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Friday, January 29, 2010

Transcript: 351 Friday Forecast, er, Market Predictions

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Coming in here on the day of the release of GDP numbers, likely to be four plus... We do it to emphasize our extreme outlier position that the economy is still in recession. Then our market forecasts, yes, straying from the economy into the market mob or at least the casino run by the market mob.

Demand Side is, as we've made clear for the past six months, not calling the current so-called growth even a "technical recovery" quote unquote. This is going to sound pretty strange, because perhaps before you hear it even, the GDP number will be out with a 4 plus number. This reflects the stimulus that was supposed to jump start the recovery. Not the recovery. So, strange-sounding or not, we continue with still in recession.

We have warned for months about the danger of another crisis, possibly centered on commercial real estate and the wholesale failure of the not too big to fail banks or on the incredible and incredibly stupid 60 billion in credit default swaps traded in dark markets with no legitimate regulation.

We may be stubborn, but we still do not see that we have been proven wrong. The most credible evidence to the contrary, in our opinion, is the blue bar on Calculated Risk's graphs is ended in late summer. The decision will ultimately be made by NBER, the National Bureau of Economic Research, and it will be made long after all the evidence is in. In our view, that means it will be decided by the performance of the economy in the next six months.

But we are SO stubborn, we won't even take their word for it. Unless, of course, they agree with us. Why?

Because there is no investment, there is no credit growth, there is no end to the housing price decrease, there is no end to the loss of jobs. What we have done is found the bottom, and now we are bouncing along it, and we are soon to find that it is sloped downward. All the talk in 2009 among forecasters of second derivatives was not an indication of an eventual turnaround. It was an indication that we were getting close to this bottom.

Three things about that:

The bottom is sloped downward. It is not flat.
Automatic and discretionary stabilizers can reduce the slope, but not make it positive.
An eventual turnaround depends on policy choices that are not even on the table.

Now, realizing that outliers like ourselves are not taken seriously, even if proven right, and are considered more annoyances than voices to be listened to, we turn to the arena where we will be taken seriously, even if we have much less confidence in our own views. The arena we are leaving is economic forecasting. The one we are entering is market prediction.

You will remember we, unlike other bears, have correctly predicted market booms in the current recession. Most accurate was our contemporaneous call of the oil and commodity boom beginning in the fall of 2007 and ending in July 2008. We called the bull on time and came out with the bear on the very day. Elsewhere, unlike for example, Nouriel Roubini who called the strength in stocks in early 2009 a "dead cat bounce" and a "sucker's rally," Demand Side allowed that there were plenty of chips for the casino and a rebound from the lows was likely.

Our errors were made early on when we suspected that Treasury prices would fall, yields rising, as a result of deteriorating fundamentals. In fact, prices have remained above our early calls, though we can see and have seen for some time the flight to quality, aka, safety and the real returns benefiting from deflation. So in spite of immense supply, we suppose bond prices will continue stable and high. There is, of course, the built-in demand from those institutions able to borrow at zero from the Fed and carry their money over to the Treasury for three and a quarter.

Stocks we predict here will fall over the next six months, as the bubble from the same zero percent financed positions deflates in response to flagging demand from anybody else. Nor retail individuals, nor institutional investors, nor hedge funds, nor foreigners are buying the stocks. They can float on an unlimited supply of chips to the professional players, but sooner or later some gotta win and some gotta lose. The first one's to take their chips off the table will be the winners. Which means everybody has their hands poised over their stacks.

That fall may have already begun. But more about that later. And of course, a crisis such as we imagined above in the financial sector would transform that fall into a crash. At the same time, bubbles in places like Australia and China, borne up by the carry trade, could collapse and create spikes in U.S. markets.

We think the stronger economies, particularly Brazil's, are saturated in real terms, but may benefit for being the only healthy fields left. We encourage Brazil to continue and increase its restrictions on capital flows. Talk about a turnaround! We are talking about Brazil as if it were Germany. Speaking of Germany, the place that looks like it could create political instability such as visited interwar Germany is China, where a huge bubble is in progress. Rather than create stability by expanding its social insurance programs, that country has created instability by funding big new infrastructure and fomenting a housing boom. The fever for housing is not unlike that in the U.S. in the early aughts, when people bought as an investment and as a sure source of retirement security.

Markets in commodities, particularly oil and metals, benefit from bubble financing as well. The current price of oil is not really out of line with historical trends, but those trends were set in the context of much stronger real economies. If supply and demand were truly the rule for oil, the price would have trouble getting to $50. On the other hand, oil goes up when the dollar goes down, indicating to some a trade relationship and to others a role for oil as a store of value like gold.

We're not commenting on gold, other than to say it is more a currency than a commodity and is subject to fevered and religious ecstasies.

In terms of specific sectors. All consumer discretionaries, including most durables, will be under immense pressure. Financial sector stocks suffer from the fact that they are not providing any service, many are insolvent, torches and pitchforks are at the moat, and the casino games they are playing are fundamentally nonproductive. The companies in Health Care, Big Oil, Big Coal, Pharmaceuticals, FIRE -- finance, insurance and real estate -- whose interests are protected by the Joe Lieberman's of the world, probably have another couple of years of up and down before they are wiped out.

As absurd as not seeing the housing bubble is not seeing the profits of corporations as being conjured up out of downsizing, accounting gimicks and foregoing productive investment. It is more a function of money needing a place to be with returns labeled above 3 percent. The labels come off.

So, to summarize. Market Predictions:

The end of the bear market rally is in sight, and may have begun.
There is a better than fifty percent chance of a major new crisis in 2010.
The crisis will again be in the financial sector, from CRE and not too big to fail banks, or from the collapse of unregulated derivatives
Treasury bond markets will be stable in the sense of having prices and yields that don't vary.
Commodity markets and oil will deteriorate over the next two years.
Brazil is the only healthy economy, but it is overbought in spite of its defenses.
Chinese and Australian markets will crash within two years.
Politically muscular sectors will hold on for longer than real economy sectors like consumer durables
The housing market has much further to fall.

Now, for context, with an assist from David Rosenberg, Glusken Scheff, whose free e-mailed daily newsletter ought to be your guide for investing.

Asian stocks hit their lowest level in a month on Wednesday with a 1.1% loss and are down now in each of the past eight sessions. And the MSCI emerging markets index slid 0.6% and is down 8% over the past six-day losing streak. In the FX market, the Yen has firmed to nine-month high against the euro in a classic sign of heightened risk aversion.

Corporate bond risks in Europe are rising too – underscored by the widening in CDS spreads – CDS (Credit Default Swaps) are also widening on sovereign debt in response to intractable fiscal deficits everywhere – with Portugal, Spain and Greece the primary suspects. The commodity complex is trading softly as well, with copper needing to play some catch-up – but the gold price is hanging tight at its 100-day moving average and it was encouraging yesterday to see it rebound even with the DXY edging higher at the same time. Bonds are on an even keel with the 10-year note yield still flirting with one-month lows and Tuesday’s 2-year auction going quite well (bid-cover ratio of 3.13x and indirect bidding – a proxy for foreign central bank activity – taking up a not-too-shabby 43% of the auction).

CPI data in Germany are showing a deep plunge for January (-0.7% MoM in Bavaria) and the U.K. retail sales figures (the CBI survey) also posted a surprising decline to kick off the year (the diffusion index swung from +13% in December to -8% in January). Mmortgage applications in the U.S. fell an immense 11% last week and there was no sign of upturn in the ABC News weekly consumer confidence index either which came in at a recessionary -48 level last week and has averaged -46 so far in January versus -44 in December, not exactly ratifying the results from the Conference Board yesterday (see more below).

The Fed released its statement indicating continuation of the wholly ineffective and dangerous zero percent rates policy for an extended period of time.

Rosenberg offers the following commentary:


On December 16, the press statement read “economic activity is likely to remain weak for a time”, and now, it reads “the pace of economic recovery is likely to be moderate for a time.” So, it would seem as though the Fed has actually upgraded its forecast! No mention was made about the downturn in the housing data (and in the December statement, we were told that “the housing sector has shown some signs of improvement over recent months”). Then again, the Fed knows that we are going to see a ripping GDP report for Q4 this Friday so why bother talking the economy down — though in my view it is on the cusp of rolling over.


Ben Bernanke was seen as likely to be confirmed by the Senate later today.

The U.S., Canada and the EU or reducing fiscal stimulus.

The President has announced his intention to freeze about 20% of government program spending. There has been no talk of the Fed backtracking on its plan to cease it its home-loan interventions or for the U.S. government extending the expiry date of its housing tax credits, again.

The Case-Shiller home price index came in a tad below expected in November at +0.24%, which is a discernible slowing from the +0.6% average from June to October. With over 9 million housing units either vacant for sale, in foreclosed inventory or occupied and listed actively, together with a competing record 11% nationwide rental vacancy rate, it’s only a matter of time before home prices succumb,

says David Rosenberg.

Treasury one-month bill rates turned negative for the first time in 10 months, as issuance declines while investors seek the most easily-traded securities amid a renewal of risk aversion.

The rate on the four-week security dropped to negative 0.0101 percent, the lowest since it reached negative 0.015 percent on March 26. The Treasury sold $10 billion of four-week bills on Jan. 26 at a rate of zero percent ...

The Ten Year yield is back down to 3.61%.

It’s going to be very interesting to see how the global economy performs without the government lifeline that has pumped over $2 trillion of government stimulus into the world economy since 2008. A disrobed emperor is not likely going to be a very pleasant sight.

And completing today's edition of the podcast, we take note of a video our daughter sent us, which most have already seen. A rap featuring Keynes and Hayek.

I wrote her back,

somehow Hayek comes out looking somewhat similar in intelligence and perspicacity to Keynes.

AND it's produced at the cost of a million dollars!!!

Therefore? It is produced to get Hayek's nonsense on a level in the popular mind as Keynes' insights.

Knowing you are probably not interested in the logical proofs, I offer only this empirical (historical fact) proof. It was the Keynesians who were crying out against the superbubble that has now burst, who were pointing to the immense credit explosion, and the Hayekians who were saying "let the market work."



  1. have you read any chartalist/modern monetary theory?

  2. I have not, except second hand through Marshall Auerbach and Steve Keen. Would be interested in some succinct description.

    My take is that while it may be correct in theory and might work in practice, getting from here to there would require a complete re-education of the population and office-holders that is not in prospect.

  3. The US, and UK markets are grossly overvalued. The price to earnings ratios are out of alignment with the reality of the economy. Some of the support has come from the excess liquidity floating around. Personally I think that the Dow will fall below 5000 and the S&P below 500.

    There has been a lot of hot money flowing into commodities and at some point these bubbles will burst as well. Oil as you say is probably over valued on current demand but longer term this may be the last few years of cheap oil as peak oil impacts on the real world.

    Real estate will suffer, as there simply will not be sufficient demand for commercial or residential property. That will mean further problems for banks with prime mortgages recasting over the next three years. Without any job creation home sales will stay low.

    I do not agree about the end of the bear market. I think that it has a number of years to run. This is based primarily on unrealistic P/E ratios now, and that will take some time to resolve itself. Then the recovery will be weak because of the actions of the deficit hawks. The US will suffer a L shaped recovery. At least until the mortgage recasts are over.

    Commodity markets will deteriorate in time. Much of the current support is down to stock building in China, and speculation. That cannot continue without China being able to export the goods that those commodities were purchased for. China is already over heating though I have more faith in China being able to regulate their crisis.

    Regarding the CDS markets. If there are any sovereign defaults, that will have detrimental impact on the banks. I would also include Ireland and possibly Iceland as being at risk.

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