Weekly Recap & Outlook – 07.30.10

Tower Private Advisors

Recent posts


  • Market upate – resistance still = resistance
  • Two very important papers released
  • Most economic news supports the double-dip view–a view we don’t yet espouse  

Capital Markets Recap

As it was posited here over the last several weeks, 1100 is stiff resistance for the S & P 500–oops, almost forgot; here’s the nuts and bolts of the markets this week.

As I started to say, U.S. stocks continue to struggle with resistance.  Namely, the S & P 500 gets knee-capped at 1100.  In addition to proving difficult to surpass over the last couple of months, it’s also where the 200-day moving average and the 50% retracement of the ’07 high to ’09 low move, as the chart below shows.

All is not right in Denmark–whatever that means.  Earnings continue to be reported with the usual mass of upside surprises.  Stocks are holding up pretty well.  Yet interest rates are dropping like nobody’s business–whatever that means.  The two-year Treasury note reached another all-time low yield this week of 0.55%.  (The two-year is generally considered a proxy for monetary policy, yet nominal rates can go below zero, where they’re at, arguably.)  The 10-year note is below 3% again, at 2.905%.  Two–you have to call them–equity permabears, David Rosenberg, formerly with Merrill Lynch, now with Gluskin Sheff in Canada, and Marc Faber, author of the excellent Gloom, Boom, and Doom Report, have wagered a bottle of whiskey on the 10-year’s yield.  Rosenberg–Rosie to his friends–says they’ll go to 2%; Faber says they won’t go below the 2.06% low reached in 2008.

Top Stories

‘Lots here, but important stuff

  • In the category of have-you-no-shame, Research in Motion (aka Blackberry) announced it would launch a tablet computer in November to, what else, compete with Apple’s iPad.
  • The Federal Reserve’s Beige Book “says U.S. economic recovery slowed,” according to Bloomberg
  • Build America Bonds program extended through 2012.  These bonds, which are issued by municipalities, have 35% (set to decline to 30% over the next two years) of their taxable interest paid by the Federal government.  Among other things that keeps the supply of tax-free municipal bonds low, mitigating the municipality fiscal issues, and–in effect–increasing Federal tax revenues.

There were two rather big, market-moving news events this week, and both came from respectable sources.  First, was a report from the Congressional Budget Office (CBO).  Second, was a report from the President of the St. Louis Federal Reserve.

The CBO, despite its etymology, isn’t all bad.  It’s website “About CBO” link says it provides Congress with nonpartisan analyses, and to provide information and estimates required for the Congressional budget process.  On Tuesday, it issued a report titled, “Federal Debt and the Risk of a Fiscal Crisis.”  Here is a link to the report, which I highly recommend; it’s not overly technical.  As I read through the eight-page report I highlighted what I thought were the important takeaways that needed to be conveyed here.  ‘Turns out its mostly highlighted, so here are the highlights of the highlights.

  • The report featured three sections:  1) projected debt levels; 2) increased chance of a fiscal crisis; and 3) the effects of such a crisis on the U.S.

Section 1 – Past and Projected Debt Held by the Public

  • The report looked at two scenarios.  One (Extended Baseline Scenario) of those assumed the Bush tax cuts are allowed to expire.  The other (Alternative Fiscal Scenarios), that they’re extended.  In either scenario the U.S. debt continues to rise.  In the former it’s gradual; in the latter, scary rapid.  As near as I can tell, Arthur Laffer wasn’t consulted for the report, as their doesn’t seem to be any allowance for increased tax receipts as a result of higher tax brackets leading to more tax-avoidance behavior (think John Kerry and $7 million I’m-the-voice-of-the-common-man yachts), the opposite of which happened during the Reagan years.
  • According to the report, there are three consequences of the increasing debt.  1) Crowding out of investments.  Increased government borrowing crowds out the funds available for productive capital investment; 2) the rising interest payment burden means either higher taxes or less government spending; and that partly leads to 3) the “reduced ability to respond to domestic and international problems.”

Section 2 – An Increased Chance of a Fiscal Crisis

  • Oh, by the way, there’s another consequence: the chance of a fiscal crisis.  Just as with consumers, as debt rises, the margin for error becomes smaller since less and less income is discretionary.  One certain consequence of such a crisis is “the interest rates on government debt rise suddenly and sharply.”  Importantly, “there is no identifiable tipping point of debt relative to GDP indicating that a crisis is likely or imminent.  But all else equal, the higher the debt, the greater the risk of such a crisis.”
  • As if to exemplify that, three examples are given.  Fiscal crises in Argentina, Greece, and Ireland are reviewed.

Section 3 – How Might a Fiscal Crisis Affect the United States

  • Here some really staggering figures are provided.  If interest rates were to jump by 4%, the interest on the debt would increase by 40% in 2011, by about $100 billion, and the interest burden in 2015 would double, to $460 billion–and that’s considering only the presently-projected debt.  Another consequence of the increase in rates would be devastating losses suffered by bond holders, including pensions, mutual funds, financial institutions (“losses that might be large enough to cause some financial institutions to fail”), and the retail investors who have bought bonds with reckless abandon, something we’ve pointed out numerous times.
  • Policy options would be limited to:  1) debt restructuring, which “tends to be very costly for countries that try it;” 2) inflationary monetary policy, which is usually considered the most likely outcome, but which would also inflate future budget deficits (a 1% increase in inflation above CBO estimates over ten years would increase the deficits over those ten years by $700 billion); and 3) fiscal austerity, which would likely affect everyone but Congress.  And here’s the troubling part of the austerity idea, especially given the tendency to Congress to kick troubles further down the road:  while austerity can be quite effective (a cut in spending = 1% of GDP would limit debt:GDP to 20%), the later the actions are taken the more severe they have to be.

As if to preempt the CBO’s report, Nassim Nicholas Taleb, in an interview with the rebranded BusinessWeek–Bloomberb Businessweek, with his characteristic arrogant swagger, said that a potential source of “fragility or danger” is government deficits, and that

The problem is getting runaway.  It’s becoming a pure Ponzi scheme.  It’s very nonlinear:   You need more and more debt just to stay where you are.  And what broke Madoff is going to break governments.  They need to find new suckers all the time.  And unfortunately the world has run out of suckers.

In the days ahead, I hope to publish a list of canaries in the coal mine of U.S. government debt that we can monitor the pulses of to see if we need to freak out and buy an insured supply of food from Glenn Beck–more on that guy later.

The second report was by St. Louis Fed President James Bullard titled, “Seven Faces of ‘The Peril’ “.  The “peril” refers to a problem suggested in a 2001 academic paper by three economists; namely, deflation.  The seven faces are seven possible policy responses to the peril.

  1. Denial
  2. Stability
  3. FOMC, 2003
  4. Discontinuous
  5. Traditional
  6. Fiscal intervention given the situation in Europe
  7. Quantitative easing

Here’s what you and policy makers need to know:  according to the paper, we are like Japan–here’s the statement that freaked out the markets:  the U.S. is closer to a Japanese-style outcome today than at any time in recent history– and none of the first six solutions are going to work if we slide in the direction we’re currently heading, toward “an unintended, low nominal interest rate steady state.”  The only and right thing left to do perform is Quantitative Easing (QE).  All the other measures involve traditional monetary policy, which is presently akin to pushing on a string.  In effect, QE “involves buying longer-dated government debt,” which is also refered to as “monetizing the debt.” 

So, while many sage observers can cite many ways in which the U.S. is not Japan, on the subject of interest rates and __flation, it’s very tough to difficult that there are critical ways in which we’re resembling the Land of the Rising Sun.

Dan Greenhaus, chief economist at Miller Tabak, says the paper’s important for several reasons.

  1. Bullard is a voting member of the FOMC (that’s really two, member + voting).
  2. He touched the “third rail of economics,” the U.S. likeness to Japan.

On the subject of Glenn Beck . . .

While most recognize the likes of Glenn Beck and Rush Limbaugh as entertainers, a few have confused them for finance experts, going so far as to liquidate investment portfolios in favor of other stuff . . . like gold.  Do you really believe that a Select Comfort bed is absolutely the best bed that Paul Harvey could have slept on or that Gold Bond Medicated Powder is really what whoever touting it would really have bought had he not been given a truckload of it and then paid to promote it?  Neither do I, and, apparently, neither do some folks that can shake things up, folks like DAs. 

New York, NY – Rep. Anthony Weiner (D – Queens & Brooklyn) and House Commerce Subcommittee Chairman Bobby Rush (D – Chicago) formally announced a hearing of the Subcommittee on Commerce, Trade, and Consumer Protection to investigate the business practices of Goldline International, a precious metals dealer that uses aggressive sales tactics and conservative spokespeople such as Fox News’ Glenn Beck to sell overpriced gold coins. Weiner and Rush sent a letter to Goldline requesting information in preparation for the hearing.

The announcement follows an exposé on ABC News which detailed Goldline’s business model. Additionally, the Santa Monica City Attorney’s office launched a joint investigation with the Los Angeles County District Attorney’s office into the possible criminal practices of Goldline International.

Well, here is a link to a Big Picture blog posting on the investigation into the bait-and-switchers at Goldline, one of Glenn’s favorite endorsements, and the graphic below walks you through it without leaving the comfort of this blog. 


This Week

The report on Durable Goods Orders was released on Wednesday, and it wasn’t pretty.  The headline figure was a drop of 1.0%, which followed a revised-to-the-better -0.8% decline in May.  What’s more, it was numerical opposite–if there can be such a thing–of what economists expected, +1.0%.  Stripping away the lumpy transportation orders didn’t help much either.  The change there was a -0.6%, which was also worse than the dismal scientists expected (+0.4%). More for double-dippers to feast on.  If there was a glimmer of hope, it was in the category of capital expenditures–capex, a proxy for which is nondefense capital goods excluding aircraft orders.  That category grew by 0.6%.  With the average corporate desktop computer virtually an antique and corporate cash at record high levels, this category almost has to be the economy’s savior, given the softness in consumer spending (see the GDP note below).

Friday served up another helping with the first release of Q2 GDP.  Instead of the 2.6% the economists expected, the actual result was 2.4%.  The Q1 figure was 2.7%, which was subsequently revised up to 3.7%, so neither the result versus consensus nor versus the prior figure was good.  In addition, Personal Consumption (70% of the economy) declined sharply, from 3.0% to 1.6%, which, too, was worse than economists expected (2.4%).  While S & P futures had been down by just three points, they promptly fell to -13.7, forcing the Bloomberg reporters to cower under their desks . . .

And then the Chicago Purchasing Managers index was released.  It showed a Chicago area in full advance, as the index rose from 59.1 to 62.3, which was far better than the dice-throwing economists’ guess of 56.0.  While not technically correct, that reading can roughly be thought of as a percentage of respondents reporting growth. 

That release wiped out the entire knee jerk drop in the S & P 500 e-mini futures, the around-the-clock version of which is shown below.

Why economic activity in Milwaukee is tracked is yet beyond me (inquiry into the ISM Milwaukee folks; haven’t heard back), but the similar report for the Milwaukee area was similarly strong.  It rose from 59.0 to 66.0, well above expectations of 57.0.  One would think that the Milwaukee reading would be similar to the Chicago reading, and a scatterplot shows that readings in the Chicago series explain 56% (R2) of the Milwaukee series.

To confirm that it’s not some other factor that explains the variance in both, I built the same scatterplot for the Milwaukee report and the Houston report.  That exercise confirmed my grasp of statistics and made intuitive sense; the R2 was just 0.16.

Next Week

As usual, in the first week of the month only one report matters, and that’s the first one listed below.

Key indicators to watch

  • Nonfarm Payrolls (July) – Friday – loss of (-)60,000 expected
  • Unemployment Rate - 9.6% expected
  • Change in Manufacturing Payrolls - +18,000 expected
  • ISM Manufacturing (July) – Monday
  • Personal Income, Spending, Saving – (June) – Tuesday
  • Factory Orders (June) 
  • Pending Home Sales (June)
  • ADP Employment Change (July) – Wednesday – similar to the Nonfarm payrolls, but two days earlier and without government jobs count
  • ISM Non-Manufacturing (July)
  • Initial Jobless Claims (weekly) – Thursday

Graig P. Stettner, CFA, CMT

Vice President & Portfolio Manager

Tower Private Advisors


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