The market is swinging back & forth, sometimes wildly lately but the trend is generally toward the sell side. From the end of May until mid-September we saw 6 successive higher cycle tops until we reached 1474.51. That trend has reversed and we now have had two lower tops & lower bottoms in the past 6 weeks. The 1474.51 number was hit, coincidentally, just as Bernanke announced QE-ternity on September 13 and is another proof of the adage to buy the rumor & sell the news. More importantly, our momentum data shows waning enthusiasm for stocks and commodities as emotions have turned toward deflation fear. From a fundamental standpoint this is probably the more pertinent immediate worry as the Fed & Treasury are barely keeping up with the inexorable debt destruction of the previous bubbles they engendered. GDP growth is, net, a function of the total value of transactions in the economy. Lowering asset prices and accompanying discounts on the debt are a drag while the stimulus of money printing is designed to be offsetting. To the extent that there are periods when the former leads the latter, we see corresponding sluggishness in the markets. The template has recently been Japan and its history of fluctuating GDP growth can serve as a roadmap for our journey. The risk that attends this scheme is always a loss of confidence by lenders. We see the unfolding capital flight and rising interest rates in Greece & Spain and realize that in the global economy this will add to the drag. Italy & soon, France will join in the frolics and none of this bodes well for our economy.
Today we had seventeen signals resulting from yesterday’s euphoria. Only 3 were confirmed and given the early action this morning we expect some of them to reverse. Overall our QPM Radar™ which tracks the ETF universe, has fallen from a positive reading in the mid 90% range to its current 76.17%, while the Composite of signals in our client list is measuring in the low 60% area.
docs/Daily Signals report 110212.pdf
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The debate over solutions to our present state of economic affairs has been narrowly one-sided. The Bernanke-Geithner-Obama factions have all been in position to employ their particular versions and the House & Senate have been bickering over which brand of snake oil to apply. It all comes down to how the Government should act to force a change in economic direction and which kind of stimulus or tax or program(s) will do the trick. Many ideas have been tried from direct loans to favored industries; Federal Reserve balance sheet expansion; debt monetization; Higher Taxes; Government takeover of Healthcare and Treasury bail-outs that run the acronymic gamut. We find ourselves deeper in debt and no better off in any respect, than when this started. The power base resists addressing the problems in any other way but merely looks for new twists on their pet theories or ways to increase the force of schemes that have clearly not worked. They have tried re-regulation known as Dodd-Frank named after two of the most notorious cheerleaders & abettors of the debt build-up that led us to this collapse. This bizarre law, written with the current governmental inclination toward fill-in-the-blanks legislation, now has about 25% of its specifications completed and is more than 8000 pages in length or approximately 10 times the number of pages in the combined Torah, Qur’an & Christian Bibles both Old & New testament.
According to a recently released study by Rogoff, Reinhart & Reinhart*, the history of Debt Destruction Deleveraging is very clear. In every instance deleveraging was accompanied by interest rates that averaged 2%. Each included a protracted period of low GDP growth - 1.5% below normal. Sadly, especially for our current claque of political hacks, the duration of each of the 26 previous DDDs averaged 23 years! No matter the potions applied by politicians, it really does take a long time to eradicate decades of debt build up that collapses of its own weight when it ceases to promote economic growth. There was one very important instance, the lone period that produced what can be described as a good deleveraging. In the 1873 -1895 U.S. experience wages rose while debt was destroyed. In ugly DDDs incomes tend to fall faster than the debt. The catalyst for the one good DDD was low tax rates – the income tax wasn’t in place - which produced a lower cost of business creation. This was complemented by Federal fiscal policies that kept a lid on government intervention. We have a choice but the current political climate & the supine complacent arrogance of the economic fraternity will only change when the ugly version causes so much pain voters finally run them all out of office.
According to the IMF the average EU country, excluding the PIIGS, has debt to GDP of 74% not including the unfunded liabilities of their various pension, health & other schemes. These latter legal responsibilities amount to as much as 200% of GDP in the case of Germany according the Bundesbank. Add to that the leverage in the ECU banking system – again not including the PIIGS – of over 25:1 and we realize that theirs is a trap the likes of which no country has ever succeeded in overcoming. As the slow motion train wreck materializes before our eyes even the optimists must concede that the European banks will suffer a loss of at least 4% during the time the EC ministers beg, borrow & steal to gain time in the attempt to save themselves. We saw it in Spain and are watching the contortions politicians in England are going through in the attempt to ignore the plight of the British welfare state. British banks have gross debt of seven times the islands’ GDP along with national debt of 86% and a National Health System that uses more than 50% of all tax revenues. We doubt the ability of Europe as a whole to withstand the avalanche of debt refunding due in the next two years while they are struggling to borrow even more money to keep the lights on.
Two weeks in Spain are hardly enough to provide in-depth insight into the obvious mess that is Spain. Obvious because no matter where we went the country was littered with derelict cranes towering over abandoned skeletons of massive apartment buildings populated by squatters meant to be offices, condos & shopping malls. It was hard to miss the ubiquitous “Vende” signs on houses all over the country. All are empty and falling into disrepair. The Streets are crowded with one person itinerant sellers of knock-off watches, handbags and assorted junk and prices for everything in stores is 50 – 70% off. The 20 something college grads are living with parents & walking by restaurants in every town we saw a running competition between the once haughty Maitre D’s, out on the pavement practically begging passers-by to come in for a meal or a drink or some Tapas – all at reduced prices. At the height of the season in Marbella or Barcelona, in Mejas, Majorca or Malaga it was the same. Large empty eateries catering to the tourists or locals are rarely filled except when Spain or England was on TV playing football. They are fighting the corruption as best they can: The Lawyers Association has sued the Chief Justice of the Spanish Supreme Court, Carlos Divar on charges he spent €35,000 of the tax-payer’s money on weekends in the top hotels in Marbella – he resigned in disgrace; The King’s son-in-law, Inaki Urdangarin is in court defending himself against stealing from the public purse & of course, endless numbers of Police Chiefs’& city officials have been relieved of their positions on similar charges. Spain is a basket case. We went to most of the resort areas and while there were some tourists, no crowds. Real Estate sales are non-existent. Friends in Malaga live in a great looking area, in a very nice villa. They've had it for sale for over 2 yrs. They’ve had no bidders and no sign of any. It’s the same all over the country. The Spanish are mostly stoic but the miners are rioting in the non-tourist areas because of pay cuts stemming from the government reducing subsidies to the industry. Socialism proves once again that it is a game of musical chairs that adds players even as the chairs are removed.
The Dow began the month at 13,213.63 and ended it down 820 points or more than 6%. Our Early Warning report of April 18 gave us ample time to position ourselves for the downturn and as a result we have skipped past the sell-off and have been fortunate enough to add several percent to our clients’ portfolio values. The “Benopause” as we call it, has confirmed once again that the Fed & Treasury are a long way from fixing the economic mess we’re in, just as it failed to do in the 2010 – 2011 Spring-to-fall hiatus wherein the Bernanke stops printing to see if his pump is in-fact primed. This also gives the lie to his boasts that he is 100% certain that he can extricate us from the mountain of paper he’s buried us under. Not only will he need to resume operations at the printers again late this year, every indication is that he will have to wait until after the election so as not to be seen as political. Proof once more of the fallacy & self laid trap that Central Bankers have been succumbing to since Keynesian counterfeiting became all the rage in the 1930’s.
Ben demonstrates his amazing prescience once more:
“A number of key systemic risk measures that evaluate the potential performance of firms during times of financial market stress have improved in recent months. These indicators of systemic risk are now well below their levels in the crisis, and, overall, they present a picture of a banking system that has become healthier and more resilient. ...Such measures include the conditional value at risk, or CoVaR, which is an estimate of the extent to which a bank's distress would be associated with an increase in the downside risk to the financial system." Federal Reserve Chairman Ben S. Bernanke, "Banks and Bank Lending: The State of Play," conference on Bank Structure and Competition, Chicago, Illinois, May 10, 2012
"In hindsight, the new strategy was flawed, complex, poorly reviewed, poorly executed, and poorly monitored."
"It was a bad strategy. It was badly executed. It became more complex. It was poorly monitored."
"We're willing to bear volatility, and um, that's life."
"This trading may not have violated the Volcker Rule, but it violated the Dimon principle."
"Just because we're stupid doesn't mean everybody else was."
“The CIO VaR changed from the 1st quarter report. JPM had been using a new model that is flawed, and went back to old model.”
JP Morgan CEO Jamie Dimon, explaining the banks’ $2 Billion loss in an investor conference call, N.Y., May 10 2012
"It is one more failing in the history of shortcomings for the model. Last week, JP Morgan Chase revealed a major defect in one of its key risk management tools. Instead of helping to predict the surprise $2 billion trading loss announced by the bank, Value-at-Risk had helped disguise the riskiness of JP Morgan's portfolio." "Fears Deepen Over Risk Model" Financial Times, May 14 2012:
We ended March with concerns that the markets would begin to weaken because our early warning system was flashing the yellow caution signal and our QPM Radar™ began to slip from its 99% positive position as the month closed. We began April 93.26% positive, not a big drop from the highs but then again an early warning might be a false signal but it is better than trying to guess as most prognosticators tend to do. Many of the economic positives of Q1 began to flatten as the month unfolded and some went into reverse. The Fed signaled that it would, in fact pause, something we suspected might happen as well. Out system continues to warn us that things are getting jammed up as the markets have been living on the feeding system of fiat money for so long that getting weaned might at best prove difficult. Several of the big winners of the first part of the year have begun to falter and a full blown correction looks like it is beginning. Our QPM Radar™ closed the month at 66.32% positive and the warning lights are flashing. Go to: http://www.quacera.com/portals/22792/flash/universe.swf to run the price & momentum Radar Player for the past 20 days.
"Twist again like we did last summer, twist again like we did last year..." Lyric from "Twist Again" by Chubby Checker
The Fed has leaked news that while they really won’t do QE3, they will do a $750 Billion “twist” program to sell short maturities & buy long term bonds. This, in the jargon, is known as a “sterilized” QE in which the attempt is made to make the stimuli appear to be neutral with no new additional cash printing & they want us to think there is no real risk to the Fed’s balance sheet. After all, this is just another bank function in which the bank borrows short term and lends long. Under normal circumstances this might be the case. The problem here is that we have a bank with nearly $3 Trillion of risky assets now planning to shift another $ 750 Billion of those assets to the riskiest end of the interest rate curve. We know from every country that lost currency credibility – Greece being the most recent – that they also lose the ability to control interest rates. With 2% or less equity securing that $3 Trillion of risk, a loss of lender confidence might just put us where Greece finds itself – with a one year government rate above 1000%. We also know that last summer's Twist was a flop and this one will be no better.
After the close on Friday, GM announced a pause in Volt production for 5 weeks along with 1300 layoffs due to the decided lack of enthusiasm for the contraption. There is also concern for the fate of those who buy these things when they wish to trade them in for a new vehicle. Seems that half the cost of the car is the engine which, after about 3 years, may have to be replaced. If you pay the $31,600 price tag (net of the $7500 tax rebate), have the thing depreciate by 43% over 3 years (same as my Toyota rav4) without subtracting a $15,000 new battery cost, you find yourself with a higher overall cost of operation in exchange for 35 miles/gallon. So, let’s say you drive the thing 35,000 miles per year and pay an average of $3/gallon. That comes to $3000 for fuel per year or $9000.00 plus $13,588.00 in depreciation. Compare this to my Rav4 Toyota which gets 15 mpg. and cost $23,000. It traded back at $13,000 so my 105,000 miles over 3 years cost $21,000 in fuel plus the $10,000 depreciation. Then let’s add in the $1.50 per day Chevy estimates you pay for electricity (http://www.chevrolet.com). At 7 days of charging per week over 3 years, it comes to $1642.50. Overall, the total cost for a Volt with no added luxury or features is more than $15,000.00 higher than a small SUV. If the Volt also needs a new battery, the comparison worsens.
Well, you might ask, what about the savings to the planet from the lowered use of fossil fuels? The answer is, of course, that the electricity will have to be manufactured in an existing Utility plant which uses coal as well as other fossils, so instead of paying one way the planet pays another. Then there’s the non Volt driving taxpayer’s share of the $7500 the Treasury pays to foster this economic Rube Goldberg contraption plus the fact that if the wildest dreams of Mr. Chu and his EPA minions are realized, we would collapse the grid if a significant minority of drivers were actually enticed into buying. Is the building of solar plants (currently at a 400% cost premium to coal or oil fired generation) going to become suddenly feasible? All in all, this is no bargain for the consumer, no win for the greens and merely a pacifier for those whose progressive but fuzzy thinking stops whenever they light up their hopium.
The Market ended the month with the S&P 500 index trading 8.5% above its 200 day SMA and up 6.96% so far in 2012. This also raised the index slightly above the last 3 short term tops in February, April & July of 2011. The July peak led to a 20% sell off that bottomed in October, 2011 at 1074.77. The Quacera QPM Radar™ of the ETF Universe we follow remains at 96.97% positive. Obviously this does not give the market much room for improvement and is a sign that we are well overbought. Our Composite YTD report, http://t.co/3zK6Lg9v via @slideshare, shows the positive signals are producing a 10.74% average gain and our negative signals have generated -6.98% which translates to a gain for short traders. We remain dedicated to providing our subscribers with the tools to navigate these treacherous markets as well as providing our Asset Management Clients with a positive risk adjusted return.
The data and reports provided here are for information purposes only. This is not a solicitation to buy or sell any security nor can the returns shown be guaranteed to indicative of future returns. Trading securities is risky and readers are cautioned that they should seek professional guidance before taking on such risk.