Six months after our last update on the Federal Reserve's balance sheet in visual form, it is time to resume updating readers on what the biggest balance sheet in America looks like, especially since now that Fed is back in the monetization business. So without further ado, here is how Bernanke Capital, LLC looked as of September 1.

• Securities held outright: $2,045 billion 
  • Total Treasury holdings increased from $783 billion to 786 billion, as it bought another $3 billion in USTs as part of QE Lite. Look for this number to grow to well over $1.5 trillion in the next 6 months
  • MBS holdings declined by $8 billion from $1.111 trillion to $1.103 trillion
  • Agency holdings were flat at $157 billion
• Net borrowings: unchanged at $60 billion from the prior fortnight.
• Float, liquidity swaps, Maiden Lane and other assets: $184 billion. FX liquidity swaps are at $44 million. The "value" of Maiden Lane I increased to the highest since November 2008, and was at $16 billion. Maiden Lane II was at $23 billion, while AIA Aurora was $27 billion. 
• The monetary base was $1.995 trillion
• Reserve balances with banks: $1.035 trillion
• Foreign holdings of USTs and MBS hit a fresh weekly high of $3.21 trillion.
• The ratio of Fed assets to the monetary basy was an elevated 1.15x, where it has been for a while.

We know from history that rather than temporary tax cuts or spending, its been the big infrastructure projects that leave behind usable assets for the private sector are the biggest bang for the tax backed buck.

Think Interstate Highways, Apollo Space Program, Darpanet (internet), Manhattan Project.

Question: What sort of projects should the US be doing in terms of Infrastructure development?

With just one month left in the quarter, most hedge funds continue to underperform the market, not to mention that the vast majority continues to be under their high water mark (most notably Citadel). And with fickle LPs, unbound by lock ups courtesy of the 2008 crash, knowing all too well they can now move their money with the facility of a HFT frontrunner churning AMZN one thousand times a second, threatening redemptions unless something changes in the last month of the quarter, hedge funds are, for lack of a better word, panicking. Yet as we have long been demonstrating, the vicious loop of high correlations and mutual fund withdrawals means that alpha generation is gone the way of the dodo. Which means that HFs will now seek to actively lever up into the market to chase the beta wave over September like never before. This is indeed confirmed by TrimTabs latest Hedge Fund Flow Report, which finds that the percentage of HF managers expecting to raise their leverage exiting August is 21.2%, the highest in 4 months, and possibly all of 2010, and triple the 7.7% responding affirmatively in May. And as riding a leveraged beta wave is nothing but a coin toss on the market with dire consequences if wrong, look for market volatility in September to hit multi-month highs, especially if macro economic conditions continue to deteriorate and investors are forced to buy against the grain. 

The chart below shows the trend of increasing desperation in the hedge fund community:

Here is TrimTabs explanation:

Hedge fund managers are also more inclined to lever up than they were last month. About 21% expect to increase leverage in the next month, sharply higher than 14% in July. Only 11% of managers aim to decrease leverage in the coming weeks, the smallest share since the start of our survey in May. We suspect managers are feeling bolder because recent outflows proved relatively mild. We estimate that hedge funds redeemed only $2.7 billion in June and $3.0 billion in July. Managers were much more reluctant to increase leverage when credit fears in Europe triggered concern about another liquidity crisis.

Additionally, TrimTabs has found that bearish sentiment on stocks in August is the highest it has been since May. Of course, the simplistic contrarian view is that with so many bears out there, the market is poised to rebound.

Hedge fund managers have turned markedly more bearish on equities. About 47% of the 104 managers we surveyed in the past week are bearish on the S&P 500, up sharply from 33% in July. Bullish sentiment decreased to 17% from 34%. The August bearish reading of 47% is the highest since May’s reading of 52%, which bodes ill for equities.

Yet despite the increasing alleged equity bearishness, there was no corresponding increase in NYSE short bets, and in fact, July saw a decline, making one wonder just how truthful the sampled respondents were in their answers:

Bearish sentiment did not prompt a spike in short bets. Indeed, NYSE Short Interest decreased 1.7% in July to land 5.4% south of the June peak. We suspect Short Interest declined because the strength of the July rally took managers by surprise and forced them to cover underwater positions. Our research shows that changes in Short Interest are historically a leading contrary indicator, so we believe the recent decrease in short bets favors lower stock prices.

So what does all this mean? Absolutely nothing. The days when hedge funds (or equity mutual funds) mattered are long gone: the only thing that is relevant these days is on what side of the bed does Bernanke wake up, and what subliminal messages about the imminent date of QE does his blinking pattern telegraph to the primary dealers. Everything else is noise. Yet the increasing leverage is a fact (we have confirmed this via independent conversations with Prime Brokers) and more than anything, it means that just like some hedge funds will make off like bandits in the next 28 days, others will most certainly blow up. Perhaps the administration can just advise where the S&P will close to within a penny of the final price on September 30, so we can proceed straight to the heckling festivities.

"We are not advocating another one. We think it's important for the market to have time to recover on its own," says Walter Molony, spokesman for the National Association of Realtors.
...
"From a political standpoint, with Congress not wanting to increase the debt, it would be too expensive," [Bernard Markstein, senior economist with the National Association of Home Builders] says. "In terms of advisable, we are bordering on where tax credits become ineffective."

"It is not high on anyone's list that we have heard. We have not heard Congress talking about renewing it," Housing and Urban Development Secretary Shaun Donovan said in response to a reporter's question about a possible tax credit renewal.

Private-sector employment decreased by 10,000 from July to August on a seasonally adjusted basis, according to the latest ADP National Employment Report® released today. The estimated change of employment from June to July was revised down slightly, from the previously reported increase of 42,000 to an increase of 37,000.

The decline in private employment in August confirms a pause in the recovery, already evident in other economic data. The deceleration in employment was evident in the major sectors and by size of business. This month’s decline in employment followed six monthly increases from February through July. Over those six months, the average monthly gain in employment was 37,000 with no evidence of acceleration.

August’s ADP Report estimates nonfarm private employment in the service-providing sector rose by 30,000, the seventh consecutive monthly gain. This increase was not enough to offset an employment decline in the goods-producing sector of 40,000. Employment in the manufacturing sector decreased 6,000, the second consecutive monthly decline.

Large businesses, defined as those with 500 or more workers, saw employment remain essentially flat while employment among medium-size businesses, defined as those with between 50 and 499 workers, decreased by 5,000. Employment among small-size businesses, defined as those with fewer than 50 workers, decreased by 6,000. In August, construction employment dropped 33,000. Construction employment has declined for over three years and the total decline in construction jobs since the peak in January 2007 is 2,275,000. Employment in the financial services sector dropped 5,000. Financial Services employment has declined for over 3 years.

STRANGE ISM NUMBER ... DOESN’T PASS “SNIFF TEST”

Here’s why:

1.Most of the regional reports were very poor in August. Either they are collectively all wrong or the ISM is.

2. The share of respondents saying they experienced “growth” was 61%, the exact same as a year ago when ISM was sitting at 52.8.

3. The ISM gain was led by employment (58.6 to 60.4 — best since December 1983) in the same month that ADP manufacturing fell 6,000 (second decline in a row — it was -11k in July when ISM employment was 58.6, so clearly the latter is proving to be, at least for now, an unreliable labour market barometer). Production also ticked up to 59.9 from 57.0 and inventories rose to 51.4 from 50.2. These are all coincident indicators, as an aside (but an important aside).
Strange ISM number, it doesn’t pass the sniff test and here is one reason: most of the regional reports were very poor in August... either they’re wrong or the ISM is

4. According to the ISM, 76% of the manufacturers surveyed said that in August, their customer inventory levels were either “too high” or “about right”. At the turn of the year, just ahead of the big inventory swing that bolstered the GDP data, this metric was sitting at 60%. As a result, it would be folly to assume that the inventory and production categories will contribute to further ISM increases in the near- and intermediate-term. Norbert Ore, who presides over the ISM survey, had this to say about inventories: “If the inventory build isn't voluntary then we have a huge issue on our hands.”

5. Meanwhile, the more forward-looking components dropped, though were hardly a disaster. But orders slipped for the third month in a row, to 53.1 from 53.5 in July, 58.5 in June and 65.7 in both April and May. That is still a sharp squeeze in the growth rate of capital goods-related order books. At 53.1, ISM orders index is down to levels last seen in June 2009 (but when they were rising in “green shooty” fashion).

6. Backlogs were down as well, to 51.5 from 54.5 in July, 57.0 in June and 59.5 in May (and peaked in February at 61.0). At 51.5, order backlogs stand at their low-water mark of the year.

7. Supplier deliveries (measure of production bottlenecks) eased for the fifth month in a row — to 56.6 from 58.3 in July and well off the March peak of 64.9.

8. Looking at five decades worth of data, the share of the time in which we see orders, backlogs and vendor deliveries all decline in tandem, and the headline ISM index rise, is the grand total of 1%. No wonder equities rallies so much — we just witnessed a 1-in-100 event! Bring your camera.

9. Export orders dipped to 55.5 from 56.5 — the lowest they have been since last December. If the overseas economy is rocking and rolling, then why on earth would this component be declining? Not only that, but it looks as though, yet again, a good part of the inventory boost we still seem to be getting is being filled by imports — that sub-index jumped four points in August and does not bode well for the trade deficit, which subtracted 3.4 percentage points from headline GDP growth in Q2.

MORE ON THE DATA

It would be something if the ISM was being fuelled by broad based increases and occurring alongside a decent path in domestic spending. But the ISM gains were narrowly based and the inventories are continuing to be built up even as domestic demand is slowing down. And it is spending that drives production, not the other way around. The fact that fewer respondents are saying inventories are at low or desirable levels is going to set us up for some pretty hefty production and ISM reversals through the fall.

Mike "Mish" Shedlock is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction. Visit http://www.sitkapacific.com/account_management.html to learn more about wealth management and capital preservation strategies of Sitka Pacific.