March 13, 2004

The Secular Bull Market in Gold is Alive and Well

Below, long-term charts for the XAU and the HUI. Charts are done in log-scale with weekly closes and a 52-week moving avearge. Despite weakness in the spot gold price, and even gold stocks "getting ahead" of the move in gold, the long-term trends behind a secular bull market in gold are holding firm. Gold is still a buy.

Three of the Six Signs

The VIX rises...then falls...investors getting edgy. OEX Bullish percentage chart breaking down. And put buyers out in force, via the put/call ratio.

March 12, 2004

Quote of the Day

From and an article titled, "Double standards of US trade policy exposed" Note that one of the strategies for "unrestricted warfare" mentioned in the book by the same name, includes using international agencies and organizations to run "interference." Call it regulatory or diplomatic warfare (something, incidentally, the United States is also very good at.) US practices have damaged the Chinese side In its anti-dumping cases against China, the United States often contradicts the principle of objectiveness and fairness, and abuses bilaterally agreed articles to allow it maintain the current anti-dumping methodology. For example, in the anti-dumping investigation into mushrooms from China, the US Department of Commerce (DOC) chose Indonesia as the "surrogate country," where mushrooms are grown in air-conditioned houses. But the DOC refused to deduct the air-conditioning expenditure from Indonesian costs and thus ruled Chinese mushrooms as being dumped.

Ask and Ye Shall Receive: Chart of the Day and the Current Account

Yesterday I asked where the balance of payments and current account numbers were. Why? I wanted to know if foreigners bought or sold U.S. investments in the fourth quarter of the last calendar year. Today, the answer. Details: *The current account deficit (combined balances on trade in good and services, income, and net unilateral current transfers) went up $60 billion in 2003--from $480.9 billion in 2002 to $541.8 billion in 2003. *Foreigners purchased $52.8 billion LESS off U.S. securities (excluding Treasury bonds) in 2003 than they did in 2002, from $291.5 billion in 2002 to $238.7 billion last year. *Net foreign purchases of U.S. stocks were down $18 billion, from $55.2 in 2002 to $37.2 in 2003. *Net foreign purchases of U.S Treasury Securities were up 50%, from $96.2 billion in 2002 to $139.3 billion in 2003 Conclusions? Foreigners bought fewer stocks and more U.S. bonds, especially Treasury bonds. Odd, it seems, with the supply of Treasury bonds ever increasing. Then again, the day after we learn the U.S. government posted its largest monthly deficit in history, the dollar rises and Treasury bonds get a "flight to safety" bid. Evidently, it is still a dollar standard world, even though the dirty big secret of American debt is out in the open. With rates still low, a speculator could do worse than buy bond calls. Oh yes, one more fact: in 2002, foreigners purchased $76.3 billion agency securities (mostly Freddie and Fannie bonds, I imagine.) In 2003, net sales of agency bonds were $48.1 billion. Hmm. A $124 billion swing in one year. GSE debt, it's asbestos for the 21st century.


The e-mail edition of yesterday's Insider contained an error. The trade deficit number ($43 billion) replaced the Federal deficit number that should have been there ($96 billion). I wrote up the story so early after the Treasury report was released that the fact checking desk in Baltimore apparently couldn't confirm it, and replaced it, changing some of the language in the final post. Sorry for the confusion.

March 11, 2004

Quote of the Day: $96 Billion

Tomorrow, in the weekly edition of SI, I'll have concise housing roundup. As I write, 30-year fixed mortgage rates are again making a new low. And earlier today, Fannie Mae raised its forecast for mortgage loan originations in 2004 from $1.9 trillion to $2.43 trillion--which would make it the third largest year for new mortgage loans in history. Of course to make those loans, Fannie will have to sell bonds. And to sell bonds it will take buyers. And while European central banks unloaded GSE bonds last year, there are still plenty of buyers. Fannie reported today that it sold $2 billion worth of 5-year bonds today, yielding 3.22%. 52% of the offering was scooped up by Americans buyers (J.P. Morgan perhaps), while Asia bought 40%, Europe 7%, and various others 1%. That's pretty robust demand, although there's a big difference between buying $2 billion in bonds and $2.43 trillion. However I remain steadfastly bearish on the GSEs and the housing sector. I've posted John Snow's comments below because he uses the phrase, "orderly wind down of affairs of a GSE that gets into serious financial trouble." That's on the heels of Greenspan talking about systemic risk. Why are the nation's top policy makers talking about the GSEs with such provocative language? What do they know that we don't know? Are they trying to send the market a signal? I think they are. And I'm selling Fannie and Freddie. But the GSEs aren't the only one with debt problems. And they've been able to unload that debt on willing buyers. Compare that to today's lukewarm reception to an auction of $11 billion worth of U.S. Treasury bonds yielding 3.75%. "People swallowed this auction like it was castor oil,'' said Drew Matus, a senior economist at Lehman Brothers, quoted in a Bloomberg article. Today's auction comes off of yesterday's government auction of $16 billion in five year notes. And both auctions come against the backdrop of a government seeking to borrow $177 billion this quarter alone to finance a half a trillion dollar trade gap. Incidentally, as I write this, I got my monthly e-mail bulletin from the Treasury revealing that... you guessed it, the government ran a deficit again in February. Have a seat though before you read it, okay. Ready? Here comes... $96 Billion. Billion with a "B." That's largest one month deficit in the last two fiscal years. In fact, I've just done a quick scan of historic data on the Treasury site, and I believe that's the largest single month government deficit in the history of the Republic. A few facts to go with it: *$15. 2 billion of the total went directly to interest on existing public debt. In other words, 8% of the government's outlays were just to pay lenders. *Spending, for the first five months of this fiscal year compared to the first five of last year, has grown 4.2%, from $898 billion last year to $937 billion this year *The deficit for the first five months of this fiscal year compared to last year is 16.4% greater--from $194 billion last year to $226 billion this year. Here's the picture folks: This won't be good for the dollar. It won't be good for stocks. And it probably won't be good for bonds prices either. It means more supply of debt with demand already half-hearted (regardless of what the Secretary says below about the "quality" of U.S. government paper.) In fact, the only green I see on my screen right now is for bond yields (TNX, FVX, TYX) and the VIX, which is up 12% as of this writing to 18.6. Not so complacent anymore. The worm has turned... Treasury Secretary John Snow Remarks to America's Community Bankers Association Government Affairs Conference March 9, 2004. Emphasis added is mine. "GSEs are able to borrow at rates that are lower than their other financial competitors, other financial institutions, because they are perceived by many in the marketplace to have a relationship with the government, they are perceived to have a government guarantee. "Since Fannie and Freddie trade at very narrow spreads to the very best paper in the world, which is the U.S. Treasury, they have become enormous entities, and they are growing at a very, very rapid rate. The debt levels they are issuing are sizable relative to the economy of the United States. "To put it into perspective, the U.S. Government debt held by the public is about $3.6 trillion; the GSEs now totals about $2.4 trillion and when you are that big you have potential significant impacts on financial markets. "Our goal at the Treasury Department is to promote the health and strength of the housing finance markets together with the health and strength of the U.S. financial system. In the United States' economy today, the two are closely related. "We also want to ensure that GSEs are living up to the highest standards of corporate responsibility. "We don't believe in a 'too big to fail' doctrine, but the reality is that the market treats the paper as if the government is backing it. We strongly resist that notion. "You know that there is that perception. And it's not a healthy perception and we need to disabuse people of that perception. Investments in Fannie and Freddie are uninsured investments. "That is why clear receivership authority is necessary Because there is investment risk, full and flexible authority for the orderly wind down of affairs of a GSE that gets into serious financial trouble is vitally important for market stability. "Blind faith in non-existent guarantees cannot be an acceptable substitute." Amen.

Cracks: Charts of the Day

My ailing but recovering macro analyst buddy Greg Weldon checks in today, saying there are, "significant CRACKS in the 'reflation-theme' as applies to the stock market, beginning with the Dow Industrials, and the Dow Transports, both of which have broken to the downside with increasing velocity and momentum." Greg offers the two charts below: First the Industrials Crack... ...And then the Transports

The Road to Serfdom, Happy 60th Birthday

Yesterday I recommended Friedrich Hayek's "The Fatal Conceit." You might be more familiar with his more famous work, "The Road to Serfdom." In that book, Hayek takes on socialism and shows how a belief in economic planning leads, both in theory and in fact, to fascism. I didn't realize that yesterday was the 60th anniversary of the publication of "The Road to Serfdom." It's a happy coincidence. Hayek was an economist from the "Austrian" school, and spent a good chunk of his post-war career in at the London School of Economics, which happens to be the building directly to the left of my new apartment building. Another happy coincidence. You'll hear the term "Austrian" quite a bit if you read the Daily Reckoning, Dr. Kurt Richebacher, and SI. But what does it mean? In short, Austrian economists see that most macroeconomic problems start with the government manipulating the money supply, hence the emphasis on monetary policy. I'll leave it at that for today. But there was a nice article on Hayek in Canada's National Post yesterday. You can find the whole thing here. Here's an excerpt. Emphasis added is mine: In the postwar era, the communist regimes continued to confirm Hayek's warnings about central planning leading to the destruction of both political freedom and economic wealth, but academics remained largely blind to such facts. Meanwhile, the emphasis in the West turned to another profoundly flawed economic orthodoxy, that of "macroeconomic management" via "countercyclical" manipulation of government spending, taxation and the money supply. Its patron saint was the effete Cambridge economist John Maynard Keynes. Hayek was an adherent of the "Austrian School," which had revolutionized economics in the late 19th century by overturning flawed classical theories of value. As a student of business cycles, Hayek -- like the rest of the Austrian School -- believed that the main reason for economic fluctuations was government monetary manipulation, so he could hardly be enthusiastic about Keynes's pretensions (although he and Keynes were friends and Keynes wrote a glowing recommendation for The Road to Serfdom). Yet again, however, Hayek's role was that of Cassandra; Keynes, by contrast, was telling politicians what they wanted to hear. Hayek continued his academic career in the United States and Europe after the war, but it wasn't until 1974 that his star at last began to rise. That year, as Keynesianism's inherent flaws came home to roost amid mounting "stagflation" -- a combination of high inflation and zero economic growth -- Hayek received the Nobel Prize for economics. The fight with socialism, however, was far from over. Comment: Hayek's ideas are going to become important again soon, to a larger audience. Whether it's "indelfation," "stagflation", or some other monetary evil, there's no doubt in my mind we've entered another period of economic paradoxes that only clear thinking and monetary modesty can cure. It starts with ditching the conceit that any central planner knows what's best for an entire economy. That sounds simple enough. But from George Bush to John Kerry, and from George Soros to Alan Greenspan, even policymakers who disagree on what to do all agree that it's the government or the Fed that should be doing it. We can thank Keynes for that conceptual malady. And we can only hope that this latest bout of fever will lead to something healthier on the other side.

March 10, 2004

Quote of the Day II: Government "Investment"

I am going to ask America’s wealthiest people – those making over $200,000 a year – to pay the same fair share they paid under Bill Clinton. Back then the rich got richer – but everyone else did too. By rolling back the Bush tax cuts for the wealthiest among us, we can start to restore fiscal responsibility and invest in education and health care for our people. We also need to shut the loopholes that force American workers to subsidize sending jobs overseas!” John Kerry today, showing his fiscal colors. Politicians love to call spending programs "investment." That makes it sound better. As if you were getting a return on your confiscated money. And just to show you I'm an equal opportunity critic, check out Ed Meese's OpEd piece in today's Wall Street Journal. Say what you want about amending the Constitution. But what are we to think when a so-called conservative like Meese to say "society as a whole" needs to do something about the problem? This is the same kind of thinking that justifies nearly any government intrusion into individual liberty. Meese writes, "In order to guard the states' liberty to determine marriage policy in accord with the principles of federalism, society as a whole must prevent the institution itself from being redefined out of existence or abolished altogether." Be very afraid when someone starts defending action in the name of "society."

Where is the PPI data?

"I don't know." That's what I ask readers who want to know where January and February producer price data is. It's been delayed. The full text of the Labor Department's explanation is below. Why does it matter? If the PPI shows rising prices, it could mean that those prices are soon going to show up in consumer prices as well....the dreaded inflation. Up to now, the PPI has been able to pass off the gains in producer prices as driven by rising energy prices. Rising energy prices hurt consumers too, not just producers, and could be the leading edge of an inflationary wave. Were that the case, the Fed would have to do what it has said it probably won't do, and what it desperately does not WANT to do, raise interest rates. Raise rates and you kill the nascent housing boom part three. Raise rates and you kill the recovery on life support. Raise rates and all sorts of bad things start to happen. Yet without obvious proof that producer prices aren't rising, there won't be as much pressure to raise rates. So are producer prices rising? Good question.... Here's the announcement: Delay of Release of PPI for January 2004 and February 2004 -------------------------------------------------------------------------------- As announced on February 17, the release of the Producer Price Index (PPI) for January 2004 has been delayed from the originally scheduled date of February 19, 2004. The length of that delay now means that the release of February data originally scheduled for Friday, March 12, must also be postponed. The delays have been caused by unexpected difficulties in the conversion of PPI data from the Standard Industrial Classification system to the North American Industry Classification System. These difficulties have taken far longer to resolve than we originally expected. We will continue to work diligently to resolve the remaining issues holding up the calculation of the PPI. When revised release dates for the January and for the February 2004 Producer Price Indexes have been determined, we plan to announce them at least one day ahead of time on this web page and through news advisories. The Bureau of Labor Statistics expresses its sincere apologies to those who have experienced any problems as a result of this delay

Quote of the Day: An All-Consuming Mortgage Payment

From "Household Debt and the Macroeconomy," a supplement to the Quarterly Review of the Bank of International Settlements. I'll have more from this publication later. "Households may be surprised in later years by the proportion of income still required to service their debt, and hence have lower than desired consumption. The higher aggregate debt/income ratio means that households will be more exposed to shocks, and will also remain exposed for a longer period than in the past." Update: This gloomy quote comes on the heels of mortgage rates making new lows and applications for new mortgages growing. The mortgage Bankers Association reported that its purchase index rose 1.4% to 428.6 for the week ended March 5. I prefer the purchase index to the overall number because the purchase index measures requests for new loans instead of refinancing for old loans. New loans, in my view, are the key to rising home prices. They represent new and growing demand. Without them, the steam behind the housing engine cools. Of course the whole thing starts with new or first-time buyers being lured in through low interest rates. At low interestst rates, buying a home appears to be more affordable even for borrowers with less money to spend on a mortgage payment. At a low interest rate, the mortgage payment is a smaller part of disposable income. But the aforementioned BIS study shows that the marginal buyers who come in at low rates are in for a rude surprise if and when rates rise. And that while the value of the asset may fluctuate (i.e. go down from its current highs) the value of the debt does not (unless you pay it off with inflated dollars.) That same BIS report goes on to say that,"Regardless of whether the increase in household debt is sustainable, the greater indebtedness has important macroeconomic implications. The household sector will be more sensitive to movements in interest rates, particularly if they are unexpected, and to changes in income, most notably arising from unemployment." One side effect of low interest rates is that they've encouraged riskier borrowers to buy homes. This has had the effect of driving up the debt/service net income ratio to its highest level in decades. People are buying a lot of house at low interest rates. But the mortgage payment is a huge portion of their net income. The opportunities for personal financial disaster begin to mulitiply. Unemployment (a pretty radical disruption to income) becomes a huge threat, not to mention rising rates, or even the natural tendency of housing price bubbles to slowly deflate, leaving the borrower with a large note and a decreasing market value. Of course, in the meantime, the low rates may very well cause another wave of homebuying/refinancing. If people think rates are going to rise (and everyone seems to think they will, but not until next year), there may be a rush of new homebuying (sort of like gun buyers rushing to buy assault weapons for the ban went into place.) And if you look, it's clear homebuilding stocks (Lennar, Ryland, KB Homes, and even the homebuilding index HGX) are all delighted at the prospect of low rates for the rest of the year. If you've got bearish positions in any of those per the recommendations I made in the "Housing Report," you'll likely be stopped out. Tomorrow or Friday, I'll revisit the housing strategy given the prospect of lower rates for the rest of 2004. The good news is the stock market looks ahead, and some homebuilders are pricing a year's worth of low rates in right now. That means we ought to be able to find some cheap, long-term, near-the-money put options for the day when the music stops.

Record Trade Deficit, "Blah blah blah," says the market.

Check out the image below, courtesy of the Dept. of Commerce. It shows a country that continues to consume more than it produces, yet whose currency rises on the news. Go figure. Why did the dollar go up when the fundamental numbers show the balance sheet of America getting worse? Who knows. The easy explanation--the one you'll read in the press--is that the U.S. is a bigger "growth" story than Europe. If you're talking about growing deficits, that's surely true. Let's look at just a few of the numbers from the report: *A January deficit of $43.1 billion--a new record *Imports at $132.1 billion, the second highest level ever *Exports of $89 billion, down 1.2% from December *Year over year, exports down 8.5% *Year over year, imports up 8.2% *Exports to Europe down $0.3 billion *Goods deficit with China, up $1.6 billion to $11.5 billion You may be wondering how the dollar can rise in the face of such stiff trade headwinds. After all, in order for the dollar to retain its value when the U.S. runs a deficit, investment flows back into the United States must match the size of the deficit. If not, the adjustment comes in the form of a weaker currency. For some reason, the Bureau of Economic Analysis has not published fourth quarter figures on the balance of payments, which shows exactly what foreign investment flows into the U.S. are. We can presume, because the dollar fell, that foreign purchases of U.S. assets were not enough to match the monthly trade deficits in goods and services. Going forward, though, what to expect? All things being equal, the dollar will find its "fair value," maybe not in a day, a week, or a month. But sooner rather than letter. What's striking about this batch of data is that a weaker dollar is not helping U.S. exports on a net basis, especially in that place where it should be helping U.S. exporters most, Europe. I look around me, however, and I don't see Brits lining up to buy U.S.-made products that are cheaper now then they were a year ago. Software wasn't flying off the shelves. Nor were Brittany Spears CDs. This leads me to believe that if a weaker dollar is really going to reduce the deficit, it will have to be because the price of imports in the U.S. is higher and Americans buy less (it's possible in theory, you know.) The rising price of imports in the U.S. will lower consumption. And of course, if that happens, it means consumer retrenchment...and a slower economic growth--which certainly isn't good for the dollar either. The hard truth is there's no way out of a weaker dollar adjustment. Try as you might, the math simply doesn't add up. It can be resisted, ignored, and mocked. But it can't be denied. And it will start showing up in the figures of foreign purchases of U.S. assets...if the government ever gets around to publishing them again (sort of like the PPI numbers.)

Strategic University: Updated Reading Recommendations

Lots of new readers lately. And whenever that happens, I usually get asked about what I'm reading, or more generally, what to read if you're looking to expand your knowledge about stocks, trading, markets, and economics. To the right on the home page of the Insider I've posted four new links of books I like. I won't do a full review here. But I'll give you a brief description. 1) Reminiscences of a Stock Operator, Jesse Livermore. First recommended to me by Steve Sjuggerud seven years ago. If you want to find out how stocks are manipulated, legally (since it's done by Wall Street, and not someone off the Street), this is the best place to start. As true today as it was when Livermore was making millions during the Crash. 2) Economics in One Lesson, Henry Hazlitt. Years ago in graduate school a student stymied an economics class I was in by suggesting that if you really wanted economic growth, you ought to go around breaking windows. After all, it meant more business for the window repairman. And with extra money in his pocket, the ripple effect would begin, i.e. the window repairman would have lots of money to pour into the economy. All wrong, of course. But hard to put your finger on exactly why. Hazlitt helps you follow your instincts with clear arguments. In the case of the broken window (originally penned by Frederic Bastiat), what's important is what never happens because the window is broken. What never happens is that the baker whose window was broken never gets to spend that money on something else, something that produces wealth without an act of destruction preceding it. Hazlitt tackles inflation, unemployment, price controls and international trade, demolishing the kind of knee-jerk bar-stool economics you read in so many newspapers or hear on television. If you're looking for one single book to understand economics, this is it. 3) Against the Gods, The Remarkable Story of Risk, Peter L. Bernstein. I'll be writing about modern attempts to manage risk through derivatives later this week. But if you want the history of it, Bernstein's book is as good as it gets. 4) The Fatal Conceit, Friedrich Hayek. John Maynard Keynes is the most famous economist of the 20th century. But it should Friedrich Hayek. And perhaps Hayek will get the credit he deserves as the social welfare states of the West run into all the economic, social, and moral problems he correctly foresees coming. He's a bit brainy. But Hayek's thought is a great antidote to the government-must-find-a-solution clap trap that is the squishy bedrock of so many current debates about economic policy. 5) Restoring the Lost Constitution, Randy E. Barnett. I haven't actually read this book yet, but it's been on my list since it came out. If you have and want to review it, send me a note. I tend to be skeptical when people are nostalgic for America 100 years ago, or an America they think existed and never did. However, I'm also of the opinion that there's a growing gulf in America over expectations for government action/protection. On one side you have conservative/libertarian/rural folks, basically laissez faire. On the other hand, you have urban progressives (or trans-national progressives as they call themselves.) Of course definitions don't mean much. Bush calls himself a conservative, but he's a big spender and wants to amend the Constitution over gay marriage, neither of which are "Federalist" or "states rights" positions. Still, civil society in America seems increasingly stretched, with positions at the extreme entrenched and folks in the middle being asked to choose. Economic distress only amplifies this political problem because it leads to calls for government action, or conversely, calls for the government to scale back its massive social promises, defense spending, and regulation and give back citizens their tax dollars. I'm not sure, but I think Barnett's book might shed some light on what kind of America we'll be living in for the next fifty years. I'm not reading any fiction right now. However, now that I'm settled in to my new London digs (for awhile anyway), I'll let you know if I come across anything good.

March 09, 2004

Financials Lead, Up...Will they lead down to? Chart of the Day

You hear the term "financial economy" a lot these days. But what does it mean? Well, in a word it means an economy where business activity is focused on buying and selling investments rather than building and selling products. Naturally, this kind of economy is great for investment retailers, namely securities brokers and dealers. As you can see from the chart, since March of last year the broker dealer index (XBD) has raced ahead of the S&P. The sloshing of money in and out of equities, bonds, and money market funds racks up big profits for the broker dealers, even if it doesn't for investors. Keep an eye on XBD as a put option candidate. I know I will.

Conspicuous Consumption

A little humor in your day, courtesy of Newsday and the AP. Police: Woman Tried to Pass Fake $1M Bill: "Associated Press March 9, 2004, 10:40 AM EST COVINGTON, Ga. -- A woman was caught trying to use a fake $1 million bill to buy $1,675 worth of merchandise at a Wal-Mart, and was later found with two more of the bills in her purse, police said. The United States Treasury does not make $1 million bills, but people can buy souvenirs of such a bill at some stores, police said. 'It looks real, but of course there's nothing real about this,' Covington Police Chief Stacey Cotton said Tuesday. 'People do crazy things all the time. I think it's just another example of some odd things that occur.' A clerk at the store immediately noticed the bill was fake when 35-year-old Alice Regina Pike handed it to her on Friday, Cotton said. Pike then tried to use two gift cards with only $2.32 of value on them to buy the merchandise, but when that didn't work she again asked if the clerk could cash the $1 million bill, Cotton said. The store then called police. "

Side Effects: Quote of the Day

Here's a speech Jack Guynn, the President of the Atlanta Fed gave last week on real estate and interest rates. It's the first time I've heard a member of the Fed worry publicly about excess capacity in the housing market, and then go on to identify it as an unintended side affect of the low interest rate environment. "But just as a doctor shouldn't overmedicate the patient, one always should be sensitive to the potential for unintended side effects of maintaining an accommodative policy for too long. Put differently, if my forecast for robust economic growth materializes, then, at some point, a fed funds rate of 1 percent will no longer be the best policy." My question is this: will a Fed funds rate of 1 percent be the best policy if the unintended side effects (excess housing capacity) keep building up and the Fed's forecast for "robust economic growth" does NOT materialize? What will the Fed do then? Raise rates anyway to pop the mortgage bubble? Doubtful. But two weeks ago we have Greenspan fretting in front of Congress about the systemic risk of the GSEs. And why not? With assets of over $1.6 trillion (mostly mortgages), Fannie and Freddie are larger than Citibank. According to the FM Policy Focus, if Fannie and Freddie defaulted on theiroustandingg debt, a taxpayer financed bailout would cost $16,434 per American. Of course it's not just Fannie and Freddie at risk. It's anyone who owns a bond sold by Fannie and Freddie. A lot of people own GSE bonds. The FDIC recently reported thatf ederally insured institutions own 17% of Fannie and Freddie's $1.8 trillion in direct debt obligations. But that's not all. Over 40% of the $1.9 trillion mortgage pool argument (bonds guaranteed by the GSEs) are owned by Federally insured institutions. One way or another, taxpayers are on the hook for at least some of the fallout from a GSE default. And then there's housing and real estate pricesthemselvess, which havebenefitedd so much from the GSE-financed boom. Today, I'll let Fed President Guynn have the last words. "At the risk of bringing this caution closer home to you and your businesses, let's think about commercial real estate. Coming off the building boom of the late 1990s, the economic downturn in 2001 was an unpleasant surprise. Office vacancy rates in the Atlanta area swelled to well over 20 percent as businesses began to slash payrolls and emptied large amounts of office and industrial space. "As it happened, low interest rates eased carrying costs and encouraged ongoing investment despite the high vacancies. I expect the Fed's accommodative policy is popular with many in this room, but some in your industry have stressed to me that at some point it will be appropriate, and helpful, to allow interest rates to return to more normal levels so that the market sorts itself out in an orderly way and returns to balance. As I said earlier, I want to avoid a situation where businesses begin to assume that policy, which was put in place to deal with a temporary economic circumstance, mistakenly becomes incorporated into business planning as the normal policy environment. "Another example strikes even closer to home for me. My son, Mike, after some terrific years with Charlie Brown and Rick O'Brien in commercial real estate development, moved into residential development in 1997. If I think about the six years Mike has now been in residential development, I realize he has not seen a downturn in the business and in fact has been riding the wave of low mortgage rates and historical rates of home building. As you might guess, Mike and I have had some interesting father-son talks about the seductive lures of such an extraordinary period. I think, at least I hope, Mike understands that, as rates move back to more typical levels at some point, some part of his business may be vulnerable -- that part induced by temporarily low rates alone. I hope he and others in the business have not assumed in their long-term business plans that this extraordinary period will continue indefinitely. And let's hope they are not creating new pockets of excess capacity that will have to be worked off as conditions return to normal." Okay, I was wrong. I'll take the last word after all. My forecast is that there is more to worry about than the pockets of excess housing capacity, although that could certainly be a catalyst for the inevitable correction. The biggest pocket of excess capacity itself is the mortgage lending market and the bonds of the GSES, now owned by so many Americans, albeit unwittingly. Working off that excess will be anything but normal.

March 08, 2004

Quote of the Day and the Cost of the Dollar ("Pathetically Low Interest")

``It's a painful condition to be in -- but not as painful as doing something stupid,'' Warren Buffett, on having cash and wanting to do something with it, but not wanting to buy something that's over priced. Buffett is hedging his dollar risk, and fully expects more dollar selling. The proximate cause--the current account deficit, simply too much debt. The currency will have to adjust to the debt level. And it does that by falling, reflecting the impaired balance sheet of America overextended. What was interesting about today's news cycle is that it's not just the debt affecting the currency anymore, it's the currency affecting the debt, at least in terms of the quantity of dollar denominated debt issued. The Bank of International Settlements (crack dealer for data junkies) issued its quarterly review today. In the section on the international debt securities market, you can see the risk of owning a falling currency is lowering the total amount of dollar denominated debt issued. The market has a slackening appetite for debt issued by the world's largest debtor. And as you might expect, a lot of debt is being issued in one of the world's strongest currencies, the euro. BIS says (emphasis added mine), A striking trend apparent in both the fourth quarter and the year overall was the growth in euro-denominated borrowings, which accounted for more than half of all net international debt securities issuance in 2003. Fund-raising in the fourth quarter was well above the third quarter figure and more than twice as high as that for the fourth quarter of 2002; for the year as a whole, the net placement of euro-denominated debt securities, at $834 billion, was almost 60% higher than in 2002. By comparison, US dollar-denominated net issuance of $150 billion in the fourth quarter of 2003 was double that of the fourth quarter of 2002, while for the year as a whole it was only 10% higher, at $463 billion And take a look at the graph below. This is more evidence of the end of the dollar standard (although not necessarily of permanent euro strength.) In the fall of last year, euro and dollar denominated debt issuance was about even. Then, as the dollar fell, the euro debt market took off, so much so that total euro-denominated debt outstanding actually overtook dollar denominated debt outstanding by the end of the year. debteurodollar.bmp What does all this mean? We'll leave aside for the day a discussion of the growth in the "financial economy" and investor risk (although the BIS also released its derivatives numbers, which I'll look at tomorrow.) For now, the immediate issue is what the falling dollar may do to U.S. companies who a) must invest huge amounts of cashflow or b) depend on debt markets to finance other activities. In the first category you have your Berkshire Hathaways. Buffet's dollar risk forces him to go into the junk bond market for higher yields. By this point, it's hard to see what the difference between low-yield U.S. "junk" is and higher yielding Mexican, Brazilian, or Russian "junk." That aside, it's good for investors in emerging markets, especially emerging market bonds. In the land where cash is trash, yield is King. By the way, this has been good news for our long-term play on euro-bonds, GIM. At a current yield of 5.38%, it's better than owning a money market fund. And with rising emerging market bond prices and euro bond prices, you have the potential to reap a capital gain as well, although that's not the specific reason I recommend owning it. In the second category you begin to see trouble for Fannie and Freddie. Yes, I've been accused of seeing trouble for Fannie and Freddie everywhere I look. And that's because I do. Rising U.S. interest rates put the brakes on the U.S. mortgage and housing market. Bad for Fannie and Freddie. But now the vicious cycle has come full. Rates have fallen. The low yield and high U.S. debt are killing the dollar. And now, the ever-weaker dollar is putting a big fat crimp in dollar denominated debt issuance, which, incidentally, FNM and FRE do a LOT of. Both Fannie and Freddie came off the mat last week on the market's perception that the Fed would probably leave rates low for the rest of this year, based on the dismal February jobs data. But don't be so sure this knee jerk assessment gets it right. If Fannie and Freddie issue bonds paid off by debt-addled American homeowners, does that deserve any other classification other than junk too? And junk yielding less than you can get in a lot of other places in the world. Places with stronger currencies. Tomorrow....a look at derivatives.

Brilliant! The Sun Goes Down in the West

Only a few hitches getting settled in and started from the London offices this morning, which is pretty amazing if you think about it. First, a tip, if you ever need to take the Eurostar from Paris and London but aren't particular about when you arrive during the day, book at the last minute. The last two times I've done that I've been sold a first class ticket at a coach price. Turns out all the coach seats were sold out. Not a bad deal. Second, I'm not sure what it says about your life that you can pack up, get on a train, move in, and unpack, all in about 36 hours. It means you probably don't have a lot of "things," which is true for me right now (although I did give a lot of books away before I left Paris.) Kind of a nice feeling though, not beholden to your "things" simply because you don't have many of them. I did bring the "good things," though, one of which includes my digital camera (which I plan on getting better at using. Below is today's sunset, looking, as you might guess, west and slightly south (out of view to your left is the Thames)

Heart Attack: Part III

The chart below shoes the S&P Bullish Percentage Index making an interesting technical move. The index is crossing below its 50-day moving average. That average, however, is still moving directionally upwards...and the index is trading well above its 200-day moving average. Still, this suggests to me that the Index is having trouble staying overbought. After all, the only way for it to stay overbought is if investors keep buying S&P 100 stocks. And with last week's labor market news but one example of the less than glamorous economic back story, it's easy to see how the OEX could go from overbought to oversold rather quickly. Tick tick tick. chespains.bmp