Posted on

I Read a Lot So You Don’t Have To — #2

The Week of 1/17/17: TL;DR of Everything: Up-to-Date as of 1/19/17

Q: Why do I write all of this?

A: Because its enjoyable and helps keep me informed.

Q: Is this a newsletter or paid service?

A: No.

Q: What information sources do you use?

A: Reuters, WSJ, Barron's, Bloomberg, Seeking Alpha, S&P Capital IQ, Credit Suisse & Vickers.

TL;DR of the TL;DR:

  • Markets show patterns similar to pre-1995 breakout; BULLISH

  • Ben Bernanke talks about how the Fed makes policy, they are inherently cautious

  • Fed’s Bullard, dovish, sees 1 rate hike between now and 2019

  • Fed’s Brainard, previous dovish, now very hawkish post election, calls for end of QE.

  • Markets are calling Fed’s bluff on hawkish rhetoric (dollar down), may change w/ Yellen speeches through week

  • Trump’s dollar comments initially sent USD dropping, Yellen comments made it rise again Weds.

  • Part-time worker numbers are finally back to pre-2008 levels

  • Overall investor sentiment on US equities is more bullish in 2017

  • Banking sector credit quality metric says strong bullish signal

  • Britain will go for hard Brexit, IMF raises its forecast for near-future US growth.

  • ECB unlikely to change policy until September according to economists surveyed.

  • Just for Fun: Summary of 2 economic research papers: Stiglitz argues against IMF policy and ideology in early 2000’s but it holds many lessons for us to this day.
    • Specifically looking at 1999 East Asia crisis and the botched government response, which was driven by U.S. financial institutions worrying about getting their loans repaid from Asian borrowers.
    • The IMF facilitated the movement of capital in the region, which induced the crisis.
    • Must view the IMF as a political institution, that reflects the interests of the financial community, and which does not promote global economic stability.

 

Beginning of Summaries:

Expectations for overall market movement; finding patterns in historic data

  • The consumer confidence index is at the same level it was at in late 1996.

    • S&P500 has just completed a 2-year breakout to new all-time highs, similar to 1995 breakout Don’t believe the bearish calls being made on CNBC, they think the current market is equivalent to what we saw in 1999. However bullish sentiment is not near 1999 extremes and prior market action is not equal to what was seen in 1999. Today’s market more accurately resemblance is 1995 breakout (which happened after coming out of tight monthly range as well).

  • Looking at historical 2-year range of monthly closes dating back to 1900. We are currently ending the 2nd of the 2 tightest consolidation periods over the last 100 years. The other one was 1994-1996.

    Similar S&P500 patterns between 1987 and 1995 and current day

A: 1987: Market 37% decline from highs before starting 7-year rally with 130% gains

A: 2008: market 56% decline from highs before starting 7-year rally with 190% gains

B: 1990: market fell 20%, bear market correction, twice in 5-year period with severe correction

B: 2011: market fell 20%, bear market correction, twice in 5-yr period

C: 1994: After 6 years of rally the market stalls, spends 18-months going sideways with two 10% corrections from its rally high

C: 2015: market stalled out and spent 16-months going sideways with two 12% corrections from rally high

D: 1994: S&P500 broke out of range to close at all-time high

D: 2016: S&P500 broke out of range to close at all-time high

There are also striking similarities in the political winds of the time periods. Clinton administration pushed deregulation of financial industry to enable banks to lend money to poorer Americans. Trump administration pushing deregulation of financial industry compared to Obama admin.

2009-2016 market followed the 1988-1995 SPY (with some deviation such as recent rally being 40% larger, though the decline preceeding it was also larger than the historical example).

With Consumer Confidence Index hitting 113.7, it is almost reaching the same level that it was at in 1996. While subjective, some see these points meaning a broadly bullish shift in sentiment.

  • The average bull market over the past 100 years has lasted 8.9 years, with average cumulative returns of 488%. The current bull market has lasted 7.8 years with total cumulative returns of less than 250%.

    • [Current bull market has been near average length but not near average strength]. Opinion: We have yet to see “optimism” shift to “euphoria” in the market; it would be unusual to see a peak without this change in sentiment.
    • Valuations not stretched comparatively speaking; look at 1999 or 1987.

 

The Fed and Fiscal Policy

Ben Bernanke’s commentary on Fed policy in light of Trump admin.

  • Markets have responded very strongly to Trump’s election whereas the Fed has reacted far more cautiously
  • Yellen in December ’16: The central bank operating under a “cloud of uncertainty”.
  • Fed policymakers forecasts showed little-to-no change in economic outlooks or interest rate projections for the next few years Fiscal policy influences economy through many ways. The fed observes these future policy effects through the lens of their models. The actual effects depend greatly on the state of the economy when the plans are put in place.
  • Today, economy near full employment, there is decreasing need for demand-side stimulus (compared to 3-4 years ago). The market reaction to Trump’s election is similar to the pattern seen in the early Reagan years.
  • Why has the market reacted (to Trump) so strongly while the Fed has reacted so lightly?
    • Fed typically opts for cautious approach
    • It isn’t clear that the near-term macro-econ effects of Trump fiscal changes will be as large as the market has forecasted
  • Significant tax cuts do seem likely this year
  • Other policy changes, such as deregulation, will have unknown economic effects
  • Fed Dec. meeting minutes say: the positive effects of assumed fiscal changes on growth and inflation were “substantially counterbalanced” by the restraining effects of higher long-term interest rates and the stronger dollar.
  • Fed seems to be sticking to baseline forecasts and treating a potential fiscal program as an upside risk.

 

St. Louis Fed Branch Dissents from the Crowd.

  • Most Fed officials see the federal funds rate around 3% in the long-term. However, the St. Louis Fed branch sees things differently.
    • Bullard at St. Louis sees 1 more rate hike between now and the end of 2019.
  • Research concluded that natural real interest rate (net of inflation) in the long-term should be negative.
    • They see inflation & employment as stable and near the Fed’s target with rates where they currently are.
    • Economy cant grow as fast as it once did due to structural changes.
    • Aging population, low growth rate for the labor force
    • This keeps credit demand low, results in less need for restrictive policy rates. Worldwide rates are low but the entire world faces similar economic headwinds and productivity challenges.
  • However, besides Bullard, the other voting members don’t currently agree. This could result in overshooting the policy rate which would send the economy into recession or deflation.
    • If US rates are higher than other countries, with low inflation, foreign capital will flow into the U.S., drives up the value of the dollar, imports cheaper, exports more expensive, thereby amplifying constrictive higher rate policy.
  • Either way, interest rates may not immediately increase as there are some in the Fed who don’t see the need for hawkish actions.
    • This could mean low mortgage rates would further support the housing market and companies could continue to borrow cheaply.

 

Currency Markets Showing Reduced Fiscal Policy Expectations/Dovish Fed

  • The dollar index is barely above 100 now. GBP is surging on news of a “hard” Brexit. Euro is stronger vs. the Dollar. Yen is stronger vs. the Dollar.
    • Trend of dollar weakness may not end soon.
  • Markets expect the Fed isn’t as hawkish as they once sounded
  • Or that Trump fiscal policy is not as big as first thought.
  • 10-yr US Treasuries are bucking the aforementioned trend, sitting around 2.35%, which is still higher than its Nov. 7th 1.82%.
  • Critical USD levels:
    • USD/JPY 111.00, Euro 1.085, Pound 1.25. Also 2.35% on the 10-yr, 2.3% is crucial.
  • Equities are showing the possible start of an unwinding Trump trade. The most affected would be Financials $XLF, Industrials $XLI, and Materials $XLB.
    • Even if Trump’s fiscal policies come through, if they are delayed these sectors ought to feel the pain.
  • Slower policy roll-out should help Biotechs and Healthcare, $XBI and $XLV, because drug-pricing will be off the table for the near future.
  • Falling dollar will be positive for Utilities $XLU and Staples $XLP.   #Part-time worker numbers and changes
  • At the worst of the “Great Recession”, part-time worker numbers spiked, but latest data shows these numbers have decreased back to pre-recession levels
  • BLS counts anyone who works 1-34 hours/week a part-time worker. Within this group, “involuntary” part-time workers are those who would prefer to work more but cannot due to business conditions or such.
  • This involuntary part-time work has a huge cyclical component. With economic downturn, this category grew to a peak of 12.6% in March 2010. Since then it has declined.
    • This decline has not bottomed out yet.
    • might be indicative of a structural change in the labor market
  • Largest number of part-time workers choose short hours voluntarily
    • These numbers are at a 10-year high
    • Blame the “gig economy”
    • People seeking something called “work-life balance” (Funny, huh?)

Last Week In Review, Next Week Expectations, Will Earnings Show Market Strength?

  • Good news: Mortgage apps up 5.8% despite doubts about interest rates rising hurting the market
  • Jobless claims at 247k is an extremely low level
  • Michigan sentiment at 98.1, despite miss on expectations is still strong
  • NFIB small business outlook surged to near-10-year-high
  • Gasoline up 20% year over year
  • Business inventories, not bad but can be spun to sound bad This week:
  • Look for Housing starts and building permits data on Thursday, leading data indicator for this sector.
  • Initial jobless claims on Thursday is the best indicator for employment trends
  • Fed speakers will appear everyday, Yellen speaks twice.
  • Expect the start of earnings season to take some of the focus off of Trump, despite inauguration at the end of the week
  • Earnings reports typically beat estimates, increased number of surveyed investors expect results to be in-line or better than estimates compared to surveys done last quarter.
  • Overall investor sentiment on US has improved with recession fears dwindling
  • Fed movements and future rate hikes drive many sector views such as Financials, Utilities, REITs.

 

Important Banking Indicator says “Bullish”

  • We can look at the credit quality of banks for a sort of “health check”. There are 3 metrics: Loan-loss provision, charge-offs and reserves for loan losses.
    • Important one of loan-loss provision
    • -80% correlation between a measure of loan-loss provision and ROA
    • Loan-loss provision up, profits down and vice versa Looking at this metric historically, the results of the ’08 fincial crisis threw them out of whack.
    • ’09-’10: policymakers made things suck worse by demanding increased loan-loss provision while also demanding banks increase capital ratios
    • This froze up lending around the U.S. because to lend a dollar, the bank would first need to secure more capital
  • Lending got back to ’08 levels by Q3 ’14
  • Massive correction in this previously “out-of-whack” credit metric since 2011 to today
  • Current 2016 loan growth is up 6.9% YoY compared to historic average of 4.2%
  • Banks need to see US GDP increase to keep pace with loan expansion and increasing profits. If GDP stays lower but loan growth rises, bank profits ought to fall.
  • Since 1991 Loan-Loss Provision as a % of assets has been at this key point only 10 times, each of those 10 times (94-96, 04-06, 13-16)

 

Misc. Global News

  • Britain will go for hard Brexit
  • World Economic Forum conference in Davos, Switzerland this week
  • China’s Xi Jinping says “Protectionism is like locking oneself in a dark room”.
  • OPEC thinks oil markets will stabilize in 2017
  • Shipping insurers will insure Iranian oil exports w/o using U.S. companies
  • IMF forecasts U.S. growth at 2.3% and 2018 2.5%; 2016 growth sucked at 1.6%
  • Trump promised to force pharma companies to negotiate w/ gov’t for drug prices with Medicare and Medicaid.
  • Trump may not keep Russia sanctions for long
  • South Korea Samsung scandal continues
  • Samsung concluded that the fires were not their hardware or software in Note 7’s
  • Baidu ($BUDI) is pushing into AI, hired former $MSFT exec
  • British American Tobacco buys Reynolds American ($RAI), creates largest listed tobacco company
  • $LUX and French Essilor (eyewear companies) merge
  • SpaceX rocket sends 10 Iridium Communications $IRDM satellites into space, company plans to replace all of its satellite infrastructure with 6 more space flights already contracted.
  • Airbus will test a self-piloted flying car
  • Trump met with Boeing CEO again, talk over Boeing contract w/ airforce one
  • Snapchat (Snap Inc.) will keep control w/ stock offering, no voting power for investors, listing likely around $20B.
  • Facebook working to stop fake news in Germany
  • Deutsche Bank likely to not give bonuses for majority of workforce this year
  • Hyundai Motors and Kia Motors plan to invest 3.1B in USA, possible build US factory
  • Trump says BMW will face 30% import tariff for cars built at Mexico plant imported to U.S.
  • Honda stock down earlier in week when a Takata airbag blew up in a Honda car
  • Noble Energy $NBL buys Clayton Williams Energy, builds on presence in Permian Basin which is big shale-oil

Trump’s comments earlier in week about USD are a shift from twenty-plus years of presidential rhetoric (DOW Jones Newswires 1-17-17)

  • Since the 1990’s the US president has been a backer of a strong USD
    • Seen as a way to keep interest rates down and inflation under control
  • Trump: “Our dollar is too strong”
    • Disrupts old mantra started by Clinton Treasury sec. Robert Rubin.
  • Obama Treasury sec. Geithner has previously backed a strong dollar as a sign of optimism about the US econ.

Fed’s Brainard Turns from Dove to Hawk post-election

  • Previous perma-dove now calls for the end of Fed supporting markets with QE
  • Rumors said she was likely to be in a Clinton cabinet, she was a Clinton donor
  • Brainard: “When the economy is either close to or at full employment and inflation is converging to or at its target, additional fiscal demand will more likely result in inflationary pressures”
    • She thinks Trump’s policy will make inflation instead of econ. Growth.
  • Since the start of QE in ’08 the Fed has indexed its build in balances versus the S&P500.
  • No longer doing this is a potential negative shock for markets.

 

European Central Bank & Stimulus (Bloomberg)

  • ECB will inject ~750b euros into the financial system in 2017
  • ECB likely to say QE must continue to help the euro recover
  • Most economists surveyed expect a major ECB policy change around September ‘17
  • ECB’s rhetoric contrasts with U.S. Fed’s Yellen who is more hawkish on reducing monetary support.
  • There is a larger debate happening about whether or not unelected monetary officials have too much power over intervening in markets.

 

Economic Research Paper Section

These are my favorite of all the readings that I summarize; if anyone has suggestions on a certain economist or writer to pursue please let me know!

[Financial Market Stability and Monetary Policy, Joseph Stiglitz, Columbia University 2002]

Stiglitz explores the International Monetary Fund (IMF) and individual government policy in the 1999 East Asian financial crisis.

  • First, no dispute that IMF policies in the east-Asian crisis were erroneous, but we want to explore what made the policies wrong, perform economic analysis on them, and understand why such policies were pursued at all.

  • The International Monetary Fund was originally intended to further global financial stability and to providing liquidity to countries in trouble. Stiglitz argues that the IMF in recent years (this was written in 2002) has been pursuing an agenda written by the special interests of the global financial elite.

    • Financial crises are becoming more common and severe around the world, the U.S. is one of the exceptions
    • Capital market liberalization has been a key contributor to this change, (as seen in next paper, IMF pushes capital market liberalization).

The erroneous IMF response was based on 3 premises:

  1. We must prevent exchange rate deterioration

  2. We can do this by increasing interest rates

  3. The benefits of doing this outweigh the costs

Basically the IMF claims it is bad to intervene into markets, except when a government can do it by borrowing money at significant cost to their own taxpayers; then it suddenly makes sense to intervene into currency markets to prevent devaluation.

The 2 Arguments the IMF uses to justify defending currency:

  • 1) Prevent inflation, in order to do this we need to defend currency, however (as we can see now in hindsight) devaluation was the basis of economic recovery in Brazil and Russia.

    • If we were consistent with this mandate against inflation, we could justify intervention into oil markets as oil has had inflationary impacts, though the IMF vehemently opposes this idea.

  • 2) Prevent Contagion (financial issues spreading beyond the country where the initial action occurs).

    • However, Brazil’s devaluation showed that currency depreciation may not always lead to contagion
    • Example) We have no data on a country like Columbia being directly affected by Russia’s devaluation.
    • Yes, any general equilibrium system should react when one area sees changes, however, this doesn’t hold water in the real world as not all foreign economies are the same or all equally linked. There is no clear evidence supporting the idea (for example) that Mexico performing a multi-bullion dollar bail-out of its currency would then stabilize Argentina.

While the IMF’s intentions were to prevent inflation and contagion, in hindsight we can see that its actions actually led to adverse effects.

Contractionary monetary and fiscal policy brought reduced incomes, reduced imports (which are another country’s’ exports). So country A’s monetary and fiscal policy caused country B to lose exports, which is by definition contagion.

  • Another erroneous assumption is that raising interest rates will stop currency depreciation
    • just because governments do it does not mean it works
  • Raising rates should make it more attractive to put money in a country, means money will flow into the country.
    • These capital inflows should then support the currency.

  • BUT there is one problem, with private sector debt, there is always the fear of the borrower going into default.

    • When you raise interest rates you put pressure on borrowers who may go into bankruptcy.
    • This means that raising interest rates is a double edged sword; a country becomes more attractive in one regard, but less attractive in another. You have to judge whether or not the bankruptcy probability will increase such that it negatively outweighs the positive of attractive higher rates for outside investment. If that happens, then you doubly fuck yourself because you cause a recession and drive away investment.

  • This can be seen in Korea

    • What caused the Korean crisis? Banks didn’t roll over their loans because they saw high bankruptcy probability in borrowers.
    • IMF says the crisis was due to “weak financial institutions”
    • but the institutions were only weak AFTER interest rates were raised, causing their borrowers to go into default, leaving them with large numbers of non-performing loans.

Stiglitz then analyzes the likely model used by the IMF to reach its monetary and fiscal policy decisions in East Asia.

  • The first is that the IMF was attempting to restore confidence in the marketplace by raising interest rates. Stiglitz calls this not “economics but of psycho-babble”.

    • The problem is that people in different countries react differently to the same events. The IMF policies may very well have encouraged investment from western countries like England, but could have had the opposite effect in different cultures. One size does not fit all.

  • The second is that theoretically high interest rates could be seen as a signal that the country was in great shape because it could sustain the high rates.

    • IMF thought temporarily high rates would cause a permanent shift in the demand curve
    • However, “there is no free lunch and no free signals”. Signals are only seen as credible if they come at significant cost. Ironically, the IMF had reduced the efficacy of these signals over time by using them repeatedly.
    • Such a signal would theoretically work in Latin America because of their lax monetary authorities, but it was the opposite in East Asia.

  • In Korea, inflation was only 4% so there was no reason for the government to signal that it was serious about capping inflation. In fact due to the massive leverage of Korean firms at the time, raising rates led to corporate bankruptcies en masse.

Increasing interest rates was a bad policy that made a tough situation worse. The economic models made incorrect assumptions, which led to inaccurate forecasts of human behavior. Small businesses folded, jobs were lost and the countries experienced capital flight, rather than capital inflows.

  • Alternative proposed by Stiglitz: Orderly unwinding of firms in a “super-chapter 11” would have alleviated the chaos.
  • Another alternative would have been capital controls, as Malaysia did. The IMF predicted Malaysia would suffer for this move but in-fact, the country experienced a shorter downturn than the rest of the region.
    • The IMF acted in the interests of creditors, rather than the countries experiencing the crisis, and thus wanted to avoid sponsored bankruptcies at all costs.

Broadly speaking, the crisis was induced by capital movement; this capital movement was a direct result of the capital market liberalization at the IMF had been pushing for years.

  • This isn’t surprising considering that the IMF is controlled by the advanced industrial countries of the world, especially the United States. China has influence but despite its rapid economic growth does not have the voting status or clout that the US does. The IMF is thus controlled by the finance ministers and central banks of these countries. The finance ministers and central banks of these countries reflect the interests of the financial system far more than the common man. (We see this again in the US Treasury response to 2008).

[“Capital-Market Liberalization, Globalization, and the IMF”, Joseph Stiglitz, Columbia University 2004]

  • The IMF has pressured developing countries into liberalizing their capital markets, basing their justification upon models with significant assumptions that may not accurately depict the real world.
    • This can lead to instability and not improved growth. Ex) Large capital outflow from a country leads to gov’t increasing interest rates and slowing economic growth. See Brazil at this time.
    • Assumptions such as the neoclassical economic model; perfect information, perfect capital markets, perfect competition. However, few developed countries, let alone developing countries are accurately portrayed by this model.
  • Economists have long expressed doubts about the virtues of capital-market liberalization (CML). The movement of capital flows have left developing countries with risks for exchange rates and interest-rates.
  • Stiglitz berates Rogoff et. al. for their IMF paper which showed clear bias when discussing CML.
  • He says the IMF should change from pressuring countries into liberalizing their capital markets and begin working with countries on how to design programs to stabilize capital flows.
  • IMF should be working harder to address underlying failures in capital markets
  • Should rely more on evidence and less on ideological leanings

Whew, thats a lot, I'm done for now. I plan on making this more of a weekly post, but if theres enough interest I may do it biweekly (like this week).

Submitted January 19, 2017 at 04:31AM by Bulletproof_Haas
via http://ift.tt/2jPgave

Leave a comment