IQR Investments

Global liquidity trap: "the easy stuff!"

2012-01-11T08:42:00.000-08:00

Germany sold six-month treasury bills with negative interest rate.

European banks are hoarding cash with ECB, trying desparately to manage their liquidity and balance sheets.

All these are evidence of a "liquidity trap" situation that Europe is in. By Paul Krugman's account, about 70% of the world is in the trap. The strange things going on now in Europe are just some latest evidence.

The concept is not hard to grasp, but the mainstream news media and investment community seem slow in catching on. It's nice to see Paul McCulley on CNBC today talking coordination between monetary and fiscal policies in such a world:

Euro, death spiral

2011-12-12T10:20:00.000-08:00

It looks increasingly likely that the Euro has entered a death spiral: Spreading sovereign debt crisis is weighing on bank capital which requires more government supports, causing more stress on government debts.

One hope is for ECB to become the lender of last resort, an idea that Germany has consistently blocked.

The latest European Summit was all about sumitting to the German will of tighter budget control, but without any economic stimulus for the troubled nations. The implications can be deadly.

The 10-year Italian government bond yield is back up to about 6.5%. If it hits 7%, Europe will be back to the full crisis mode again, much sooner than the summit "leaders" have expected.

Jobs sorely missed

2011-10-06T06:47:00.000-07:00

- Connecting dots. Follow your heart and intuition.
- Love what you do. Keep looking. Don't settle.
- Know you may die tomorrow.

Idle labor, idle capital, perverse austerity

2011-09-27T08:24:00.000-07:00

The great recession of 2008-09 has left us persistent high unemployment, record low interest rate, large corporate and bank reserves. Consumers are struggling to repair their balance sheets, yet neither governments nor large corporations are doing much to help solve the economic slump.

What's going on? Can "market" solve the problem on its own? And what do we mean by that, anyway?

The only sensible diagnosis I've seen so far by economists is that the "advanced world, accounting for 70 percent of world GDP at market prices, is in a liquidity trap."

What should be done?

In the words of Nobel Laureate Peter Diamond:

On the nation’s unemployment problem and how infrastructure spending could help solve it:

–Most of [the 9.1% unemployment rate], more than half of it, is inadequate aggregate demand and what we need now, very badly, is more fiscal stimulus and the continuation by the Fed of rolling out monetary stimulus as it fits their projections of what’s going on.

–Right now we have idle labor, idle capital… [and] interest rates are low, so doing it sooner has that advantage compared to doing it later. And third we do get a Keynesian multiplier out of it. –The fact that infrastructure spending will be phased in slowly doesn’t seem to me a shortcoming right now, because all the forecasts we’ve seen say coming out of this [malaise] is going to be a slow process.

Are we headed for another recession?

–There’s no question that we’re vulnerable….. It’s really important to put into place policies that would have the long-run effect of reducing debt growth. But there’s nothing on the debt side we need to do immediately. We do not have a debt crisis. We have a long-run debt problem and austerity today is perverse from the point of view of unemployment, and insofar as the economy is vulnerable that will make it more vulnerable, and of course a double-dip [recession] will lose us a lot of tax revenue.

Professor Diamond is known for his "search" model of labor market, which brings in a form of market friction to explain the lack of clearance in labor market. Even he thinks the unemployment problem is mostly an aggregate demand problem. The rest could perhaps be attributed to "structural" problems such as skill mismatch.

The interview with WSJ's Kelly Evans shows these takes and views:

Doing a lot more with a lot less

2011-09-23T08:37:00.000-07:00

The U.S. corporations have recovered remarkably well. Revenues and earnings are growing in a slow-growth economy. As Jack Welch puts it: The American corporations have learned to do a lot more with a lot less.

Large corporations have a lot going for them: extremely competitive labor market and technologies allowing them to cut costs. On top of that, cost of capital has been driven to historical low as the Fed fights the great recession. They're also able to tap into the fast-growing emerging market economies for demands on their goods and services. The Fed is lending a helping hand here too by maintaining the easy money policy which tends to drive down the dollar.

A natural question to ask the government is why can't it do a lot more with a lot less? The Republicans are clearly on the affirmative. But can austerity really help small businesses and help create jobs? You just can't run a government as if it's a corporation.

Can labor or consumers manage to do a lot more with a lot less? Somehow you just can't push that logic very far with tens of millions of unemployed and under-employed.

Obama's job bill may be too little too late, if it gets passed in some form at all. The Fed's latest "operation twist" (a double twists) may be too little as well. A twisted QE may have more sense given the grim outlook. More firepower should be concentrated on the mortgage market. At least the Fed is trying.

Luxury resilience and operation twist

2011-09-19T08:35:00.000-07:00

The mainstream de-leveraging consumers continue to struggle in face of persistent high unemployment and housing market slump. The great recession hit both their income and their wealth hard. Low-end retailers such as JC Penny and Walmart are not doing well.

The mainstream consumer is powerless in driving the recovery.

Consumer spending is now overwhelmingly the story of the luxury shoppers. While a small segment of consumers, they wield an outside impact on the broader economy, earning roughly 50% of the total income in the U.S. and making about 48% of total expenditures.

The newly rich in emerging economies are also making their spending power felt around the globe from luxury accessories to luxury cars and homes. Here are some interesting recent reports:

Hermès cannot meet demand for luxury.

LVMH Sees No Slowdown in Luxury Goods Demand.

Urban luxury homes are back in demand, aided by new foreign buyers from Russia, China and Brazil.

Luxury spending picks up even as economy sputters (The Detroit News).

Even the recent market volatility hasn't affected their mood to spend.

The stock market recovery since 2009 has a lot to do with it. The Fed's easy money policy has a lot to do with it.

If the Fed wants to stimulate the economy, the wealth channel is both obvious and effective. This segment of the consumers are credit-worthy, cash-rich and asset-rich. They're the most likely candidate to lever up somewhat. If the banks want to lend, who else would they want to lend to?

Businesses catering to their needs are expanding, both domestically and internationally (see the recent earnings reports from Tiffany, Raulph Lauren, Nordstrom for example).

The recovery on the highend will trickle down. The Fed must pay a lot of attention to this most promising pillar of economic recovery where monetary policy has been and will continue to be effective.

If the Fed twists this Wednesday, risk-premium would be lowered. Investors would be chased out of safe-haven to take on more risks. Risk assets would be supported to some extent to counter the fear of Euro/Banking crisis and the fear of recession. This is not to create another asset bubble, but to ensure the recovery is in-tact.

More work to do for the Fed chief

2011-09-09T07:14:00.000-07:00

Europe is clearly the big drag and big risk for the global economy and the market. U.S. may be the hope. President Obama's job speech last night looked like a refreshing refocus on the real thing, but he faces a difficult uphill battle to get the package through Congress.

The Fed may be able to do a bit more. Mr.Bernanke has been avoiding specifics in his last two big speeches, but provided a clear sounding board to the White House and to the Congress. The economic recovery is at risk of stalling, and the circus in Congress is making things worse.

Yet, it's troubling that Mr.Bernanke appeared troubled by "exceptionally cautious" households:

One striking aspect of the recovery is the unusual weakness in household spending. After contracting very sharply during the recession, consumer spending expanded moderately through 2010, only to decelerate in the first half of 2011. The temporary factors I mentioned earlier--the rise in commodity prices, which has hurt households' purchasing power, and the disruption in manufacturing following the Japanese disaster, which reduced auto availability and hence sales--are partial explanations for this deceleration. But households are struggling with other important headwinds as well, including the persistently high level of unemployment, slow gains in wages for those who remain employed, falling house prices, and debt burdens that remain high for many, notwithstanding that households, in the aggregate, have been saving more and borrowing less. Even taking into account the many financial pressures they face, households seem exceptionally cautious. Indeed, readings on consumer confidence have fallen substantially in recent months as people have become more pessimistic about both economic conditions and their own financial prospects.

Spending power of a typical household comes from their current income and/or their asset. If their asset is not liquid, they can borrow against it. Both sources are under heavy headwinds, as noted by the Fed chief. How much more can they do?

If Mr.Bernanke cannot get over this, and continues to hold out hope that the households will step up spending miraculously, then we're unlikely to see decisive actions from the Fed. Perhaps this is what's troubling the market.

The Fed's dual mandate

2011-09-07T12:09:00.000-07:00

New speech from Chicago Fed President Charles Evans makes it clear why the Fed should be more aggressive in tackling the unemployment problem.

The entire article is well worth a good read. Relative to the concerns and comments from the disenting regional Fed presidents, his arguments are based both on macroeconomic theory and empirical studies.

What seems to be lacking, however, is more convincing arguments on the efficacy of un-conventional monetary policies such as QE. On this front, the article is drawing on works by Michael Woodford and perhaps Paul Krugman to argue for setting consistent policy expectations over the medium and the long run.

Ideally, the accommodative monetary policy is most effective when combined with an expansionary fiscal policy which can create final demand directly.

Higher inflation rate may be allowed by the Fed

2011-08-30T10:59:00.000-07:00

Interesting two-part interviews with Charles Evans, Chicago Fed president. He argues that the Fed's accommodative policies have been working, and he would support further aggressive easing.

In particular he mentioned that a high level of inflation rate (say, 3% per anum) should be allowed.

He also mentioned a recent opinion piece on Financial Times by Professor Michael Woodford, a leading monetary macro economist, which focuses on setting inflationary expectations as a policy tool.

Stiglitz: reverse tax, medical benefit, war & downturn

2011-08-24T08:04:00.000-07:00

He touches on the wrong focus in Europe, the broad policy reversal that are needed, and what the Fed can and should do.

What are the options on the fiscal side?

2011-08-23T07:05:00.000-07:00

For a serious discussion on tax reform and practical options to create jobs, here.

Was QE2 effective?

2011-08-13T13:27:00.000-07:00

Slow growth and market turmoil have brought us back to QE. Markets are expecting QE3, to be telegraphed perhaps as soon as the end of August at Jackson Hole.

It's important at this juncture to ask if QE2 has been effective. Most financial commentaters have dismissed its effectiveness out of the casual observation that the economy is still not growing very much and unemployment rate is still very high. Here is an example.

John Mauldin's latest newsletter "The Beginning of the Endgame" asks the same question about QE2:

What about QE3? Let’s look at how that last move turned out. We ended up with more money on the Fed’s balance sheet and higher commodity prices. The NFIB survey I cited last week showed there was no great demand on the part of small business for loans. 91% had what they needed. What they want are sales and customers! The trade data yesterday showed exports fell by over $2.3 billion last month. That suggests a slowing world economy. Which is borne out by numerous other indicators.

Is this a fair assessment of QE2? Would one expect QE2 to create sales and customers for small businesses such that they demand for more laons? The Federal Reserve has no such power and one should not expect anything like this to start with. A fiscal stimulus may have that effect if it's designed to create final demands for these businesses. As to trade, a weaker dollar has helped. But again, the Fed can't control the world demand for U.S. goods and services. Is a slowing world economy the failure of QE2?

This type of off-hand, sloppy remarks help to cloud the general perception of monetary policies.

St Louis Fed's assessment is a good starting point. It's mostly effective, but its effect is difficult to be disentangled with the effects from other adverse shocks such as the Japanese earthquake and the European debt crisis.

One can argue perhaps QE2 wasn't large enough.

We also hear very often that normal transmission mechanisms (e.g. multiplier effect via banking system) for monetary policy have been broken, therefore QE2 or QE3 would not be effective. Paul Krugman has a different take. There are a wealth effect and a weak-dollar effect. These two effects have important investment implications.

QE is probably not the best tool to stimulate growth when the economy is weighed down by heavy debt loads. But it's probably the only viable tool to save the economy from slipping into another recession.

Fed should maintain QE and create moderate inflation

2011-08-08T18:30:00.000-07:00

Dow dropped another 634 points today. A lot of fear in the market. This isn't because of the S&P downgrade. Investors are panicking over slowing growth or a potential contraction. Are we heading right back to recession? What can one expect from the Federal Reserve which is having a FOMC meeting tomorrow?

Ken Rogoff expressed a clear view in this interview. He thinks that the Fed should have never stopped QE2, in fact he thinks that the Fed should make it open ended and make it clear the objective is to create inflation.

Quoting Bloomberg:

Rogoff recommended the Fed say in “very clear statements” that it’s trying to create “moderate inflation.” “In the classic classroom QE, it’s open-ended,” Rogoff said. “You say, ‘I’m trying to create inflation of, let’s say 2 or 3 percent, and I’m going to do whatever it takes.’”

The Fed should also avoid repeating that officials are trying to boost stocks, Rogoff said, calling that a “bad idea.”

The Standard & Poor’s 500 Index tumbled 6.7 percent yesterday to 1,119.46 in New York trading, its biggest decline since December 2008. The benchmark Stoxx Europe 600 Index dropped 4.1 percent yesterday in London to 228.98, its biggest retreat since March 2009.

The Fed should have extended its asset-purchase program, “as controversial as it was,” instead of ending it, Rogoff said. The central bank completed the second round of bond buying in June, purchasing $600 billion of Treasuries.

“They need to move much more decisively,” Rogoff said.

Liquidity trap and the parodox of thrift

2011-08-05T12:34:00.000-07:00

How to interpret the economic paralysis we're in and how to think about the options we have? Here is another pretty coherent Keynesian view.

The arguments are pretty much in line with Paul Krugman's diagnosis.

QE3 maybe the only stimulant

2011-08-02T18:59:00.000-07:00

However imperfect, Quantitative Easing round 3 may be the only option to prevent the economy slipping back into recession.

Is US making the same economic mistakes as Japan?

2011-08-01T18:12:00.000-07:00

Difficult times call for heroic measures. But we are not seeing much of that in the government... It's difficult to sort things out. You want to read commentaries that are at least self-consistent. Paul Krugman represents such a view, in favor of the Keynesian intervention. However, that requires a heroic adminstration and a collaborative Congress which we probably don't have.

See his prognostic for the next few years.

Does market see demand destruction?

2011-03-10T13:49:00.000-08:00

Energy has been a good performer this year. But today energy stocks of all stripes are selling off, big time. With oil hovering above $100/b, perhaps the market is seeing potential demand destruction, not only for oil, but also for other commodities?

China's surprise trade deficit adds to the heightened uncertainty. Middle East issues are not going away anytime soon, but market will probably get used to it.

We think this is an opportunity to take some risk, especially in the energy sector.

Buffett on Stocks, Bonds and Commodities

2011-03-02T10:29:00.000-08:00

CNBC's Squawk Box team has done a long interview with Warren Buffett. This is one of the segments I like.

Two types of assets to buy: One type of asset itself will deliver a return to you; the other type will depend on what the next guy will be willing to pay for it.

Resilient market

2011-02-25T10:15:00.000-08:00

Despite so many headwinds including the uprising in the Middle East, market is heading up higher. Consumers are buying more. Corporations are spending more, but still not hiring.

Corrections have been shallow and short.

Why market is so resilient?

There maybe a lot of buying on dips from retail and institutional investors. There have also been a steady stream of corporate share re-purchasing.

We feel that the Fed's accommodative monetary policy is the key here. Perhaps the wealth effect is creating the crucial virtuous cycle, which eventually will reach the lagging housing market and labor market.

But inflation is becoming a threat with $100 oil and $3+ gasoline.

Fueling recovery: business and consumer lending on the rise

2011-01-17T13:45:00.000-08:00

Credit is the fuel for economic recovery and expansion. We may be seeing the beginning of the next credit expansion, with the nation's largest commercial banks finally increasing their lendings to both businesses and consumers, see this WSJ report.

Signs of a lending rebound in business loans already were evident at some big U.S. banks, and Mr. Dimon cited "fairly broad-based strength across corporate, middle market, even small business." But consumer lending has lagged behind because of unemployment, foreclosures and the reluctance of many Americans to go deeper into debt.

Now, the economy is gaining momentum, as shown by the Commerce Department's report Friday that consumers spent more for the sixth straight month. That means profit-hungry bankers are growing more eager to make new loans, especially to borrowers with strong credit histories.

JP Morgan has just reported a great quarter. More are yet to come from Wells Fargo, Bank of America, and Citi this week.

According to Dick Bove, an influencial bank anaylst, banks are entering a "golden age."

What the bond markets are saying

2011-01-09T12:34:00.000-08:00

It's often very important for equity investors to look at what the bond markets are saying.

The long-term yields of US Treasuries have stabilized after the December FOMC meeting. They were creeping up since the Fed indicated its intention to do QE2, and especially after the bi-partisan decision to extend Bush-era tax cuts. US government has no trouble borrowing. The upward sloping yield curve is re-assuring for bank stocks and general equities.

European countries are a different story. The Euro crisis is pretty much still with us. Credit spreads for Greece and Ireland continued to climb in recent weeks. The Greek bond spread is now wider than it was in May, 2010 before it was bailed out by EU and IMF (see Atlanta Fed Financial Highlights). All eyes are now on Portugal as its government are trying to convince investors that they can narrow their budget gaps. The yield on Portuguese 10-year bonds stood at over 7 percent as of last week, according Bloomberg. Can ECB and IMF manage the situation before the crisis spreads to Spain? Investors are not convinced.

In the US, a worrisome development continues to be the muni market and state budget crisis. Illinois is the poster-child of the fiscal mess. The state's bonds have the highest spreads of any state. Illinois's 10-year bond spread has widened in recent weeks to 2.1 percent above the benchmark. A year ago, that spread was less than 1 percent... meanwhile, Bernanke's testimony last week made it clear that the Fed has very limited power to bail out the states.

The bright spot is US corporate bonds. Companies are taking advantage of investors' hunger for yield and the general belief that the corporate sector is healthy and may be poised to deliver the much-needed hiring. Corporations have sold more than $35 billion of investment grade bonds in the first week of 2011, according to the Wall Street Journal, on track to reaching the highest amount sold in the year-opening week since 1995.

Taken together, we agree that it may be wise to invest in US equities, and focus on companies that conduct businesses in states that are relatively healthy and can take advantage of the needs from the emerging markets. Avoid European exposures for now. And be vigilant about systemic risks posed by the Euro crisis and the US state budget crisis.

We do not think China's and India's inflation problem pose such a systemic risk to global financial markets, but it's something to watch out for.

Explosive optimism

2011-01-01T13:28:00.000-08:00

This weekend's Barron's has the usually bearish Alan Adelson put up a big warning in "Signs of a Top?"

Market sentiment following the surging December is characterized as "explosive optimism." Indeed, forecasts from Goldman Sach's Jim O'neill's 20% stock market gain and "Year of USA" proclamation, to various market gurus that Barron's has assembled, to the recent low in VIX all seem to agree on a very good year ahead.

Could this be the sign of a temporary market top before the real economies produce sufficient results to support it?

This is probably the most important question to ask heading into the first week of 2011. Perhaps the December surge was really just an amplified "window dressing" and short-covering effect when all the under-performing portfolio managers tried to buy the year's big winners and short sellers ran for the cover. If so, these stocks are over-bought and can see sell offs in January.

As noted by Adelson, one important area to watch is indeed the commodities-related stocks which seem to have not reflected the new policy stand by China trying to reign in inflation and the potential bubble in property markets. China has raised interest rates multiple times and bank reserve requirement multiple times. And RMB has not appreciated much. It seems pretty clear that the easy bank-lending policy of the crisis era is now on reverse.

Yet, from copper, iron ore, to other industrial metals and the companies engaged in their productions, the market continues to assume an ever-expanding appetite out of China. FCX has hit 120/share! Can this continue in the new year? If that reverses, it could be a leading signal for things to follow. For a good anlysis of the copper market, and a fair warning, see this Seeking Alpha article.

Happy holidays, but be worried about global risks

2010-12-24T07:24:00.000-08:00

The year end rally has been strong. It's not all surprising given the steady climb in auto and other retail sales. Consumers maybe back from more than two years of belt-tightening. That's a big deal.

Retail investors may be tip-toeing back to equity markets as well, moving away from bond funds as the long-term rates are rising.

Institutional investors may be pushing the winners all the way to the end of December. We don't know. But given the predominately bullish commentaries we read everywhere, there is a great likelihood the market is setting itself up for a big correction comes January.

Here is an interesting indicator of the extreme bullishness.

Banks and other financials may be in a good position to benefit from the firmer recovery undergirded by the Fed's QE2 and the Congress's tax deduction extension. We have benefited a great deal from our large positions in WFC, BAC, USB, and some home builders.

But, this is the time to be very cautious. Dark clouds are swirling, people just don't talk about them much. European debt crisis is very much alive and not going away anytime soon. US unemployment rate will be elevated for years to come. Deficit problem is not been tackled in any systematic way. China's inflation problem may require much more severe measures than expected. These are known problems. Granted, market's tolerance is higher when these problems are known. Still, it seems very likely that more surprises may be lurking around the corner.

Andy Xie, an independent economist, has this piece about US and China. His main point:

China may have won the last race. To win the next one, China must tackle its inflation problem, which is ultimately a political and structural issue, in 2011. If China does, the U.S. will again be the cause for the next global crisis. China will suffer from declining exports but benefit from lower oil prices.

On the other hand, if China has a hard landing, the U.S.’s trade deficit can drop dramatically, maybe by 50%, due to lower import prices. It would boost the dollar’s value and bring down the U.S.’s Treasury yield. The U.S. can have lower financing costs and lower expenditures. The combination allows the U.S. to enjoy a period of good growth.

One could describe the global economy as a race between the U.S. and China, to see who goes down first.

We're now 50% cash, increased our shorts. We'll be even more defensive if the market continues to rally next week.

State Budgets: Day of Reckoning

2010-12-22T17:15:00.000-08:00

While the VIX has been trending down to below 16%, the lowest level since April of 2010, the Muni bond market may be telling us something quite different. The yield spread (against an index of the highest-rated muni bonds) on debt issued by the State of Illinois, for example, has been increasing rapidly from pre-crisis level of about 0.2% (2008) to about 2% in late 2010.

The video below from CBS 60 Minutes is a must see.

Will weak local governments create a similar systematic financial problem posed by the weak Euro members?

Rising mortgage rates goes with rising housing starts?

2010-12-16T10:14:00.000-08:00

Housing starts have been in the dump for most of 2010, especially after the experiation of the tax credits. This morning's report shows some life in this important sector. Perhaps the sector is now ready to stand on its own feet.

Mortgage rates however have been rising rapidly since the Congress and the Administration started to work on extending the Bush-era tax cuts. Investors have been shunning Treasuries, in favor of cash, commodities, or equities. This is not necessarily a reflection of rising inflation expectations, although that could be part of the reason (judging from the implicit inflation rate priced into TIPs). On balance, investors are probably betting that the expansionary monetary policy as expressed in QE2 should work well in the thort term with the accommodative fiscal policy should it passes the House. Rising long-term T rates, which causes the T yield curve to steepen, is a sign that the economic recovery may quicken 2011-2012.

The Fed's goal was to stimulate the economy via asset inflation. It has so far succeeded in chasing investors away from the "safe haven" of the Treasuries, into more risky assets that are more tied to the US and global economies.

That's only the beginning. For this twin stimulus to work, the private sector needs to move up in a big way to employ more works. Millions more. More jobs would help housing starts. And more housing starts would jump start more construction jobs.

For people looking to buy a house, mortgage rates in 5-6% are still relatively low. The dominating variable is job security. Besides, when the rates rise to a certain level, bond funds and foreign government would purchase more long-term US government bonds to help hold down the rates.

In this mix, banks that have repaired their balance sheets and have successfully re-positioned themselves to take advantage of the steep yield curve and the economic recovery should be ready to print profits in the boat loads. One of the prime beneficiaries will be Wells Fargo, whose market cap has again overtaken that of JP Morgan today with its share rising over $30. A recent Barron's article has put WFC's shares at $35-40 range based on its normalized earnings power, which it should start to show itself in 2011 when Wachovia branches are all converted.

Investors should hold on to these bank shares, and some of the home builder shares for an interesting "rabbit ride" in 2011.