Market Currents
The U.S. recovery is going just fine, and potential bad news is discounted in share prices, Abby...
-
Monday, June 7, 2010, 2:47 PM ETThe U.S. recovery is going just fine, and potential bad news is discounted in share prices, Abby Joseph Cohen says. Rather than focusing on Greece or the recent jobs report, investors should consider the big picture - the underlying health of the economy and whether GDP growth and job creation will improve.
Other date
Latest Articles
This news story has 35 comments:
NOT!
(Dear Abby: What is really in the market is that you "like the S&P +20% from these levels. Whatever the price." Sincerely, been around the block.)
This is exactly what many here on SA (and elsewhere) are doing. And it is why we keep looking over our shoulder at how those economic data streams are trending. There are reasons for uncertainty and most of us are trying to reduce that (the uncertainty).
Greece (and other PIIGS) are merely background music to the larger concerns about financial system stability, jobs and GDP growth and trade imbalances. The delicate trade-offs between government deficits and deflationary collapse provide the foreground music.
It is fine to get a 30,000 foot perspective, but the good Ms. Cohen's comments today are of such a broad scale that it is like an earth orbit view where all you can see are the blue and white features of the atmosphere and the outlines of the major land masses. Not much help, at least for me.
When bright/talented/motivated people are having trouble earning a buck... look out below.
Certainly, there are numerous obstacles for the economy to navigate and myriad reasons offered why the good ship USA may hit a shoal, and forever mentioned in the litany of woes that may befall us is "deflation."
Without taking sides in the market-direction debate, I just want to ask few things about the supposed deflationary threat:
1) If there were really such a risk of deflation, somebody explain the amazingly steep yield curve. Such curve historically --and, usually,
accurately-- forecast inflation.
2) How do we wind up with deflation, when every major government in the world has been printing currency overtime?
3) Somebody provide me real-world examples of anything, outside of real estate, that's showing even the slightest sign of deflationary behavior?
Printing money:
The most difficult concept for many to understand involves the effects of collapsing credit (unwinding). It can happen in two ways, the first is a severely deflationary unmitigated collapse such as occurred in the 1920s and early 30s. The second way it can occur is the path attempted this cycle with the credit collapse cushioned by the creation of additional currency. The currency replaces the credit destroyed by the collapse of the credit bubble.
Most "money" is not in the form of currency but is in the form of credit. If you define "money" as the vehicle of exchange then the meaning of my statement becomes clear. People buy things with credit and currency. When the vehicle of exchange is too much dominated by credit (too little currency), excesses can lead to the collapse of credit (defaults) and the value of "things" (labor, physical objects and services) can decline.
The policy of the major world governments in the current credit collapse is to attempt to replace some of the lost credit with currency so rampant deflation can be avoided. This is a natural reaction of governments that are already greatly in debt. The only outcome for such governments if they do not cushion the unwinding process is to themselves default on debt.
The problem that can result is that if currencies are printed in excess of that which is needed just to prevent persistent deflation the outcome is higher inflation. That is the risk we face now, but we are still far from the tipping point to date. There is still a lot of air remaining in the credit bubble. But, if we try to get most of the air out by printing money we will increase the probability of going too far and passing the tipping point. The debate is really centered on where the tipping point is. Actually, nobody knows. It will only be evident if we actually go past it.
Deflation:
The areas where there has been deflation (in addition to real estate) includes other assets such as credit assets and equities. Commodities are also in a negative trend after reaching the top of a cycle in the summer of 2008. Commodity price cycles tend to last for several years and we are only two years into the current downtrend. A major area of deflation that is not so often recognized as such is cost of labor. This is evident in the developed world as more and more labor becomes sourced to developing economies at much lower cost. The deflation of the value of labor is the aspect of deflation that has the longest duration of the factors I am mentioning here. It has been ongoing for well over a decade.
Steep yield curve:
You are exactly correct when interest rates are determined by market forces. Interest rates today are strongly influenced by government intervention. ZIRP and quantitative easing have created a steep yield curve. The deflationary pressures have destroyed much demand for credit in the private sector so the manipulation of the yield curve is easy to maintain. This creates a high income environment for the banks (borrow at zero, invest in treasuries at 3%) so they can work off their credit instrument losses over time. So the banks that should have been brought to the "bar of financial justice" are being allowed to work off their transgressions, not by doing community service, but by suckling at the breast of the taxpayer (increasing the national debt).
What we have now is a contrived steep yield curve that is being maintained to transfer debt from private hands (the banks) to public hands (the national debt).
Sorry to have been so long winded, but, for me, your questions were not simple.
Thanks for the lengthy reply. A few more comments:
I fully understand credit, as a component of overall money supply and that currency isn't merely paper dollars, euros, etc.
Yes, the governments are working overtime replacing lost private credit by printing money, keeping rates low and even artificially providing gains, so banks will amp up their balance sheets. The net sum, for the moment, is not an expansion of credit or a massive increase in the circulating money supply.
I will take issue with one aspect of your reply that, I believe serves as a fundamental point of argument between various sides of the sovereign debt debate: the movement of debt from the balance sheets of corporations, even small countries, to that of the "big boys," i.e., U.S and EU, is salutary in at least one respect, that is, currency-controlling countries (or even the ECB) cannot be forced into structural defaults. They can choose to permit a default, but they cannot be made, technically, to default because they possess the power to create currency.
Individuals can default, banks can default, countries that borrow outside their currencies (Argentina, Iceland, etc.) can default, but nobody owing debts in a currency that can be replenished by a sovereign power, of which they are a member, can default, unless that sovereign permits it.
In the case of the EU, that's really the big question, isn't it? The ECB can inflate its own currency ad infinitum (within reason) to subsidize weaker members of the flock, just as some weaker states here run annually on net inflows from Washington. The question remains whether the ECB (i.e., Germany) will permit this to happen. In the U.S., there's little question that Uncle Sam supports states, even cities (remember NYC?), but, that's still the big question remaining in this noble concept underlying the EU.
Of course, if we dissolution of the EU, then, no doubt, we'll suffer another severe recession, if not worse, as fear overtakes all. I'm not sure I see that as an imminent threat, but it's there. On the other hand, if the EU decides to gradually inflate its balance sheet by taking on more debt and printing more euros, then, even more inflationary fodder will be in place.
Remember, it's only the economy's hesitancy, mostly bred in fear, I think, that's holding back expansion. Typically, in such situations governments are remiss in drawing down excess capital to well after the recovery horse is out of the barn. I suspect they will be equally, if not more, hesitant this go-round, and this time there's more excess capital floating around than ever before (keep in mind that even private bank deposits are at all-time-record levels).
So, my final conclusion is that barring Armageddon of some sort, that stage is set for a definite inflationary episode. The question to me is merely when it begins and how severe, not if it occurs. Only a persistent vegetative state to world commerce --like a depression-- could avert that for a lengthy period, but I'm not betting on that, at least not at this juncture.
Thanks for the dialogue. (We can be equally long-winded.)
You are correct about my poor discussion of default in the case of "world" currency nations. They could, of course, elect to default, but that is not likely. Instead they are likely to chose to monetize the debt and inflate away the liability. In order for that to occur, the currency value of labor, real and commodity assets (and their equity representations) must inflate. I think this is the eventual inflation to which you refer.
Good discussion.
Basically, it is hard to focus on any picture when your boat is being rocked every day by waves of negative sentiment. When the Euro, bond spreads, corporate bond market, and VIX settle down, we can evaluate what that picture may be. Until then, it will be hard to make any fundamental arguments for better stock action.
I am. Which is why I'm out of the market. It's nothing more than a Ponzi scheme at this point.
"Hear no evil, see no evil, speak no evil."
I guess that's why an alarming majority of stock market investors lose money. They buy when everything looks good and when prices are expensive, and they sell and shit on stocks when everything looks bad, even though things are selling at a bargain. Echo optimism when the markets are going up and echo pessimism when markets are going down. Buy high, sell low.
In this case I think the real issue is with Abby Cohen and with Goldman Sachs. Consider the source. For some reason when you hear a bullish call from the general direction of Goldman Sachs the first thought in the minds of many is that they must have some long positions they want to unload ...
Remember that most stock investors' time horizon is longer than any of these jokers' can predict.
Another fascinating trend. Everyone is now an economic forecaster and macroeconomic specialist. The worthies on this thread most of whom cannot balance a check book are now competent to decipher economic data and sovereign risk ratings and opine on the future of the market. It is completely hilarious. So many experts.
How many macroeconomists and true quants are there on the planet. Can they all be on this thread?
So what is happening? The euro is driving US stock prices - the way it trades defines the market trend - that really makes no sense if you think about it for a nanosecond - currency - a foreign currency driving US stocks? Phantom sovereign default risk in Europe is pulling you away from equities into long dated US treasuries - that's the safe haven? OMG. You are all experiencing one of those Mr. Market moments and you don't know it yet.
The smart tack is to take a step back and look at the recent earnings - large cap US stocks are trading at 12 times here with interest rates at zero and with a good earnings season just gone and another on its way. The smart risk reward bet would be to buy here - which is why none of these jokers is doing that - 1050 and below is a good price and you have a good chance of seeing 1300's by the end of 2011 and with that a 15% return over 18 months.
Look at some of the stupidity. Some examples. All big caps because that is what I mostly like at the moment. That and some REITS.
BP generates about $30 bill of cash per year. The stock trades at a 9% yield. Let us say the cost is $60 bill over 5 years. A fantastic sum. They can cover it and still have almost $20 bill to spare for capex and even some dividends. For context Hurrican Ike which took out Galveston and Houston in 2008 cost about $20 bill. Katrina cost $80 bill. You can use these events to scale the damages. You need to add more for potential punitive damages but the amount of property damages is far less than either of these events.
Banco Santander. A 10% yield. Rock solid balance sheet. And an international franchise. But don't take it from me. I am sure all of you are banking analysts to rival the best. I am sure you can all figure it out.
Intel which just reported record margins and is caught up in the middle of a massive upgrade cycle. They just reported revenues in Q1 - traditionally softer that beat their next quarter - Q2 estimates. That used to hapen in the 90's when Intel was a growth stock and you guys were falling over yourselves to buy it at 30 to 50 times. Now the stock yields 3% which is only 30 points below the US 10 year! Incredible that I would see Intel trade at a yield like that.
Look at Norfolk Southern - it yields 2.5% and you just all saw the rails report today showing strong traffic growth. Yes traffic is down 10% from 2008 but the stock is down over 30% from 2008 levels and they have more pricing power and their costs are lower now versus then - so their economics are better and in 2008 we were heading into recession and now we are coming out of it.
These are just a few examples. Take a look at Nestle, any European pharma, GE even Microsoft. Take a good look at the S&P 100 as a group.
A long message because it is remarkable to me to observe the level of "group think" and "pumpkin headedness" there is out there. I profit from it so I cannot complain too much but it is also just dismaying to see such an arrant and predictable displays of stupidity day in day out on these pages. It just pains me to see so called experts and their followers piling on in such a foolish fashion.
E
-Hungary is tied to the whole macro situation (it's real bad, and very linked to global banking by the way) of Europe, hence the reaction.
You say, "How many macroeconomists and true quants are there on the planet. Can they all be on this thread?"
-God, I hope not! Look where have all those "experts" gotten us! Most are either working for O or on CNBC right now.
-Currency driving markets makes PERFECT sense. The amount of capital and liquidity in global currency trading dwarfs that of the US markets. (The Earth revolves around the Sun, not the other way around.)
-"Step back and look at earnings"? News Flash - people are waking up to the "earnings" tricks as well as the reality of national debt, state defaults, unemployment, bank failures and need I mention housing?
BP and earnings - ok, let me help you. BP "used to" do 30B cash. Have you driven by BP stations doc? Ghost towns. No one is purchasing BP products...no one. What do you think that's going to do to them as they hemorrhage money into the Gulf clean-up? I'll give you a moment to do the math.
I'll stop there...but keep in mind that "group think" among smart people is sometimes a good thing. You might want to consider a coin always has two sides, it will improve your wealth accumulation. You say you "profit from it", but I don't see that when comparing these market moves to what you've written the past year. They contradict. good luck.
But...let me pick only one example from your response - let's take your BP issue -
Their retail business. It is meaningless. They make no money in refining either. They could sell it or give it away and it would not really matter a whole lot. Their cost to find oil in 2009 was about $12 BOE - oil sits at $70 - you can do the math. Upstream is where the money is. They spend over $1 billion on alternative energy alone - solar, wind, etc. in 2009. Boom turn off that spigot and they have enough to pay some fishermen on the Gulf coastand then some. I am not saying it is a good investment but there is a lot of hysteria out there on BP and some other issues - all a prudent man can do is sort through the facts and make some educated guesses.
But clearly you are expert and I on the other hand am a babe in the woods.
I like my odds here - so let's do this.
Are you a scotch drinker?
I will bet you a bottle of The Macallan 25 or donate the cash equivalent about $700 to a charity of your choosing if the S&P is below 1050 by end 2011. If it closes above 1300 - you reciprocate. Anywhere in between - we call it a tie or we can both make the donation. I like that too but I am relaxed about it. I like JDRF or Alzheimers Foundation of America.
You might as well profit from your "smarts" and take advantage of poor me.
E
I think you are right on about the macro picture. I think the last time there was such a divergence about the underlying trend of the macro economy and pessimism in the market was during LTCM.
For LTCM, at least there was some direct US exposure. This time it's ridiculous stuff like insignificant posturing by some minor european politician (what's Hungary, 1% of euroland gdp?).
The market went up 35% in three months after LTCM.
(E, your whisky choices are out of my range, I'll stick with Dun Bheagan Islay to celebrate or drown my sorrows, as the case may be).
(I do like Scotch, and the Macallan 25 is a nice choice, but too pricey. It's one of those "Wow, you bought an expensive Scotch" trophies.)