Capital Markets Update

By Louis S. Barnes                          Friday, October 26th, 2012

Markets seem at last to have noticed the possible range of consequences from the election 10 days hence, and the result is a wide-eyed, jaw-dropped, don’t-do-anything.
Absent constant paddling, stocks tend to sink, and that’s what they’ve done between frozen days. Bonds tend to glaciate altogether. The 10-year T-note still cannot break 1.85% going upward, and its trading range since August has narrowed bottom-up: from all-time low 1.40% in July to 1.55% in September, now can’t fall below 1.70%. Mortgages are motionless just below 3.50%.
Stocks also suffer from poor prospects for earnings. What a surprise. By some estimates nearly two- thirds of S&P500 earnings in the last half-dozen years have come from overseas, rising with global trade volume. As that volume now has flattened (at best), so have earnings. It is fair to say that the US is in better shape than elsewhere, but not enough so to propel earnings.
Third-quarter GDP arrived at 2.0% annual, imperceptibly above the 1.8% forecast. The Chicago Fed’s National Activity Index in September rose to exactly 0.00 (three-month average -.37), as dead flat and flat gets. Housing is improving, but the change is far oversold in financial media. September sales of new homes were up 27% year-over-year from a very low base, yet NAR reported no change in pending contract volume for September. One of the very best overall housing measures is mortgage-insurer MGIC’s quarterly Market Trend Analysis, third quarter figures just released. Reporting on 73 metro markets, measured strong-stable- soft-weak, it found 14 “improving” versus only one “softening,” the best ratio since 2005. However, not one was rated “strong.” 28 were found to be stable, and the remaining 45 either soft or weak.
Disinterest in the election until the first debate was a good idea. Government in the last two years has been too painful to watch, and the two-year parade of Republican candidates drove away crowds. In the old days of Party control, Gingrich, Paul, and Bachmann would not have been allowed near a podium; and the others looked like a country club board of directors assembled to vote women off the golf course.
Now, the race too tight to call, markets must consider either outcome. A Romney White House might bring energetic action, economic understanding not seen since Clinton, and regulatory relief, but it’s impossible to know how much a desire for small government and free markets might be overdone.
Markets have also discovered that next year is probably Perfesser Bernanke’s last. There are able, mainstream replacements in either party, but for all the carping about Bernanke he has done better than anyone in government. Heroes are not easily replaced. Yet another discovery: although all assume some deferral of the Fiscal Cliff past January, a fiscal contraction is coming, no matter what or who.
An Obama re-election is especially murky because he’ll have the same Congress he’s been unable to work with for the last two years. And in that unchanged Congress lies perhaps the only unexamined issue in this election, heavily distorted by the Left side of the media. Who are we, as an electorate?
The longest and widest plank in the Democratic platform is the pitch that Republicans are the party of the One-Percenters. Billionaires. No economic agenda except to protect their goodies. And an American Taliban social agenda. Latter-day Scrooges and bad-hearted preachers.
One would think Republicans like this would be a minority.
Ahem. The House of Representatives has 435 seats. Districts are reallocated among states based on population changes, and the shapes and political contents of each district are determined by state governments, those decisions supervised by the courts. We do rig and gerrymander, but have been in serious pursuit of “one man, one vote” for 50 years. The House now has 240 Republicans, 190 Democrats, and 5 vacancies. That huge Republican majority arrived in 2010, the 63-seat net gain by Republicans the largest in any election since 1938. The most surprising thing to me in the 2012 election forecasts: no poll expects the Democrats to recapture more than 10 seats, and most think 5.
Deeper into grass roots… Bloomberg reported this week that both houses of 15 state legislatures are controlled by Democrats. 26 by Republicans.
If you’re reading this you’re a policy junkie of some sort. The best visual of our electoral divide is CNN’s John King and his magic map, county-by-county, Red or Blue or undecided grey. On every one of King’s maps, Blue America is an urban archipelago floating in a Red rural sea, suburban beachheads decisive.
I met a certified Lefty here, a program director for a civic group, professionally a therapist, both of us arriving too early for the show. I asked her views, saying no argument intended, just curious. She described fear among her circle, clients and friends; fear that the helping hand of government would be withdrawn from those with no other recourse. She said that was her main motivation to vote with Democrats, and laughed as she said the rest of her family were not so damned pleased by her leanings.
Where are they? Small town on the prairie 150 miles east. And how are they, and what are they thinking? They are afraid. Of? They get up early, they work killing hours, they look after each other, their neighborhoods and churches, and they’re afraid that the government people will bury them with rules and take more of what little they have, and then there won’t be anyone to help.
Buy any election theory that you like, except this one: good guys versus bad guys. We are far more alike in the most important ways than different. And we are all struggling to figure what we should do together.

Capital Markets Update

By Louis S. Barnes                                   Friday, October 19th, 2012

Long-term rates rose in the last ten days, at their worst the 10-year T-note to 1.83% from 1.65%, and mortgages to 3.50% despite the Fed’s new $40-billion-per- month QE3.

 

Many fear a general round of rate increases for the usual reasons: Europe back from the brink, an overdone bond-buying panic, a positive turn in the US economy, and the always-popular endgame of central bank money printing. It’s often hard to isolate the cause of market movements, but not this one. Nor is it hard to spot the reversal today, 10s back to 1.77%, stock market hitting a li’l ol’ air pocket.

 

Europe has been central to this spike, hopes there high for the two-day Brussels summit ending today. Markers: the euro itself rising to $1.31, and yields on Spanish bonds down almost by half. It is hardly an accident that rates here topped yesterday as the summit turned out to be yet another exercise in talking about more talking. Market pressure is down for the moment in the euro-zone, as nobody wants to lash himself to tracks in front of a potential ECB rescue locomotive, no matter how foggy the prospect. As it has seemed for a year, the euro issue will be forced by the social pressure and politics of open-ended depression, and nobody has a model for that groundswell.

 

Economic data here… all is relative. Those expecting recession have been wrong. The ECRI has forecast recession for a solid year, but its own index has turned up. Lest that thought overwhelm you with optimism, it is “up” into no-man’s-land.

 

Housing… for reasons best known to stock-pushers, public analysts focus on sales and construction of new homes, which at cyclical peaks account for perhaps 4% of GDP. Yes, one can add the contribution of drapes, furniture, appliances, and landscaping, but the big deal is prices, always and especially during this collapse of household balance sheets. Sales of existing homes influence the value of some 70 million dwellings; new homes now are 1% of that figure. Existing sales are up 11% year-over-year, and the distressed fraction is down from about 35% to maybe 30% — good news but not enough to pull the economy anywhere.

 

Shifting gears to a subject central to Europe and soon to be here, the IMF this week released some new thinking on the austerity “multiplier.” If a nation cuts its budget deficit by an amount equal to 1% of GDP, how much will it cut GDP? Old thinking had assumed .5%, but actual experience in Europe has led the IMF to a multiplier in the range of .9% to 1.7%. There you have the physics of black holes. The more you try to cut your deficit, whether by tax increases or spending cuts, your economy falls out from under you faster that you can repair your national wallet.

 

Side note. The austerity multiplier in Europe may be so high for other reasons, namely the insanity of bolting low-productivity economies to the currency of an uber-productive one. Thus the high multiplier there may have no grim implication for the US.

In any event, the Left and most of Center in Europe (and soon, here) howl that austerity is too much too fast, and what we need is stimulus, usually in the form of “investment.” Properly calibrating austerity is serious business, but the stimulus multiplier is in question, too. Prof Michael Pettis writes the best English-language China blog www.mpettis.com , and this month explores the difference between stimulus and pork. Any government spending adds some sugar, but must over time add specific and measurable productivity beyond cost. Every friend returning from China and Europe remarks on the gleaming newness of infrastructure, but are these investments an addition to productivity, or a warmer, dryer place for panhandlers in a meltdown?

 

Investment has been so overdone in China that its stimulus multiplier may be zero.

 

The most concerning element in these multipliers: what happens at crossover? When you can no longer afford austerity, but your finances are so poor that you can’t borrow more money for stimulus? You can dream for a while about the magic free-money machine at central banks, but Argentina and Zimbabwe are plain-sight lessons.

 

What happens? You are going to default. Then you can start over.

A Bottom Forming?

Capital Markets Update

By Louis S. Barnes                                   Friday, October 12th, 2012

Financial markets are surprisingly stable, especially credit markets. Following the Fed’s September QE3 announcement of open-ended intent to buy mortgage-backed securities, the 10-year T-note left to the mercy of markets, 10s have not traded above 1.75% or below 1.50%. Meanwhile, 30-fixed mortgages have broken as low as 3.25%.

That spread — 10s/MBS roughly 1.60% — is the lowest/tightest since previous normality hit the wall in 2007. I had thought that Mortgage Absolute Zero was about 3.00%, but if the Fed buys MBS for long enough to work off presently infinite refinance demand (many months, maybe EOY 2013), retail mortgage prices can fall below the 3.00% barrier just by more compression of spread.

Today, the main thing holding rates above 3.00% is the profiteering of big banks, increasing their margins as the Fed tries to shrink them. The worst of the piracy: jacking margins on refis of underwater households. I would say, “Shame,” but to no effect on bank boards and executive suites ethically un-reformed through this whole process. All the new rules in the world cannot substitute for a sense of citizenship.

While we enjoy new, super-historical lows, more in prospect, consider the causes….

US data is as unchanged as can be, on a 1.5%-2.0% GDP slope but fragile. The September small-biz survey by the NFIB downshifted by an undetectable 0.1%. The trade picture was a bit more cautionary, both imports and exports contracting; imports slide when US demand fades, and exports dim when the outside world fizzles.

The strongest positive here is housing, but its improvement is far oversold in media commentary. Most economic punditry comes from financial markets, which had housing wrong all the way down, and can be counted upon to have it wrong on the way up. Housing industry analysts tend to perpetual optimism, correct only by accident.

The finance guys cannot process the differences between their markets and housing: their securities are uniform and move all together, while our houses are no-two-the-same and any concerted market movement is at the neighborhood level. Terms of credit affect stock and bond markets, but nothing like housing. Imagine if you wanted to sell a share of Apple today, and had a willing buyer at $630 but the NASDQ exchange required an independent appraisal of the stock, made you wait two weeks, and then capped the price at $500 based on “sound underwriting.”

Housing now enjoys very gradual improvement, especially in states whose foreclosure-by-trustee has speeded the process. However, the “recovery” that finance types see propelling the entire economy is still over the horizon. “Mortgage Equity Withdrawal” is a measure of net contribution of housing to personal income, during the bubble adding as much as 10% per year(!). Since 2008 MEW has subtracted about 3% annually from personal income, and still does — no mere headwind, but hail in the face.

The greatest risks are overseas, quantifiable in some ways, but timing unknown. Greece lies prostrate in depression, its national debt still 160% of GDP requiring another restructuring transfusion. That debt is now held by European governments, the ECB and the IMF, none of which can face the need to write off the two-thirds necessary to allow the Greek economy to function. Thus the next transfusion will be just enough to buy time, not for Greece itself, but the utterly corrupt European leadership.

That leadership had a signal week on other grounds. France-based EADS and UK-based BAE were close to merger, $90 billion in combined aerospace and defense sales, the merger a benefit to both, enabling competition with the likes of Boeing. Any big merger in Europe requires multi-governmental approval, and Germany insisted on a Munich HQ for the new company and expansion of German operations. All media concur: on Wednesday Angela Merkel personally pulled the plug on the merger, and Germany did not attempt any form of denial. “One Europe” the euro objective? Sure.

The global balance is delicate, but the economic/political weakness in Europe, China, and emergings still strongly favors the US, if only by removing any threat of inflation, which is the prerequisite for continuing QE3 and super-low rates here.

Are The Numbers Driving this Real?

Capital Markets Update

By Louis S. Barnes                             Friday, October 5th, 2012

The first week of every month brings the largest and freshest load of economic data. For once, don’t pay attention to it for three reasons: the data do not show meaningful change; the most important data by far is overseas; and third… for the next month, politics matter more than anything.
Before Tuesday evening, everybody could hear Brunnhilde warmin’ up.
On Tuesday night my wife, Bronx-born native Democrat, 25-years an RN delivering babies, women’s rights combatant unimpressed by puffed-up males in white coats — as apolitical as I am a total junkie — at 6:57pm MST came to sit on the couch. She did not move for an hour and a half. I took out recycling, got some booze, read my book; she stayed put. She asked some questions about health care math, who Bowles and Simpson might be, but stayed glued to the show. Maybe one-third of the way in she observed, “Obama looks awful.” A little past halfway, “If the election were tomorrow, I’d vote for Romney.”
Knock me over with a feather. Part of her reaction, I think: Romney did not have a tail, nor horns growing out of his head. The greater surprise, after 18 months of televised bickering among unattractive Republicans, and an inert White House: that anybody watched. Watch we did, 67 million of us, almost 20 million more than watched the first debate in 2008. And no political operative has a model for the consequences of epic grass-roots tweeting and e-yodeling during and after the debate.
The election is not tomorrow, and my wife and zillions of others may change minds more than once. However, instead of a minds-made-up election, this one may be an extraordinary deferred-decision election, boredom until showtime.
Back to data. The twin ISM surveys taken at the end of September found manufacturing activity improving from just below breakeven 49.6 in August to 51.5, and the service sector from 53.7 to 55.1. These are not trend-changers, just stumbling on in the same mire. Today every financial-political engine asserts discovery of meaning in a reported 114,000-job gain in September, an 86,000 upward revision in summer numbers, and a half-million people taking part-time jobs improving the unemployment rate to 7.8%. Give it up. Every one of these data points is miles within the range of statistical accuracy, let alone trend.
Jack Welch’s remarks today (GE CEO, nickname “Neutron Jack”) asserting White House manipulation of jobs data, are harmful to us all. Give up on that argument. There is enough mistrust, and government stats are as straight as we can make them.
Long-term interest rates wrinkled upward at the jobs news, tons of people trying to find meaning in bonds, response to jobs and so on. Drop it. If anything, worried buyers of bonds sold a few on yet another hope for Euro-self-bailout, maybe Spain this weekend. Please. Germany’s ISM number crawled back up to 47.4 from 44.7 but will be back below 45 before it sees 50. France fell to 42.7, comparable to rock-bottom here in 2009, but not at bottom there. China is below 50, now persistently so, even in official stats which everyone assume (correctly, there) are overstated.
The action is here. All polls agree that changes in the Senate will be minor, likely still a thin Democratic margin, not a working majority. To my surprise, the mass of ornery Tea Pots elected to the House in 2010 will be back, only a handful sent home. The largest numerical shift in the House since 1948 will remain in place, the hard-Right ego of Eric Cantor able to block his own party caucus and any legislation.
If Mr. Obama is re-elected, he will face exactly the same people and intransigence as in the summer 2011 budget wreck, plus fermented ill-feeling. Yet, it may take a Democrat to lead entitlement reform and cuts in future-promised spending.
On the other hand, perhaps only a Republican can get the House under control, and it may not matter what kind of budget deal gets done so long as there is one. Fast.
I know who I’ll vote for, but I don’t know if it’s right, or how it will turn out. I am certain only of how much is riding on how it turns out.