THREE THINGS I THINK I THINK
1) The recession IS over. But WHICH recession?
The recession is technically over. Most of us have been aware of this for quite some time. Earnings are growing, jobs are tepidly growing and the economy is growing again. Of course, this all sounds familiar to anyone who has studied de-leveraging cycles. An economy can grow while at the same time experiencing a balance sheet recession. This was clear in Japan where GDP actually expanded throughout the entirety of their lost decades:
Of course, global imbalances remain and the western world is still suffering from the damage caused by the credit bubble. While there has been much de-leveraging thus far the problems still largely remain. The continuing European sovereign debt crisis is exhibit A. The continuing troubles in the U.S. banking system are exhibit B. And the continually weak credit data is exhibit C. With U.S. housing in the early stages of a double dip it’s likely that the balance sheet recession in the USA will be tested again in 2011. If the housing double dip surprises to the downside we should not be surprised to be talking about the balance sheet recession for several more years as balance sheets are once again turned upside down and consumer credit problems persist. In addition, the Euro crisis appears far from resolved. And if I am correct about the banking sector it looks like Ben Bernanke is thinking ahead about bank bailout part deux. So, while the recession may have technically ended, the balance sheet recession is still very much alive.
2) What really caused the equity markets to rally since September?
In commentary yesterday David Rosenberg said the September-November rally in equities was not driven by better economic data:
“The bottom in the equity market rally came, not on a piece of data towards the end of August, but on the back of the comments from Ben Bernanke in Jackson Hole that another round of quantitative easing was coming our way. This is why the rally ended, not on any particular piece of economic data, but right after the FOMC meeting a few weeks ago — a classic case of buying the rumour and then selling the fact.”
This is factually false. The market technically bottomed on August 25th two days before the Jackson Hole speech. The market then kicked around the bottom until September 1st when China reported a strong PMI report and the ISM manufacturing report came in at 56.3 versus expectations of 53. The market rallied 3% on this news as it was clear that China was perhaps reversing several months of negative PMI reports and the USA was not going to suffer an immediate double dip. At the time sentiment was horrible and a double dip was widely expected. Over the ensuing few weeks we saw steadily improving jobless claims, improving global PMI reports, confirming ISM reports, improving PCE data, and the cherry on top was a very strong earnings season. Why is this important? Because the rally hasn’t been only due to expectations of QE. It has been primarily the result of improving economic conditions.
3) Is this the ultimate hedge?
In May 2010 I highlighted an interesting trade as a hedge against the Euro crisis:
“A fascinating trade is developing in treasuries and the gold market. We have this interesting correlation between treasuries and gold prices in recent months. As the Euro worries continue to develop both gold and treasuries have become safe havens. Of course, this has shocked the inflationistas of the world – many of whom are short treasuries and long gold, however, in this world of continuing low inflation treasuries continue to perform just fine. Aside from the firm fundamentals (U.S. government debt is not a concern and inflation remains low while the fundamentals for gold remain quite constructive) what’s become so interesting in this environment is that gold is acting more and more like a currency. In the long-run I feel as though this is entirely unjustified as gold will never serve as a reserve currency ever again. But we have what I believe is a unique window of opportunity here to buy both gold and treasuries as risk asset alternatives. It’s a beautiful hedge in a world that is grappling with the potential death of a fiat currency (the Euro) and continuing inflation or deflation. I don’t particularly like either treasuries or gold at this exact moment, but I will be a tempted buyer of both on any pull-backs. If the Euro crisis hits Defcon 1 (something I say is a relatively high probability event in the next 24 months) then gold and treasuries will soar.”
What makes this trade so interesting (still) is that they are the favored instruments of deflationistas and inflationistas. I continue to believe that we are in an environment where disinflation will continue and the risk of deflation will remain higher than hyperinflation. But that doesn’t mean gold can’t perform well in this environment. In fact, I have long said that gold is likely in the midst of an irrational bubble. The argument is simple – as fears of sovereign debt remain investors will continue to demand gold as a hedge against fiat currencies. What’s interesting here is that there is no solvency risk in the USA therefore we need not fear bond vigilantes in the USA. We truly are not Greece. Our monetary system is simply not the same. So, as long as the balance sheet recession continues in the western world the deflationary threat will remain and treasury yields will remain low, but the bid in gold will also remain as investors interpret the Euro crisis as a failure of fiat money.
Again, sane heads at pragcap. A little different from the madness at ZH.
Yes, gold does not offer good protection from inflation. History demonstrates that the inverse correlation between gold and global currencies is weak: http://globaleconomicanalysis.blogspot.com/2007/02/is-gold-inflation-hedge.html
A period of very high but stable inflation in a stable economy offers myriad investment opportunities that are much more lucrative than gold, leaving gold as the ugly sister that nobody wants to dance with.
Gold is simply an *instability hedge*.
So if it looks as if the global economic situation is stabilizing then, regardless of whether we have deflation, inflation or flatulation, gold prices will decline as all the money locked in gold gains the confidence to chase higher returns elsewhere.
Have you considered the possibility of hyper-flatulation?
Instability hedge or the best performing asset class for the last 10, 5, 3 and 1 years? It depends on the conceptual frame.
Ive been somewhat disappointed with the price action in gold over the past three weeks in the context of all the sovereign fears.
Two other growing concerns I have are the lingering threats of additional disinflation, which may upend the negative real rate story and enhance the value of cash (never understood the gold wins in deflation too argument) and the global move to austerity. Both are major pillars of golds bull case.
Taking your hedge even further I like trying to capture the spread ratio compression bt long gold / short silver and long the 30 / short the 10 here.
2-3% inflation seems to be a result of a healthy economy and not the cause.
that is the window gold does not work.
tho i am not a gold buyer either right now, i do not expect to see that anytime soon.
for next 8 years we are japan….housing and therefore the consummer must come back first.
The economic reports since September have been more positive. It is fair for people to put aside the possibility of a double dip.
However, despite that all QE are not a stimulus at all, there are still a significant amount of fiscal stimuli and other for the past 6 months
1. Transfer payment (welfare, including unemployment benefits)
2. State bailouts
3. Extra cash by withholding mortgage payments
4. China’s excessive money supply
Would the current level of economic activities be the same without all of these? I would bet no.
With China now facing its own consequences and likelihood of further U. S. fiscal stimulus diminishing, can the stock market sustain its moment to move to new high (say 1300)?
My take is margin has topped, earning prospect is low and the market has topped around 1250 before a major pullback.
TPC,
Have you noticed that the Chinese and Russians have begun trading together directly with their own currencies, i.e., without the dollar.
As I have said repeatedly on here, doesn’t matter what you monetary nerds call it!!
BALANCE SHEETS MATTER!!! And if we do not control and begin to reduce our debt, it will all end in tears. Yes, perhaps 10-20 years down the road, but it will end….
We need politicians with the will to take a frigging hatchet to entitlement programs and get out of piece of crap countries like Afghanistan and other unnecessary engagements. Not that I think these were unnecessary wars, but we are not the police force of the entire world. And how can a country that runs such large deficits continue to dole out so much in foreign aid.
THIS NEEDS TO BE ADDRESSED NOW, BEFORE THE SNOWBALL HAS PICKED UP TOO MUCH STEAM. We stay above 11k on the dow, and watch out for next year though, new highs on the Dow very likely!!!!
In other words, don’t be short!!! You get a drop before June and close the suckers out…
China and Russia trading with their own currencies instead of $ is irrelevant. I mean, that is what most countries do. They trade with their own currencies. Why did they need to convert everything into dollars anyway?
We need to start worrying when they will no longer accept dollars from the US. Especially, if OPEC demands that oil be paid for in gold bullion. And remember, Arabs have a great cultural affinity for gold. I mean, they just like the stuff.
One more comment on your gold thoughts buddy, gold has never acted as the “hedge” on inflation, it has soared in times of crises with regard to credit issues. In other words, it responds to imminent devaluation, not the actual occurrence of inflation. It’s the canary in the coal mine and such a small market that until significant demand picks up, it can be manipulated to the core.
Second, for all those who continue to claim that a return to the gold standard would solve all of thus, just read history (as one of my favorite authors has pointed out): Greece, Byzantine, Rome all fell before the invention of paper money and had some sort of gold standard.
Yet they all fell. The problem is DEBT, not the unit of currency.
The only thing that the gold standard bugs have right is that some reference to gold may limit our idiotic politicians from driving us into so much debt (or obligations to issue FRNs TPC, in homage to you) so fast.
I agree with your first paragraph – gold responds well to crises.
Your second paragraph neglects to mention that the romans repeatedly debased their coinage to the point of resorting to silver dipping.
Diffused,
You bet, but that’s really my point. A gold/silver standard, per se, will do nothing to deal with the actual PROBLEM, i.e. too much debt thereby requiring the “silver dipping” in the first place.
All governments default, all governments will devalue. Until you show me one that hasn’t, that’s the rule!
OK – from the angle of a true gold standard being unworkable due to the nature of governments, I agree completely. I just thought you were suggesting that the Romans fell despite a quasi-true gold standard.
BTW, I read this book…
http://www.amazon.com/Gold-Future-Money-Nathan-Lewis/dp/0470047666/ref=sr_1_2?s=books&ie=UTF8&qid=1290623915&sr=1-2
…over the holidays last year. Found it fascinating (from a historical perspective), but the book’s thesis is ultimately unworkable.
Thanks for the link Diffused. Here’s my takeaway, some kind of reference to gold would be ok, but a pure gold standard would be unworkable and doesn’t do what we would want it to do anyway.
Look at FDR, he devalued the dollar from $20 = oz of gold, to $35 = oz of gold. He just did it by executive order.
At least then you knew what was happening and how much devaluation of the currency had happened. I would be fine if there was some kind of gold standard reference point, in a manner of speaking. But having money BACKED by gold is a dangerous game and gave us the Great Depression to a large extent.
there are debts, and then there are debts
Currency issuers have to manage REAL GOODS budgets, so the debt that matters for them is their Output Gap and their capability gap relative to their competitors. Issuers create currency at will, purely for internal bookkeeping – the bigger and/or more complex the user base, the bigger the currency supply must be.
Currency users, on the other hand, actually DO use currency debt as an accurate proxy for their local REAL GOODS budgets.
Anyone confusing the two definitions is distracted by class conflicts between traders/bankers seeking to preserve currency value, and the domestic real economy that manages real value and lets fiat currency value & Fx rates float.
The purely nominal currency debt of a sovereign issuer is constantly conflated with that real debt – when, in fact, the currency supply & inflation can be better thought of as an engineering “control curve” that shifts with context without changing it’s fundamental shape (i.e., it retains the “control spectrum”).
TPC, regarding rallies, as of mid day, both dollar and S&P indexes are up! Provided it holds, what does it mean? Has something changed?
The economic data is definitely improving. I actually covered my equity shorts this morning and moved back to a neutral position. I am still long USD though. The latter has not been a good trade although it wasn’t a bad trade either. I thought the downside would be better given the timing of my trade (poor entry at 1180, but nailed the 1220 top), but the mkt clearly hasn’t been convinced hat equities are overbought. The USD trade has been quite good and I would expect it to remain so as the QE trade unwinds and Europe remains entangled in the sov debt crisis.
All in all, US economic data is looking pretty strong right now. I am not turning bullish on equities as I bet we trade sideways into year-end and then will re-evaluate the situation.
I am actually lucky to get out of this trade without losses. The bid under this market has been amazing in recent months. NO ONE is bearish anymore.
Wow.
So do you take ride to 1300, as many predict, or re-short at 1220? Do you now incline to believe the economic tide has turned, or need more data?
Housing is dead. But it does not seem the market no longer cares about housing any more.
There is a simple analysis that 2% increase or 4% increase of retail sales really does not make a difference as the dollar amount is just about 20 billions. 20 billions can’t do much to the economy. But if we believe the trend has changed, that will be a different story. Do you share this view (of the beginning of an uptrend)?
I’ll re-evaluate in a few weeks. I have neutral readings right now so no need for me to get overly bullish. Disappointed in the short trade though….Market had every excuse to roll over hard. Sentiment has just overpowered it plus a strong buy the dip in Q4 likely due to lagging PMs.
Thanks for sharing. Let us know when your views crystallize.
TPC,
That’s the crazy thing though my friend, pretty much EVERYONE is bearish. Three main areas of investments: stocks, bonds and real estate.
Real estate is dead/flat for two more decades, guaranteed (at least for sure residential).
Bonds — my God can we buy any more damn bonds.
So where does the money flow — stocks. Yet the retail investor, as much as I can tell, is not jumping into the market with both feet. When that happens I will start to get very nervous.
But your long dollar trade really is pro-market in a strange way. To wit, dollar devaluation will be slow and orderly thereby allowing one to arbitrage the difference. IOW, I don’t care about a 5% drop in the currency if I can make up a 10% return in the equity market.
My final takeaway is that if the yearly close is above 10,800 we see new highs in the Dow going into the next year or so. Put that in your pipe and smoke it.
Three things America has going for it that allow for this bs profligate spending not to kill us: 1) the military; 2) the reserve currency and no real “debt”; and 3) pretty good private sector companies.
It’s a time to be excited buddy, you make soooooooo much more money being long than short over time.
I think the market is probably dead money into year end. Will re-evaluate in a few weeks and see how things go.
Yep, you may be right there. I’m calling for this into Spring of next year. I will wait to see how we close though for the year.
Glad to see you’ve been right. We’ll revisit this conversation in a few weeks. Happy thxgiving Prescient.
Yes we have military power, the reserve currency, and good companies, but our Achilles Heel is petroleum. Peak conventional oil is already history, and the difference has been made up with coal gassification, fracking, natural gas reforming, and tar sands. At some point in the not too distant future, conventional oil will drop to the point that the unconventional sources can no longer fill the gap. At that point, the price of gasoline will soar to the moon and beyond. We can print dollars, but we can’t print oil.
So deflation = UP?
Make up your mind TPC
Your constant trolling of this website is growing very tiresome.
mmmmmm, maybe I will finally reign in my long lines and getting ready jump short.
I am a contrarian sign now? Hmmmm. The conviction calls I’ve made on here have been absolutely atrocious trades to take the other sides of. For instance, you said you were interested in taking the opposite side of my dollar trade the day I initiated it in mid October:
“the dollar will resume its fall and test the 2008 lows by the end of the year.”
I like that readers try to keep me honest, but let’s not take things out of context or start implying that I have somehow been horribly wrong when I clearly haven’t been.
Let me add – I’ll be the first to admit that the equity short over the last 6 weeks was not a great call. But it also wasn’t a bad call. The USD trade on the other hand was beyond contrarian and right on the money.
Don’t let the rejects get you down TPC, I’d trade with you any day of the week and your record speaks for itself. I go to ZH for fun, and PM stories and just excellent WS dirt, I come here for the real skinny and in-depth conversation from individuals that don’t always see the world ending tomorrow.
Have a great Thanksgiving as well my friend.
I thought your USD trade was ambitious but I do not know your entry point–
It’s hard to be hedged short the last 2 months of the year — tells me your a reluctant Bull
But a Bull none the less
overall–pretty good calls
The equity short is very disappointing, but as you said this is generally a poor time of year to fight the tape. I still think the dollar trade can advance and thee QE2 trade can unravel a bit more, but the equity markets have a bid under them like I’ve rarely seen. I tried to fight it and am lucky to get out without a scratch. Reload and live to fight another day I guess.
TPC,
Surprised that your equity short(s) didn’t work out…
I entered mine in late October as, from a weekly technical perspective, multiple candidates were sitting in overbought territory with indicators turning south. The SPY is confirmed this signal with a 2-3 week delay as of last week. Most (not all) of these trades are in the money and, from a technical perspective, don’t show signs of turning back north yet. Are people seeing something that I’m not? (I don’t trade from daily charts, only to precisely execute an entry, actual trading decisions are made from weekly and monthly charts).
Monthly is heading up but it’s hardly convincing, the kind of activity that I like to fade, meanwhile weekly gave a short entry signal back in late Oct and continues to read (to me) as “enter short”.
No emotional involvement in positions, maybe I’m wrong. I’ll cover if it looks bad, but for now I’m still net short.
On the dollar position, I independently bought the USD/EUR on minimal leverage leading up to QE2. Plan to hold this one while the situation in Europe continues to degrade. Over at ZeroHedge I got junked into oblivion for saying that: QE is not inflationary, rumours of the dollar’s demise are greatly exaggerated, and that those chasing the inflation trade were going to get burned.
But hey, that’s ZeroHedge, most signs of intelligence have been replaced by frat-boys drinking too much Red Bull.
Firstly, Relax! Without intending to offend, a little less insecurity please! You present a great blog which i love to frequently daily, thank you.
Are you a contrarian indicator now? No and I’m sorry if there was a little tongue in cheek there. But the fact is although you have not been trading short or unprofitably, your bias all year has mainly been to the short/negative side and you have for the most part missed a major bull move. Yes I know you can come back with numerous posts showing bullish tendency and even some trades, but it’s not a 80% bull move. You can’t argue that your views has been to the negative, so my comment above was more that I was surprised to see you potentially leaning to the bull side. As you point out, NO ONE is bearish anymore, including yourself on that comment I replied to.
As for the US dollar trade you choose to reference, it’s interesting you took only one sentence of that comment and used it out of context. Here is the comment again:
” The dollar index could rally back up to 80 in short order. The rush to the door on all risk assets could be impressive.
But I doubt this is a short opportunity, the dollar will resume its fall and test the 2008 lows by the end of the year and equities will have test the April high’s. Just an opinion of course.”
1. No mention on my behalf of taking the opposite side/trade. No challenge, just a comment.
2. Clear disclosure of it being just an opinion! Not a trade.
3. But on the merits of your argument, I clearly state a) “the dollar could rally back to 80″. Well it has rallied back and funny how it actually touched 80 today! b) “the dollar will resume its fall and test the 2008 lows by the end of the year” well if you’re that interested in my blog comment, I guess you would need to wait more than a month before picking at that one.
I have no interest in being one of those commentators that critique your posts or views with the goal of stirring the pot or offending the author. If I do or do not agree I think I have the right to post my opinion as such.
Happy Thanks-giving to you and all.
Ah. Thanks for clarifying. There’s a fair amount of snarky comments when it comes to presenting investment views on the internet so it’s difficult to tell whether someone is simply trolling around or being sarcastic.
I present my views primarily because it is a good confirmation process. The readers here are supremely smart and I hope to create an environment where we can all collectively piggyback off one another. That’s why I am short with people who sometimes just look to pick a fight. If you have a differing opinion PLEASE present it with evidence and a sound argument. If it’s reasonable and justified I think we all benefit. I am the first to admit that I am not right all the time. No one is in this business. I think we can all benefit from a consistent running and intelligent debate. That’s all. Thanks again for clarifying.
TPC
By buying equities you are playing THE INFLATION TRADE (based on The Ben Bernaks MONEY PRINTING as far as I’m concerned)……because if you were playing the DEFLATION TRADE you would short equities and go long treasury bonds.
Just thought I’d point that out, it is a subtle difference.
Cullen, Tomorrow being what it is I wanted to take this opportunity to say thanks for all your hard work on this blog. I follow many different blogs and for my money you consistently provide the best content and analysis. Your diligence and willingness to engaging in spirited and meaningful debate in the comment sections is much appreciated. Thanks again and here’s to hoping for no new posts tomorrow. Take a well deserved break.
Ditto x 100 S.D. Great post.
And one other thing, anyone who claims to be right 100% of the time is a liar or God.
The only people I trust are those who are willing to admit if a call was off, which is why I would trust trading with TPC and listen to people like Tim Knight from SOH.
These are the only people who have one damn bit of credibility in my book.
Agreed.
BTW, TPC, I think it’s too early to rate your market call right or wrong just yet. Admittedly, we’re going into the holidays and year end, and people apparently still believe in the power of circular bailouts, so it’s a tough time to fight the tape here.
Well, if the equity markets tank from here I will have been right in theory and wrong in action. If I had to guess I’d say we finish the year right around 1200 or so.
I give thanks to this blog and the excellent commentary. Thank you, Cullen.
If anyone eats and drinks too much tomorrow, or are bored, try tackling this fun puzzle!!
http://www.nytimes.com/interactive/2010/11/13/weekinreview/deficits-graphic.html?scp=1&sq=budget%20puzzle&st=cse
That was a fun treat! I must be bored today!
TPC a good institutional broker once told me that you should never short a market going into Christmas – too many fund managers away and the junior guys NEVER sell their boss’s favourite stocks. Market can easily trend up on no volume and this is what normally happens.
The time to go short I think will be mid-Jan. S&P could be 1220-1250 by then.
Good thinking BK. I have to admit I was worried about getting short in Q4. It’s not something I’d usually attempt. As you said, fund managers tend to hold thru to the end….It’s interesting to note that many commodity markets and the dollar have reversed hard and equities just remain buoyant….Fund managers buying the dips?
TPC,
Good post and I agree with most of your points. This market however is not improving because the economy has improved. Quite the contrary, most of the economic news has actually been pretty poor but the spin meisters have done a good job, and there really is money to be made by traders as the Fed pours $8-12 billion dollars a week through back channels. You take out the constant inflow of Fed money and this market would have dropped like a rock long ago. We really are following the path set by FDR’s group. They held the market up by seeding growth through public work projects from 1933 – 1937. But as prescient 11 said all debts eventually have to be paid one way or another. I still believe that by taking this path we are causing the end game to be much worse.
Yes. The debts incurred during the Great Depression were paid all right. They were paid in blood in World War II. And WW II produced the great boom that kept the USA high and mighty up through the 1960s.
“They held the market up by seeding growth through public work projects from 1933 – 1937. But as prescient 11 said all debts eventually have to be paid one way or another.”
mediocritas and AndyC: I’m with you. I may be wrong and time will tell, but when I read that TPC had covered his shorts I started to cover mine as well. I shorted before TPC did. Then,I thought that maybe the rally was because a lot of people are covering their shorts and I looked back at a post that TPC had from Consumer Metric Institute. I don’t agree with everything they say, but I just don’t see GDP growing very much over the next quarter and if that is the case, then there may be a reversal in popular opinion. Also, if the dollar continues to climb, that seems to be bad for the equity market. Finally, if Europe flops: what can I say? So,maybe I’ll lose some more money, but I believe what TPC has been saying and I’m going to hold on for awhile. I love TPC’s blog, but I will wait, not because of TPC, so he should not feel responsible for what I do. I’m not an economist, but I simply don’t see a recovery. Good luck to all.
GLH,
My major concern with shorts is that I think the market is dead money for the rest of the year. If we remain at current levels until 12/31 it’s highly probable that I could be short again. I just don’t see the market tanking in the final month of the year.
Cullen, happy thanksgiving and thanks again for your excellent work!
By the way: today I covered my shorts on European indexes as well since I think the mkts lost a very good opportunity to seriously tank in the last couple of sessions.
Thanks Octopus!
I don’t totally buy this. The only way Japan or we or anybody continues to grow in a balance sheet recession is the continious creation of more and more debt by the government. No one on earth can say or justify that this is good or will not end badly. The fact is for all but a small population the future indeed looks very bleak and for future generations it looks even worse.
politicians, being owned, will always do the wrong thing…..basic premise of investing.