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Aside from the totally asinine and impossible strategy of attempting to borrow the global economy out of a debt crisis, we currently face a staggering array of risks unprecedented in modern history. Fortunately, the Idiocracy is fat and happy, comforted by the abiding assumption that printing money is the secret to effortless wealth…
Is History Repeating … Or Throwing a Head-Fake?
Chart courtesy of Tom McClellan of the McClellan Market Report (via Mark Hulbert)
Hulbert notes that the chart “has been making the rounds on Wall Street.”
On the other hand, Martin Armstrong predicts that a worsening economy – and bank deposit confiscation – in Europe will cause people to flood into American stocks as a “safe haven” for a couple of years.
And the Fed has more or less admitted that propping up the stock market is a top priority.
Posted by Jeff Rubin on January 27th, 2014
Judging by pump prices, Canadian drivers might think oil companies were rolling in profits that only move higher. Lately, though, the big boys in the global oil industry are finding that earning a buck isn’t as easy as it used to be.
Royal Dutch Shell, for instance, just announced that fourth quarter earnings would fall woefully short of expectations. The Anglo-Dutch energy giant warned its quarterly profits will be down 70 percent from a year earlier. Full year earnings, meanwhile, are expected to be a little more than half of what they were the previous year.
The news hasn’t been much cheerier for Shell’s fellow Big Oil stalwarts. Exxon, the world’s largest publicly traded oil company, saw profits fall by more than 50 percent in the second quarter to their lowest level in more than three years. Chevron and Total, likewise, are warning the market to expect lower earnings when fourth quarter results are released.
What makes such poor performance especially disconcerting to investors is that it’s taking place within the context of historically high oil prices. The price of Brent crude has been trading in the triple digit range for three years running, while WTI hasn’t been far off. But even with the aid of high oil prices, the supermajors haven’t offered investors any returns to write home about. Since 2009, the share prices of the world’s top five publicly traded oil and gas companies have posted less than a fifth of the gains of the Dow Jones Industrial Average.
The reason for such stagnant market performance comes down to the cost of both discovering new oil reserves and getting it out of the ground. According to the International Energy Agency’s 2013 World Energy Outlook, global exploration spending has increased by 180 percent since 2000, while global oil supplies have risen by only 14 percent. That’s a pretty low batting average.
Shell’s quest for new reserves has seen it pump billions into money-devouring plays such as its Athabasca Oil Sands Project in northern Alberta and the Kashagan oilfield, a deeply troubled project in Kazakhstan. It’s even tried deep water drilling in the high Arctic. That attempt ended when the stormy waters of the Chukchi Sea crippled its Kulluk drilling platform, forcing the company to pull up stakes.
Investors can’t simply count on ever rising oil prices to justify Shell’s lavish spending on quixotic drilling adventures around the world. Prices are no longer soaring ahead like they were prior to the last recession, when heady global economic growth was pushing energy prices to record highs.
Costs, however, are another matter. As exploration spending spirals higher, investors are seeing more reasons to lighten up on oil stocks. Wherever oil producers go in the world these days, they’re running into costs that are reaching all-time highs. Shell’s costs to find and develop oil fields, for instance, have tripled since 2003. What’s worse, when the company does notch a significant discovery, such as Kashagan, production seems to be delayed, whether due to the tricky nature of the geology, politics, or both.
Shell ramped up capital spending last year by 50 percent to a staggering $44 billion. Oil analysts are basically unanimous now in saying the company needs to rein in spending if it hopes to provide better returns to shareholders.
Big Oil is discovering that blindly chasing production growth through developing ever more costly reserves isn’t contributing to the bottom line. Maybe that’s a message Canada’s oil sands producers need to be listening to as well.
Global stocks were hammered on Friday for a second straight day on news of a slowdown in China and turbulence in emerging markets. The Dow Jones Industrials suffered its worse drubbing in more than two years, tumbling 318 points on Friday to end a 490 point two-day rout. Emerging markets currencies were whipsawed by capital flight as foreign investors fled to the safety of U.S. Treasuries. Turkey’s lira and the Argentine peso were particularly hard hit setting record lows in the 48 hour period. The scaling back of the Fed’s $85 billion per month asset purchase program, called QE, has altered the dynamic that made emerging markets the “engines for global growth”. The policy reversal has triggered a selloff in risk assets and sent EM currencies plunging. Here’s a summary from Bloomberg:
“The worst selloff in emerging-market currencies in five years is beginning to reveal the extent of the fallout from the Federal Reserve’s tapering of monetary stimulus, compounded by political and financial instability.
Investors are losing confidence in some of the biggest developing nations, extending the currency-market rout triggered last year when the Fed first signaled it would scale back stimulus. While Brazil, Russia, India, China and South Africa were the engines of global growth following the financial crisis in 2008, emerging markets now pose a threat to world financial stability.” (“Contagion Spreads in Emerging Markets as Crises Grow,” Bloomberg)
Paradoxically, Bloomberg editors blame the victims of the Fed’s failed policy for the current ructions in the markets. In an article titled, “What’s Behind the Emerging-Market Meltdown” the editors say,”emerging-market governments … should recognize that this week’s financial-market turmoil was, to varying degrees, their own fault.” … “the best way for emerging-market governments to restore confidence would be to improve their policies.”
Logically, one would assume that the editors would throw their support behind capital controls or other means of stemming the destructive flow of speculative capital into domestic markets. But that’s not the case. What the editors really want, is policies that trim deficits, slash public spending, and allow foreign investors to continue to wreak havoc on vulnerable economies that follow their free market diktats. The article is a defense of the status quo, of maintaining the same ruinous policies so that profit-taking can continue apace.
The Fed was warned early on that its uber-accommodative monetary policy was spilling over into emerging markets and creating conditions for another financial crisis. Take a look at this excerpt from an article in Bloomberg back in 2010 where Nobel prize winning economist, Joseph Stiglitz, explicitly warns the Fed of the dangers of QE.
“The U.S. Federal Reserve’s plan to boost purchases of bonds poses “considerable” risks by increasing capital inflows to emerging markets, Nobel Prize- winning economist Joseph Stiglitz said in Santiago today.
“All this liquidity that they’re creating is not going back to grow the American economy and is going to Asia and other emerging markets where it’s not wanted,” Stiglitz said…..Increased capital inflows could cause emerging market currencies to appreciate and could create asset bubbles, he said.” (“Stiglitz Says Fed Stimulus Poses `Considerable’ Risks for Emerging Markets,” Bloomberg, Dec 2010)
Events have unfolded exactly as Stiglitz predicted they would, which means the Fed is 100% responsible the carnage in the stock and currencies markets.
The policy has pumped nearly “$7 trillion of foreign funds” into EMs since QE was first launched in 2009. According to the Telegraph’s Ambrose Evans-Pritchard, “much of it “hot money” going into bonds, equities and liquid instruments that can be sold quickly….Officials are concerned that this footloose capital could leave fast in a crisis, setting off a cascade effect,” Pritchard adds ominously.
Whether last week’s bloodbath was just a prelude to a bigger crash is impossible to say, but it is worth noting that the Fed has only reduced its purchases by a mere $10 billion per month while still providing $75 billion every 30 days. That suggests that markets will probably face greater turmoil in the months ahead. Check out this clip from USA Today:
“Emerging markets need the hot money but capital is exiting now,” says (Blackrock’s Russ) Koesterich. “What you have is people saying, ‘I don’t want to own emerging markets.’…
The bigger fear is if the current crisis in currency markets morphs into a full-blown economic crisis and leads to financial contagion, says Matthias Kuhlmey, managing director of HighTower’s Global Investment Solutions.
“The currency story is fascinating and can be a slippery slope – be cautious,” says Kuhlmey, adding that the Asian crisis in the summer of 1997 that started with a sharp drop in the value of Thailand’s baht, turned into a broader economic crisis that engulfed Indonesian, South Korea and a handful of other countries. It also rocked financial markets.” (“Why emerging markets worry Wall Street,” USA Today)
So, is this the Big One, the beginning of the next financial crisis?
It’s too early to say, but investors and analysts are worried. Fed tightening (via “taper”) will be felt in markets around the world. The trouble in emerging markets will intensify deflationary pressures in the Eurozone and put a damper on China’s growth. Slower global growth, in turn, will create balance sheets problems for undercapitalized and over-leveraged banks and other financial institutions which will increase the probability of another Lehman Brothers-type default.
According to Reuters, a normalizing of interest rates in the US, (which most analysts expect) “could cut financial inflows to developing countries by as much as 80 percent for several months. In such a case, nearly a quarter of developing countries could experience sudden stops in their access to global capital, throwing some economies into a balance of payments or financial crisis, the Bank said.” (“Rout in emerging markets may only be in Phase One,” Reuters)
Clearly, the potential for another financial meltdown is quite real.
For more than four years, the Fed has buoyed stock prices and increased corporate margins through massive injections of free cash into the financial markets. Now the Central Bank wants to change the policy and ease its foot off the gas pedal. That’s causing investors to rethink their positions and take more money off the table. What started as a selloff in emerging markets could snowball into a broader panic that could wipe out the gains of the last four years.
The Federal Reserve is entirely responsible for this new wave of financial instability.
Mike Whitney lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at email@example.com.
Is this how it starts?
The third great market crash of the 21st century?
At Ben Bernanke’s perhaps final public appearance at the Brookings Institution on January 16th, the beginnings of the 2008-2009 financial crisis were linked to the issues of a French bank in the summer of 2007, an incident little noticed at that point in time.
This time around will it be the currency problems of frontier and emerging markets? The default of a Chinese trust fund, discussed in some detail here atForbes? Or something else altogether, totally hidden at the moment? Or nothing at all?
With U.S. equity markets suffering their deepest losses since 2012, there were plenty of disparate concerns to go around this past week.
These included the fear of the Fed’s tapering ultimate timing and impact, weakening China growth, those currency devaluation jitters, a lackluster U.S. earnings season, perceived overheated equity market valuations, and that China trust fund, to mention a few. There was also the end of week concern that the selling could feed upon itself, as those market-makers selling puts on indices and calls on the VIX could get squeezed and have to hedge next week with more S&P futures selling.
On the week, the Dow gave up -3.5%, finishing below 16,000 for the first time since mid-December. The S&P 500 lost -2.6%, closing below the key 1800 level at 1790. And the NASDAQ fared the best, down “only” -1.7%, helped by the relative strength of some of its high-fliers. Notably, the VIX popped close to +46%, ending the week just above 18, although still far below panic levels.
It is a bit iffy to reconstruct the true narrative of the week, as things seemed to get rolling to the downside on Monday evening. Influential Fed watcher Jon Hilsenrath of the WSJ wrote of January FOMC tapering possibilities:
A reduction in the program to $65 billion a month from the current $75 billion could be announced at the end of the Jan. 28-29 meeting, which would be the last meeting for outgoing Chairman Ben Bernanke.
Coincidence or not, the next four trading days were all on the negative side of the ledger for the Dow, although the S&P hung in decently on Tuesday and Wednesday. But then China’s HSBC PMI numbers hit, indicating a drop in January to 49.6 from December’s final reading of 50.5, moving “below the 50 line which separates expansion of activity from contraction.” (Reuters).
This, combined with the currency devaluation news, with Venezuela, Argentina, and Turkey leading the headlines, seemed to fuel the overall“emerging market risk” theme which overwhelmed markets on Friday.
Not helping were some comments coming out of Davos. Larry Fink ofBlackRock BLK -3.95% said there was “too much optimism” in the markets. He added, according to Bloomberg , “The experience of the marketplace this past week is going to be indicative of this entire year. We’re going to be in a world of much greater volatility.”
This came on the heels of Goldman’s chief strategist, David Kostin, saying two weeks ago that market valuations are “lofty by almost any measure.”
But the real outlier came from Dr. Doom himself, NYU professor and head of Roubini Global Economics, Nouriel Roubini. Roubini seized on yet another global issue, tweeting:
@ Nouriel: “Japan-China war of words goes ballistic in Davos” and “A black swan in the form of a war between China & Japan?” along with various comments on the emerging market issues, saying, “Argentina currency crisis & contagion to other EM – on top of weak China PMI – suggests that some emerging markets are still fragile.”
The China/Japan “conflict” story was the shocker, and apparently goes back to some comments allegedly made by Japanese Prime Minister Shinzo Abewhich compared China/Japan tensions to those found between Germany and Britain prior to World War I. (CNBC) In an interview with Business Insider, Roubini called the events of last week “a mini perfect storm,” alluding to“weak data in China, fresh currency market turmoil in Argentina, and a worsening chaotic situation in the Ukraine.”
It is a bit amusing to note that while Mr. Roubini was serving on several panels at Davos, giving press interviews, and tweeting non-stop, he also found time (or one of his associates did) to post a ranking of “top Tweeters” from the World Economic Forum, showing himself in 5th place. (See Twitter imagehere.)
Let’s take a very quick look at a few of the other notable quotes from newsmakers this week:
–“I don’t think it (marijuana) is more dangerous than alcohol.” –President Obama in a New Yorker interview published last Sunday. The remark created a firestorm of controversy, including reportedly negative feedback from DEA Administrator Michele M. Leonhart and many others. (Huffington Post)
–Apple is “one of the biggest ‘no-brainers’ we have seen in five decades of successful investing.” –Fund manager and legendary investor Carl Icahn, in continuing to tout AAPL’s undervaluation and push for stock buybacks by the company. Forbes also noted that Icahn grabbed headlines last week for now getting involved with eBay and urging a spinoff of its PayPal holding.
–“Gross: PIMCO’s fully engaged. Batteries 110% charged. I’m ready to go for another 40 years” –PIMCO’s Bill Gross tweeting after the highly visible and speculation-provoking departure of Mohamed El-Erian. Mr. El-Erian reportedly said in a letter to PIMCO employees, “The decision to step down from PIMCO was not an easy one.”
–“It’s a very juicy target.” –Andrew Kuchins, Russia Program Director for CSIS, in commenting on the terrorist threats at the Sochi Olympics and the need for extensive security and preparedness planning. (USA Today)
–“It’s so easy to enter, a caveman could do it.” –Warren Buffett, a bit jokingly, in announcing his company’s sponsorship of a $1 billion March Madness challenge along with Quicken. (Fox Sports) The simple idea is that an absolutely perfect bracket will produce the billion-dollar winner, but the offer includes also some twenty $100,000 winners for the best, if imperfect, brackets. There is also a charity angle, but at something like 1 in 9.2 quintillion odds (we have seen varying estimates all over the place) Berkshire is likely not facing too much risk here.
–“A lot of people got dead in that one.” –retired NYC detective and now security consultant/media celebrity Bo Dietl on the Don Imus program, commenting on the history of the Lufthansa “Goodfellas” robbery and this week’s arrests in the case.
–And in another high profile criminal case, famed lawyer Roy Black said of client Justin Bieber, “I’m not going to make any comments about the case except to say Mr. Bieber has been released on bond and we agreed that the standard bail would apply in this case.” (CBS Miami)
–“We’ve lost some of our consumer relevance.” –McDonald’s CEO Don Thompson in a call after client traffic comps greatly disappointed in the recent earnings release. This was the flipside of Netflix, which surged dramatically after their latest numbers and user figures, with NFLX stock up some 17% despite the terrible market week.
–“We believe POS malware will continue to grow.”–The FBI in a statement on the troubling hacking of Target and other retailers, which was revealed in far greater detail this week, including the hacking intrusion of Neiman Marcus. (Yahoo)
–“It was so awesome!” –ESPN reporter Erin Andrews, in a slightly hard to believe remark on the antics of Seattle defensive back Richard Sherman after last week’s NFC title game. Her initial real-time reaction to the interview seemed at odds with that statement, as she stood in utter disbelief in the post-game situation. (seattlepi.com)
Let’s close it out there, as all eyes will be on the opening of foreign equity markets tonight and the U.S. futures trading. Well, maybe not all eyes, as the Grammy Awards also kicks off this evening. But the really big event of the week will be President Obama’s State of the Union address Tuesday evening. Presidential senior adviser Dan Pfeiffer predicted in an email of the upcoming SOTU address, according to Bloomberg:
Pfeiffer: ‘Three words sum up the president’s message on Tuesday night: opportunity, action, and optimism. The core idea is as American as they come: If you work hard and play by the rules, you should have the opportunity to succeed.’ While Obama ‘will seek out as many opportunities as possible to work with Congress in a bipartisan way,’ Pfeiffer said he ‘will not wait for Congress’ to act on some of his goals.’
Have a good week!
With today’s biggest drop in stocks in over 4 months, we are reminded of three recent charts that raise considerable questions as to the path forward. From Mclellan’s 1928 analog to Hussman’s bubble trajectory and the extremes of bullish sentiment, this week marks a ‘line in the sand’ for bulls to take this to the Hendry moon or for it not to be different this time…
Mclellan’s 1929 Analog…
Hussman’s Bubble Trajectory…
Based on the fidelity of the recent advance to this price structure, we estimate the “finite-time singularity” of the present log-periodic bubble to occur (or to have occurred) somewhere between December 31, 2013 and January 13, 2014.
And the Market’s Most Bullish Bias On Record…
Is it any wonder there are less BFTATH-ers left?
Charts: John Hussman, John Mclellan, and @Not_Jim_Cramer
By Adam English 2013-12-31
Here we are, at the last day of a year that has defied all the odds.
The Dow and S&P 500 have posted out-sized gains in spite of what can generously be called tepid economic growth.
The regional governors and economists over at the Fed are undoubtedly enjoying the afterglow of their resounding success with the latest tapering announcement a couple weeks ago.
Investors, banks, and policymakers are most likely enjoying their holiday vacations while planning what to do with the fat bonus checks that are en route.
Of course, the disenfranchised poor are worse off than ever. Millions just lost their only source of money for food, and millions more are stuck in a downward spiral of debt traps and part-time work.
But these downtrodden masses don’t have any money to pour into the markets to boost gains. To the market and policymakers, they were only included when it came time to package self-enriching schemes in populist rhetoric.
Tomorrow, it’ll be time to start thinking about the next set of yearly returns, and none of the big players are worried.
Next year promises more of the same in their eyes. The Easy Money Battle of 2013 was won.
Unfortunately, many of them don’t see that it was a Pyrrhic victory. The cost is already too high to succeed in the end.
A Terrible Record
Clearly, the temptation in the market is to take the latest Fed announcement and ensuing rally as a call to double down on wildly bullish sentiment as 2014 starts.
I have little doubt that we’ll see this shaken out of the market sometime in the first half of next year. When you take a look at the Fed’s record on tapering announcements, it doesn’t look good.
By my count it has one win, one tie, and five losses.
The first mention of winding down QE programs came back on May 22nd. Hints of a reduction in stimulus measures in the Federal Open Market Committee (FOMC) minutes caused an immediate 1% drop in the Dow and a volatility spike.
On June 19th, there were no taper hints. Ben learned his lesson. However, the markets still knew it was imminent. The Dow closed down 1.3% while the S&P 500 fell 1.4%.
July’s announcement caused a 0.7% drop for the Dow and another volatility spike.
September was an aberration and a virtual tie because the government shutdown distracted everyone.
October saw no date set for a taper. There was some volatility and a slight dip in the markets for the afternoon.
Then on December 18th, the November FOMC minutes were released, causing a 290-point gain in the Dow and exuberant front-page headlines.
It’s clear the Fed’s record is pretty abysmal, filled with fumbles and confusion. But the trend appears to suggest that the markets have made peace with the idea. At least on the surface.
So what changed over time?
The overall tone of the statements and Bernanke’s remarks suggests that the Fed is still very “dovish” and willing to err on the side of caution. That helped, but it isn’t enough on its own.
In reality, the folks at the Fed spent the last half-year scratching their heads trying to figure out how to make a taper palatable to the markets. The result was a massive concession in how the taper would proceed.
The Fed now intends to hold interest rates at historic lows past the point when the unemployment rate falls to 6%. This is a large adjustment — over 1% lower than in earlier statements.
The flow of easy money into corporations has been extended through most — if not all — of 2014.
Wall Street could take or leave the $10 billion per month trimmed from bond purchases as long as the virtually free money guaranteed by low interest rates keeps flowing with no real end in sight.
Corporate Cash Cow
The rate banks pay on overnight loans, or the federal funds rate, was at 4.5% in late 2007. As the recession bit into the economy, it was slashed to 0.25% and has stayed there ever since.
Long-term rates quickly followed suit and fell from over 5% in 2007 to record lows near 1.5% in the second half of 2012. Since the beginning of 2013, 10-year Treasuries have crept back to 3%, still well below normal levels.
Corporations capitalized on the low interest rates by issuing $18.2 trillion of bonds worldwide since 2008. Currently outstanding corporate debt has risen over 50% to $9.6 trillion over the same period.
Many of these loans were simply created to push corporate debt obligations out as far as possible. Instead of using them to create growth, it just delays loans from maturing until 2017, 2018, or 2019.
Interest paid by U.S. businesses peaked in 2007 at $2.83 trillion, and then it fell sharply to $1.34 trillion in 2011, the last year data is available from the St. Louis Fed.
At the end of the recession in 2009, companies listed on the S&P 500 paid roughly $4 a share in interest per quarter. Now, they are paying around $1.50 a share in interest on average.
These dramatically lowered interest rates account for an estimated 50% of total profit growth, not including indirect savings from lower leasing or rental costs.
Stock buybacks using debt-fueled funding have also been very popular and have provided quick boosts to stock prices and created earnings per share increases that are not based on growth or performance.
In fact, earnings have tripled since 2000, back when the economy was in far better shape.
The Fed has created a massive boom for corporate America through historically cheap debt and that is what the markets wanted to keep most of all. The Fed capitulated and the markets rejoiced.
Meanwhile, the EBITDA margin (earnings before interest, tax, depreciation, and amortization divided by total revenue) operating profitability peaked at 25.6% in late 2007 and recently fell below 20%.
Of course, this can’t possibly last in perpetuity. Debt will become more expensive, and payments will eat into profit margins.
We have not seen the last time the Fed will disappoint markets, create a volatility spike, and ultimately drive losses for investors.
Still On Shaky Ground
Going forward, the Fed and anyone in the market have a handful of things to remember that should temper the irrational exuberance we’re seeing in the market.
First, Fed policy is overly dependent on creating artificially high asset prices to alter economic behavior for investors and companies. The economy has not substantially improved enough to subsist on meaningful corporate growth, consumer spending, or housing sales.
Secondly, the impact of easy money through abnormally low interest rates is hard to quantify, especially in the short-term. Bullish markets that overextend their gains on very uncertain stimulus will inevitably see very disruptive corrections.
Finally, the Fed is not the only central bank that is actively pushing asset prices higher and fighting to maintain economic and financial stability. China, Japan, and Europe are all using extraordinary measures to intervene.
If any of these major economies see demand that is too weak, experience corporate or bank liquidity and credit crunches, or fail to juggle sovereign debt, the domestic economy will take the full brunt of the blow.
The Fed has fully deployed all of its tools to spur growth while expanding its balance sheet by about $4 trillion with little real effect. Economists put the total return for the Fed’s intervention as low as 0.25% of GDP.
As we close the books on 2013 with large gains for the markets and on a high-note for the Fed, we know what to expect for now. The Fed will have to continue pushing you to put your wealth into the market, and the big players will keep holding the rallying market hostage as they rake in massive profits.
However, the cost has been too high. The Fed may push the day of reckoning well into 2014 or beyond, but there is no way around the correction and burden it will place on us all.