The latest investor sentiment levels turned in mixed readings for the week.  The AAII reported a decline in bullish investors from last week’s extreme reading of 45% to 35.4%.  Neutral sentiment jumped to 35% while bearish expectations actually climed to 29.9%.

Charles Rotblut of AAII says this displays a level of cautious optimism:

“The numbers show that individual investors remain cautiously optimistic. While they are happy to see the major stock indexes reach new highs for the year, individual investors continue to keep an eye on their short-term profits. I do think the the slow pace of the market’s upward move over the past several days combined with the below average volume has not gone unnoticed.”

The Investor’s Intelligence poll, on the other hand, showed another jump in bullishness as 46% of financial advisers are now bullish.  This was up from last week’s reading.  Although bullish, it is not quite at the levels that preceded the January/February sell-off when bullishness jumped to 52%.

By Comstock Partners:

The market rallied when the FOMC said it would keep the Fed Funds rate at current levels for an extended period just as it rallied when it became likely that the EU would paper over (at least temporarily) the Greek financial crisis.  The market apparently continues to have great faith that the various central banks throughout the globe will continue to bailout and guarantee that they would never let any entity fail and would assure continued economic growth indefinitely.  In other words, what economists and strategists used to refer to as the “Greenspan put” has now essentially become the “Bernanke put”.   We at Comstock have no such conviction that piles of additional debt issued or assumed by governments can cure the problems that were brought on by too much debt in the first place.

In this connection the delusions and hopes associated with the current rally bear a lot of resemblance to the unwillingness of investors to recognize reality at the market tops of March 2000 and October 2007.  In the late 1990s and into early 2000 the market gave enormous valuations to tech stocks with no earnings and, in many instances, little or no sales as thousands of people with no market experience spent their time day trading their way to huge profits that evaporated, along with their initial capital, in the ensuing market carnage.

When the game ended with big losses and a potentially deep recession, the Fed stepped in by keeping interest rates at 1% for an extended period and encouraging, along with others, a massive boom in housing.  Despite warnings by reputable individuals such as Paul Volcker and by institutions such as the IMF and the World Bank, the stock market soared.

Even when the dangers of the housing boom started to become evident in the media and the industry began to weaken, the stock market surge continued unimpeded.  In August 2006 an article in Barron’s described in detail the number of new mortgages and home-equity loans that were interest-only, no-money-down and adjustable-rate. Other articles explained so-called “liar loans” whereby purchasers were able to get mortgages with no documentation of income or assets.  In the same period various mortgage lenders went public with their dire problems.  These companies included, among others, H&R Block, Impac Mortgag, Countrywide, Accredited Home Lenders and Washington Mutual.  During the following period revelations came out almost daily how mortgages were packaged and sold, sliced and diced and distributed all over the globe.  In June 2007 two big Bear Stearns hedge funds came close to collapse and still Wall Street didn’t get it.  The stock market kept rising into October as investors belittled the importance of subprime mortgages, and, in any event, assumed the Fed would take care of everything.

Now, once again the markets are assuming that central banks around the world will save the economy despite the severe problems that are known to all and despite the fact that the S&P 500 has already experienced two declines of more than 50% within the same decade.  The economic recovery remains extremely weak, plagued by consumer deleveraging, a weak labor market, tight credit, a hidden inventory of homes to be foreclosed, significant amounts of toxic debt still on the books of major financial institutions and the dire financial condition of state and local governments..  In addition there are the continuing problems of sovereign debt, the unsustainable boom in China and the threat of “beggar thy neighbor” policies as illustrated by the current trade and currency tensions between the U.S. and China.

Meanwhile, as in 2000 and 2007, the stock market is once again flying upward, feeding on its own momentum and the faith that governments will never let bad things happen.  The general feeling seems to be that fundamentals don’t really matter any more as long as the market is rising.   As past massive declines have proven, however, fundamentals don’t matter until they do.

The United States government has made a curious series of interventionist moves over the course of the last 18 months.  Some have been beneficial, but not surprisingly, few of these policies are actually helping the economy recover from the Great Recession.

As I’ve previously mentioned, Keynesianism can work.  There is good government spending and bad government spending, despite the constant shrieking from Austrian economists with regards to all spending being bad.  Giving money (on a silver platter) to banks who are not reserve constrained is exhibit A of bad spending.  Spending money on a healthcare plan in the middle of a recession is a close runner-up. The banking bailouts not only set a terrible social precedent, but were also implemented with the belief that banks are reserve constrained – something that is entirely false.

The great recession was never a banking sector problem despite it being labeled as a “credit crisis”.  In reality, this was a consumer driven crisis.  The results prove this.  The banks have recovered, but lending hasn’t improved.  Why?  Because this is a consumer driven recession.   Banks aren’t reserve constrained.  Finding willing borrowers, on the other hand, is a whole other matter….

The healthcare debate is a bit more messy.  While the social aspects of healthcare spending are likely positive, you just have to wonder about the motives of the men pushing this plan when we are mired in the worst recession in 75 years.  Is healthcare really our top priority when unemployment remains near 10%?  More importantly, is this an efficient form of government spending when we could easily target job creation or other productive investments in the long-term growth of America (China’s high speed rail system comes to mind here).  Meanwhile, we have an antiquated infrastructure.  Where are the priorities?

But the political pandering is taking a turn for the worst in recent days and surprisingly, markets are ignoring this potentially devastating global debate.  Hypocritically, the latest government pandering is targeted at the Chinese and their “manipulative” government.  Oh those darned Chinese and their interventionist ways!  How dare they manipulate their currency!  (Nevermind that the United States indirectly “manipulates” its currency via monetary and fiscal policy on a daily basis..)

Ironically, the Chinese implemented an unnecessary and all too effective stimulus plan (in essence, they targeted long-term investments in their nation while we targeted bank vaults) in response to the downturn.  This has resulted in a remarkable rebound in China that helped thwart a more severe global downturn.  Now, economists like Paul Krugman are blaming China for the “liquidity trap” that the rest of the world is suffering from.  But is China really to blame for the current predicament?  I don’t think so.  The current crisis was caused by a complex mix of de-regulation, excessive private sector debt levels, private sector greed and financial “innovation”.   In addition, where were all of these complaints when China was largely driving the 2003-2007 recovery and unemployment was at 4%?  This attack on China is not only misguided, but has potentially dramatic economic consequences.

Paul Krugman says we should slap China with a 25% tariff.  This is not only an extremely dangerous protectionist precedent, but very seriously risks the viability of what meager recovery we are seeing.   Such a policy will directly impact U.S. corporate operating margins and/or result in higher prices on store shelves.  With the U.S. consumer still extremely weak the last thing they need is a round of price hikes.  Such a move by the government could not only undermine our standard of living, but could also destroy any potential for future corporate hiring as companies seek out other avenues of continued profit growth.

Furthermore, the growth in China is viewed as stable and sustainable, but we are not so certain.  China is going to confront a potentially vicious battle with inflation in the coming years as wage inflation surges and aggregate demand continues to climb.  Remember, they didn’t have the severe private sector debt problems that existed in many other nations, yet they flooded the market with stimulus (i.e., unnecessary spending).  The resulting inflationary strains from the stimulus are already causing significant strain on local manufacturers.  An increase in their costs would only put more strain on these firms and further hurt the recovery in China.

The assumption of course is that Chinese consumers might pick up the slack, but the Chinese are habitual savers.  There is no guaranteeing that this will change in the near-term.  This is no time to be contributing to any potential problems in China just so you can pander to your political party.  If we lose China’s strength in this recovery we will all lose.

Many blame the current bout of high unemployment in the United States on difficulties caused by China’s currency peg.  First, there is very little historical evidence that tariffs improve employment.  Second, very few people were complaining about labor shortages in the United States when the unemployment rate was running at 4% just 4 years ago.   Thirdly, anyone who thinks these jobs will magically come back to U.S. shores is kidding themselves.  U.S. multinationals will not crush their margins just so an American can have a job that a Vietnamese is willing to do longer for less.   This is the pure and simple truth of the global free market.

I am not against all forms of government intervention (I have been an advocate of harsh regulatory changes), but a tariff is not an efficient form of government intervention in the current environment.  A tariff simply gives the U.S. government more control over resource allocation and forces citizens to purchase goods and services they would otherwise reject. Why should Americans be forced to accept a lower standard of living just because a few politicians want to look tough and a few economists haven’t thought about the real-life effects of such measures?

Humorously, Peter Schiff laid into Krugman and accused him of a lack of economic understanding and then stormed into a tirade about how government debt was going to result in China selling bonds and losing faith in the U.S. government’s ability to meet their obligations (which can’t technically happen).  The irony and fear mongering here is almost sickening.  Peter Schiff displays, perhaps, the greatest lack of understanding of our monetary system of any pundit in the world.  Do you wonder why this man, who essentially predicted the downturn, lost phenomenal amounts of money for his clients?  Schiff, unfortunately, like many of our politicians doesn’t understand how our monetary system actually works.  He completely fails to connect the dots between “printing money” and how money actually gets credited and debited in the economy.

He is stuck in a gold standard world that is no longer applicable (the gold standard is dead, it ain’t coming back and that is a good thing).  He thinks we borrow and tax in order to spend (false!).  He thinks we “print money” recklessly that leads to inflation.  He thinks foreigners fund all of our spending.  He thinks the Chinese are going to dump all of our dollars and cause the currency to collapse in a spectacular Zimbabwean fiasco. It all sounds very scary, but is pure and simple fear mongering.  In exchange for real goods and services, we send the Chinese pieces of paper that they can either leave in their bank vaults earning 0% or they can wisely invest in U.S. assets (such as t-bills).  If they sell, they sell. That won’t stop the flood of U.S. dollars entering their borders looking for a dusty floor on which to earn 0% (at their detriment).  Could they dump dollars on the market?  Sure.  But as Michael Pettis said, this would have a negligible impact on the deep U.S. capital markets:

“the net effect was one of the most massive short-term transfers of wealth ever recorded from one group of countries, the European belligerents, to another, the US.  European dumping caused a collapse in prices, and US investors ultimately scooped up the assets up very cheaply….We have seen asset dumping before, and on an even larger scale, and the US capital market is deep enough that it might easily absorb it.”

Regardless, the U.S. and Chinese economies are inextricably linked.  The Chinese will not stop buying our bonds because it is to their detriment to do so.  Likewise, we will not stop consuming their cheap goods and services.

Our problems are domestic and this protectionist fury will not help solve this.  Over the course of the last 10 years the U.S. economy has muddled through a boom and bust cycle (in large part thanks to Fed meddling) that has left it deeply scarred.  We have become too dependent on a get rich quick financial sector (which should have been downsized) while forgetting what real innovation and productivity can generate.  The government’s constant meddling in the economy has done little help all of this as we attempt to reside in a capitalist society where losers never lose and prudence rarely pays off.  Even worse, we have spoiled our children without teaching them what hard work and ingenuity can lead to.   It’s no coincidence that the “greatest generation” of Americans was raised by the most hardened generation America has ever seen.

Nonetheless, two devastating recessions later, U.S. corporations are actually in remarkably good condition.  Corporate cash levels are at record highs and U.S. businesses are as lean and mean as they’ve ever been.  Much of this strength over the last 10 years has been attributable to China.  Not only has China contributed substantially to top-line growth in the S&P 500, but operating margins have become so wide over the last ten years that you can drive a Mack truck thru them.  As we’ve previously mentioned, this recovery has been absent of revenue growth, but the one thing that has kept corporations from imploding is margin expansion.  Access to cheap labor and services abroad has been a large contributor.  While the government bails out bankers and homeowners (who should be renting), corporate America is trying its best to play its role in the rebound.  That’s in large part because of China.  While many are still complaining about the jobless recovery, the truth is that corporations are well positioned to begin hiring again.

The same positive statement cannot be made for U.S. consumers and the Chinese are in no great rush to encourage their consumers to become more like the debt-laden U.S. consumer.  As Axel Merk recently said:

“Chinese reject this [consumer credit based] approach because they don’t want to promote a U.S. style, debt driven consumer boom.”

This brings us to perhaps the most interesting facet of this debate: the social aspect.  The real problem is that Chinese do not consume enough.  Recent data shows that the Chinese savings rate is 30% – up from 16% in 1990.  Unfortunately, Americans, being the narrow minded bunch that we are, fail to understand the social reasoning behind this dynamic.  We just don’t understand it because, well, we think it is our patriotic duty to own the latest gizmo and gadget.  But the mentality is not the same in China.  Some presume it is due to a government that can’t be trusted to take care of its people when they are older.  Others say it is due to the growing gender gap and marital competition.  Either way, the inherent desire to save in China is a social aspect that we Americans simply can’t relate to.  Slapping them with a tariff or forcing them to adjust their currency will not change this overnight.  And in the short-term it could have deeply negative ramifications for us all.

China is not to blame here.   We forget that they are still a maturing economy and socially different.  The process of currency revaluation simply cannot be forced.  As Annaly Capital recently said, their currency peg is “unsustainable”, but the process of moving off it should not be rushed – particularly in a time of such great economic uncertainty.  Unfortunately, there are votes to be won in November and that means politics once again takes precedence over the long-term well-being of Americans (and Chinese and Europeans).  And what does this all mean?  It means the trade war cometh.  Let’s just hope the politicians don’t cause a double dip in their quest for another term…..

Sources:

1. Why do the Chinese save so much? – Columbia Business School

2.  Fear is the reason Chinese save so much -  NYT

• FedEx says the recovery is spreading -  $Yahoo

• China: The coming costs of a superbubble -  Katsenelson

• A China-US reckoning -  Forbes

• The Eurozone needs markets, not bailouts -  Merk

• Why the bears are dead wrong -  WSJ

• Bullish on bank stocks! -  BW

• Bearish on bank stocks! -  TSCM

• The rally looks frothy -  MW

• This is the most important part of the rally -  Chenard

Stephen Schork, president of Schork Group Inc., talks with Bloomberg’s Lori Rothman about the outlook for natural gas and crude oil prices. Natural gas futures dropped to the lowest price in more than five months as a surplus of the fuel gained following a smaller-than-forecast stockpile decline.

Source: Bloomberg TV

Must read here by Alan Greenspan. In this newly released paper he discusses the causes of the financial crisis and the Fed’s failures leading up to it. Interestingly, we continue to implement many of the same strategies that Greenspan admits were a failure and have done little to resolve the other causes.

Stocks were mixed on the day as the S&P finished with marginal losses and the Dow and Nasdaq posted gains.  In many ways it was a continuation of the incredible streak we’ve seen over the last 5 weeks.  The SPY was just a fraction from extending its winning streak to 15 sessions.  The Dow extended its winning streak to 8 sessions.  While the S&P was lower on the day the losses were marginal and any downside was immediately and relentlessly met with bullish action.  The S&P traded lower by 0.4% in early morning trade, but like every dip over the last 5 weeks it was quickly bought.  This has been a powerful trend in recent weeks as the few down days we’ve seen have been minor losses.  The relentless march towards 1,200 continues in a nearly straight line higher.

Breadth was weak on the day at 1.5:1 and continues to show signs of weakness as the broadness of the rally has certainly waned in the last week.  Volume was low again, but this has become a trademark characteristic of positive days in the last month (which has been essentially every day).  Notable action included a move out of risk assets today.  While the Dow powered higher banks and small caps (the trademark high beta movers of the recent rally) were weaker on the day.  This could be the beginning of a change in risk appetite as investors begin to rotate from high risk names to more defensive names.

From Daily Futures:

U.S. Economy
The U.S. Labor Department said that jobless claims were down 5,000 last week to 457,000, roughly as expected.

The Labor Department also said that consumer prices were unchanged in February and up 2.1% from a year ago, slightly less than expected. The June 2011 eurodollars were down .035 at 98.455.

The Conference Board’s index of U.S. ‘leading’ indicators was up .1% in January.

The Philadelphia Federal Reserve’s regional index of manufacturing increased from 17.6 to 18.9 in March, better than expected.

Grains and Cotton
The USDA said that, as of last week, 2009-2010 exports of:
Corn remained up 6% from a year ago.
Soybeans improved from up 33% to up 34% from a year ago.
Wheat remained down 21% from a year ago.
Cotton improved from down 23% to down 20% from a year ago.

On March 31st, the USDA will release its prospective plantings report for 2010. May corn was lower for most of the day, but closed up 2 cents at $3.76, the highest close in over a week.

July wheat ended down 6.75 cents at $5.02, pressured by today’s stronger U.S. dollar.

According to Bloomberg news, a Chinese cotton researcher expects cotton acreage in China to be down nearly 5% this year. May cotton closed up 1.04 at 83.04.

Livestock
It looks like beef demand is picking up. The USDA said that net sales of beef totaled 13,000 tons last week, up 40% from the four-week average. June cattle closed up 1.20 cents at a new contract high of 95.17, ahead of tomorrow’s monthly cattle on feed report.

June hogs closed up 1.90 cents at a new contract high of 82.92, blamed on fund buying.

Coffee
May coffee closed up 1.95 cents at $1.3555, the highest in three weeks with talk of dry weather in Brazil.

Orange juice
With winter in the rear view mirror and the USDA’s latest Florida orange crop estimate at 131 million boxes, orange juice prices may be losing some of their panic. May orange juice fell 4.40 cents to $1.4410, the lowest close in two weeks.

Energies
The U.S. Department of Energy said that underground supplies of natural gas were down 11 billion cubic feet last week to 1.615 trillion cubic feet, a smaller decline than expected. Supplies are now down 2% from a year ago. May natural gas dropped 21.8 cents to a new contract low of $4.153.

May crude oil was down .67 at $82.54, pressured by doubts about demand while prices are near contract highs.

Metals
After today’s consumer price report, some must be wondering where the inflation is that was expected to result from increased government spending and low interest rates? April gold ended up $3.30 at $1,127.50 in spite of today’s gain in the U.S. dollar.

Currencies
We keep hearing that Europe is about to provide financial aid to Greece, but no specific agreement has come about yet. Supposedly, Germany is the obstacle. The June euro closed down 1.34 cents at $1.3620.

Freight traffic posted big year over year gains for the week ending March 13th.  According to the AAR railroads posted their third consecutive week of gains:

“U.S. railroads originated 287,837 carloads during the week, up 3.2 percent from the comparable week in 2009, but down 12 percent from 2008. In order to offer a complete picture of the progress in rail traffic, AAR now reports 2010 weekly rail traffic with comparison weeks in both 2009 and 2008.

Intermodal traffic totaled 203,626 trailers and containers, up 15.1 percent from last year but down 5.9 percent compared with 2008. Compared with the same week in 2009, container volume increased 19.4 percent and trailer volume dipped 3.8 percent. Compared with the same week in 2008, container volume was up 3.4 percent while trailer volume fell 37 percent.”

Breadth of the data was fairly strong as 13 of the 19 commodity groups posted gains.  The largest gainers were metals, grain, lumber and chemicals.  Coal loadings were down 5.1%.

Source: AAR

Good thoughts here from David Rosenberg on the price of real estate in the United States.  Rosenberg points out that housing is still an excessively high percentage of household assets.  If history is any guide it could mean there is at least another 10% downside in house:

“Chart 4 is the ratio of U.S. household real estate assets relative to the entire asset pie in the personal sector.  At 26.7%, it is well below the bubble peak of 33.6%, but is still just back at the starting point of when the mania was just beginning (a decade ago). “

“While the latest ratio for Q4 is below the long-run norm it is still nowhere near the 24% bottoms we have seen in the past (to mean revert, you ultimately have to move through the mean).  If we were to retest those lows, it would mean a further 10% correction in housing valuation.  Not sure the bank stocks are braced for that possibility.  With a 67% homeownership rate and a $500 billion to $1.0 trillion equity hole, we are well beyond the pale of normalcy.”

Source: Gluskin Sheff

Today’s FX View from IB:

Wednesday’s forex activity was notable for two things: The dollar weakened as risk appetite accelerated sending riskier asset classes and currencies to multi-month peaks. The euro failed to join the party closing down on the day. It should, like a strong derby favorite, have taken up the early running, but we all quickly noticed how hobbled it looked resting at the back of the pack. Sure enough we find today that the questions are starting to arise about the very existence of a financial rescue package for Greece in the event it can’t roll over spring bond maturities over the next two months. Overnight developments leave us with the mental imagery of politicians in Berlin holding up traffic signs emblazoned with the words, “U-turn here for IMF building.”

Euro – We have become accustomed to hearing little substantive in the aftermath of EU ministerial meetings at which defense plans were supposedly discussed. Any press conferences or statements have been confined to merely stating facts surrounding the need for Greece to get its own house in order coupled with strong supportive words from fellow nations. However, the words yesterday from Germany’s chief finance minister telling Greece to pay a visit to the IMF if it feels the need for financial assistance is a real deviation from the previous script. It also leaves Chancellor Merkel treading a fine line between standing behind Greece and actual facing up to the nation as an opponent.

Needless to say the outcome is a reversion to ongoing fears for the euro, which slipped to around $1.3650 before rebounding to $1.3685. Headway for the single currency has suddenly become difficult to envisage. However, it has to be remembered that in the aftermath of the recent budget there was not only adequate but also ample demand for the €5 billion government bonds issued by Greece. The gradient of the uphill task facing the nation going forward evened out somewhat in the aftermath. Looking forward, IMF assistance is an option for Greece and looking beyond that the outlook might even improve. Arguably EU members won’t be dragged down by lending to Greece and may make a test case in sending the nation cap in hand to the IMF. For its part Greece is shored up by binding loans from the IMF, which could improve its credit-worthiness to future bond buyers.

For today, however, the perceived aversion to the euro was stepped up by investors as they sold it in favor of dollars, the pound and the yen.

U.S. Dollar – This morning’s dollar rebound on risk aversion fears continues to gather steam mid-morning while equity prices are contradicting the lack of risk appetite by putting in another positive performance. Weakness in the euro is the main reason behind today’s gyrations while in the big scheme of things, the dollar is currently confined to a narrow range.

British pound – Aside from a rebound in the dollar to $1.5307 the pound is holding onto recent gains. A midweek employment report showing far fewer job claimants seems to be the tonic sterling needed, while a smaller hole in the public finances was revealed today, which further boosted sentiment towards the pound. .

Japanese yen – The yen is rising alongside the dollar after an overnight story carried by the Chinese Securities Journal reportedly stated that the Peoples Bank of China banned banks from lending to unscrupulous developers who hoarded land and withheld apartments from sales in the hope that land and property prices would rise further. This story has gained traction with speculation growing that China is set to take further measures to cool its economy. The yen strengthened earlier per dollar reaching ¥89.75 before slipping to ¥90.35. Against the euro the yen appreciated to ¥123.60 from ¥124.00. Against the Australian dollar the yen rose marginally to ¥83.29.

Aussie dollar – The China story once again served to tarnish the shining Aussie dollar, which is weaker at 92.18 U.S. cents. In midweek trading the Aussie surged to 92.52 U.S. cents, while Thursday’s forewarnings of measures to slow Chinese growth have tempered the bullish export scenario.

Canadian dollar – The Canadian dollar took a further step towards parity reaching 99.30 U.S. cents in midweek trade. The currency has attracted plenty of interest as measures by the government might ensure that it’s the fastest nation to eradicate a budget deficit with its plan to do so by 2015. Signs of stronger growth and rising inflation might also spur the Bank of Canada into faster action on the monetary front causing an additional appeal from a yield perspective. But it also appears that government ministers are far more sanguine surrounding the impact of an appreciation in the Canadian dollar. Just seven months ago they raised their fists to speculators warning that currency appreciation was dashing the recovery and that it would take necessary measures to reverse the move. And while they never lived up to those promises, political leaders have recently stated that the impact on a shrinking manufacturing sector is lessening over time. Additionally, ministers are now predicting that gains in productivity would outpace the appreciation of the loonie whose strength was showing little sign of impacting the nation’s competitiveness.