Fin/Inv

The dollar broke to new lows this afternoon. As soon as it did the commodity complex exploded.

I'll have more to say on the ramifications in the weekend report.

The late-day selloff may have felt bearish on Thursday. One very simple study I ran last night suggested otherwise...

(click image to enlarge)



The number of instances was a little bit low. These results are strongly suggestive of upside over the next few days, though. The profit factor (gross gains / gross losses) over the first 3 days is especially impressive. Also compelling is the fact that every instance saw at least 1 close above the trigger day close within the next day or two.

“The Chinese government is one of the few governments in the world that knows its GDP numbers three years in advance. I’d be a bit careful about China.” Marc Faber, CNBC

Marc Faber is an international investor known for his uncanny predictions of the stock market and futures markets around the world. Dr. Doom also trades currencies and commodity futures like Gold and Oil.

The latest Newsweek cover says it all:





Rosie turns grudgingly bullish?
In addition, perennial economic bear David Rosenberg allowed in his latest missive that the economy might be turning around [emphasis mine]:

[T]here is no doubt that after the sharpest downturn in housing, production and employment since the 1930s, that the laws of gravity themselves prevent the economy from any further deterioration. Nothing is going to zero, and there is always the chance that housing sales edge back up towards their demographic levels, auto sales recover to their replacement demand levels (plus GM getting back into the leasing game), and inventories get rebuilt in line with spending levels. The government has its hands in 40% of the economy and when public sector officials can influence how banks can value their assets, how mortgage servicers should be doing their business, who shall fail in the financial industry and who shall not; and when we have a central bank that is not just the lender but the market of last resort, even for RVs, and a government willing to run up its deficit to levels that would have made FDR blush, then perhaps we can end up seeing a recovery occur sooner than we had thought.

You can almost hear the agony in his voice as he penned those last few words.

On top of that, Mark Hulbert reported about a week ago that newsletter market timers were getting too bullish.

As the S&P 500 rally tests the magic 1,000 level, it’s worthwhile to think about these sentiment data points.

FN: The full article is mind boggling.

Wall Street Analysts Keep Telling Big Earnings Lie: David Pauly: "At a time when the financial industry’s credibility is at an all-time low, you would think Wall Street’s finest would break their necks providing transparency.

Not so. Stock analysts continue to promote corporate earnings lies, insisting that net income isn’t really what investors need to know.

Instead, their earnings estimates ignore often huge expenditures that can’t help but affect a company’s health.

In analystspeak, Intel Corp. wasn’t hit with a $1.45 billion fine from the European Union in the second quarter for anticompetitive practices.

After setting aside funds to cover the fine, which Intel is appealing, the semiconductor-maker had a quarterly loss of $398 million, or 7 cents a share. Disregarding the fine altogether, analysts maintain the company earned 18 cents a share, beating their average estimate of 8 cents.

As Wall Street tells it, the employee stock options Google Inc. granted in the second quarter didn’t cost its shareholders $293 million.

Google, according to generally accepted accounting principles, earned $1.48 billion, or $4.66 a share, in the period. Not enough for Wall Street, which prefers to say the company earned $5.36 a share, leaving out the cost of stock options."

The last hour rally has been common lately. The last hour is often viewed as the “smart money” hour, when institutions place many of their trades. Some indicators track either just last-hour movement or 1st hour and last hour. While the market has consolidated the SPY has moved up in the last hour for 4 days in a row now. I looked at other situations like this.

FN: You can see the rate of change increasing... as the move higher becomes parabolic. Yesterday, the first crack appeared. Intraday the drop hit 7%, and day closed with a 5% loss.

“I am 100 per cent sure the US will go into hyperinflation. Buy a US$100 bond and frame it to teach your children about inflation by watching the US bond value diminish to almost nothing over the next 20 years." Marc Faber

Marc Faber is an international investor known for his uncanny predictions of the stock market and futures markets around the world. Dr. Doom also trades currencies and commodity futures like Gold and Oil.

"I much prefer to buy when things collapse" Jim Rogers, Bloomberg Television

Mark Thoma shows us a historical chart of the personal savings rate since 1960 and asks how much of the recent increase (from an average of about 0.5% from 2005 through 2007 to a peak of almost 7% in May of this year) is permanent? One must, of course, take the May figure with a grain of salt: the savings rate rose in May largely because tax withholding was reduced; unless that attempt at a stimulus is completely ineffective, we should expect the savings rate to decline as people start taking advantage of the new disposable income. But even before May the savings rate this year was running consistently above 4%, which is a dramatic change from a few years ago. Let’s use the April figure – 5.6% – as a guesstimate of what the “true” savings rate is right now and ask how much of that will be permanent.

Not much, thinks Brad DeLong:

I would guess that only a small part of the rise in the savings rate is permanent. Financial distress was and is much greater than in past post-WWII recessions, and financial distress is associated with transitory rises in the savings rate.

I’m inclined to disagree. Undoubtedly the savings rate will fall somewhat as the degree of financial distress declines, but I think there’s a good case to be made that much of the increase is permanent.

For one thing, from the point of view of households, “financial distress” may be extremely slow to lift. If the Japanese experience is any guide, it is a very slow process to get a severely distressed banking system to start lending normally again, and it’s not clear that things are going to be any easier for the US. Meanwhile, most forecasts expect the unemployment rate to remain quite high for several years. It could take 3 years, or 5 years, or 10 years, or 20 years before the financial distress lifts.

Granted, even 20 years is not forever, and 3 years is certainly not forever, but it’s long enough to stop thinking about household behavior as being continuous over time. We can reasonably surmise that, even without so much financial distress, the savings rate would have trended upward over time. Presumably households would gradually have come to recognize that they weren’t saving enough. (Can zero be anywhere near enough?) And as baby boomers’ children settle into their own careers, they would cease to be a drag on their parents’ savings, and at the same time those parents would have to start worrying seriously about retirement. The financial distress messed up this scenario (or maybe just speeded it up), but the underlying trend should still be going on “beneath the surface.” By the time the distress lifts, there will be other reasons for the savings rate to be higher than it was in 2006.

That argument is rather speculative, I admit, but there are more solid reasons to expect the savings rate to remain high. While the current, comparatively high savings rate may reflect the effects of financial distress, the low savings rates of the 2005-2007 period did not merely represent the absence of financial distress. What is the opposite of financial distress? Financial ease? The degree of financial ease during that period (which was the culmination of a process that had been building on and off for a couple of decades) was well beyond normal, and well beyond what we can expect in the coming years, even if recent sources of distress are resolved fairly quickly. Consumption was supported (and aggregate saving accordingly reduced) by a fountain of credit that will not re-emerge with such force unless people in Washington and on Wall Street make some big mistakes.

The ready availability of credit to consumers was in large part the result of lax regulation, careless investing, and the assumption that home prices would never decline significantly on a nationwide basis. With respect to regulation, the pendulum is clearly swinging in the other direction now. Careless investors have learned their lesson for a generation. And housing prices have disproven the earlier assumption.

After the collapse of housing prices, not only will lenders be more cautious: borrowers also won’t have as much collateral. It will be quite a while before typical homeowners have as much equity as they did in 2006.

Moreover, the meltdown may have shaken confidence in the concept of securitization to the point where it will take a decade or more to restore even healthy securitization markets (if they can be restored at all), let alone the severely intoxicated ones that we were seeing in 2006. It won’t be easy for households to borrow money for consumption in the coming years. The ones that had negative savings rates will be much less common, while the ones that had positive savings rates will still be there. I expect we’ll be seeing savings rates noticeably higher than zero for years to come.



UPDATE: With today's revisions, the increase in the savings rate is much less dramatic, from an average of 1.8% during 2005-2007 to 5.2% in the second quarter of 2009. (Revised monthly data are not yet available.) My guess is that the rate going forward will be higher than the 3.5% average of 2002-2004 but probably not as high as the second quarter, when the lower tax withholding begins to appear in the denominator.


DISCLOSURE: Through my investment and management role in a Treasury directional pooled investment vehicle and through my role as Chief Economist at Atlantic Asset Management, which generally manages fixed income portfolios for its clients, I have direct or indirect interests in various fixed income instruments, which may be impacted by the issues discussed herein. The views expressed herein are entirely my own opinions and may not represent the views of Atlantic Asset Management.

There was a great interview with Mohamed El-Erian this morning on CNBC. El-Erian always presents a well though-out, articulate, and accessible perspective on various financial issues. This morning's interview was no different as he discussed the recent market rally and whether the economy is beginning to recover. As for the recent moves in the stock market, El-Erian believes that the run-up in prices, especially the July portion of the equity market rally, is part of a "sugar high," implying a correction is in order. As for the economy, El-Erian believes the current optimism is based on some false assumptions, including:

• Corporate profitability can be maintained with additional cost-cutting. Not true. You need revenue growth.
• The stimulus spending will have a permanent effect. Not true. Just look what happen in China on Wednesday when they decided to cut-back stimulus spending.
• The stabilization of housing is sufficient to get the economy growing again. Not true. A housing recover is necessary, but is not sufficient by itself.

El-Erian goes on to say that what we need is final demand, producing longer-term and sustainable demand sources. We also need to know that deleveraging in the private sector has completed its course. People need to feel comfortable to once again to engage in consumption and investment. Furthermore, the recovery is no longer just about the financial sector. It is about the real economy, in particular wages and employment. Until those recover, we can only have tepid growth, but not the level of growth necessary to turn the economy around. Finally, El-Erian mentions how the helium in the growth balloon is being driven mainly by public debt. For the balloon and growth to stay afloat, you need the private sector to kick-in and take over, as well as have the public sector begin dealing with its debt issues. Simple, to the point common sense. Good stuff as always.


Source: CNBC Video

Several weeks ago I presented research that improved the efficiency of the Faber market timing model for the S&P500 by some 50%. By efficiency I meant that the new and improved model made more money with less time in the market and with less draw down. The research can be found in this article, "Inflationary Pressures Are A Legitimate Concern".

"Through out history when you had these massive currency and trade imbalances, and debt imbalances like we have now, it has lead to currency crisis or at least semi-crisis." Jim Rogers, Bloomberg TV

I am working on a fairly long entry that I will post this weekend about why a trade rebalancing and a consumption/savings rebalancing will take place in both China and the US whether or not we want it.  This week has been crazy, among other reasons because a festival in Taiwan has invited one of our indie bands and one of our experimental bands (Carsick Cars and White) to perform this weekend at the Music Terminals Festival in Tao Yuan City.  Getting visas for these kids has been brutally difficult and they actually had to cancel one of their club gigs, on Thursday, because of problems with getting things done on time.  Still, if any of my readers are going to be in Taiwan this weekend, I strongly recommend that you check out the festival, which besides the two Beijing representatives features a lot of great bands from around the world (or if you prefer club gigs, check them out Friday night at a pre-festival show at The Underworld, in Taipei).

So much for the good news.  The bad news is described in an alarming article in today’s Wall Street Journal which shows that trade tensions are continuing to rise.  

I have been hearing rumblings for a while about tougher stances being taken in Europe and the US in response to the perception that China is exacerbating the global contraction in demand by increasing subsidized resources available to manufacturers, most importantly by channeling a huge increase in lending at interest rates subsidized by Chinese household consumers and socializing the risk.  These new protectionist moves seems to be an expression of just this.  The article goes on to say:  

As I have been arguing for over a year, as unemployment around the world rises and as the necessary contraction in US net demand picks up pace, there was inevitably going to be a conflict with China as Chinese policymakers responded to the collapse in trade in the only way they could, by substantially stepping up investment.  The result is that China’s trade surplus has contracted very slowly – much more slowly than the contraction in the US trade deficit – and the result was a huge squeeze on the tradable goods sectors around the world. 

The fact that policymakers in Europe, China, Japan and the US seem to have no clue as to how difficult the transition for each of the other countries is likely to be, and so are doing not nearly enough to coordinate their response (in fact lecturing and finger waggling seem to the favorite forms of policy coordination), makes trade conflict almost a dead certainty.  I don’t think there are necessarily any bad guys here – each country is desperately doing what it can to get itself out of this mess – but there is a lot of failed opportunity and I am pretty sure that the trade environment will continue to decline. 

The problem is illustrated in two interesting recent pieces.  My friend Dan Rosen, of the Rhodium Group, has a very illuminating July 17 report that shows the composition of Chinese growth in the past decade.  He shows that for the past five years net exports accounted for about 10% to 15% of Chinese GDP growth, before collapsing to minus 41% in 2009 YTD. 

Until recently investment’s share of GDP growth peaked at around 65% in 2003 – a very high share by any standard – and going back the full thirty years of China’s reform period achieved an historical high astonishing of 81% in 1985.  From 2005 to 2008 the investment share of GDP growth averaged around 40% – still high – and then in the first half of this year accounted for a mind-boggling 88% of this years GDP growth. 

This year’s growth, in other words, is almost wholly a function of the massive increase in investment, and this increase in investment started out largely in the form of reopening production facilities and producing more “stuff”, without any significant rise in consumption.  As we know, when production increases faster than consumption, either the trade surplus or inventories must rise. 

On that note Xinhua published the following article on Monday: 

The per capita consumption spending volume of Chinese urban residents stood at 5,979 yuan (875 U.S. dollars) in the first half of this year, up 8.9 percent year on year, the National Bureau of Statistics (NBS) announced Monday.  Deducting price factors, the growth reached 10.3 percent.   The per capita disposable income of Chinese city dwellers rose 9.8 percent year on year to 8,856 yuan in the first six months. Deducting price factors, the increase reached 11.2 percent, said the NBS. 

Consumption has been rising at around 9% a year for the past several years.  Notice that if GDP growth slows to under 9%, the savings rate in China will automatically decline. 

The second interesting piece is put out by the Economic Policy Institute, a group I believe not noted for its commitment to free trade.  It shows China’s share of the US trade deficit excluding oil.  According to their numbers: 

Year

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Share

26%

27%

28%

31%

35%

40%

45%

54%

69%

83%

Perhaps as a consequence of a fiscal stimulus aimed at boosting investment and production, China’s share of the US trade deficit has grown significantly.  Since the US trade deficit is shrinking quickly, this means that other exporters are getting killed.  As I have argued for a while, this is not sustainable and will almost certainly cause trade tensions to erupt. 

Does this mean China is behaving in a predatory way?  I don’t thinks so.  I have warned for a long time that it would be very difficult for China to make the necessary transition to a consumption-led economy quickly enough to accommodate the global adjustment taking place.  Unless it is willing to see its economy collapse, there is simply no way China can reduce its negative net demand quickly enough to match the contraction in US demand and so avoid squeezing the hell out of the global tradable goods sectors.  That is why policy coordination is so important, especially between China and the USD, and of course that is why I continue to be a pessimist.  I do not think this policy coordination is taking place.  I will write about this more later this week. 

To continue the discussion of last week, we are getting more conflicting signals about policy confidence.  On the one hand Bank of China seems to love this party.  According to an article in today’s Bloomberg: 

Bank of China Ltd., which doled out the most loans among Chinese banks in the first half, plans to keep expanding credit unless the government clamps down on the nation’s record lending boom.  The nation’s third-largest bank will maintain its original target of generating about 10 percent of China’s new loans in 2009, Beijing-based spokesman Wang Zhaowen said by telephone yesterday. Bank of China may “fine tune” its strategy in line with any government policy changes, he said.  

…Bank of China will continue to lend to 10 key industries with government policy support, including steel, shipbuilding and automobile, Wang said. About 30 percent of its loans went to those industries in the first half.  

On the other hand two of the other members of the Big Four seem a lot more cautious.  Today’s South China Morning Post has this article: 

Mainland’s two biggest state-owned commercial banks have put a lid on their lending targets for the year, according to domestic media reports, in a move that will significantly slow overall credit growth in the second half. Industrial and Commercial Bank of China (ICBC) is aiming to issue full-year new loans of 1 trillion yuan (HK$1.3 trillion), while China Construction Bank (CCB) has set a goal of 900 billion yuan, Caijing magazine reported. 

The two banks, mainland’s largest by market value, granted new loans of 825.5 billion yuan and 709 billion yuan, respectively, in the first half.  If they stick to their reported targets, this would imply that ICBC would have already issued 83 per cent of its full-year lending total, while CCB would have already issued 79 per cent. 

It is surprising to me that these members of the Big Four are responding so differently, at least in public.  I wonder if the management of the different banks belong to different factions and so interpret the fiscal stimulus package differently.  Perhaps my friend Victor Shih, who understand these things better than I do and who sometimes reads my blog, might comment? 

Finally the Financial Times on Monday continued the thread discussed in my Saturday post with an article called “China warns banks over asset bubbles.” 

Chinese regulators on Monday ordered banks to ensure unprecedented volumes of new loans are channelled into the real economy and not diverted into equity or real estate markets where officials say fresh asset bubbles are forming.  The new policy requires banks to monitor how their loans are spent and comes amid warnings that banks ignored basic lending standards in the first half of this year as they rushed to extend Rmb7,370bn in new loans, more than twice the amount lent in the same period a year earlier. 

…Beijing’s concerns are echoed in other countries across the region, most notably South Korea, where the government says it is taking steps to cool a real estate bubble, and Vietnam, where the government has ordered state banks to cap new lending to head off inflation.  regulators are now concerned that too much money is being lent by the state-controlled banks and the country’s tentative economic rebound could come at the cost of a stable financial system. 

In statements published last week, Wu Xiaoling, who recently retired as deputy governor of the central bank, warned new lending this year would probably reach as high as Rmb12,000bn, a staggering increase of 40 per cent of the entire stock of outstanding loans in just one year.  

…Ms Wu hinted Beijing may soon raise the amount of money banks must hold on deposit with the central bank, marking a change of policy from last year when it aggressively slashed the reserve requirement ratio and interest rates.  The central bank has also ordered 10 banks, including Bank of China, to buy Rmb100bn worth of central bank notes with a maturity of one year and a return of just 1.5 per cent, according to Chinese media reports.  This move is interpreted as a warning to banks that have been the most active lenders that they should now start to rein in their excessive behaviour. 

Below are some links of interest, just in case you missed them. Some may have already been posted to Twitter.

• Economic calendar for Wednesday, July 29th (Briefing.com Economic); Durable Orders at 8:30 AM EST, Crude Inventories at 10:30 AM EST, and Fed's Beige Book at 2:00 PM EST.
  
• Earnings calendar for Wednesday, July 29th (Briefing.com Earnings)

• Small investors in the UK are turning to absolute return funds as they attempt to protect themselves against another downturn (UK Daily Mail).
• Betting on positive GDP. Intrade odds for positive Q3 GDP growth are at 73% (Carpe Diem). On the other hand, even though some are optimistic on positive GDP, those betting on whether a Government run health care plan with a public option will be signed into law by the end of the year is down to 25% (Bespoke Investment Group).
• The recession may be close to being "technically" over, but does that matter? (The Pragmatic Capitalist)
• Don't fool yourself, earnings are in their worst decline in history (Trader's Narrative).
• This seems to be an interesting "recovery" given that all the usual economic/sector suspects are missing in action (Financial Armageddon).
  
• Sam Zell gives his thoughts on real estate (Calculated Risk). CNBC interview with Sam Zell below (CNBC Video).
  
  
• The Nasdaq vs S&P 500 trend-following strategy (MarketSci Blog).
• PIMCO takes its bond prowess into active management with the PIMCO 1-3 Year U.S. Treasury Index Fund (TUZ). (ETF Trends)
• Microsoft and Yahoo! may be near a new search deal (WSJ). Does anyone care anymore?
  
• Alpha/beta separation does not actually require separating anything (AllAboutAlpha.com).
  
• A negative divergence between energy stocks and the S&P 500 (The Financial Ninja). Energy stocks take a slide on lower consumer confidence numbers (WSJ).
  
• Don't over think light volume rallies (The Big Picture).
• How are SPXU and UPRO being traded? Bill Luby at VIX and More provides some insight.
• SEC issues new rules on short-selling (WSJ).
• CFTC Chairman Gensler considers enacting limits on traders who place bets on energy contracts (WSJ). In other CFTC news, previous reports which had the CFTC blaming speculators instead of supply and demand for the crude oil run-up in 2008 may have been premature.
• Wilber Ross sounds off on FDIC regulations and Tier 1 capital rule requirements, and whether anyone will buy banks again (CNBC Video).
  

"There is a bubble that the FED and the government are creating right now and this is a bubble in government debt, in the size of it. They are being very sucessful at that.

Eventually the US Government will go bankrupt the way California is almost bankrupt, but that will take some time. The next bubble im my opinion can be a bubble again in equities." Marc Faber, Bloomberg TV

Marc Faber is an international investor known for his uncanny predictions of the stock market and futures markets around the world. Dr. Doom also trades currencies and commodity futures like Gold and Oil.

Some interesting headlines came across my desk in the last few days and something doesn’t add up. The first headline was entitled Naked girls plough fields for rain:

Farmers in an eastern Indian state have asked their unmarried daughters to plow parched fields naked in a bid to embarrass the weather gods to bring some badly needed monsoon rain, officials said on Thursday.

Witnesses said the naked girls in Bihar state plowed the fields and chanted ancient hymns after sunset to invoke the gods. They said elderly village women helped the girls drag the plows.

The Wall Street Journal also reports that the Indian monsoon season has been very uneven this year [emphasis mine]:

After India's driest June in 83 years, four of 28 provinces have declared drought, and many farmers don't have enough water to grow a full crop. More than half of Uttar Pradesh, the most populous state and a key rice and sugar cane-growing area, is suffering from drought.

A poor crop yield could push up food prices, straining the government's budget and complicating the central bank's efforts to revive the economy without letting inflation get out of hand.

Something doesn’t add up here. India has an economy that is still very agriculturally dependent. How can the Reserve Bank of India forecast deflation to end this year?

In its review of macroeconomic and monetary developments in the first quarter to the end of June, the Reserve Bank of India said on Monday: “There are indications of inflation firming up by the end of the year” because of rising commodity prices, high food prices and the government’s fiscal stimulus measures.

I would remind you that India accounts for a large part of the world’s physical gold demand. Much of that manifests itself during the wedding season after the monsoons and demand is dependent on how the crops come in.

In a year where the monsoons are below average and uneven, what is that going to do to Indian gold demand?

Just wondering…

Marc Faber Latest Video Interview, July 28 2009.

Marc Faber is an international investor known for his uncanny predictions of the stock market and futures markets around the world. Dr. Doom also trades currencies and commodity futures like Gold and Oil.

One observation I explored last night was the fact that volume is decreasing not only since the March bottom, but on a year over year basis as well. July volume appears likely to come in lower than in 2008. Since the long-term trend of volume has been steadily up I decided to look at other times the market’s monthly volume had declined on a year over year basis. There were 543 months in the test and the average month gained a little over ½%. There have been 125 times where volume has come in lower than the same month the year before. Results following such months were in line with all months as a whole. I also checked to see if it mattered whether the month was positive or negative, or whether it closed at the highest monthly level in 6 months made any difference. Somewhat surprising to me, I was unable to decipher any edge, bullish or bearish, to a year over year decline in volume.

Below are some links of interest, just in case you missed them. A few have already been posted to Twitter.

• Economic calendar for Tuesday, July 28th (Briefing.com Economic); S&P/Case-Shiller Home Price Index at 9:00 AM EST, and Consumer Confidence at 10:00 AM EST.
  
• Earnings calendar for Tuesday, July 28th (Briefing.com Earnings)
  

• Hedge funds investing in Asia now appear to be a popular asset class among the wealthy in the region, with AUM expected to rise from $14 billion in 2001 to $160 billion by the end of the year (HFMWeek).
• Jeremy Grantham's quarterly letter (GMO, The Pragmatic Capitalist). Always insightful. This one is no different given his views on China and emerging markets.
• Even with the relatively positive housing news Monday, U.S. efforts to modify mortgages has faltered (WSJ).
• Are there two housing bottoms, one for activity, and another for price? If so, the price bottom may not have been reached yet, even if housing activity is picking up (Calculated Risk, Clusterstock).
• Potential problems with commercial real estate rears its ugly head again (Fortune). As it turns out, banks in the U.S. hold $1.8 trillion of commercial loans, with regional banks set to take the biggest hits. Some large regional banks with exposure include PNC of Pittsburgh, KeyCorp of Cleveland, and BB&T of Richmond, Va., each with more than half their loan books in commercial loans. Ouch.
• Bank failures appear to be accelerating (The Big Picture).
  
• Bank of America plans to cut 10% of its branches (WSJ).
• Lending continues to slow as bankers and borrowers refrain from taking risk (Financial Armageddon).
• There has been a 585% year-over-year change in CMBS delinquencies (Zero Hedge).
  
• The next financial crisis is on its way and will be triggered by commercial real estate, credit cards, and student loans, says Kirby Daley, fromNewedge Group ( The Pragmatic Capitalist).
• The truck tonnage index declined 2.4% in June (Calculated Risk). What does this mean for the recovery?
• "The End Of The End Of The Recession" (Zero Hedge). A pretty detailed macroeconomic presentation from Zero Hedge in collaboration with David Rosenberg, Chief Economist & Strategist at Gluskin Sheff and Associates. The link is a few days old, but worth a look if you have not seen it.
  
• The SEC issued new rules on short-selling that will require more transparency, albeit delayed (WSJ, Financial Times). This comes as the CFCF pins the blame for the 2008 crude oil spike on commodity speculators (WSJ).
• The VIX was up on a quiet day (The Financial Ninja), and looking oversold as equities appear stretched.
  
• Looking at the individual sectors, everything except energy seems overbought (Bespoke Investment Group).
  
• Apparently the FX market is slowing down as Forex trading volume shrinks (Kathy Lien).
• When breaking the S&P 500 into 10 deciles (10 groups of 50 stocks), the two deciles with the most institutional ownership are up the most, while the two with the lowest institutional ownership are up the least (Bespoke Investment Group). Is this institutions standing behind their bets and adding more, simply staying strong during a short squeeze, or something else? Or nothing else?
• The AirShares EU Carbon Allowances ETF (ASO), which gave investors a way to play the cap-and-trade market, is calling it quits and liquidating (ETF Trends).
  
• Traders are not happy with plans to limit natural-gas trades (WSJ), with some market makers considering pulling out of the market.
• Is it dispersion time - the idea being to go long options gamma in individual names or sector specific ETF's, and go short gamma in index ETF's or index options (The Daily Options Report).
• Hedge fund replication for all (Bull Bear Trader, greenfaucet). MIT Professor Andrew Lo discusses hedge fund replication and his SG Global Alternatives A (GAFAX) fund that is available to average investors.
  

FN: Energy (XLE) stocks have not made it back to the previous swing high around $54. Volume has completely vanished. Meanwhile the broader market, the S&P 500 (SPX) has exceeded the previous swing high. This negative divergence in something so cyclical does not exactly scream of "green shoots".

They say that you should never talk about sensitive topics like sex and religion in polite company, the topic of health care is also one of those topics. Nevertheless, I am going to wade into this touchy topic.

I lived in Canada from 1967-94. I moved to the US in 1994 and I returned to Canada a couple of years ago. Given the extensive debate on the Obama health care proposals, I feel compelled to speak up about the differences between the Canadian and American health care systems.

Much of these experiences are personal and your own mileage will vary.


Canada: The grass isn’t necessarily greener
The overriding feature of the Canadian health care system is universal access. Canada is a giant HMO, with health being managed by the provinces.

Fist, some words about access and waiting times. For essential procedures, waiting times are excellent. During the early 1990s, I went into a retail eyeglass store for new glasses and an eye exam. The optometrist saw something that he didn’t like and referred me to an ophthalmologist at the local hospital, who discovered that I had a retinal detachment and scheduled me for surgery. The total time from the day I walked into the optometrist to the day of the scheduled surgery was two days. You can’t ask for anything better than that.

Yet the waiting times for non-emergency routine exams can be maddening. Waiting times to see a specialist, like a dermatologist, can be two or three months. This is the point at which many Americans get upset. If we examine outcomes, life expectancy is higher in Canada than the US. The CIA Handbook shows US life expectancy at 78.11 years, behind Canada at 81.23 and many other developed countries (Australia 81.63, France 80.98, Sweden 80.86, Israel 80.73, Italy 80.20, etc.)

A New Yorker article also indicates that more and faster health care isn’t necessarily better:

Americans like to believe that, with most things, more is better. But research suggests that where medicine is concerned it may actually be worse.

In a 2003 study, another Dartmouth team, led by the internist Elliott Fisher, examined the treatment received by a million elderly Americans diagnosed with colon or rectal cancer, a hip fracture, or a heart attack. They found that patients in higher-spending regions received sixty per cent more care than elsewhere. They got more frequent tests and procedures, more visits with specialists, and more frequent admission to hospitals. Yet they did no better than other patients, whether this was measured in terms of survival, their ability to function, or satisfaction with the care they received. If anything, they seemed to do worse.

The issue here is coordination. Remember the original idea of the HMO (before it became a dirty word)? In an ideal world, an HMO assesses the patient’s health and risk factors and then puts resources into preventative care, which is a lot cheaper, rather than being reactive with treatment, which can be enormously expensive. Under the current system, many doctors are siloed in their own specialties and there is little coordination and consideration of overall care.

Ironically, I found that I received better care and better insight for a chronic condition from a Canadian organization which can be best described as a wellness clinic, to which I pay a fee, than I did in the US. My American physicians included doctors from world class hospitals such as Mass General Hospital in Boston, which was part of Harvard Medical School, and people listed in the Who’s Who for my condition. I have no complaint about any of these individuals. All of them were knowledgeable and dedicated to their jobs, but coordination was lacking.


Problems on both sides of the border
Opponents of the Canadian system cite horror stories. Yet there are horror stories on both sides of the border. People drop the ball everywhere and it doesn't necessarily have to an indictment of the system. Here are two stories to which I have first or second hand knowledge. One occurred in a world class US hospital, to which people come from all over the world, the other occurred in a regional hospital in Canada.

Case 1: A expectant mother is rushed to hospital because her water broke and there is risk of infection if the baby isn’t born soon. She is told that they need to induce labor right away. After she is admitted, hospital staff put her in a room and forgot about her.

Case 2: A woman visits her terminally ill father in the hospital. When she arrives, he appears to be asleep so she sits down and reads a book. After about half an hour, she tries to wake him and discovers that he seems to be dead. She goes to the nursing station and is informed that the patient had passed away about two hours ago, but no one bothered to call and notify the next of kin.

Anecdotes make good headlines and they make good stories, but they don’t tell what’s wrong with the system. The Canadian health care system’s problems aren’t necessarily the waiting times, which can be frustrating, but extra and unexpected costs that were not part of the initial design. The system was conceived and financed in a day when the practice of medicine consisted mainly of doctors and nurses, either in a standalone practice or in a hospital. Fast forward a few decades, we now have a huge array of medical equipment and drugs that are available to the practitioner.

When I returned to Canada, I found the system glaringly short of medical diagnostic equipment (like MRIs). Given the structure built into the system of nurses’ unions, medical associations (which are in effect doctors’ unions), there is little left in the budget for equipment and drugs.

This state of affairs has resulted in a two-tiered system, much like the British NHS. You are entitled to a basic level of care, but if you don’t want to wait for an MRI, then you need to cough up money. Several months ago, my wife broke her foot and went to the hospital. She was offered a plaster cast for free. If she wanted a removal walking cast, she had to pay.


The American system: Great access, but…
When I lived in Boston, I was fortunate to have worked for a company that took care of its employees well with a gold-plated health plan. You had access to any doctor in the Boston area and the co-pays were extremely low.

The lack of waiting times was great and so the lack of requirement for a referral to see a specialist, but I wasn’t sure if the care because I wasn’t necessarily qualified to make decisions. Here is the perspective from the New Yorker:

Providing health care is like building a house. The task requires experts, expensive equipment and materials, and a huge amount of coördination. Imagine that, instead of paying a contractor to pull a team together and keep them on track, you paid an electrician for every outlet he recommends, a plumber for every faucet, and a carpenter for every cabinet. Would you be surprised if you got a house with a thousand outlets, faucets, and cabinets, at three times the cost you expected, and the whole thing fell apart a couple of years later? Getting the country’s best electrician on the job (he trained at Harvard, somebody tells you) isn’t going to solve this problem. Nor will changing the person who writes him the check.

A question of incentives
In Canada, much of the practice of medicine is just that, the practice of medicine. Most doctors are engaged in well-paid piecework ($X for an examination, $Y for an operation, etc.) The government takes care of much of the practice management by functioning like a giant HMO. In the US, physicians take on much more of the burden of practice management themselves.

Economists know that people respond to incentives.

During my time in the US, I met many doctors who were dedicated to their profession. The US has built a health care system where doctors become salesmen. In a number of cases where the diagnosis or the solution is not so clear-cut, I encountered numerous situations where the doctor was subtly, or in one case not so subtly, selling the patient on a procedure.


About the same cost
Overall, I found that my out of pocket costs under the US system were roughly the same under the Canadian system. Under the US system, the main cost was health insurance. Under the Canadian system, the main costs were drugs and medical equipment and tests, which were discretionary.

The difference is universal access. There is something wrong when a former supreme court justice (a Reagan appointee no less!) worries about health care availability for her own family [emphasis mine]:

BIG NUMBERS, like 45 million uninsured Americans, are hard to grasp. But that number came home to me at a recent conference. The keynote speaker was former Supreme Court justice Sandra Day O'Connor. Her topic was our healthcare system, and her message was personal and anguished.

The gist was that even she lives in constant fear of major uninsured health bills. Not her own -- those of her son. He can't afford insurance because his son -- her grandchild -- has a preexisting condition.

I know that this post won’t win me many friends. For Democrats who look north for a model health care system, the Canadian system has many warts – and they are major ones. Cost pressures are relentless and the Canadian solution doesn’t address all the problems.

To the Republicans who say that they don’t want a government bureaucrat to make health care decisions for individual, I have two answers. Is having an accountant with green eyeshades make decisions, which is what is happening now, any better? Moreover, we have a legion of government bureaucrats in uniforms (that you most likely support) making decisions for you in faraway places like Iraq and Afghanistan. If you truly embraced free market principles, would the likes of Eisenhower, Westmoreland, Schwarzkopf and Petraeus performed any better if they had been given option based incentives to pursue their wars?

I have written before that the difference between the entrepreneurial spirits in America and Europe young engineers in the US want to grow up to be Bill Gates, where young engineers in Europe want a job with Siemens. If we were to transpose that analysis to health care, should young medical researchers aspire to discovering the cure for cancer or to commercialize the cure for cancer?

How you answer that question frames your response to the health care conundrum.

Dr. Andrew Lo , MIT Professor and founder of Alpha Simplex, was recently on CNBC's Fast Money program discussing hedge fund replication using a combination of exchange traded futures and currency forwards.


Source: CNBC Video
In essence, hedge fund replication attempts to mimic the betas and returns of either individual hedge fund strategies, or the entire hedge fund industry, using common and liquid exchange traded assets, such as futures, forwards, swaps, and even ETFs. In using such assets to replicate returns, is it hoped that one can not only replicate betas and returns, but do so with comparable or less risk, and of course, less cost that a traditional hedge fund.

The specific fund that Dr. Lo helps manage, along with Jeremiah Chafkin and Robert Rickard, is a long/short replication mutual fund named the Natixis ASG Global Alternatives A (GAFAX) fund. The fund is relatively new, with an inception date of September 30, 2008, and has an expense ratio of 1.64% and an initial sales fee of 5.75% - not cheap, but less than your typical 2/20 hedge fund fee structure for longer holding periods. Year to date the GAFAX fund is up only 4.86% compared to a positive 8.74% return for the S&P 500. Nonetheless, the diversification effects of the fund have helped its returns be relatively flat since inception, compared to roughly a 20% loss in the S&P 500 over the same period. Given that the fund is less than one year old, extensive risk-return data is not yet available.

While replication strategies can attempt to replicate either single or multiple strategies, the GAFAX fund is broad-based in that it does not try to mimic one specific type of hedge fund strategy, but instead tries to get the beta and return of the diversified exposure of the entire hedge fund industry. Therefore, such a fund will not report returns that match the top outperforming funds each year, but will also hopefully avoid significant exposure to strategies that may have recently blow-up due to current market or macroeconmic factors. Furthermore, even though the fund is using reported past return data to develop its replication, the lag in performance is not expected to be as dramatic since the fund is modeling more broad-based returns, and once again is not subject to the investment changes of one hedge fund or strategy.

Hedge fund replication has been an active area of research for a number of years, both in academia and industry. It will certainly be interesting to see how such techniques perform outside the labs of academia and closed doors of industry, and whether or not such investment strategies catch on with the retail investing public. If you are looking to learn more about the field of hedge fund replication, there are a number of places to start. First, check out Dr. Lo's MIT homepage and Laboratory for Financial Engineering website were you can download some recent abstracts, publications, and working papers on hedge funds. Second, check out the wonderful blog AllAboutAlpha.com and its various articles on alternative beta and hedge fund replication strategies. The following academic papers - available on the Internet (there are others as well) - will also given you an idea of a few hedge fund replication research approaches and modeling techniques.

Can Hedge-Fund Returns Be Replicated?: The Linear Case, Hasanhodzic and Lo
Alternative Routes to Hedge Fund Return Replication: Extended Version, Harry Kat

A few books on the subject include the following:

Hedge Funds: An Analytic Perspective, Andrew Lo (includes a chapter on replication, content from his papers)
Alternative Beta Stategies and Hedge Fund Replication, Lars Jaeger

Once again, these are just a few resources available on the Internet or at your local bookstore. As mentioned, the field has been active over the last few years, and subsequently has produced a number of good articles, books, and online resources. Enjoy.

FN: It may be nothing... but volatility (VIX) was up 5% on a quiet day. VIX is deeply oversold and scraping along the bottom of the 10 day MA envelope. A bounce is certainly due and equities are stretched.

For all things VIX related check out VIX and More. Volatility and the volality of volatility is far more complicated than you may know.

“The real theme is the divergence between earnings and revenues." -Steven Ricchuito, Mizuho Securities

FN: There is a dirty little secret to earnings season. In all the excitement over bottom line beats, nobody really noticed the top line misses.

Analysts, after being complete wrong all of 2007 and 2008 have finally collapsed their estimates, lowering the bar to the point where even a mortally wounded company can stumble over it. That was to be expected, and isn't really important. Most of the bottom line beats were the result of draconian cost cutting. Bonuses and merit raises first, big budget items second and finally people. Lots and lots of people. They all beat because they cut people faster than anybody expected. These kind of cuts can't be repeated and companies won't be able to pull the same miraculous bottom line beat next quarter.

Far more important and ominous are the top line misses. Revenues have collapsed and continue to do so. Big economic bellwethers all reported revenue declines of about 30%. Revenue at 143 companies fell on average of 10%. This is the true state of the economy and it is still in a 'controlled' free fall.

Something to really think about is the feedback loop. When companies attempt to shrink themselves to profitability on a grand scale, what do you suppose happens in the months afterwards? The former employees are faced with insurmountable problems. First, they cannot easily find a job precisely because companies in general are pursuing these massive cost cutting strategies. They are therefore unemployed for much longer periods of time than would otherwise be the case. Second, they cannot continue to live as they did before being let go. Drastic reductions in personal consumption must be made. This is particularly bad, and we've already seen the savings rate go parabolic to reflect this change in behavior, after a gigantic, prolonged credit bubble.

So if this were a turned based simulation with the following conditions:
- The economy employs 1000 workers.
- The mean income for each employee is 100 per round.
- The mean expenditure for each employee is 100 per turn, or 100%.

Round 1.
- There are 1000 workers employed, making $100 000, and spending $100 000, or 100%.

Round 2
- Companies fire 10% of the workers, or 100 workers.
- The economy employs 900 workers, making $90 000, and spending $90 000, or 100%.

Round 3
- Workers grow concerned over job security and decide to save money. They now spend only 90%.
- The economy employs 900 workers, making $90 000, and spending $81 000, or 90%.

Round 4
- Companies grow concerned over growth forecasts and decide to cut costs, firing another 100 workers.
- The economy employs 800 workers, making $80 000, and spending $72 000, or 90%.

Round 5
- Workers freak out! Dual income households are down to a single income. Everybody knows somebody that lost a job. Many are helping friends and family out. The savings rate increases again. Now only 80% of income is spent.
- The economy employs 800 workers, making $80 000, spending $64 000, 80%.

Round 6
- Companies freak out! They've been beating bottom line estimates by cutting jobs, but they can see their top lines getting hammered. With no end in sight, they cut another 100 people.
- The economy employs 700 workers, making $70 000, spending $56 000, or 80%.

Round 7
- Where and how this self fulfilling destructive cycle ends nobody can know for sure. It happened during The Great Depression and it was not pretty.

John Praveen at Prudential International Investments says, "Because of rising unemployment and rising household savings rate, the rebound will be anemic or weak."

In reality it is almost impossible to have a rebound with unemployment AND savings rising. In my example rising unemployment cut much deeper into consumer spending than you might expect. A 30% cut in jobs cut income by 30%, but spending by 44% or 46% more! Now imagine an model of an economy where spending was actually greater than 100% of income to start. Imagine and economy where consumers relied on home equity lines and rapidly appreciating assets to spend well beyond their means. Then imagine them going from being a net negative saver, to a saver.

You think maybe that's what's happening here today?

Sales Fail to Keep Pace With Profits as Economy Stays Sluggish: "Sales growth lagged behind profits as companies in the Standard & Poors’ 500 Index beat analysts’ estimates this week, a signal that economic recovery may be slow.

Second-quarter revenue at Caterpillar Inc. and Freeport- McMoRan Copper & Gold Inc. tumbled more than 30 percent from a year earlier, though earnings topped the average of analysts’ predictions. Amazon.com Inc.’s profit skidded and sales missed estimates. United Parcel Service Inc.’s sales slid 17 percent. Microsoft Corp. saw annual sales drop for the first time in 23 years as a public company.

“The economy is coming back but it is not going to come roaring back,” said Mark Zandi, chief economist at Moody’s Economy.com. Companies “are going to be reluctant to add investment and jobs until they get better sales.”

Revenue at 143 companies in the S&P 500 reporting this week, many of them bellwethers for the American economy, fell on average 10 percent from a year ago, according to Bloomberg data. Seventy managed to top the analysts’ consensus for sales, while 107 did so for earnings per share.

The economy probably declined 1.5 percent in the three months ended June 30, marking the fourth straight drop and the longest such streak since quarterly records started in 1947, according to the median of 66 economists in a Bloomberg survey."

Also notable from Friday afternoon is the fact that new highs contracted substantially while the S&P made a 50-day high. The percentage of stocks hitting new 52 week high dropped from a little over 7% on Thursday to under 5% on Friday. I looked at other times the SPX made a 50-day high while the drop in new highs equaled 2% or more of the total issues.

(click image to enlarge)


What I found interesting and compelling about the above test was NOT the size of the average decline. In fact that was somewhat weak. It was the fact that 95% of instances closed below the trigger day close at some point in the next 5 days. This suggests that while the lagging new highs might not indicate an immediate selloff, the market has consistently struggled to move higher.

I have often thought that the 2009 rally resembles the rally off the September 11, 2001 lows that lasted into March, 2002. Even though the causes of the "crisis" are different, there are many noteworthy similarities.

Below are some links of interest (at least to me), just in case you missed them. A few have already been posted to Twitter.

• Economic calendar for Monday, July 27th (Briefing.com Economic). New Home Sales at 10 AM EST.
  
• Earnings calendar for Monday, July 27th (Briefing.com Earnings).
  
• Investors await data on GDP and housing this week (Financial Times). Consensus forecast project a 1.5% fall in GDP for Q2, with falling inventory levels and lower production dragging the number down (WSJ). Anything much worse could stall and reverse the recent rally. Calculated Risk finds a little sunshine in some of the recent economic numbers. Nonetheless, even government meddling in the housing market may have its limits (Bearishnews). In somewhat related news, Barry Ritholtz also covers some issues with National Association of Realtors and the use of appraisers (The Big Picture).
• The total amount of loans held by the 15 largest U.S. banks fell by 2.8% in Q2 (WSJ), with more than half of the loans in April and May coming from refinancing and renewing existing business credit, and not from making new loans.
  
• More news about how investors are continuing to move their money into emerging market ETFs (ETF Trends).
• Looking for an ETF with global exposure? Now there are two to choose from, but they are not exactly the same, even though they appear so (ETF Trends).
• Demand for emerging market debt has risen to record levels, offering an encouraging sign for the world economy (Financial Times).
• Are unemployment statistics meaningless? Are spillover effects zero? Econbrowser tackles the questions.
  
• A look on how the "cash for clunkers" is going to work (The Big Picture).
  
• U.S. Pay Czar begins looking to rework / renegotiate contracts deemed excessive. Seven banks and companies, including Citigroup, Bank of America, American International Group, General Motors, Chrysler, Chrysler Financial, and GMAC Financial Services must submit proposals for their compensation packages (WSJ).
• Information Arbitrage takes on the wall street trader compensation model - arguing that the issue is inextricably tied to risk-taking, where the "heads I win; tails you lose" payout paradigm rewards risks taking and places little premium on risk management.
• In an attempt to get its pension back to a solid footing, CalPERS is looking to double down on recent bets as it is considering pouring "billions more into beaten-down private equity and hedge funds. Junk bonds and California real estate also ride high on his list. And then there are timber, commodities and infrastructure. That’s right, he [CalPERS fund manager, Joesph A. Dear] wants to load up on many of the very assets that have been responsible for the fund’s recent plunge." (Fundmastery Blog)
  
• Content is still king. Apple working with record labels to boost digital sales of entire albums by bundling interactive booklets, sleeve notes, etc., with music (Financial Times). Also, the company is planning to offer a tablet-sized computer by Christmas.
• Even videogame makers are now starting to feel the recession, with sales down a record 29% year over year (WSJ). Xbox 360 and Nintendo's Wii sales are down 38%.
• Stocks and corporate bonds are benefiting from the upbeat market mood, with yields on higher-quality company bonds lower - with prices higher (WSJ), as some investors who are not on-board for the "V-shared" recovery are choosing to hedge their bets with corporate bonds over stocks.
• The Relative Strength Index (RSI) has traded 9 days in a row at an extreme RSI(2) reading over 90 (MarketSci). So is this an obvious bearish signal? Maybe not, given the non-normal forces that may be driving the market.
• Has the long awaited Dow Theory bull market signal finally arrived? Apparently so (Investment Postcards).
• Constructing a portfolio wisely and safely by building a macro view (The Pragmatic Capitalist).
• Exactly what are the forces acting on the VIX? VIX and More elaborates.
• A nice summary of links on portable alpha and alpha/beta separation is available at AllAboutAlpha.com.
  
• Finally, Nouriel Roubini believes Ben Bernanke deserves reappointment (Economist's View). Nonetheless, he is still bearish ........ I think. As for Bernanke, it appears that most of the motivation for his moves came from not wanting to be the Fed Chairman presiding over the second great depression, even though it made him angry to bailout the very bankers that made the mess in the first place (WSJ). Yes, it made us angry too. The Pragmatic Capitalist also chimes in on whether or not Bernanke should be reappointed - let us say that the PG is not quite on the same page as Roubini (The Pragmatic Capitalist). Michael Panzner believes that the moves show that we did not learn enough much over the last two years (Financial Armageddon).