Market Talk

The ramifications of the Japan quake are impossible to know at this point, and the human toll will obviously be the most important, and devastating, aspect of the whole disaster.

In the cold math of the markets, the earthquake will spark economic activity. Lumber futures in the U.S. are higher this morning in anticipation of the rebuilding effort. There’s the thought that with the nation’s nuclear plants offline, crude oil demand will rise. But that’s cold comfort for all the bad things that are going to happen, both economically and from just a mere human standpoint.

Capital Economics’ Julian Jessop has started sketching out the ramifications:

The consequences of the major earthquake and tsunami that hit Miyagi Prefecture and other areas in north-eastern Japan today are not yet clear and the impact on local people is of course foremost in everyone’s minds. But the financial markets also need to consider the economic costs and the implications of the disaster for the public finances. These could be considerable.

While noting environmental disasters often have a smaller economic impact than initially feared, since the resulting reconstruction boosts demand, and that Japan is uniquely prepared for earthquakes. But considering the state of Japan’s economy, the timing is very bad.

The timing of the disaster could not have been much worse. The economy had already
contracted in the final quarter of last year. This shock may be too small and too late to have much impact on GDP in Q1, but does marginally increase the chance that output will decline in the current quarter as well. Moreover, a large part of the reconstruction costs will probably have to be met by local authorities and ultimately by central government, which is already struggling to bring public debt under control. Overall, it will be that much harder to deliver a credible long-term fiscal plan in the summer if the economy is stuck in recession, the public finances are in an even worse state, and many people are still suffering the after-effects of this disaster. At the very least, the scope for fiscal stimulus to mitigate the economic damage is much less than it was in 1995.

Japan is still the world’s third-largest economy, so what happens there is very likely to have some kind of impact overseas.

Okay, let’s have a show of hands: who thought Europe’s sovereign-debt crisis was over? Anybody? Bueller? Bueller? Who’s that with your hand up? In the back?

Oh, it’s you, Mr. Market. Mr. Market, tsk tsk.

Today’s sell-off is being pegged in some part on Moody’s downgrade of Spain, which “reignited” fears of that Europe’s sovereign-debt problems are still, well, problematic. You can almost forgive the market for taking its eyes off this particular ball. After all, the Fed’s been buying the drinks since August, and the market is never one to look that gift horse in the mouth.

Then, too, the news this past month or so has been dominated by the Jasmine Revolution spreading across North Africa, and there’s been a recovery here in the U.S., the sustainability of which is a constant source of obsession (and rightly so.) And the Charlie Sheen thing’s been going on for years. At least, it feels like it’s been going on for years.

But it’s hard to believe that the market was really shocked by the Spanish downgrade. The fact is the U.S. stock market is due, overdue, for a correction, and even despite the central bank’s best efforts, one is going to come. Call it gravity. The news, the trigger for the sell-off, it’s just an excuse.

To be sure, there was a notable confluence of bad news today. Besides the Spanish downgrade, there was a surprising jump in jobless claims, and a surprising widening of the trade gap. These two combined to take the enthusiasm over the economy recovery down a few notches (no surprise to regular readers of this blog, to be sure.)

But the fact is, stocks are and have been overbought for some time now, and the recent reappearance of that particular species, the retail investor, that seems to come out the most at market tops only made the market even more top heavy. Woe be to the last one into a crowded trade.

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We’ve been talking a lot about oil prices and the economy, and while we (rather naturally) worry about how much damage it will do to the U.S. economy, we must entertain the notion that it may do be quite as bad as fear.

To that end, here are some thoughts from Merrill Lynch’s David Bianco on the subject. Bianco isn’t very worried about the effects of Middle East strife on the U.S. economy, unless said strife pushes crude over $120/barrel “for an extended period.” The Merrill boys still see the S&P 500 closing the year at 1400, “and see upside risk to our 2011 year-end target.”

From Bianco:

US may be able to weather high oil prices relatively well
Despite being the world’s largest importer of oil, oil is less than 40% of US energy consumption. Natural gas and coal together account for more, and their prices are 50% and 20% lower than their 2008-average prices respectively. Although gasoline prices are back to early 2008 levels, Americans now drive 40 billion less miles per year with a more fuel-efficient fleet. Ten million cars were scrapped in 2009. Thus, households are actually spending a smaller percentage of their disposable income on gasoline than they were in early 2008 (3.5% vs. 4%). However, further rises in gasoline prices would not bode well for continuing strong growth in discretionary consumer spending.

Higher oil prices are a wealth transfer, not a wealth loss
High oil prices are a wealth transfer from consumers to producers of oil. Some of this occurs within the US (energy companies) and some outside (oil exporters). Higher oil profits are likely to be partially recycled into energy investments and consumption. From 2004-08, capex by US energy companies increased three-fold and US exports to oil producing nations tripled. For every $1 of imports from oil-producing nations, $0.30 is recycled back into the US via exports. Many MENA oil producing countries are likely to increase infrastructure spending, which should benefit US capital good exports. Bonus depreciation in 2011 provides an incentive for US energy companies to increase capex spending. Also, oil prices staying above $120/bbl on a sustained basis is likely to increase domestic drilling.

For some perspective, Americans drove about 2.9 trillion miles in 2010, according to the DOT and as reported by autoblog. So a decrease of 40 billion miles is a bit more than a 1% drop.

This just in: gas costs $3.50 a gallon. If it doesn’t where you live, just wait. It soon will.

The AAA’s daily fuel gauge shows the national average for regular is $3.50. I believe it was $3.47 on Friday. There’s nothing magical about the $3.50 level, except for its psychological effects.

The big problem is that with $3.50 here, the $4 level comes within hailing distance, and it was when gas prices hit $4 in the summer of 2008 that the feta really hit the fan.

Listen, the real fear here isn’t an end-of-the-world kind of thing. Whatever happens in the Middle East, at some point the world will return to something approaching normal, like it always does (which is not exactly the same as normal; when you think about it, we live in a pretty dysfunctional world.) The real fear, for us here in the U.S. at least, Europe, too, for that matter, is that the uprising drives oil prices high enough to derail the recovery.

Crude prices are up more than $2 this morning, pushing Nymex crude futures to near $107/barrel. Brent, the European benchmark that is more directly affected by the events in Libya, is pushing $118/barrel (and lots of people note that a big chunk of U.S. gas prices, being imported, are more sensitive to Brent prices than Nymex.) Given that it takes a few weeks for crude prices to filter through to y0ur local service station, you can expect that prices will keep rising.

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As with many others, I’m keenly interested in what happens when the Fed’s QE2 program ends. Will there be a QE3? Will the markets crash without the Fed in there proffering support? Will anyone even notice what the Fed does if Charlie Sheen keeps talking?

One thing I’m wondering is this, and I don’t have a good answer for it although I’m asking around: let’s say the Fed decides not to do another round of asset purchases. It’s still sitting on more than $2 trillion of securities. Let’s say the Fed decides to hold them to maturity, something that been talked about. If that’s the case, sans a bond-selling program that would effectively drain some of the liquidity it put out there, the Fed can sit on its zero-percent interest rates and bloated balance sheet and still have interest rates that are negative on an inflation adjusted basis.

In other words, they don’t need to do a QE3 to still be very loose with their policies. There are issues of timing and reinvesting maturing debt on the balance sheet, but in general I think the Fed can keep monetary policy wide open without undertaking another big program.

It seems reasonable to me to see it that way, but I don’t have a PhD in economics. Actually, I don’t have a PhD in anything, but that’s another story. Gluskin Sheff’s David Rosenberg has contemplated a world without QE3, and comes to the conclusion that it’ll look a lot like the world without QE2, an era that lasted from approximately April to August 2010.

WHAT HAPPENS IF THERE IS NO QE3?

We are now being asked this constantly and the follow-up is “who picks up the slack if the Fed stops its bond-buying program”?

The answer(s) is hardly complicated since we have a template for this in 2010. It is a very simple guidepost.

Last year, from April 23rd through to August 27th, the Fed allowed its balance sheet to shrink from $1.207 trillion to $1.057 trillion for a 12% contraction as QE1 drew to a close. Go back a year to the Federal Open Market Committee minutes and you will see a Federal Reserve consumed with forecasts of sustainable growth and exit strategy plans. A sizeable equity correction coupled with double-dip fears were nowhere to be found.

Now over that interval …

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I have long thought that the scuttling of mark-to-market accounting as codified in FASB 157 is one of the most overlooked causes of the sudden, almost overnight improvement in the state of the banking sector that started near the market lows in 2009.

It was also a prime, prime example of crony capitalism. The banks wanted to get rid of mark-to-market, they needed to get rid of it, because if they had to mark all the lousy, bad loans to anything approaching reality, we’d suddenly find ourselves with a lot of suddenly insolvent banks. So the banks leaned on Congress, Congress leaned on the FASB, the FASB quickly caved and today we’ve got a bunch of zombie banks on our hands complaining that they’re burdened by too much government oversight.

But ultimately, there will be reckoning. It may be a sudden panic and collapse, or it may be more subtle, a slowly crumbling edifice that nobody notices is crumbling until one day it’s gone. At some point, though, somebody has to pay the piper. Who do you think that’ll be?

Our elected and appointed officials, in our name, abolished accounting rules that were inconvenient. Turned Fannie and Freddie into massive Hoover vacuums to suck up every bad mortgage in the nation. Debased the dollar. Spent trillions in government money and guarantees to protect a small band of connected players. We haven’t charge a single responsible person with any crime, criminal or civil.

Know the saying about not being able to spot the mark at a card game? You’re the mark, bub.

Barry Ritholtz breaks this thing down. Please go read the entire post. Here’s a snippet:

Many of the bailouts, mortgage mods and behaviors we have today exist to serve a single purpose: To allow the banks to kick the can down the road as far as they possibly can when it comes top their dual portfolio of bad mortgages and bank owned Real Estate (REOs).

Consider how ironic this is: From the GSEs becoming a dumping ground for every crappy mortgage to the failed policy of HAMP/mortgage mods, to the arbitrage between the the Fed’s ZIRP policy and Treasury’s 10 year bonds, nearly every reaction to the financial crisis has been a willful, concerted effort to kick the can down the road.

Rather than go Swedish, and force a shorter painful pre-packaged bankruptcy process, we have opted to take the long slow route.

The problem is with this strategy is we have more cans than road.

(Now, really, honestly, I planned to write this before Barry did a post about my Cramer post; this isn’t some mutual admiration society (although I do know and like him,) and it’s not like Barry needs the traffic boost from us.)

I’m not a pessimist. But I get pretty cranky when my car dies in the driveway, my son gets sick, when the person on the bus behind is gabbing on their cellphone, when the financial system drops an atom bomb on the economy that we’re still dealing with, when the central bank plays God with the markets, when companies wrap themselves in the flag and then ship jobs to China, when politicians from both parties wrap themselves up in the flag and then take millions of dollars from the companies shipping jobs overseas, and then rewrite the rules to favor the companies shipping jobs overseas, when…

Well, you get the picture. I consider myself an optimist. But I am also a realist, and I have to tell you, right now, realistically, everything stinks.

Okay, you got me; not every single thing in the world stinks, and like the New York Knicks, everything that stinks can get better. It may take a major upheaval, a revolution or exiling Justin Bieber to Inner Mongolia to make it better, but it will get better.

Now, if you’re a player, a real player, a Koch brother or Jamie Dimon, then everything’s great. But, for the rest of us, here’s just a partial list of everything that today stinks. Tell me if I left anything out.

The economy stinks. We are not creating anywhere near enough jobs, which means we’ve got millions of people stuck on unemployment, and millions more who are employed but are seeing their wages and benefits undercut by the lack of demand. We have a completely shot-through housing market. The list is endless. We will be lucky, and I mean David-Tyree-catching-the-ball-against-his-helmet lucky, to avoid another global banking crisis.

Stocks stink. I don’t want to hear about bull rallies. The market is largely controlled by computers programmed by pros who can suck all the value out  of a stock 200 times over before you even get near it. The average investor does not stand a chance, not a chance, of getting real value out of the stock market.

Bonds stink. The Federal Reserve has been driving down interest rates in the interest of driving investors further out along the risk curve, into, say, stocks (and commodities.) Where you’ll get crushed by the quants and bots. That’s not even factoring in default risk. I’d go so far as to say that today, there is not a single safe investment for the average person. Not one.

The Republicans stink. Poppy Bush had it right when he blasted “voodoo economics,” but nobody in the party listened, we had 30 years of “supply-side economics” that led directly to an all-time economic crisis. Republicans stink.

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Bruce Krasting caught the biggest tidbit to come out of Ben Bernanke’s rather boring testimony today (which I first saw on Zero Hedge) , does the grim math, and comes up with a conclusion that shows just how worthless, literally worth less, the Fed is making the dollar.

Alabama’s Richard Shelby asked the Fed chairman how he decided that $600 billion was the right amount for QE2. You can watch the C-Span video for yourself; the exchange comes around the 32-minute mark.

The Fed chairman explained that the central bank’s rule of thumb has been that roughly $150-$200 billion in bond buying has the same effect on the economy as a 25 basis point rate cut in the fed funds rate. So, by going out and buying $600 billion worth of Treasurys, the Fed is essentially cutting interest rates by 75 basis points. I say essentially, of course, because with the actual fed funds rate at zero (a band between zero and 25 basis points, to be precise,) it can’t cut interest rates any further. So it buys bonds.

Krasting takes the rule of thumb to its logical conclusion:

The sum of QE 1, QE lite (the top off of QE1) and QE2 is $2.35 trillion. Using Bernanke’s formula you get a range of 4% to 5% as the approximate interest rate consequence of QE. (2.35/.15 or 2.35/.2)

That is an extraordinary number. The Fed’ ZIRP policy set interest rates at zero. QE has brought that to -4.5% (average) based on Ben’s numbers.

I don’t think that this has ever happened before in the USA. The examples I can think of in history outside of the US all ended badly. Ben has set monetary policy so that interest rates are 5-6 % below inflation. There can be only one possible result. Inflation of everything we use is going to explode. Food, clothes, energy, transportation, ball bearing, plastics, you name it. The only thing that is not going to get inflated is wages and residential real estate. Cheap money will not fix structural problems.

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“Only don’t tell me you’re innocent. Because it insults my intelligence — and makes me very angry…”
-Michael Corleone, The Godfather

Listening to Ben Bernanke repeatedly deny that the Fed’s QE2 program has played any role in jamming up commodities prices stirs the same emotions Michael felt when his brother-in-law Carlo denied fingering Sonny for Barzini’s people.

Bernanke continues to insist that rising commodity prices are due to supply and demand dynamics, and denies any culpability of the Fed’s easy money monetary policy. Senators at today’s testimony on the Hill let that assertion go unchallenged. Would’ve been nice if someone asked Bernanke to reconcile ISM’s February manufacturing survey today, listing roughly 30 commodities up in price, none down, but only three commodities — capacitors, cocoa powder and electric components — in short supply.

It’s a simple enough question: Dr. Bernanke, there’s a laundry list of commodities up in price, and many of their run-ups began in late August, coincident with early mentions of potential QE2. Less than a handful of commodities were reported by manufacturers as being in short supply. So how can supply and demand dynamics alone explain the sharp run-up in commodities during the past six months, when there appear to be few, if any, supply constraints?

For an organization like the Fed where credibility is crucial, it’s amazing that its officials continue to stand by such a flimsy rationale for high commodity prices. Continue reading…

There’s been an awful lot of news escaping the North Africa and the Middle East today, and it’s all pushing crude prices higher. There have been a raft of rumor, vehemently denied, that Saudi tanks were moving into Bahrain. That tanked Saudi stocks.

Libya remains in a state of civil war, there are reports that Iranian police fired teargas on protesters, Oman is deploying troops amid its strife and Yemen’s separatists are already looking at a future past the monarchy. Clearly, this is driving up oil prices. Lately, the Nymex benchmark is up 1.6% at $98.49, and the Brent benchmark is up 1.7% at $113.66.

As we wrote yesterday, keep your eye on the $103-$104/barrel level of Nymex crude – a move over that could have serious repercussions – and remember that the revolt spreading across the Africa and Arabia isn’t going to be tied up in a neat little bow like some half-hour sitcom at the top of the hour, and it’s likely to go off in directions that absolutely nobody is expecting.

Nobody is seriously talking about $4 gas, or $5 gas, but it is a real possibility. Which means that if it comes, nobody will be ready for it. GM’s chairman this morning said the industry isn’t ready for $5 gas. The national average for regular unleaded is $3.37, according to AAA. We know the spike from last week will be working its way to the pump over the next couple weeks, so expect prices will keep rising. If the popular revolt keep spreading, if crude prices climb over that $103 range, and the oil market – about as festering a pit of hot money and speculation as there is – drives it ever higher, you will see $4 gas here in the States.

“I don’t think the industry learned a lot of lessons from 2008—they will this time around,” Daniel Akerson said at the Geneva motor show. “It would not be a good thing to see $5-a-gallon gas right now.”

You know what? It wasn’t just the auto industry that didn’t learn the lessons of 2008. But they may yet get the chance to take a make-up test.