marketAnalyticZ

Emerging Market Cyclical Decline, Developed Market Previous Investment, Looks Bigger Than Greece

2015-08-24T20:02:00.002-07:00

I've never witnessed a candlestick in the Dow Jones Industrial Average of today's kind. What's more is that this candlestick formation is common among all indices and heavily traded stocks. Learned observers seem to have a common opinion that this is not only unusual, but also historical.

The bizarre dynamic happened with market futures opening with indications of a significant decline, 800 points down for the Dow. Next was a climbing opening for the Dow, reaching about only 400 points negative, then a nose dive of up to 1,100 points. That is a capitulation to sell. Then I saw the sellers capitulate to higher pricing and the Dow reached a point of being down only 140 points.

Volatility shot through the roof, and the prices of options also shot up. Then down, then up. In fact liquidity in options seemed rather slow due to the rapid and extreme movement in index pricing. Such pricing difficulty presents complication for one seeking to open a new position at this time. Even exiting a profitable position was difficult today. But really not bad at all, with these price movements. Essentially, the exits got clogged today, then the entry got clogged, then market makers didn't want to undersell the market or oversell the market.

Market pricing at this point isn't just an issue of a couple day's sentiment. Reality is in the equities of China collapsing. China is the 2nd largest single country economy in the world. By itself, China's stock can do what they do. But when China's stock market makes significant moves, one must search for implications. The most ready implication is confirmation of pricing discrepancy between China's real GDP performance against China's equity earnings performance.

Perhaps China's stock market got well ahead of itself. And maybe China's policy makers realize that.

What appears to be most concerning for U.S. markets is emerging market currency decline, due to cyclical demand declines. This dynamic pressures pricing of all commodities. Should emerging markets really be entering the decline aspect of their economic cycle, the yield hungry investors from developed economies provided substantial debt to the emerging markets. Today, the combination of emerging market debt and emerging market cyclical decline bring a ration of reality to U.S. equities. That seems to be what we see.

China is Once More Disturbing Markets

2015-08-18T23:46:00.001-07:00

I trade the markets, and I've found an unsettling development this week. Where last week I found the markets respond in deep decline to China's currency devaluation, that same market came back the next day in a seriously bullish action. In fact, the market closed up considerably. This last price action happened on Wednesday of last week.

Since Thursday of last week, the major indexes are flat. Essentially, the bulls showed major resilience, but no capacity to follow-through over a few days now. Same with the bears, which got their back broken on Wednesday of last week.

Otherwise for the Dow, Walmart guided down and Home Depot outperformed. I think Disney was downgraded, by someone (ESPN cable issues). Disney owns the franchise. Yet, the only proprietary franchise merchandise I care to get off ESPN is during college football season (cancel and reconnect).

Looking at Monday, the indexes were up and finished with a little rally at the close. That looked bullish going into Tuesday, and looked promising for a follow-through increase. But on Tuesday morning, the indexes were down, and finished the day down, and more pointed is the indexes were down only marginally.

Today of August 19, for the first time in several days, a significant decline was observed in all indexes. Such a decline was not linear. Rather, the decline occurred after a major rally, but the push up ended in considerable decline given the range since last week.

Causation certainly appears to be China and it's stock index losing 6% on Tuesday, only to lose 4% today but find a 1% gain at closing today. This leads to the appearance of the Chinese government support of their stock market not being the salvation once thought.

Probably more concerning is that the People's Bank of China released more money to their associated central banks than since January 2014. That by itself is meaningful. Especially when this release of funds occurs at a time after a currency devaluation.......How much money did China expend in preventing a collapse of their currency. How much more money will be needed for a second resetting down of currency price.

Perhaps an appropriate question is whether China devalues again. Market pressures seem to want more devaluation. And, China wants their currency to reflect markets. Their stock market, however, isn't so much based on a market. Large stock holders can't sell and the government today took a step back on Tuesday from supporting prices. Perhaps China's troubled state owned enterprises are buying stock to support the market. Yet, if China follows the policy of their currency, and remain consistent with their stock market intervention limitations, that stock market is going to follow market influences in a fashion similar to their currency.

Further Chinese yuan/renminbi devaluation only increases the cost of China's bloated foreign currency debt. It also makes China's exports comparatively cheaper. Between the two "onlys", which is more powerful?

By devaluing a currency, a country makes debt burdens more difficult for domestic businesses that hold foreign, especially U.S., denominated debt. This situation namely arises in China for its property development businesses, which seem to be a Potemkin village. However, most of this debt is held by state enterprises, which is ultimately China's corporate debt, and not the state held debt.

Memorial Day

2015-05-25T18:45:00.001-07:00

Given Memorial Day, we must remember those forever loved, now lost, in the service of our Country.

https://www.youtube.com/watch?v=BB2Ad04mukI

2015-05-06T21:33:00.000-07:00

Just last Monday, Fed Chair Yellen said equity prices are high. Yes, that seems to be a rational conclusion. After all, the S&P 500 P/E appears around 20, plus some change. Nonetheless, I hear that historically such a number isn't too high.

Reality is that in the past, even with equity bubbles, there was the prospect for increasing business propositions. Namely, the internet in early 2000's. A bubble occurred, popped and finally did realize a profound growth potential. Which by the way created super technology to create the banking bubble realized in 2008 with Lehman and others.

Now, banking is probably way too conservative on lending criteria. Yet they have to be to comply with capital requirements and the balancing of equity versus lending. That dynamic leads to stunted growth in capital development in business.

We also have a condition of net loss of jobs globally, due to automation. That obviously leads to a net loss of consumers. I've mentioned previously what Henry Ford did for his company, and the market, many decades ago.

Today, consumers remain as real as they did yesterday. So often, a corporation will automate a job once held by a human, to be replaced by a machine. Like I've said, the machine doesn't buy any products, while the human will ultimately by products, if not a Ford pickup.

To make sales, one needs buyers. Therein resides the difficulty of this present day economy. Corporate revenues, a.k.a sales, are flat to down. That does not simply imply a flat buyer of products, it screams a flat and down buyer of products.

O.K. I will play the game.....who the hell do you sell to when all jobs are gone.....How about selling to call center folks all day long. Thank God they can hire a plumber.

Tell you what, after lifting about a ton for exercise and running a few miles, there is nothing I adore more than a McDonald's hamburger and french fries. No ice cream, I save the appetite for meat and potatoes. I get my ice cream in the morning. If I wake up in time.

Fed Did Talk Down the Dollar, But we are Bid Up All Other Assets

2015-03-18T21:37:00.001-07:00

You got me. The Fed statements were....shall I say very dovish. In fact, I heard substantial commentary that the Fed came out unexpectedly dovish. My view is that the Fed talked down the dollar overall, with immediate market results. Perhaps the Fed took a page out of the ECB's play book, is what it looks like.

What disturbs me is how equities went wild on a fatter hog rally. Reality is, the Fed will not be pumping more cash into this system. The ECB will be pumping cash into the euro system. How does that cash translate into U.S. dollars given the current trade difference of currencies between euro and U.S. dollar? Not like it used to be.

People that make a living off this stuff will have to play the game. In the mean time, I recall Chair Yellen saying equities aren't BEYOND historical norms. Does it really take pricing beyond historical norms to prove a problem? Prevention of bubbles is the first teaching to learn. Second is deflate the apparent bubble in order to prevent an explosion.

Certainly a bubble was occurring with the U.S. dollar. That was talked down today by the Fed, and good work. That is the best thing I can take out of the historical message. Otherwise, it's bid up on other asset's high prices.

Where Will Markets be Upon Fed Remarks: Disappoint Equities and the Dollar

2015-03-17T23:31:00.000-07:00

Tomorrow at 2:30 Eastern Time, the U.S. Federal Reserve will hold its press conference that will announce its monthly decision. This meeting is especially crucial due to whether the central bank will increase interest rates or not. Most particular in investor curiosity is guidance, or language of some sort. From the Fed suggesting when the inevitable rate increase will likely occur, to when it might not occur, are the signals. That is, will the interest rate increase happen this year or next, or this Spring or Fall. Also of note are indications of under what circumstances a rate increase might occur. These matters are of considerable import in bull/bear market debates.

Where the Fed has been using a word, being "patience", on their timing of increasing interest rates, market consensus is that the Fed will eliminate the word "patient" from their often elusive "message" to the markets. The entire question does reside in how the Fed fills the hole left behind from abandoning "patient". Does the Fed replace the idea of patience with "light this candle" and rush interest rates (unlikely, they look like s.m.art.). Or does the Fed say they are going on light throttle touching increases, to see how the ship flies. Or, do they speak with a big stick and walk lightly with a month to month review of interest rate increases. This approach would really be learning how to fly through this unprecedented valley of history.

Ultimately, given the rise in the U.S. dollar and the rise in U.S. equities, the Fed needs to disappoint both asset classes. Increases in the U.S. dollar have been untold for nearly a half century. The rise in U.S. equities produce a consensus regarding a needed correction of considerable depth outside of channel up trajectories. Look at IPO's (especially among technology companies), falling earnings projections, sustained stock pricing, and challenges to revenue quality.

Small capitalization stocks see a weakness as well. How many services do these small cap companies offer to the employees of big capitalization companies? Or, how many services do these small caps offer to the big caps? Or, how many small caps are looking to be acquired by a big cap? These are drip down feelings for small caps, if big caps get hit too hard with our global environment.

To further make the point, for a big cap company to appropriately acquire a small cap, a condition of health should exist in the big cap. Consequently, a disturbing condition would occur should a big cap start acquiring small caps to help hide global weakness produced by dollar strength and declining global demand. By the way, dollar strength and weakening global demand are trends that don't look very transitory, unless the Fed acts to arrest the dynamic in some fashion.

Looking at actual influences on Fed decision making, perhaps a look at the last CPI data will help on perspective.

Strongest perspective is to say that while the headline CPI from the BLS for January, last reported on February 26, 2015 was -.7%, and for the year ending January it was down -.1%. But the story isn't over. Food for the months of July to last December held a run rate of price increase in the area of .3% to .2% and found a flat .0% in January, 2015. Overall, for the 12 months ending this last January, the rate of price increase for food resulted in 3.2%, well above a 2% Fed mandate. Out side of energy, most elements of the CPI increased more than 2% for the 12 months ending January. The increases beyond the Fed's 2% inflation mandate are:

Home food ending 12 months January increasing 3.2%.
Away food ending 12 months January increasing 3.1%.
Medical care commodities (same period) 3.9%
Shelter (same period) 2.9%
Transportation services (same period) 2.1%
Medical care services (same period) 2.3%

How about this versus petroleum, natural
gas and coal 's substantial decline: (shocked by this)

Electricity (same period) 2.5% (increase)

Keep in mind, energy in general has declined over the last year from 20% to 35%, depending on products. The meaning to be taken is that petroleum prices are essentially the only element that prevents the Fed from exceeding its inflation target of 2%. Last Fed meeting, Chair warned of "transitory" energy prices...meaning petroleum and gas. These two elements are children on the play ground of where the reality exists.

I've heard every day for the last 3 months about a bottom for petroleum, or no bottom. Petroleum is in a transitory dynamic driven by its own market cycle, which is a new cycle given U.S. production. Consequently, petroleum's influence on inflation can, and will, change based on that sector's response to the market.

These facts show the importance of the service industry in the U.S. and its association with the real U.S. economy. Looking at BEA reports, services in the U.S. have exceeded goods in sales by about 50%. Further, most of the above GDP areas that are exceeding 2% inflation are service industry related. Consequently, most of the U.S. economy is motoring above 2% inflation. It's only when one factors in giant drops in petroleum that one sees a muted disinflationary environment. Taking out the oil influence, the U.S. is experiencing a level of inflation generally well above the target of 2%.

Why oil is transitory are common and daily debates on where, when, who and at what consequence any price of oil will be realized. These debates could finally be realized on the side of inevitable market stabilization. Any stabilization will probably be increasing petroleum costs, that add to existing inflation that already exists through other areas of the economy. Overshooting the target by the Fed is their risk at this point. After all, petroleum is going through a cycle that will be self-correcting by its own giant market, without the Fed raising or lowering rates.

Where Fed Chair Yellen mentioned transitory energy prices in terms of interest rates, it appears real. Tomorrow's announcement seems to be setting up to be more aggressive than just removing the word patient. More like, see how the motor works on an aircraft never having reached this elevation.

Reality is, the U.S. dollar needs to be disappointed by "not enough", equities need to be disappointed by "too much", and bonds need to hold ground by warming up to their month long yield increases. At least until the Fed's next review of circumstances. Perhaps, if the buck gets talked down a little, with enough doubt on movement, equities will perhaps respond. Bonds can be let down at their choosing in their own confusion. Let's see how it plays out.

Markets Now Seem Risk On, But Fundamentals Have Not changed

2015-02-23T22:33:00.000-08:00

Did you see that market reversal? It looked so bearish, but then there was a complete pattern change. How about that. Once oil stopped its fall, everything went risk on. While I absolutely agree that American innovation is at work every day, I can't agree that the American company is an island unto itself.

The American consumer is proving tepid, except with, of all things, SUV cars. I like any vehicle with a wide foot print and a comparatively low profile. I like this feature for safety reasons. That really limits my options to a couple of companies.

Looking at the chart of the U.S dollar, we can see stability. Take a look:

From oil and the U.S. dollar, compare high risk assets, such as high yielding bonds:

We do have a risk on attitude. My posit is that two causative points exist for a rally in risk on assets. First, and for some reason, a bottom in oil has been thought to be found. Excluding fires and strikes, the fundamentals have not changed in oil. Where gas pricing can be seasonal, the fundamentals also have not changed. Even if SUV sales increased, reality is this idea of "subprime" vehicle loans. Frank reality is, versus the real estate market, those vehicles get repossessed over night and sold the next day. Second is why not buy in a bull market where any news is good news, despite U.S. multiples advancing on stock pricing.

Confusing the issue is the drop in U.S. treasury values. Stated otherwise, the spike in U.S. treasury yields. Look at the 10 year:

Any person with a conscience can see that rise in the 10 year yield, which means a drop in the price of the 10 year U.S. Treasury Bond, is a whole bunch really fast, despite trends and changes in fundamentals.

The guard to put up now is despite no real change in economic fundamentals over the last month, one should become cautious. This looks so much like a strange head fake to be caught on an over-head cross punch, if you've ever boxed. Maybe not. But look at the fundamentals.

Looking at currency markets, we are seeing in equity and debt markets, what I think is a bull's head bounce on risk assets, not a real issue that will deviate from stronger cross market trends. I could certainly be wrong.

Always remember, I offer opinions only, no investment advise. For investment advise, learn from ideas and ask of the person holding your money.

Reality of Markets, Look at European sustainability

2015-02-07T00:10:00.000-08:00

Equity markets were down today. I don't like to say bearish chart patterns might be gaining more conformation. If you please, see yesterday's post on this space.

I must, however, notice fundamental data. Germany"s industrial production disappointed by showing a December number of advancing .1% v. an expectation of .5%. Year over year, Germany's industrial production is down -.4%. Combine this with CPI data from Germany, and a point should be evident.

Today, France showed a growing trade deficit for December, despite a persistent decline in their currency, being the euro. France's trade deficit actually grew in December by 3.4B euro. But, to be intellectually honest, I must explain that France grew in exports by 1.8%, and this does reflect a 5th rimonth of continued gains. France needs that. But France also shows a 2.6% rise in imports. I have key chains France might like.

United Kingdom (England), similarly showed a merchandise trade (balance of trade) number of -10.2B sterling. Anticipation was only -9.1B euro.

We need to see this data for what it is. Essentially for me, I was surprised that my chart patterns proved out today. Now, more data must be considered. Any reader of this internet, or mobile communication space, must become astute and self responsible.

I write opinions. Which, in the course of how opinions develop, need to be challenged. I have to welcome all thoughts, ideas and people that want to review the previously spoken....If there is something to be said, bring it, my friend. I will treat you with respect, dignity and I will try to answer any question.

Market Volatility: A View on Markets, Based on Bonds and Charts

2015-02-06T01:29:00.000-08:00

Obvious for markets today is the volatility associated with price movements. My first exhibit is this chart of the S&P 500, which looks rather "whipsaw" in fashion:

Evident from the chart is how the S&P has went up and down in fast gyrations. Such movement would certainly dissuade me from having any association with this market at first glance. Yet, as one can see, a range has been set. Second observation is that a chart pattern might be proving itself. If one opens the chart, today's high of the S&P remains lower than the last high. The last high was on January 22 at 2063, today's high, on February 5, reached only 2062. That sets into place a bearish descending triangle pattern, given two essentially equal lower price points of 1992 on January 15 and January 30. One can argue a third horizontal price point on January 6 at 1992 on the lower end of the candle.

Such a set up tends to portend rather bearish. Same can be said for the Nasdaq, but not as technically precise, here's a look:

Nasdaq reveals also a falling triangle pattern. Open the screen up and one can see more clearly...being falling highs for the Nasdaq, with a February 5 close at 4,765 versus its previous high on January 26 of 4,771. Add to this the nearly equitable triple bottom of December 16, January 6 and January 16, and we have a close to perfect descending triangle.

By themselves, no one can rely on but a few chart patterns to see the tea leaves. Reality is that the Dow can look rather bullish. A cautionary tail for all stocks is the out-performance of Disney for the Dow and Apple for the S&P, and certainly for the technology space.

Consequently, I have to visit the VIX to gain a better understanding. Let's see:

What I see are higher lows and lower highs. In the chartist's form of understanding, and if I'm not mistaken, this looks to be a defining form of a bullish symmetrical triangle. Meaning the VIX could go up, based on chart patterns. When the VIX goes up, stocks go down.

Charting, I suppose, is based mostly on past behavior that has proven itself reasonably reliable over time. The question raised by that proposition is how reasonable. I looked for other indicators to spell out this issue.

I couldn't help but notice the yields for short term U.S. treasuries. Those yields have been resiliently high in anticipation of an increase in short term interest rates by the Fed, and have helped to flatten the yield curve. Because of this, we need to look at the charts and see what they say. Right below is a chart of the 5 year U.S. Treasury:

Next below is the 10 year U.S. bond, which really provides a baseline, being longer term, this chart provides dimension for our next diagrams:

Did you see the progressing drop in yield of the 10 year U.S. Treasury bond over 2014. In 2014, money liked the idea of low yield and safety. Most noted, however, is the drop in the 10 year yield at the start of 2015, steep. Does that drop in yield betray a deeper issue, perhaps of global implications?

This 10 year U.S. Treasury yield countervails, but eventually meets, sentiment in short term treasuries. Let's look again at the 5 year U.S. bond:

One can see how the five year treasury bond held its yield so well through 2014, but sacrificed so much ground at the start of this year. What do you suppose made the 5 year treasury lose so much yield? Or, stated otherwise, gain so much in value nearly over a month?

This question is confirmed in its need for an answer by taking a gander at the U.S. Treasury 2 year, we need to see:

This 2 year treasury bond increased in yield through 2014 like nobody's business. Only in the stock market "correction" of October, 2014 did it break its trajectory. Now, it has once more broken its trajectory.

My observation is that short term treasury yields fall when, in the short term, economic prospects look weak, safety is needed, and uncertainty exists. Such prospects result in a later than expected increase in rates by the Fed. Further, such increases in the price of short term treasuries typically are associated with stock market weakness. But, it is here that we are witnessing a divergence. Despite short term treasuries breaking their trend line, stocks are simply too volatile to touch.

Viewing treasury bond activity along with the activity in the stock exchanges, and VIX signals, one can expect a decline in markets. In fact, tomorrow will tell if the chart patterns for stock exchange indexes such as S&P and NASDAQ get further confirmation, or lost. The chart pattern for the VIX looks disturbingly resilient.

Overall, fundamentals need to be noticed, and these fundamentals seem to be leading indicators based on short term treasury yields.

Conoco Phillips, Occidental Petroleum earnings, lets learn from the Guilded Age.

2015-01-28T22:21:00.001-08:00

Oil earnings in the morning, with a Q4 price squeez.

In the morning starts the 4th quarter earnings announcements for oil and refining companies. While most of these companies did well through the end of Q3, 2014, the price of oil started its sell off really on September 30 last year. Since that time, West Texas Intermediate as gone from a September 30, 2014 value of $91.32 to a December 31, 2014 price of $53.71.

Comparables for oil companies will be Q3, 2013, when West Texas traded at $94.25 on December 31, 2013. For Q4 of 2014, the West Texas grade of crude traded down, but experienced deep losses in December. Basically West Texas started Q4 at $90 and ended on December 31 at $53.71. That involves a steep percentage loss in market value.

Where the U.S. consumer stands, they fill more volume on the same budget.

Congruent with this fall in oil prices has been a notable decline at the pump for gas prices. This could explain an expansion of consumer confidence, which posted a sharp increase outside of analyst estimates. Last month, the gauge posted at 93.1, expectations were for 96, and the reality returned a 102.9. Better than the most optimistic of expectations.

Despite this lift in consumer confidence, we have three U.S. metrics to address, and were reported just recently. The first is the -.9% decline in retail sales for December. The second is a reduction in durable goods orders of -3.4% for December and a -.01 decline in industrial production.

Overall, the American consumer is skeptical of job condition improvement and wages. Also, and most noted, is the American consumer is filling up their gas tank at cheaper prices. You see, as prices decline, one can use the same previously budgeted dollars to gain more volume. This explains the decrease in the Energy Information Administration's volume of distillates, including gasoline. People are simply filling up at the same price point, but getting more volume.

Ultimately, consumers will not have to fill up for considerable periods. Because they have more volume in their tank, at the same budget price point, versus a few months ago. Also, better MPG is a fact.

We also have the reduction of capital expenditure from oil producers, a noted fact. Then we have job cutting occurring in the once vibrant and job generating oil space. This is also a noted fact. These developments come from perhaps one of the most vibrant spaces of the American economy. Consequently, any producer of oil production would want to see a return in real demand from consumers. That is, without a doubt, a matter of competitive price advantage.

So, let's see what American oil producers say in the morning. Obviously, margins will be stretched. Certainly, for a few production and refiners. We've seen where some airlines hedged at high prices, and have to pay back those hedges.

The real need of economies is for consumption, equating to why jobs happen.

No economy in this world can afford to spend too much on the concept of simple transportation at this time. Global economies need the consumer and jobs to grow, with a little pricing power of wages, therein will reside the power of company earnings. Pricing demand can occur outside of financial engineering (stock buy backs and dividends) , QE, or EQE, and also outside of routinely depressed interest rates. My proposition for this is Apple, how about that? They expanded sales, despite the cautions of others.

To be certain, so many companies for the last many years have relied on returns to stock buyers, without regard to the consumers of their products. Do we have to go back to the Guilded Age. I think Henry Ford gave people a wage to buy products. What an idea. Now companies hire robots that will never buy, but instead consume a company's maintenance budget and cap ex budget. All the while these robots save considerable dollars, ultimately to deplete the work force that consumes. The logical result is a net loss of available consumers to buy the product.

We are entering a static state of a real economy, and an artificially financed economy. Today, Bill Gross put it best by saying this economic situation we are in hurts capitalism.

Dow down, consumption surplus, investment in delivery

2015-01-05T14:34:00.000-08:00

Today, the first real trading day of the year, markets saw nearly a 2% decline in the U.S., and that happened firstly in Europe, and Asia. Real issue is a global transition from investment and creation of production, to who is going to consume.

I saw Rick Santelli on CNBC talk about no real rise in 10 year yields. He said it, and his time horizon is very reasonable, he provides a very good perspective. Follow him on http://www.cnbc.com/id/15837966 .

A point to review is capacity of consumption. QE has certainly provided the investment to build capacity. Now that the U.S. has been through a strong cycle of money that grew production capacity, can the American consumer buy it up? Chinese consumer is nascent at best, Japanese consumption is notorious. Europe can be a likely card. Greece leaving the euro at this point wouldn't really matter, save for further deterioration of the countries constituted to honor the currency.

Fact is, the investment cycle associated with QE is confronting that next day. Next day is who buys that invested production? That is a question of global implication, only because it's the U.S. Dollar.... That next day view of hoped growth wanted a rise of demand. All of us wanted to see, and expected, global growth of demand, but it didn't happen. There is an inclination to deflation.

That is why oil and markets went down today. What I see, and look forward to, is the second stage of growth across the globe. That is, transporting production and the technology to do it. But, this time, more efficient and effective.

2014-12-21T21:05:00.000-08:00

Sony pulling a Hollywood production:

If there should be anything inviolate in this country, it is the rights granted by the Constitution of this country. While I will forever seek to protect another person's rights against what I consider to be my own, the balance is the American Life. Its continued genesis is shared through time's lament of lost life, and the shared fortune naturally brought by a time like Christmas. Through these ideas, we find the combined fortitude that gives cause for the U.S.A, and a blessing never to be taken for granted. Sharing of blessing is known in this country, and expressed by well recognized holidays.

In my appreciation for reasons why people look to this nation for various purposes: I know, having learned from others, the steely spine of our U.S.A . At this point, so much can go unspoken, but certainly recognized and felt by the American public.

I recall a State of this grand United States that has a motto of Tread on me Not. I also recall an international law that says don't export extortion. I also recall a publicly broadcast press conference from the President of the United States. President Obama said the U.S. will respond, but at its own choosing.

From this, U.S.A. holds the hand, and certainly against further cowardly attacks.

Unlike many countries, we make an effort to leave no "man" behind. Please consider www.woundedwarriorproject.org/ Freedom is certainly not free.

2014 showed signs of substantial yield seeking, now second step is an investement in technology and transportation

2014-12-21T00:08:00.002-08:00

The global market was once disjointed when it entered 2014. Late in 2013, we saw oil service industry gluts and signs of pricing pressure for the underlying commodity. We also saw commodity currencies at highs, such as the Australian dollar, China attempting hawkish methods of monetary rebalancing despite commodities stock piled at its ports, and rising local government debt that leads national debt, not to mention China's corporate debt.

As the year moved forward, we saw Japan enhance their QE in magnificent proportions. But the Japanese economy stalled due to an April consumer tax increase, and never has deviated the decline in yen, or the yields on JGB values. Europe, in like mind has the European Central Bank (ECB) buying covered bonds. They are talking about buying other forms of debt, if not equities.

Between the Japan and Europe QE, and U.S. propositions of tightening, a serious decoupling is occurring between the considerations of enhanced QE and indications of cyclical rotation in the emerging markets, and commodity based advanced markets. All influence the other advanced markets, against the emerging markets' associated mutual currencies of trade.

To explain, advanced markets relied for a long time on the developing growth of emerging markets and on commodity based markets to feed the idea of global growth. Now, we have those same growth markets needing to develop a more complex cycle of production, versus a simple proposition of re-investment in continued growth. This opposes the once known thesis of supplying these markets with easy U.S. cash. Perhaps, in the future, academics will confirm the declining influence of QE over markets, even when different countries enhance QE.

At this time, U.S. equities grow as did the production capacity of these emerging and commodity based countries. This occurs while the U.S. has good corporate earnings, though revenues have been generally slower. Nonetheless, the U.S. is the best of countries, among countries, in terms of economic performance.

Let me say, when the U.S. dollar appreciates, with its assets, that appears to be a carry trade. Recently, a carry trade idea was to buy a dollar and invest in higher yielding assets. Essentially, a carry trade is gaining from a currency, while also buying assets that grow. To make this work, you need to buy advancing currencies (sell declining currencies), and use the money to buy higher yielding asset classes. In this proposition, one must not be greedy. Reason is that currency markets will hurt, and remember pigs to get fat, but hogs will be slaughtered. So, caution and understanding the trade is of the utmost need.

Basic example today of a carry trade was: sell the euro to buy the U.S. dollar. With the proceeds, buy U.S. equities.

The U.S. is still looking at a bull market of sector advantage. This concept is shifting the extraction and growth that once dramatically grew economies into the efficient utilization of economic production and ultimately delivery capacity. Creating synergies and ultimate production to utilization of capacity, mostly in natural resources, will be driven by technology. Logical reason is simply the need of emerging and commodity economies to transition their investment into the maturity of processing and delivery of production.

This need goes into the technology needed to meet inventory and delivery against production levels. The need continues into transportation and end use utilization needs. Logistics, ordering, and order confirmation..... and all associated technology is what I look forward to. Among various markets.

Consumption is needed to create this product shift, and associated demand to absorb capacity.

If the U.S. economy leads the world by virtue of its consumers: A few dollars more (Clint Eastwood movie), can make a difference, as with money in the American consumer's pocket to help the globe.

Developing larger groups of consumers by larger production delivery systems, technology, logistics can all create a higher demand for the production capacity once created. Down side risk is wage depression sustained by over capacity due to inability to move surplus capacity, resistant local regulatory regimes and regional banking regimes that fail to move productive capacity, and globally declined demand. Upside advantage is removal of regional commodity glut bottlenecks due to inability to move commodities to market while transitioning from extraction to marketing, efficiency of moving production to market with improved technology that helps to efficiently move various products regionally and globally, and diversified product movement that results in value added synergies for production. Also, upside is preventing regulatory risk, in an environment that, among emerging markets, wants to protect their shores.

Ultimately, these emerging countries must weigh their shores going forward against the heft of their allowance of in-flowing investment capital. Consequent of country investment inflow, partnerships have developed. As a practical matter to protect their foreign currency reserves and current account these countries must acknowledge their growth partners, simply as a partnership matter. To allow confidence in investment partners, and to allow investment on a deeper level, these countries must allow inventory and shipment technology. That is, second step methods to prevent capital outflow.

Together, all countries can acknowledge emerging market currency risk. And search primarily for all countries to recognize a level of investment risk in global growth, and then seek private market methods to mitigate such risks. Especially in this environment of substantial first stage investment, a natural recognition means accounting for the second step of securing foreign investment. That is preventing capital flight to sustain capital on any second step to maintain building partners.Where not all companies are poised for, or want to engage in second steps, there are certainly those that want to and can. And with a view to safety and security.

Sustaining value of capital investment for both investor and host country seems very mutually beneficial for both the host country and the investor. Prevention of capital flight, which creates currency disturbance, is the mutual injury to guard.

Matters certainly appear that where emerging market businesses might not have the common technology known in advanced economies, there is a new level of development to be had. It's a level of development known to those that can apply advanced technology on a cost effective basis firstly. Secondly is not selling the impossible or imprudent, rather selling the effective for business partner needs. There certainly will be room to grow mutual investment. Where a rule of law secures investment over time, a rule of law can still exist, and comes to exist by popular movement and expectation.

Bank Penalties For BNP Causing Discord, Safty Resides In The Common Interest Of Banking Sustainability

2014-06-20T12:13:00.000-07:00

Banks committed sins leading to 2008, and they do continue to sin. But most bank transgressions really come from the past with mortgage backed securities. JPM was fined over $20B and BAC looks to be similar. As a taxpayer, I can find justification in too large to manage institutions paying homage to regulatory authorities in largess, in some fashion.....Certainly given 2008 consolidations and associated sins of failing banks that were consolidated into bigger banks. Consequence was the too big to fail idea. Now we see the too big to manage idea.

There is also the Whale Trade with J.P. Morgan, and the serious LIBOR fixing issue with BNP Parabas, a French bank. Still, U.S. is looking for about $10B in penalties from BNP. European authorities have requested consideration from U.S. authorities, but encountered denials.

Now, because of the BNP issue the EU Legislature is proposing as law a single bench mark to gauge price. Perhaps suggested in such a move is fixing European law to prevent major penalties from U.S. regulators. But using only one bench mark is objected to by the European Central Bank (ECB) as not a realistic indicator of true value. Where the ECB"s objection is factual, the EU's position marks a reasonable political line.

By virtue of the U.S. not bi-laterally discussing proposed U.S. penalties on European banks, the appearance conveyed by U.S. representatives is perhaps not only unfriendly, but also arrogant. Truth be told, we live in the same world. Further, Europe is our strongest ally geopolitically.

What would Winston Churchill say under these circumstances....Probably he'd let the finance ministers and bankers figure this out. But today, one really can't let the fox into the hen house. Unless, of course, we understand common ownership of the hen house.

On top of the U.S. Department of Justice, or other regulators seeking penalties, regulatory regimes are hard on banks. Obvious consequences are reduced bank lending, increased reserves and provisions for banks paying regulators. Also a consequence is reduced capacity to increase revenue to fill capital and retained earnings in order to meet regulatory requirements.

Bottom line of overall government action in terms of banking is reduced lending. Today, banks have to protect themselves, certainly if they have shareholders. Bank's are essentially guarding fractional reserve banking to their benefit, even if lending is a minor motivational force. Still, should banks not protect reserves in this environment, they will become an absorbed casualty among an all together glutted banking M&A forced market. Of course it wouldn't hurt if banks just played right.

True need is to find a way to keep banking out of its own hen house, and government not to compete for that same hen house through either regulation or its own lending. Therein resides the market. To accomplish a true market isn't by creating new derivatives of old assets whether they be failing or good. Rather, transparency and published market pricing is what's needed. That was proposed after the Great Depression, was instilled, and brought markets as they now exist, but now markets are in further need of transparency and access.

Changes needing to be made are updates to transparency and price discovery. There are so many new products on the market today, and so many are hidden behind a curtain whether by price, fundamentals or correlation . Eliminate that curtain, and global investors will be able to consider price in comparative terms.

ECB's Current Move: Inflating Deflation by Deflating Rates. When is the Next Move?

2014-06-04T22:04:00.000-07:00

In the morning we can expect the ECB to put some meat on the bones of its talk. Generally anticipated is the ECB will make a move. What appears rather mellow is the expected move to be made. Economists expect the ECB to start lite with a cut in the main refinancing rate to .15% to .10%. The ECB is also expected to ease the interest rate on deposits from banks at their facility. Economists expect this rate to go to .1%, and economists consider this to be a negative interest rate.

One can only consider this to be a negative interest rate when considering divergent inflation/deflation rates in the euro area. For instance, euro area HICP (harmonized index of consumer prices) was at .2% month over month for April of 2014 and .7% year over year. For May, this same data dropped to .5% year over year. A negative trend in inflation is occurring and certainly far from the ECB's goal of just under 2.0% inflation.

Such inflation, actually deflationary, numbers make an ECB deposit rate of .1% essentially a negative .1% in the short term and only .4% year over year. That is, to find the real interest rate, or yield, one subtracts the rate of inflation from the stated rate. Or, in deflation, one adds the rate of deflation to the stated rate to find the real interest rate.

Keep in mind, Germany demonstrated actual deflation in April with a Consumer Price Index (CPI) of -.2% and a year over year inflation rate of 1.3%. France was flat on its CPI at 0.0% with a year over year inflation rate of .7%. European Producer Price Index numbers are even worse. European Union flash GDP numbers generally disappointed with import number exceeding export numbers, certainly for Germany.

Add to deflationary pressure in Europe the slowing economies of China and Japan (let alone geopolitical risk in Eastern Europe), and one can see the reason for toughening exports out of Europe aside from a high euro.

Simply generating negative interest rates in Europe doesn't kick start economies like Europe. But it might help restart Europe's shadow banking system by giving confidence to other financial intermediaries. ECB's potential action can help mitigate yesterday's term structure risk and essentially move maturity transformation to safer ground for past market transactions.....If only these past transaction had a present day liquid market. I'm referencing, of course, markets to move otherwise illiquid bank loans.

Such wishful projections assume a market, outside of sovereign debt, through which participants can diversify otherwise illiquid assets based on price and maturity. Future looking market participants, however, might see chasing deflation, by deflating the currency, by reducing rates in the present economic/market climate, as growth potential. It's possible.

Treasury Yield Declines and Stock Market Highs

2014-05-04T21:20:00.001-07:00

Friday's Employment Situation report bodes badly for general economic strength. On April 9^th when the FOMC minutes were released, the Fed made a prescient remark by noting that a 6.5% unemployment rate is an outdated concept for measuring employment. They also said rates won't be increased in the first half of 2015.

Now, Friday's report shows an unemployment rate of 6.3% when consensus estimates expected 6.6%. Initially, this data looks good, save for 806,000 people leaving the labor market. Overall, 92M people are employable, but can't find jobs.

Some data does look good such as Apple's beat on earnings, Facebook and Netflix are similar. Just last month, however, growth stocks sold off significantly. On April 4^th, for example, Facebook fell 4.6% and Netflix fell 4.9% with Nasdaq declining 2.6%.

Other data also looked good in April such as Industrial Production stated on on April 16^th, showing a March increase of .7% when consensus estimates were a rise of .4%. Retail Sales stated in April also exceeded estimates as did Durable Goods Orders and the ISM Manufacturing Index.

Yet, if Friday's Employment Situation report reveals causation, perhaps more than weather explains a Q1 GDP of only .1% growth against an expected growth rate of 1.1%. Pending home sales have been in decline for nine months prior to March. New home sales declined14.5% in March and year over year, decline is 13.3%. Existing home sales are down 7.5% on the year.

Reality for U.S. equities are how they are loitering about their ceiling and trade within a range in terms of S&P 500 and the Dow. Nasdaq simply looks challenged to gain momentum to approach previous highs. Breadth indicators show a rather balanced market, probably revealing ultimate indecision. Therein resides the negative divergence among equities versus treasuries.

Decisive movement can, however, be found in long term treasuries, confirming equities' negative divergence. Where equities hover around highs, treasury yields have been in considerable decline with the 20 year falling 60 basis points since December 31, 2013 and the 30 year 59 basis points. While shorting bonds in 2013 was convention, covering short positions appears to be an inadequate explanation given other dynamics that drive people to safe havens.

U.S. economic prospects aren't immune from implications arising from Europe, Japan and China. Telling of this proposition is the moderating yield curve with long term treasury yields having been in rather stark decline.

J.P. Morgan, Citigroup, Bank of America: A Banker's Paradox

2013-12-18T14:39:00.000-08:00

Banks like J.P. Morgan (JPM), Citigroup (C) and Bank of America (BAC) entered a period of historical transition starting in 2008 with the financial crisis. JPM absorbed Bear Stearns and Washington Mutual, with legacy costs now hopefully known. Similarly, BAC absorbed Merrill Lynch and Countrywide with risks and costs now also hopefully known. C wasn't in a position to absorb weaker banks, but essentially got absorbed by the Federal government, along with some automakers.

Federal Reserve's monetary easing continues to support economic stability. Also created by monetary easing is a low interest rate environment, putting bank interest income into decline since 2008.

From excessive leverage leading up to 2008, bank regulators have sought standards that make banks build equity capital and liquidity, while decreasing assets. Risk of new rules look to reduce return on equity for banks. Still, regulatory regime makes equity the major source of capital for banks.

Proposed regulations involve a Supplementary Leverage Ratio (SLR) and a Liquidity Coverage Ratio (LCR). These proposals add confusion over how cash and government securities will be treated in a bank's capital structure.

Five years after the financial crises, JPM, BAC and C continue to transition, with little visibility of where transition might lead. Poor visibility comes primarily from SLR, LCR and persistently declining interest income.

A paradox comes from these banks having to choose between increasing capital or reducing assets when neither presents a practical solution for maintaining earnings.

Basel III Capital Ratio Increase Already Part Of Banking Balance Sheets

Banks, having been familiar with Tier I Common Capital Ratio, and having adapted their balance sheets accordingly are basically in compliance with Basel III Capital Ratios. Basel I, II and III are international banking standards created by the Basel Committee. Central banks and sovereign bank regulators enforce Basel standards.

Tier I Common Capital Ratio is a risk based standard measuring a bank's ability to absorb loss on assets by relying on equity. By dividing common equity and retained earnings against risk weighted assets (RWA), one finds Tier I Common Capital ratio under Basel III at a 7% requirement, versus a Basel II standard of 4.5%. Also, when judged appropriate by regulators, Basel III has a countercyclical buffer that may be imposed of 0-2.5% on top of 7% Tier I Common Capital. This buffer applies when excessive credit growth generates added risk, such as in years leading to 2008.

JPM, C, and BAC have no problem meeting a 7% Basel III Tier I Common Capital ratio. JPM, for instance, has Tier I Common at 10.5% under Basel II. Under Basel III, JPM currently projects 9.3%. BAC is similar, having a current Tier I at 11%, and a projected Basel III at nearly 10%. C is now at 12.7% reasonably suggesting a Basel III ratio of at least 10% if not 11%.

Suggested by major banks exceeding Basel III Tier I Common Capital is their ability to meet countercyclical buffers.

Supplementary Leverage Ratio Is Different From Previous Leverage Ratio And Introduces New Items

Non-risk based leverage monitoring isn't unusual in U.S., but is new to Basel III framework and, therefore, new also to European banks. Though leverage ratios aren't new in U.S., Bear Sterns executives testified regarding the financial crisis that their leverage was high as 40 to 1.

U.S. leverage ratio historically, and under Basel III, considers defined capital against total assets without weighting value of assets according to risk--usual for a leverage calculation. However, new for U.S. leverage calculation is SLR proposing to include cash and government securities as leverage, together with off balance sheet holdings.

Addressing lax leverage monitoring born out of a real estate bubble, in August, 2013 Office of the Comptroller of the Currency (OCC) issued a notice of proposed rule making announcing SLR. According to OCC, SLR will divide Tier I Capital (which adds convertible debt and preferred shares to Common Capital) against "total leverage exposure". Previously, leverage ratio was Tier I Capital divided by "total on balance sheet assets". Changing denominator from on balance sheet assets to total leverage exposure is consistent with Basel III. It also would have revealed excessive banking leverage in 2008 with off balance sheet derivatives.

Real issue with SLR is its inclusion of cash and government securities as leverage. Reasoning is currencies have variable values, and when interest rates rise, treasuries will decline. No risk weighting of assets is considered. Essentially, bank holding companies like JPM, BAC and C must have a ratio of 5%. To be well capitalized, a ratio of 6% and a minimum of 3%.

Supplementary Leverage Ratio Forces Choice Between Raising Equity Or Cutting Assets

Banking industry representatives provided comments pointing out problems with the proposed SLR. Banks say including cash and government securities unrealistically increases leverage exposure. Also, given that return on currencies and government debt can be small, but still used in SLR without risk weighting, banks would be encouraged to move out of cash and government securities and into higher yielding and more risky assets.

Estimated effect on banks is either raising $200B in additional capital (equity) or eliminating $1.7T in assets to bring banks into compliance with the ratio.

Regulators, in their measurement, identify 2018 to be the compliance deadline. They estimate a shortfall of $63B to $113B in Tier I Capital across six Bank Holding Companies, which includes C, JPM and BAC. Also estimated by regulators is a yearly cost of $474M to $694M due to lost tax benefits from deducting interest payments on debt. (Federal Register (2013), p. 51111 to 51112). Regulators foresee banks changing their capital structures moving further into equity and more out of debt.

FDIC vice-chairman, Thomas Hoenig, indicated late November that excluding cash from leverage exposure could be acceptable, but expressed resistance to excluding treasuries. Should regulators include cash and treasuries as leverage, banks will have to transition by making a choice between expanding equity against cash and treasuries, or move out of cash and treasuries to decrease their leverage exposure.

Either approach isn't attractive from an equity investor's perspective. Expanding equity results in share dilution, while moving out of cash and treasuries hurts liquidity and increases risk. SLR presents a paradoxical situation where equity investment in banks becomes less attractive. Without banks being able to attract equity investment, they become impaired in ability to meet, maintain or increase Basel III Common Capital.

Also implicated is reduced liquidity in government security and money markets by impairing market making should banks chose to cut cash and government security holdings. Added to the regulatory paradox is LCR, which encourages cash and government security holdings.

LCR Contradiction With SLR, Focus On Deposit Funding And Banker's Paradox

OCC issued a notice of proposed rule for LCR on November 29. LCR is a part of Basel III and proposes banks such as C, JPM and BAC hold High Quality Liquid Assets (HQLA) in sufficient quantity to equal net cash outflow over a 30 day period of stress. Such proposal grows out of 2008 bank liquidity melt down due to insufficient liquid assets.

HQLA are assets capable of being converted into cash with little or no loss in value during a period of liquidity stress. OCC says cash, government securities and certain corporate securities qualify. However, such assets can be a source of penalty under SLR.

Holding enough HQLA to meet 30 days of cash outflow, under liquidity stress, essentially means having enough cash and/or treasuries to self fund operations for thirty days. Stress scenarios include deposit withdrawals, with customers having an operational relationship with the bank withdrawing less than those without a relationship. Hope is to encourage banks to lend to depositors thereby creating an operational relationship. Depositors are expected to be a primary source of bank funding as opposed to wholesale short-term borrowing.

Regulators propose phasing in LCR with banks meeting 80% HQLA to 30 days cash outflow by January, 2015 and 100% by 2017. Currently, regulators estimate a HQLA shortfall of $160B among the 16 bank holding companies covered under the rule. (Federal Register, p. 71853). With banks moving into lower yielding HQLA to reach compliance, regulators estimate a decline in net interest margin of between 10 to 15 basis points. Associated cost is estimated at $160M to $241M in lost yield.

Where SLR can make raising equity difficult with cash and treasuries being a source of penalty, banks very well could chose to cut cash and treasuries. Banks will be hesitant to cut higher yielding though more risky assets due to seeking yield. But LCR requires 30 days of unencumbered cash and treasuries to fund operations.

Banker's paradox is whether to raise expensive equity in a harsh regulatory environment or cut assets.

Appearance for banks is to maintain Tier I Common Capital ratio by carefully balancing higher yielding assets against bare need of cash and treasuries to meet LCR requirements. Such approach optimizes yield, while at least meeting contradictory needs between SLR and LCR.

Bank Earnings Drive Ability To Increase Bank Equity, Earnings Have Enough Pressure Without Regulatory Contradiction Driving A Paradoxical Choice

Current earnings reality for C, JPM and BAC is declining interest income since 2008 despite faster declines in interest expense over the same period. This dynamic has forced banks to seek income from alternate sources.

Making JPM a strong institution in 2008 was diverse streams of income. When interest income fell due to default, JPM obtained 42% of total revenue from noninterest income. BAC obtained 38% of total revenue from noninterest income and C saw their declined interest income helping to absorb noninterest income loss. Trailing Twelve Months (TTM) shows JPM's noninterest income at 55% of total revenue. BAC's TTM noninterest income is 51% of total.

C continues to acquire up to 62% of revenue from interest despite nearly 5 years of declining interest income. Saving C is capping noninterest expense in 2012 and TTM. Also, C raised noninterest income 11% TTM, thereby reversing previous trend of decline. Consequence is highest EPS for C in several years.

While noninterest income has generally offset declines in interest income, saving all banks are major reductions in credit loss provision, which allows more revenue to flow down income statement to shareholders. JPM is making the least provision for credit loss currently at .08% of revenue TTM v. 2012 at 3.5%. BAC is 6.3% TTM v. 9.8% for 2012. C's credit loss provision is 11.5% v. 15.4% for same period.

Until interest rates move up, further declines in interest income can be expected. Gaining progressively more income from noninterest sources turn banks into service companies, blunt desire of banks to loan, and have restructuring costs. Once credit loss provisions wind down, banks will no longer have released reserves to support earnings. Risk of financial sector regulation is declined demand for bank equity, due to a difficult earnings environment and contradictory regulations, with associated costs.

Fundamentally, SLR requires raising more equity capital against cash and treasuries, while changing capital structure in a way that increases tax liabilities. LCR requires banks to increase HQLA, locking up assets in low yielding instruments, and costing lost yield. Both regulations can result in reduced returns on equity. While SLR and LCR are new and proposed concepts, both look to challenge banks on top of known issues.

Financing Government No Longer Is Entertaining, Get The Job Done

2013-10-15T23:35:00.000-07:00

This article was initially posted October 15, 2013, but withdrawn. Late on October 16, 2013, Congress agreed on a means to open government and raise the statutory debt limit, for a short time. Now, this article reminds how close U.S. came to default, and desperation of American circumstance. Should this circumstance be revisited, a violation of trust between those elected by people and those who elect people will occur.

No one outside of Washington finds charm in what occurred, regardless of blame, or party. Such matters are the business of those elected and expected in their course of business, regardless of party affiliation. When February, 2014 arrives, elected negotiating parties need to realize the lives of those they represent.

October 15, 2013 text:

Solving U.S. Debt issue isn't recreational at all. Nor is it intramural sports as Republicans and Democrats pretend. It's not even fun politics, or a weird reality tv show. It's not House of Representatives being Kardashians, versus Senate as Hiltons'.

Frank reality is in real America waking up every day early to feed their kids. That is where America starts its day.

All Americans then deliver their children to school, and go off to work. While at work, parents have to deal with increasing earnings objectives of their employers every day. Children have to deal with newest learning objectives popular with political party in control.

America deals with these demands, every step of every day. Why can't Congress and the Presidency deal in like manner with their job. Why can't they deal with what's needed.

Debt default tells of a failed nation, mired in blame and conflict. Blame, failure and conflict is where Senate Chamber and House Chamber bring this country. It is two Chambers of American Governance..... In Failure.

This country has pride, in spite of and in despite of politicians.

For the sake of God, Main Street does not want to explore, nor has the capacity to explore, a failed U.S. Government.

Debt Limit or Debt Ceiling, a Natural Need to Increase, Against Declining Budget Deficits: A Work in Evolving Evolution

2013-10-11T23:17:00.000-07:00

U.S. is center stage now while people wonder if a default on debt will occur. Issue isn't driven as in Europe with doubts of country capacity to pay. In the U.S. capacity to pay is no question, rather U.S. concern of default arises from willingness to pay. Willingness probably is too simplistic, in that major fiscal policy issues between political parties create doubt on U.S. debt payments. Compromise between political parties define willingness to pay. Essential to addressing compromise is high spending versus inadequate revenue, funded by debt.

Debt ceiling issues arise from U.S. fiscal budgeting. In 2009 for example, U.S. government budget had a deficit between expenditures and tax revenue exceeding 10% of its GDP. Such imbalance requires U.S. to fill the difference by issuing debt, otherwise known generally as treasury securities, or treasury bills, notes and bonds.

When fiscal budget deficit to GDP ratio exceeds rate of GDP growth, imbalances of revenue against spending occur resulting in debt carrying over year on year and increasing. Such is the circumstance for the U.S. and essentially all developed economies. But in the U.S., a law exists which nearly all other developed economies don't have. This law is the statutory debt limit, or debt ceiling.

For most countries, ability of a government to borrow is an expected consequence of its penchant to spend. Accordingly, government borrowing is automatically linked to spending. In U.S., however, politicians can spend all day long exceeding revenues, but they hit that debt ceiling, despite spending commitments that exceed the debt ceiling. Once hitting this limit, gut checks and evaluation of expenditures happen. Even government, especially government, needs to step back from time to time, look at their spending, real revenue and their accumulated debt.

Denmark is, as far as can be seen, the only other country with a debt limit, limiting debt to fund budget deficits. Denmark places their debt ceiling so high, it doesn't become topical in government financing. In the U.S., it is obviously topical. Simply letting government spend, and borrow to do so, becomes a dangerous proposition in politics. Especially when no one wants to increase taxes or cut budgets. So, in the U.S., it appears the debt limit law is testing American appetite for government largess, or austerity.

U.S. debt ceiling issues in 2011 first questioned balance of government largess versus austerity. After brinksmanship, near disaster, and a credit downgrade by S&P, resolution came through the Budget Control Act of 2011. This measure set in place a piecemeal plan to address spending and debt. While it had some scaling by associating budget cuts with increasing the debt limit, scaling ultimately saw congressional inability to cut budgets. Without both parties reaching a budget cutting agreement, sequester became the automatic and default solution.

Sequester, or fiscal cliff, propositions were realized in January of this year. Many told of major economic declines for U.S. They could have been right. But, we have the American Taxpayer Relief Act of 2012 being passed January 2, 2013. This legislation considerably mitigated fiscal cliff cuts. It also increased the debt limit to $16.699 T. This is where we are today, along with Treasury engaging in its “extraordinary measures” to bridge the fiscal policy gap.

Where U.S. GDP hasn't increased at a higher rate than increasing government budget deficits, debt accumulation continues. There appears to be a $715B shortfall for FY2013 and a projected shortfall of $672B in 2014. All suggesting a new debt ceiling of $17.8T versus its current level.

Such an increase in the debt ceiling appears needed even with considerable reductions in the U.S. budget deficit. Where 2009 saw a budget deficit of more than 10% of GDP, Congressional Budget Office said in May, 2013 that budget deficit to GDP ratio for fiscal year 2013 ending September, 2013 was on track for 4% (providing the projected $672B deficit in 2014). Still, debt exists, but is less than could have been otherwise.

Now, to pay for previous government approved appropriations, government must agree in some fashion to approve more debt. Also necessary is continued work to reduce the budget deficit, if only to reduce growth rate of U.S. debt to GDP ratio.... Or, U.S. can hugely increase its GDP. But increasing GDP is more elusive than setting a balanced budget.

Covenant-Lite Lending, ETF Participation, All Show Relaxed Credit Markets Seeking Higher Yield...And Bankruptcy Protection?

2013-09-17T20:51:00.000-07:00

Leveraged Loan and High Yield Bond ETF's a Reflection of Credit Activity

Whether banks are lending or hoarding cash is a major concern in today's market. Obviously U.S. banks are cautious given America's past financial crises, which saw it's fifth anniversary this weekend. Now debt markets are tilted in favor of borrowers. To a degree, in fact, that makes one question extent and prudence of borrower accommodation in view of covenant-lite debt.

Two exchange traded funds (ETF's) demonstrate degree of borrower as opposed to lender accommodation. These ETF's are high yield bond and leveraged loan products. Namely, we have SPDR Barclays High Yield Bond ETF (JNK), with an average trade volume of 6M shares. Second, is PowerShares Senior Loan Portfolio (BKLN) trading an average of 3M shares. Both are reflections of lending to business, either through bond issuance or loan syndication. With these kinds of bonds and loans, banks are "also" participants, along with various institutional lenders (pension funds) and hedge funds.

These ETF funds reflect demand for yield associated with leveraged loans and high yield bonds. They also reflect a trend in debt markets of relaxing covenants that otherwise protect lenders. A common argument is that covenant-lite debt prevents bankruptcy. Also arguable is that covenant-lite debt forestalls a bankruptcy or restructuring only for progressing financial deterioration.

High Yield Bond ETF's, Declining Cash Flow and Declining Covenant Quality

JNK, a high yield bond ETF, has witnessed, as with all other fixed income modalities, major retail cash outflows given prospects of Fed tapering. For year to August, an August 22 Forbes report shows high yield bond fund outflow of -$7.3B versus last year's same period in flow of +$21B. Despite outflows, high yield bond demand remains solid with JNK resisting net cash outflow to sustain pricing at its 200 day average. In fact, JNK has dipped twice of recent below its 200 day average and, as of August 20, started an arduous journey returning to and exceeding this level now.

Accounting for JNK price resilience is demand for yield, or income, against a now expected mild Fed tapering and consequent anticipation of leveling interest rates. JNK price resilience goes back to July when reports show bonds rated CCC and lower gained some 7.1% year to date while investment grade bonds declined 5%.

Along with high yield bond price resilience is an equal decline in creditor protection seen in indenture covenants. Moody's reports an index of covenant quality. Ratings range from 1 to 5 with 1 being strongest of debt covenant provisions while 5 is weakest. Debt covenant provisions were very strong following the financial crises and Great Recession, for good reason. However, in July 2012, strength of covenant provisions started a decline. By November 2012, covenant quality reached a new low with high yield covenant-lite packages reaching 30% of issuances versus a 17% historical average according to Reuters. November 2012 showed a covenant quality score of 4.15.

For August, 2013, Moody's showed a covenant quality rating of 4.01 versus July's 3.79. Starting latter 2012 to present, we see a sustained and expanding borrower oriented market for junk bonds.

Leveraged Loans and their Sustained ETF Pricing, but Declining Covenant Quality

Leveraged loans show same dynamic, but without cash outflow for their ETF's. Senior loan funds--sometimes called bank loans or leveraged loans--showed 65 consecutive weeks of cash inflow as of September. Reason for leveraged loan ETF sustained positive cash flow is nature of a loan over a bond. Loans conventionally have credit protection by being senior to even "senior notes" in terms of creditor protection. They also enjoy interest rate protection by being variable. Usually, a bond or note will have fixed interest where loans will be LIBOR plus negotiated basis points.

Also accounting for strength in loan ETF's is underlying loan market strength. Institutional leveraged loan volume for first half 2013 increased 122% at $268B versus same period 2012 at $121B. Institutional firms appear to be lending with confidence, while bank leveraged loan lending is up 3%.

Though loans enjoy superior credit and rate protection over bonds, they remain subject to strengths and weaknesses of their borrower. Like decline in high yield bond covenants, loan covenants have also been in very significant relaxation.

Leveraged loan covenant relaxation is breaking records and exceeding frothy pre-crises levels, substantially. As of August 8, 2013, Forbes reports $162B in covenant-lite loans. Number is 22% above 2012 levels and contrasts with just under $100B in 2007. Leverage ratios have also expanded beyond 2007 levels. Despite this, total debt does appear below 2007.

With leveraged loans and high yield bonds both granting declining creditor protection, environment is certainly borrower friendly. With 56% of loan issuances being refinancing, companies are taking advantage and relieving themselves of creditor oversight, limitations and burdensome performance (or maintenance) covenants.

Performance covenants in loan agreements have traditionally been used to help assure loan repayment. Limiting covenants in bond indentures protect payments to bond holders. Complying with covenants can, however, constrain business decision making and blunt a company's ability to pursue investment and opportunity.

What Covenants get Removed to Form Covenant-Lite Loans and Bonds

High yield covenant-lite indentures generally don't have a limitation on indebtedness provision and/or a limitation on restricted payments provision. Leveraged loan covenant-lite agreements are missing a maintenance covenant.

Covenants are generally divided into maintenance and incurrence covenants. A maintenance covenant requires a company to maintain a certain level of performance and are associated with leveraged loans. For instance, a leverage covenant might require a company to maintain its leverage at no greater than 4x debt/EBITDA. Other common maintenance covenants are cash ratio and interest ratio. Cash ratio monitors cash flow to debt service and interest ratio monitors EBITDA to interest expense.

Incurrence covenants, typically associated with bond indentures, require companies not to incur other obligations that might impair payment to, or credit priority of, bond holders. Common are limitations on indebtedness and restricted payments.

Limitation on indebtedness prevents a company from incurring additional debt that would make its leverage ratio exceed, for instance, 4x debt/EBITDA. Limitation on restricted payments limits a company's cash outflow. This is done by restricting dividend payments, acquisitions and certain investments. Generally, restriction on payments limit a company's external investment.

Covenant-lite Debt Preventing Bankruptcy, or Making Bankruptcy Impractical

When there is an absence of a maintenance covenant in a company's loan, and an absence of limitation on debt and no restricted payments on its bond indenture, no limitation on leverage or cash outflow exists, despite other peoples' money as leverage. Accordingly, the company isn't under a burden to keep earnings in line with debt. The company is free to make decisions, including accumulating more debt, as if it was financing itself on its own cash flow.

While most companies will obviously choose not to financially explode, real issue arises from a capital structure perspective. Notion is that covenant-lite debt prevents bankruptcy by giving a company latitude to develop additional funds.

Or, another way of looking at it, covenant-lite debt allows a company to kick the can down the road accumulating more debt, or issuing more equity, or both. All the while the company has expanding leverage multiples and equity dilution. What a potential nightmare.

Without having restrictive covenants described above, companies with covenant-lite debt don't have objective measures determining when enough is enough. A company could potentially become a debt machine, until an actual default occurs. Meaning the company is actually out of cash, after potentially having entered into lease buybacks, deteriorating available collateral.

Because bond holders generally are junior in creditor priority to loan holders, bonds will probably get nervous first. But, nervousness might not show until there are few assets for distribution among previously expanding creditors.

If companies leverage up due to the latitude given them with covenant-lite debt, deterioration of macro liquidity could impair ability to refinance their leverage, hastening crises, rather than preventing it. After all, most covenant-lite lending is due to refinancing currently, and not leveraged buyouts.

Covenant-lite debt does grant considerable latitude to companies. So long as companies don't use it as an invitation to over leverage, and liquidity conditions allow refinancing of debt. every thing looks good.

Circumstance to really watch is frequency of a triumvirate of all three covenants missing at once.

Asian Cost of Labor, India's Currency Swap Agreements and European Bank Overleverage: Dichotomies All

2013-09-01T20:04:00.001-07:00

Dichotomies identify recent market activity. From U.S. GDP to Eurozone GDP, things look better. But add China's policy direction, with emerging market direction, and one can see the point. Coming political battles over U.S. debt ceiling, elections from Australia to looming elections across emerging markets and ultimate monetary policy stance in developed markets give cause for murky water.

Example of dichotomy appears when comparing GM's experience to that of emerging markets' maturing growth. On August 12, reports reveal GM plans to gradually exit South Korea due to rising labor costs and aggressive unionization. Movement like this for GM is significant in that South Korean production is roughly 20% of company's global output. Justification of move appears in South Korea's cost of production per vehicle being 40% above GM's average global cost.

Contrast GM's move away from production in South Korea with Apple's move into consumer markets in China. Apple's proposed deal with China Mobile fits well with growing labor costs and shortages in China. Fundamental for deal making is a rising consumer class prepared to buy smart phones, which is evidenced by generally recognized reporting of China smartphone use exceeding U.S.

Technological compatibility with China's "proprietary" mobile network (Qualcomm's TD-SCDMA compatible chip sets) and carrier subsidization are major issues of discussion. Both are necessary components of any deal making. Consider, however, Apple's loss of technology arising from Samsung production and a droid platform. Apple must be cautious entering a new space of shared technology. But for an estimated $50B benefit, one probably wouldn't care to test the water.

Perhaps palliative and insulating, but not curative, are rounds of currency swap negotiations among emerging markets and their major trading partners. India leads on this proposal. Sometimes called central bank liquidity swaps, these swaps essentially involve native currency deposits in a central bank with U.S. dollar reserves. U.S. dollars are loaned against native currency deposits, with interest rate differentials paid, but currency differential rate previously agreed upon.

India's major currency swap agreement is with Japan at $15B. This agreement was initially written in 2007 at $3B and was part of Japan's other similar agreements with South Korea, Malaysia and Thailand. All products, and extensions, of the "Chiang Mai Initiative", which followed 1997-1998 Asian currency crisis and resulting overtures of "ASEAN plus three" cooperation.

India appears ready to tap such resources, certainly out of need. To leverage resources, India is proposing to sell their obtained U.S. currency to native oil refiners. Thereby, India optimizes and controls flow of foreign currency reserves. Simultaneously, India is looking to support policies reducing petroleum consumption, and other causes of current account deficit.

Where Eurozone GDP flash report on August 14 exceeded expectations with a .3% increase, other influences still weigh. France, Germany, Finland and---Portugal---all saw positive growth. But, through Q3 so far, reports are certainly gaining strength that EU banks are over leveraged and under capitalized. This, despite how many years of struggle.

July 22, thefinanceinsider.blogspot.com reported EU bank assets are 3.5 times EU GDP at 33T euro. Obviously, European governments backstopping a general banking crises under this number are hamstrung. On August 11, ft.com reported EU banks generally must cut assets by 3.2T euro, and major banks specifically must cut 661B euro in assets and raise 47B euro of new capital. All must occur over next 5 years to meet Basel III standards and avoid specters of insolvency. Three banks are of most concern, being Barclays, Deutsche and Credit Agricole.

Supporting EU banking imbalance is July 30's Deutsche Bank's Q2 report showing net profit dropping by 49%, while revenue was up 2%. Net income found itself at 335M euro versus forecasts of 767.6M euro. Hurting profit was increasing provision for legal expenses by 630M euros to 3B euros.

August 29 showed Deutsche issuing stock to raise 2.96B euro at 32.90 per share in European trade. Goal for company was 2.8B euro, and despite dilution, exchange trade increased 6.9% according to Bloomberg. Goal is to increase capital by 5B euro and planned is a 2B euro subordinated debt issuance.

July 30, also saw Barclays' H1 profit down -17% at 3.59B pounds. Decline was due to restructuring costs and 1.35B pound provision for payment protection insurance impropriety and 65M pound provision for interest rate hedging impropriety.

Barclays has been under pressure from U.K.'s Prudential Regulatory Authority to raise capital, having identified a shortfall for the bank of 3B pounds end of 2012. Also on July 30, Barclays announced its plan to raise capital. Issuance of 5.8B pounds of new shares will address capital shortfall, along with issuing 2B pounds of convertible bonds, which appear subject to heavy hair cuts if bank has trouble.

Barclays on August 30 increased per share issuance expectation price from $88.00 to $92.00.

Overall, emerging markets aren't only cycling down, but are in broader transition. Where developed country money moves out of emerging markets, we also see hesitation of direct investment due to rising costs of production, consequent of a rising consumer class. Other hand shows a rising consumer class for sales prospects. Europe looks to be improving, but banks remain over extended, despite a considerable period of deleveraging. Even with years of deleveraging, European bank stock issuance to re-capitalize is being well received. Imbalances seem intuitive.

EMERGING MARKET WEAKNESS: INDONESIA RUPIAH DECLINE AND CURRENT ACCOUNT DEFICIT

2013-08-18T09:28:00.000-07:00

South East Asia Focal In Emerging Markets And Indonesian Economic Decline

Emerging market hardship may be expressing a larger influence on global market dynamics than generally reported. Where we see preferred stocks taking a nose dive against common stocks, interest rates continuing to increase and, of course, emerging market currency declines; we also see global equity markets high, but finding more headwinds to push higher.

May, 2013 time frame points to a generally recognized "shift" attributed to comments of Federal Reserve tapering of QE. Other dynamics also appear to be at work, pointing to issues outside of Europe.

South East Asia holds interesting events. Point of interest is Indonesia. It boasts the largest economy in South East Asia at $878B USD GDP in 2012, and eclipses a combined Thailand and Singapore GDP of just under $700B USD. Indonesia's GDP growth rate has been stellar with an annual growth rate of 6.5% coming out of global recession and extending through late 2011. 2012 saw policy propositions that looked protectionist and such appearances frosted investment. GDP has been in decline for last four quarters putting in a Q2 2013 growth rate of 5.81% versus a Q1 rate of 6.03%.

We have witnessed a 70 basis point decline in Indonesian GDP, which previously enjoyed exponential growth. While GDP declines, foreign currency debt, or external debt, have increased. Data shows external debt challenges GDP at $251B USD. External funding of high emerging market growth is not only routine, but contains its own boom and bust cycles.

Indonesia's External Debt, Declining Currency And Rising Bond Yields

External debt is composed of obligations denominated in foreign currency. Resultantly, Indonesia needs reserves of foreign currency to service its external debt. Two problems are developing which raise concerns. First, Indonesia's non-convertible currency, the rupiah, is in depreciation declining 7% this year to lows last observed in 2009, amid the financial crises. Second is an exhausting of Indonesia's foreign currency reserves. Now at $92.7B USD, these reserves have dramatically declined and are also approaching lows witnessed during the financial crises. Reserve declines have followed Bank Indonesia's, Indonesia's central bank, efforts to support rupiah. Now, Bank Indonesia has essentially no choice but to allow market determination of rupiah value.

Feeding problems is a declining GDP amid a July inflation rate of 8.61%, highest rate in four years. Suggestion is that inflation isn't demand driven, or the product of a fast moving economy. Rather, inflation appears to be arising from rupiah weakness. For example, exports are down 4.5% y/y for 15 months of consecutive decline. Retail sales started trending down mid 2012 reaching a y/y low of 8% first part of 2013. While June numbers show a 14.8% growth rate, inflation may drive the number, especially in view of fuel price spikes due to elimination of a fuel subsidy.

Attending inflation is a rise of Indonesia's 10 year government bond yields. Now at 8.13%, Indonesian yields have increased 264 basis points since March 31, 2013 when yields were 5.49%. Contrast this with Thailand's 10 year which is now at 3.99% moving from a March 31 3.42% to increase 57 basis points. Singapore, now at 2.48% rose to this level starting from a March 31 1.367% level to see a rise of 111 basis points.

Just as Indonesian bonds have exceeded peer group bonds in rising yields, they have also exceeded peers in the rate of their widening spread against Bunds and Treasuries. Indicated is an obvious and dramatic increase in Indonesian risk premiums, amid a slowing Indonesian economy.

Indonesia's Balance of Payments Deficit Reveals Macroeconomic Concern

Most troubling for Indonesia is their global balance of payments, pattern of increasing external debt, and abysmally low foreign exchange reserves. For balance of payments, Q1 2013 saw a current account deficit---meaning more imports and therefore domestic expenditure as opposed to income---of -$5.27B. Capital/financial account---which is money invested in Indonesia and therefore income---also saw a deficit of -$1.37B. This resulted in Indonesia using more of its foreign exchange reserves to finance not only a current account deficit, but also a capital/financial account deficit. Consequence was a drain in foreign exchange reserves of $6.62B, yielding the $92.7B in reserves. Down from a 2012 average of just below $115B.

Q2 2013 data released August 16 showed a dramatic current account deficit increase to -$9.85B. Capital/financial account actually showed a surge in foreign investment, but not enough to finance current account deficit. Capital/financial account showed a positive $8.196B. Still foreign exchange reserves made up the difference by declining another $2.477B.

Further rupiah depreciation resulted given balance of payment news with spot prices being at a 2.5% premium against the 1 month non-deliverable rupiah forward contract (NDF) at 10.636/USD and spot at 10.373. Last week, Indonesia's 10 year bond yield increased over 60 basis points.

Indonesian Steps To Solve A Looming Currency/Economic Dilemma

Trouble arises from Indonesia's foreign debt exposure and its cost against a declining rupiah, compounded by declining foreign exchange reserves. Now, accumulation of foreign exchange reserves is becoming much more expensive for Indonesia. Declining rupiah and increasing domestic bond yields are driving inflation, and potentially a liquidity if not solvency problem.

Theoretically, Indonesia could issue more domestic bonds to build foreign currency reserves. Such a proposition confronts already high and increasing costs of borrowing compounded with rupiah now subject to market pricing. Markets aren't fond of rupiah or Indonesian bonds.

Monetary policy solutions by Bank Indonesia look cautious and perhaps dubious by possibly worsening problems. While key interest rate in Indonesia has been raised in response to inflation and in effort to support rupiah, declining growth makes further interest rate increases dangerous to sustaining growth, especially given foreign debt exposure. Last week, Bank Indonesia ordered increases in bank reserves. Indonesia last increased bank reserves in 2010 due to inflation resulting from a hot economy.

Now, Indonesia's economy is cold. But, Indonesian banks must increase their secondary reserves (government bonds and Bank Indonesia certificates) to 4% versus a previous 2.5%. Further, banks must reduce their loan to deposit ratio of 100% to a range of 78% to 92%, depending on risk composition.

Indonesia's Balance Sheet Mismatch of Maturity and Currency

While measures increasing bank reserves look to address inflation and improve bank capital, they are essentially a removal of liquidity in a system that already is demonstrating liquidity risk. Balance sheet mismatching shows two themes that attend emerging market crises: 1) maturity mismatch by using short term lending to fund long term projects; and 2) currency mismatch by using foreign currency denominated loans to fund rupiah generating projects that don't earn foreign exchange.

Indications of mismatches noticed in past experience exist today. Nature of modern banking is to use short term deposits to fund long term loans thereby arbitraging the yield curve. However, Indonesian yield curve can be inclined to flat, hurting banking margins. If Indonesian banks borrow at Indonesian rates, spreads between funds borrowed and lent can be small to flat. Resulting implication is Indonesia's external debt is driven by seeking lower interest funding offshore for domestic loans.

For instance, on August 31, 2012 the spread between Indonesia's 1 year bond versus its 10 year bond was 1.37%. By January 31, 2013 the spread declined to .48%. Spread rose to 1.36% in April but is back in decline showing a current spread of .98%.

Bank Indonesia reports external debt by distinguishing short term and long term debt. Short term is less than one year, while long term debt is greater than one year. According to Bank Indonesia, most external debt is attributed to private sources and is at least one year or more and accordingly characterized as long term. Indonesian loan funding at one year developed country rates against the Indonesian 10 year rate allows Indonesia's banking system and lenders to escape the Indonesian flat yield curve. But, foreign currency risk gets magnified. Then comes a re-weighting of risk for banking assets and reductions in capital asset adequacy ratios for Indonesian banks when global economic weakness shows.

Still, short term external debt held by private sector is at $36.26B according to Bank Indonesia and long term debt at $95.28B. Showing is 38% of Indonesia's external debt is less than one year, versus majority of Indonesia's capital projects of at least 10 years.

Given foreign currency depletion on balance of payment reports, Indonesia has not garnered sufficient industry to raise foreign currencies against loss of domestic currency due to excessive imports. Without creating commerce that accumulates foreign currency, Indonesia's funding of its growth looks very vulnerable to currency risk, maturity risk in down cycles and a longer term condition. A condition of financing growth still reliant on external sources.

Emerging Market Balance of Payments, Current Account Deficit, And Banks

2013-08-12T22:00:00.000-07:00

One can look at drivers of growth and earnings over last couple of years. Where developed country huge GDP's have gone almost up, or flat and into decline, emerging markets have been the investment vehicles for U.S. dollars. These dollars have now come to end.

Yet, we see drivers of money finally finding a last death in a U.S. stock market. Like a Frankenstein monster, this stock market refuses to see comparative pricing levels. Bubbles....who really cares at this point. Entire proposition of a cycle exhausting comes from real time data.

China, a major global driver, is obviously running by a different tune, a different set of monetary policy. China, by the way, has been hesitant in bringing new accommodative monetary measures. They seem very internally focused amid growth rates that now disappoint, if not show "new sprouts of growth". Investors really have to be more astute and see direction, instead of sprouts.

Major emerging markets are now in current account and cash flow deficit, together with falling currency values. This means these falling markets have higher foreign debt exposure, versus their currency values when these foreign loans were garnered to finance past growth. Simple proposition now days is these emerging markets have an overhang of debt, owed in foreign dollars, when their native dollars pay back less of foreign debt every day.

Add to this increases in current account deficits and developing capital/financial account deficits in emerging markets, and these countries are reliant on cashed in U.S dollars. That is, these markets have declining net income, but growing reserve currency values. Sure, these reserve currencies, brought by foreign investments cashing in, can help support their native currency. But, after substantial declines in native currency, these markets will use all of their foreign currency reserves to maintain a balance against foreign debt. One must realize, foreign currency denominated debt in these countries is how financing of investment occurred.

Once foreign currency reserves are exhausted to support foreign debt amid declining native economies and currency values, a currency crises arises. As always, given time, an emerging country shows its interconnection in a system of global finance. 80's Latin America, 90's was Asia. Great Recession?

Developed country banks generally are divergent with European banks, which look weak as cats, where U.S. banks look strong. Europe in general remains in recession, U.S. only avoids recession due to a strategic cash lockup in U.S banks.

Markets currently see money only from a banking perspective....huge earnings growth from financial sector recently. Biggest investment of last four years, being emerging markets, is now convincingly turning against itself.

Major question right now is why oil is high, equating to levels of when emerging markets had positive balance of payment numbers. Emerging markets are now cash flow negative, and oil is currently in speculation....on the wrong side.

With Brent and WTI almost at parity, and no major plays on global delivery, it's unfounded speculation hanging over from reversing a couple pipelines into the Gulf of Mexico.

Q2 Economic Performance Improved, But Q3 Could See Headwinds

2013-07-21T17:24:00.001-07:00

Is The Glass Half Full Or Half Empty

We enter Q2 earnings season in an awkward fashion amid conflicting indications and risks. Second quarter activity saw a boom in interest rates starting in May and only relaxing of late. Associated with this are the record dollars flowing out of bond funds pushing down prices and lifting yields. Then we saw a U.S. dollar gyration spiking down through May, and then spiking up through June. Stocks saw the future of tapered QE in later May and into June, but are making new highs currently in July. Developing country currencies fell against the U.S. dollar while China's economy stepped back.

Some have attributed increasing interest rates to increasing demand driven by growth. Others say interest increases are due to excess liquidity that hasn't spurred demand, but rather increased systemic market risk once the liquidity tap is turned off. It appears both arguments have foundation. But the latter argument has more "real life" support over the other.

Q1 saw lackluster economic performance among indicators. GDP started at a decent 2.4% growth, but inevitably was revised to reflect indicators ending up at 1.8%. For many, this was not surprising given data out of China, Q4 Japan recessionary pressure and of course Europe.

Q2 Started With Weak April Data, Except Housing

April started weaker off of March's minor rally. Dallas Fed Manufacturing Survey, for instance, pulled a positive 7.4 points in March for business activity and a good 9.4 for production. But when April came, the floor fell with business activity at -15.6....real pessimism....and production -.5 points. Construction spending in April fell -1.7% against a March gain of 1.5% with public outlays leading a decline. Retail sales were abysmal and import/export prices showed deflation. April's factory orders data (reflecting March activity) were down -4.8%.

April's other Fed regional indexes also demonstrated disappointment in manufacturing. Of the regional indexes that were positive, they were only hanging on while others remained in contraction. Durable goods orders were all negative and industrial production was teetering to negative.

Only silver lining was the Fed's $40B per month purchases of mortgage backed securities. Contrasting pessimistic data was April's existing home sales, up 10.3% in March and 9.7% in April year over year. Median time for an existing home to stay on the market for sale fell to 42 days from 62 days in March. Banks were obviously producing mortgages to feed the Fed. Pricing advanced 6.2% in March and another 4.8% in April with annual pricing up 11%.

New home sales witnessed similar results with sales up 2.3% in April despite constrained demand. Demand against supply saw new home prices rise 14.9% annually in April. Appears that while mortgage lending was occurring, construction loans to builders remained tight.

Consumer sentiment also elevated in April probably due to more friends of friends buying houses and employment improving. Employment situation report of April exceeded expectations adding 165,000 jobs in April. Market expected 153, 000 jobs to be added while March saw only 138,000 new jobs. Also a factor is the dangerously euphoric equities market. IRA's and 401(k)'s increase giving a feeling of improved retirement security. But euphoric parties come to an end.

Despite other economic indicators, homes and consumer sentiment advanced in April. This dynamic carried through to May and is now seen in June data being revealed today in July. Further, the positives in homes and consumer sentiment are penetrating other indicators positively. Domestic demand has picked up.

May's Housing Data Continued, Other Indicators Improved and Interest Rates Shot Up

Firstly, May saw interest rates start an aggressive increase with spreads between high yield and investment grade widening. U.S. dollar strolled up to the 84.40 level by mid May only to crash into 80.60 by mid June. May 22 saw Fed FOMC minutes that shook equities down, only for deep drops come Bernanke's post FOMC press conference of June 19. That event dramatically dropped equities. All the while, money flowed out of developing currencies, and therefore markets. There interest rates are being cut, while U.S. interest rates increase.

For economic indicators, May saw productivity and cost indicators look better, factory orders (reflecting April) gained 1% against a previous -4.7% loss. Retail sales showed a 4.3% gain year over year with auto sales being important as always with a gain of 1.8% for a second consecutive monthly advance. Industrial production held its own at 0, avoiding more declines. Durable goods orders grew. Interestingly, essentially all Fed regional manufacturing indexes picked up considerably, save for Kansas City, perhaps due to some devastating tornadoes.

Employment advanced with an additional 175,00 jobs versus market expectations of only adding 167,000. But a tenaciously high unemployment rate didn't relent and stayed at 7.6%.

Real source of raising all ships in May is, of course, homes. Existing home sales advanced 12.9% year over year and beat market expectations by 180,000 ending up at 5.18M versus April's 4.97M. This amounted to a highest sales rate since 2009's home purchase stimulus credit. Prices went up 15.4% year over year, perhaps too much, though supply showed a respectable increase over April.

New home sales are similar. Sales of new homes grew in May to 476,000 versus prior month of 466,000 and market expectations of growth at only 460,000. New home supply increased by builders apparently finding additional funding ability to better balance supply with supply going to 4.1 months in May versus 4.0 months in April. Despite a moderate fall of 3.2% in new homes prices in May, perhaps due to elevated pricing, year over year pricing showed a 10.3% gain against April's 14.9%.

Consumer sentiment advanced going from April of 76.4 to May's 83.7, with the market expecting 78.0. Suggestion is increasing home values, people buying homes again and perhaps a more stable jobs market.

Ending Q2, Starting Q3 Data Looks Strong, But Caution Due to Mortgage Rates And Weakened Forward Looking Housing Data

Entering June involved all the dynamics mentioned above, but bolstered by Fed members convincing markets of dovishness. This occurred essentially by June 25, when equities started a climb, after getting spooked on June 19 by Bernanke's remarks . The U.S. dollar started its climb off its bottom on June 19. Meanwhile, between June 17 and 25, the 10 year treasury yield spiked up. Indicated is division in markets and growing weight on dollar and interest rate movements versus a progressively unconvincing rise in equities.

Current economic indicators show optimistic propositions. Employment reveals a gain of 195,000 jobs for the most recent report, demonstrating a three month real advance in numbers. Industrial production is up, along with capacity utilization and manufacturing. Fed regional manufacturing indexes look very good so far with Empire State at a positive 9.46 points and new orders positive though softer than last month at 3.77. Philadelphia Fed Survey is at a strong 19.8 points with new orders a convincing 10.2 positive points.

Threat to what appears to be leading this economic advance is a fall for June, reported in July, of housing starts and permits. Housing starts were an adjusted 928M in May with June coming in lower at 836M, when the market wanted to see an advance of 951M. June's starts to home construction is down 9.9% month over month versus an increase of 8.9% in May. Still, housing starts stay vigorous at a 10.4% increase year over year. Permits for home building also disappointed on July 17th with the report showing June's numbers at 911M versus May's 985M and a market expectation of a high 990M.

Q2's economic rise was Fed money eventually trickling down to real home purchases. All of this was accomplished by banks ensuring strict Basil III reserves while also loaning on mortgages. Consumers became more confident due to rising home values and perhaps stock invested accounts. This dynamic punched through into other indicators of U.S. domestic demand. Result is currently growing strength in domestic demand. This occurs while global demand is weak.

While domestic demand appears to be gaining strength, cause for demand essentially originates out of housing. Unconventional Fed intervention explains advances in housing markets. Increases in demand outside of housing are now only starting and, therefore, do not explain increasing interest rates. A fragile economic environment that hasn't really found broad based support despite Fed intervention probably more so explains rising rates.

Weakness to watch is a fall in housing starts and permits. Caution comes from increasing mortgage rates, bank risk aversion and poor global economic performance. If Q2 trends continue into Q3, hopefully some stable economic growth will take hold.

J.P. Morgan Shareholder Vote, Remembering Whale Trades

2013-05-11T17:34:00.000-07:00

Given the stockholder proxy now confronting voters, it seems appropriate to recall circumstances for JPM. I wrote this piece at the time, but delayed its publication on this space. Banks have been kicked around like a can on a common street. Still, banks supply funding for basic activities, to more complex endeavors. I've always enjoyed Jamie Dimon's moxie. In the U.S., we have a Wall Street and a Main Street. The two meet often. When they meet, you want a banker on your side with a back-bone...even if it's institutionalized.

Once, J.P. Morgan Senate Hearings Explored a London Whale Tale

U.S. Senate hearing today revealed considerable information into the J.P. Morgan Chase "Whale Trade". A fundamental discovery is that of the $6B loss, much of it consisted of excess deposits at the bank that weren't being used for loans to businesses and individuals. Due to deposit money being used, FDIC insured funds were put at risk.

Information out of the Senate hearing today makes the Whale Trade look like a hedge that became its own position. Appears that this hedge was losing so much money, hedging the hedge became a net loss.

Trouble appears to come from the hedge position being a synthetic credit derivative securing a core position. Most derivatives tend to make market movements at faster rates than the security from which they are born. Simple stock options are a derivative. A synthetic is essentially a derivative on a derivative among counterparties to the underlying or core security.

Once a gain is realized in a derivative of an underlying security, the gain is typically in multiples of the underlying's move. Same applies for losses. Derivatives can typically be characterized as put or call positions against an underlying position. A synthetic position is more like a put or call on an underlying derivative of an underlying security.

Changes In Value At Risk Reduced Real Risk, By Appearances

Real problem for JPM is their Value at Risk model (VaR) and how the limits of this model were exceeded during the Whale Trade. Once exceeded, JPM came up with a new VaR model that reduced the "appearance" of risk exposure by 50%.

This move made their positions on their prodigal synthetic derivative hedge, that refused to come home with its losses, look smaller in terms of overall firm risk. Reality now seems that this model wasn't "sufficiently" back tested against the old VaR model. Without sufficient back testing, the new model could look arbitrary to regulators. Perhaps, hind sight is 20/20.

Adding to issues is an apparently contemporaneous development wherein daily profit & loss statements from JPM to their chief regulator, Office of the Comptroller of the Currency (OCC), were suspended. Despite reports having been routinely delivered previously, these reports were suspended for two weeks at what I'm sure is a peripety of this drama.

Suspending daily profit/loss statements to OCC also appears to include major confusion over the extent of losses. Not only was JPM's VaR changed, but representations of the loss made to OCC put the amount at $550M in Q1, 2012. However, internal memoranda indicated the loss to be around $719M.

What Happened To Risk Management, And How To Capture It Too Late

JPM is a seasoned firm, defined by Securities Exchange Commission rules. Such an incongruity in numbers indicates a break in reporting structures. When reports start to deviate, there is a level of "free lancing", or rogue activity occurring.....somewhere. Corporate structures must then isolate the problem and capture causation. In so doing, corporate must first understand the problem's origin, its nature, then quantify or value the problem, and then control the problem.

Evidently pursuing such a process, it looks like JPM isolated the problem, perhaps apparent in their change in VaR models. This only allowed the problem to grow. By decreasing the value at risk, the huge Whale Trade became smaller. With it being smaller, more money could be committed to correct the hedge, growing it into a frighteningly high risk synthetic derivative core position.

JPM witness statements seem to confirm such a proposition. By April, the firm was indicating an internal loss of $1.2B, despite a previous OCC report of $580M. JPM's chief of CIO at the time stated that she understood OCC was receiving mark to market reports with daily profit and loss statements. All the while, she didn't know of suspending reports for two weeks to OCC.

Passing the buck...At some point, less senior personnel have to know what is going on. If not, more senior personnel will get an "all is well" indication. Next obvious question is the pressure of performance.