Weekend Links

How many years has the economic crisis set back the most affected countries?

China's foreign exchange reserves move the Euro.

Is an engineering degree better than an MBA if you plan to start a company?

Marketing dollars vs. the time spent by consumers on different categories of media.

With more investors entering the market and less interest in homeownership, the US is seeing the number of homes rented increase.

Debt and Occupy Wall Steet

I liked this essay's explanation of the zeitgeist behind the Occupy movements.

I think there is a simpler story though to be told about modern economic growth being driven primarily by increased private debt levels.  (Update: my view expressed here is heavily influenced by Steve Keen's writing.)  It is less malevolent than the corruption of politics by money explained by the linked essay and simpler to address.  

My story would be that constantly increasing debt levels of the past 3 decades created false demand that was unsustainable when the debt growth stopped.  The extra demand smoothed out the business cycle while the debt grew creating a self fulfilling "great moderation" of stable dependable economic growth that allowed and incentivising high debt levels.

High debt levels benefit asset owners by driving up prices and lenders by increasing interest payments which also explains the shifts in wealth distribution.  There was also a kicker to the wealth concentration at the end of the debt build up where "the 99%" were convinced to take on large debt loads to purchase houses which, as an un-productive asset, require either the owners salary or price appreciation to enable the interest payments.

Recognising the current imbalances as a debt problem would add "eliminating tax incentives for debt funding" and possibly   add "managing the aggregate debt level" to the responsibilities of the world's central banks.  

I don't think this is a difficult narrative for people to understand and I imagine most are aware of the increased presence of debt in their lives.  While discussion of the government debt level is a popular media topic and the level of education loans is starting to make headlines there is much less discussion of the overall private debt level making me think that the majority of people are still looking for a return to the good old days of steady debt growth.

Memorial Day Links: No Bubble in Australian Housing and Greek Problems Continue

"The short story is that the escalation in housing costs has been mainly motivated by underlying demand- and supply-side fundamentals, not leverage as some doomsayers would have us believe. "


“Could this be the last weekend of the single currency? Quite possibly, yes.” (Hat tip Calculated Risk)

Long-term perspective on currencies and central bank policies

I was doing some house cleaning, tagging old entries and came across something I wrote in 2005 on central bank policies:

On a related note, foreign CBs will not turn net sellers of dollar assets. They will stop adding to USD reserves which still creates a substantial problem for U.S. interest rates. The markets will continue testing the CBs' appetite for dollars until we see real policy changes and a market determined equilibrium.

This referred to the US dollar but the underlying logic still applies to this week's scare regarding China turning seller of Euro assets.  China has deep pockets and very little interest in adding to currency instability.  The status quo (Yuan pegged at sub-market rates to stimulate Chinese exports) has done well by them and while it can't go on forever now would be a shockingly poor time for a drastic change.  Why would they do this in the midst of speculative fervor to short the Euro and a general panic regarding European assets?

My 2005 self went on to make the following predictions:

There will be some sort of market event with the most likely candidates being housing and interest rates.

This market event will ultimately require international cooperation (G7, G10). It may take a series of trials (maybe a series of crises) by various CBs and governments but eventually they will need to coordinate policy. The world will need to decide how to handle the issue of the weakening dollar as its main reserve currency.

On a related note, foreign CBs will not turn net sellers of dollar assets. They will stop adding to USD reserves which still creates a substantial problem for U.S. interest rates. The markets will continue testing the CBs' appetite for dollars until we see real policy changes and a market determined equilibrium.

Unemployment seems like the best indicator of how hard or soft the landing is in the real economy. Below the June '03 high of 6.3% seems like a good definition of a soft landing for the U.S.[The main question being discussed was whether the US was whether the Fed hiking cycle was leading up to a soft landing.]

The U.S. current account deficit will get worked off through the growth of emerging market consumption rather than U.S. economic contraction. These emerging economies are the logical target for the world's investment dollars so once the market regains control of capital distribution they should see some benefits.

While this was a useful high level map, in the end it mostly helped me to avoid risks.  The policy coordination I expected has yet to materialise and instead it is a dog eat dog world of competitive currency devaluations.  This makes a fertile (read volatility swings) ground for trading, especially in currencies.  I expect this will continue until central bank coordination occurs enabling debt-heavy importing countries to start paying off their creditors.

UK Property Derivatives Market

From the FT:

Major players in the financial services industry are to partake in a trading game in property derivatives starting next month in a drive to accelerate the development of the market in the UK.

The initiative, which is being spearheaded by Hermes, the investment fund, is intended to give investors, property companies and investment banks the chance to gain practical experience in trading derivatives in a realistic environment – but on a virtual basis. The exercise is also aimed at gauging the level of potential demand.

Derivatives are financial instruments that effectively allow investors to bet on the direction of a particular market. A property derivative would give investors and companies exposure to the sector without having to own bricks and mortar. Buying derivatives is also often quicker and easier than physical property transactions.

Now that is interesting. I have believed for a very long time that with the massive amounts of wealth tied up in real estate and the normal concentration of risk by geography that a derivatives market was overdue in the sector. I am not familiar with the particulars of the contracts but it will be interesting to see how increased derivatives trading will impact the underlying market.

Bad Reaction

I wrote last week that I thought we were headed for a decision point and today looks like it. I am not doing a lot but am positioned for April's downtrend in equities to resume. My reaction to yesterday's economic releases is best captured in David Altig's quote from Reuters:

U.S. retail sales staged their sharpest drop in nearly a year in May while producer prices showed the biggest decline in nearly two, according to government data on Tuesday that may ease inflation fears but show consumers may be faltering.

I have been thinking a consumer slowdown or at least the fear of one was on the horizon so maybe I am just fitting the data to my view but it does not seem unreasonable. The CPI number this AM is also consitent with the idea that the worry going forward will be slack demand.

While commodities and their producers have managed a bounce the transports don't seem to be tagging along like they did last year. Norfolk Southern (NSC) and FedEx (FDX) stand out for their weak patterns. Last year the transports stormed higher through 9 months of market weakness and I repeatedly heard the reassurance that the sector was a leading indicator. I think this belief is rooted in Dow Theory and I am no expert there but I always try to note when once important "relationships" suddenly stop being discussed. That sector is giving the best support to the bear case in my view. Weakness in transports is also consistent with a continued weak production numbers.*

The bull case is still strongest in housing. Whether it is the all clear or just evidence of too many shorts remains to be seen. Also on the bull side was Walmart's (WMT) positive response to yesterday's data. Continued strong action in these sectors is pretty inconsistent with a thesis based on a weakening consumer.

*The airlines did not really play in last year's rally but the S&P downgrade of Northwest (and the insider sales) probably has some future relevance to the transport sector and possibly credit markets.

VXO and SPX Divergence

The VXO already took out its Feb low last week and looks like it will manage the same trick again today. The SPX still needs to take out 1229 to keep pace so the market's forward view of risk is leading the actual price action.

Between this and my estimate of where sentiment is at I am going to buy some puts for the Fall. I am looking at the 1140 and 1100 strikes because I like to have the gamma around inflection points.

I probably won't short anything in cash unless TOL slips back below 85. Looking at other things too for that judgement but the breakout in homebuilders in the face of a lot of bearish commentary sums up my defensiveness best.

A divergence the other way occurred on May 13th just for some perspective.

New Home Sales - Signs of Inventory Problems?

From Bloomberg:

Purchases rose 12.2 percent to a 1.431 million annual rate in March following a 1.275 million pace in February, the Commerce Department said today in Washington. Economists forecast a 1.19 million sales rate in March, according to the median estimate in a Bloomberg News survey.

....

Residential investment contributed 0.19 percentage point to the 3.8 percent rise in gross domestic product in the fourth quarter. While that was more than the prior three months, it was less than the 0.86 percentage point in the second quarter.

Sales rose in three of four regions. They increased 21.9 percent in the Midwest to 217,000 at an annual pace; 13.8 percent in the South to a record 733,000; and 9.9 percent in the West to 399,000. They fell 8.9 percent in the Northeast to 82,000.

The median price fell to $212,300 in March from $234,100 a month earlier. Compared with the same month last year, the median price is up 1.3 percent.

The number of new homes for sale fell to 433,000 from 437,000 in February. The median number of months those homes have been for sale fell to 3.6 months in March, the lowest since August 2003, from 4.3.

[emphasis added]

I saw that headline print and my first thought was about the high recent inventories and how the headline might not be that great if producers had blinked and lowered prices. The numbers give some support to that idea. Not a disaster but certainly something to watch when every headline is pointing out a record high.

I am getting pretty bearish on housing over the next 6 months. Like the rest of the market it probably pays to be patient after the recent weakness. I would not expect the housing stocks to reach for new hghs like new home sales did.

*update 12 PM - I have looked through the past median price data and am less convinced the price drop means anything. I have a natural contrarian reaction when I read the word "record" relating to monthly % changes though. The better interpretation is probably that if the U.S. consumer is hitting some sort of wall it has not showed up in housing data yet.

My Two Cents on the Currency Debate

This week's econoblog has breathed some new life into the currency debate. David Altig and Kash are exploring what actually constitutes a hard landing, while Brad Setser takes issue with Andrew Samwick's reliance on the calming effect of central bank actions.

As I said on Monday, I am not so sure that any hard landing scenario will necessarily be kicked off by dollar selling. Based on Kash's sevenfold path through a hard landing, maybe we are already at step 4. If we do see market weakness in stocks, real estate, or credit spreads (i'm adding that one), it should shake up monetary and fiscal policies. Once that happens we get to watch the policy decisions to see if market weakness will translate into real economic weakness.

I have some general beliefs about what might happen but guessing my way through the possible scenarios is a bit beyond me.

• There will be some sort of market event with the most likely candidates being housing and interest rates.
  
  
• This market event will ultimately require international cooperation (G7, G10). It may take a series of trials (maybe a series of crises) by various CBs and governments but eventually they will need to coordinate policy. The world will need to decide how to handle the issue of the weakening dollar as its main reserve currency.
  
  
• On a related note, foreign CBs will not turn net sellers of dollar assets. They will stop adding to USD reserves which still creates a substantial problem for U.S. interest rates. The markets will continue testing the CBs' appetite for dollars until we see real policy changes and a market determined equilibrium.
  
  
• Unemployment seems like the best indicator of how hard or soft the landing is in the real economy. Below the June '03 high of 6.3% seems like a good definition of a soft landing for the U.S.
  
  
• The U.S. current account deficit will get worked off through the growth of emerging market consumption rather than U.S. economic contraction. These emerging economies are the logical target for the world's investment dollars so once the market regains control of capital distribution they should see some benefits.
  

Signs of a Hard Landing?

I just finished reading econoblog at the WSJ featuring Nouriel Roubini and David Altig. It was a thorough debate on the USD / foreign borrowing dilemma but it did not really cover much new ground. Probably just seemed that way to me because they have both been talking about the topic for quite a while on their respective blogs.

Their discussion was whittled down at the end to whether a fall in the dollar due to a lack of foreign central bank demand would necessarily lead to a hard landing. I was left with a feeling of irony because right here the world seems to be tilting towards a hard landing (or at least the sudden fear of a hard landing) but it is not because of the dollar. Instead it stems from new found inflation fears, higher interest rates, and some credit issues at GM (maybe AIG, FNM, C...). If these trends continue the next big risk I see in the pipeline is clearly the housing market. The housing market has gained increased importance in this economic cycle because of the impact of refinancings on consumption. Interest rates may become range bound for a little while but even so it seems like the demand for housing is going to pull back and perhaps be overwhelmed by supply. Charts of the housing stocks show a lot of room before next support.

For the stock market, I tend to agree with Barry Ritholtz that we are seeing the sort of deterioration in internals associated with at least medium-term weakness. Check out the McClellan summation and notice how much weaker it appears than the market. I also like to watch the percentage of NYSE stocks above their 200 DMA which is currently hitting levels not seen since last May (59%). I am still long some post FOMC purchases but am shortening my original horizon of 2-3 weeks to be flat by the end of this week. A pullback tomorrow does seem likely but if stocks can stay above Thursday's lows maybe we can get a better rally into the end of the week. The rally may go longer but I want to position myself to be net short and not be trapped long if the rally fails abruptly.

Circling back to currencies the dollar is going to challenge its downtrend line very shortly with its 200 day MA sitting just above that. It might try to shake things up by getting through those levels for a short time (and maybe DXY 85.45 as well) but within the next 3 weeks I imagine it will again be headed lower. Commodities are taking a well deserved rest / pullback while some related commodity stocks look pretty ugly for the short term. Maybe a buying opportunity but like the dollar I would act over weeks rather than days.

Housing article

Minyanville brought this article on housing speculation to my attention today. There has obviously been a ton of stuff written about the housing market and by now I would guess everyone has chosen sides about whether we are in a bubble or not. I just wonder how many people that are buying houses really know how the market is managed by the building / development companies.

At any rate, the influence that the sellers have on price should make everyone question exactly what the risk is in the house. Most people equate price volatility with risk but to do so in this case could be pretty deceptive.

Morning Already?

I recommend reading Nouriel Roubini's article on the housing bubble. He addresses the arguments on both sides of the issue and ultimately views the presence or absence of a bubble as a matter of faith. My faith says it is not the best time to be buying houses.

He also has a good summary of how the world economy got us to where we are.

So, the missed chance by the Fed to tighten early on to prevent the stock market bubble (and its further Fed Funds easing in 1998) was an important factor in allowing the bubble go on and eventually burst. Then, the bursting in early 2000 - only partly driven by the 175bps reversal btw mid 1999 and mid 2000 - was the main factor behind the 2001 recession (dot.com and Nasdaq crash leading to a real investment crash after the real investment bubble that had been itself fed by easy liquidity for too long). And the attempt to avoid the real consequences of the dot.com (and of all stock markets) crash then triggered another massive Fed easing - from 6.5% to 1% - that created the great bubble of 2003-2004 with all risky assets - equities, emerging market debt, housing, high yield corporates, commodities and even long-treasuries - surging in value and becoming overvalued and feeding even further the US households' leverage build-up and savings contraction. So, as Ken Rogoff once put it, massive Fed easing (6.5% to 1%), massive and reckless fiscal easing (from 2.5% of GDP surplus to 4% deficit) and sharp dollar fall (15% trade weighted so far and still going) gave us the best recovery that money can buy; but it also gave us the most drugged and artificial recovery that money can but leaving the US imbalances worse than before: twin deficit, short-term financing of these deficits with increasing rollover risk, sloshing liquidity, housing and risky assets bubbles, low savings and high leverage in households and among highly-leveraged agents, carry-trades and chasing for yield.

This summary in my mind is what explains why the Fed seems worried about inflation while the bond market remains calm. The Fed is not seeing a current problem so much as seeing an abundance of liquidity being provided through the corporate bond market. Today's CPI number while reassuring bond investors (and maybe stock investors), will not really relieve the current worries at the Federal reserve.

None of this really matters today. For, today I think JPM picked the wrong day to miss earnings.

Something to watch

If I am right on interest rates and they don't resume this morning's fall then I would keep an eye on housing stocks. The lack of economic growth and higher interest rates is not really their cocktail of choice. The charts in that group will bear a striking similarity to the oil sector if they swan dive from here.