Op-Eds
August 24, 2010
Matrix Analytix Equity To Real Estate Capital Reallocation Theory: Capital Flight Out Of Equities To Produce Housing Bottom In 2011...
* Significant reassessment of traditional investment vehicles ongoing due to unprecedented concerns over deflation here in the US, with extreme focus on structural integrity of equity market yielding major concerns over asset classes' ability to act as a long-term investment vehicle
* Concerns over deflation and structural integrity of equities causing major capital outflows in asset class with nearly $50B in domestic equity outflows year to date, and most recently the exit of major hedge fund players whove performed extremely well for decades (ie Stanley Druckenmiller's Duquesne Fund Management)
* Equity outflows causing major decline in overall market liquidity making it more difficult for hedge funds to initiate and unwind large positions...equity outflows also causing a decline in pool of risk-taking capital which will result in additional hedge funds closing up shop over the next 6-12 months
* Equity outflows have created decrease in market liquidity which is now leaving the door open for much more significant manipulation by larger players....larger players now using manipulation in equities to yield significant profits in short-dated options (note weekly option instruments now expanded to several equities with very high volume in weekly index options)...low volume 2% manipulated move in S&P producing 100-200% gains overnight...note major banks under tremendous pressure to produce earnings as yield curve flattens, trading volumes decline, and FinReg disrupts traditional bank activity (in other words, sharks are very hungry and looking for any possible instrument to produce returns...they are well aware that we are in an environment where only strong will survive).
* Increase in manipulation in equities yielding dramatic disruption in traditional correlations against bond yields and currencies which is posing major problems for black boxes....black boxes which have performed well in past environments of high volatility now being reconstructed to adapt to new environment in equities which continues to tend toward chaos...again, hedge funds finding it increasingly difficult to put on meaningful medium-term trades with many likely unable to survive this long period of chaos
* As choatic period in stocks continues, capital continues to flee equity market ultimately reallocating into Treasuries where yields continue to sit at multi-year lows (nearly $200B in net inflows into bond funds year to date vs $50B in net outflows in domestic equity funds)....relentless bid in Treasuries continues to signal major concerns over deflation and skepticism over current equity pricing
* With significant amount of investment capital now sitting in Treasuries with record-low yields and/or money markets with near-zero yield, at some point this capital will become dissatisfied with lack of meaningful returns and look to reassess the two markets which can produce higher yields, namely the equity and real estate markets
* As market participants look to reassess these traditional markets on a risk/reward basis we expect market participants will begin to note several attractive data points within the scope of the housing market which will produce a strong bias toward capital deployment into the housing market vs. equities:
1) With possibility of deflation likely modeled into most risk analysis models expect market participants likely take note of the fact that while equities have yet to deflate, the housing market has not only deflated but currently sits at extremely depressed price levels on a historical basis thereby yielding a much more favorable risk/reward profile vs that of equities.
2) As Average Americans reassess how to redeploy investment capital, expect skepticism over the structural foundation of the equity market to continue lingering within the psyche of Average investors which will ultimately lead to a focus on the intangible nature of the assets yielded in a stock investment (outside of a stock certificate) vs. the tangible nature of assets yielded in a real estate investment (an actual home, apartment, piece of property, etc.)...this tangible nature of an investment in real estate will further lead to the assessment that unlike stocks, real estate (especially homes) can not go to zero value and hence their downside risk is limited.
3) Mortgage Rates currently sit at historic lows acting as an extremely strong incentive for real estate investment (should you have the ability to get a loan, which we'll address shortly)
4) Since Americans are significantly reducing their exposure to equities, the governments "interest" in seeing higher equity prices to perpetuate a wealth affect will decline (as equity appreciation now begins to affect less and less Americans), leaving the housing market as the most significant market which can have an affect Americans' wealth...we expect to see significant government tailwinds for the real estate market (specifically aimed at price appreciation) over the next several years.
5) The expiration of the Bush Tax Cuts at the end of 2010 which will raise capital gains taxes across the board will act as a significant disincentive to owning equities beginning in 2011 as the appeal of buying and selling equities especially for short-term gains declines (transactions now yield less and less profit due to increase in taxes)....we expect that the imposition of these new tax hikes will therefore increase the appeal of long-term investments such as real estate, especially as the downside risk of owning real estate is now diminished.
* We acknowledge that we are making the significant assumption that should market participants come to the conclusion that an investment in real estate far outweighs an investment in equities, that they will indeed be able to qualify for a loan which would enable them to adopt this investment. And of course there is major risk to this thesis in the form of unemployment, as higher unemployment levels make buyers less and less qualified for large principal, high down payment loans and hence unable to carry out this transaction. However we believe that the marked increase in personal savings over the past 3 years, where savings rates as a percentage of disposable income have increased from just over 1% in 2007 to over 6% in Q2 of 2010 (according to the Bureau of Economic Analysis), will lead to higher consumption rates in 2011 (as Americans have traditionally been unable to save for prolonged periods of time) which will lead to higher demand for goods and services, thereby producing higher demand for labor and a bottom in the job market with a downtick in unemployment in 2011...this decrease in unemployment and most notably the increase in job security will lead to an easing of lending standards especially at the low end of the mortgage market (sub-$500K loans), and therefore an increase in the ability to finance real estate transactions. Note we also expect continued government incentives for real estate purchases over the next several years, as home prices remain a significant factor of wealth, consumption, and therefore economic activity which the government has a keen interest in seeing uptick due to much desired increase in tax revenue.
* Now of course, should demand for goods and services increase and unemployment begin to decline in 2011, equities are likely to appreciate as well, however we believe that current widespread skepticism over the structural foundation of equities will remain pronounced for several years leading to continued declines in investment into the equity market and more notable increases in the traditional market of real estate especially as market participants look to take advantage of record low mortgage rates, depressed housing prices, and much more favorable risk/reward levels.
CONCLUSION: While housing prices are expected to continue declining near-term due to uptick in foreclosures, we expect the significant amount of investment capital which has been pulled from equities and currently sits in Treasuries and/or money markets will become redeployed into the housing market in 2011 which will therefore begin clearing supply of houses available and put a bottom under housing prices especially at the low-end of the market. We moreover expect the recent increase in savings rates will lead to increased consumption of goods and services in 2011 which will therefore lead to an increase in demand for labor, a decrease in the unemployment rate, and ultimately an easing of lending standards (due to increased job security and increased confidence from lenders that borrowers will be able to repay loans) which will act as a significant catalyst to real estate purchases in an environment already ripe with record low mortgage rates. As such we expect to begin accumulating long-term January 2012 call options across the board in homebuilders heading into year end 2010 as we expect to see a bottom in these stocks in the next 6 months with significant price appreciation in 2011. Highly expect Housing Stocks will be the Trade Of The Year for 2011.
August 5, 2010
Volumeless Rally In Equities, Commodity Rebound Mired In Sea Of Deflationary Signals...
S&P trading rangebound (1115-1125) on zero volume for a fourth session in a row now...midday sessions have come to a near standstill with very little buy or sell interest from the hours of 10:30-3:00....how this portends for tomorrows session, well there appears to be very little anxiety heading into tomorrows unemployment report (very weak sell side volume heading into numbers)....market expecting nonfarm payrolls of -87K with unemployment rate to uptick slightly to 9.6% from 9.5% in June...unless numbers come in significantly worse (more than 150K in job losses) expect "invisible hand" may take advantage of little sell side pressure to drive markets higher or at least keep market losses somewhat mitigated....remember the government right now has a very keen interest in seeing higher equity and commodity prices as market participants are currently highly focused on signals of deflation....declining asset prices (equities, commodities, and real estate) are very strong signals of deflationary pressures so really feels as if there is some ongoing intervention in the equity and commodity markets (real estate market has already deflated for the most part) to offset any deflationary pressures that might be present due to weak demand and ultimately quell any concerns over deflation so that prices dont begin to spiral downward out of control....a deflationary spiral stems squarely from a negative perception of prices as consumers begin to withdraw demand due to the perception of being able to buy assets at lower prices in the future....note however that while equity and commodity prices are being artificially skewed, the Treasury market (which is much more liquid and much more difficult to manipulate) continues to signal very weak growth, high unemployment, and very significant concerns over deflation....while equity markets have rallied 11.5% off their July 1st lows, the 10-Year Note continues to sit at a 1-year low today (in terms of yield) just over the 2.89% level....significant demand for low risk yield continues to be be present in financial markets, with very weak demand for high risk assets denoted by absolutely anemic volume in equities on this recent rally (a prime characteristic of deflation)....also note the dollar (which trades in the most liquid market on the planet and also nearly impossible to manipulate) continues to decline signaling a prolonged period of low interest rates (ie very little concern over inflation), very weak domestic growth, and more than likely a new round of quantitative easing measures...in other words, while the relatively low liquidity equity and commodity markets are attempting to signal a global recovery (and hence a more inflationary environment), the two most liquid and therefore most efficient financial markets (Treasury and FX) continue to invalidate the claims made by these markets ultimately portraying a much more accurate environment with significant deflationary headwinds...key question is how long does this manipulation in equities and commodities last before deflationary headwinds are simply too strong to ignore?
July 29, 2010
Equity Market Being Propped Up As Market Remains Last Line Of Defense Against Deflation...
Recent 1 to 1 Treasury to Equity correlation continues to break down as we noted monday...note Treasuries holding near high of the day as equities rally back into green...something is amiss in the financial markets right now with one of these markets being artificially skewed...again most likely culprit is equities as this market is much more easily manipulated due to lower liquidity profile relative to the treasury market....believe equities are being artificially propped up as a defense against widespread acceptance of deflationary pressures for if headlines start to cross that equities are cratering due to deflation, consumer spending will certainly come to a screeching halt (due to perception of lower asset prices in the future) which will certainly give deflation the green light to take hold of this economy...ultimately believe equity market pricing is the last line of defense against the reality of deflation which is why we are seeing such a strong defense against lower prices....in the end however, deflation is such a strong force that any attempt at short-term manipulation of asset prices will fail.
February 18, 2010
Previous Employment Levels Founded On High Credit Limits...
The uptick in unemployment is directly correlated to the extreme tightening in credit standards we've seen over the past year or so. The environment of lax credit "easy money" we experienced over the past several decades artificially inflated the perceived purchasing power of households by most likely several magnitudes. If someone had $2,000 in bank but had a $10,000 credit card, there was no reason this person couldn't ratchet up credit card debt to the hilt and pay it off slowly. This was no doubt due to confidence in "job security." If I feel confident that I will have a job one year from now, I then believe that I will be able to finance any debt I may incur for the foreseeable future and can continue spending well beyond my earned income.
However, the underlying "bid" in the job market over the past several decades was ironically and without doubt directly correlated to this lax credit environment. In this environment, if someone with $2,000 in the bank had purchasing power of $10,000 and was more than willing to spend up to that amount + a percentage of earned income, then the demand for goods and services throughout the economy was in fact significantly driven by that credit portion of someones purchasing power and hence employers were bidding for labor based on a demand for goods and services founded on credit lines. In other words, high credit lines were producing "job security" which was producing demand based on easy access to credit lines...which was producing "job security", etc
Now what we've experienced over the past year or so is a significant retraction of those credit lines down to levels equivalent to real earned income. In other words, someone with $2,000 in the bank now most likely only has access to $5,000 in credit and that credit is most likely already spent. In other words, $5,000 of purchasing power has been eliminated from the economy and hence the demand for goods and services must be adjusted downward by the same amount unless the decrease is offset by an increase in spending by cash (which we know is not the case). Therefore, employers must now adjust their expectations of production to this lower level of demand which requires the need for less labor. Therefore, the bid for labor declines significantly, unemployment rises, and the level of "job security" declines. In the short-term this produces an increase in cash saving levels, and a decrease in demand for goods and services. The labor market is adjusting to a new paradigm in credit standards which are certain to remain for several years until cash levels increase to a level which allows for the re-extension of credit and confidence by creditors that those debt levels will be repaid in a timely fashion. In other words, expect unemployment to remain relatively high for several years until cash savings level increase dramatically and credit lines begin to be re-extended. However, expect even when those credit lines are re-extended they will be to a much lower level than their previous highs as the market has seen the consequences of extremely easy access to credit, and hence the lows and new historical averages in unemployment will begin to rise in response to new lower levels of credit.
October 4, 2008
Mortgage-Backed Securities: Wall Street Attempts To Create An Entity With No Consequences...
Banks can't stop lending forever, thats how they make money....they take your money, pay you an interest rate on it, then lend it out at higher rates....they can not axe out the latter part of the equation indefinitely if they wish to remain in business over the long run....right now banks are just waiting out the storm just as we are to see which institutions are going to survive so they know which counterparties they can do business with confidently.....risk aversion is extremely high across the entire landscape of our financial ecosystem right now....no one wants to take on any risk whatsoever.....equities known as the best asset class to own over the long run are viewed as extremely risky, real estate is still working off excesses and prices have yet to find an official bottom, and treasury bonds the least risky asset of all are paying out yields at multi-decade lows.....however the aggregate effect of extreme risk aversion will prove to be a good thing over the long run, as over this period of time where the financial system is adjusting from one of very high risk tolerance to one of very low risk tolerance, those parties who have based their models on taking on high amounts of risk will inevitably cease to exist as risk-taking counterparties pull capital at very high velocities.....those models predicated on demand for risky assets will fall by the wayside while those models less reliant on the returns of high risk assets will be just fine......its funny how easily we forget that risky assets paying high yields do carry RISK....did wall street just completely forget about the idea of risk when investing in subprime mortgages....say it with me "SUB-PRIME".....NOT PRIME......NOT HIGH QUALITY....LOW QUALITY.....HIGH YIELD......HIGH RISK! these wall street bankers were not idiots....theyve been playing this game for decades knowing that anytime you have anything that pays a higher than average yield on an investment it means without doubt that you are taking on additional risk.....that is why you are being paid a higher than average return....to ASSUME THAT RISK! so first mistake made by wall street....taking on higher risk assets without some sort of hedge or idea that these risky assets might in fact prove to be risky assets and lead to higher than average losses.....where was this in the game plan? i cant find it anywhere....its like going into battle without any plan for possible missteps, miscalculations or even outright losing.....now mistake #2, and this is even bigger than mistake #1, LEVERAGING HIGH RISK ASSETS....how on earth can global institutions rationalize leveraging assets which payout high yields and are known to carry higher than average risk without any sort of assumption that this plan (now carrying even higher risk due to leverage!) may in fact not work as planned?? seriously i cant figure it out.....the only explanation i can think of is the idea of herd or mob mentality.....institutions looked around and saw every institution across the globe taking on these high yield high risk assets and said to themselves, look we know theres risk here, but first of all we cant just sit around while our competitors pull in higher than average returns....we'll look like losers....we need to compete.....second of all, if these assets dont work out, and all of our competitors are holding them as well, well lets face it the whole system cant come crumbling down.....can it? no....we hope not.....no way the Fed will save.....they have to they no choice.....this was the backstop!......this is the idea of mob mentality.....you no longer become a single individual but rather one small part of something much larger which allows individuals to take on actions without risk of individual failure knowing that in the end any sort of consequence will be divided out between a host of individuals possibly equating to consequences less than that of the consequence of a single individual action.....and moreover that if the entity accumulates enough individual participation to become larger in size and in power than that of the overseer of the system then there becomes the possibility that the entity can not be stopped and/or that there remains no FATHOMABLE OR REALISTIC consequence to any action carried out by the entity.....ie TOO BIG TO FAIL. we've heard this idea over and over over the past several months....too big to fail.....what does that mean? it means that when an entity becomes large enough (so large that it becomes necessary for the survival of an entity even greater than itself), then the overseer of the system shifts from dealing out consequences to any negative action carried out by the entity, to one of trying to preserve the entity for fear of causing the destruction of the entity even larger than itself .....the overseer is forced into a position where the dealing out of consequences creates even larger consequences not only for the overseer but for the larger entity that the overseer hopes to preserve....this is what wall street knew and hoped for by taking on these risky loans and leveraging them....that in the end it would become large enough that no possible consequence could present itself without creating even larger consequences for the entity even larger than itself ie the entire ecosystem....this is the driving force behind the creation of large powerful entities...that when they are created, if they are able to breach a certain threshold of power and size within an ecosystem and work their way into all aspects of the ecosystems daily functions, then they can not be dealt any sort of consequence without creating much larger consequences for the entire ecosystem and are hence free to carry out riskier than normal actions because of the lack of any realistic consequences....it becomes an entity, while possibly negative for the ecosystem, is also necessary for the survival of the ecosystem...and therefore all entities are forced into a position of submission and are forced into believing that they need the entity for absolute survival.
September 15, 2008
Equity Market Being Used As Source Of Funds By Financial Institutions...
The stock market is being used as a source of funds right now which is not good....the largest players in the equity market have major major capital issues right now....AIG needs $80 Billion just to survive, that is a HUGE number (Goldmans entire market cap is $53B...they basically need a Goldman and a half) and they are just one major player....sure, institutions and market participants across the financial spectrum have used the equity market as a source of funds for a long time but never have the largest institutions in the financial ecosystem been under this much pressure to raise capital...and never have they experienced the need to raise capital for the ultimate sake of survival...that need to raise capital to meet margin calls in order to survive was usually (for the most part) limited to us the small guy...the market could easily weather that kind of selling pressure as long as the big guys were in there buying our stock on the cheap as we forcibly liquidated our holdings...now the shoe's on the other foot with large institutions joining us aggressively on the ask, which puts us in uncharted waters....liquidation of this magnitude leads to extremely rapid declines in asset prices especially those assets widely held by many large institutions....this rapid deterioration in stock prices ultimately leads to the point where stocks are no longer viewed as representing ownership in fundamentally sound companies but rather as a mere source of funds...a way to raise cash....you sell stock you get cash, thats what institutions need cash.....this is when panic begins to set in, it gets scary and stock markets crash, its when people become fearful of owning stocks as an asset class because of rapidly declining asset prices. after todays action you can tell real fear is developing in the market and people are really JUST starting to get a bit nervous about owning stocks....you're starting to see stocks that were worth $60-70/share go to zero....and these arent just any stocks, they were the biggest balls in the market....people are starting to think about what they own and what its really worth if panic sets in....i mean is it that far fetched to see AAPL selling in the 90s....the big boys could sell that stock off another 40 points down to $100 and funds would still be getting out with a profit...thats how you have to think right now....think about how much fund ownership your stocks have and know that those funds are having major problems and need cash.
July 14, 2008
Gold To Replicate Oil's Parabolic Move, 30-Year Treasury Yields To Soar...
With multiple bank failures looming and the US government doing nothing but take on bad debt and assets onto their balance sheet we are looking for new lows in the US dollar as the fundamental backdrop of the US financial system continues to worsen by the day. Inflationary pressures continue to mount with Oil and food hovering near their all-time highs, and the US continues to be hardest hit with respect to inflation due to the high cost of imports based on the declining purchasing power of the dollar. Note that while Europe for example has to pay the same $145 for a barrel of Oil that we do, their currency has also appreciated almost 20% since last year thereby mitigating some of their inflationary pressure. Furthermore, with the US posting its sixth straight month of job losses in June, and the employment picture getting seemingly worse by the day, you can expect the unemployment rate to start ticking up toward 6% by year end. Take into consideration that these looming bank failures will definitely lead to large job losses in financial services in addition to layoffs recently announced within the energy-sensitive transportation sector i.e. airlines and car companies like GM.
In essence, what is happening is that the US government is taking on very large amounts of debt at the same time that their revenue base (i.e. tax collection) is declining due to higher unemployment and high inflation which curbs consumer spending on discretionary items and hence produces slower growth for US corporations and therefore less corporate tax generation. Think of the US as a large company with debt levels climbing significantly and revenue and profit declining. What usually happens in a situation like this? Well lenders usually begin to become much less willing to lend capital at prevailing rates, and at the same time the debt-laden institution is more likely to want to raise additional capital to maintain sufficient debt to equity ratios (and/or bailout failing financial institutions). The rising debt levels coupled with declining income lead to the perception of a higher probability of default (even if slightly) and the higher probability gets priced into borrowing costs in the form of higher rates needing to be paid to lenders. What will happen is that demand for newly issued treasuries will begin to wane and large current holders of bonds (ie China and Japan) will likely be more inclined to reduce their holdings of US debt as risk levels associated with these bonds rise in conjunction with the fact that the value of these bonds continue to decline due to the devaluation of the dollar. You can see how a situation like this turns into a rather vicious circle, with weak fundamentals affecting dollar values and dollar values causing a negative change in behavior which in turn puts pressure on fundamentals. High inflation coupled with slow growth, rising unemployment, a weak currency, and rising debt levels is likely the worst situation an economy can be in which is why monetary policy is seen as so critical in maintaing all-important price stability. When inflation begins to soar, and central banks begin to lose credibility in containing inflation expectations it is very difficult to work an economy back to stable ground without severe consequences. Hence, we are expecting the yield on the 30-Year Treasury Bond to go much higher than the 4.44% it currently sits at as the risk associated with holding US debt increases and the expectation of prolonged high inflation begins to take form. Note that while the Fed has full control over rates at the short end of the yield curve (ie Fed Funds Rate), the Fed has zero control over yields at the long end which are completely set by open market forces.
Now looking at the trades, Gold has several things going for it on a fundamental as well as technical basis. First off, we are in a financial storm predicated on worries over the soundness of financial institutions and the inherent value of the US dollar. This is the perfect backdrop for gold, as global investors tend to run to the yellow metal as the ultimate safe haven in times of uncertainty within the financial system. Secondly, inflation expectations remain high and the dollar continues to weaken. Thirdly, central bank diversification out of US bonds is likely to benefit gold as central banks tend to increase their gold holdings in times of uncertainty and environments where risk aversion is prevalent. Fourthly, the recent double bottom at 85 on the GLD chart looks eerily similar to the double bottom at 80 we spotted on the USO chart back in March which ultimately presaged Oils parabolic move from the 80s to 140s. Take a close look at the USO chart below, paying particular attention to the mid March 2008 to early April 2008 double bottom at 80. Now stretch it out over a couple months rather than one month, and notice how closely it resembles the mid April to mid June double bottom at 85 on the GLD chart. They are almost perfect replicas and we believe we are at the same exact stage of the Gold breakout with respect to Oil....just beginning a major move to the upside. Moreover, with Oil nearly doubling over the past year and significant percentage gains made, it is likely that hedge funds and large institutions are now in search of the next asset class which may have greater potential for larger percentage gains down the road. This will likely lead them to Gold, as the asset class is similar and it keeps them highly hedged against inflation. Hence, with fundamentals as well as technicals in place we believe that Gold has potential to become the new Oil going into year end, and are looking for a very strong double top breakout over 100 in the GLD very soon. In this kind of environment, with inflation expectations running high as well as multiple looming bank failures there really is no limit to how high Gold can go.
July 7, 2008
US Economy At Major Turning Point, Intervention Needed Now...
Paulson + Bernanke & Co. have been awfully quiet while we sit here at this critical juncture in the economy and markets, and they really need to step in and do something now if they plan on averting a major economic meltdown. This malaise we currently sit in is at a major pivot point in my opinion. Once Oil breaks above $150 and the DOW breaks down into the 10,000 range it's over, as confidence will have been completely shot and any sort of intervention will have minimal impact. Whether its forex intervention, raising interest rates, and/or raising margin requirements it needs to be done now. Say what you want, but a combination or dollar intervention + raising margin requirements should take some wind out of the sails of Oil and a host of other commodities. Yes I know, Oil is a supply/demand story but breaking the momentum might buy some time for the reality of a global slowdown to set in. Second of all, we are nearing the start of the all important China Olympics which have been an important contributor to demand for energy as China gears up to showcase its country to the entire world. After the culmination of the Olympics or likely before that (as the mkt is forward looking) we should see commodity prices start to come down as the market begins to price in slower economic growth out of China. The rebuilding efforts due to the devastating earthquake in China is sort of a wild card, but the way I see it, it ends up being a zero sum contributor as the increase in government spending to rebuild the country will likely get cancelled out by a decrease in consumer demand due to the necessity of millions of people needing to rebuild their lives first and foremost. Thirdly, the slowdown which appears to be picking up steam overseas in europe is likely a net positive for the US as the relative weakness associated with the dollar and the US economy dissipates a bit as market participants begin to realize that the US is not much worse off than our european counterparts, and may in fact be closer to the end of their malaise than those just beginning to slowdown. We are in such a complex economic environment with Oil + food making all time nominal highs, inflation fears accelerating, slowdowns picking up overseas, the continued perceptions of stress within the banking system, and housing prices continuing to decline that something needs to happen now at least as an effort to quell the momentum to the downside. Traditional, untraditional, it doesn't matter, time is really against us at this point as every day that goes by things seem to get a bit worse. What the puppet masters behind the curtain are doing right now is beyond me, but i have a feeling they're working on something....just doesnt make sense that theyre just waiting for this thing to play out as they know what the end result is if nothing is done.
April 5, 2008
Global Darwinian Forces May Produce Major Exogenous Event Blindsiding US Economy...
By all economic measures, the United States is clearly in a state of marked weakness. Economic growth is at or near zero, unemployment is rising, the banking system is in critical condition, housing prices continue to decline, the US consumer is up to its ears in debt, the dollar continues to make new lows versus every major currency, inflation shows no signs of abating, and the Fed is running around like a headless chicken literally doing everything it can to prevent the entire system from collapsing. This is not a subjective assessment, it is our grave reality. So what now? Where do we go from here?
Well the obvious answer would be to fix everything that appears to be broken, clean up inefficient systems, attempt to reinvigorate the economy, and ultimately rebuild confidence in the US financial system over time. However, what I fear most is that in this time of distress we may no longer have the luxury of time. I believe it is possible that one of the many emerging superpowers may make a play for global dominance in the near future. Yes, I know this is a bold statement, but let me explain. Over the past several decades the United States has clearly been the world's superpower. It has been the steam engine driving the global economy as continuous wealth creation here has driven demand for foreign goods thereby creating wealth and GDP growth overseas. We are clearly the largest consuming nation in the world, and most of our foreign counterparties have done everything they can to see that growth here continues as incremental gains in US GDP inevitably trickle down to their own economies. However, it appears now that the global economy has approached the point where our significance in the global growth equation has diminished. It appears as if our emerging market counterparties have grown to a level where collectively they are able to maintain global growth without the neccessity of US demand. Where is the evidence of this? The commodities market. We have virtually every major commodity (Gold, Oil, Coal, Grains, Corn) at or near nominal highs, with many now approaching their inflation-adjusted highs. What is most notable however is that these commodities are making this move with the United States literally on the brink of recession! How is this possible? How is it possible that Oil is near $110 per barrel with such weak US demand? How is it possible with the US near recession that global Oil demand is still greater than global Oil supply with Oil being pumped at maximum capacity? It is because of decoupling. The world no longer relies on the US as the primary engine of global growth anymore. This position has been taken over by the likes of China, India, and Brazil. While the US has been toiling with credit crises, a housing slump, and increasing debt loads, the emerging economies have grown into such a dominant state of hypergrowth that their only challenge is to make sure that growth does not get so excessive that it becomes unsustainable, and moreover that inflation remains contained. This dominant position, I'm afraid, may produce some sort of climactic consequence for the United States. Let me explain.
We as mere individuals, will never understand the desire to become a global superpower. This desire is something reserved for continents, nations, and unions as it is impossible for us as mere individuals to achieve such status. However, even though we may not have the capacity to understand this desire, we know that it exists. We know that every single day every sovereign nation is actively working or has the innate desire to become the strongest entity in the world. Why does this happen? What is the driving force behind this phenomenon? Well in my opinion it is driven by the underlying principle that the world lacks enough supply of natural resources to prolong the existence of every single nation over the long run. Over time, as the world begins to approach levels where natural resources are being fiercely competed over because of inadequate supplies and/or unusually high global demand at the margin, the strongest nations will attempt to force weaker nations into further weakness in the hope that this action may curtail overall demand and allow the strongest nations to accumulate necessary supplies at cheaper prices. It is Darwinism at its purest, and it is ultimately driven by the idea that while economic harmony may exist when the strongest parties are satisfied with the distribution of goods and resources, extreme competitive behavior will arise when those parties become dissatisfied with the allocation of resources, especially those resources necessary for independent survival. It is very much akin to the behavior of animals living in a jungle free from the so-called orders of society. When all animals including the strongest are fed and all so-called entities appear satisfied, harmony may exist because there is no need for competition as supplies of resources are adequate enough to meet the demands of all entities. However, if/when the strongest entities become dissatisfied with their levels of consumption, we will likely see an extreme uptick in competitive behavior as the idea of the natural order for satisfaction dictates that the strongest must be first to be completely satisfied. If/when this natural order appears to be imbalanced in that the strongest are not receiving adequate supplies, the strongest entities will likely seek to not only eliminate those entities which they believe will restore natural balance, but they will specifically seek to eliminate those who they believe will be easiest to eliminate (i.e. those entities who appear weakest). Make sense? Ok so what resource are we speaking of specifically when we speak of resources necessary for survival? We are speaking of crude Oil. Every single other commodity is secondary to crude oil in terms of necessity for survival. Gold, corn, wheat, coal, even steel are all secondary commodities. We don't need corn or even grain to survive, and coal and other fossil fuels are simply alternatives to the most important fossil fuel of all, crude oil. Without crude oil, factories would come to a stand still, refineries would be unable to produce gasoline, airplanes would be grounded, heating oil would be unable to be produced, and ultimately unemployment would skyrocket as productive inputs are unable to function and means of transportation become idle. It is the reason why there is literally no limit to how high the price of oil can go over the long run. Its significance as the world's primary energy source produces wars, wreaks havoc within the economic supply chain, and has the capacity to bring entire nations to its knees.
Well the obvious answer would be to fix everything that appears to be broken, clean up inefficient systems, attempt to reinvigorate the economy, and ultimately rebuild confidence in the US financial system over time. However, what I fear most is that in this time of distress we may no longer have the luxury of time. I believe it is possible that one of the many emerging superpowers may make a play for global dominance in the near future. Yes, I know this is a bold statement, but let me explain. Over the past several decades the United States has clearly been the world's superpower. It has been the steam engine driving the global economy as continuous wealth creation here has driven demand for foreign goods thereby creating wealth and GDP growth overseas. We are clearly the largest consuming nation in the world, and most of our foreign counterparties have done everything they can to see that growth here continues as incremental gains in US GDP inevitably trickle down to their own economies. However, it appears now that the global economy has approached the point where our significance in the global growth equation has diminished. It appears as if our emerging market counterparties have grown to a level where collectively they are able to maintain global growth without the neccessity of US demand. Where is the evidence of this? The commodities market. We have virtually every major commodity (Gold, Oil, Coal, Grains, Corn) at or near nominal highs, with many now approaching their inflation-adjusted highs. What is most notable however is that these commodities are making this move with the United States literally on the brink of recession! How is this possible? How is it possible that Oil is near $110 per barrel with such weak US demand? How is it possible with the US near recession that global Oil demand is still greater than global Oil supply with Oil being pumped at maximum capacity? It is because of decoupling. The world no longer relies on the US as the primary engine of global growth anymore. This position has been taken over by the likes of China, India, and Brazil. While the US has been toiling with credit crises, a housing slump, and increasing debt loads, the emerging economies have grown into such a dominant state of hypergrowth that their only challenge is to make sure that growth does not get so excessive that it becomes unsustainable, and moreover that inflation remains contained. This dominant position, I'm afraid, may produce some sort of climactic consequence for the United States. Let me explain.
We as mere individuals, will never understand the desire to become a global superpower. This desire is something reserved for continents, nations, and unions as it is impossible for us as mere individuals to achieve such status. However, even though we may not have the capacity to understand this desire, we know that it exists. We know that every single day every sovereign nation is actively working or has the innate desire to become the strongest entity in the world. Why does this happen? What is the driving force behind this phenomenon? Well in my opinion it is driven by the underlying principle that the world lacks enough supply of natural resources to prolong the existence of every single nation over the long run. Over time, as the world begins to approach levels where natural resources are being fiercely competed over because of inadequate supplies and/or unusually high global demand at the margin, the strongest nations will attempt to force weaker nations into further weakness in the hope that this action may curtail overall demand and allow the strongest nations to accumulate necessary supplies at cheaper prices. It is Darwinism at its purest, and it is ultimately driven by the idea that while economic harmony may exist when the strongest parties are satisfied with the distribution of goods and resources, extreme competitive behavior will arise when those parties become dissatisfied with the allocation of resources, especially those resources necessary for independent survival. It is very much akin to the behavior of animals living in a jungle free from the so-called orders of society. When all animals including the strongest are fed and all so-called entities appear satisfied, harmony may exist because there is no need for competition as supplies of resources are adequate enough to meet the demands of all entities. However, if/when the strongest entities become dissatisfied with their levels of consumption, we will likely see an extreme uptick in competitive behavior as the idea of the natural order for satisfaction dictates that the strongest must be first to be completely satisfied. If/when this natural order appears to be imbalanced in that the strongest are not receiving adequate supplies, the strongest entities will likely seek to not only eliminate those entities which they believe will restore natural balance, but they will specifically seek to eliminate those who they believe will be easiest to eliminate (i.e. those entities who appear weakest). Make sense? Ok so what resource are we speaking of specifically when we speak of resources necessary for survival? We are speaking of crude Oil. Every single other commodity is secondary to crude oil in terms of necessity for survival. Gold, corn, wheat, coal, even steel are all secondary commodities. We don't need corn or even grain to survive, and coal and other fossil fuels are simply alternatives to the most important fossil fuel of all, crude oil. Without crude oil, factories would come to a stand still, refineries would be unable to produce gasoline, airplanes would be grounded, heating oil would be unable to be produced, and ultimately unemployment would skyrocket as productive inputs are unable to function and means of transportation become idle. It is the reason why there is literally no limit to how high the price of oil can go over the long run. Its significance as the world's primary energy source produces wars, wreaks havoc within the economic supply chain, and has the capacity to bring entire nations to its knees.
March 17, 2008
Bear Deal Forces Market To Reassess Market Caps Of All Financials...
With Bear being taken under by JP Morgan for a truly embarrassing $2/share, the market will move to rethink valuations in every single financial stock. The deal exposes the significant downside risk in every financial institution as the consequence of a run on the bank is brought to reality. With risk/reward profiles for financials now significantly out of whack (downside risk for most of them now is probably 50%-100% with upside being 20% in the most optimistic scenario) the market will move to dump these stocks very hard as institutions are literally unable to quantify a long position and must remove any semblance of a financial off their books if they hope to maintain any clients. There is simply no reason to own any financial right now. The only question that remains is whose next? Is it Lehman, is it Citi, or maybe even WaMu? All seem like good candidates, with technicals and short interest dictating significant probabilities of much more downside.