations is through multiple expansion which is simply going to require the Federal Reserve to continue to pump $85 billion into Treasury’s and MBS securities each month. I am confident they will comply.

There are a few analysts out there who are discussing the potential bubble forming in equities and other risk assets as Bernanke’s plan is working to the extent that asset prices are rising. However, even fewer analysts are pointing out that both retail and institutional money is constantly chasing yield at this point.

Simply take a look at the 2013 price action in high yield dividend paying stocks, high yield bonds, preferred stocks, and master limited partnerships. It is safe to say that a bubble has formed not just in equities, but in various fixed investments as well. Consider the following chart of the S&P 500 Index (SPX) shown as the dotted trendline and Johnson & Johnson (JNJ) shown as the solid black line.

Obviously from looking at the chart above, JNJ has outperformed the S&P 500 Index year to date. Has JNJ suddenly become a growth giant? Is it all about earnings growth and/or forward earnings potential or anticipated growth?

Or is the rally in JNJ really about the fact that Johnson & Johnson has a long history of paying strong, rising dividends. I am sure there are plenty of sell side analysts who will tell you that JNJ is going to $100 / share in the future for a variety of macro or quantitative reasons.

The sell-side analysts will tell you the economy is strengthening or that large cap multinational companies are seeing strengthening fundamentals and earnings growth. They are called the sell-side for a reason; they want to sell you stock.

Furthermore, my favorite recent discussion is about future earnings projections and the new strength that we are going to see in earnings. The following chart was posted at www.zerohedge.com and originally came from Standard & Poors. The chart below illustrates the trailing 12 month operating earnings per share of S&P 500 companies.

Based on the above data, how is the stock market fundamentally sound when earnings are collapsing? I guess the Federal Reserve is going to print profits for the S&P 500 companies. Actually earnings are irrelevant when central banks all over the world including the Federal Reserve are juicing the markets with a sea of liquidity and where multiple expansion trumps real earnings or value.

Furthermore, these same central banks are openly purchasing equities and allocating sizable portions of their balance sheets to stocks. Several central banks around the world have more than 10% of their reserves allocated to stocks at this point in time. The world is long risk and money is still flowing into bonds at the same time. Simply look at the recent price action in Treasury’s for the past few weeks or note the strength in municipal bonds in aggregate since mid-March.

This brings me to my final point. For the past several years, bonds and stocks in the United States have rallied together. U.S. treasuries and domestic equities have been trending higher for more than three years as shown below. The S&P 500 is shown as the dotted line and the 30 Year Treasury Bond Price Index is the black solid line.

It is without question that both the S&P 500 Index and the 30 Year Treasury Bond have been trending higher for the past 3 years overall. Both underlying assets have produced strong gains during the same period of time. Now this brings me to my final question for readers to ponder. If both the S&P 500 Index and the 30 Year Treasury Bond can rally together, what happens if they selloff together?

The answer to that question is the real problem. Many sell-side analysts and economists ignore the bubble that the Federal Reserve has created in equity valuations. The bubble continues to be fueled by the monstrous liquidity injections that they have conducted beginning with the original quantitative easing. However, what is even less acknowledged by the sell-side is the massive artificial bullish valuations that have been created in the bond market.

Long dated treasuries are being purchased by the Federal Reserve to artificially hold down interest rates. This ongoing practice is causing a separate bubble to form in fixed income investments. So now we have a bubble in equities and long-dated treasuries forming and the sell-side continues to trumpet that higher prices are likely. Ultimately the sell-side may be right in short to intermediate time frame, but the end game has a finality that few want to consider.

When these bubbles finally pop as all excessively valued assets do, the result is going to devastate financial markets. It may be in 6 months or it may be in 10 years, but history will not be thwarted. The central banks can try to outsmart history, but they will ultimately fail.

Courtesy JW Jones via Chris Vermeulen (EconMatters author archive here)