Tag Archives: Lost Decade

Minding the Gap: Potential Real GDP vs. Real GDP

I was listening to Tom Keene Friday morning on Bloomberg Surveillance (a great show to listen to, by the way) and Tony Cresczenci was discussing the “output gap” or as I always thought of it, the difference between potential and actual real GDP.  So I made this chart to illustrate how I view it:

The blue line is forecasted potential real GDP while the red line is the actual real GDP.  The black circle represents the output gap and you can see it’s significant.  In fact, you can’t find a much bigger one (at least when you see it visually) since, well, you know when.  So just from a visual standpoint that tells me something.

But what about the sideways purple parabola?  That represents a range of projected paths real GDP can take.  I don’t know what the true shape of that parabola is, it can look the one above or it can look the one below, or anything in between:

Now if we assume potential GDP in the blue line is accurate, or said differently, we have no reason to believe it is inaccurate, recovery is all about seeing the gap between the red and blue lines close.  Hence the v-shaped recovery paradigm.  But what about other scenarios?  Other outcomes?

To answer those questions I went back to some of the earliest posts I wrote and found a few I wrote on Thailand and Japan which took a look at how things have turned out in both of those countries, because they’re the closest experiences we can draw on to compare with our current situation.  So thinking about the purple parabolas, we have four basic scenarios: the red line flattens out, it rises parallel to potential real GDP, the aforementioned v-shape or it falls again (the double dip).  The last two are easy to see and recognize so I’m focusing on the other two.

If the red line flattens, congratulations: we’ve replicated Japan.

If the line continues on a parallel path, we would’ve replicated Thailand post-97:

But I can’t help but bring up unemployment, because discussions of Japan and Thailand that don’t factor in that dimension are incomplete.  Here are the charts I have on that:

On one hand, we see in Japan that fewer people are producing a constant level of output, while in Thailand, more people are producing output but the gaps between the path of GDP in the mid 90s and its current one are widening.

If either scenario happens here, neither one is going to be a positive development.



Filed under government, macro, Way Forward

What to Do With All That Cash…

This is an extension of some discussions I’ve been having and some blogs I had recently written on inflation and bonds.  Because as you think about inflation and investment returns, you inevitably come to a point where the discussion turns to the cash on corporate balance sheets.  I was going to put up some charts based on the Federal Reserve’s Flow of Funds data but thanks to Google, the Trader’s Narrative and the good folks at the Financial Times, I don’t have to (click here for the video).  But let’s take a look at some of these charts to tee this up:

Indeed, this view shows there’s a record amount of cash available. But when you look at it on a debt-adjusted basis…

Not so massive a pile now, is it?

Share buybacks seem to be the most obvious use of the excess cash at the moment.  And with good reason.  The prospects for future growth don’t look particularly good at the moment.  So if you were going to do fundamental analysis of equities right now via a dividend discounting model (let’s use the Gordon Growth Model as an example):

Your denominator gets larger as the spread between required rates of return and growth rates expand.  And as a result, the valuation for the stock is lower. If this sounds like a bearish case based on fundamental analysis, it is.  How do you boost the price in this event?  Simple: demand a lower rate of return.  Good luck in getting your investors to go along with that.

But let’s try to take this train of thought and think strategically.  If you’re a corporate Treasurer or CFO and view the economy and your business the same way, that means you would be expecting P/E multiple compression: prices fall while earnings level off and growth rates turn anemic.  All of which leads to an interesting question: why do a buyback now if you can get more bang for the buck later?  The case could be made for saving some dry powder.

As always, feel free to leave a well-reasoned, on point comment.


Filed under finance, macro, Markets, risk management, Way Forward

I’ve Got Some Theories About The Real Estate Tax Credit

I read this post from Jacob Roche about what has happened in housing since the tax credit expiry.  There are a couple of surprising aspects to what we’re seeing so far.  First, a look at prices (emphasis, mine)

What I found was that on both a raw and population-weighted basis, prices increased after the tax credit expired, by about 5% in both measures. Most interestingly, on a dollar basis, prices increased by a raw $9,766.77 and a population-weighted $5,280.89 — very close to the $8,000 credit. This is extremely counter intuitive. If the tax credit expiration effectively raises all home prices by $8,000, why would sellers raise their prices roughly another $8,000, and why would buyers agree to it? In some areas, like New York, DC, and San Francisco, prices increased by the tens of thousands. Also interesting is that some of the biggest price declines occurred in Texas, although removing Texas from the population-weighted data changes the average by only a small amount — the biggest percentage decliner in the list is in Texas, but it’s also the smallest city in the list.

via Real estate prices, post tax credit.

The post goes on to look at the sale data (again, emphasis is mine):

Number of sales gives the data another dimension however. Roughly three-fifths of the cities in the list saw fewer sales post tax credit, and the declines in sales were generally much steeper than any of the increases. It’s regrettable Trulia doesn’t give the exact numbers, making it difficult to estimate how much money is flowing in or out of the market, but one could at least make a rough guess that the price increases are being offset by fewer sales. Interestingly, a couple of the cities with declining prices saw increased sales.

Now I have some theories about this behavior, purely using intuition and my own read of buyer and seller psychology.  On prices, I think the sales price increase is a sign sellers know the market is not as liquid now as it was with the tax credit.  So as a result they’re looking to maximize the price paid.  I would’ve thought prices would’ve been higher under the tax credit because both buyers and sellers would treat the credit as “found money.”  What I mean by that is if you find money that you had no expectation of getting, you’re more likely to splurge – to spend on things you may not have thought of getting before, but since you have the cash you decide to get it anyway.  Apparently it didn’t quite work out that way.

As for sales volumes, that’s not a surprise.  We figured sales would be lower as the market becomes less liquid.  And Jacob’s point about money flow is a good one.  Because ultimately that’s what it’s all about.  So when pundits talk about Case-Shiller price increases, my first question is how many sales-pairs made up the estimation?  Fewer transactions at higher prices can still result in negative money flow.

Overall, I think the tax credit did more harm than good.  Prices offered and prices bid are moving further away from each other, thereby resulting in fewer housing transactions which are actually done.  The market is becoming more illiquid and the process will take that much longer to heal itself and for transactions to clear in a meaningful way.  Plus, how much money was spent on this and did it get us the outcome we wanted?

Don’t think so…


Filed under finance, government, macro, Markets, Way Forward, You're kidding

On Inflation and Bonds… in < 140 Characters

Today I saw an interesting tweet from Jennifer Ablan:

And based on a daily move like this…

you get the impression there’s a divergence.  Stocks have a gangbuster move to the upside while bond yields have been moving lower.  Is Goldilocks appearing again?  Hardly.

But I had a response for her:

Yes, I cited Japan as the example.  But I don’t think they’re going to be alone.  Indeed, there are a couple of ways to look at inflation.  One is just prices paid and you can use the Consumer Price Index or the Personal Consumption Expenditure index.  Well, by either measure, they’re headed lower:

PCE hasn’t fallen the way CPI has but they are both still going lower.  Why?  Because as Steve Keen demonstrated with his Minsky-based approach, aggregate demand is falling because private debt is collapsing and unemployment is rising:

And the 2/10 spread has responded in kind:

One point I’d make is that when you step back and see what’s going on in bonds, unemployment, inflation and debt is there could be a new feedback loop between these things that has taken root.  I don’t know the mechanics of it, but I’d say there’s a link between these phenomena going on.

And it isn’t pretty.  Just ask the Japanese how well things turned out for them the last 20 years…


Filed under finance, government, macro, Markets, Way Forward

At The Precipice: The Choices We Make vs. The Choices We’re Forced to Make

Author/Editor’s Note: You are about to embark on reading a post that is long, wonkish and meandering.  So while I admit it being this way, I will make no apologies for it.  This post is what it is.

This is a tough post for me to do.  Tough because so many discussions that seem disjointed and siloed, are in fact ones in which I see connections and I think the topics are interdependent: you can’t discuss X without discussing Y and Z.  So on that note, I’m going to talk about the inflation/deflation *and* the expansionist/austerian debates.  There’s a smattering of other things in here, too.  Like the unemployment conundrum.  Or Green technology.

Because while those topics are worthy of having separate discussions, you can’t come to any satisfying conclusions about any of them without looking at the first two debates, which are inextricably linked, and trying to tie them together with the other topics. It’s ambitious, I know, but I’m going to attempt it.  But with Jackson Pollack as a navigator and both Hunter S. Thompson and Jack Kerouac sitting in the back seat of this car, there’s no telling how this will come out.

I’ve read just about everything written over the past couple of weeks, discussed a lot of this stuff with folks on Twitter.  On blog comment forums.  And all I can say is I’m struggling to come to terms with this stuff, just like other folks I’ve discussed it with, and that has led me to come to some really profound – yet uneasy – conclusions which I’ll get to later on.

Inflation vs. Deflation

There’s been a lot of ink spilled on this.  Are we being confronted with one?  With both?  Let’s consider a few things in answering that.  First, a look at core CPI:

Not inflationary by any measure.  Prices are collapsing as a at least two effects I can think of are hitting the labor markets: persistence in long-term unemployment and under-employment: the folks who work part-time but are ready and willing to work full-time if a job is available.  Both of these effects are eventually reflected in GDP, personal income and last but not least, tax receipts.  Both of these effects are providing downward pressure to prices, plus they force people to choose products/retailers they wouldn’t choose before.  So the actual basket of stuff that’s getting sold now is different than the basket of stuff that was being sold before when people either had jobs or the jobs they had then paid them more.  Chalk that up as the choices we’re forced to make.

Another thing about inflation is the use of debt to fuel asset purchases and consumption.  Easy credit – and appetites that had been whetted by easy access to credit – had fueled a lot of purchases we had seen before the onset of the recession, and the levels of consumption we had seen conditioned others – such as auto manufacturers, strip mall developers, etc. – to expect those growth rates in consumption (and at that those nominal levels) going forward.  Well, this next chart shows that’s not happening:

About the only thing we can cheer about here is that the rate of decay is slower than it was the past year.  But it’s still declining as debt is shunned – a choice that can fall either in the camp of choices we can make or the camp of choices we’re forced to make.  A comment I saw on this struck me as being interesting, both right and wrong at the same time:

In one sense that’s true, and in another, it’s not.  I think in a macro, aggregate demand context, it’s very true.  Somehow we need to get back to the levels – think about the debate between growth rates and levels – we saw in that time frame.  But there has to be some product or some asset that would induce that kind of demand again.  Well, has that occurred?  Are securitized markets improving?  Well, you tell me.  Are they?

Did that make you choke on something?  If so, you don’t want to see this one:

Forget about securitized credit for a second.  This is bigger than that.  These two charts are about debt revulsion and market illiquidity.  This is not coming back. The king is dead.  Long live the king.

Lastly, a y-o-y chart on total bank credit.  Note that on a y-o-y basis, we’ve gotten to a point where credit is just not falling as fast; that’s not the same as growth:

As Kevin Depew observed in a spectacular piece at Minyanville:

Make no mistake, there are the same underlying economic problems here that exist all across America in cities both small and large: too much real estate development, too few home buyers; too many cars, too few cars buyers; in short, too much malinvestment, thanks to decades of artificially cheap credit.

via Five Things You Need to Know: The Modern Stealth Depression Revisited | Markets | Minyanville.com.

So there you have it.  Artificially cheap credit and malinvestment, and fewer financial intermediares to give credit to us.  You could easily make parallels to agribusiness, where our food supply is controlled by a small number of national players, juiced on artificially cheap corn.  But that’s a whole other discussion, that can only be done after watching Food, Inc.

But with respect to the deflation in credit that is happening after seeing those two charts, frankly it doesn’t scare me.  Because as I had heard and read about in understanding addiction “the mind that brought you here will not be the mind that leads you out of here.”  We’ve got to find something else that can lead us out of this morass of corroding debt and overindulgent consumption.  That means giving up the ghost that more of the same will get us out of here.  It won’t.

But that won’t stop people from trying to go back to what was done before and try to make it work.  Charles Mackay’s classic is filled with such behavior, where people thought the road back to recovery was paved by the habits and assets that brought them to the brink the in the first place, only to see those efforts fail. Yet we try it over and over again.  In short, not only does this sort of behavior exemplify Albert Einstein’s definition of insanity, we want to repeat the definition to ourselves to make sure we get it right.

So that’s in favor of the case for deflation.  But what about inflation?  Also, what are to make of the run-up in the price of gold – the classic inflationary hedge?

This came up at Street Meet, which I had the privilege of attending.  Is this move an inflationary hedge?  Sure, by many it is.  But with all due respect, I offered that there was a second motivation, which is a real psychological shift: the move has nothing to do with inflation or deflation, but a move to store value in gold as a hedge against poor decisions made by central banks.  The fact of the matter is, central banks have lost the modicum of trust they had. Over the past three years, how many times have you read about something *good* a central banker has done?  Outside of the droning of some economists, not much.  The move to physical commodities as a store of value away from paper/fiat currency is a revolt against central banks.  Taken to its ultimate end, we won’t need an “End the Fed” bill to render them obsolete; just settle transactions in anything but paper money.  No potency cocktail of ginseng, Viagra or Cialis would help them at that point.

And meanwhile, yields head lower for Treasuries:

That’s a 20 year chart.  Here’s a 5 year:

Which is also having an unintended consequence, which factors into the austerity/expansionary debate.  Risky assets are also yielding less as well:

This is on a 20yr chart.  They want to head lower, and they will head lower.  One other thing to note: look at the sweeping parabolic nature of Baa rates from the last downturn in ’00 to the current one.  I bet if I found a parabola to fit that trend, the coefficients this time around would be bigger than the coefficients on the mini parabolas you see in the ’90s.  Why?  The convexity of yields.  Also, looking at the time periods between the cycles, I am starting to think that we’ve compressed economic cycles now with all of the cheap liquidity and stimulus.  That subject is probably more open for debate than the compression of market cycles, which is another topic we touched on at Street Meet and one where folks could easily agree that cycles in markets have compressed.

At any rate, here’s a 2 year chart:

The channel that had formed is breaking down, as 10yr yields head lower.  Another way to look at this?  Spreads between Baa bonds and 30yr Treasuries.  The Baa yields published daily are yields for bonds with more than 20 yrs left to maturity, so the spread to 30yr Treasuries can serve as a risk-free proxy:

As I, as well as others pointed out, defaults on high yield and leveraged loans/bonds are much lower than everyone has expected.  I’ve said it before, but I’ll say it again: we may be watching a new feedback loop form between rates and defaults.  Central banks pushed liquidity into the market, suppressing rates on, well,  everything.  High yield assets benefit as default rates head lower, thereby making them less risky compared to higher quality assets.  Risk compression is in play, and it may not end anytime soon.

But this is an important facet to the next debate.  A debate where the discussion of interest rates almost never gets discussed.

Austerity vs. Expansionism

This discussion and the inflation/deflation one are linked.  If inflation is the issue, austerity is will correct it.  Deflation on the other hand, is different.  In a deflationary environment, consumption and/or investment is encouraged as the capital inflows kick-start economic activity.  But when there are charts like this…

and this…

It’s bothersome.  The debt keeps increasing and to listen to the expansionists, it needs to keep expanding.  Because governments are the only ones that can fill the void and consume while the private sector repairs their balance sheets, for which there’s no guessing how long that can take.  Indeed, this is one of the basic tenets to Richard Koo’s framework for dealing with balance sheet recessions.  Plus, looking at Japanese bond yields, they’ve only gone lower as inflation has become a distant memory.  And that was 20 years ago.  Indeed, the biggest takeaway in my mind from Koo is that instead of bemoaning the Japanese experience, we should be embracing it.  Sure there are some things that they did wrong (lack of structural reform, banks not charging off losses, big banks that got bigger – gee why does this all sound so familiar), but by and large,  the policy of governments taking on ever larger deficits to stop deflation is something to be accepted, not fought.  I can see in one sense that is true.  As I read and re-read posts and comments on this debate, there are a couple of things I see as true: there is no magic debt/GDP percentage where everything goes bust and as interest rates head lower, the interest burden is lessened, which allows more debt to be taken on.  Indeed, it’s like a feedback loop sprouts up out of nowhere as a result.  Like a weed staring at you in your driveway which forces you to ask “how did this get here?”

But is that how we want our government to operate?  Taking on debt so we don’t have to?  I realize the comparison to Japan is not a perfect one, for at least two reasons: the difference in savings rates and the composition of their debt market: practically all domestic investors.  Indeed the sovereign default question is puzzling when one looks at Japan, because while their debt/GDP keeps rising, the only talk of default comes from outside of their borders – not within.  This chart is as of end of last year, but it still gets the point across:

But GDP growth has not resumed in a robust manner, it has languished and continues to do so.  Personally, in Japan I see an economy that has spent a lot of public bucks and gotten very little bang for it all.  It just seems to me there has to be a better use of all of that money.

And then I read this (emphasis, mine):

What we haven’t yet experienced—at least in a sustained manner—is deflation. That, combined with the enormous fiscal stimulus, may explain why unemployment has stabilized to some degree now despite sustained private sector deleveraging, whereas it rose consistently in the 1930s….

Whether this success can continue is now a moot point: the most recent inflation data suggests that the success of “the logic of the printing press” may be short-lived. The stubborn failure of the “V-shaped recovery” to display itself also reiterates the message of Figure 7: there has not been a sustained recovery in economic growth and unemployment since 1970 without an increase in private debt relative to GDP. For that unlikely revival to occur today, the economy would need to take a productive turn for the better at a time that its debt burden is the greatest it has ever been..

via Steve Keen’s Scary Minsky Model « naked capitalism.

Here’s the figure:

Keynesians and MMTers beware.  This speaks to secular deflation: a large, demographic and psychological shift away from the use of debt. Debt-induced growth won’t work if there’s no appetite to take it on and there’s no productive use for it that has a greater benefit than the costs of servicing it.  Maybe Keynes got it wrong.  Perhaps it should be the Paradox of Debt instead of the Paradox of Thrift: societies resist taking on debt just as they should take it on, because they already took on so much beforehand.  I’ve heard the argument before that that shouldn’t matter because a government can always print more money to cover the interest.  And risk inducing hyperinflation as a result?  Because governments don’t know what the optimal quantity of money is better than any one of us do.  Plus, taken to its extreme, that kind of outcome can be viewed as a technical default.  The political risk of being the next Zimbabwe or Wiemar Republic is very real, currency standards (fiat vs. gold) notwithstanding.

And it might actually be worse.  If you can’t trust a government to act prudently with respect to fiscal matters, how can you trust that rules that are made by that body are fair?  That they are enforced fairly?  Or interpreted reasonably? Again, these are conversations that are thought of in isolation, but can only be treated in a satisfying way when discussed concurrently.  Chalk this up as a choice we can make – for now.

But the austerity argument has its own warts.  Cutting safety nets is largely out of the question, because as Andy Grove wrote in Bloomberg Businessweek:

I fled Hungary as a young man in 1956 to come to the U.S. Growing up in the Soviet bloc, I witnessed first-hand the perils of both government overreach and a stratified population. Most Americans probably aren’t aware that there was a time in this country when tanks and cavalry were massed on Pennsylvania Avenue to chase away the unemployed. It was 1932; thousands of jobless veterans were demonstrating outside the White House. Soldiers with fixed bayonets and live ammunition moved in on them, and herded them away from the White House. In America! Unemployment is corrosive.

via Andy Grove: How America Can Create Jobs – BusinessWeek.

I very much value what others who have fled oppression in such countries as Hungary in the 1950s have to say because they’ve seen what oppressive, overreaching governments are capable of.  Are we there yet?  No, but when you see things like this – on Independence Day no less – it makes me wonder how close we are.

But back to the safety net issue and what to cut.  There’s obviously little wiggle room on one side of the equation – the safety nets.  They’ve become interwoven into the fabric of our society and the best thing we can do is strive to ensure fraud, waste and abuse are minimized.  Eliminating it is a joke so when politicians talk in such absolute terms, I just laugh.  Or holding up unemployment extensions for the sake of the deficit?  Please.  Nevermind the fact we’ve got whole departments of the Federal government where  nobody knows what they do, how effectively they do it or what it costs to keep all those folks in their “jobs.”  Talk is the most inflated currency out there.

But then you read things like this:

President Barack Obama Friday signed a law giving consumers already in the process of buying a home three extra months to close the deal and still get a popular tax credit from the government.

Homebuyers that signed the contract by April 30 but failed to go to closing by the original June 30 deadline have until September 30 to finish their purchases.

Homebuyers with contracts signed by April 30 who failed to go to closing by the original June 30 deadline will now have until September 30 to complete their purchases.

via Housing Fix: Obama Signs 3-Month Extension of Homebuyer Credit – CNBC.

You just can’t help but feel, well, deflated.  The old saying of “good money chasing after bad” applies.  Just as it did with TARP.  With Bear Stearns.  With AIG.  Pork-barreled projects stuffed into legislation at the 11th hour, 59th minute.  Need I pile on?  So when folks tell me it doesn’t matter how it gets spent, just as long as it does get spent, I have to disagree.  Throwing money at the things that got us into this situation will not be the things that get us out of it.  Nor will wasteful pork-barrel spending.

Also to the austerians’ credit, there is a valid case to be made for government and entitlement restructuring.  The current way healthcare benefits like Medicare are collected and distributed is one area ripe for restructuring.  Social Security is another.

True market reforms are what’s needed, not just debating about levels and amounts of stuff to increase or decrease.  I like the way Joe Wiesenthal expressed it:

Lost in this debate is any discussion of what actually goes into a competitive or dynamic economy. There are so many factors that go into this. Let’s just rattle off a few that could have an effect:

  • Immigration
  • Education
  • Tax fairness
  • Labor mobility
  • Labor flexibility
  • Environmental policy
  • Demographics
  • Family planning policy
  • Health policy
  • Agricultural policy
  • The weather
  • Corruption

We could probably go on forever, listing factors that would help determine whether a given economy was competitive or not. And yet this stimulus vs. austerity debate ignores all these things, as both sides pretend that these are secondary, as opposed to foundational, aspects of what makes the economy hum.

via Why It’s Time To End The Whole “Stimulus Vs. Austerity” Debate.

And I couldn’t agree more.  Rather than take this time to really sit down and think what it’s going to take to move us forward, we’re mired in squabbling and posturing.  It’s easy to do because it’s lazy.  Most people would rather argue about throwing money – or not throwing money – at a problem because these topics make most people’s heads hurt.  But in reality it just sets the table for the last two things I’m going to look at.

Jobs and Green Tech

By now, we all know that unemployment has basically held steady, at 9.5%.  And the participation rate continues to be a negative on the economy.  So I took a look at both of them, together in this chart:

Looking at this chart, we can see that unemployment – when compared to labor force participation – hasn’t been this bad since the recessions of the ’80s.  The ’80s marked another transformational period in this country as we saw the decline of manufacturing and the rise of the service-based and information-based economies.  This becomes very clear when you see capacity utilization:

The lower lows are a sign of technological innovation taking root in each phase of the economy.  Automated manufacturing uprooted people from working in manufacturing several decades ago and we’re seeing something similar in our current economy as we’re able to produce more with less.  This presents us with a couple of problems.  First, as we get more efficient, we have to find better uses for capital that give us returns we want.  This is a huge issue as Keen pointed out earlier: we need better returns on capital to fund our debt.  We’re not finding it now and we need something – an innovation – a radical breakthrough in something from somewhere, anywhere – to get us there.  Second, there’s this issue :

Over the past couple of weeks I have been fascinated with the topic of overpopulation as I explained in my last post that “overpopulation was the greatest threat to sustainability in my book.”

Long story short he believed that the two classes capitalists and landlords (where Labor was considered equipment of the land) a typical feudalistic setup, population unchecked would grow at an exponential rate or geometric ratio.

via BankrChick (Tonight I do).

So overpopulation while we get more efficient and yet at the same time, we need to conserve more of our resources.  Not an easy task.

This is where Green tech could fill the void.  The theory being that Green tech would allow us to make something again and put people back to work while at the same time, if we export our products (not the technology and there’s a big difference between the two in terms of exporting), we can solve it all.  Mr. Birds 1 & 2, you’ve just been killed by one green, eco-friendly stone.

But in my mind, it won’t in its current state, for two reasons.  First, let’s start with the job creation issue.  I went back to Andy Grove on this:

Such is the case with advanced batteries. It has taken years and many false starts, but finally we are about to witness mass-produced electric cars and trucks. They all rely on lithium-ion batteries. What microprocessors are to computing, batteries are to electric vehicles. Unlike with microprocessors, the U.S. share of lithium-ion battery production is tiny (figure-E).

That’s a problem. A new industry needs an effective ecosystem in which technology knowhow accumulates, experience builds on experience, and close relationships develop between supplier and customer. The U.S. lost its lead in batteries 30 years ago when it stopped making consumer electronics devices. Whoever made batteries then gained the exposure and relationships needed to learn to supply batteries for the more demanding laptop PC market, and after that, for the even more demanding automobile market. U.S. companies did not participate in the first phase and consequently were not in the running for all that followed. I doubt they will ever catch up.

via Andy Grove: How America Can Create Jobs – BusinessWeek.

He’s saying we’ve been out of the game for so long we may not be able to compete in this new area.  I don’t necessarily agree.  We’re at a disadvantage yes.  But in my mind, Green tech isn’t good enough yet.  Ethanol cars?  Please, you’re harvesting an ag crop to turn it into fuel, plus you have to burn billions of BTUs to turn it from starchy sugary food into something you can use in a car.  Yes, cellulosic ethanol may be better because there’s less refining that has to be done, but you’re still faced with the fact that you’re using a fuel that will 1) not be as efficient as gasoline (your vehicle’s range is diminished) and 2) is actually corrosive to the engine since ethanol is a form of alcohol and it burns quickly and dryly.  Electric cars?  After watching this review by the guys at Top Gear and reading this rebuttal from Tesla (note the charging time and compare that to the time it takes to fill up a petrol car), it’s clear to me that electrics aren’t ready for primetime, Tesla’s IPO be damned.

There are other cars that might be though, and in comparing the two, it raises a point I want to make: green tech, to be palatable,  needs to raise the bar.  Planting a solar farm 20 football fields wide and 20 football fields long of solar panels out in the middle of nowhere isn’t going to help us if there’s a better use for the land and we tear up miles more of land to get the power from the solar farm to a generation station that can put that power on the grid.  There has to be a better way to do this that fits the lives we live today or offers us something better than we already have.  Otherwise it will fail.

Which leads me back to the austerity/expansionist debate: why isn’t the government investing more in this?  High speed rail could substitute air travel as it’s cleaner and can be more efficient (and possibly more convenient), but nobody is talking about setting up an incubator to research it.  Government can step in there.  What about other alternative energy sources and investing in more R&D in the other issues like making power transmission more efficient – so things like wind and solar power make more sense?  Instead we’re bailing out car manufacturers that are slaves to fossil fuel technology, but our economy as a whole has moved past volume production in this manner for at least 3 decades.  The things that got us to this precipice will not be the things that will lead us away from it.  The government has the opportunity to be the biggest angel investor ever and they’re not taking the chance to do it.  That’s disappointing.

So What Do We Do Now?

But I’m hopeful.  Maybe we should realize, as Kevin Depew says “the time for preparations and battening down the hatches has passed. It’s here.”

Which echoes Joe Wiesenthal’s sentiment.  We need to focus on the bigger picture issues.  Education for our children is still going to be an issue that will still be there.  Care for an aging population is still going to be with us, as well as figuring out what our economy can produce as those of us who follow the Baby Boom have to keep things moving somehow.  These are all things we can still choose to do something about, even as other things we can’t do anything about (the trajectory of real estate prices, for example) head along their own paths.  We don’t have to let our actions or even our lives be governed by that stuff.

I don’t know about you, but I’m glad that we don’t have to let those things dictate outcomes.  Because on this Independence Day weekend, I’ll take the power of choice – the freedom to choose, in fact – any day of the week over the alternative.


Filed under finance, government, macro, Way Forward

The 6.30 Libor Earthquake, Aftershocks and Tsunamis

First, let’s update our Dollar/Euro Libor spread chart.  That’s the one that really matters now because looking at the Libor curves in isolation won’t help us understand what’s going on:

Across all maturities, we saw rates increase about 1bp from Wednesday into Thursday.  Not a healthy sign.  Indeed, I along with others were wondering about the €310bn that didn’t settle and it’s looking more and more like the liquidity it provided is gone and now there’s a mad scramble – a tsunami of buying, if you will – for Euros:

But if you’re watching the Euro-Yen cross like I am, you still need to use the Dollar-Yen as a crossing pair to get a Euro-Yen quote. The last time I checked, the Euro-Yen cross was at 110.039. In a word, ugly.  That cross has been the great carry trade cross for years, so any movements in this cross should be noted and heeded.

But I also wanted to take a look at some other trading activities in futures:

Surely with the correlations we’ve grown accustomed to, a rise in the EURUSD should mean stocks, commodities and well, everything that is not cash is headed higher.  But right now, it doesn’t because of the banking issues in Europe.  Gold collapsing the way it did was rather stunning, frankly.  And the fact that crude oil, in the midst of the summer vacation/driving season coupled with a natural disaster of epic proportions, couldn’t maintain the trend line on the daily chart that would imply $80/bbl, is telling.  And the message seems rather ominous and foreboding:

Meanwhile, two Treasury ETFs, SHY (iShares 1-3 yr Treasuries) and TLT (iShares 20+ yr Treasuries) have benefited from the safe haven bid.  If you executed a bear flattener by shorting the SHY and going long  the TLT, you would’ve had a very nice 6 months, in spite of the gains in the SHY:

My point in showing all of these charts?  It’s to try and present/describe a macro level picture that shows one simple message: the problems in Europe can’t – and shouldn’t – be underestimated and the spillover/contagion/whatever buzzword you want to use that means “spreading” are the worst kinds of scenarios you can think of: higher probability and high severity.  I characterize them as “higher probability” for two reasons:

  1. Never underestimate people’s ability to underestimate tail events.
  2. The probability of a spooky tail event occurring  is increasing.

I don’t know how long the EURUSD “rally” lasts.  It will last as long as banks in Europe are afraid their balance sheets are too illiquid.  It could be over in days, weeks or months.  I don’t know.  But I do know that trade is not acting the same way it would have in the past for a reason.

This will be an interesting month…

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Filed under finance, International, macro, Markets, risk management, Way Forward, You're kidding

How Quickly Are We Turning Japanese?

I came across this piece from the Business Insider.  Their post talked about one of the more surprising aspects of this recession: the low default rate in high yield credit.  I’ll openly admit, in the words of Frank Vitchard, “I did not see that coming!”

They referenced a Fitch report, “The Extreme Credit Cycle – Making Sense of a 1% U.S. High Yield Default Rate”, which talks about this development.  According to Fitch, the high yield default rate went from 13.7% with 151 defaulters last year, to a forecasted 1% default rate for this year.  A stunning drop, to say the least.  But let’s a take a look at the following chart, which comes out of the report:

The thing I note is the divergence in growth rates between TTM revenues and TTM EBITDA we’ve seen since ’07.  In ’05 and ’06 you can see  the growth rates tracked pretty closely together, but in ’07 as the economy started wobbling, TTM EBITDA started turning negative.  Plus, EBITDA went lower, farther and sooner than revenues.  But EBITDA growth is slowing down, possibly peaking.  Not much of a surprise since we knew companies were cutting costs via layoffs and forgoing cap ex.  But what are we talking about when we refer to EBITDA?  From WikiInvest:

EBITDA = Income before taxes + Interest Expense + Depreciation + Amortization

via Metric:EBITDA.

Ah, yes…. Earnings Before I Trick the Damn Auditor… actually it’s Earnings Before Interest, Taxes, Depreciation and Amortization.  I don’t particularly like the metric because the things it leaves out are, well, kind of important.  But the metric is supposed to reflect a relatively clean cash flow measure.  I guess to me, aside from the drop in income (which is obvious), the thing I’m most curious about in the high yield space is which component had the biggest impact in the second half of ’08 as well as the second half of ’09: was it interest expense? Or depreciation and amortization?  The answers we get there can help explain why we’ve seen such a dramatic drop-off in default rates.

My theory is interest expenses have taken such a dramatic cliff-dive it has only served to help high yield companies in managing interest costs and as a result their weighted average cost of capital.  This differs from Fitch’s conclusion that it’s the cap ex piece.  How did I arrive at that?  Let’s take a look at the chart:

The coverage metric EBITDA less CapExInterest feel further going from a peak of just over 3 times coverage to roughly 1.5 times coverage – about a 50 percent drop in a coverage metric.  Yet the EBITDA/Interest only fell from a peak of near 5 times coverage to a low just under 4 times coverage.  So I don’t buy the reduced CapEx story all that much.  I think the story is really in the reduced interest expense.

And on the heels of that, we read this from Bloomberg:

Investors are returning to junk bonds after the worst month since 2008 on speculation the economy is growing fast enough to avert corporate defaults without sparking inflation.

“High yield is the place to be,” said Manny Labrinos, a money manager at Nuveen Investment Management who oversees $1.8 billion of fixed-income assets. “Sub-par growth is somewhat of a Goldilocks scenario because it means rates stay low and people are still going to reach for yield.”

High-risk debt has returned 1.76 percent in June, almost double the gain of investment-grade corporate bonds, Bank of America Merrill Lynch index data show. Underscoring demand, CNH Global NV, the Fiat SpA unit that makes tractors and harvesters, boosted the size of its speculative-grade offering by 50 percent to $1.5 billion in the largest junk-bond sale since April 20.

via Junk Bonds Revive on Bernanke `Sub-par’ Economy: Credit Markets – Bloomberg.

So the paper is exceptionally well-bid, but what would you expect in a rate environment like ours?  Indeed, as one of the more astute people I follow on twitter said:

And this:

The reason I worry about it is the same reason I worry about sovereign deficits.  The amount of debt worries me not because I think there’s some magic debt/GDP number from which there’s no point of return, but because low rate environments are highly convex and rate shocks can kill.  Especially when growth rates for GDP, earnings, etc. grind lower.  At some point, you’re bound to have a problem.  I’m going to cover more on the sovereign-related stuff later.

In the meantime, chew over the idea that with rates so low and liquidity being so excessive, defaults in high yield will continue to surprise to the downside, grinding returns lower still.

Seems we have started another feedback loop, just like the Japanese did, 20+ years ago…


Filed under finance, macro, Markets, risk management, Way Forward