"Trying to Stay Focused on the Big Picture"

In his weekly blog post on July 6, 2012, Doug Noland has described the real risk of a credit bubble and compared it with the real risk of asset inflation. In his description, asset inflation is the initial reaction to monetary and fiscal avoidance of austerity. The cost is a heightened and delayed reaction to excess credit and money supply which will create a maladjusted economy characterized by a lack of solvency among the many and wealth held by only a few. Here is a link to the entire post and here is a major section of his post for future reference.

"Policymakers will, as we’ve witnessed again recently from European politicians and central bankers, respond to heightened systemic stress by ratcheting up their responses.  Yet, and also no surprise, these increasingly desperate measures will have depleted and fleeting effects – and really tend only to heighten market instability.  The big unknown remains the timing of when market confidence in the capacity of policy measures to incite market rallies is finally depleted.  Without this carrot, I expect we’ll be facing an altered global market environment.

The structure of today’s marketplace (especially with respect to the proliferation of hedging and derivative trading strategies) is conducive to short squeezes.  This is compounded by the policy environment backdrop whereby market players (sophisticated and otherwise) fully recognize that policymakers are determined to backstop the markets.  This incentivizes speculation and, I would argue, has nurtured Bubble Dynamics.  Understandably, trumpeting global market resilience in the face of European debt tumult and slowing global growth has become common.  I continue to fear that the confluence of complacency, policy impotence, and endemic global market speculative excess creates unappreciated systemic fragilities.           

Extraordinarily divergent macro views have solidified.  Some see the makings for a new secular bull market.  I instead see an increasingly susceptible global Credit Bubble and attendant historic financial mania.  A critical facet of this thesis remains that policymakers will go to incredible lengths to sustain Credit, financial and economic booms.  And while this guarantees difficulty in assessing the timing of when catastrophe might strike – it seemingly ensures such an outcome.  With unsettled markets only adding to confusion, I thought it appropriate this week to touch upon Credit theory to try to bring a little clarity to the muddled macro backdrop – Trying to Stay Focused on the Big Picture.

Economic Condition Review: August 2011

Looking back since my last review in June the world has recovered from the tsunami and earthquake damage in northern Japan (Japan is still in recovery/clean up mode), the civil revolt and dictator overthrow in Egypt has resulted in a power vacuum which will be resolved by election later, the dictator of Libya, Muammar Gadhafi, has been defeated by his opposition according to news reports. Other uprisings are beginning to build in several other oil producing countries in the region, including Syria and Persian Gulf states. The threat of crude oil shipments being interrupted is a growing concern for all countries importing from this region. Despite these pressures, the price of Brent Oil has softened recently from more the $120 to now $108.62.

In Europe, the socialist government of Portugal has collapsed and is now moving on with a new center-right government. The government of Greece has had to renegotiate the bailout terms with the ECB (Germany and France) as a condition of getting the last installment of their bailout package. The renegotiated plan now calls for Greece to liquidate much of its net worth (state owned assets like airports and transportation services) as well as agree to new austerity. Can it get any more dire in Greece? Misery likes company and Italy, the eighth largest economy in the world, is drawing attention to itself for having public debt at 120% of GDP. That's second, to Greece, in the euro zone. Spain is on the radar screen now as well.

China is still wrestling with internal high food and shelter inflation threatening the massive lower classes, potentially destabilizing the power of the ruling party. Published reports describe interest rate increases are the tool to fight inflation in China, to slow lending for business and personal discretionary consumption.

In the US, the Treasury market is finding some strength on a risk-off move. The yield on the 90 day Bill is 0.00%, the 2 yr T-note is 0.19% and the 10 yr T-bond is 2.06%! The US$ is weak, trending between 73.50 and 76.00 during the past several months, and currently near the 74 mark. 'Risk off' has been a reaction to the US Congress displaying their lack of ability, building the case daily until the beginning of August when they finally extended the US public debt limit. The public display of incompetency was so much greater than expected that some economic activity slowed as a result of the spectacle and resulting loss of confidence in the leadership ability of the US government.

Calculated Risk has a summary of the recent economic reports which illustrate that the economy is not growing, but is not collapsing into recession. New home building is slow and existing home inventory is still large. Industrial production is  trending sideways or improving. Same trend for production capacity utilization.

The Federal Reserve is pulling the strings to guide global perception about the strength of the US$. The Fed has no choice but to continue it's zero interest rate policy and money printing practice. They will attempt to support the Treasury market when the primary dealers and global participants back away more than they have now. As mentioned above, yields are at historic lows. Doug Noland has this caution in his blog this weekend. "Fiscal and monetary policies are rapidly losing credibility.  Treasury prices may be inflated, but don’t mistake this for confidence in our system’s “core”." Financial markets around the world are expecting a return to quantitative easing (QE3) sometime soon. Bernanke is speaking at the annual Fed Conference at Jackson Hole where last year he hinted at QE2. The world will wait for his message on Aug. 26. Calculated Risk has a post on what he expects from this years Jackson Hole speech. There is a building awareness that the Fed is wrecking the currency. On top of the loss in confidence for the US government, the reaction to a new plan of quantitative easing does not guarantee support for financial markets. Doug Noland writes "The American people no longer buy the notion that piling on more debt and “money printing” offers a reasonable solution.  They are appreciating that it’s instead the problem, and there will be less tolerance for this “experiment” going forward."

Bullish or Bearish?

This is such an important and difficult discussion topic. A lot of net worth is at risk to a bear market mauling. Saving it from the potential value destruction depends on having a plan or at least having a clear idea of what market orientation is reflected in the asset allocation strategy at work now. Is it a bull market strategy or a bear market one? Having a position provides a base of information. My observations from talks with peers and industry colleagues is that many are paralyzed bulls and remaining at risk to the bear. There is nothing bad with being a bull or a bear. Losing money is what is bad and that is what I'm concerned about. If this period is recognized as a secular bear market period, which many call it now, losing money will be the outcome for those who could not get comfortable zipping on a bear coat for a while.

Here are a pair of perspectives to define the distinction between the bullish and bearish economic outlook, mostly measured by the stock market. Bob Doll, who is paid to be a bull, represents his investment manufacturing employer. The bear is David Rosenberg. His employer is a wealth management firm in Canada where he is chief economist, a position he held previously at Merrill Lynch. He should be expected to walk his talk. This interview was conducted back in March. After the video clip, there are some graphs that try to look at the economy from the positions taken by Doll and Rosenberg to examine what has changed compared with their expectations. They have not changed their market outlooks since March. One of them should, which one?

Doug Noland is Still a Bear, Feeling Bullish

Last week in his market summary and outlook, portfolio manager, Doug Noland, wrote of his concerns over the news we heard last week. It was news of Greece's debt problem with no EU solution known and that China was yet again raising the reserve requirement of its national banks to slow growth of both loan issuance and their internal inflation. (I wrote about China, including the reserve requirement policy of the People's Bank of China, last month in China Economy Clocked at 107mph in an 80 mph Zone.) These had the combined effect of causing investors to pull back on the amount of risk they wanted in their holdings. As a result the S&P finished this week up 0.9% and down 3.6% YTD. I have been looking forward to Noland's article this week expecting he would offer a little expansion of his analysis and outlook, which he did in the Global Reflation Update.