Wednesday, August 11, 2010

Morning Note...


Futures are down ~1.5% this morning on weak economic data in Asia overnight, a delayed reaction to the FOMC’s rate decision and commentary from yesterday afternoon, and cautious commentary from the Bank of England.  Thus the drivers of global financial markets (US, Asia, Europe) are all weaker.  Yes, this seems to be “one of those days” where a quick glance at the Bloomberg “Top News” headlines tell you everything you need to know:

*Stocks, U.S. Futures Slide as Fed Sees Slowdown; Yen Touches 15-Year High…
*Bank of England Cuts Growth Outlook in Sign Economy May Need More Stimulus…
*Economists Reduce U.S. Growth Estimates as Lack of Jobs Hinders Consumers…
*China's Industrial Output Growth Weakens on Curbs as Inflation Accelerates…

Additionally, the U.S. Trade Balance for June widened more than expected to -$49.9B from the prior -$42B (and the -$42.1B expectation) and Japan reported weaker-than-expected June machinery orders.  Regarding the Fed, yesterday’s announcement has pundits wondering two things:  1) What does the Fed know that we don’t?  Bernanke and company gave no clues in recent speeches as to the potential need for another toe dipped into the quantitative easing pool.  So what changed?  Why weren’t expectations better managed and the market better-prepared?  The general takeaway seems to be “things must be worse than they appear.”  2) What happened to the exit strategy?  The general takeaway there would be “if the Fed is still involved, the financial conditions of the world can’t be good.”  According to Bloomberg news, The Federal Reserve reversed plans to exit from aggressive monetary stimulus and decided to keep its bond holdings level to support an economic recovery it described as weaker than anticipated.  So, net net, the FOMC scared us a bit yesterday, and the bond market (record low yields in the 2yr and sub-2.75% on the 10yr) is really telling all you need to know.  BTIG’s Mike O’Rourke noted some of this last night, and essentially previewed today’s weakness (emphasis mine):

Making Replacement Purchases of securities is the option we liked least for the markets.  On the positive side, in taking this course of action, the Fed has clearly indicated that they are willing to act should the recovery falter.  On the negative side, in shifting policy the Fed gives credence to economic weakness, indicating that it warrants a response.  The problem is this response will not move the needle in its influence upon the economy, and for every sign of weakness that emerges, investors will be looking for a response from the FOMC.  Thus far, it is a positive sign that the market did not take today’s move and extrapolate it into a more pessimistic scenario.  This offers hope that our fears may be unfounded.  That being said, it is still early and the FOMC just officially eased policy and the S&P 500 lost 60 basis points today and the Russell 2000 lost 2%.  If you are in the bullish camp with us, you don’t feel good about that result. 

He adds (emphasis mine):

A Fed that is attempting to be vigilant in supporting recovery is a positive, so today’s action does not change our outlook on the market but it does modestly elevate the risk level.  At this stage of recovery, you want Fed policy to be accommodating for investing, but you don’t want it to be the reason for investing.  We view it from this perspective, from its April peak to its July low the S&P 500 dropped 17%.  Despite the pain of the drop, there was a major positive for investors, barely a word was heard from the Fed.  The lone exception was that the barely used Central Bank swap lines re-opened to help Europe.  The equity market bottomed on its own and rallied on its own, without an adrenaline boost from the Federal Reserve.  It is not often that the equity market experiences a correction of such magnitude, without being accompanied by a policy response from the Federal Reserve.  Now that the FOMC is back into the mix and intervening, that healthy progress in the market is tainted.

And some GBP and UK concerns and China weakening to the mix – which subsequently drives up the USD on a flight to quality – and you have another technical pressure applied to U.S. equities this morning.  All in all, it ain’t pretty.  Nevertheless, the bulls remain.  To whit, I found this prediction from BCAP’s retail desk to be of particular note (and I like these guys, but…we shall see):

Macro:  S&P 500 futures have traded over $13B notional (60% above yesterday) as they are looking down 1.2%.  The cause of the weakness is 1) investors worried about FOMC commentary around slower growth and 2) a slowing Chinese economy.  It seems like the market gets scary every morning and then rallies in the afternoon.  I'm betting the same exact thing happens again.  We will be bidding for stocks on the open across the board.  Feel free and test us!

In other news, there are two things worth pointing out.  First, read the op-ed in the quote section below.  Solid food for thought.  Second, yesterday’s political “victory” by the Obama Administration (who won passage of a schools bill) is being slightly brushed under the carpet for what it really is:  another bailout.  Essentially – and this is admittedly a simplified and limited understanding, smarter folks will have to correct me here – the Federal government is bailing out those States and Municipalities with school systems that are financially underwater.  Look, obviously education is hugely important – no one will argue that.  But once again the Federal government takes on a huge burden of debt in making this “save.”  For better or for worse, call it what it is – another bailout.  And it sets a precedent whereby every chirping municipality will be begging to be fed by the mother bird government…  How is this a good thing?

ACM initiated Neutral at GSCO.  CITI ups STWD.  BofAMLCO cuts TWTC.  WEFA cuts NRGY.  GSCO cuts TSCO.  CREE beats by 4c but guides revs lower. CFN beats by 1c.  LDK beats by 14c.  M beats by 6c. RGNC announces 14M share offering.  MPWR cut at STFL.  MTGN lower on earnings. 

Asia mixed but generally lower overnight.  Europe down nearly 2%.  USD +1%.  EUR/USD 1.3008.  Oil -125bps.  Gold +90bps. 

S&P 500 PreMarket 8:30am (last/% change prior close/volume): 

Today’s Trivia:  Today marks the first day of Ramadan, a month-long period of dawn-to-dusk fasting for Muslims.  But what does Ramadan actually commemorate?

Yesterday’s Question:  Interesting thought in today’s “instant gratification” world of light speed communication…word of what famous announcement reached London on this date in history?
                                                                                                                                                             
Yesterday's Answer:  Amazing to think about given today’s technology, but word of the British Colonies’ Declaration of Independence did not actually reach London until August 10th, 1776. 

Best Quotes:  U.S. Is Bankrupt and We Don’t Even Know It: Laurence Kotlikoff  2010-08-11 01:00:00.0 GMT

     Aug. 11 (Bloomberg) -- Let’s get real. The U.S. is bankrupt. Neither spending more nor taxing less will help the country pay its bills.
     What it can and must do is radically simplify its tax, health-care, retirement and financial systems, each of which is a complete mess. But this is the good news. It means they can each be redesigned to achieve their legitimate purposes at much lower cost and, in the process, revitalize the economy.
     Last month, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: “Directors welcomed the authorities’ commitment to fiscal stabilization, but noted that a larger than budgeted adjustment would be required to stabilize debt-to-GDP.”
     But delve deeper, and you will find that the IMF has effectively pronounced the U.S. bankrupt. Section 6 of the July 2010 Selected Issues Paper says: “The U.S. fiscal gap associated with today’s federal fiscal policy is huge for plausible discount rates.” It adds that “closing the fiscal gap requires a permanent annual fiscal adjustment equal to about
14 percent of U.S. GDP.”
     The fiscal gap is the value today (the present value) of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

                        Double Our Taxes

     To put 14 percent of gross domestic product in perspective, current federal revenue totals 14.9 percent of GDP. So the IMF is saying that closing the U.S. fiscal gap, from the revenue side, requires, roughly speaking, an immediate and permanent doubling of our personal-income, corporate and federal taxes as well as the payroll levy set down in the Federal Insurance Contribution Act.
     Such a tax hike would leave the U.S. running a surplus equal to 5 percent of GDP this year, rather than a 9 percent deficit. So the IMF is really saying the U.S. needs to run a huge surplus now and for many years to come to pay for the spending that is scheduled. It’s also saying the longer the country waits to make tough fiscal adjustments, the more painful they will be.
     Is the IMF bonkers?
     No. It has done its homework. So has the Congressional Budget Office whose Long-Term Budget Outlook, released in June, shows an even larger problem.

                    ‘Unofficial’ Liabilities

     Based on the CBO’s data, I calculate a fiscal gap of $202 trillion, which is more than 15 times the official debt. This gargantuan discrepancy between our “official” debt and our actual net indebtedness isn’t surprising. It reflects what economists call the labeling problem. Congress has been very careful over the years to label most of its liabilities “unofficial” to keep them off the books and far in the future.
     For example, our Social Security FICA contributions are called taxes and our future Social Security benefits are called transfer payments. The government could equally well have labeled our contributions “loans” and called our future benefits “repayment of these loans less an old age tax,” with the old age tax making up for any difference between the benefits promised and principal plus interest on the contributions.
     The fiscal gap isn’t affected by fiscal labeling. It’s the only theoretically correct measure of our long-run fiscal condition because it considers all spending, no matter how labeled, and incorporates long-term and short-term policy.

                        $4 Trillion Bill

     How can the fiscal gap be so enormous?
     Simple. We have 78 million baby boomers who, when fully retired, will collect benefits from Social Security, Medicare, and Medicaid that, on average, exceed per-capita GDP. The annual costs of these entitlements will total about $4 trillion in today’s dollars. Yes, our economy will be bigger in 20 years, but not big enough to handle this size load year after year.
     This is what happens when you run a massive Ponzi scheme for six decades straight, taking ever larger resources from the young and giving them to the old while promising the young their eventual turn at passing the generational buck.
     Herb Stein, chairman of the Council of Economic Advisers under U.S. President Richard Nixon, coined an oft-repeated
phrase: “Something that can’t go on, will stop.” True enough.
Uncle Sam’s Ponzi scheme will stop. But it will stop too late.
     And it will stop in a very nasty manner. The first possibility is massive benefit cuts visited on the baby boomers in retirement. The second is astronomical tax increases that leave the young with little incentive to work and save. And the third is the government simply printing vast quantities of money to cover its bills.

                        Worse Than Greece

     Most likely we will see a combination of all three responses with dramatic increases in poverty, tax, interest rates and consumer prices. This is an awful, downhill road to follow, but it’s the one we are on. And bond traders will kick us miles down our road once they wake up and realize the U.S. is in worse fiscal shape than Greece.
     Some doctrinaire Keynesian economists would say any stimulus over the next few years won’t affect our ability to deal with deficits in the long run.
     This is wrong as a simple matter of arithmetic. The fiscal gap is the government’s credit-card bill and each year’s 14 percent of GDP is the interest on that bill. If it doesn’t pay this year’s interest, it will be added to the balance.
     Demand-siders say forgoing this year’s 14 percent fiscal tightening, and spending even more, will pay for itself, in present value, by expanding the economy and tax revenue.
     My reaction? Get real, or go hang out with equally deluded supply-siders. Our country is broke and can no longer afford no- pain, all-gain “solutions.”

     (Laurence J. Kotlikoff is a professor of economics at Boston University and author of “Jimmy Stewart Is Dead: Ending the World’s Ongoing Financial Plague with Limited Purpose Banking.” The opinions expressed are his own.)