The Treasury double short fund TBT has had a great run since New Year’s, when the long bond yielded just 2.5%, the lowest level since the WW2 era. I suspect that a lot of readers were with me on my bond short back then, as most bearish-minded folk had been chomping at the bit to short Treasuries (or had already been short while they ran up from summer 2008).
Now I think it’s time to think about buying this horribly overvalued security again simply because it is so universally hated.
The bounce has been faster and more comprehensive than I expected. I was thinking that we would top around these levels, but by summer or fall, not early May. I have continued to scale into distant-expiry SPY and QQQQ puts, favoring ITM and ATM, and have now deployed about 1/3 of the money I am willing to allocate to shorts. I also have a smidgen of shorter-term positions in certain ridiculously high-flying restaurant and other consumer stocks.
The bond sell-off and commodities rally indicate that inflation fears now have the upper hand, as most people still believe deflation will be a short-lived phenomenon. The aforementioned movements are setting up nicely for long and short replays, respectively.
Notwithstanding a long-overdue correction, I suspect that stocks have further to run, and am no longer such a skeptic of certain Elliott wavers’ target of S&P 1050. Bullishness is now at 80%, up from 2% in March, but judging from attitudes on TV, there is still a great deal of skepticism to be overcome before we can call a top. That said, the speed and evenness of the advance leads me to expect much more choppiness for the remainder.
Shorting precious metals has been frustrating, and I suspect that we are repeating the pattern of last spring, when we had to work our way through several months of chop after receding from manic levels (1030 gold that time, vs 1007 in February).
It is important to keep in mind the real situation, not just the current market mood (though you can’t trade on fundamentals alone). We can’t work off the greatest credit bubble in history in 18 months and just a 57% loss in the stock market. The real (private, productive) economy is not going to stop shedding jobs, let alone add them, for years, and people are so indebted that they cannot be enticed to reflate the asset bubble or return to previous levels of wasteful spending. It will take a generation to work through our debt and lifestyle delusions.
It bears repeating that today’s official headline unemployment number (8.9%) cannot be compared to numbers from before the 1990s, when the Clinton administration changed the reporting methodology to exclude large segments of unemployed. A more useful measure for historical comparisons is U-6 unemployment, which now stands at 15.8% for April. Today on Bloomberg I heard Christina Romer say that things were nothing like the Great Depression, as she compared apples to oranges. In reality, we are at solidly depressionary levels already.
Also bear in mind that stock valuations remain at bubble levels. This is easy to see when you remember that stocks have no intrinsic value other than marked to market book value and heavily discounted future earnings. The major indexes’ trailing PE’s on net earnings will be under 10 by the time this is over. We still need to work off the bubble that was blown in the 1990s, which didn’t finish deflating in 2003 because of the easing of credit. Every kind of credit is tightening now, unless of course you are a bank holding company.
Last fall, Dow Jones launched the Global Dow index, composed of 150 stocks from around the world. A quick glance at its 10-year chart shows that stock prices have only so far blown off the froth from 2006 and 2007:
Source: wsj.com
Stocks are driven by mood, and mood today seems to be highly coordinated around the globe, so rather than scrutinize the twists and turns in the Dow, DAX or Nikkei, perhaps this new index is the best reference.
What is most striking about this picture, as opposed to that of the S&P500, Eurostoxx 50, or Nikkei, is that stock prices are only 2/3 of the way back to the 2002 lows, as opposed to right upon them.
This says to me that even this first stage of the crash has further to run. Fundamentals are deteriorating with blazing speed, but market participants remain in secular bull market mode. Too many are still buying the dips, or at least ignoring their losses and hoping for a rebound. The stock market is still viewed by most Americans as the best way to save for retirement, and the myth persists that if only your time horizon is longer than a decade or so, stocks will always beat cash.
This wave off of the November lows is looking weaker and weaker. We had our chance for a strong bounce like the one after the crash of ’29 (the Dow was up about 45% from November ’29 to April ’30), and all we could muster was about 20%.
Today’s action is a pretty strong indication that panic has been lurking just below the surface. With the sell-off in bonds possibly having run its course, precious metals stalling out at resistance, and a very low put/call ratio indicating extreme trader optimism, the news of the Great Pork Package and latest bankers’ bailout may be just the catalyst we need for a sell-off. Hope is fading fast.
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Oh, and it is worth mentioning that John Mauldin reports that a contact at S&P told him that the latest quarter’s earnings are apparently coming in at a NEGATIVE $7 for the index. I have been saying all along, that if this is a depression (it is), PE’s should bottom out at well under 10 and even dividend yields should be in the double digits. Whatever figure you come up with as a final bottom target for the S&P, it should be a very low multiple of very low earnings.
As many readers know, I have been bearish on gold lately. I have been buying puts on GLD and GDX and bought more yesterday, though I do have a big chunk of assets in bullion (20x more than in puts). My bullion is not for sale, but I suspect that the reality of deflation and its likely duration has yet to fully sink in, and that we are due for a demoralizing event in the gold market.
Gold is not fully treated as money at the moment, though fiat currencies don’t satisfy all of the criteria for money either. Only precious metals can fully satisfy them, when governments allow.
So gold is not really money now, since its liquidity is limited, but it is a long-term store of value that outlasts currencies and governments. This is the key point: from the perspective of a large player who can afford warehouse costs, other metals or commodities can also serve as a store of value and hedge against fiscal calamity. Copper and cotton and rice will never go to zero either.
Almost all other commodities are down by huge percentages, though gold hangs on. It makes sense for gold to outperform the others, since it is more liquid and portable and people naturally prefer it during a crisis, but the premium seems way too high.
Once this panic phase of the depression is over, and a general funk and low-velocity environment settles in, with the dollar and other currencies having survived to the surprise of so many gold owners, the metal could be again seen as dead weight and fall as people still need plain old folding money to pay their bills, debts and taxes.
That is how I see things. Only time will tell if I am right.
This is deflation, a contraction of money and credit. Hardy anybody argues about that anymore. So what happens next? Will Obama and the bailout maniacs inflate a new bubble in green energy in their new, green deal? Maybe, but it would only be a limited bubble, not the worldwide craze in any and all non-dollar assets that we saw the last time around.
Don’t assume that any new bubbles at all will form for a long, long time. The mood has shifted from risk to hoarding. Now that people have been burned by everything from dot-coms to gold miners and are scared to death of losing their jobs, they are going to hang onto the one thing that still works: Washington Wallpaper, the little notes that promise, “I owe you nothing but more of these IOUs.
Deflation will rage, until it doesn’t. We are still early in this phase, since among the public there is still a healthy fear of the dollar and paper money in general. But over the next year, as commodities and foreign currencies slide still lower and consumer prices stay solidly and noticeably negative, people will forget about the deficit and the $100 trillion in debt at just the wrong time.
This is the rule of maximum pain for the maximum number. The dollar is not yet ready to fail because it is too feared and despised. But when people let their guard down and sell for $450 the Krugerrands that they are paying $900 for today, take all that they have, because then the real fun will begin.
Just as the public will get too complacent about holding I-owe-you-nothings (Doug Casey’s phrase), Congress and Obama will get too complacent about printing them up, and the whole debt-based money system will come crashing down. I don’t pretend to know how it will play out (hyperinflation or just plain-old, “sorry, we can’t pay” default), but it will be visibly ugly, and I am glad I’ll only be watching it on TV. This won’t be pretty anywhere, but the US is not a civilized country anymore, and it has a most uncivil government.
The essence of why bailouts will only deepen our problems is that real credit cannot be created out of thin air. This counterfeit operation is what caused the bubble to begin with, and by trying to put out a fire with gasoline, Bernanke, Congress and Obama are going to burn down the whole city.
Frank Shostak, the Chief Economist at M.F. Global, knows a thing or two about economics, which is not something you can say about many of today’s economists. The Mises Institute website publishes this essay of his on credit, which illustrates the critical identity between savings and investment, and the proper role of banks in an honest system.
Central-bank policy makers have said that the key for economic growth is a smooth flow of credit. For them (in particular, for Bernanke) it is credit that provides the foundation for economic growth and raises individuals’ living standards. From this perspective, it makes a lot of sense for the central bank to make sure that credit flows again.
Following the teachings of Friedman and Keynes, it is an almost-unanimous view among experts that if lenders are unwilling to lend, then it is the duty of the government and the central bank to keep the flow of lending going. …
It is true that credit is the key for economic growth. However, one must make a distinction between good credit and bad credit. It is good credit that makes real economic growth possible and thus improves people’s lives and well-being. False credit, however, is an agent of economic destruction and leads to economic impoverishment.
Good Credit versus Bad Credit
There are two kinds of credit: that which would be offered in a market economy with sound money and banking (good credit); and that which is made possible only through a system of central banking, artificially low interest rates, and fractional reserves (bad credit).
Banks cannot expand good credit as such. All that they can do in reality is to facilitate the transfer of a given pool of savings from savers (lenders) to borrowers. To understand why, we must first understand how good credit comes to be and the function it serves.
Consider the case of a baker who bakes ten loaves of bread. Out of his stock of real wealth (ten loaves of bread), the baker consumes two loaves and saves eight. He lends his eight remaining loaves to the shoemaker in return for a pair of shoes in one week’s time. Note that credit here is the transfer of “real stuff,” i.e., eight saved loaves of bread from the baker to the shoemaker in exchange for a future pair of shoes.
Also, observe that the amount of real savings determines the amount of available credit. If the baker had saved only four loaves of bread, the amount of credit would have only been four loaves instead of eight.
Note that the saved loaves of bread provide support to the shoemaker, i.e., they sustain him while he is busy making shoes. This means that credit, by sustaining the shoemaker, gives rise to the production of shoes and therefore to the formation of more real wealth. This is a path to real economic growth.
Money and Credit
The introduction of money does not alter the essence of what credit is. Instead of lending his eight loaves of bread to the shoemaker, the baker can now exchange his saved eight loaves of bread for eight dollars and then lend those dollars to the shoemaker. With eight dollars, the shoemaker can secure either eight loaves of bread (or other goods) to support him while he is engaged in the making of shoes. The baker is supplying the shoemaker with the facility to access the pool of real savings, which among other things includes eight loaves of bread that the baker has produced. Note that without real savings, the lending of money is an exercise in futility. …
The existence of banks does not alter the essence of credit. Instead of the baker lending his money directly to the shoemaker, the baker lends his money to the bank, which in turn lends it to the shoemaker. …
Despite the apparent complexity that the banking system introduces, the act of credit remains the transfer of saved real stuff from lender to borrower. Without the increase in the pool of real savings, banks cannot create more credit. At the heart of the expansion of good credit by the banking system is an expansion of real savings.
Now, when the baker lends his eight dollars, we must remember that he has exchanged for these dollars eight saved loaves of bread. In other words, he has exchanged something for eight dollars. So when a bank lends those eight dollars to the shoemaker, the bank lends fully “backed-up” dollars so to speak.
False Credit Is an Agent of Economic Destruction
Trouble emerges however if, instead of lending fully backed-up money, a bank engages in fractional-reserve banking, the issuing of empty money, backed up by nothing.
When unbacked money is created, it masquerades as genuine money that is supposedly supported by real stuff. In reality, however, nothing has been saved. So when such money is issued, it cannot help the shoemaker, since the pieces of empty paper cannot support him in producing shoes — what he needs instead is bread. But, since the printed money masquerades as proper money, it can be used to “steal” bread from some other activities and thereby weaken those activities.
This is what the diversion of real wealth by means of money “out of thin air” is all about. If the extra eight loaves of bread aren’t produced and saved, it is not possible to have more shoes without hurting some other activities — activities that are much higher on the priority lists of consumers as far as life and well-being are concerned. This in turn also means that unbacked credit cannot be an agent of economic growth.
Rather than facilitating the transfer of savings across the economy to wealth-generating activities, when banks issue unbacked credit they are in fact setting in motion a weakening of the process of wealth formation. It has to be realized that banks cannot relentlessly pursue unbacked lending without the existence of the central bank, which, by means of monetary pumping, makes sure that the expansion of unbacked credit doesn’t cause banks to bankrupt each other.
We can thus conclude that, as long as the increase in lending is fully backed up by real savings, it must be regarded as good news, since it promotes the formation of real wealth. False credit, which is generated “out of thin air,” is bad news: credit which is unbacked by real savings is an agent of economic destruction.
Fed and Treasury Actions Only Make Things Worse
Neither the Fed nor the Treasury is a wealth generator: they cannot generate real savings. This in turn means that all the pumping that the Fed has been doing recently cannot increase lending unless the pool of real savings is expanding. On the contrary, the more money the Fed and other central banks are pushing, the more they are diluting the pool of real savings. …
If the pool of real savings is still growing, then doing nothing (and allowing the interest rate to reflect reality) will allow the recession to be short lived and economic recovery to emerge as fast as possible. (At a higher interest rate, various bubble activities will go belly up. As a result, more real savings will become available to wealth generators. This in turn will work towards the lowering of interest rates.)
We suggest that decades of reckless monetary policies by the Fed have severely depleted the pool of real savings. More of these same loose policies cannot make the current situation better. On the contrary, such policies only further delay the economic recovery.
By impoverishing wealth generators, the current policies of the government and the Fed run the risk of converting a short recession into a prolonged and severe slump.
If Princeton and the rest weren’t run by fools and knaves, this is the kind of thing they would be teaching, not Bernanke’s brand of institutionalized theft.
I recommend reading Shostak’s whole essay. Click around the Mises site while you’re there. It is a wonderful resource for real economics, the kind that can make you money. The Rothhbard and Mises files would be good places to start.
The market has been severely hamstrung for decades, and now that it is fainting from loss of blood, its vampire captors point to it and say, “see, markets need to be restrained or else they fail.”
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I won’t actually comment on Krugman, other than to say that he is a socialist, and like many of his breed who do not actually implement collectivist scams (as opposed to Raines, Paulson, Mozillo, Congress, et al.) but provide intellectual support for them, he seems to have a soul, albeit a lost one.
Anyone who understands the principles of the market and defends them in public these days must feel the way I do: that we are simply narrating the decline. You can’t argue with history. You can just put it down as you see it, now in the hope of carrying a few embers of common sense through or out of the West as it enters some kind of dark age.
It is astounding that after recently observing Hitler, Stalin, Mussolini, Mao, Peron, Castro, Chavez and a hundred other tin-pot dictators destroy or hobble their nations through various forms of collectivism, the entire West is now leaping headlong in that same direction, with hardly a second thought. No credit is given to the principles of individualism, private property and freedom of contract, nor the great market economy that created the prosperity these societies are so eager to squander. The market has been hamstrung for years, and now that it is fainting from loss of blood, its vampire captors point to it and say, “see, markets need to be restrained or else they fail.”
This episode will play out over generations, and it will end with tens of millions dead and the end of the very civilization that codified respect for the individual.
The end of the Enlightenment means the end of freedom and the end of freedom means the end of centuries of increasing living standards, from food and health care, to travel and communication, to privacy and personal security.
The West is simply finished. It’s best hope is balkanization, in case any regional pockets of common sense remain, though I can’t think of any that are physically and culturally strong enough to withstand the violence to come. Perhaps Switzerland, for a while.
I’m sick of hearing the phase “America’s crumbling infrastructure” from the press and politicians. They have been pushing this theme for at least 18 months now. Observers should look for the motive behind all such recurring news themes, because nothing gets on the air on into print without one.
In this case, we are clearly being prepped for New Deal #2, involving at least the following programs:
From Bloomberg, here are the latest brilliant ideas from the Senate:
Sept. 25 (Bloomberg) — Senate Democrats proposed a $56 billion economic stimulus package that would increase government spending on unemployment benefits, food stamps, infrastructure projects, aid to state governments and heating aid to the poor.
Senate Majority leader Harry Reid, a Nevada Democrat, said today that the legislation is needed to help millions of Americans struggling with the slow economy.
“We must not forget Main Street as we work to address the crisis on Wall Street,” he said, adding that the plan would “create hundreds of thousands of good-paying American jobs and prevent cuts in critical services for millions of Americans.”…
The Senate plan would extend unemployment benefits by as many as 13 weeks, expand food stamp aid and provide states coping with high Medicaid costs with an additional $20 billion in federal assistance.
Highway Projects
The plan would also spend $11 billion on highway and other transportation projects, $5.1 billion for heating assistance to the poor, $1.2 billion for the National Institutes of Health and $250 million for NASA.
Will Keynesianism never die?
Politicians and bankers love this repressive and discredited doctrine because it justifies all manner of scams. Today’s professors won’t admit it, but they haven’t changed a bit since falling hook, line and sinker for Orwellian nonsense that intentionally punishes savings and private investment, maintains a dumb consumer class, and allocates full freedom and power only to a ruling class of “philosopher kings”. They tinker around the edges of this egomaniac’s* theory, but they assure us that without the State pulling the levers (following their guidance of course), the economy will crumble down to the stone age.
The last thing America needs in a Depression is more government involvement in the economy, especially not government jobs for government-designed projects. This just steals from the sensible and allocates to the connected, while wasting the capital on unneeded projects with negative returns.
Relax, go for a drive.
The highway and other infrastructure in the US is among the best in the world, especially the road system. I have driven in a lot of places, and nothing beats four lanes each way with stadium lighting, fast and even drainage, huge reflective and logical signage, and perfectly cambered cloverleafs. It is just a joy to drive when you come back after being away. And by the way, American motorists, even New Yorkers, are very safe and considerate by world standards. The are not the Swiss, but we can’t all be.
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* Here is a character study (PDF) of the most-revered economist of the 20th century by one of the smartest and most honest economists of the same, Murray Rothbard, who’s writing happens to be a joy to read. How many Keynesian professors can you say that about?
There is lots more on Keynesian economics here, from America’s real libertarian think tank, the Mises Institute (not The Stato Foundation).
Bottom line: Paulson brings a bazooka to an H-bomb fight.
Bond update first:
As usual of late, today’s action in Treasuries was the exact opposite of the stock market: a massive sell-off. High bond prices reflect fear, which hit a new high earlier this week. Today’s action was not just a short-squeeze. It was collective relief, a pause for our nerves. We will need them for what is yet to come. Here are the bonds (Bloomberg):
Click image for sharper view.
Does he even know how that thing works?
Like all of the bailouts, the planned socialization of (admittedly bad) mortgage debt puts another chain around Lady Liberty’s neck for the short-term of benefit of a few bankers. But hey, what’s another trillion or so when taxpayers are already on the hook for $100 trillion?
Here’s Paulson on the program’s ostensible goals:
The federal government must implement a program to remove these illiquid assets that are weighing down our financial institutions and threatening our economy. This troubled asset relief program must be properly designed and sufficiently large to have maximum impact, while including features that protect the taxpayer to the maximum extent possible. The ultimate taxpayer protection will be the stability this troubled asset relief program provides to our financial system, even as it will involve a significant investment of taxpayer dollars. I am convinced that this bold approach will cost American families far less than the alternative – a continuing series of financial institution failures and frozen credit markets unable to fund economic expansion.
*Opposite rule of government action
According the rule of opposites (the most reliable indicator for predicting the outcome of government actions), we now know that the program will threaten the economy, not protect the taxpayer, cost far more than the alternative, and impede economic expansion.
The Sum of All Debts
And yes, these kinds of programs are highly inflationary, but they still pale in comparison to the size of the debt and equity that is imploding. The Fed’s balance sheet is 900 billion and growing, the deficit next year will certainly be over $1 trillion, and GDP, which used to ostensibly be $13.8 trillion, is shrinking fast. These figures put upward bounds on the payload of government’s bazooka.
To put this in perspective, Paulson’s gang is squaring up against the following:
The amounts by which the latter figures are contracting exceeds the government’s reflation efforts by some multiple. Deflation will continue — accelerating in the near term — and not abate until so much wealth has gone to money heaven that government’s expenditures finally surpass its rate of implosion. Despite the bailouts, and what will surely be a new New Deal and probably an expanded war in Asia, that point of equilibrium will arrive years from now. In the meantime, cash is king once more.
Risk hangover
One more point on the banks: they may be relieved of their bad debt and provided with fresh reserves, but the inflation machine will remain impaired because individuals and corporations have just learned a very hard lesson about debt and will be averse to borrowing for many, many years to come. Borrowing like we have seen in recent decades requires an appetite for risk, but the stuff now makes people nauseous.
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*Rule of opposites as applied to government action: Every action that government takes results in the opposite of its stated intention. (credit to Mish for identifying this law of nature)
The list goes on ad infinitum.
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PPS — For a full rundown of why these bailouts won’t stop deflation, read chapter 13 of Robert Prechter’s Conquer the Crash. He predicted this exact scenario years ago.
Hedge fund managers said to pack dirt under fingernails, roughen hands on bricks to avoid suspicion and possible shipment to North Dakota re-education camps.
These days it seems like we are living in an Onion article (1 , 2). It would be funny if it were not the end of the world as we know it.
I’ve been a bear since spring of 2006, preparing for a depression since early 2007, and have had no illusions about the death of the idea that was America. I saw these events coming a mile away, but the speed with which they have arrived is shocking.
By edict of the Duma…
I figured that the shorting ban (WSJ article) would pop up somewhere near the midpoint of the bear market, maybe Dow 8000, but this train to Animal Farm is an express. When will they ban international money transfers? Unapproved foreign travel? Gold?
The speed with which our leaders are dropping any pretense of respect for markets just makes me that much more bearish. 8000 could be next month, not next year as I had figured. And I have to rethink my bottom target of 3500. Really, that would not be the end of the world — this market started at 800 back in 1982, and you have to remember that equity values go POOF after an economy gets as leveraged as ours is. 75% stock market drops are not black swans. They follow credit bubbles like day follows night.
Markets are so bourgeois, anyway.
The possibility of Dow zero just ticked up a standard deviation or two. What happened to the Moscow stock exchange after 1917 anyway?
The end of the stock market? Impossible, right? Well, if our Bolsheviks enact their desires to use government funds to buy all manner of securities (as the Russians are now doing), they could eventually own everything, not just the mortgage market and a huge insurer.
Buyout mania, with a twist.
If a security’s market price is $10 and the government offers $20, that is not ‘market support’, that is a buyout. Of course, there are limits to this sort of nationalization, namely the difference in scale between the Fed’s $900 billion balance sheet and the many tens of trillions of dollars in US private equity and debt instruments, so at first they will be very selective (ahem), but they do have two tools to help them work around those limits: printing presses and guns. In a few short years, when the former lose their potency, the latter can be brought to the fore.
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PS — Of course, my opinion is that this rally (futures are up 2% on top of today’s dramatic close) is just a short squeeze and dead cat bounce. The air pocket under stocks just got a whole lot bigger. 90-day T-bills last traded at 0.07%. The stall warning light is still on.
