Forget about all that talk concerning the Mayan calendar and December 21, 2012. The date you should be worried about is January 1, 2013. I’ve been reading so much about it that I decided to try a Google search using “January 1, 2013” to see what results would appear. Sure enough – the fifth item on the list was an article from Peter Coy at Bloomberg BusinessWeek entitled, “The End Is Coming: January 1, 2013”. The theme of that piece is best summarized in the following passage:
With the attention of the political class fixated on the presidential campaign, Washington is in danger of getting caught in a suffocating fiscal bind. If Congress does nothing between now and January to change the course of policy, a combination of mandatory spending reductions and expiring tax cuts will kick in – depriving the economy of oxygen and imperiling a recovery likely to remain fragile through the end of 2012. Congress could inadvertently send the U.S. economy hurtling over what Federal Reserve Chairman Ben Bernanke recently called a “massive fiscal cliff of large spending cuts and tax increases.”
Peter Coy’s take on this impending crisis seemed a bit optimistic to me. My perspective on the New Year’s Meltdown had been previously shaped by a great essay from the folks at Comstock Partners. The Comstock explanation was particularly convincing because it focused on the effects of the Federal Reserve’s quantitative easing programs, emphasizing what many commentators describe as the Fed’s “Third Mandate”: keeping the stock market inflated. Beyond that, Comstock pointed out the absurdity of that cherished belief held by the magical-thinking, rose-colored glasses crowd: the Fed is about to introduce another round of quantitative easing (QE 3). Here is Comstock’s dose of common sense:
A growing number of indicators suggest that the market is running out of steam. Equities have been in a temporary sweet spot where investors have been factoring in a self-sustaining U.S. economic recovery while also anticipating the imminent institution of QE3. This is a contradiction. If the economy were indeed as strong as they say, we wouldn’t need QE3. The fact that market observers eagerly look forward toward the possibility of QE3 is itself an indication that the economy is weaker than they think. We can have one or the other, but we can’t have both.
After two rounds of quantitative easing – followed by “operation twist” – the smart people are warning the rest of us about what is likely to happen when the music finally stops. Here is Comstock’s admonition:
The economy is also facing the so-called “fiscal cliff” beginning on January 1, 2013. This includes expiration of the Bush tax cuts, the payroll tax cuts, emergency unemployment benefits and the sequester. Various estimates placed the hit to GDP as being anywhere between 2% and 3.5%, a number that would probably throw the economy into recession, if it isn’t already in one before then. At about that time we will also be hitting the debt limit once again. U.S. economic growth will also be hampered by recession in Europe and decreasing growth and a possible hard landing in China.
Technically, all of the good news seems to have been discounted by the market rally of the last three years and the last few months. The market is heavily overbought, sentiment is extremely high, daily new highs are falling and volume is both low and declining. In our view the odds of a significant decline are high.
Charles Biderman is the founder and Chief Executive Officer of TrimTabs Investment Research. He was recently interviewed by Chris Martenson. Biderman’s primary theme concerned the Federal Reserve’s “rigging” of the stock market through its quantitative easing programs, which have steered so much money into stocks that stock prices have now become a “function of liquidity” rather than fundamental value. Biderman estimated that the Fed’s liquidity pump has fed the stock market “$1.8 billion per day since August”. He does not believe this story will have a happy ending:
In January of ’10, I went on CNBC and on Bloomberg and said that there is no money coming into stocks, and yet the stock market keeps going up. The law of supply and demand still exists and for stock prices to go up, there has to be more money buying those shares. There is no other way in aggregate that that could happen.
So I said it has to be coming from the government. And everybody thought I was a lunatic, conspiracy theorist, whatever. And then lo and behold, on October of 2011, Mr. Bernanke then says officially, that the purpose of QE1 and QE2 is to raise asset prices. And if I remember correctly, equities are an asset, and bonds are an asset.
So asset prices have gone up as the Fed has been manipulating the market. At the same time as the economy is not growing (or not growing very fast).
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At some point, the world is going to recognize the Emperor is naked. The only question is when.
Will it be this year? I do not think it will be before the election, I think there is too much vested interest in keeping things rosy and positive.
One of my favorite economists is John Hussman of the Hussman Funds. In his most recent Weekly Market Comment, Dr. Hussman warned us that the “music” must eventually stop:
What remains then is a fairly simple assertion: the primary way to boost corporate profits to abnormally high – but unsustainable – levels is for the government and the household sector to both spend beyond their means at the same time.
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The conclusion is straightforward. The hope for continued high profit margins really comes down to the hope that government and the household sector will both continue along unsustainable spending trajectories indefinitely. Conversely, any deleveraging of presently debt-heavy government and household balance sheets will predictably create a sustained retreat in corporate profit margins. With the ratio of corporate profits to GDP now about 70% above the historical norm, driven by a federal deficit in excess of 8% of GDP and a deeply depressed household saving rate, we view Wall Street’s embedded assumption of a permanently high plateau in profit margins as myopic.
Will January 1, 2013 be the day when the world realizes that “the Emperor is naked”? Will the American economy fall off the “massive fiscal cliff of large spending cuts and tax increases” eleven days after the end of the Mayan calendar? When we wake-up with our annual New Year’s Hangover on January 1 – will we all regret not having followed the example set by those Doomsday Preppers on the National Geographic Channel?
Get your “bug-out bag” ready! You still have nine months!
EU-phoria Fades
The most recent “light at the end of the tunnel” for the European sovereign debt crisis was seen on Friday June 29. At a summit in Brussels, leaders of the European Union member nations agreed upon yet another “plan for a plan” to recapitalize failing banks – particularly in Spain. The Summit Statement, which briefly summarized the terms of the plan, explained that an agreement was reached to establish a supervisory entity which would oversee the European banking system and to allow recapitalization of troubled banks without adding to sovereign debt. By owning shares in the ailing banks, the European Stability Mechanism would no longer have a senior creditor status, in order to prevent investors from being scared away from buying sovereign bonds.
The bond markets were relieved to know that once again, taxpayers would be paying for the losses sustained by bondholders. The reaction was immediate. Spanish and Italian bond yields dropped faster than William Shatner’s pants when he passed through airport security. Spain’s ten-year bond yield dropped to 6.51 percent on June 29 from the previous day’s closing level of 6.87 percent. Italy’s ten-year bond yield sank to 5.79 percent from the previous closing level of 6.24 percent.
Global stock indices went parabolic after the news from Brussels on June 29. Nevertheless, many commentators expressed their skepticism about the latest plan. Economist John Hussman of the Hussman Funds discussed the shortcomings of the proposal in his Weekly Market Comment:
The criticism expressed by Charles Hugh Smith is particularly relevant because it addresses the latest move by the European Central Bank to lower its benchmark interest rate by 25 basis points (0.25%) to a record low of 0.75 percent. Smith’s essay, entitled “Sorry Bucko Europe Is Still in a Death Spiral” consisted of sixteen phases of the death spiral dynamic. Here are the final seven:
Of course, Mr. Smith is forgetting that the Martians could call upon those generous taxpayers from planet Zobion for a bailout . . .