About - Friday 03 Sep, 2010
Banks, battles, and the psychology of overconfidence
The pace of economic decline appears to have slowed, but the labor market remains weak and, in response, the Federal Reserve is likely to maintain interest rates at "exceptionally low levels for extended periods,"
By Malcolm Gladwell in The New Yorker
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Guest Observer - Tuesday, 14 July 2009
Insight: This crisis is not over
If we do not yet have inflation and we cannot have a new bubble then there must be more deleveraging and unwinding of the global credit bubble to come.
By Tim Lee in the Financial Times
Guest Observer - Monday, 13 July 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
The interview with Larry Summers in Saturday's FT was quite extraordinary in his revelation of what kind of economy is going to emerge from the current recession and what that has to mean for the dollar. He starts his argument by noting:
The American problem this time has more in common, at least qualitatively, with the Japanese post-bubble problem, where the issue was not reassuring foreigners but maintaining sufficient domestic demand forward to push the economy.
Generating sufficient economic demand is somewhat problematic if the U.S. is going to be a less leveraged economy, even though Bernanke has said that he would like to see people get back to spending by using the take-out from refinanced mortgages -- and current low interest rates should help that along. Isn't this how the whole mess got started? If the personal saving rate goes back to zero once job growth returns then policy has saved the day but not the economy.
Say what you want about Summers, and many have, but he is not stupid and so he goes on to outline the economy to emerge -
This new American economy, Summers hopes, will be "more export-oriented" and "less consumption-oriented"; "more environmentally oriented" and "less energy-production-oriented"; "more bio- and software- and civil-engineering-oriented and less financial-engineering-oriented"; and, finally, "more middle-class-oriented" and "less oriented to income growth that is disproportionate towards a very small share of the population". Unlike many other economists, Summers does not believe that lower growth is the inevitable price of this economic paradigm shift.
How do you suppose all this is going to happen? Summers then says so --
As Summers puts it, "The global imbalances have to add up to zero and so, if the US is going to be less the consumer importer of last resort, then other countries are going to need to be in different positions as well." On this possibility, Summers is bullish. "The very great enthusiasm for accumulating reserves that one saw globally is likely to be a smaller factor over the next decade than it has been in recent years," he predicts.
Putting 2 and 2 together he is saying that China, Japan, and the like will not run their export machines by flooding the world with their currencies in order to keep the dollar up so American consumers will buy their productive overcapacity. That game is over. Obama likely told that to the Chinese in his private meeting with the premier in London earlier this year and now he is telling us. The dollar will weaken against our trade deficit partners to the betterment of creating a more balance growth path in the U.S. This isn't about national pride in the currency, this is about leveling the playing field -- at last.
Guest Observer - Thursday, 9 July 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
Aaron Task writes for thestreet.com and has a post today in Yahoo finance declaring Government stimulus as "War on Capitalism". Normally I let this nonsense pass unnoticed but its sheer repetition has too many believing it is true. First off, Obama and Bush II were saving capitalism not declaring war on it. If they wanted to declare war they would have let WB, MER, C, and BAC follow Lehman into bankruptcy, not done anything to unfreeze capital markets, and let the consumer and business spending implosion set off a debt/deflation cycle as debt underlying income and profit expectations turns onerous and assets subsequently need to be sold to raise cash. When Roosevelt was President his response to increased carping by bankers and the like was that "they sound like a man saved from drowning and then complains that his hat wasn't saved as well". More things change ...
The kick-off for the Task post is the possibility that another round of massive stimulus is coming - and the doubt that it even works. Fact is, stimulus worked well enough in the 1930s for the economy to exit recession in March 1933 and the country to fall back into recession in May 1938 when the stimulus was reduced. Looking back, the stimulus wasn't big enough until World War II solved that problem. As for the Japan example, it doesn't hold as a comparison because they took way too long to allow failed banks to recognize losses and merge into healthier ones, the necessary step to revive lending. Remember when Japan was going to rule the world and everyone was concerned about whether they would buy U.S. debt, etc? Turns out that they might yet as this nation in a 20-year malaise more and more supplants Western banking as the source of capital to finance the Asian economy.
As for the current run of U.S. macro policy, when the economy was collapsing last Autumn it became evident that a two-prong attack was necessary. Any stimulus package designed to replace imploding consumer and business spending with government consumption would fail if the capital markets remained closed. As for the quality of the packages, monetary and fiscal alike, they are a hodge-podge. For the spending package there was no choice if there was going to be increased spending now rather than later. Without Republican support Obama needed Democrats and no self-respecting politician was going to let $787 billion get spent without a favored project tossed in. Another package? Given the back loaded spending and signs of an abating recession, I doubt it will be necessary.
The crux of the issue for Mr. Task and like minded people is the massive amount of government debt to be financed and the overwhelming amount of outstanding Treasury debt on the books. The numbers are the numbers but none of it is particularly scary -- if the spending gets the country growing in terms of real growth. It is high real growth and low inflation that reduces the debt not inflation (see the 1990s).
Herein lies the issue, how does real growth revive? A decade long run of government infrastructure spending helps but it can't be the whole thing because bridges roads and tunnels are less important to growth than the Web and cell phones - see India and China. In addition, I am not exactly sure what the sum total of the government's plan is attempting to do other than avoid economic disaster today. An obviously worthy goal but how do we recognize when enough is enough. A better balanced economy is a less leveraged economy. This means policy cannot look to get back to 4.4% unemployment, 5.5% is a more sane target.
For the U.S. to have balanced growth our major trade deficit partners (China and Japan among them, Europe not) must allow their currencies to appreciate to market levels. They have kept their currencies too cheap and manufacturing costs cheaper in order to keep their export machines growing by buying more and more dollars. How do you think they ended up with too many Treasurys and the U.S. ended up with too much capital chasing too few investment opportunities. We do not have a free trade world with free floating currencies and acting as if we do is how the Fed helped create the mess the economy is in.
Guest Observer - Wednesday, 1 July 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
There seems to be a growing sense that home prices are not going to recover, on a national scale, before the economy shows signs that the recession is ending. To confuse this notion with some facts, the chart below shows the year-over-year percent change in the median price for existing homes over the course of the business cycle (shaded areas are recessions). Recession definitely impacts home prices, some more than others for many different reasons - affordability, real interest rate levels, unemployment rate, etc. But in each cycle, home prices recover before the economy does -- at least as far as NBER dating is concerned.
Because the perception of recovery lags reality, this means that home prices begin to recover long before consumers believe the recession has ended and certainly before the unemployment rate starts to turn down. All of which is to say that in the coming months we will see home prices begin to recover even though the recession is not officially over. My forecast is for home prices to begin move higher in the third quarter (www.econmkts.com) and to finish 2009 with prices about 11% below year-end 2008 levels.
Guest Observer - Tuesday, 23 June 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
Oil is a key indicator for the turn in the economy and, as my last post illustrated, for when the yuan is going to resume revaluing to the dollar. Technical analysis of price action isn't mystical -- price patterns reflect shifts in the balance of supply and demand -- how people are voting their money rather than their opinions.
The chart below is the daily spot dollar price for Brent crude (this is an index so divide by 10 to see the actual price). The move from the low set year end has a decided counter-trend price pattern and has barely retraced more than 23.6% of the decline that began in July. The current run also looks a bit exhausted as prices broke through their channel ceiling and have since pulled back to the top of the channel. The daily slow stochastic is giving a sell signal as it breaks down through 80.
So the daily chart gives every indication that the six-month oil market run has topped out but I wouldn't put the big bear hat on just yet. The price is still above some important moving averages that now look like support and commodities typically retrace 50% of a trend move before the trend resumes. In addition, commodity prices almost always have that counter trend look to them when coming off a bottom -- as opposed to stocks and bonds. Lastly, the weekly chart (see below) is still signaling higher prices.
In sum, oil prices are taking a brief breather before the uptrend resumes. The 50% retracement level is $80, also a level where some believe China will resume yuan revaluation to the dollar. Look for oil to hit $80 before any serious down move could resume -- if it does resume.
Guest Observer - Friday, 19 June 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
As everyone has now figured out (if they didn't know before) markets aren't rational only efficient at averaging out everyone's expectations for the moment. The graph below charts out the yield on the Jun 2010 Eurodollar contract against the average Fed funds rate expected for summer 2010. Remember that the Euro contract is the yield on a three-month deposit made the day the contract goes to delivery, so the rate necessarily includes an expectation of where the funds rate will be plus a credit spread.
The market, in its infinite wisdom, is pricing in the Fed raising the funds rate several times between now and summer 2010. By August 10, the rate will be 1.5%. Considering all the depression talk that is quite a run to be discounting especially with no easing in credit spreads. At present that forward spread for summer 2010 is 47 basis points and has generally averaged around 42 basis points since May 10 -- when the winter scare was finally priced out of the market.
It is not quite clear to me how the Fed will be actively raising the base lending rate while banking spreads are still at recession-like wides. Looking at the level of the Eurodollar rate against the spread to expected Fed funds, someone is going to be wrong. The Fed will not be tightening, not for a long time and there is a very good chance that Bernanke will not even be running the Fed when summer 2010 rolls around. Reads to me like an arbitrage opportunity (at your own risk, etc.).
Guest Observer - Friday, 29 May 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
The combination of easy monetary and fiscal policies has never been kind to equity market performance, at least in the post-war. By performance, I am looking at the ratio of the Dow Industrial Averagk Twain noted, are as useful as having your head in the oven and feet in the ice box and saying the average temperature is 72 degrees. This ratio fluctuates and has trended up or down for extended periods of time (see chart below).e to GDP. Since 1947 the mean and the median have averaged 0.76 but averages, as Mar
Equity market performance is being measured as the DJIA divided by GDP because this ratio is the reason why money with an investment horizon approaching infinity invests in equities versus bonds. Bonds will return the coupon but the stock market will return the economy's growth. Investment horizons less than infinity make this investment tactic a bit problematic, as we have seen in the past few years. Consequently, if one believes we are entering or are already in a period when the equity market underperforms the economy then a large equity allocation doesn't make much sense.
As for what causes longer-term trends in the ratio, the Misery Index (unemployment rate plus the year-over-year percent change in core CPI) seems to be a fairly good indicator -- a negative correlation of -0.79. As for what drives the Index, it seems to be periods of tight versus easy macroeconomic policy. The era of tight macro policy that began on a Saturday night in October 1979 ended during the fourth quarter of 2001 when the dot.com bust recession collided with the beginning of the war on terror. If you believe we will be in the current easy policy mix for the foreseeable future, and it has hard to see how we won't be, the equity market will have its ups and downs and perhaps even more ups than downs but relative to economic growth the overall market will underperform.
Guest Observer - Friday, 22 May 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
The above chart from Bloomberg compares the yield on a Goldman Sachs note -- 5.5% due 11/15/2014 with a generic 5-year Treasury.
Before the financial world imploded, the spread between the two was generally inside of 80bps. As things went from bad to worse the spread widened and seemed to be topping out at around 300bps until Lehman's bankruptcy shot the spread out to 855bp and the spread has been narrowing ever since. Narrowing but at 330bps, the pre-Lehman levels, and that seems to be about it.
Investors have obviosuly pulled back from an Armaggedon outlook to something a bit more routine, like a recession. Another way to look at this is that the financial system may now be relatively solvent but the system's exposure to the nonfinancial sector is keeping a few people from getting a good night's sleep.
Guest Observer - Monday, 11 May 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
There has been a lot of talk lately about the steepening of the yield curve, as if this is a bad thing. Even the Fed seems bent on keeping longer term yields from getting too high and aborting mortgage activity -- refinancing and otherwise. Truth is a steep yield is a necessary although not an entirely sufficient requirement for economic recovery. The curve is not a talisman, it works as a forecast of economic activity because it indicates whether banks are making money or not. When they are they lend and when they aren't they don't.
The chart above illustrates the historic interplay of Fed policy, the curve and unemployment. Before every recession the Fed tightens, the curve flattens until it goes negative and then the recession begins and unemployment rises.
Since 1982 it takes less and less of a rise in the funds rate to create a negative yield curve and not as negative a curve to tip the economy into recession. While the curve doesn't need to get as negative to send the economy into a tailspin it is taking steeper positive yield curves with a lower funds rates to get the economy restarted. Employment, as always, follows with a lag.
A good part of these dynamics of the past 30 years relates to lower inflation rates but a good part also owes to the increased and increasing indebtedness of the economy, corporate and household. It does not take much of an increase in high real interest rates to make leverage a burden and create the subsequent drop in activity. Conversely, with so much debt on the books and inflation low it takes a much longer period of low rates and a steep yield curve to get credit creation growing at the rate where an economic recovery can take hold.
The yield curve is finally steep enough to begin to turn the economy and put a cap on the unemployment rate -- if the Fed lets well enough alone. At this stage of a downturn, a market pricing in concerns about inflation and crowding out is a good thing -- it means investors are thinking recovery not depression. There is a whole cadre of healthy financial institutions ready to step in and fill the void left by the financial leaders of the past cycle. Still, every cycle since 1982 has taken that much longer for recovery to take hold and get unemployment back to pre-recession lows. This cycle will prove the same and more so. At least the bottom seems to be behind us.
Guest Observer - Tuesday, 28 April 2009
From Guest Observer Steven Blitz, of Blitz Bits on Capital Markets & The Economy
Paul Krugman, in his op-ed article today, is outraged that Wall Street pay is reportedly returning to pre-crisis levels. His outrage may be understandable but like so many others he is blaming the consequences for the cause of our problems. He writes --
"All of which explains why we should be disturbed by an article in Sunday's Times reporting that pay at investment banks, after dipping last year, is soaring again -- right back up to 2007 levels.
Why is this disturbing? Let me count the ways.
First, there's no longer any reason to believe that the wizards of Wall Street actually contribute anything positive to society, let alone enough to justify those humongous paychecks."
If pay and contribution to society had any relationship then elementary school teachers would be earning more than Mr. Krugman for writing his column. After all, of what value does Mr. Krugman have to society? His pay, even his bully pulpit at the Times exists because the newspaper believes that people want to read what he has to say and will pay the NYT for the privilege. If more people are buying the paper or hitting the NYT website to read Mr. Krugman the more money the paper earns. Mr. Krugman would certainly want his share of the marginal revenue and the Times will certainly want to miminize his contribution to circulation so as to profit more from his articles. All of this is how business and wage setting works and has nothing to do with contributions to society.
Compensation is a tricky subject fraught with populist notions and high-horse orations, but if firms are paying a lot then they are making a lot -- be it newspapers, baseball teams or banks. As for Wall Street wizards, their big paychecks, and their contribution to society, let's get to the basics of what the financial sector does and the role of innovation.
The financial sector intermediates funds between lenders and borrowers and charges a handling fee priced in basis points. The more funds there are to intermediate the more absolute cash is generated by those basis points. Because of technical innovations, less people are needed to move this money about so the revenue is spread amongst fewer people. If a trader earns a few hundred million in profits for the firm, how much should he be paid? That is up to the firm, but I can tell you it will be a lot more than minimum wage. And if increasing sums of money are looking for yield what should the financial system do, turn it away? Of course not. Someone figures out how to manufacture the yield the cash is looking for and that someone and someones who now create lots of revenue for the firms to the tune of hundreds of millions should get paid what? As close to marginal revenue as Mr. Krugman would want to earn at the NYT.
The underlying problem is the policies of the world's central banks and their creation of all this capital flowing through the system. Innovation is a way for banks to handle huge flows relative to their capital base, innovation doesn't create flows. Run a monetary policy that constrains the growth of credit and hence the leverage of the U.S. economy and that will take care of bankers pay and inflation.
Policy is instead flooding the system with public money to replace private debt in order to get the economy back to running at some too high of a multiple of debt. At the same time the government and assorted pundits want banks to earn less profit from handling renewed capital flows because these firms were saved by government and are trading off of government capital. The government should then demand a bigger dividend on its shares, common or preferred, but of course that is why the banks want to hand back the TARP money ASAP.
Bankers are far from guiltless in the current debacle, and the firms that mismanaged and misread their profits should have gone out of business. The broader societal function filled by MER, AIG and others would have been picked up by someone else. Government has instead been trying to keep firms in business rather than manage the implosion from the loss of several players. To now ask bankers to play nice as the funds start flowing again is, well, good luck to that.
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