On German Negative Yields

In a nutshell, this article summarizes the problems we are facing.Viewing the remainder of this article requires a Subscription

Bank Runs Are Deflationary First, Inflationary Second

It is Thanksgiving, so for most Americans an opportunity to spend time with family, go crazy, and use the excuse to purchase some frivolous electronics at half of what our neighbors paid last month - a truly feel-good holiday.Viewing the remainder of this article requires a Subscription

The Problem With Pessimism

The problem with pessimism is that you’re always almost right and almost on time.Viewing the remainder of this article requires a Subscription

Lots of news, but what’s important?

There is a flood of data and headlines that seems almost spiteful to anyone trying to enjoy their usually-slow August. For me, it gives a good excuse to turn away and read even slower as most of the flood is meaningless for my portfolio. That being said, some of it is not.Viewing the remainder of this article requires a Subscription

It’s the End of The Euro as We Know It…And I Feel Fine

For a brief moment, the markets believed. For a brief moment, the Greek problem was solved. But then reality set it. Greece’s fiscal austerity and monetary headache is going nowhere and German’s are getting fed up with supporting their neighbors.Viewing the remainder of this article requires a Subscription

Black Swan

I continue to think about black swans – not the movie. It’s a bit of a tautology to say that we can only identify them in hindsight, that is, we can only tell that an unexpected event will happen AFTER we’re caught off guard. The corollary to that is if we’re caught off guard, then it must have been a black swan event. I think investors and market participants often use that as an excuse. Continuing with that line of thinking, then, the implications for the pundit, writer, or talking head (or anyone not actively making decisions) is to try to mention as many possible events or outcomes as possible. Then, when one hits, the non-decision-maker can always say that he predicted it. In that light, prognosticators have a distinct motivation to talk about the possible, without thinking of the probable.

In contrast, decision makers often base their decisions on the probable. At its root, most institutional money managers don’t want to take any career risk, and “no one gets fired for buying IBM” (although, these days, maybe they get fired for buying HPQ). The idea behind this mentality is one of momentum, namely what’s happened in the recent past is likely to continue.

The last group – I guess you might know where this is going – looks at expected return. This last group are number crunchers at heart. I hope I fall into this camp more often than not. This group relies on SUMPRODUCT. The idea behind this group’s thinking is that you need to know both the possible outcomes AND the probability of each outcome. The expected return crowd is comfortable making appropriately sized investments given the expected outcome, recognizing full well that the expected outcome will deviate from the actual outcome in any given turn BY DEFINITION. The key for this group is that there is always a possibility that they/we don’t anticipate; except, you can anticipate the unanticipated by making an “other” category. This other category will now be factored in and will only be limited by the assumptions you input into it. Other, remember, can go in both direction. In essence, it’s a haircut. The more investors lump into the other category, the smaller they should trade.

I happen to have a lot of things in my “other” category. I worry about the weather. I think about terrorism. I think about supply shocks in every commodity imaginable. I think new technologies will revolutionize the way we live. And on and on. The implication is that I invest more conservatively than I would without my “other” category. I think a lot of people I speak to invest bigger than they should. Great when your PNL is going up. Hurts more on the way down. How big should you invest? Well, it probably depends how many things you think should be lumped into your “other” category.

In anticipation of the rebuttal, I’ll provide it myself… Fear, and especially fear of the unknown, can lead to inactivity. You might decide that so many things are unknown and in the “other” category, that your positions become miniscule, or even non-existent. In that scenario, you should also be afraid of inaction and indecision, and weigh that option. Against the risk of loss through action. You’ll probably find that inaction is worse.

In that light, our decision to hold cash, while simultaneously holding securities that would benefit from inflation might seem at odds. It is. It’s part of our inflation barbell strategy, namely in our analysis, inflation will EITHER increase or decrease, we’re just not sure yet which one. The one thing we’re pretty confident in, though, is that it won’t stay here very long. Food for thought as we move forward in our tactical allocation research.

Relevant ETFs: XLU, CROP, GLD, TBT

Quick note

Check out the dollar index. In a somewhat counterintuitive effect the USD shot up. A combination of factors, but in the end, when investors don’t want to hold financial assets and prefer cash, you have the observed impact. Rising yields here are NOT inflationary. Rising gold is NOT inflationary. They are signs of a debt deflation era that has a long way to run.

Deflation probabilities’ uptick

This is from the Atlanta Fed:

March 24, 2011
Longer-term deflation probabilities move up slightly

Prices of Treasury Inflation-Protected Securities (TIPS) with similar maturity dates in 2015 can be used to measure probabilities of a net decline in the consumer price index over the five-year period starting in early 2010. One measure of the deflation probability was11 percent on March 23, up slightly from10 percent a week earlier. An alternative lower bound on this deflation probability ticked up from 0 percent on March 16 to 1 percent on March 23.

Link is here.

This is a very short time frame and can fluctuate easily (as you can see from the time series). That being said, it’s tough for the probability of deflation to get any lower, which to me says that it might be a good time to check out www.intrade.com or, if you’re an investor, just find who are the winners and losers from deflation materializing. It just needs to materialize more than the market expects for it to make a significant impact.

Relevant ETFs: TLT, VNQ, RWR, REK, GLD, SLV, XLF

MacroView

A bit later than usual…

As always, MacroView is produced in collaboration with MacroMan. To show the extent of our need to SEEK conflicting data, today’s MacroView has a number of charts showing support/resistance for inflation triggers. I’m not in the inflation camp for the time being. I see no wage pressures, a consumer slowdown, increased savings rate, lower velocity, lower housing, excess capacity, etc. That being said, one must always let the data lead, and I’m open to re-interpretation…

macroviewmarch17

Feeling like an outsider

Everyone is talking about inflation. All the time. Wheat. Everywhere I turn. Every chart that is burnished. Cotton. Newsletters. Bloggers. Traders. Inflation. Copper. So it makes me feel like an outsider when I don’t really think inflation is the problem we need to worry about. Or rather, it’s not a simple case of rising prices and depreciating fiat currencies.

Let me point out a few discrepancies I’ve noticed for the inflation camp. Prices of commodities are rising, which will be passed on to the end consumer. For me, that’s a maybe. I think there is a lot of room for substituting down and for limiting purchases. We see it in company reports – Dean Foods doesn’t sell the brand name milk as people switch to the generic. That’s trading down. I think there’s also room for stopping certain purchases much quicker than analysts anticipate.This leads me to worry about margin compression much more than a pick-up in inflation.

On a related note, we don’t see employment and wages going up. Where do inflation mongers think that the funds for increased prices will come from? I don’t see wage inflation picking up in the near future.

Housing is down, and it’s not coming back yet. Without housing (and I’m talking about global real estate in general) where will this mythical demand for such commodities as copper come from? China’s property bubble is bursting, the US housing market is going down, Japan’s demographics will soon lead it to destroy housing, etc. Other than fear and speculation, what’s driving the underlying demand? Silver and gold going up is not a sign of inflation. On the contrary, they are signs of fear and rightfully so. Fear can be fear of inflation, but it can also be fear of instability and deflation. Their price movements are certainly not a support for the inflation camp.

What makes my position even more difficult is the fact that I agree with a lot of the underlying issues these same inflation campers are mentioning. Printing is dangerous for the dollar. Housing has not been a store of wealth. Producer prices are rising. etc. On top of it, I agree with SOME of the implications. I am negative on long term treasuries and credit in general. I like gold and the precious metals complex. I like the energy complex. And more.  However, I diverge on some fundamental issues: I don’t think like retail and don’t believe the retailers will be able to pass along price hikes. I think a Chinese slowdown is already here and will ripple through the commodities space. I anticipate major margin compression and am very negative on equities. I think gold and silver are harbingers of fear that will cause people to hoard cash as well. I don’t anticipate wage inflation.

All of that was a long-winded way of saying I haven’t found a camp where I feel totally comfortable.

Relevant ETFs: JJA, DBA, COW, MOO, TBT, TLT, EEM, SPY, TIP

Just to confirm

Jobless claims higher than expectations by about 50K, durable goods orders continue to deteriorate (down 2.5%). We’ll see what that means for inflation expectations going forward, but without wage inflation and without orders to generate revenue and growth, the current inflation scare and commodity run-up might hit a wall.

Inflation fears are back

Inflation fears and fear-mongering are back in full swing, but I don’t buy it. I have to admit that I have benefited on multiple levels from the inflation fears making their rounds, as I have short exposure to treasuries, and long exposure to precious metals including palladium and platinum, which have outperformed gold and silver. I’ve also faced some headwinds, as I have been long the dollar versus the euro and yen for a long time. Separately, I’ve been overweight energy for a whole host of reasons, but inflationary pressures have certainly helped keep the price high.

So why am I doubting the recent fear mongering over ever-higher corn prices and the run up in everything from lean hogs to cocoa? My main reason is the consumer. First, on an anecdotal level: Go into any department store. These days, they’re seeing more traffic than in the recent past, a positive. Yet, almost everything is on sale. 30-50% sales are now the norm, and quite honestly, I don’t know why anyone would buy without the sales, especially given that you can buy so many things pre-sale, namely, buy it now, put it on hold, and get the sale price, while the store gets the carry. That’s fine for cashflows, but it’s only borrowing from future revenue; I guess it’s a cheap loan. Second, inflation in staples can seep through, but we’re not seeing it keeping up with the rise in inputs, which necessarily means a squeeze on margins. Don’t believe me, just check out MCD, which just came out with earnings. This is great for the midwestern farmer (voter) and land owner, fine for the coastal consumer, and crappy for everyone in between. Certainly it’s not a net positive for stocks that won’t be able to keep up earnings and meet these valuation expectations.

But back to our mongering…The question remains of what happens to the firms in between that are getting squeezed? For starters, I don’t think employment can pick up, which in turn will lead to continued low savings. In fact, numbers just released show that consumers are dipping into their savings at unprecedented levels. Considering the fact that these funds aren’t coming from HELOCS, they must come out of investable and liquid assets. That can only go on for so long. In a debt deleveraging cycle, which we are facing, the main problems will be margin contraction coupled with more difficult financing. Inflation fears today will end up being ephemeral and much deeper, scarier structural problems will surface. For traders playing the rotation, this is a fine time to look at underperforming commodities and just consistently rotate into them. For investors, the commodity space, except some very specific exposures, will not provide the anticipated returns.

Relevant ETFs: MOO, COW, DBA, GLD, SLV, PALL, PPLT

Separating the noise from the louder noise

There’s obviously been a lot of news since last night and I’ve been trying to wrap my head around it, but for starters let’s mention some of the big items:

Belgium and Spain are only the latest, but not the only(!), reasons for the euro to fall…and fall it did. We’re back to a 1.32 handle. Why do I say that they’re not the only reasons? Well, for starters, I thought the euro was structurally flawed before any downgrade, and continue to think so. The euro is now trading by default since there’s no alternative in Europe. Imagine for a moment if Germany came out tomorrow and said that it would start issuing Marks. The euro would be DOA.

On our side of the pond, we have treasury yields continuing to move up. 10 year yield is now above 3.5%! We’ve discussed the phenomenon before where we can have deflation AND rising yields at the same time. Locking in 3.5% for 10 years isn’t that attractive afterall. We’ve been calling it biflation, but I’ve been researching some underlying elements to help explain the phenomenon. Each time I come to the same issue: What cause yields to rise?

• If yields are REACTING to inflation and inflation expectations, then they are lagging commodities, but still part of the same message we’re getting from other asset classes. This could be bullish for equities and real estate, as well as supporting the runup of commodities in general (such as copper, industrial commodities, etc).
• If they are LEADING and are a result of fear over solvency, or frontrunning the pack (e.g. fear China will sell their holdings), then the recent run-up could be part of a debt-deflation cycle which is very negative and could be a harbinger of increased real costs of borrowing, economic slowdown, deflation across asset classes, etc. This would be very bearish for industrial commodities such as copper, but still supportive of precious metals as stores of value.

This dichotomy is the debate being had across the street. The first case is easier to deal with – we have the fiscal and monetary tools to stop inflation, and while painful down the road, we know it. The second case is similar to what happened during the Great Depression (and I don’t use that comparison lightly). It’s a world where fiscal and monetary policies are powerless, and it’s the scenario Bernanke fears most. Unfortunately, increased government spending does not and will not stop scenario two from occurring, so it just leaves us more vulnerable. We are maintaining our short treasury exposure.

Gold down. Oil up. Noise for me, since these are long term positions.

Muni bonds have gotten hit recently (as we predicted a few months ago). Noise for me at this point since we cut all exposure. At some point, yields will become attractive enough to take long term positions, but for me, not yet.

Tax bills, healthcare constitutionality, and WikiLeaks – all noise.

David Rosenberg (Rosie) discussing the rise of inputs versus no retail pricing power causing the mother of all margin squeezes?

The U.S. PPI, at +0.8% MoM in November and the core (which removes the effects of food and energy) at +0.3%, were both above expected but skewed by a seasonal rebound in auto pricing. Outside of that, core would have been as expected at +0.2%.

What is striking, however, is how cost trends are accelerating at the early stages of production in lagged response to the recent leg of the commodity boom. The “core crude” PPI jumped 3.1% MoM and is now up 30.2% on a year-over-year basis. This is the very early pipeline stage.

At the same time, core intermediate PPI leapt 0.7% and is up 4.7% from a year ago. When we get to final core goods PPI, the YoY trend is running at a mere 1.2% (and -0.7% on a three-month annualized basis).

In other words, the closer you are to the commodity complex, businesses have greater pricing power. And, the closer you are to the consumer at the final stages of production, the less pricing power you have. (emphasis mine)

That’s not noise. It’s just further confirmation that equity valuations are too high.

The Fed can’t manage the economy, but they can still do interesting research

The Breadth of Disinflation

By Bart Hobijn and Colin Gardiner

In recent months, inflation as measured by the personal consumption expenditures price index has been trending lower. This slowdown, known as disinflation, has raised concerns that inflation might actually drop below zero and enter a period of deflation. An examination of the distribution of inflation rates across the range of goods and services that compose the index suggests that downward pressures on inflation are relatively high by historical standards.

For the full paper, click here. I continue to believe that debt deflation will put downward pressure on the traditional stores of value (real estate, equity, bonds), while monetary and fiscal policies will haphazardly put pressures on “needs” or inputs – biflation. This will have the effect of squeezing margins, and increasing pricing uncertainty, which in turn will make it difficult for businesses to invest and plan. Coupled with high unemployment, increasing unfunded pension liabilities, and geopolitical instability, the “fingers of instability” which we have discussed in the past are now long and networked – meaning a small disturbance can have large consequences.

Brazil tries to push money away

LOS ANGELES (MarketWatch) — The Brazilian government has raised the tax on fixed-income foreign investment to 6% from 4%, according to news reports Monday evening. It also raised the tax on margin deposits on futures markets to 6% from 0.38%. Earlier this month, the government, in its bid to cool the rise of its currency /quotes/comstock/21o!x:susdbrl (USDBRL 1.6720, +0.0078, +0.4687%) , doubled the so-called IOF tax on foreign fixed-income investment, multi-market funds and equity funds to 4%. “We continue to believe that the authorities will continue to tinker with its toolbox to find the right combination of policies to curb excessive [real] appreciation,” wrote Win Thin, global head of emerging markets strategy at Brown Brothers Harriman, in a note late Monday. “The tax on margin deposits appears to be geared towards addressing speculative, leveraged bets on the currency,” he wrote.

From Marketwatch.com.

As emerging markets try to cool speculative appreciation, the pressure is on Bernanke & Co. to print more if they want to continue down the path of stimulating inflation. The real question is whether emerging markets will be more careless and flamboyant than Bernanke. I happen to think that we’re at an inflection point and even Bernanke won’t be able to debase the dollar that much more against the emerging markets, Europe, Japan, and the rest of the world. He might try, but they’ll try harder. It’s a scary situation regardless of who “wins”, since we’ll all be the worse off for it.

Next up: protectionist measures, tarriffs, increased taxes on foreign investors, and roadblocks to trade. Not a great situation.