Sarkozy: Do we know what we’re doing? Merkel: Shut the fuck up…
About two days ago I had a friend ask me for some help for an interview he’s got coming up. The guy he’s been connecting with sent him one of his weekly write-ups about the current economic/market conditions and told him that’s the sort of thing he’d have to start knowing. Here’s basically what I talked to him about (this will be a long post, I’m trying to be in-depth so anyone can follow).
For starters, the sovereign debt crisis in Europe is the most important thing going on right now. I’ll get into how it affects the US in a minute. Greece is the most likely default case of anyone right now, as CDSs on greek debt have about a 450 bp spread (i.e., expensive as shit to buy those CDS’s, b/c there’s a very high probability of default). The ECB/IMF/EFSF (European Financial Stability Facility) are continuing to pump money into its bond markets, as well as Italian, Spanish, and Portuguese bonds. Whether they think Greece will ever be able to repay this debt is almost irrelevant (they won’t), so these cash flows are being used to keep rates from ballooning and to stop a full on default. Worst case scenario is Greece defaults, which triggers CDS payouts (not good for the US), margin calls, and significant flight from European sovereign debt. The last part of course could see defaults by more important countries such as Spain and Italy, but that is less likely (I refuse to say highly unlikely b/c as you can see this shit has never really been seen before). The main problem is European banks, who hold a huge amount of these sovereign bonds. If we see a restructuring of sorts, or huge drops in bond prices, these banks will have to make enormous writedowns. After this, further possible events include major drops in equity and bond prices of these banks as investors flee from fear the banks will have liquidity, or even solvency issues. This of course is a classic self-fulfilling prophecy: investors fear they’ll lose big from these banks, so they dump them, which of course causes the actual problem they feared in the first place.
The US comes into this directly in two ways. First, US banks have written a colossal amount of CDS’s for European banks over the past 3-4 years. As of early July, we’ve sold $34 bln, $54 bln, and $41 bln in Greek, Irish, and Portuguese debt CDS’s alone. That’s not even counting CDS’s on European banks. If there’s widespread default (again, unlikely, but possible), then the US will be losing BIG on those payouts. The second way is economic rather than financial. Europe is one of our main trading partners, and if they enter a recession (probably will), we’ll be taking a big hit in export losses and possibly face import shortages as production slows down there. This also ties into emerging markets (esp. China), as expectations are quickly rising that we’ll see a pretty hard landing in a year or two. In other words, nearly every country is facing stagnant (or negative) growth for a few years, which… is bad.
For those who’ve wanted to actually stay in a good mood, and therefore haven’t watched the news in awhile, the main political/economic topics right now are the US debt level, and our struggling economy. Before I get into this, let me make on thing clear: you cannot solve a debt crisis in a recession. Whether or not the media/politicians have been playing up the debt situation, I really have yet to see any issues arise from the ACTUAL debt level itself. Obviously the track we’re on is unsustainable and blah blah blah, but I’m talking over the course of a couple years. Our gov’t is having no trouble at all borrowing money; the 10YR Treasury is still sub-2%… from a buy&hold/investment standpoint that is absolutely outrageous. It just goes to show that when the world is freaking out, everyone looks to the US.
As much as I hate to say it, the real issue is the political system. I’m not saying we need to raise taxes or cut spending or whatever the buzzwords are right now, I mean the political process is absolutely KILLING our economy right now. It took over half a year for the debt limit to be raised, literally up to the last possible moment. The next day, BAM! Equities plummeted and Treasury yields approached record lows (and to my utter disbelief, reached those lows a few weeks later). This of course wasn’t expected, as the pundits had been chirping “yields will pop as the world realizes we can’t repay our debt!”. Bull. Fucking. Shit. This isn’t a series of graphs relating debt levels to interest rates or whatever, this is real life. What’s more, we have an entire year before election season, and you can bet your sweet ass no politician will be willing to make the tough decisions if it means pissing off their voters.
The debt ceiling squabble was one of the most atrocious displays of leadership I’ve ever seen, and I’m not exaggerating. The hard decisions weren’t even close to being made. If I remember correctly, we raised the debt ceiling by about $1.5 trillion and promised to cut about $2 trillion over the next 10 years. I don’t even have to do the math to see that $2 trillion over 10 years is a joke when we’re projecting a $1.5 trillion deficit in 2011 alone. If anything, all we did was push the decisions off for another few months. The debt level itself isn’t the immediate issue, it’s the perception that our leaders are unable to make the necessary decisions to get the US on the right path.
This perception is twofold. On one side we had non-stop political bashing occurring all summer long, with both sides bickering over what should be cut, what’s off the table, and who’s to blame for our national debt’s recent surge. On the other side, we have a country who is on the brink of relapsing into recession (sidenote: I don’t know why, but I think the term double-dip is so fucking stupid). Unemployment is STILL above 9%, and won’t return to normal levels for awhile. What’s more, I believe the drop we’re seeing in equities is due to people realizing the Fed has run out of bullets. Which is another way of saying that their policies aren’t doing what they said they would. Rant:
Let me get this straight. The Fed is making sure rates stay low, which is a good thing to have. But jesus christ have you not opened your eyes? I’m usually agree with the Fed/Bernanke, but what the fuck. Rates are at all time lows! And nobody is borrowing! Not only are rates at all time lows, but they’re there without your doing. People aren’t arbitraging Treasuries, they’re using them as a bank. If we have another international recession, Treasuries are gonna continue to be the safest asset. So what is the point of more bond buying? Does buying the 10YR down to 1.85 from 2 and the 30 from 3.1 to 2.9 really do anything? Rates are there. Save the ammo. God damn.
Alright back to the main point, bulls are currently pointing to corporate profits and equity levels as the main reason why we shouldn’t end up in a recession. I think that that is exactly why we’re entering a recession. Corporations are preparing for the worst by hoarding cash and laying people off. The majority of them will weather the storm to come, but people as a whole are left out to dry. If everyone is scared to lose their job, they’re gonna take whatever pay they get and hold onto it. Which, ya know… doesn’t help the economy grow. The uncertainty that’s clouding everything is all hanging on one major thing–Europe. People are waiting for Merkel/Sarkozy/anyone to come out and save the day. Obviously if they had the strategy to end all strategies for fixing the European debt crisis, we’d have heard about it already. As of today, Germany has said they’re capping their bailout funds at 221 billion euros, which gives the EFSF about 450 billion euros when recapitalization is needed (for both banks and the various countries who will undoubtedly need them).
I’m pretty lost right now, so I’m just gonna end this here. I’ll go back and go through each area more in depth throughout the next week(s), but this is a dece start. As you can see, everything is connected, even more so than 4 years ago. My prediction: we’re not gonna see an end to this until the EU is literally on the brink of collapse. That’ll be an interesting time… hopefully I have a job by then.
Dow is down 172 11,951 and S&P is down 18 to 1,270 on the day. I’m beginning to get the feeling that the markets are playing off the news too much. Not only that, but expectations for the year were just incredibly too high. Now, Obama’s analogy of “if you get hit by a truck… it’s gonna take a while to mend ya know?” may be extremely retared, but he’s not wrong on the original point. You don’t have the Dow literally lose like 50% over a year and a half and just expect 3% yearly growth right off the bat. To reiterate what many have pointed out, this was the worst recession we’ve had since the Great Depression. These high expectations are only hindering growth. Record corporate profits obviously imply they’re hoarding a lot of cash, but it’s not like they’re gonna keep it forever. That money will be reinvested. Unemployment will eventually decrease. Have some faith in the market.
Larry Fink was on CNBC today giving his insights. Dudes a baller, I usually believe almost everything he says. Plus he just doesn’t look like a scumbag. He’s bullish on equities. One of his main reasons is the fact that the bond market is extremely overstuffed. I just posted a day or two ago about how some people are hoppin’ on bonds because they’re just looking for any safe rate of return. Well, there’s almost no profit opportunity now. The private sector benefitting a lot with the weak dollar and are in a great position to grow. Honestly, there’s not much room for this economy to go south unless you consider a depression a possibility. Which it’s not, and a “double dip” won’t happen either. There’s far too much liquidity for another recession. The worst possibility I see is just very slow growth for another year or two from uneasy investment. But the markets, and the economy as well, will pick up.
As for my thoughts on the speculation of QE3, I’ve found myself getting consistently annoyed of those who say it has failed. Investment has increased over the past year. The unemployment rate has dropped over 1% since it started, and I’d venture to say that without QE it wouldn’t have dropped nearly that much (as in it would probably be the same). People are so quick to say QE has failed because the growth is so slow, but where’s the evidence that the economy would be in a better position without it? I don’t see it and I haven’t heard it. All these fuckin’ bears are just scaring everybody, that’s what I think. A little more optimism would help ease consumer confidence.
During the Fed Chairman’s press conference today, Bernanke got a tough question from dopeboy Dimon. He asked:
“Has anyone bothered to study the cumulative effect of these things, and do you have the fear, like I do, that when we look at it all, it will be the reason” why banks aren’t lending, he asked. “Is this holding us back at this point?”
He goes on to mention that exotic derivatives are few and far between now, boards and regulators are tougher, banks’ liquidity and capital levels are very high, and lending practices are far tighter than in the past. On top of that, the new proposed 3% surcharge for “big banks” out of the Basel III discussions has created even more uncertainty.
People have been fuckin’ loving Jamie Dimon over the past year or two. JPMorgan is arguably on top of the financial sector right now, especially with GS on the ropes. One of the issues with him asking this question all the way down in Atlanta is pretty obvious: why did he have to ask such a basic (but important) question in a public forum? Two possibilities. The first is he’s had this conversation with Bernanke before, but didn’t get the answer he wanted. Asking it in front of an international audience might force Bernanke to give a different, crowd-pleasing answer. The second, and more intriguing one is that he’s actually never been able to ask the question. In other words, he’s tried to get an answer out of the Fed (preferably Bernanke) and has never gotten one. If that’s the case, then that’s not good. Even though conspiracy theorists would consider it a sign of our impending enslavement to the Fed, the CEO of JPMorgan should be able to have a conversation with the Chairman of the Fed pretty easily.
Now I’d love to have a strong opinion on this, but there’s not much of a point to that. Banking regulations could be a reason for slow growth (strict lending reduces consumer spending), but businesses are borrowing at ridiculously low levels. Corporate capital accumulation and investment is very strong right now. The uncertainty in the banking sector could just as easily be a symptom of the slow recovery. Some of that chicken or the egg bullshit I guess.
The European debt crisis is finally beginning to be handled. The ECB has said that they will probably back Greek debt rollovers. After all of the talk of default it really makes you wonder. What is the point of pretending a country will be allowed to default? The US is on the brink of defaulting, but there’s no chance that happens. If the debt ceiling isn’t raised and we do default, shit is gonna hit the fan. Rates will skyrocket, and we can kiss a recovery good-bye. And for what? To teach us a lesson? Doesn’t make very much sense to me.
But, finally we’re seeing the euro bounce back up, hitting a 1-month high against the dollar. With the current state of US consumers (i.e., not spending), we gotta hope this climb continues if we want exports to pull us out of the hole. Rates have been higher in Europe for some time now, so what’s hopefully the end of the euro plummet will help. The slip in the euro was undoubtedly due to European debt crisis worries, but the continued asset purchases keeping US rates extremely low should help the euro’s rebound. We’ll find out today what Bernanke says about the future of QE2. It’d be nice if he could put sort of a range on the market and say something like “if the market falls we’ll be ready to add some liquidity”, which would hopefully keep shorts out without sparking a rally. Especially now with economic data that doesn’t support the movements of the market, people have been jumping onto rallies because there’s not much information to say they should do otherwise. Hence the bubble-worries over the past few months.
The recent success in the euro/dollar is now being seen in equities as the S&P 500 index bounced off a 2 1/2 month low. As of now, the index is trading at 12.2 times estimated profits… which is cheap as hell. Meanwhile, oil is dropping as expectations of OPEC announcing an increase in production quotas gain steam. This should help transportations, and in turn exports, who have faced a lot of problems from oil prices over the past few months. I just heard today that the 16 largest US airlines reported an on-time rate of 75.5%… weather has been a motherfucker lately.
I have to agree with what Obama just said in his press conference with Angela Merkel. Freaking out over one month of poor economic data is exactly what we’re trying to avoid. If focus continues to be on the short-term, there’s no chance we’ll keep volatility and speculation down. While neither is explicitly bad, too much is obviously bad for growth. Hopefully the increases we saw today will mark an upturn in markets. With poor housing markets, and now poor jobs data bogging down the recovery, the upswings in markets are a good sign for future growth.
Nobel Prize winning economist and MIT prof Peter Diamond just reported today that he’s withdrawing his name from consideration for the Fed Board. I just finished reading his op-ed in the NYTimes, which can basically be described as “fuck you guys I deserve this”. I mean the title of the op-ed is “When a Nobel Prize Isn’t Enough”… way to make it awkward douche bag.
For those who don’t know, he’s been nominated by Obama about 3 different times to fill 1 of 3 Fed Board vacancies. Each time, hardly any Republicans voted for him, the last one being a unanimous rejection by the GOP. This shouldn’t come as a surprise, as Diamond was one of the biggest supporters of the Fed’s monetary stimulus, QE1 and QE2. Naturally, Republicans want someone in there who will curb the government’s spending habits. So, not shocking at all, Diamond tries to defend himself and his bruised ego in the op-ed. This is where you start to think saying “fuck you guys I deserve this” would’ve prolly been the better move.
After a few paragraphs of mentioning how much he’s chroned up over the years (make no mistake, dude has balled real hard), he starts trying to counter the statements made by Senator Shelby, the main opponent of his appointment. The gist of the op-ed is that he thinks the higher-ups aren’t putting enough emphasis on the analysis of unemployment into their monetary policy ideas. He goes on to explain the technicals of unemployment and how to analyze which type (structural vs. cyclical) is the main “culprit” of our heinously shitty u-rate of 8.7%. He then states that his years of diligent research have allowed him to decide that structural unemployment is the problem… that’s about it.
I’m gonna guess a lot of people are lookin’ around thinkin “shit… might be a good thing he’s dippin’ out now”. If you’re not catching my driftingtons, this guy prolly wouldn’t have gotten jack shit done if he were on the board. He’s basically saying nobody is paying attention to the connection between monetary policy and unemployment. Look pal, we see you’re a smart guy and you obviously know what you’re talking about in regards to what the problem is and blah fuckin’ blah, but you ain’t the only one. Nothing’s gonna go the way you want if you hold up a bunch of charts saying “would ya just LOOK AT IT!?” while your other hand is up your ass. The right dude for the job is gonna be able to take those already well-understood ideas and push them through legislation. In other words, it’s gotta be someone who realizes the political process isn’t gonna change anytime soon, and knows how to work it too. It ain’t gonna be some dude who runs away crying holding up his trophies when nobody listens to him.