The world?s major central banks launched a coordinated attempt to restore liquidity to the financial markets today, sending risk assets everywhere flying. The group moved to substantially lower interbank dollar swap rates, from 100 to 50 basis points. These swaps involve Federal Reserve dollar deposits with the European Central Bank and offsetting ECB Euro deposits with the Fed.
This eases liquidity concerns inside the European money markets. The action included the Federal Reserve, the ECB, the Swiss National Bank, the Bank of Japan, and the Bank of Canada. Clearly, the Europeans do not have a 2008 style systemic collapse on the menu.
The initiative made sure the bear trap that sprung on Monday bit even deeper into short sellers, as it was intended to do. The Dow (INDU) opened up 300, the (FXE) 1.54%, oil $1.50, silver 1.53%,? Australian dollar (FXA) a stunning 2.5 cents, and copper (CU) 12 cents. Bellwether Caterpillar (CAT) popped 5.3%, while my favorite, Freeport McMoRan leapt by 6.3%. The action assures that my call for a Christmas rally in global risk assets plays out, although earlier than I expected.
You really have to wonder what disaster was imminent to force the central bankers? hands. Many suspect that a major European bank was on the verge of going under, possibly a French one. So far, the major casualties have been American institutions, notably MF Global (MF) and Jeffries (JEF). It will take a few months for the truth to leak out.
The coordinated action puts my short term 1,266 target for the S&P 500 within easy reach. The big moves we were seeing in oil and the Australian dollar gave us plenty of warning that Santa Claus might show up early this year, but it is nice to get confirmation.
As for the Euro, the positive benefits are likely to be ephemeral, as the European bazooka is just a short term patch and does nothing to address the continent?s horrific systemic problems. I am therefore happy to keep running my outstanding euro short position.
Looks Live He Arrived Early This Year
For the first time in three years, China (FXI) has cut its prime lending rate by 50 basis points. The timing caught many analysts by surprise, as such move was not expected until the lunar new year in early February. Perhaps recent data showing collapsing exports prompted the Mandarins in Beijing to hurriedly move up the timetable.
The Middle Kingdom?s action is one of the most important developments in financial markets this year, since it represents a major sea change, and is hugely positive for the global economy. It could signal a coming year of additional incremental interest rate cuts and bank reserve reductions designed to keep the country above the ?red line? GDP growth rate of 8%. Observers were also stunned by the magnitude of the cut, 50 basis points, compared to the usual 25 basis point move seen by the People?s Bank of China.
I have been comfortably out of Chinese equities for more than a year, vowing not to return to the mainland until interest rates fell. Now the worm has turned. It may be time to take another look at companies like Build Your Dreams (BYDDF), which has risen by 50% since my undercover visit there last month. Other names like China Telecom, China Mobile, and Baidu (BIDU), are also starting to look interesting.
We Want Lower Interest Rates!
Mark Fisher of MBF Asset Management and Dennis Gartman of the eponymous Gartman Letter joined forces today to launch a new exchange traded note, or ETN, that promises to capture the ?RISK ON? trade. The instrument is designed as an improvement over the old Volatility Index ETF where traders attempted to capture short term market swings.
The note has the following makeup:
longs
48% energy
46% equities
30% foreign currencies
18% agricultural commodities
10% metals
shorts
36% sovereign bonds
14% foreign currencies
While the first day trading volume was large and the timing propitious, with the Dow up 300 points at the opening, the note presents several risks. The exact definition of ?RISK OFF? evolves by the day, and the quarterly resets and rebalancing?s may not be frequent enough to catch the changes. This is why the fund sponsors kept gold out of the mix, which morphed from a ?RISK OFF? asset in the first half into a solidly ?RISK ON? one in the second half, and could well change gender once more.
There is also the problem of rolls, backwardations, and contangos, which have long bedeviled ETF?s in the commodities area, such as with the one for oil (USO) and natural gas (UNG). Tracking error can be problematic for these kinds of funds, which offer carry hefty management and administration fees. This could attract opportunistic hedge funds which are already coining it shooting against existing commodity and leveraged ETF?s.
I wish Dennis and Mark the best of luck with their new endeavor. But another thing that scares me is that new ETF?s often come out at market tops to cash in on market fads. Look no further than the disastrous rare earth (REMX), wind (FAN), and solar (TAN) ETF?s, which plunged not long after launch. Could this mark the end of the ?RISK ON?/?RISK OFF? parameter that has served me so well in recent years? Better to execute your own ?RISK ON?/?RISK OFF? trades simply by reading this letter and taking the trade alerts.
Don?t Follow the Lemmings
My worst fears about the deteriorating state of the US residential housing market were confirmed today with the release of the closely watched Case-Shiller Home Price Index. Nationwide, Q3 delivered a 3.9% decline in home prices, hot on the heels of a whopping 5.8% plunge in Q2. Most markets are at 8-10 year lows with the exception of Detroit, which is plumbing a new 20 year low.
Negative equity cities, and indeed, entire states, are proliferating like wildfire. The data give even more strength to the bleaks forecasts I delivered in my recent November 16 piece on the subject, ?Why Residential Real Estate Will Not Recover.?
The market took no prisoners. Year on year falls were greatest in Atlanta (-9.8%), Minneapolis (-7.4%), Las Vegas (-7.3%), and Tampa (-6.7%). The closest Q3 haircuts were seen in Atlanta (-5.9%), San Francisco (-1.5%), Tampa (-1.5%), and Las Vegas (-1.4%). What is going on in Atlanta? Haven?t they heard that the Civil War is over and they can stop burning the city? The only green figure was seen in Washington DC, which saw a 1% YOY gain, buoyed by an every rising tide of spending by the government and the lobbyists there to grease the works.
There seems to be a generational migration towards rental housing underway. New families are not being formed at past rates, as unemployed adult children living rent free in parents? basements do not exactly make hot marriage candidates. Almost all new construction has been shifted to multifamily dwellings. In San Francisco I have seen condo projects converted midstream into rentals before buildings are even finished to satisfy the new demand.
If you followed my advice years ago and unloaded your dwelling, why should you care about any of this? There is not a chance that the banks have taken a further 25% decline in home prices into their plans. Collapsing house prices brings collapsing banks, but this time congressional gridlock assures there will be no TARP and no bail outs. Goodbye financial system. This is what bank share prices are screaming at us, which look like grim death warmed over.
I would spend more time looking for great deals in the real estate market. But quite honestly, it is kind of a downer spending your Sunday afternoon visiting an open house, only to find the listing agent hanging from the shower head. Rent, don?t buy.
Not Exactly a ?BUY? Signal for Housing
?We?re spending billions in Iraq and Afghanistan. Let?s rebuild America first. If you build us a bridge or a school in West Virginia we won?t blow it up and we won?t burn it down,? said Senator Joe Manchin.
The coming bear trap that I warned about last week sprung this morning on the non-subscribing unwary, triggering panic buying by short sellers in all ?RISK ON? assets. Oil (USO), gold (GLD), silver (SLV), copper (CU), and foreign currencies all moved in lockstep to the upside. The trigger was news that leaked out over the weekend that the International Monetary Fund would make available several hundred billion dollars to bail out the beleaguered European ?PIIGS?.
Never mind that the IMF immediately denied any such moves from multiple offices around the world. The tipoff that something big was coming was the strong performance during Friday?s stock market opening, ostensibly off the back of healthy ?Black Friday? figures, which rapidly faded at the close. I suppose the big money was too busy fighting turkey indigestion to maintain the ephemeral gains. Once the buying started during the Sunday Asian market hours, it was all over but the crying.
With many managers poo-pooing today’s move, one has to ask if this is a one day wonder, a much needed 24 hour holiday from the deluge of bad news from the Continent?
The charts below suggest that this is more than a one day wonder and that there is more juice to go. Certainly breaking the 50 day moving average at 1,205 would be a positive development. At the very least, we should take a run to the old S&P 500 support level at 1,230, which should now pose substantial resistance. Break that, and the 200 day moving average at 1,266 comes into play, close to the three month highs we saw two weeks ago.
The interesting mover today was the Euro, which hardly moved at all, the ETF (FXE) gained a scant 0.53%. You would think that the troubled European currency would be the primary beneficiary of any rescue attempts. It wasn?t. This feeble response tells me that the Euro is fundamentally flawed, is still the currency that everyone loves to hate, and is looking at more downside than upside. That is why I didn?t join the lemmings this morning scrambling to cover shorts.
Cover Those Shorts!
If you want to delve into the case against the long term future of US Treasury bonds in all their darkness, take a look at Foreign Affairs, the establishment bimonthly journal read by academics, intelligence agencies, and politicians alike, which I am sure you all have sitting on your nightstands. In a well-researched and thought out article penned by Roger C. Altman and Richard N. Haas, the road to ruin ahead of us is clearly laid out.
The US has no history of excessive debt, except during WWII, when it briefly exceeded 100% of GDP. That abruptly changed in 2001, when George W. Bush took office. In short order, the new president implemented massive tax cuts, provided expanded Medicare benefits for seniors, and launched two wars, causing budgets deficits to explode at the fastest rate in history. To accomplish this, strict ‘pay as you go’ rules enforced by the previous Clinton administration were scrapped. The net net was to double the national debt to $10.5 trillion in a mere eight years.
Another $4 trillion in Keynesian reflationary deficit spending by president Obama since then has taken matters from bad to worse. The Congressional Budget Office is now forecasting that, with the current spending trajectory and last year?s tax compromise, total debt will reach $23 trillion by 2020, or some 160% of today’s GDP, 1.6 times the WWII peak.
By then, the Treasury will have to pay a staggering $5 trillion a year just to roll over maturing debt. What’s more, these figures greatly understate the severity of the problem. They do not include another $9 trillion in debts guaranteed by the federal government, such as bonds issued by home mortgage providers, Fannie Mae and Freddie Mac. State and local governments owe another $3 trillion. Double interest rates, a certainty if commodity price inflation continues unabated, and our debt service burden doubles as well.
It is unlikely that the warring parties in Congress will kiss and make up anytime soon. It is therefore likely that the capital markets will emerge as the sole source of any fiscal discipline, with the return of the ‘bond vigilantes.’ They have already made their predatory presence known in the profligate nations of Europe, and they are expected to arrive here eventually. Such forces have not been at play in Washington since the early 1980’s, when bond yields reached 13%, and homeowners paid 18% for mortgages. Since foreign investors hold 50% of our debt, policy responses will not be dictated by the US, but by the Mandarins in Beijing and Tokyo. They could enforce a cut back in defense spending from the current annual $700 billion. They might even demand a retreat from our $150 billion a year commitments in Iraq and Afghanistan.
Personally, I think the US will never recover from the debt explosions engineered by Bush and by ‘deficits don’t count’ vice president Chaney. The outcome has permanently lowered standards of living for middle class Americans and reduced influence on the global stage. But I’m not going to get mad, I’m going to get even. I am going to make a killing profiting from the coming collapse of the US Treasury market through buying the leveraged short Treasury bond ETF, the (TBT). I am sticking to my short term forecast for this fund to rise from the current $19.16 to $26, then $32, then $40. And that is despite a hefty and rising cost of carry of nearly 0.5% a month.
Looks Like I Can?t Afford the Next War
?Better to have stop and go, than no go at all,? said hedge fund legend, George Soros, about the choppy prospects for the US economy.
The garlic eaters don’t want to repay their debts, and the beer drinkers don’t want to lend them any more money. That pretty much sums up the financial tensions that exist within Europe right now. The PIIGS countries of Portugal, Ireland, Italy, Greece’s, and Spain are lurching from one emergency financing to the next. European interest rates are sky high. Never mind that much of that money was borrowed to buy Mercedes, BMW’s and Volkswagens, which enriched Germany’s economy mightily.
This is one of many reasons why I think the Euro will continue to fall against the dollar, possibly to as low as the mid $1.10’s sometime in 2012. The US is growing, and Europe is not. End of story. American interest rates are rising, while Europe’s are not. Another end of story.? This always attracts capital to flow out of the low yielding currency and into the high yielding one, which is creating a rising tide of buyers of greenbacks and sellers of Euro’s.
On Friday, Italian, Spanish and Portuguese bonds traded better than expected. Germany’s Chancellor Angela Merkel hinted they might bend a little on terms. The? China and Japan have said they would happily take down a chunk of the high yielding European debt. With ten year Japanese Government Bonds yielding a paltry 1%, can you blame them?
Would You Want to Owe Her Money?
I just flew over one of my favorite leading economic indicators yesterday. Honda (HMC) and Nissan (NSANY) import millions of cars each year through their Benicia, California facilities, where they are loaded on to hundreds of rail cars for shipment to points inland as far as Chicago.
Three years ago, when the US car market shrank to an annualized 8.5 million units, I flew over the site and it was choked with thousands of cars parked bumper to bumper, rusting in the blazing sun, bereft of buyers. Then, ‘cash for clunkers’ hit. The lots were emptied in a matter of weeks, with mile long trains lumbering inland, only stopping to add extra engines to get over the Sierras at Donner Pass. The stock market took off like a rocket, with the auto companies leading.
I flew over the site last weekend, and guess what? The lots are full again. During the most recent quarter, demand for new cars raced up to an annual 13.5 million car rate. Now what? I’ll let you draw your own conclusions. Sorry the photo is a little crooked, but it’s tough holding a camera in one hand and a plane’s stick with the other while flying through the turbulence of the Carquinez Straight. Air traffic control at nearby Travis Air Force base usually has a heart attack when I conduct my research in this way, with a few joyriding C-130?s having more than one near miss.
