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Stock Market Bears Have Not Yet Left The Building

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The new year has brought an onslaught of optimistic forecasts about the stock market and the economy.  I suspect that much of this enthusiasm is the result of the return of stock market indices to “pre-Lehman levels” (with the S&P 500 above 1,250).  The “Lehman benchmark” is based on conditions as they existed on September 12, 2008 – the date on which Lehman Brothers collapsed.  The importance of the Lehman benchmark is primarily psychological — often a goal to be reached in this era of “less bad” economic conditions.  The focus on the return of market and economic indicators to pre-Lehman levels is something I refer to as “pre-Lehmanism”.  You can find examples of  pre-Lehmanism in discussions of such diverse subjects as:  the plastic molding press industry in Japan, copper consumption, home sales, bank dividends (hopeless) and economic growth.  Sometimes, pre-Lehmanism will drive a discussion to prognostication based on the premise that since we have surpassed the Lehman benchmark, we could be on our way back to good times.  Here’s a recent example from Bloomberg News:

“Lehman is the poster child for the demise of the banking industry,” said Michael Mullaney, who helps manage $9.5 billion at Fiduciary Trust Co. in Boston.  “We’ve recovered from that.  We’re comfortable with equities. If we do get a continuation of the strength in the economy and corporate earnings, we could get a reasonably good year for stocks in 2011.”

Despite all of this enthusiasm, some commentators are looking behind the rosy headlines to examine the substantive facts underlying the claims.  Consider this recent discussion by Michael Panzner, publisher of Financial Armageddon and When Giants Fall:

Yes, there are some developments that look, superficially at least, like good news.  But if you dig even a little bit deeper, it seems that more often than not nowadays there is less there than meets the eye.

The optimists have talked, for example, about the recovery in corporate profits, but they downplay the layoffs and cut-backs in investment that contributed to those gains.  They note the recovery in the banking sector, but forget to mention all of the financial and political assistance those firms have received — and are still receiving.  They highlight signs of stability in the housing market, but ignore lopsidedly bearish supply-and-demand fundamentals that are impossible to miss.

In an earlier posting, Michael Panzner questioned the enthusiasm about a report that 24 percent of employers participating in a survey expressed plans to boost hiring of full-time employees during 2011, compared to last year’s 20 percent of surveyed employers:

Call me a cynic (for the umpteenth time), but the fact that less that less than a quarter of employers plan to boost full-time hiring this year — a measly four percentage-point increase from last year — doesn’t sound especially “healthy” to me.

No matter how you slice it, the so-called recovery still seems to be largely a figment of the bulls’ imagination.

As for specific expectations about stock market performance during 2011, Jessie of Jesse’s Café Américain provided us with the outlook of someone on the trading floor of an exchange:

I had the opportunity to speak with a pit trader the other day, and he described the mood amongst traders as cautious.  They see the stock market rising and cannot get in front of it, as the buying is too well backed.  But the volumes are so thin and the action so phony that they cannot get comfortable on the long side either, so are buying insurance against a correction even while riding the rally higher.

This is a market setup for a flash crash.

Last May’s “flash crash” and the suspicious “late day rallies” on thin volume aren’t the only events causing individual investors to feel as though they’re being scammed.  A recent essay by Charles Hugh Smith noted the consequences of driving “the little guy” out of the market:

Small investors (so-called retail investors) have been exiting the U.S. stock market for 34 straight weeks, pulling almost $100 billion out of the market. They are voting with their feet based on their situational awareness that the game is rigged, and that the rigging alone greatly increases the risks of another meltdown.

John Hussman of the Hussman Funds recently provided a technical analysis demonstrating that – at least for now – the risk/reward ratio is just not that favorable:

As of last week, the stock market remained characterized by an overvalued, overbought, overbullish, rising-yields condition that has historically produced poor average market returns, and consistently so across historical time frames.  However, this condition is also associated with what I’ve called “unpleasant skew” – the most probable market movement is actually a small advance to marginal new highs, but the right tail is truncated and the left tail is fat, meaning that there is a lower than normal likelihood of large gains, and a much larger than normal potential for sharp and abrupt market losses.

The notoriously bearish Doug Kass is actually restrained with his pessimism for 2011, expecting the market to go “sideways” or “flat” (meaning no significant rise or fall).  Nevertheless, Kass saw fit to express his displeasure over the degree of cheerleading that can be seen in the mass media:

The recent market advance has spurred an accumulation of optimism.  S&P price targets are being lifted by many whose memories are short and who had blinders on as the equity market and economy entered the last downturn.  Bullish sentiment, coincident with rising share prices, is approaching an extreme, and the chorus of bullish talking heads grows ever louder on CNBC and elsewhere.

Speculation has entered the market.  The Iomegans of the late 1990s tech bubble have been replaced by the Shen Zhous, who worship at the altar of rare earths.

Not only are trends in the market being too easily extrapolated, the same might be true for the health of the domestic economy.

On New Year’s Eve, Kelly Evans of The Wall Street Journal wrote a great little article, summing-up the year-end data, which has fueled the market bullishness.  Beyond that, Ms. Evans provided a caveat that would never cross the minds of most commentators:

Still, Wall Street’s exuberance should send shudders down any contrarian’s spine.  To the extent the stock market anticipates growth, the economy will have to fire on all cylinders next year and then some.  At least one cylinder, the housing market, still is sputtering.  Upward pressure on food and gas prices also threatens to keep a lid on consumer confidence and rob from spending power even as the labor market continues its gradual and choppy recovery.

The coming year could turn out to be the reverse of 2010:  decent economic growth, but a disappointing showing by the stock market.  That’s the last thing most people expect right now, precisely why investors should be worried about it happening.

The new year may be off to a great start  . . .  but the stock market bears have not yet left the building.  Ignore their warnings at your own peril.


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Double Bubble

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I’m sure there has been a huge number of search engine queries during the past few days, from people who are trying to find out what is meant by the term: “quantitative easing”.  My cynical, home-made definition of the term goes like this:

Quantitative easing involves the Federal Reserve’s purchase of Treasury securities as well as mortgage-backed securities from those privileged, too-big-to-fail banks.

The curiosity about quantitative easing has increased as a result of the release of the notes from the most recent meeting of the Federal Open Market Committee (FOMC) which boosted expectations that there will be another round of quantitative easing (often referred to as QE II).  On October 15, Federal Reserve chairman Ben Bernanke delivered a speech at the Federal Reserve Bank of Boston.  After discussing how weak the economic recovery has been (as demonstrated by lackluster consumer spending and the miserable unemployment crisis) Bernanke pointed out that the Fed’s current predicament results from the fact that it has already lowered short-term, nominal interest rates to near-zero.  He then noted that the federal funds rate will be kept low “for longer than the markets expect”.  Bernanke finally got to the point that people wanted to hear him discuss:  whether there will be another round of quantitative easing.  Here is what he said:

In particular, the FOMC is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation over time to levels consistent with our mandate.  Of course, in considering possible further actions, the FOMC will take account of the potential costs and risks of nonconventional policies, and, as always, the Committee’s actions are contingent on incoming information about the economic outlook and financial conditions.

In other words:  They’re still thinking about it.  Meanwhile, former Secretary of  Labor, Robert Reich, wrote a great essay telling us that the Fed will go ahead with more quantitative easing.  After defining the term, Professor Reich added this important tidbit:

Problem is, it won’t work.  Businesses won’t expand capacity and jobs because there aren’t enough consumers to buy additional goods and services.

I’m sure that was a helluva lot more common sense than many people were expecting from a professor at Berkeley.  Beyond that, Professor Reich gave us the rest of the bad news:

So where will the easy money go?  Into another stock-market bubble.

It’s already started.  Stocks are up even though the rest of the economy is still down because money is already so cheap. Bondholders (who can’t get much of any return from their loans) are shifting their portfolios into stocks.  Companies are buying back more shares of their own stock.  And Wall Street is making more bets in the stock market with money it can borrow at almost zero percent interest.

When our elected representatives can’t and won’t come up with a real jobs program, the Fed feels pressed to come up with a fake one that blows another financial bubble.  And we know what happens when financial bubbles get too big.

Another bubble currently under expansion is the “junk bond” bubble.  Sy Harding wrote an important article for Forbes entitled, “Fed Still Blowing Bubbles?“.  Here is some of what he said:

The economy’s problems at this point don’t seem to be the level of interest rates, but the lack of jobs, dismal consumer confidence, and the unwillingness of banks to make loans.

However, just the anticipation of additional quantitative easing and still lower long-term interest rates has already potentially begun to pump up the next bubbles, as investors have moved out the risk curve in an effort to find higher rates of return. Money has been flowing at a dramatic pace into high-yield junk bonds, commodities, and gold.  And the stock market has surged up 12% just since its August low when talk of another round of quantitative easing began.  Meanwhile, the U.S. dollar has been trashed further on expectations that the Fed will be ‘printing’ more dollars to finance another round of quantitative easing.

Nevertheless, Sy Harding isn’t so sure that QE II is a “done deal”.  After making his own cost-benefit analysis, Mr. Harding reached this conclusion:

It’s a no-brainer.  Blow another bubble and worry about the consequences down the road.

Yet in his speech Friday morning Fed Chairman Bernanke did not go all in on quantitative easing, stopping short of announcing a new policy, saying only that the Fed contemplates doing more, but “will take into account the potential costs and risks.”

So uncertainty remains for a market that has probably already factored in a substantial new round of stimulus.

This raises an important question:  How will the markets react if the consensual assumption that there will be a QE II turns out to be wrong?

Bond guru, Mohamed El-Erian of PIMCO,  recently wrote a piece for the Financial Times, in which he asserted his conclusion that judging from the FOMC minutes, “it is virtually a foregone conclusion” that the Fed will proceed with QE II.  El-Erian described this anticipated action by the Fed as an effort to “push” investors “to move out on the risk spectrum and buy corporate bonds and stocks”.

Getting back to my earlier question:  If the Fed decides not to proceed with QE II, will the bubbles that have been inflated up to that point make such a large pop as to drive the economy toward that dreaded second dip into recession?  On the other hand, if the Fed does proceed to implement QE II:  What will be the ultimate cost to taxpayers for something Robert Reich describes as a “fake” jobs program “that blows another financial bubble” and accomplishes nothing else?

As Professor Reich has pointed out, the Fed itself is the one being “pushed” to take action here because “our elected representatives can’t and won’t come up with a real jobs program”.  Unfortunately, any “jobs program” initiated by the government has become a “third rail” issue with mid-term elections looming.   As I stated previously, if the economic crisis had been properly addressed two years ago, when the political will for an effective solution still existed, the Fed would not be faced with the current dilemma.  But here we are   .  .  .   just blowing more bubbles.


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The End

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July 29, 2010

The long-awaited economic recovery seems to be coming to a premature end.  For over a year, many pundits have been anticipating a “jobless recovery”.  In other words:  don’t be concerned about the fact that so many people can’t find jobs – the economy will recover anyway.  These hopes have been buoyed by the widespread corporate tactic of cost-cutting (usually by mass layoffs) to gin-up the bottom line in time for earnings reports.  This helps inflate stock prices and produce the illusion that the broader economy is experiencing a sustained recovery.  The “jobless recovery” advocates ignore the extent to which the American economy is consumer-driven.  If those consumers don’t have jobs, they aren’t going to be spending money.

Although many observers seem to take comfort in the assumption that the jobless rate is below ten percent, many are beginning to question the validity of the statistics to that effect provided by the Department of Labor.  AOL’s Daily Finance website provided this commentary on the June, 2010 unemployment survey conducted by Raghavan Mayur, president of TechnoMetrica Market Intelligence:

The June poll turned up 27.8% of households with at least one member who’s unemployed and looking for a job, while the latest poll conducted in the second week of July showed 28.6% in that situation.  That translates to an unemployment rate of over 22%, says Mayur, who has started questioning the accuracy of the Labor Department’s jobless numbers.

*   *   *

In fact, Austan Goolsbee, who is now part of the White House Council of Economic Advisers, wrote in a 2003 New York Times piece titled “The Unemployment Myth,” that the government had “cooked the books” by not correctly counting all the people it should, thereby keeping the unemployment rate artificially low.  At the time, Goolsbee was a professor at the University of Chicago.  When asked whether Goolsbee still believes the government undercounts unemployment, a White House spokeswoman said Goolsbee wasn’t available to comment.

Such undercounting of unemployment can be an enormously dangerous exercise today.  It could lead  some lawmakers to underestimate the gravity of the labor market’s problems and base their policymaking on a far-less-grim picture than actually exists.  Economically, and socially, that would make a bad situation much worse for America.

“The implications of such undercounting is that policymakers aren’t going to be thinking as big as they should be,” says Ginsburg, also a professor emeritus of economics at Brooklyn College.  “It also means that [consumer] demand is not going to be there, because the income from people who are employed isn’t going to be there.”

Frank Aquila of Sullivan & Cromwell recently wrote an article for Bloomberg BusinessWeek, discussing the possibility that we could be headed into the second leg of a “double-dip” recession:

The sputtering economy and talk of a possible second recession have certainly rattled an already fragile American consumer.  Consumer confidence is now at its lowest level in a year, and consumer spending tumbled in May and June.  Since consumer spending accounts for more than two-thirds of  U.S. economic growth, a nervous consumer is not a good omen for a robust recovery.

Job creation is a key factor in increasing consumer confidence.  While economists estimate that we need economic growth of 4 percent or more to stimulate significant job creation, the economy has grown at only about 2 percent to 3 percent, with a slowdown expected in the second half.

*   *   *

With governments struggling under the weight of ballooning budget deficits and businesses waiting for the return of sustained growth, it is the American consumer who will have to lift the global economy out of the mire.  Given the recent news and current consumer sentiment, that appears to be an unlikely prospect in the near term.

The same government that found it necessary to provide corporate welfare to those “too big to fail” financial institutions has now become infested with creatures described by Barry Ritholtz as “deficit chicken hawks”.  The deficit chicken hawks are now preaching the gospel of “austerity” as an excuse for roadblocking any further efforts to use any form of stimulus to end the economic crisis.  One of the gurus of the deficit chicken hawks is economic historian Niall Ferguson.  Because Ferguson is just an economic historian, a real economist – Brad DeLong — had no trouble exposing the hypocrisy exhibited by the Iraq war cheerleader, while revisiting an article Ferguson had written for The New York Times, back in 2003.  Matthew Yglesias had even more fun compiling and publishing a Ferguson (2003) vs. Ferguson (2010) debate.

At The Daily Beast, Sir Harry Evans emphasized how the sudden emphasis on “austerity” is worse than hypocrisy:

As for the banks, one of the obscenities of our time is that so many in the financial community who owe their survival to the massive taxpayer bailouts, not only rewarded themselves with absurd bonuses, but now have the gall to sport the plumage of deficit hawks.  The unemployed?  Let them eat cake, the day after tomorrow.

Gerald Celente, publisher of The Trends Journal, wrote a great essay for The Daily Reckoning website entitled, “Let Them Eat Losses”.  He pointed out how the kleptocracy violated and destroyed the “very essence of functioning capitalism”.  Worse yet, our government betrayed us by forcing the taxpayers “to finance the failed financiers”:

No individual, business, institution, nation or empire is too-big-to-fail.  Had true capitalism been allowed to function unimpeded, the bloated, over-extended, inefficient and gluttonous firms and industries would have failed.  There would have been hardships and losses but, finally rid of its financial tapeworms, the purged system could be restored to health.

No “ism” or “ology” — regardless of purity of intent or moral foundation — is immune to corruption and abuse.  While capitalism itself is being blamed for the excesses that brought on financial chaos, prior to the most recent gambling binge, in tandem with the blanket dismantling of safeguards and the overt takeover of Washington by Wall Street, capitalism was responsible for creating one of the world’s most successful and universally admired societies.

As I discussed on July 8, because President Obama lacked the political courage to advance an effective economic stimulus package last year, the effects of his “semi-stimulus” have now abated and we are headed into another recession.  Reuters reported on July 27 that Robert Shiller, professor of economics at Yale University and co-developer of Standard and Poor’s S&P/Case-Shiller Index, gave us this unsettling macroeconomic prognostication:

“For me a double-dip is another recession before we’ve healed from this recession … The probability of that kind of double-dip is more than 50 percent,” Shiller said.

“I actually expect it.”

During the last few months of 2009, did you ever think that someday you would be looking back at that time as “the good old days”?