Losing Money Isn’t a Crime

Jonathan Macey writes in today’s Wall Street Journal – an essay whose title, “Losing Money Isn’t a Crime,” is spot-on (h.t.Viewing the remainder of this article requires a Subscription

Central Bankers as The Chosen People

A couple of weeks ago, Dylan Grice at SocGen came out with a piece about how politicians use the time-tested strategy of "marginalize-then-brutalize" to turn blame for society's ills towards a small minority, thereby deflecting any responsibility.Viewing the remainder of this article requires a Subscription

Geopolitical turmoil

The Middle East is an informational black hole. Is Libya calmer or not? Is Bahrain flaring up? Are the riots in Saudi Arabia under control? Where’s Iran? All of the unknowns are pushing oil higher, and the threat of supply disruptions are becoming all too real, even as domestic inventories rise.

In the meantime, China currency talk is getting louder as leaders try to push for yuan reserve currency status. Why? At this point, I’m inclined to believe that the Chinese leadership might be thankful for unanswered prayers. With social unrest increasing, the yuan getting revalued higher may increase any slowdown, bring the real estate bubble to its knees, and actually increase social unrest in the short term. True, inflation might be mitigated, but it’s all about the speed and unintended consequences, 2 things that I’m not sure the government will be able to control.

Lastly, I can’t help but be amazed at the big, pink elephant in the room that is being totally ignored: the euro is unsustainable, yet it’s getting stronger!?!? Can anyone say “Ireland”? Great. Now that we know that Irish bondholders are getting a haircut, what about the rest of the complex? Spain is about to go back 30 years in terms of development. With already high unemployment and a real estate bubble that is not being priced on anyone’s balance sheet, Spain is the big risk for the euro now, but no one is talking about it. Instead, the euro is getting some relief bid that it’s not collapsing. Well, it should…and it will – at least in its current form.

Where to look?

There is so much noise that sometimes it’s difficult to focus. Today has seen some big moves across different asset classes, but I have to point out a couple:

• Silver making new highs. Without the fanfare of gold, silver continues to shine. I’m sticking to my original recommendation of splitting your precious metals exposure to silver, gold, platinum, and palladium. If it was happening by itself, I would say that it’s just a speculators game now. But it’s not. The precious metals are sending central banks a message. The metals were just a step ahead of bonds.
• Treasuries. Treasuries have rallied recently, but they’re struggling. Like a flurry in April, which signifies the death of winter, so too the recent rally is a fool’s bounce. Treasuries cannot be the refuge they once were; government policies have ensure that for the foreseeable future.
• Oil. Energy is a necessity, integrally tied to a country’s ability to produce good, but more importantly food. Instability in the largest energy producing region in the world will continue and provide a supply-shock-bid to the complex. I prefer the second derivative beneficiaries, namely, the domestic suppliers of coal and nuclear. Government policies will start bolstering these players as energy self-sufficiency will once again come to the front of the political debate.
• Emerging markets. Risk in EM countries has been underpriced for the past 10 years. Investors who piled into regions with no democratic and capitalistic foundations will have a tougher and tougher time getting out. Hopefully, investors aren’t holding large allocation to the region. Long term, I’m looking for opportunities to invest in India, not China; Brazil, not Russia.
• US equities. I have to throw in a mention. I am short IWM. Have been for a few weeks. Will stay for a while. Yes, I have long exposure in specific sectors and companies, but the overall market is unhealthy. I’ll have more to write about the specifics of equity valuation later in the week.

Relevant ETFs: GLD, GDX, PHYS, SLV, PSLV, IWM, RWM, TBT, TLT, INP, PALL, PPLD

Asia is the real story

The world is worried about oil, and rightfully so. The Middle East is in turmoil – I get it. However, as an investor, now is the time to focus on the marginal buyers and sellers, and while securing energy supplies is a key theme for my energy focus, I am now more focused on the stories that are being under-reported in Asia.

Yesterday, I mentioned the social unrest that is happening in China, which few are talking about. The day before we pointed to the bank runs in South Korea. Today, Bloomberg ran a story with the following heading: “World’s Biggest Pension Fund ‘Will Likely’ Sell Japan Bonds” (h.t. Mish’s Global Economic Analysis). Here are the opening paragraphs:

Japan’s public pension fund, the world’s largest, said it may become a net seller of bonds to cover payments in the world’s most rapidly aging society.

The Government Pension Investment Fund, which oversees 117.6 trillion yen ($1.4 trillion), in September forecast that it would sell 4 trillion yen in assets in the business year ending March 31 to fund payouts. Sales may be less than that in the year starting April as bonds reach maturity, said Takahiro Mitani, president of the fund, known as GPIF.

Why is this important? Because internal purchasers, most notably the pension system, have allowed the Japanese government to continue printing endlessly, and have made Japan the single most vulnerable developed country (in terms of finances, not politics). If Japan’s pension plans will become net sellers, the governments printing will only exacerbate the increase in yields and will force either a massive cut in spending, massive cut in entitlements, or massive inflationary pressures. This is zero hour for Japan. It also does not bode well for local Japanese sellers as they’ll face ever-higher input costs. It could be OK for exporters who will benefit from currency differentials, although that might be negated by internal taxes and politics. I’m staying short the yen and will look to increase the position in the next few months.

Japan’s example should serve as a warning for governments and inflation-mongers alike. Governments can print endlessly and still face deflationary pressures for years and decades, with no net benefit, and with huge eventual costs placed on their citizens.

Relevant ETFs: YCS, FXY, DXJ

Just a quick note about China

I have been hearing about intermittent shutoffs in Twitter for a while, but now it looks as if LinkedIn is being blocked in China. Looks like the Chinese are afraid that the same social networks that are helping overthrow decades of dictatorships in the Middle East will also be used to overthrow decades of authoritarian rule in their backyard. See the story on TechCrunch: http://tiny.cc/qcizm. As I mentioned yesterday and prior, Asia is the marginal buyer that I am keeping my eye on for the next pressure point for world markets. There’s a good chance the Middle East is only a precursor.

Who benefits from a declining euro?

Will the euro break 1.29 today? Well, if not today, then soon. Spreads are unsustainable for rolling over maturing debt, and Italy is the next to fall. I anticipate growing anger from Germany that will make each future bailout more expensive both for the offending countries and the holders of existing debt. A couple of beneficiaries in my mind…

Turkey is sitting pretty. The xenophobic Europeans shunned the country, but it’s having the last laugh. Its demographics are good, growth is OK, internal demand is growing, etc. They’ll have to figure out how to compete with a weaker euro, but at least they won’t be saddled with the same cross holdings of bad debt.

Russia and China are chomping at the bit. If Germany backs off bailouts, and the US hands are limited anyway, Russia and China can demand large concessions in return for bailout money. I’m anticipating some port access, military concessions, favorable trade agreements, etc. to be handed out. At the same time, the US will voice anger, but our own mismanagement will limit our dissent.

Why won’t Europe benefit from a declining euro? Because the wealth destruction will be faster than the increase in monetary competitiveness. Given the continuing employment deterioration and increasing local inflation, which in Europe actually leads to quicker social unrest than would be anticipated from well-functioning democracies, the lower euro will more likely lead to less faith in government policies, not more.

Geopolitics for breakfast

Asian markets are open already, but European and later US investors, will get some more geopolitics for breakfast.

South Korea is down just over 1% as I write this, mostly over tensions with North Korea, military exercises, etc. When money gets tight, tensions run high. I think this is only the beginning of world flare-ups. Shanghai, is down 3%, with property and bank shares leading the charge. How many times can I write about property and finance companies being a sham in China before investors realize they will not get paid for the risk of Chinese investments. If you’re not local and tapped into the bureaucracy, stay away at these valuations!

In the meantime, the euro is ticking lower and I am guessing that it breaks the 1.30 handle before everyone goes away for Christmas. Which brings me to another thought of the evening…

Everyone is expecting a slow, boring week, and the volumes will probably reflect that. But what if they’re wrong? For those who fly, you’ll understand the following analogy: the most dangerous times in a flight are the take-off and landing. The next two weeks are the landing for 2010. Thinner volume, ridiculously low-priced VIX, 6-sigma currency vol, rising bond yields, etc. all lead me to want to buy insurance. I’m already so underweight equities, and short so many asset classes, that I’m not adding to anything, but new funds would definitely be searching for insurance at these levels.

Unemployment at 9.8%

The numbers came out and depending on your interpretation…well, actually, it’s tough to interpret these positively:

(From BLS) The unemployment rate edged up to 9.8 percent in November, and nonfarm payroll employment was little changed (+39,000). Temporary help services and health care continued to add jobs over the month, while employment fell in retail trade. Employment in most major industries changed little in November.

CalculatedRisk.com did a great job of putting all the numbers into charts and I encourage you to look there, but I want to highlight one in particular and the summary:

This graph shows the number of workers unemployed for 27 weeks or more.

According to the BLS, there are 6.313 million workers who have been unemployed for more than 26 weeks and still want a job. This was up from 6.206 million in October. It appears the number of long term unemployed has peaked, however the level is extremely high – and the increases over the last two months is very concerning.

Summary

Perhaps the worst news was the jump in the unemployment rate to 9.8% without an increase in the participation rate. If the participation rate had increased, at least that would mean people were becoming more confident and rejoining the labor force. Instead the Labor Force Participation Rate was flat at 64.5% and this is a very low level. Note: This is the percentage of the working age population in the labor force (here is the graph in the galleries of the participation rate).

Most of the underlying details of the employment report were weak. The positives included small upward revisions to the September and October payroll reports, a slight increase in average hourly earnings, and a slight decline in part time workers.

The negatives include the unemployment rate increasing to 9.8%, few payroll jobs added (only 39,000 jobs), the decline in the employment-population ratio, the steady participation rate at a very low level, and the increase in workers unemployed for over 26 weeks.

You wanted a weaker currency…

The euro continues to head lower, and so far, Germany is the only one that’s OK with it.

All German surveys are coming in strong, and rightfully so, with its export focused economy. Problems loom for them, however. For starters, bailouts don’t solve the problems, the just change the creditors and buy more time. In the case of Ireland, the bailout bought a few quarters of stability – at best. The market is already discounting further down the road. Spanish and Portuguese yields continue to soar. Certainly, the number of eurozone countries hurting alongside the euro is increasing.

There’s also an interesting and little-discussed North-South in the eurozone, with northern countries, including UK, Scandinavia, Germany, etc. holding up better (albeit with their own sets of problems, but then again, who doesn’t have them?) than their southern counterparts in Spain, Italy, Greece, etc. Ireland sticks out like a sore thumb, but you get the general idea.

A thought for Obama

Did North Korea just hand you a game changer on a silver platter? Here’s a thought: North Korea is sending out a feeler – will Obama OK a retaliation by South Korea? China is in on the talks and while it wants to back North Korea, might let the retaliation happen, just so it can get some concessions from the US. Yup, it’s a Prisoner’s Dilemma on drugs. In the meantime, the person glued to the TV is Ahmadinejad. If the US let’s North Korea’s moves go unanswered, he knows he’s in the clear. Otherwise, he’s finding a hole in the desert to hide for a while. I expect the former, but hope for the latter.

This is an opportunity during a difficult period for the world. Obama has a chance to bring different countries together around a common enemy, and to rally against extremism, global nuclear proliferation, etc. and to use it as an opportunity to calm talks over economic and currency wars. I hope he uses it wisely.

Did you already go on vacation? Part II

Just when you think you’re out…

North and South Korea exchange artillery fire - and money has to choose sides. Obviously the Korean won is the first to feel it (down about 3%), but let’s look at the second degree. If there’s tension in the peninsula, the Chinese will side with North Korea for ideological reasons and national (political?) pride. Fine, except that investors know that the US will choose South Korea. Which means that the big investor money (US invests more than North Korea) might leave China. That will in turn exacerbate Chinese inflation, already a big concern for the Party. Where that leads? Hopefully, to some strong words that leave a lot of room to maneuver around for all sides. The alternative is for Chinese protectionism/nationalism to drive politicians into a corner where rare earths shipments are again halted, food is hoarded, etc.

In the meantime, the euro continues to head lower (down 1.3% as of this writing). They’ve got their own problems to deal with without worrying about the Korean peninsula today.

Small Cheesemaker Defies F.D.A. Over Recall

To her devotees, Ms. Estrella is a homespun diva of local food. With her husband and six adopted children from Liberia, she makes tasty artisan cheeses from the milk of her 36 cows and 40 goats and sells it at farmers’ markets.

Some even winds up on tables at fancy restaurants in Manhattan and Los Angeles.

But to the federal government, Ms. Estrella is a defiant businesswoman unable to keep dangerous bacteria out of her products. Last month, the Food and Drug Administration moved to shut down her business, Estrella Family Creamery, after tests found listeria in some of her cheese and she refused to agree to a broad recall of her products.

Although no illnesses have been linked to Ms. Estrella’s cheese, listeria is a sometimes deadly bacteria that is especially hazardous for the very young and the very old. Pregnant women who become infected can have miscarriages or stillbirths.

Read the full article here.

This blog is not about chronicling the regulatory or policy framework, per se; however, the investing environment happens in that same framework and thus policy needs to be analyzed, and more importantly, trends in policy and regulation need to be noted. The current trend, which can be traced as far back as the 1930′s with the New Deal, is towards increased government intervention, heightened regulatory risk, and ever shifting policy regimes. This trend makes it tougher for small businesses to start and grow, and will give larger companies an advantage in the competitive landscape.

We already see this in medicine (http://www.crainsnewyork.com/article/20101114/SMALLBIZ/311149979):

Over the past few months, hundreds of New York area doctors have dealt with the choice Dr. Steinberg is mulling. In exchange for a steady paycheck, these doctors have signed contracts that mandate they hit productivity and patient-satisfaction benchmarks. An added benefit for giving up their autonomy: relief from the pressures of federal health care reform and Medicare cuts.

…The situation is most acute for cardiologists, whose revenue has been hit by federal cuts for diagnostic procedures. A full 60% of the specialty’s businesses are in merger talks with hospitals or other practices, according to a recent survey by the American College of Cardiology.“There have been fundamental changes in reimbursement” for all physicians, says Dr. Andrew Brotman, NYU Langone’s senior vice president and vice dean for clinical affairs and strategy. “They’ve made it more difficult for independent practitioners to operate, and many have sought other opportunities.”

…and we’ll see it service companies from law firms to accounting firms. The implications are vast: from higher structural unemployment to lower levels of productivity gains. For investors, it also means that large firms might have an advantage; it also means that going public will be even more expensive. We’ll continue to explore the specific implications, but for now, I hope Ms. Estrella is able to hold out and stanch the tide of increased costs and regulations for business-owners.

The Sacrificial Bank

I don’t know which bank it will be, but one of the big ones. Obama and Bernanke are facing mounting political pressure: Deflationary pressures continue, commodities are correcting, risk assets are coming down, etc. while on the other hand political pressure against QEII is mounting and already it looks too big to the hyperinflation crowd and too small to the Keynesians. So what’s a bureaucrat to do?

Set an example by sacrificing one of the big banks and that should get the people off your back for a while. I think the political strength to bail out one of the banks will be gone in the next go-around. Already, Europe is going to need to bail out their own banking system as the euro falters, and the federal government will need to bail out California alongside countless municipalities such as Philadelphia. If they bail out the next bank failure, Obama will have no retort during the debates against the claim that he’s socializing everything. If he lets one of the banks go under, he’ll be able to point to his supposed strength and market-oriented mentality.

Given that I think the banks are still undercapitalized and have not marked down the majority of bad debt on their books, I believe we’ll hit a new financial snag in the next few months, but this time, the government won’t step in. Roger Altman who is rumored to be the next financial appointment might end up being an interim installment for Geithner who will end up being the fall guy for the tough decisions that need to be made in the next few months.

If I had $600 Billion, I’d be rich

The Fed cam out with QEII and the essence is that there will be $600B pumped into the market for the next 8 months in the hopes of stimulating economic growth. I won’t go into the differing opinions of whether QEII will actually work, but simply state mine: if QEI didn’t work, why would QEII? We don’t have a liquidity problem that can be solved with more POMO activities. We have credit/faith problem, which isn’t solved with free money; quite the contrary, something that is free isn’t worth anything.

When the dust settles, I don’t think this round of QE will make much of any difference. The focus now is the turning point in the yen, the turning of Chinese growth numbers which I believe will come in over the next few months, and the breakdown of the euro (Ireland and Greece are only the beginning). The dollar will look like a superstar compared to the alternative, and will squeeze nay-sayers.