Tuesday, August 25, 2009
Wednesday, August 12, 2009
Thursday, August 6, 2009
Here we go again
Inflation AND Deflation
We might as well buy some marble and hire a good engraver. The Fed and central banks around the world have all but written the epitaph of the next great boom bust period in global history. It will be a liquidity driven “recovery” that pales in comparison to the boom bust cycles we have previously created. The problem this time around is that it’s likely too boom in all the wrong places while the continued bust occurs across the entire consumer spectrum….
The Federal Reserve compounded the problems that the Bank of Japan created when they too added their own bit of carry to the market via the form of easy monetary policy. Of course, the results have been spectacular (in both good and bad ways). The added liquidity has created some of the greatest bull markets imaginable (not to mention a few memorable bears). Unfortunately, the men wielding the power of this liquidity were unaware of its potency and even less capable of containing it. I fear Ben Bernanke has opened Pandora’s box (or Greenspan’s box) one too many times and though the results have surely been miraculous in the near-term it is unlikely that this liquidity glut will end any differently than the last few. The major difference between this boom and past booms is that central banks around the world are mishandling the power of liquidity (as opposed to one or two).
Deutsche Bank elaborates on the potential outcome:
Will global excess liquidity continue to rise in the wake of expanding central bank balance sheets? Or will global excess liquidity be cut back due to softer lending?
The very recent re-acceleration of narrow money (M1) growth was driven primarily by rapidly expanding central bank balance sheets. This is particularly true of the US. Noticeably, US commercial banks are currently reported to hold deposits at the Fed worth almost 6% of US GDP, a steep increase from an average of 0.3% of GDP over the past two decades. These sizeable excess reserves by US commercial banks with the Federal Reserve suggest that the Fed’s extra-liquidity injections have not (yet) been transformed into new credit and hence money. Rather it has mostly stayed within the US banking sector for now, pointing to frictions in the credit creation process.
Although the central banks’ extra-liquidity injections are at the moment urgently needed to support the banking sector, the credit channel and hence the overall economy, they involve the risk that credit and money could surge at a future point in time to undesired high levels once the economies and hence lending stabilise again. Therefore, central banks need to pull the extra money out of the system when the credit multiplier process normalises eventually and before it starts running hot. Should the CBs exit strategies succeed, then the current extra-liquidity injections might overall be beneficial for the economy because they would support credit at times of financial turmoil without boosting credit and money to unsustainable, excessively high levels over the medium to long term.
Although central banks should be able to withdraw large parts of their (temporary) extra-liquidity programs by simply not rolling them over, the central banks’ commitment as well as timing remains crucial for success. Moreover, some nonstandard central bank measures (such as the Fed’s outright purchases of US Treasuries, agency debt as well as mortgag ebacked securities or the ECB’s outright purchases of covered bonds) might be more difficult to reverse quickly. Although central banks have a wide range of possible instruments to re-absorb today’s extra-liquidity injections whenever this becomes necessary at a later point, only the future will tell whether they started to act in a timely fashion. Given that central banks will try hard to avoid any further setback in economic activity, monetary policies could again turn out to be too accommodative for too long.
There are a number of different outcomes that could occur here. Scenario 1 would involve hyperinflation as central banks around the world fail to rein in excess liquidity. In this scenario precious metals, raw materials and stocks would all explode to the upside. The dollar would crumble, your savings accounts would get obliterated and bonds would deteriorate substantially. Think every gold bug’s dream.
Scenario two is the inverse and would be a deflationary environment where the massive debts built up over the past 20 years continue to crush U.S. consumers, capacity utilization remains low and de-leveraging continues for years. Think Japan redux. The dollar and bonds soar while most other assets crumble. I don’t see either scenario specifically occurring.
What I fear will occur here is scenario three: inflation and deflation. More specifically, inflation in the assets we need (think gasoline, consumer goods) and continued deflation in the assets we own (think housing and stocks). Many investors are arguing over the inflation versus deflation debate without recognizing that both can occur in various asset classes. While the liquidity glut is likely to cause inflation in commodities, the continued de-leveraging in the consumer sector is likely to cause deflation in many other assets.
Further compounding the problems at the central bank is the emergence of a U.S. dollar carry trade. Strategists at various firms have been recommending a carry trade using the U.S. dollar. Investors will effectively short dollars, purchase higher yielding currencies and use the proceeds to speculate on various assets - most likely inverse dollar plays such commodities. This could compound the Fed’s issues as they fight to reflate the assets we own. In essence, we would get inflation in the assets we need while high unemployment, stagnant wages and low capacity utilization keep a lid on the assets we own.
As Anna Schwartz said, the Fed is fighting the “last war”. The Fed has vowed to print our way out of this mess while allowing mistakes to go unpunished. The long-term bulls are dancing in the streets in recent weeks despite stock prices that are still 30% off their highs, 10% unemployment and housing prices that are 30% off their highs. Don’t lose sight of the forest for the trees here. This isn’t a sprint we’re experiencing, it is likely to be a marathon. They say history has a way of repeating itself and this movie looks like one I’ve seen one too many times before….The best thing that might result from all of this is that Ben and company actually are fighting the “last war”. Rather, the “last war” we allow them to so foolishly start….
Monday, August 3, 2009
The Truth about Earnings
“Overall earnings still remain depressed even after a large amount of cost cutting which has increased unemployment to 9.5% and U6 unemployment to 16.5% none of which includes employees on furlow several days each month without pay.
The sales figures are misleading. Sales are down 15.6% in Q2 versus being down only 12% in Q1. For Q2 if you take energy companies out of the mix, then sales are down 10% versus prior year and if you also back out materials sales are down 8% versus PY). For Q1, without energy and materials sales were only down -6% versus PY.
That means that in Q2, excluding the effect of commodities, sales are down -8% versus PY, wheras in Q1 they were only down -6% in Q1. There is a seasonal effect on sales so in someways a same quarter prior year comparison in necessary. Ex energy and materials, there appears to be continued deterioration.
If we compare Q2 2009 to Q1 2009, aggregate sales are only up up 3% based on the companies reporting so far. If you take out energy, sales are up all of 1.5% and if back out materials, then sales are up all of 1.3%.
Overall considering seasonal factors and excluding the rising price of oil and other commodities, it looks like sales are down or maybe just flat versus Q1.
By sector, industrials were down -9% vs PY in Q1 and are down -15% vs PY in Q2. (Looks like quarter on quarter deterioration.) Consumer discretionary was down -17% in Q1 and is down -18% in Q2. (Slight deterioration). Consumer staples are down -2% in both quarters. Tech seems to have mildly improved, being down -13% in Q1 and -11% in Q2.
Notably utility sales were down -5% in Q1 and are down -12% in Q2. Significant reduction. (Also Q2 versus Q1 2009 is down -16%.) Not sure how much maybe commodity price pass-through. (Electric usage goes hand-in-hand with economic activity. It is used as a check on the GDP numbers coming from places like China wheras statistics are even more manipulated than in the US.)
I completely agree that the year-over-year comparisons are backward looking but they do provide prospective on the magnitude of the decline, as well as the magnitude of growth. The quarter on quarter changes provide a sanity check for how much progress is currently being made. As we saw in the GDP report the primarily thing holding up growth is government spending.
I did forsee the magnitude housing crisis and sold most all of my stock in mid to late 2007. I bought tentitively in March, but I clearly misjudged the extent to which the markets would rally without any sizable correction. (So far I avoided a large loss, but also largely missed a potentially big opportunity.)
My concern is that the markets have overshot the extent of economic progress which will be made this year. World trade has declined dramatically. Will it really spring back or are we now stabilized at a lower level. Large export economies (Japan, Germany) are springing back a bit but from a very depressed level. China’s rebound seems to be more government stimulus than export driven. Rail and port shipments remain at depressed levels and show few signs of rebounding (current July statistics).
What is an investor to do now? How much upside potential versus downside risk in the near-, mid- and long-term? To me it seems that the risks are substantial in both directions. Momentum could drive the S&P 500 up to 1,200 although expectations seem to be for the mid 1000s probably followed by a correction. On the other hand, unexpected deterioration in economic news could potentially trigger a sharp pullback which could feed on itself by investors wanting to lock in recent gains.
The markets seem to be quite manic-depressive. Three weeks ago all talk was of a re-test based on less than great economic news and technical levels, now all talk is of how high we can go based on better than expected earnings and technical levels. (Per Howard Silverblatt the overall the earnings were actually a bit below expectations and only 41% beat estimates, although I have only seen the statistic 70% beat reported.)
I think that effect of mass unemployment has not begun to hit yet and may be very under-appreciated. Certainly a big wave of foreclosed homes will be hitting the market in coming months after delays, modification attempts, large number of vacant homes being held off the market and new unemployment driven foreclosures. Is the potential for unexpected negative news priced into the market? How quick of a recovery is priced into the market at this point? Judging on the progress from Q1 to Q2 we are at stabilization but recovery is yet to be seen.
Might there also be a risk that instead of the expected inventory building upswing that is universally expected we may see a Q3 which is still flat overall. Inventory to sales levels STILL remain very elevated overall.
Q2 was very light on write-offs. Maybe we will see in increase later this year. Last year write-offs were low in both Q1 and Q2 (following large write-offs in Q4 2007, but then increased dramatically into Q3 and the kitchen sink quarter of Q4. (Did Q408 and Q109 really account for all losses that will be seen over the coming quarters?)”
Deleveraging is a Freight Train
http://pragcap.com/deleveraging-is-a-freight-train