 | | The Daily Reckoning | Monday, December 5, 2011 |
- Eric Fry introduces the “risk way on” trade,
- Dan Amoss: “We may even see the Fed and the ECB lend to the IMF,”
- Plus, Bill Bonner on the pride before the fall, mounting debts and plenty more...
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|  | | | | Risk Way On | | Why “Risk On” Trades Have Suddenly Become Fashionable | | |  | | Eric Fry | Reporting from Laguna Beach, California...
The stock market rallied big-time last Wednesday after the Fed and a gaggle of other central banks announced their latest scheme to rig the financial markets. On the surface, the central banks merely promised to cut the cost of borrowing dollars. Beneath the surface, as we explained last week, the central banks committed themselves to subtle forms of money-printing.
The transition mechanisms that will provide all the yummy goodness to the financial markets are called “swap lines.” And even though most investors probably don’t understand exactly what they are or exactly why they are supposed to be such a great thing, the Dow Jones Industrial Average rallied nearly 500 points immediately after the Fed announced them. At the same time, investors dumped their “safe haven” Treasury bonds. Professionals refer to this kind of market action as the “risk-on trade.”
Investors tried to put on even more risk during Thursday’s and Friday’s trading sessions...but they couldn’t seem to keep it on. The Dow jumped 80 points Thursday morning, before ending the day with a small loss. Friday morning, the Blue Chips soared 170 points, but then slumped into losing territory by the close. In other words, “risk on” in the morning, “risk off” in the afternoon.
“Risk on” and “risk off” are, of course, the two newest catch phrases in the CNBC talking-head lexicon. But you editor would like to submit a third catch phrase for consideration — the “risk way on” trade. That trade seems to be the one most folks are putting on these days, but there’s no name for it.
In other words, the investment world is full of pricey assets, denominated in questionable currencies. Sure, stocks are risky. But everyone knows that already. What everyone does not seem to know is that the “risk off” Treasury bonds may be just as risky, if not riskier than stocks. A 10-year obligation of a heavily indebted government feels very “risk on” — especially when that obligation yields a paltry 2% per year and is denominated in a currency the Federal Reserve is actively and unapologetically printing.
If that’s “risk off,” please give us a heaping portion of “risk on”...especially because the Fed’s spiffy new swap lines merely add to the risks. As recent history demonstrates very clearly, the form of central bank intervention tends to produce lots of volatility, but not much else.
Just two months ago, for example, the Federal Reserve and several other central banks announced “coordinated action” to provide US dollar swap lines that would provide “excess liquidity” through the end of the year. US stocks bounced about 3% on the news, but then tumbled about 10% over the ensuing two weeks.
During the 2008 crisis, a series of “coordinated intervention” announcements produced even more dismal results.
NYSE floor trader, Art Cashin, provides an insightful retrospective:
A friend and floor alumnus, Terry Reilly, passed along this review of prior coordinated moves by the central banks on dollar loan swaps and how the markets reacted:
Lehman Bros. collapsed on September 15, 2008. Swap lines were initiated with the Bank of Japan, Bank of Canada and the Bank of England on September 18...[Prior to the announcement], the Dow was at 10,600 and it would rally 700 points during the next two trading days. But it would reverse course and close at 8,450 three weeks later.
On October 13, 2008 the Fed took off the limits on swap lines and the market soared 930 points the next day from 8,451 to close at 9,387. The market would reverse course again and close at 8,175 within two weeks.
Swap lines were extended with the Central Banks of New Zealand, Brazil, Mexico, Korea and Singapore on October 28. The market rallied 1,400 points in just 5 trading days from 8,200 to 9,600 only to find itself at 7,550 within the next month. The difference in 2011 is that we haven’t had a large systemically important institution fail — yet... Was this response to the crisis done with the knowledge of an impending failure? Did [the central banks] get out in front of a looming large systemic failure that would have been brought on by a lack of liquidity? “Yes” is the answer, according to the King Report. “It appears that a big European bank got close to failure Tuesday night,” King relates. “European banks, especially French banks, rely heavily on funding in the wholesale money markets. It appears that a major bank was having difficulty funding its immediate liquidity needs. The cavalry was called in.”
Additionally, King speculates, problems here at home may have also spurred the cavalry into action. “Fed concern about Bank of America was probably a prime factor in implementing the latest scheme,” says King. “If BAC had fallen below $5, there could have been an avalanche of selling because some institutions cannot buy or hold a stock that is less than $5 per share. [Editor’s note: BAC hit $5.03 the day before the central bank intervention.] A cascading BAC could have generated an ‘Emperor has no clothes’ moment for BAC. (Buffett would have been chagrined). So it was imperative that someone closed BAC above $5 on Tuesday and that some scheme had to be implemented to drive the price higher on Wednesday.”
So just as expected/hoped, the markets rallied sharply on Wednesday, enabling BAC and a few other troubled financial institutions to live to fight another day. But the fight is far from over...and the troubled financial institutions are unlikely to emerge victorious, no matter how many times the central bank cavalry storms into battle.
As the King Report correctly concludes, “The crisis won’t be solved by cutting rates or by providing even more easy credit. The problem is not liquidity, which is at a record; the problem is solvency...The requisite purge & restructuring has not yet occurred.”
We agree. Prepare for another round of “risk off”...or maybe even “risk way off.”
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| | The Daily Reckoning Presents | | Print...Ready...Aim | | |  | | Dan Amoss | All central banks are desperate to stop stress from building in the global banking system. Despite what they say, job No. 1 of every central bank is to do whatever it takes to prevent a disorderly collapse of banks caused by “bank runs.” These central bankers are crazy, and nothing will stop them from supporting the status quo.
A group of the largest central banks in the world announced a coordinated easing program on Wednesday morning. This will involve printing more of their home currencies and lending these currencies to other central banks, which, in turn, will re-lend these currencies to local banks.
Many European banks have, essentially, been cut off from borrowing in the private credit markets. So central banks are going to ignore the fact that most of these European banks are insolvent and offer them easier and easier access to long-term funding in whichever currency they need to borrow.
The entirely predictable result will be similar to what we see in the US: zombie banks whose assets will feature fewer and fewer private-sector loans and more and more government bonds.
How is this supposed to foster global economic recovery? It seems like a perfect accelerant for global stagflation.
In other words, the world will have plenty of consumers, financed by government budgets, which are, in turn, financed by both compliant private banks and central banks. But will the world have enough producers?
The Fed and most of the other central banks believe the Western economies suffer from “deficient demand” and, therefore face the risk of “deflation.” But I disagree...vehemently. Bad credit needs to default and infirm corporations need to perish if the Western economies are to have any chance of beginning a new phase of renewal and growth.
But that’s not the plan that’s on the table. “Plan A,” in the modern playbook of central banking is to artificially support asset prices and to bail out sickly too-big-to-fail banks. The plan sounds like it could be relatively painless, but it will be extremely painful.
In the end, savers of paper money will pick up the tab — over a multiyear period — for all of these government- and banking-created disasters. The system of government, banking and central banking, as it’s currently configured, will force the responsible to bail out the irresponsible...once again.
Once central banks start lending to insolvent banks, there can be no orderly exit. When sovereign defaults occur — and they will, in Greece and Portugal, and probably Italy and Spain — there will be an acceleration of money-printing to keep the system propped up.
We may even see the Fed and the ECB lend to the IMF, which will re- lend cash to the PIIGS in the form of a “debtor in possession” loan that will, effectively, allow European banks to keep pretending that they have no losses on PIIGS bonds.
Here’s a fun game: Try to imagine your own fiat-money-driven, rule- changing scenario for “rescuing” the Western financial system. There’s a pretty decent chance the central bankers will try it at some point.
But there’s a big difference between press releases that goose the stock market and policies that foster genuine economic growth. This week, for example, the public in Greece and Italy are likely to be furious when their “technocratic” leaders from the banking establishment sign away their sovereignty to the EU and the IMF at this week’s summit. There will be more riots and strikes, which will make the goals of budget austerity even less likely than they are already.
Despite the obvious state of unavoidable depression in the PIIGS economies, the EU and ECB will get more and more radical in their tactics to protect the core EU banking system from collapsing under the weight of credit exposure to the PIIGS. All of this action is being done to protect banks, and as a result, will steadily suck the lifeblood from the private sector.
In short, I am not optimistic.
Therefore, my strategy at the Strategic Short Report remains the same: Identify the likeliest victims of the ongoing credit contraction in the private sector. American Airlines (AMR), a company I urged my subscribers to sell short several months ago was a classic example. AMR just filed for bankruptcy. There will be many more.
Regards,
Dan Amoss,
for The Daily Reckoning
Joel’s Note: The most important part of identifying the likeliest victims is, of course, ensuring you’re not one of them. Dan’s AMR play, which he closed out last week, gave his readers the chance to bank a 95% gain as the stock crashed into Chapter 11. Nothing “victim” about that.
And if, as Dan forecasts, a wash of bankruptcies awaits the massively overleveraged global financial system, adding a short strategy to your arsenal could not only help you avoid getting caught under a falling market, but could also help you turn the situation to your advantage.
His next prediction concerns a major European sovereign default. To learn which one will fall...and when...read his newly inked report, here.
| | | | | Bill Bonner | | Zombified Government Spending | | |  | | Bill Bonner | Reckoning from Baltimore, Maryland...
The huge rally on Wednesday of last week fizzled by the end of the week.
What a week. Full of sound and fury...signifying nothing.
Wednesday’s rally was the “seventh best day for the DJIA in 110 years,” reports our Bonner Family Office analyst, Chris Hunter. “And sure, this sounds pretty impressive. But it’s useful to bear in mind that the best day in history for the DJIA was on October 13, 2008 (when the index shot up 936 points). In the next few days the DJIA was down 11%. Then it shot up again by 15%. Then it nosedived by 25%. The next best day after that for the index was October 28, 2008. And the sixth best day came six days after the top of the Nasdaq bubble, on March 16, 2000.”
Yes, dear reader, the pride of a big rally is what goeth before the fall of a big dip. Or worse.
House prices were down again for another month — making 15 out of the last 16 with falling prices.
But last week’s news was mostly good. Unemployment went down. House sales went up. Manufacturing data was mostly good...unless you looked at the trends in Europe, which were all bad.
And the shopping news was mostly good too... Auto sales were healthy, said the papers. Gasoline was selling for under $3 a gallon.
All of which could lead a determined hallucinator to imagine that the whole Great Correction thing had been called off.
Wouldn’t that be something, dear reader? What if we weren’t just wrong about the details but about the whole shebang? What if the number of new job offers continued to increase? What if consumers continued to buy things? What if Europe got control of its debt problem...and America’s economy began to really grow again?
But wait...the growth of the last 30 years came from spending money we didn’t have. In Europe, the government spent it. In America, households spent it. In Britain, both spent it.
Could that happen again? Certainly, that’s what the feds are aiming for...by reducing rates in Europe and lending at zero in the US. And bailing out big debtors. Heck, we won’t rule out anything.
But there must be limits on how much debt an economy can take. And by all indications, we blew by those limits long ago. Take the whole developed world. Put together its debts. Those debts grew at an 11% rate throughout the last decade, nearly 3 times faster than GDP. Now, they’re 310% of GDP.
You’d think that would be enough to sink the planet into a global depression. At a 5% interest rate, the carrying cost of that debt equals 15.5% of total output. That’s zombie finance — paying for toys for children who are now grown up...and trips for people who are now dead. It’s as if the average working stiff were putting in nearly one day a week just to pay the costs of the past.
Government finances are the most zombified of all — as you would expect. In the US, for example, taxpayers pony up about $2.1 trillion per year. But the feds owe $15 trillion. This puts the ratio of revenue to debt at about 1 to 7. At 5% carrying costs, it would cost the feds $750,000,000,000 per year in interest — or about a third of tax revenues. That would leave only about $1.35 trillion to cover the costs of federal spending — which is now at $3.5 trillion per year.
And it’s worse. Because the feds also have to roll over about 40% of their debt in the next three years.
Of course, the rest of government spending is zombified too. Into our office on Friday walked a dear reader. It turned out he was a doctor, author of many textbooks on natural remedies and alternative cures and once a very high-ranking official at the National Institution of Health.
“Zombified?” he began. “You don’t know the half of it. Just drive up that corridor north of Washington. It’s filled with gleaming office buildings. Many of them are bio-tech businesses.
“What a business! Their research is done at taxpayer expense by the NIH...or funded by it. They come out with these shock and awe new drugs. And then, investors think they’ve got an Aspirin, Motrin or Viagra on their hands. So they go into the marketplace and sell billions in shares to investors. And then, they sell the patented drugs back to the government. The US government is the biggest drug buyer in the world. And it doesn’t quibble on prices. Because a lot of the people who work at NIH and other health bureaucracies know that if they want to make real money they’ll move up the road to the bio-tech companies...and with the salary and options they have a chance of making beaucoup money. It’s all very cozy.
“And the real story is that the pharmaceutical industry rarely comes out with a really effective and safe drug. When I go to the doctors I ask for a prescription for drugs that were developed in the ’70s. Not just because they’re much cheaper...but because they now have 40 years of experience with them. We know which ones are reliable and which are dangerous. We don’t know that with the new drugs. And most really aren’t very effective anyway.”
Not to be distracted...we return to our theme. Can such a corrupt, zombified and heavily-indebted world suddenly sprint ahead?
Normally, it would have to shuck off its burden of debt. Normally, the zombies would have to find honest employment first. We will keep an open mind, but our guess is that the smart money is still selling stocks on rallies...and buying gold on dips, not the other way around.
And more thoughts...
Our new friend mentioned the I-70 corridor from Washington, DC to Gaithersburg and Frederick, Maryland. It is a center of the “bio- tech” industry — very near the source of its funding, regulators, and market, in Bethesda.
You drive up towards Frederick. You pass shiny new buildings. Whole new suburbs. Bright foreign-made cars full of people who look like they might be Pakistanis, with PhDs in molecular science.
But keep going and the world changes. Once you pass by Hagerstown you are out of commuting range. Soon, you are in what could be the ‘real’ America. People drive pick-up trucks. There are few new houses. Few fancy restaurants. In fact, there may not be a single one between Hagerstown and Pittsburgh.
Some of Southwestern Pennsylvania’s mill towns are practically zombietowns. We used to visit Charleroi as a child, because our father’s brother lived there. That was in the 1950s and early ’60s. Coming from the Maryland tobacco fields, it seemed as is we had entered into the hub of sophisticated urban life. There were shops, bars, movie theatres. There were young people on the streets. Children playing in the alleys. There was music coming out of open windows...union hall dances...bars on practically every street corner...diners...new cars... And the place hummed to the rhythm of the steel mill by the river.
Today, everything has changed. We went up last week for our aunt’s funeral. The steel mills have shut down. Production has long since moved to Korea, India...the countries where the bio-tech engineers come from. We heard no whistles calling the workers to their posts. We saw no houses that looked as though they had been built in the last 4 decades. We saw no children. We saw almost no people at all, save those using walkers and canes.
The only industries seemed to cater to zombies.
“Did your doctor miss your cancer?” asked one billboard for a shyster lawyer.
“Injured on the job?” asked another...which seemed like an unlikely thing. We’d be surprised if anyone in town had a job.
It looked as though government had misallocated resources to the town, in an effort to make it appear that it wasn’t dead. A central pedestrian street had been tarted up. But there were no pedestrians. A modernesque building houses a local “development” authority, but there was no development to authorize.
You need a cheap place to live, dear reader? One house had a hand- painted sign on the door:
“House for sale. $1,000 down. $346 a month.”
How about that? You could buy the house next to it too...and open a Cappucino Bar. Don’t bother with the free Wi-Fi. Or the cappuccino for that matter.
We wondered: will the bio-tech corridor someday pack up and move to India too? Then, will Gaithersburg be as derelict as Charleroi?
*** Here’s our old friend Frank Giustra, writing in the Vancouver Sun:
We’ve been down this path before
As civilizations mature, they tend to make the same mistakes. We are in the middle of one of those mistakes right now...
The type of economic restructuring both America and Europe need is so difficult and painful that, even if the current political systems were functioning, it would still take many years and the kind of courage and sacrifice that does not seem to exist.
“What has been will be again, what has been done will be done again; there is nothing new under the sun.” Ecclesiastes 1:9
If, as an investor, you are looking at the US and Europe, and are confused by the barrage of sombre news relating to economic issues — such as stubbornly high unemployment, collapsing housing prices, soaring government-debt levels, waning consumer confidence and a precarious banking system — I don’t blame you. As far as I can tell, so are the legions of experts, media and politicians, those we have traditionally trusted to explain such complex economic and financial matters to us. And why have all the herculean efforts to save us from these maladies failed so miserably, despite the fact that we seem to be drowning in remedies?
It seems as though America and Europe are going down for the count. As Canadians, we have a solid financial system and a stable government that functions as it was designed to do. And yes, we Canadians can take comfort that we are somewhat shielded from the profligate and irresponsible policies of our American and European friends, but given their sheer size and our inter-connectedness, we can’t completely escape the collateral damage when the stuff eventually hits the fan.
As the above Ecclesiastes quote (generally attributed to King Solomon) suggests, history is replete with examples of repetitive behaviour. Observing the behaviour of today’s policy-makers, I suspect this quote is as valid today as it was more than two millennia ago.
We are in an unholy mess and however loudly the sane few may plead, the chances it will get turned around without disaster striking are slim indeed. The type of restructuring both America and Europe need is so difficult and painful that, even if the current political systems were functioning, it would still take many years and the kind of courage and sacrifice that does not seem to exist. One of these days, some unforeseen event, akin to the child in Hans Christian Andersen’s The Emperor’s New Clothes declaring “But he isn’t wearing anything at all!” may serve as the tipping point that brings the entire financial system to its knees.
To get a proper understanding of the current situation, we should start by ignoring all the noise propagated by the experts, media and elected officials.
Our global financial system is based on the very simple and fragile concept of confidence. So you can’t really blame the policy-makers and politicians for not telling the public the “entire” truth; feeding us constant reassurances, peppered with a little mendacity. And to make things worse, it’s just human nature for us, the recipients of this information, to reject the idea that the worst can happen, hence our willingness to find reassurance in the misinformation we are fed. But folks, the worst CAN happen.
I doubt the citizens of Imperial Rome ever considered that their empire, which stretched from the Atlantic Ocean to the Caspian Sea, would eventually collapse on itself from the sheer weight of effort and resources needed to maintain it, or that 16th-century Spaniards ever thought their high standard of living, sustained by the plundered riches of the New World, would disintegrate once the supply of gold dwindled.
Or that the upper-class 19th-century Brits leading up to 1918 ever fathomed that the sun could cease to set on lands ruled by the British Empire. History has shown that when great nations mature and over-extend themselves, they revert to the paths of least resistance: borrow and/or print money. They all did it and they all failed; this time will be no different.
If Einstein’s definition of insanity — doing the same thing over and over again and expecting different results — holds true, we should move to have all of America’s and European policy-makers locked up in padded cells.
This hubris — holding on to time-worn ideas about what made a nation great in the first place, but ignoring the hard sacrifice that went with it — has prevailed throughout history and is as relevant today as it was for every great nation that came before America and the European Union.
Still, the “experts” continue to reassure us that America was built on a foundation of entrepreneurial spirit; we can get ourselves out of any mess. (At least the Europeans know better than to preach such fantasy.) I sense that some of those ideas don’t hold up as well as they once did, especially as the world outside of America has become highly competitive.
At some point in the evolution of a great nation must come a time when the simple math of mounting debt, lack of productivity and printed money plays havoc with ingrained beliefs. This is one of those times in history.
Therefore, as much as I would love to provide solutions to this mess-in-waiting, I would rather give some thoughts as to how to protect yourself.
Consider the following precaution as a condom for your portfolio or savings: protection against STDs (savings’ total destruction).
The bottom line is that the money needed to bail out Europe and to fund America’s spiraling debt and future unfunded obligations is in the tens of trillions. IT DOES NOT EXIST. It has to be created by printing money in massive quantities, and despite all the rhetoric you will hear against such policies, in the end it’s the path of least resistance. Printing money is an invisible tax on savings, much easier to initiate, than, say, raising taxes or cutting back on services and entitlements.
However, there is a lag on its negative effects, a perfect policy tool for elected officials who inevitably kick the can down the road to future governments. Policy-makers in most democracies live in a 24/7 campaign mode, which prevents them from making difficult, long- term and most certainly unpopular decisions. Simply said, we operate in a system not conducive to decisive action.
Witness last week’s dismal failure by the US Congressional Super Committee to reach agreement after months of bitter negotiating on what was essentially a ridiculously minuscule reduction of the deficit over the next decade and you get the picture.
There will be a quantitative easing three (QE3) in the US and the European Central Bank (ECB) will eventually follow suit in printing money in American-style amounts, despite Germany’s resistance to date.
If the world continues to print money, currencies will be debased against “tangible things” such as gold, farmland, exclusive real estate, rare art and collectibles, select equities to list a few. Therefore, having your savings invested in cash, bonds, money and markets, could mean a complete destruction of those savings by runaway monetary inflation.
Having said that, timing is an issue you must weigh carefully. There is a chance that another financial crisis such as we experienced in 2008 would cause the value of real assets to go down and, by definition, make cash holdings more valuable for a short period of time, until further “printing” reverses the trend once more.
I would recommend owning plenty of gold and, depending on your available resources, select real estate and collectible art, which works well for wealth preservation, and having an adequate pool of cash, which would only be used to acquire additional “real assets” in the event of another crisis.
It’s your wealth, your life savings; you are the only person who can protect it.
No one else really cares.
Wake up and smell your future.
Frank Giustra is a Vancouver business executive with interests in the mining and filmmaking industries, and a noted philanthropist. Regards,
Bill Bonner,
for The Daily Reckoning
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