If this is a recovery...

If this is a "recovery", then I need to take high school english again. Recovery from an injury means regaining health and mobility. I see little health in the following stats considering the massive stimulus it took us to get there.

First of all, how do job loss trends like this...

...translate into increasing home prices?

It must be this...

...since I don't see a rebound in Buffet's favorit metric...



...or here in US daily oil consumption (even though the reported numbers are only until July)...


Bottom line. All I see is a little prop up, not recovery. Remember, my previous blog mentioned that we are now at the peak effect of the stimulus and that it will wear off from here. At least the headlines have toned down from the cheery "That was easy!" messages of two months ago. Let's see if they turn into "This is kinda hard?" in March when the Treasury stops buying agency debt.

Stimulus Watch: More evidence US at the peak

Previously this blog noted that not only has the whole world enjoyed a stimulus boost but that US is at the very peak of stimulus spending. To date, this is the amount of funds that have been dispersed.



Now Christina Romer, Chair, Council of Economic Advisers in Testimony before the Joint Economic Committee is confirming suspicions…

“In a report issued on September 10, the Council of Economic Advisers (CEA) provided estimates of the impact of the ARRA (American Recovery and Reinvestment Act) on GDP and employment. ...

These estimates suggest that the ARRA added two to three percentage points to real GDP growth in the second quarter and three to four percentage points to growth in the third quarter. This implies that much of the moderation of the decline in GDP growth in the second quarter and the anticipated rise in the third quarter is directly attributable to the ARRA.”

In fact, Romer’s assessment is that after Q3 2009, the stimulus will provide no boost to GDP growth.

“Fiscal stimulus has its greatest impact on growth around the quarters when it is increasing most strongly. When spending and tax cuts reach their maximum and level off, the contribution to growth returns to roughly zero. This does not mean that stimulus is no longer having an effect. Rather, it means that the effect is to keep GDP above the level it would be at in the absence of stimulus, not to raise growth further. Most analysts predict that the fiscal stimulus will have its greatest impact on growth in the second and third quarters of 2009.”

This might lead to an interesting confluence of events. Bank of America executives have said that there will be a spike in 4th quarter foreclosures as various State and Federal foreclosure moratoriums will wear off and mortgage modification programs are exhausted. “Cash for Clunkers” is now in the past. The home purchase tax credit, a dubious incentive itself, has been applied to maximum effect according to CalculatedRisk. CNNMoney.com also noted that despite extended benefits, 7000 people fall off of unemployment benefits a day.

But who is to say there will not be yet another stimulus program to compensate for this new situation? As long as the debt markets keep buying US debt, it seems that politicians will continue to find temporary solutions to draw out timelines for recapitalization of the financial system and consumers.

Defensive Investing: Preparing for a currency war

Many people have been talking about how low interest rates and stimulus will devalue the USD. It is more interesting to talk about how long the Fed will apply pressure to the value of the USD and what to do about it.

Historical analysis that says that the Fed usually keeps rates low until 1 year after the peak of unemployment. Since we have not hit the peak of unemployment yet and do not expect it to occur until the beginning of 2010, the Fed will flood us with money until 2011. The USD has already lost 20% of it's value, and could lose another 10-20% more value in the next year.

But the economic policymakers outside the US are not naive. A low USD is like a tariff on imports for America. They know this and like to counteract the problem. On Tuesday Brazil put a 2% tax on all foreign investment into their country to devalue THEIR currency against all other currencies. The next day Turkey announced a similar proposal. Southeast Asian countries (Thailand, Indonesia, Hong Kong, Singapore, Malaysia) have started buying the USD to try to devalue their own currencies against the USD.

So what are we seeing, no one is going to take this lying down. It will turn into a currency war, with everyone racing to the bottom. Southeast Asia and Brazil can put in counter measures, but that only slows the progress. The USD will devalue, but at what price? The US has the biggest pump to flood the world with money, but it does not mean we will benefit the most from the flooding? Likely, but not necessarily.

What to do?: 100% of the known readers of this blog receive income in USD, have debt denominated in USD (if they have debt), and have over 90% of their available cash denominated in USD. A little diversity is a nice defensive measure and never hurt anyone.

As the USD devalues, emerging market currencies become more expensive and stocks in emerging markets equity prices rise. But in this environment owning equities is just like owning a lottery ticket. I think owning emerging market bond fund (EMB) or government debt of other countries (IGOV) in very small portion for a buy and hold scenario is a good step hedging step. Even better is just getting a CD denominated in currency in countries with 1) manageable deficits or no deficit 2) commodity exposure that is an Achilles heal to a devaluing USD (i.e. oil). Two safe choices for the next couple of years will be CDs denominated in the Brazilian Real or the Norwegian krone. Offered at Everbank.com with a minimum $10,000 deposit per CD, the CDs can be rolled every 3 months. The annual interest rate is 4.5% for the Brazilian real and .25% for Norwegian Krone. The money will be there and protected from the degradation of USD and is FDIC insured to boot.

Author recommends opening one rolling 3-month CD denominated in Brazilian Real and 3-month CD denominated in Norwegian Krone.

The Fed: Saving the system by any means necessary

I am not sure when the US market lost the concept of rule of law. The idea that there are winners and losers is a concept lost during our recent crisis. But whenever it did lose it's way and start rigging the markets so blatantly, it was a sad day.

"Oct. 20 (Bloomberg) -- Bank of America Corp. signed off on its government-assisted purchase of Merrill Lynch & Co. after U.S. regulators said the deal might boost the shares, e-mails from two executives showed. Instead, the stock collapsed.

“The chairman of the Federal Reserve indicated it would be structured in a manner such that BAC stock should go up when announced,” Chief Financial Officer Joe Price said in a Dec. 29 e-mail to executives of the Charlotte, North Carolina-based bank, including Chief Executive Officer Kenneth D. Lewis."

The idea that the Federal Reserve is intervening to create the illusion of value in the purchase of an insolvant corporation strikes as market manipulation and the corruption of free markets. But who cares, the Dow is up, right?

Update on October 23rd: Apparently Mish Shedlock agrees with me...

Emerging Markets: More in line with the US market than first meets the eye

I buy into the idea that the greatest opportunity for growth in the future will be outside the US. Even more immediately, I will show in this post that the decline of the dollar will make smart emerging market investments even more attractive in the coming deflationary correction.

For example, let's refer to recent history regarding the behavior of the market during the crisis days of Nov 2008. At that time there was a tremendous flight to the USD dollar as investors sought safe investments during the crisis. During that time, the Brazilian Real lost 50% of it's value due to declining commodity purchases and concerns over the world economy.

One of the investments I find attractive in South America is Brazilian bank Banco Bradesco (BBD). I expect that banks will profit from the emergence of a new middle class in Brazil. BBD was trading at $10 in November. As of today the stock closed at $21.50, clearly outpacing the market as a whole. But this is not so simple, because since November the Brazilian Real has recovered 40%, the stock has only appreciated 60% in local currency. This only slightly outperforms the 53% returns of the S&P 500 index from March 2009 bottom. This is occurring not just for Brazil, but for Mexico and many other markets where currency appreciation has occurred against the USD. Many investment magazines and pundits have been pumping emerging markets as outperforming the US. Actually, performance is equivalent, it is just the currency basis that provides the advantage.


What do we gain from this observation?



1) When panic strikes, and there is a flight to the USD, emerging market companies become very cheap

2) If the US, in response to a panic, uses easing methods to address the downturn, this is bullish to US investors interested emerging market stocks simply because of the basis risk (or in this case reward) from monetary easing and a devaluing USD.

I have no positions to recommend at this time. But it is easy to foresee another stage in the crisis due to deflation that is addressed once again with huge floods of dollars. At that point, it will be important to recognize this pattern and take positions in companies like BBD, CETV, TLK, SBS, and GMK to reap benefits from this occasion.

Stimulus Watch: China stimulus effect declining

Commodities are the key sign for watching the effect of the stimulus program in China. Across the board, signs are starting to show that the largest stimulus program (as a percentage of GDP) is already starting to wane in effect. In the comments, let me know what other factors you are watching to track China's stimulus progress through the system.


(1) Oil consumption


Even though China recently became the #1 consumer of automobiles, oil consumption peaked in July and has been declining. "August seems to have brought a reality check for refiners in China," said Vandana Hari, Asia news director at Platts. "Domestic fuel demand has clearly been lagging their high processing rates, and storage space is finite."


(2) Copper demand


The large state sponsored infrastructure projects drove tremendous demand for copper and semi finished products. There were even reports of pig farmers stockpiling the metal as a speculative investment. But there is cracks in this demand too... "Traders say the market was worried that China, the world'slargest consumer of copper, may have overdone the stock building,which boosted prices in the first half of this year. Chinese copper and semi-fabricated imports fell 20 percent in August from July at just over 325,000 tonnes, and off 30 percent
from a record 476,000 tonnes in June."




(3) Iron Ore

Even iron ore, like copper, linked to China's massive development projects. "Cash prices for iron ore delivered to China from India have fallen 26 percent to $82 a ton since August, according to Metal Bulletin prices for the week ended Sept. 4. Iron ore from Australia has fallen 28 percent since Aug. 13 to $76.1 a ton yesterday, according to the Steel Index. Iron ore inventories at China’s major ports reached 76.5 million tons for the week ended Sept. 4, the highest level this year, according to data provided by Beijing Antaike Information Development Co."

(4) Lending

"The drop in new bank lending -- to an average of 383 billion yuan ($56 billion) in July and August compared with a monthly average of over 1.2 trillion yuan in the first half -- will also pull down transactions in the coming months, said Gao Shanwen, chief economist at Essence Securities."

(5) Constrained Lending -> Real Estate Asset Price Declines by End of Year

Policy tweaks and slower lending will probably be enough for now, analysts say, allowing Beijing to stop short of declaring a full-fledged campaign to stamp out property speculation similar to one in 2007. Ge projected that housing prices would drop toward the end of 2009 or early next year, by about 10 percent, much less than a 20-30 percent fall witnessed last year."

Clearly the world economy would suffer greatly if the program disapated in effect so quickly.

Let me know how you are preparing for the stimulus to wear off and when you expect the timing to occur.

The TARP game is over, next step is an Uber Big "Bad Bank"

Obama's team came storming into office in the midst of the crisis with all the intent of saving the world financial system. They did it, temporarily at least. As it happened, the crack Obama team handed out cash to failing entities, abandoned accounting scrutiny, and finally provided a little transparency to balance sheets but no accountability for resolution. The markets gained faith in the new system, not because the banks had resolved their problems but because the government was credible and tangible in supporting all major market mechanisms.




This sunlight on the system gave the banks a chance to redeem themselves by opting out of government support by repaying the TARP money. To obtain this freedom, the banks announced their financial health based on increased capital and risk control measures. Was this actually done? No. Now the support programs (agency debt purchases, MBS purchases, T Bond purchases, money market funds(1), home purchase tax credits) are scheduled to lapse. Bloomberg reports "New York Fed President William Dudley, who is vice chairman of the FOMC, has sounded more cautious. "The market expects us to complete these programs,” he said Aug 31. “To contradict that market expectation is a pretty high hurdle.”(2)




What now?




The Obama team remedies addressed the symptoms, but the source was the undercapitalized American consumer and no remedy was found for their plight. As credit cards charge offs, unemployment rates, foreclosure statistics, and many other financial measures all zoom past stress test scenarios, the solvency of the banking system will be in question again by the Spring of 2010. At that point, balance sheets will have to be recapitalized again. Will the banks come back for TARP? No sane bank will risk the public anger of returning to the government as doctor after already claimed to be "cured" and going in for the same penicillin. The credibility of the stress tests will be demolished and the actual health of every bank that took the test will once again be on the table.


What will the government do in that situation? There is no way the Congress will hand out another $750B to the Executive Branch with no strings attached like last time. At least not if they care about holding their jobs come election time. The Executive Branch will have lost their opportunity to single handedly manage the crisis. Instead Congress will take center stage in bringing credibility back to the banking system the only way possible for a government entity. That will require complete nationatization of "bad bank assets" with the taxpayers footing the bill but banks taking a major equity hit in the process.

(1) "Treasury Announces Expiration of Guarantee Program for Money Market Funds" US Treasury Department Press Release, Sept 18, 2009
(2) "Housing Risking Relapse Confronts Bernanke Conundrum"By Kathleen M. Howley, Sept 21, 2009, Bloomberg.com

The author is long SKF at $25.