Friday, January 23, 2015

Peter Schiff On China's Peg To The U.S. Dollar

On the economics of the Swiss removing their peg from the Euro:

"In the future the Swiss surrender may be looked at as the first significant counter-attack against our current global system of monetary insanity. The mistake was not ending this peg, but in adopting it in the first place. The Swiss once again have a strong currency with expanded purchasing power. Yes, Swiss exporters may lose market share to international rivals. But the amount of Swiss francs they will actually earn from each unit sold will likely increase. So the Swiss may be able to export less and still earn the same money. In addition, the cost of imports will fall, allowing the Swiss to buy more with less. 

Contrary to the common current belief, the goal of an economy is not to manufacture more products for others to buy, but to be able to buy more products yourself. In that respect, exports are merely the means to achieving that end. The less you need to export to pay for your imports the better. In other words, the goal of an economy is to consume, not to work. If we could consume without working we would happily do so. Working without consuming, not so much. In the past, the Swiss prospered with one of the world's strongest currencies. It will do so again."

On the economics of China removing their peg from the U.S. dollar:

Wednesday, January 21, 2015

Jim Rickards On The Perfect Storm

Jim Rickards reviews the potential losses in the junk bond market around the world due to the oil price decline and the dollar's impact on emerging market debt. The following is a quick summary; the full article can be read at The Daily Reckoning in A Perfect Storm.

Over the coming months, I believe we could see an economic meltdown at least six times the size of the 2007 subprime mortgage meltdown.

In the national defense community, military commanders are known for fighting the last war. They study their prior failures in preparation for the next conflict. The problem is that each war inevitably involves new tactics for which they’re completely unprepared. The same mistake is made in financial circles. Financial regulators are no different than military commanders. They fight the last war. The last two global meltdowns, in 1998 and 2008, are cases in point.

The next financial collapse, already on our radar screen, will not come from hedge funds or home mortgages. It will come from junk bonds, especially energy-related and emerging-market corporate debt.
The Financial Times recently estimated that the total amount of energy-related corporate debt issued from 2009-2014 for exploration and development is over $5 trillion. Meanwhile, the Bank for International Settlements recently estimated that the total amount of emerging-market dollar-denominated corporate debt is over $9 trillion.
If default rates are only 10% — a conservative assumption — this corporate debt fiasco will be six times larger than the subprime losses in 2007. The world is looking at a debt catastrophe much larger than LTCM in 1998 and the mortgage market in 2008. Regulators are completely unprepared for this because they have been busy fighting the last war.

Free College

With rates on U.S. treasuries hitting record lows politicians have learned an important economic lesson over the past 8 years; more supply equals higher prices (bond values rise when rates fall). Or maybe that only occurs at the peak of an irrational asset bubble, but that's a much larger conversation for another morning.

The U.S. tax payer currently writes a check for any amount requested to attend college. Now that the tax payer's student loan balance sheet of over $1 trillion is beginning to experience massive defaults and losses the President has come up with an easier solution; free college.

Free health care, free wars, free social security and now free college. I can only imagine what they'll add to the list before the government bond bubble implodes.


ECB Decision Week

Tomorrow the European Central Bank (ECB) will announce their widely anticipated QE plans for 2015 and beyond. Although we're early in, this announcement may be the most important financial event of the year. I'll have much more to say about the program after we get the details, but here is an excellent walk through of why it may be too little, too late, for the Eurozone:

 

Monday, January 19, 2015

Feeling Frothy? CMBS Issuance Making A Comeback

It's hard to believe we're already back to 2004 levels as the chart below shows. CMBS are loans for commercial buildings (office, retail, industrial) that are bundled together and sold to investors. Fannie & Freddie (U.S. government/taxpayer) provide loans for apartments which allowed that market to surge back much faster in terms of volume issuance (many cities are already back above their 2007 bubble peak in apartment prices). Without the government/taxpayer guarantee on commercial mortgages, investors have been tip toeing more slowing back into the water. If the current risk-on yield driven mania lasts another two years we could see this number approach the insanity of 2005 - 2007 before it all comes crashing down again.


Sunday, January 18, 2015

Should You Buy Assets That Have Recently Performed Well?

Ben Carlson recently updated the asset allocation on his site, which shows the biggest winners and losers every year by asset class going back to 2005. The quilt is color coded which helps you identify a very important lesson within the pattern; the asset class or classes that lead the pack for a series of years tend to lag in subsequent years (and vice versa). Click for larger image:



There are a ton of examples we could use over the last 9 years, but look at emerging markets (green) and cash (dark blue) from 2005 to 2007. Emerging markets were the darling sector as we entered the new millennium (along with REITs and commodities). Most don't remember, but U.S. stocks lagged considerably during this period. People I worked with at the time talked about how they had 100% of their 401k in foreign funds because they crushed the U.S. markets every year. 

As a side note; U.S. stocks significantly outperformed the rest of the world in the 1990's (another example slightly further back in history of an asset class leading the pack and then trailing in subsequent years). 

Cash and bonds were considered trash during the 2005 to 2007 run because so many people were crushing it in real estate and foreign stocks. Then in 2008 cash and bonds had an incredible year with 2% and 5% returns respectively. Why? Everything else was completely destroyed making a 2% return look spectacular that year.

Over the past three years we have experienced an echo of what occurred in the late 1990's. The United States has become the darling market of the world as everything else has lagged or declined. U.S. stocks, bonds, real estate and even the U.S. dollar are soaring in unison. Money is flooding into American assets from around the world (and within the U.S.). 

Commodities have been steadily declining since mid 2011 and over the past 6 months it has turned into a complete rout. Cash has once again become trash and completely forgotten. Foreign currencies have experienced massive declines against the U.S. dollar and global stocks (other than China) peaked in July of 2014 and have been quietly declining for 6 months. 

Unlike 2012 to mid 2014 when it felt like everything was rising, markets are beginning to fragment. The only assets still soaring are U.S. everything, Chinese stocks and foreign government bonds (yields are hitting record lows around the world). 

The world markets are pricing in a deflationary recession (see commodities falling due to demand pressure and government bonds rising as investors rush to deflationary safety). The markets forgot to tell this to U.S. stocks which have broken away from the rest of the world like a runaway supernova. US stocks are now more expensive relative to foreign stocks than they were at the peak in 2000:


World stocks tracked alongside the U.S. markets during the 2008 decline and the subsequent rise until early 2012 when the U.S. broke away from the pack. 


The divergence became more clear in 2014 as global markets topped and began to fall while the U.S. continued to soar higher. 


The same divergence occurred with commodities but it has been even more drastic (see the massive separation in performance from mid 2011 to present day below):


Here is the divergence zoomed in over the past 5 years:


Here is the consensus view from financial analysts and economists entering 2015:

The United States will carry the world out of the deflationary recession it is falling into and U.S. stocks will lead world markets upward. The U.S. dollar rises alongside real estate and bond yields. 

The two most likely scenarios I see in 2015 - 2016 are:

1. World economies barely avoid a global recession in 2015 due to a larger than expected QE program from the ECB and a more dovish Federal Reserve, which keep the speculative risk on juices flowing for one more year. The markets that have lagged (commodities and international assets) catch up to U.S. assets (similar to 2003 - 2007) for a final blow off top. 

2. The United States follows the world downward into a global deflationary recession and U.S. stocks catch down to all other asset classes that have already or are beginning to price this in. Risk off. Cash is king. (similar to 2008). 

I believe the second scenario is more likely, but is important to see is that either way U.S. stocks will be a relative under performer. Perhaps it is time for a new color to move toward the top of the quilt in 2015 and 2016. Time will tell which new hero emerges. 



 h/t ZeroHedge, Bloomberg

Friday, January 16, 2015

Removing The Birth/Death Model From U.S. Employment Data

Couple of great charts this week from STA Wealth Management on the infamous birth/death model used as part of U.S. employment data.

The first is the business openings vs. startups in the United States going back to 1977. As the chart describes, 2008 was the point when births dropped below deaths and it has remained that way since.


400,000 businesses are being born annually while 470,000 are dying. This goes counter to what the government has reported in the birth/death model where they essentially guess at how many jobs are being created due to new businesses being born.

In the chart below you can see the government's employment growth (blue bars) against what the series would look like if the birth/death model was removed (black line).



This is part of the troubling situation the Federal Reserve finds itself in. The "recovery" has been in asset prices not the real economy, and the unemployment rate sits at 5.8%. This is due in large part to the birth/death model described above, Americans taking lower paying jobs and/or reduced hours, and people dropping out of the labor force.

Additionally, the Fed must weigh the impact of the oil price collapse on U.S. employment moving forward. That sector has been the lone bright spot in the American economy since 2007, not only due to job creation but higher paying job creation.

For more see: Why Are Young Americans Not Starting Companies?


Thursday, January 15, 2015

Jim Grant On The Swiss Shocker

Jim Grant echoes my thoughts from this morning:

"It is a day to take the measure of our infatuation with central banking."

He goes on to discuss how this move will impact soaring real estate prices in Switzerland and the global bond bubble driven by central banks around the world. Incredibly, Grant actually explained why the Swiss would make this move in his September 2014 Interest Rate Observer.

Thrills, Not The Money

A Swiss citizen sitting down with his broker this morning after finding out his stock portfolio lost 15% overnight.


See: Historic Overnight Move In The Currency Markets

Historic Overnight Move In The Currency Markets

In September 2011, Switzerland's central bank announced they would defend their currency against the euro at $1.20. Money was flooding into Switzerland from Europe as many people felt banks would close or governments would default on debts (Greece, Italy, Spain). As money entered the country, euros were sold in exchange for Swiss francs, which caused the franc to rise violently against the euro.

As we have seen throughout the currency wars over the past four years when your currency rises rapidly it causes problems for corporations within your country. Your exports are less competitive and business operations taking place outside your country experience lower profits or even losses.

The floor at $1.20 meant whenever the value of the Swiss franc reached $1.20 against the euro, the Swiss central bank would enter the market and purchase euros (selling francs). This caused their balance sheet to mushroom in size as they have had to defend the peg continuously since the announcement in late 2011.


Knowing the Swiss central bank stood ready to defend the currency at 1.20 allowed currency traders to put on massive (leveraged) stops on the Swiss/Euro currency pair at 1.20.

Then this morning happened....

Overnight, completely out of the blue while most of the world was sleeping, the Swiss central bank decided to remove the peg. Computer algorithms triggered massive buying orders on the news. This then instantly triggered the stops at the 1.20 line.  The Swiss franc strengthened from 1.20 against the euro down to 0.75 in a matter of seconds. There is no historical comparison to this type of movement in the developed currency markets. The Swiss franc has fallen back to 1.03 as I write this, but who knows where we go from here. Switzerland's stock market crashed 12% in 10 minutes, the largest decline since the 1987 worldwide crash.

What non-professional currency traders should learn from this action is the all consuming trust in central banks to control every market around the world should be questioned. This is more relevant for investors in developed countries who have been implicitly promised central banks will always push their stock portfolios higher. They have been implicitly promised interest rates will always remain low, currency markets will always remain calm and inflation will stay subdued.

As we have seen overnight, even the explicit promises can be removed in the blink of an eye.