Retail Sales - Not Rosy Despite What the News Media Tell You

Just how much consumers are spending can be an important window into the prospects of the economy.  However, there is a risk relying on advance retail sales as it is based on quite a small sampling.

That being said, here is the key takeaway on the "rosy" numbers reported this morning:

Lets look at the year over year numbers first.  Total retail sales are down around 3% year over  year from a terrible October last year.  What green shoots exactly are we talking about?

Ex Autos picture is even clearer and down worse than the total number.  What's up? Autos, courtesy of the clunker program.

Now for a review of the month over month:
Change from prior month for Total Retail Sales: +4.7
Change in autos: +4.0

The majority of the increase in retail sales was a result of a rise in auto sales.

Anecdotal Stories from the Upper West Side of New York

These are personal stories I have heard or seen with my own eyes and ears the past 10 days:

Today at Gristede's Upper West Side:
I see a middle class guy leaving the store, despondent.  The counter clerk told me the guy was buying 2 packets of peanuts and the card only had $0.90 and the poor guy's bill was only able to cover 1 packet.   The guy told her that was all the money he had and the peanuts would be his dinner for tonight.  Happy Halloween, America.

Couple days ago Walking Down Broadway in the 80s:
A man walking down the street with his family of wife and two little girls.  I overhear the man say, "Sorry honey, I can't, I'm unemployed..."

Yesterday, was on my way back from Blockbuster and I looked into the faces of the people on a bus heading uptown and it broke my heart.  The saddest, most forlorn, broken, sad people that I can ever want to see.  Spirits broken.  Unhappy.

The coup de grace.  Today my landlord who happens to be Jere Burns - you can look him up on IMDB - has his third wife who is probably 20 years younger contact me and tell me that they are going to be taking over the apartment 1 month early.  No discussions, no nothing.  Why? Because Jere is going to be back in New York and wants the apartment.  I paid the guy for the full term upfront.  The wife maniacally called me every day while fedex was delivering the check, it felt so petty and embarassing to have to deal with her.  Obsessed with money.

I am back in New York after a few years.  I left during the dot com years because I was tired of the assholes that work here, tired of the hustlers.  But when I left people were happy.  You could still see people walking down the street laughing and cheerful.  Today it is hard to find people walking down the street smiling, at least where I live on the UWS.

Even so, I find that New York is far better than the rest of the country and is faring relatively well.  Prices of real estate have corrected but there are no foreclosures in Manhattan, a few in the suburbs.  The UWS is still a tough place to find an apartment, being one of the more desirable places in the city for families.

The city has become the poster child and in some ways always has been the poster child of what is right and wrong with our country.  We can all form our own conclusions. I would love to hear your thoughts.

What Could Possibly Go Wrong With the Recovery?

Debt
Just one month into the 2010 fiscal year, the U.S. government is on track for a record $2 trillion annual budget deficit.  That’s the word from the Treasury Department, which quietly announced a $176.4 billion October budget deficit yesterday.

The U.S. government finished its historic streak of debt sales today with a record $16 billion offering of 30-year bonds, auction results on the weak side. This was on top the $65 billion in 3-year and 10-year paper auctioned earlier this week, both records in their own right.

“The market is sending many errant signals right now,” notes Dan Amoss. “U.S. policymakers are trying to reinflate stocks, houses and wages, while also recapitalizing an undercapitalized banking system with overt and covert subsidies. All of these actions are extraordinarily costly — so costly that creditors are getting nervous.

“A failed auction for U.S. Treasuries, looking out over the next couple of years, is not out of the question. 

If this happens, conditions in the interest rate derivative market, with a notional value in the hundreds of trillions of dollars, could get ugly fast.

The question then becomes: who bails out the federal government? The Fed’s printing press could be cranked into overdrive, but if holders of dollars look to get rid of them as quickly as they’re created, this sort of policy route will losing its potency over time.

The U.S. is not Japan, We are Worse
the US economy is not exactly like the Japanese economy. Japan had high savings…and a positive trade balance. It could run up huge government debts and “owe it to itself.” It could finance its government debts with the savings of its own people, in other words. It never had to worry about foreigners refusing to buy its bonds…or selling them suddenly.

America’s government debt is different. The US doesn’t save enough to finance its own deficits. So it depends on the kindness of strangers. And if those strangers ever lose faith in America’s ability or willingness to repay its debts, they’ll drop the dollar like an annoying girlfriend. 

FHA Cash Reserves At All Time Low
The Federal Housing Administration said Thursday morning that its cash reserves had dwindled significantly in the last year after a record drop in home prices.

The results of the F.H.A.’s annual audit showed the agency’s capital reserves to be 0.53 percent, far under the 2 percent minimum mandated by Congress. A year ago, the capital reserves were 3 percent.

It is tightening loan standards in hopes it will not become another drain on the United States Treasury, but is reluctant to clamp down so much that it snuffs out the tentative recovery in housing.

During the news conference, Secretary Donovan and the agency’s commissioner, David H. Stevens, said that the cash reserve, the figure that has fallen to 0.53 percent of loans outstanding, was merely a supplement to a much larger fund that the F.H.A. was holding against expected losses. Between the two accounts, the agency has $31 billion to cover losses over the next 30 years.
Barofsky Says TARP ‘Almost Certainly’ Will Bring Loss to U.S.

New Mortgage Applications Plummet
Housing demand is not sustainable. Applications for new mortgages, announced Thursday morning, dropped sharply in the previous week to levels not seen in almost a decade. This decline was consistent with Toll Brothers' (TOL Quote) conference call on Wednesday, in which the company's Chairman described demand since Labor Day as uneven.

I don't see what replaces housing as a driver to growth -- the sector was responsible for over 40% of job growth in the 2001-2007 period.

IEA Says Rising Oil Price Risks Derailing Economic Recovery
The International Energy Agency Thursday revised it 2010 world oil demand forecast slightly higher, but warned that rising crude prices, if sustained, risk smothering the fragile economic recovery underway.

Dollar Dying
We have a Federal Reserve and Treasury which have agreed to double team the ailing dollar as they print money to no end and effectively punish the prudent while rewarding the speculators (the same bastards that helped create this mess to begin with).  Our tax issues have not yet reared their ugly head, but trust me, they are coming.

Massive Govt Revenue Shortfalls
What we haven’t quite dealt with is how the government is going to overcome their massive revenue shortfalls and ever expanding debt.  As Jim Jubak recently described, they are going to come back to the consumer for another blow to the knees.  No, the bailouts weren’t enough.  Destroying the dollars in your pockets isn’t enough. Because of their fiscal irresponsibility they are going to raise your taxes in 2010.  And don’t be fooled.  The income tax may not spike, but they will get you in every other way they can. Sales tax, real estate taxes, etc etc. You are paying for their mistakes. Whether you were prudent or not.

Municipalities are in financial disarray and won't provide their normal anchor to growth - 10 states face financial peril
Dropping tax revenue, rising unemployment and yawning budget gaps are wreaking havoc in states from Arizona to Wisconsin, a new report shows. The 10 most troubled states are: Arizona, California, Florida, Illinois, Michigan, Nevada, New Jersey, Oregon, Rhode Island and Wisconsin.

Other states -- including Colorado, Georgia, Kentucky, New York and Hawaii -- were not far behind.

Already, less than five months into fiscal 2010, several states are looking at additional budget cuts.

And in California, Gov. Arnold Schwarzenegger said Tuesday that his state is facing a budget gap of up to $7 billion.  Budget projections show that states could face deficits as large as $260 billion in 2011 and 2012 after stimulus funding is exhausted. State economies usually take up to two years longer to recover after the nation's fiscal health begins to improve.

Yet More Bubbles & A Warning from Donald Tsang

The Federal Reserve’s policy of keeping interest rates near zero is fueling a wave of speculative capital that may cause the next global crisis, Hong Kong’s leader said.

“I’m scared and leaders should look out,” said Donald Tsang, chief executive of the city, said in Singapore today. “America is doing exactly what Japan did last time,” he said, adding that Japan’s zero interest rate policy contributed to the 1997 Asian financial crisis and U.S. mortgage meltdown…

“We have a U.S. dollar carry trade at the moment,” Tsang, 65, said in a speech where leaders of the Asia Pacific Economic Cooperation forum are gathering for a weekend summit. The carry trade is where investors borrow cheaply in one currency and use the funds to invest in other currencies.

“Where is the money going — it’s where the problem’s going to be: Asia,” Tsang said. “You can see asset prices going up, not only in Korea, in Taiwan, in Singapore and in Hong Kong, going up to levels that are incompatible or inconsistent with the economic fundamentals.”

A sampling of recent inflationary developments
* A 15 percent increase in health insurance premiums for small businesses

* A 50 percent increase in car rental costs

* A 15 – 25 percent increase in long-term care insurance rates for California retirees

What Could Possibly Go Wrong? S&P 1200 here we come

Consumer Sentiment One of the Few Accurate Econ Stats Is SkyDiving

Consumer Sentiment - Huge Miss

Released on 11/13/2009 9:55:00 AM For November, 2009 Prior Consensus Consensus Range Actual Sentiment Index - Level 70.6 71.0 69.0  to 72.0 66.0

Highlights Consumer confidence is having a fainting spell. The Reuters/University of Michigan's reading on confidence, the consumer sentiment index, fell back a very steep 4.6 points to a very weak 66.0. Weakness is split between current conditions and the outlook. Inflation expectations remain subdued. Consumer confidence is declining even as manufacturing, housing and even retail report concrete improvement. The weakness is rooted in the still contracting jobs market.  But note that movements in consumer confidence data don't always track movements in retail spending. The retail trade report for October, where the outlook is good, will be Monday's highlight.

Treasuries Not Confirming

This pretty much sums up my views at this point, coming back to the key question of inflation or deflation.  What will win in both scenarios is Gold.  I agree with Rosenberg below.  The finance mafia are going to inflate stock prices and destroy the dollar which in turn will unleash inflation on the masses.  This is exactly what the Fed wants.  Higher oil ditto.  A low US dollar makes Americans poorer.  While the U.S. wants to see inflation take hold, in the end, the U.S. consumer is unwilling to reflate.  Reference the consumer credit report last Friday. Easy money is chasing assets.

But treasuries are still signalling deflation.  And like Rosenberg, I still believe the deflationary forces in wages, consumer fear, layoffs, a weak consumer balance sheet, rising inflation in commodities and imports, are going to exert strong forces nearer term on consumers.  The Fed's linkage intended to come through housing and asset reflation will be offset by continued bankruptcies, option arm defaults etc. 

Via ZeroHedge & Rosenberg: Another reason to be bullish on gold is the recurring trade spats. Indeed, this is good news for the commodity complex as security of supply resurfaces — see China Attacks U.S. in Fresh Trade Spat” on page 2 of the weekend FT. If it’s not Chinese-made tires fingered by an increasingly protectionist U.S.A. one day, it’s steel pipe the next. This latest anti-dumping measure by the United States is facing a severe rebuke, as per the press reports, in China.

In addition to these trade protectionist actions, there is also the matter of more stimulus measures being undertaken in a mid-term election year at a time when the Treasury is expanding its debt issuance to new records right across the maturity spectrum. All anyone needs to do is have a look at the article Congress’s Blank Check For Housing in the weekend WSJ — to see this happening at a time of 10% budget deficit-to-GDP ratios, had indeed become a bottom-less fiscal pit.

Since the USA will not default, not raise taxes nor cut spending, the only logical recourse will be to print vast sums of U.S. dollars to fund this surreal foray into deficit finance. In other words, reflate. As we keep on saying, under Dr. Bernanke’s tenure, the monetary base has risen twice as much as nominal GDP has and the two lines continue to diverge. At the same time, gold production peaked a decade ago. It’s all about scarcity of supply, and as Sri Lanka’s central bank just reminded us, and India before that, there are buyers with deep pockets lining up to diversify into bullion. Here are the ‘what if’ realities stack up:

• If India were to lift is gold share of FX reserves from 6% to 20%, where it was during the strong U.S. dollar policy days of 15 years ago, we estimate that gold would go to $1300/ounce.
  
• If China were merely to copy what India just did and raise its share to 6%, then gold would go to $1,400/ounce, based on our in-house analysis.
• If the USA were to go back to a 40% ratio of gold reserves to money supply (using the monetary base), where it was a century ago when the Fed was first created, from 17% currently, that would equate to three years’ supply of bullion, and alone take the gold price up to $2,750/ounce, based again on our research on price sensitivities to central bank buying activity.

Now gold is in a secular bull market and by no means are we suggesting that everyone line up at the vaults right this second — for the time being, it is too much front page news and a crowded trade, so it won’t hurt to wait for a pullback and get in at better prices (as an example, see Inside the Global Gold Frenzy on the front page of the Sunday NYT business section).

You see, when Bob Farrell wrote “The 10 Market Rules to Remember” he made sure that they were interesting reading and in doing so, some people get a laugh out of Rule Number 9 (“When all the experts and forecasts agree, something else is going to happen”) and Rule Number 10 “Bull markets are more fun than bear markets”). Nevertheless, they are just as important as the other eight rules. The obvious reason why Rule 5 is important (“The public buys most at the top and least at the bottom”) is that it also captures the inverse relationship between sentiment and the position of the market (ie, bullish sentiment peaks when the market tops and turns down and bearish sentiment peaks when the market bottoms and turns up). All that “agreement” adds enormous credibility to conventional opinion, just when it is most important to envision and prepare for the contrary. Lately, (you) have been experiencing shock at the policy responses by the U.S. government relative to the credit crisis and economic slowdown. Policies that encourage increased indebtedness by households and businesses are combined with massive deficit spending and Federal Reserve balance sheet expansion and the latter particularly, has enormous inflationary implications while exerting downward pressure on the value of the U.S. dollar. The problem with this understanding is that most everyone agrees.

To wit: According to Consensus Inc., bulls on the U.S. dollar are currently at 28%. Bulls on Treasury bonds are currently at 59% after hitting a low of 21% in early June when rates peaked in this cycle. Bulls on gold are at 78%. Bulls on the stock market are at 74% and they haven’t been that high since October 2007. It has become a crowded trade, and something very contrary to the expected outcome is likely to occur, at least over the near term.

Walter Murphy, our favourite technical analyst, expects a substantial rally in the U.S. dollar and a decline in gold over the medium term, even if those moves are counter-trend. He thinks that the war is on inflation, but the battle is deflation and this is a bear market rally in stocks. We have said repeatedly that it seems too early to call for an economic expansion with so much unfinished business in the process of household balance sheet repair. And, keep in mind that the deflationary forces emanating from the household are much greater than the inflationary forces associated with government stimulus, at least so far.

What Is Being Missed By the Unemployment Report & Structural Issues

One of the items that no one refers to that is different this time around is that over the past decade, businesses figured out a way to hire employees without having to take on the burden of payroll taxes, insurance etc on behalf of these employees.  For instance

• All real estate companies hire real estate agents as independent contractors
• All mortgage brokers hire mortgage agents as independent contractors
• Recently, I have become aware that even small hedge funds are now involved in the practice of hiring employees as independent contractors
• A huge number of freelancers in advertising, legal and other services industries are hired as independent contractors
• and so on..

This is yet another way that businesses figured out to screw workers out of benefits, reduce costs, reduce legal benefits.  The practice is pervasive across a large number of industries.

My question is what happens to U6 when we add in all the brokers, mortgage agents, construction workers, graphic designers, legal associates etc that have quit.  Remember as an independent worker, the company that hires you has no costs incurred for keeping you on as an employee.  I don't need to remind you what a shamble real estate has been the past few years with a pickup only occurring in the past few months.

The real unemployment numbers, whether you look at U6 or the reported unemployment rate, is far worse that what is being reported.

Structural Destruction
As a bull, there really is nothing in this data, nor in the initial claims data that supports the optimism of the bulls.  Consumers continue to lose over 500,000 jobs a month.  We are now close to a point where the structural impacts become damaging.  Companies are thriving by laying off workers and reporting no top line growth but bottom line earnings.  But earnings are driven by consumer spending.  The feedback effects have been muted to date as a result of massive stimulus spending. 

What's Coming
Over the coming months, option arms will reset, commercial real estate is about to collapse, the states are in financial shambles and the consumer is dying.  Valuations are at ridiculous levels.

Enjoy the optimism.  Unfortunately, in coming months, the reality is about to hit and we will not get back to this level of confidence for many quarters.

Rising Productivity, Euro Sales, Falling Wages - Consumer Is Getting Squeezed

Three pieces of news out today and while we all know the take that the media will take on these is wildly optimistic, bringing buyers into the market, my take is all three are actually a commentary on a European/U.S. consumer that is being squeezed at work, spending less, feeling less confident and making less money.  None of these are good signs for the bulls.

Some sobering data about the recovery:  Retail sales post surprise fall
As the recovery gets underway, the key component - the consumer - is missing.  This is primarily the result of the policies pursued both sides of the Atlantic - namely preserving the status quo structure, implementing policies that only benefit the few while increasing the debt burdens of the many.

LONDON -- Retail sales in the 16 countries that use the euro fell for the third straight month in September, indicating that, with unemployment on the rise, consumer spending has yet to provide a support for growth.

The European Union's statistics agency Eurostat said Thursday that sales volumes in the euro zone fell by 0.7% in September from August and declined 3.6% from September 2008. The decline was unexpected, with economists surveyed by Dow Jones Newswires last week estimating that sales grew 0.1% on a month-to-month basis.

The August data were revised to show a 0.1% fall on the month, having previously recorded a 0.2% drop.

Consumer confidence has rebounded from its collapse early in the year, but rising unemployment will likely be a drag on spending for many months to come.  Sales of food and drink fell 0.9% on the month and 2.3% on the year, while nonfood sales declined 0.6% on the month and 4.1% on the year. In the 27 EU member countries, sales fell 0.4% on the month and fell 2.5% on the year.

Productivity Surge Signals Job Growth to Follow was the headline.  

The Labor Department said on Thursday that productivity surged at a 9.5 percent annual rate, the quickest pace since the third quarter of 2003, as companies squeezed more output from a smaller pool of labor to hold the line on costs.

Isn't this a different way of saying that there is no topline growth in the economy and companies are squeezing profits by cutting costs.

Meanwhile, deflationary pressures continue to filter through wages.

Unit labor costs fell 5.2 percent last quarter after declining 6.1 percent the previous period. Analysts had forecast a drop of only 4 percent.

Breaking Down the Bull Argument from David Dreman

This Month in Forbes by David Dreman :

Is Recession Normal? No
David Dreman, 11.16.09, 12:00 AM ET

Let's look more closely at the bear case. While it's true the market has had an enormous rally since early March, it is important to remember that it had fallen more precipitously than at any time since the Great Depression. The financial sector of the S&P 500, for example, fell 83% between June 1, 2007 and Mar. 6, 2009. This sector's decline was steeper than the overall market's decline between September 1929 and the 1932 low. So yes, this rally is strong and sharp, but remember that it comes off the worst stock market drop since the 1930s. It still hasn't really come close to recovering the ground it has lost. The Financial Select Sector SPDR Fund (XLF) is trading at 60% below its 2007 high.
So please don't judge the current rally in the context of typical market cycles. Remember, about a year ago our global financial markets were in a state of panic. If you check market history, you will see that the rallies following such panic attacks tend to be sharper and swifter.

As I point out in one of my previous posts, we agree that rallies are sharp and vicious off severe selloffs.  No arguments there.  But neither has the case for a new bull market been made yet by Mr. Dreman.

And please don't fixate on trailing price/earnings ratios. Multiples are inflated because earnings are depressed. It's that simple. We are in a severe recession, and hundreds of companies have ailing income statements.

Stock market investors aim to see around corners, and they should be doing that now. Corporate earnings will be down sharply this year (particularly if you include writeoffs), but they will rebound over the next three years. I can't tell you how quickly the recovery in earnings will come, but I am sure it will come. Go back to that market of 1932, when the Dow Jones industrial average bottomed out at 41.22. The Dow almost tripled within the next three years, even though it took earnings almost five years to catch up to where they were before the crash. In short, it's normal for stocks to rebound ahead of earnings.

Mr. Dreman is comparing the current cycle against the Depression.  Fine.  It took the market three years to bottom and during that time there was in fact a 50% rally.  But the market fell another 80% after that.  Further, the market did not get back to the levels of that initial 50% rally of roughly 300 on the Dow until 1954!  That is 22 years later Mr. Dreman.  Not a convincing argument that we are to look blindly into the abyss and trust that earnings will recover, debts will be repaid, valuations will catch up to the market.

I'd be more inclined to be receptive if the market exhibited characteristics of a bottom.  The market was overvalued compared to historical metrics at bottoms on Price / Sales, Price / Earnings, Dividend Yield.  Bottoms are also usually accompanied by hatred, revulsion.  Markets tend to die a slow death and then are born anew when no one is watching.  Granted we got revulsion from a section of the market, but market participants were frothing at the bottom. That by definition is not a true bottom.  I am not convinced by a long short.

The bears have a different view. They think the economic malaise will last for years or even decades, as in post-1989 Japan. Get used to a new normal in our economy, they say, one in which growth is sluggish or nonexistent for a whole generation. I say rubbish.

The great global investor John Templeton (1912--2008) said that the four most dangerous words in investing are "This time it's different." In more than 30 years of managing money I have witnessed many a shift in market sentiment. It lurches from irrational exuberance (as with tech stocks a decade ago) to irrational gloom (bank stocks in March). I just don't accept today's gloomy view.

In fact Mr. Dreman you're the one asking for blind faith and telling us this time is different, that the market can avoid historical characteristics of stock market bottoms, that we can issue mountains of debt to work off a debt crisis, that there is a fundamental loss of moral hazard, that the consumer is tapped, that Japan is in a debt and demographic crisis and will not assist in this recovery, ditto U.K.

Finally you Mr. Dreman are another child of the bubble in U.S. prosperity of the past 30 years and your automatic assumption, similar to Washington Politicians, is that the U.S. will revive because it has always done so in the past 30 years.

I would point you to this weeks Barrons article on the Depression.  Everyone underestimated the depth of the correction because there hadn't been a severe correction in over 20 years.  Ignore history at your own peril, Mr. Dreman.

Japanese Demand for U.S. Debt Is Bound to Weaken Dramatically

By way of the always dramatic and usually accurate Ambrose Evans comes this piece that ties in with my view that markets are not recognizing the severity of the Japanese situation and how this will impact future purchases of U.S. Treasury securities.

It is Japan we should be worrying about, not America

Japan is drifting helplessly towards a dramatic fiscal crisis. For 20 years the world's second-largest economy has been able to borrow cheaply from a captive bond market, feeding its addiction to Keynesian deficit spending – and allowing it to push public debt beyond the point of no return. 

The rocketing cost of insuring against the bankruptcy of the Japanese state is telling us that the model has smashed into the buffers. Credit default swaps (CDS) on five-year Japanese debt have risen from 35 to 63 basis points since early September. Japan has suddenly decoupled from Germany (21), France (22), the US (22), and even Britain (47). 

Implications: The Japanese carry trade is likely to continue losing favor, leading to a strengthening impact on the Yen and weakness for the Dollar.

Secondly, the rapidly deteriorating situation makes it increasingly a fait accompli that the Japanese will not be able to continue their Treasury purchases at a time the U.S. desperately needs their support in the wake of the Fed's completion of their $330 billion purchase program.

Simon Johnson, former chief economist of the International Monetary Fund (IMF), told the US Congress last week that the debt path was out of control and raised "a real risk that Japan could end up in a major default".

The IMF expects Japan's gross public debt to reach 218pc of gross domestic product (GDP) this year, 227pc next year, and 246pc by 2014. This has been manageable so far only because Japanese savers have been willing – or coerced – into lending for almost nothing. The yield on 10-year government bonds has been around 1.30pc this year, though they jumped to 1.42pc last week. 

"Can these benign conditions be expected to continue in the face of even-larger increases in public debt? Going forward, the markets capacity to absorb debt is likely to diminish as population ageing reduces saving," said the IMF. 

The savings rate has crashed from 15pc in 1990 to near 2pc today, half America's rate. Japan's $1.5 trillion state pension fund (the world's biggest) has become a net seller of government bonds this year, as it must to meet pay-out obligations. The demographic crunch has hit. The workforce been contracting since 2005.
The pillars of the government debt market are crumbling. If Japan's bond rates rise to global levels of 3pc to 4pc, interest costs will shatter state finances. 

Japan is descending into a debt situation where it is only a matter of when not if.

No one knows exactly when a country tips into a debt compound trap. But Japan must be close, even allowing for the fact that liabilities of the state Loan Programme (FILP) have fallen by 40pc of GDP since 2000. 


"The debt situation is irrecoverable," said Carl Weinberg from High Frequency Economics. "I don't see any orderly way out of this. They will not be able to fund their deficit. There will be a fiscal shutdown, a pension haircut, and bank failures that will rock the world. It is criminally negligent that rating agencies are not blowing the whistle on this." 


"This is incredibly dangerous," said Russell Jones from the RBC Capital Markets. "The rate of deflation is shocking. The debt dynamics are horrible and there is the risk of a downward spiral." 

And some particularly ominous conclusions that portend where we think U.S. strategy is headed:

It wasted its immense fiscal firepower, scattering money for 20 years on half-baked spending projects to keep the economy afloat. QE was too little, too late, and this is the lesson for the West. We must cut borrowing drastically over the next decade, and offset this with ultra-easy monetary policy. Does Downing Street understand this? Does the White House? Does the European Central Bank? Clearly not.

 

Are You A Child of the Bubble?

Many investors – as well those in charge - have grown up without knowing or experiencing anything but a bull market in the U.S.  Since the 1950s America has been dominant and the expectation is that this dominance will continue.  As a result our leaders have made and continue to make choices that assume the continuation of trends of the past years.  Sadly, this is a reason why this recession and its consequences will last with us for a long time.

Let’s review some of the economic challenges that still lie ahead of us.

Option ARMs are a disaster – 30 day + delinquincies are reaching close to 50% of all outstanding option ARMs.  The St. Louis Fed has stated that they were concerned about Option Arm and Alt-A loan delinquency rates. Delinquencies have moved steadily higher with the 30 day + delinquency now reaching close to 50% of all outstanding Option Arms.

The thing about these products is that the minimum payment is at times less than half what a fully amortizing normal payment would be and the borrowers that chose these did so in the past few years and are now sitting on negative equity.  Loan modifications are not feasible in almost any scenario and the incentive is to walk away.  Housing has not bottomed by a long shot.

Sentiment Is Dipping .. came out of Gallup yesterday


Sentiment about the economy is starting to backslide, after a brief tip up.

Fifty-eight percent of those polled say the economic slide still has a ways to go, up from 52% in September and back to the level of pessimism expressed in July. Only 29% said the economy had "pretty much hit bottom," down from 35% last month.

64% said the rise of the Dow Jones Industrial Average didn't have much impact on their views of the economy. Just 42% said the economy will get better in the next 12 months, down from 47% in September. In contrast, 22% said things would get worse, up from 20%.

Bottom line, consumers are not feeling more confident about the recovery because they have not participated in the recovery.  The recovery has been driven by stimulus money which is finding its way into the banks and bonuses.  Does a 30%+ jump in Hamptons sales tell you where the money is headed?  It also explains why New York city has held up relatively well compared to the rest of the country.  But New York and Wall Street are not the economy.

We Just Had the 3rd lowest sales for September since the Census Bureau started tracking sales in 1963

Calculated Risk reports on New Home Sales.  The Census Bureau reports New Home Sales in September were at a seasonally adjusted annual rate (SAAR) of 402 thousand. This is a decrease from the revised rate of 417 thousand in August (revised from 429 thousand).

Even uber-bearish housing analyst Mark Hanson was taken aback by the shortfall in home sales this morning. Even he thought that the remaining homebuyer tax credit, plus all the other stimulus out there, would produce a rise in new home sales.

But no. September was the worst month since 1981.

Permanent Bailouts for the Top 20 Banks?

Paul Volcker and senior Harvard economist Jeffrey Miron both testified to Congress this week that the government is trying to make bailouts for the giant banks permanent.

Writing Wednesday in The Hill, Congressman Brad Sherman pointed out that :

In my opinion, Geithner’s proposal is “TARP on steroids.” Section 1204 of the proposal [the proposal being the "Resolution Authority for Large, Interconnected Financial Companies Act of 2009"] allows the executive branch to use taxpayer money to make loans to, or invest in, the largest financial institutions to avoid a systemic risk to the economy.

TARP was limited to two years, and to a maximum of $700 billion. Section 1204 is unlimited in dollar amount and is a permanent grant of power to the executive branch.

When I asked Geithner whether he would accept a $1 trillion limit on the new bailout authority (if the executive branch wanted to spend more, it would have to come back to Congress), he rejected a $1 trillion limit, insisting that the executive branch be able to respond without coming back to Congress.

That is a huge gravy train to the top 20 [financial institutions] because it allows them to borrow money at a lower rate. Think of what this does to moral hazard.

A sustainable recovery with 530,000 weekly claims?

That’s what we seem to be expecting based on the huge uptick in equities since March. While stock markets have long since moved it up a gear, the employment market is stuck in neutral. The latest seasonally-adjusted jobless claims numbers came in at 530,000. The widely-followed four week average is still 526,250 and is not coming down.

Global Economies Are Not Doing Any Better – Greece Downgraded

Last week, Fitch downgraded Greece's foreign and local currency ratings from A to A- due to a ballooning deficit that has spiraled out of control.

Now, Moody's is also considering a cut for Greece. It's an understandable move, considering that Greece's increasing deficit is already 12.5% of its GDP.

Moody's: "The deterioration of the fiscal position raises serious questions about the sustainability of Greek public finances and the problem will be compounded by a less favourable global economic environment going forward," says Arnaud Marès, a Senior Vice President in Moody's Sovereign Risk Group.

Why Japan Is In Worse Shape Than the U.S.

Another on target analysis and the reason why it makes sense for all investors to protect themselves from an inflationary spiral in the U.S.  Secondly, many investors are looking to diversify out of dollars, are Yen really that better a choice?  What about the pound or the euro? lots of issues there as well. 

Japan appears vulnerable, because it is even more indebted and its poor demographics are a decade ahead of ours. Japan may already be past the point of no return. When a country cannot reduce its ratio of debt to GDP over any time horizon, it means it can only refinance, but can never repay its debts. Japan has about 190% debt-to-GDP financed at an average cost of less than 2%. Even with the benefit of cheap financing the Japanese deficit is expected to be 10% of GDP this year. At some point, as American homeowners with teaser interest rates have learned, when the market refuses to refinance at cheap rates, problems quickly emerge. Imagine the fiscal impact of the market resetting Japanese borrowing costs to 5%.

Over the last few years, Japanese savers have been willing to finance their government deficit. However, with Japan’s population aging, it’s likely that the domestic savers will  begin using those savings to fund their retirements. The newly elected DPJ party that favors domestic consumption might speed up this development. Should the market re-price Japanese credit risk, it is hard to see how Japan could avoid a government default or hyperinflationary currency death spiral.

For years, the discussion has been that our deficit spending will pass the costs onto “our grandchildren.” I believe that this is no longer the case and that the consequences will be seen during the lifetime of the leaders who have pursued short-term popularity over our solvency. The recent economic crisis and our response has brought forward the eventual reconciliation into a window that is near enough that it makes sense for investors to buy some insurance to protect themselves from a possible systemic event. To slightly modify Alexis de
Tocqueville: Events can move from the impossible to the inevitable without ever stopping at
the probable. As investors, we can’t change the course of events, but we can attempt to protect
capital in the face of foreseeable risks.