Stock Market Strategy: All signs point to a continuation of the current rally. We will continue to use the direction of liquidity and the behavior of the credit markets as our fundamental guides to equity investing.

The primary news story making the rounds today involves the European bank stress test results. I have included the official results and accompanying statement below for your perusal. If you would rather the cliff notes I will summarize: Completely worthless nonevent.

CBES releases results of the EU Stress Test — 7 banks fail test

The exercise includes a sample of 91 European banks, representing 65% of the European market in terms of total assets, in coordination with 20 national supervisory authorities. It has been conducted over a 2 years horizon, until the end of 2011, under severe assumptions. In total, aggregate impairment and trading losses under the adverse scenario and additional sovereign shock would amount to 566bn € over the years 2010-2010. The aggregate Tier 1 ratio, used as a common measure of banks’ resilience to shocks, under the adverse scenario would decrease from 10.3% in 2009 to 9.2% by the end of 2011 (compared to the regulatory minimum of 4% and to the threshold of 6% set up for this exercise). The aggregate results depend partly on the continued reliance on government support for currently 38 institutions in the exercise. The aggregate Tier 1 ratio incorporates approximately 197bn € of government capital support provided until 1 July 2010, which represents 1.2 percentage point of the aggregate Tier 1 ratio. As a result of the adverse scenario after a sovereign shock, 7 banks would see their Tier 1 capital ratios fall below 6%… See release here.

Once again traditional financial news outlets fail to focus on issues that actually move the markets and instead waste time and energy on government sponsored propaganda. The typical word on the street from this story is as follows: ‘Street expected 10-11 banks to fail test and only 7 failed so things are better than expected.’

Enough said about the theater of the absurd a.k.a. European banking stability. Please follow me into the realm of reality as I focus on events that are actually having a tangible impact on the equity markets. Committed RCM blog readers will recall this quote from my July 14th post, “The above chart also suggests a change in trend may be in the offing”. At week’s end, it would appear suggestion has turned into sage advice as the rally that began July 7th makes new highs.

Tangible event number one:

Quantitative Easing round #2 is currently underway. How do we know this you ask? The Fed made no comment in the FOMC minutes release and Ben Bernanke said nothing of note to Congress. So how do we know Q.E.2 has begun? The answer lies in the chart below. As you will see, worldwide liquidity is once again on the upswing. This rise and fall of liquidity has been and should continue to be the single biggest factor determining market direction. Close scrutiny of the graph will reveal the selloff of assets in 2008 was led by liquidity contraction, the rally of 2009 occurred on the heels of liquidity expansion and the first 6 months of 2010 suffered from another reduction of liquidity. However, in the last three weeks worldwide liquidity has expanded progressively, hence a rally in asset prices should not surprise. We can expect further asset gains, equity, commodity or otherwise, as long as this liquidity trend continues….

Tangible event number two:

The credit markets are the first to be effected by the liquidity situation. Our credit guru, Mike Johnson, spotted the positive behavior of the credit markets at the end of June. The liquidity expansion began, credit markets immediately stabilized and true to form equities followed. Another review of MJ’s thinking seems appropriate…  

…intraday credit market volatility continues to decline and this indicates that equity volatility is biased to continue to decline. This is clearly a positive for the broader equity indices.  

One of the reasons we became bullish at the end of June was because of the improvement in bank CDS spreads, the normalizing of GS’ CDX credit curve, improvements in consumer credit losses, and improving CDX IG spreads. COMPARING THE PERFORMANCE OF THE CREDIT MARKETS TO THE EQUITY MARKETS (SPX) would indicate that SPX has the potential to rise to the 1150-1175 range QUICKLY. The steepening of CDX IG credit curve further indicates that this 1150-1175 range is even more likely to be reached relatively soon.

Tags: ben bernanke, CDX index, commodities, Credit, credit markets, equity markets, EU Stress Test, FOMC, liquidity, Q.E.2, Quantitative Easing, stock market strategy

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On Friday of last week I outlined a case for impending equity market strength. Please refer to this post titled, Stock Market Strategy: Reduce Shorts Expect Equity Market Rally , for complete details. Today, I would like to review recent news events and the market’s subsequent reaction to see if our bullish call has horns.

To begin, I’m going to share a family secret with you. Gary Rosenthal considers this axiom one of the most important precepts to investing and has drilled the concept into my thinking over the years.

Gary, (father, mentor, principal) has developed a remarkable reputation during his 44 year professional involvement with equity investing. He began his career as an equity analyst writing 50 plus page in-depth research reports. To my Dad, breaking down balance sheets, income/cash flow statements and dissecting management teams is a joy not a job.  Because of this devotion to the uncovering of truth Gary has succeeded at every level of the investment community from advising institutions to counseling private investors to the building of family wealth.  

Rosenthal Investing Axiom: One must constantly test one’s investment thesis as complacency can quickly turn into calamity. We must with vigilance watch for signposts along the investing highway that either confirm or deny our vision.

So, without further ado a test of our nascent bullish vision shall commence:

The obvious tends to offer the best starting point. Since our call on Friday the NYSE Comp.(Our favorite index) has rallied 3.3% and is up 7.4% since the low on 6/8. Moreover, during the last three trading days a couple of our forecasts have become fact.

1) We contended that the market would respond well to positive developments regarding imminent financial regulation (FINREG.). The story below illustrates the onset of positive news flow gathering about FINREG. and in this case the apparent lack of imminence….

Lincoln Considers Compromise on Swaps-Desk Provision

June 14 (Bloomberg) — Senator Blanche Lincoln may modify her proposed rules on derivatives by giving commercial banks two years to push out their swaps trading desks into subsidiaries. The compromise proposal also would allow the Federal Reserve to provide system-wide emergency assistance to swaps dealers, according to a draft obtained by Bloomberg News and confirmed by Lincoln’s office today.

Read More…

2) We believe negative economic news will no longer drive the equity markets to new lows. On the contrary, we believe negative news is the new positive. Every disappointing economic development now drives politicians closer to another stimulus package as the pressure of the midterm election process grows near.  Threat of a double dip recession will give impetus for the Fed to resume quantitative easing the main fuel for equity market fire. Case in point, the Payroll data released on June 4th was terrible and yet markets held ground and set up a double bottom…

Payrolls in U.S. Increase 431,000 in May, Jobless Rate at 9.7%               

June 4 (Bloomberg) — Employers in the U.S. hired fewer workers in May than forecast, showing a lack of confidence in the recovery that may lead to slower economic growth.

Read More…

…The following two stories only strengthen our resolve as equity markets are higher by 2% today in the face of economic hardship…

Empire Employment – Strike 3? PMI’s Suggest NFP Growth Rolling

Last weeks weak retail sales already suggested that next months NFP may underwhelm with a headline of sub 300k including the census jobs next month. That would naturally suggest poor private sector employment and with the Empire Employment data out this morning that indeed appears to be increasingly the risk. Indeed, that relationship supports the roll we have already seen in the Chicago and Philly data…..Strike 3?

Read More…

Builder Sentiment Tumbles As Tax Credit Expires

The NAHB Home Builder Survey reported a massive 5 point drop, reaching 17, on expectations of 21. The reason for the plunge – concerns about the end of the tax credit. Not even Goldman could spin this news favorably: “Housing market index 17 in June vs. median forecast 21. The National Association of Home Builders reported a 5-point drop in its housing market index for June, pushing it back below the 20 level that had been the low prior to the latest housing market recession.

Read More…

We will continue our vigilance and report our findings on this blog. So far the signposts all point to a confirmation of our beliefs. Further equity market upside would not be surprising.

Tags: Blanche Lincoln, bullish, equity markets, Financial regulation, finreg., Investment, NFP, NYSE Comp., payrolls, Short, stock market strategy

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The Bear is Full Right Now & May Need Time to Digest

The Grizzly we stalked in April and found in May has been devouring pathetic bulls for the last six weeks. The time may have arrived for this satiated animal to take a break.

Please refer to the chart of the NYSE Composite below for a clear picture of the six week mauling. Note the time frame of this chart is longer than previously posted NYSE Comp. charts. I’ve chosen the daily chart as opposed to the 60 min. chart because I’d like to draw your attention to the longer term trend.  Notice the black trend lines bracketing the uptrend in place since last year.  I’ve also highlighted in yellow the recent double bottom reached in the last 2 weeks. This chart clearly illustrates the easy money made on the short side is over for now. Support has been reached at the bottom of the channel and a natural bounce to work off some serious oversold conditions would not be surprising.

I have spent a disproportionate although necessary amount of time over the last 2 1/2 months emphasizing the dangers of holding a long equity portfolio.  However, now that the market trades near the bottom of the long term channel, I feel comfortable discussing issues that may lead to higher equity prices. We are monitoring the following list of developments. Should the developments unfold favorably a market rally worthy of participation may occur:

1) As the November midterm elections draw near, a flurry of government handouts (like the story below) to spur economic growth should be expected. These handouts will be viewed favorably by the markets.

WASHINGTON (Dow Jones)–People hoping to take advantage of the first-time home buyer tax credit would have an extra three months to close their home purchases and still qualify, under a measure introduced in the U.S. Senate Thursday.

To be eligible for the tax credit, home buyers must have a valid contract by April 30, 2010 and close the transaction by June 30, 2010. The Senate measure would allow home buyers until the end of September to complete their transactions.

Senate Majority Leader Harry Reid (D.-Nev.) and Sens. Chris Dodd (D., Conn.) and Johnny Isakson (R.-Ga.) intend to offer the measure as an amendment to the jobs legislation pending in the Senate.

2) I’ll take the thought above a step further and say bad economic news may cease to drive stocks lower. Instead the market may view bad economic news as positive because the threat of a double dip recession will surely drive politicians to create new stimulus. Case in point, today’s bad economic news,  “May Retail Sales -1.2% vs +0.2% Briefing.com consensus” failed to send the markets lower by the close. As I write this missive the NASD Comp. trades over 1% higher on the day.

3) Credit leads equity. This relationship continues to dominate the market place. Michael Johnson of MS Howells & Co. understands this relationship better than most. I affectionately refer to MJ as the credit Guru and his modified list of issues below demands our attention:

 Almost Time to Be Bullish

 We have provided a list of reasons as to why we are in the process of changing:

 1. If GS’s CDS credit curve steepens of so that its 1- to 5 year and 3-5 year CDS credit curves are positively sloped.

2. The re-steepening of money center bank CDS curves should begin to cause both equity and credit market volatility to decrease. Although we have only begun to see a decrease in credit market spread volatility, we expect this trend is likely to grow in the next two weeks.

3. Moody’s announcement, along with an S&P note last week, that they will not downgrade the banks and force them to confront a structural market inefficiency that could stress their business model is a huge positive.  

4. The recovery in Bank Pfd prices indicates that equity prices are likely to stabilize and begin rising again.

5. New issue market appears able to bring deals during periods of market stability

4) Financial regulation (FINREG.) by congress represents a major road block for the equity markets. Fears run high that politicians will make a bad situation worse. While I don’t disagree with these concerns, I do believe that fear often creates opportunity. Equity market participants frequently overreact. Once FINREG. is completed a major uncertainly will be lifted and uncertainty tends to be worse than reality. As time draws closer to the July 4th FINREG. deadline watch for positive market action to FINREG. developments.

Disclosure: Short GS Less than .25% of fund

Tags: bear market, CDS, Credit, equity markets, Financial regulation, finreg., GS, NYSE Comp., retail sales

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The news cycle is moving almost as fast and furious as the equity markets. I have combined commentary from around the web that I feel best represents the issues we are all facing.

Needless to say, the CNBC story suggesting a ‘fat finger’ was the cause of the market chaos we witnessed last week is pure tripe…unless of course they are referring to a certain infamous finger located in the middle of the hand….

ZeroHedge: Summary Of The Biggest Bail Out Ever: Even Keynes Is Spinning In His Grave

Europe has now followed the Fed in its all in move to prevent the disintegration of the euro and of Europe. As we expected, the EU was leaking various rumors to gauge market interest, and as speculated earlier, the final cost ended up being just short of one trillion. Here are the key summaries:

• EU Crafts $962 billion show of force to halt crisis
• Full blown monetization: ECB will buy public and private bonds
• Fed reactivates swap lines with Bank of Canada, BOE, ECB, BOJ, and the SNB

In other words, total and unprecedented monetary lunacy, as every cental bank, under the orchestration of the Federal Reserve, will throw money at the problem until it goes away, which it won’t. As we have long expected, Bernanke is now willing to sacrifice the dollar at any cost to prevent the euro unwind. This is nothing than a very short-term fix, whose half life will be shorter still than all previous ones.

Read More…

Market-Ticker: EFA Euro Zone Notes

I’m listening real-time to the “conference” this evening… these are “first blush” comments…

They’re throwing the kitchen sink at this, but it’s not real money for the most part – it’s “guarantees.”  Exactly how they get the rest of the €600 billion is open to question.  Only €60 billion is “real money.”

Read More…

Market-Ticker: Bernanke: Liar (Again)

From The Fed:

In response to the re-emergence of strains in U.S. dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the re-establishment of temporary U.S. dollar liquidity swap facilities.

There’s been no “strain” in dollar funding markets.

There has been an extreme level of strain in Euro funding markets.

Read More…

Mark Fisher is a legend on Wall Street and in the commodity trading world. His take on the Selloff last week is spot on…

http://www.cnbc.com/id/37002752

Mark J. Lundeen from Lemetropolecafe writes: …If I’m correct that we will be revisiting the March 2009 lows, and then on to new Bear Market lows, we will see plenty of big up days ahead of us.  How’s that?  Well, unknown to most people, the really big up days occur during the Big Bear Markets.

The venerable Richard Russell wrote: “I believe that bear market has taken over again. I expect stocks to be locked into an extended downtrend for the rest of the year. For that reason, I expect a flood of bullish propaganda to pour out from the Administration, the Treasury, and the Fed. But it will be so much water over the dam, and after a while the voting public will realize that is just more of the government’s BS. The government’s rosy propaganda will become a joke.”

Tags: CNBC, equity markets, EU, euro, Fed, keynes, Richard Russell, Wall Street

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Yesterday, the equity markets sold off over 2% while the US$ and GOLD moved sharply higher. That’s right, you read correctly, Gold and the US$ moved up together. This action comes as no surprise to the partners of RCM. Over the last year or so, I have explained to anyone willing to listen that the real move higher in Gold prices will occur in spite of or along with an initial move higher in the US$.

One reason the US$ initially moves higher with Gold can be accredited to the carry trade unwind which artificially drives funds back into US$ investments. As an example simply look at the strength of US Treasuries yesterday. As risk is unwound money moves into the relative safely of US Treasuries. I write ‘relative safety’ because as currencies around the world continue to devalue owning US Treasuries will not protect buying power. The only true safe haven in a world intent on currency debasement will be the precious metal Gold and Silver.

I will allow Briefing.com to supply the summary of yesterday’s trading. As you will see they have done an exemplary job…

WRAPX End of Day Summary: Stocks Drop Sharply in High Volume Trade

A high-volume selling effort in response to downgrades on the sovereign debt of Greece and Portugal sent stocks to their worst percentage loss in more than two months, but drove the dollar to its best gain in four months… Early trade was rather lackluster as widespread weakness among overseas markets weighed on mood of morning participants… Data didn’t do anything to improve the mood either. The S&P/CaseShiller 20-City Composite made its first increase since 2006 with a 0.6% year-over-year increase, but that was still weaker than the 1.3% annual increase that had been expected… Consumer confidence climbed in April as the Conference Board’s Consumer Confidence Index came in at 57.9, which was not only higher than the 53.5 that had been expected, but was the best reading since August 2008…

Weakness quickly worsened when it was learned that credit analysts at Standard & Poor’s downgraded Greece’s debt to junk and cut Portugal’s debt two notches to A-. Subsequent selling pressure sent the Dow down roughly 150 points in just 30 minutes. It even pushed through its 20-day moving average for the first time since February. It was never able to recover and, as a result, finished near its session low…

The wave of selling sent volatility sharply higher. In fact, the Volatility Index made its way up more than 30% to its highest level since February…

Many market participants fled to the dollar for safety. That gave the greenback a 1.3% gain against a basket of foreign currencies. The euro was especially weak as it fell to 1.3179 against the buck. That puts it on par with its one-year low against the dollar…

Tags: Bookmark and Share Tags: case-shiller, equity markets, gold, Greece, Portugal, precious metals, silver, sovereign debt, US Treasury, US$

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Is it a bear or a windmill we’re stalking?

You may find yourself asking that question as the equity markets drift higher seemingly oblivious to a myriad of negative news.  Classic commentary such as “the market climbs a wall of worry” or “the trend is your friend” are being bandied about with increased regularity.  Of course, these sayings are useless when the bottom falls out of the market but for now they appear reassuring as they add to the overwhelming feeling of complacency pervading the equity markets.

In the interest of  remaining open-minded and having a strong desire to avoid Don Quixote’s fate, I will offer the following analysis that could buttress a case for continued equity price support. 

Instead of relying on hackneyed phases and static commentary let’s focus on the building strength of the inflation trade.  Yesterday, the FOMC minutes were released with the following headlines… 

FOMC Minutes Released: Fed says economic activity expanded at a moderate pace in early 2010, inflation is likely to be subdued for some time

Fed Minutes say if economic outlook worsened or trend inflation declined further, “extended period” of low rates could last “quite some time” – Reuters

Read complete FOMC Minutes  

 The Fed clearly feels inflation is of no concern. Apparently, all FOMC members with the exception of Hoenig are unwilling or unable to read commodity price charts.  Several key raw materials are experiencing impressive price appreciation as seen in the following charts…

Copper:

Crude Oil:

Platinum:

Palladium:

If this commodity price surge continues then conceivably equity prices could continue to grind higher as often happens at the beginning of an inflationary period.  You may notice, I did not include a Gold or Silver price chart in the above group.  As you will see below, Gold and Silver prices have yet to hit a new high and will need to do so for the inflation trade theory to be legitimate.  

Gold:

Silver:

Tags: bear market, commodities, copper, crude, equity markets, Fed, FOMC, gold, Inflation, OIL, palladium, platinum, silver

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The equity markets move higher responding to the results of the healthcare vote Sunday? If you can’t see through that illogical logic then no amount of reading this blog will help you. Please stop reading this post, don’t pass go and choose a card from the community chest as that seems to be the order of the day.

For the rest of you, I will say that we are still sifting through the data trying to determine the true fallout from said vote. So far, we are fairly certain the biggest beneficiary will be the Central Bank of North Dakota. I will get back to you with more detail when the situation warrants. Until then enjoy this piece from Jim Cramer. Kindly hold your collective groan, we don’t like Jim either but a broken clock…. 

“Passage Of The Healthcare Bill Means The Double-Dip Is Coming” – Market Insight From Permabull Jim Cramer Who Just Turned Bearish

Obamacare Will Topple the Rickety Market By Jim Cramer RealMoney

Either the market doesn’t care that the health care bill will pass –  and it will — or it doesn’t think that the proposal will cost that much — something I think is nuts. Which brings us to a very tenuous crossroad: We have to wonder if this is one of those occasions, like in 2008, where the market doesn’t see the coming catastrophe. Or perhaps the market sees any resolution as positive….

READ MORE…

Meanwhile, I suspect the real story from this weekend that will affect markets going forward centers on U.S.- Sino relations. The U.S. equity markets correlated closely with their Chinese counterparts from March ‘09 to Dec. ‘09. However, 2010  ushered in a rather disturbing divergence that has only accelerated in the last four weeks. The question remains whether or not the weakness of the Chinese markets will weigh on our equity markets, but I suspect the following stories will not be a help….

China’s commerce minister: U.S. has the most to lose in a trade war – Washington Post

Washington Post reports that China’s commerce minister warned the United States on Sunday that if it launches a “trade war” against China by levying punitive tariffs on Chinese imports, the United States will suffer the most. Chen Deming also said the U.S. government’s “obsession” with China’s exchange rate could not be seriously addressed until it stopped blocking the export of high-tech products, such as supercomputers and satellites, to China. “If some congressmen insist on labeling China as a currency manipulator and slap punitive tariffs on Chinese products, then the [Chinese] government will find it impossible not to react,” Chen said in an interview with The Washington Post. “If the United States uses the exchange rate to start a new trade war, China will be hurt. But the American people and U.S. companies will be hurt even more.”

Stunner: China Set To Announce Record Trade DEFICIT In March

Say goodbye to China’s “export economy” paradigm. In a stunning development for trade hawks, and pretty much anyone who follows the biggest liquidity bubble in history, China Daily has announced China is about to announce a record trade deficit (yes, not surplus, deficit) for March. This makes the whole CNY undervaluation debate pretty much moot, as even China now moves into the ranks of net importers….

READ MORE…

Tags: China, equity markets, health-care, obama

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The following story represents perhaps the largest obstacle facing equity market integrity today.  The previous statement is not hyperbole. The collapse of equity prices in 2008 was presaged by a python-like constriction of credit. If the private sector cannot access credit then business grinds to a halt and as we saw in 2008 economic cataclysm ensues… 

Credit markets flash hottest warning signal since crisis

European credit markets are flashing the most serious warnings signs in a year as the yields on risker bonds rise sharply and a string of companies cancel share flotations, raising fears that the recovery may falter in coming months.

The Markit iTraxx Crossover index measuring yields on lower-grade debt has jumped by almost 130 basis points since mid-January to 514, while the main index of investment grade bonds has jumped by a third to 93. “This is the biggest move since the financial crisis in early 2009, said Gavan Nolan, Markit’s credit analyst.

The rating agency Moody’s said market ructions have led to a “material” rise in borrowing costs over the last month, prompting the cancellation of debt issues by the Dutch energy group New World Resources, Italy’s Snai betting group, and the UK’s Travelport. Sixteen companies wordwide have pulled debt issues worth a $7.3bn (£4.66bn) since mid-January, including Canada’s Bombardier.

Read More…

…Will the Sovereign debt issues of Europe migrate across the pond?  The following story suggests the answer may be yes. The lack of foreign demand for US debt will have the effect of increasing rates. However, since an increase in rates would be the death knell of our supposed economic recovery we would expect the Fed to attempt to fill any gap foreigners create. These actions would be, of course, US$ bearish. So while the talk of an end to Q.E. intensifies reality of the situation suggests otherwise….  

Foreign demand falls for Treasuries – Financial Times 

Financial Times reports foreign demand for US Treasury securities fell by a record amount in December as China purged some of its holdings of government debt, the US Treasury department said on Tuesday. China sold $34.2 bln in US Treasury securities during the month, the US Treasury said on Tuesday, leaving Japan as the biggest holder of US government debt with $768.8 bln. China overtook Japan as the largest holder in September 2008. The shift in demand comes as countries retreat from the “flight to safety” strategy they embarked on upon during the worst of the global economic crisis and could mean the US will have to pay more to service its debt interest. For China, the shedding of US debt marks a reversal that it signalled last year when it said it would begin to reduce some of its holdings.

“Credit is a system whereby a person
who cannot pay gets another person
who cannot pay to guarantee that he can pay …”
Charles Dickens (1812-1870)

Tags: China, Credit, credit markets, equity markets, Q.E., sovereign debt, US Treasury, US$

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Euro zone gives Greece 30 days to show good on deficit – Reuters

The tsunami of Greek fear begins to ebb and like proverbial clockwork the US$ drops almost 1%, the equity markets rally over 1% and Gold runs back above the $1100 level up over 1.5%.

By now, as readers of this blog, the financial market behavior described above should come as no surprise.  I exposed the market’s playbook on Feb. 9th and directly addressed the perennial gold bears by saying, “They have not owned Gold during its nearly 300% increase over the last 10 years, but somehow, through a haze of delusional arrogance, they are sure prices have peaked.”

In the five days since that comment Gold has rallied 5%.  Coincidence? Maybe. I’ll concede, sometimes we’re simply lucky, but when understanding is acute luck becomes more pervasive and that, my friends, is called success.

For the last few months, the fear of  reduced stimulus and quantitative easing has gripped the markets. In an apparent effort to support the US$, government officials and Fed members have raised the expectations of economic growth and reduced expectations of Q.E.. I have, time and again, called this type of  jawboning nothing more than propaganda. I explained as much in my Jan. 20th post and highlighted the “need for a new round of stimulus” demand from the conference of mayors on Jan. 22nd as the beginning of a shift in the wind.

Well, today, I would like to say, the wind is a steady 10-15kts in the direction of stimulus and looks to be increasing over the coming weeks.  Evidence for this forecast below…

IMF tells bankers to rethink inflation – WSJ

WSJ reports the IMF’s top economist, Olivier Blanchard, says central bankers should consider aiming for a higher inflation rate than they do currently to lessen the chances of repeating the recent severe recession. Mr. Blanchard said the global economic downturn revealed flaws in macroeconomic policy, especially the reliance primarily on interest rates to manage economies. Although Japan had fallen into a decade-long funk despite low inflation and low interest rates, “most people convinced themselves that the Japanese didn’t know what they were doing,” Mr. Blanchard said in an interview. In a new paper with two other IMF economists, Giovanni Dell’Ariccia and Paolo Mauro, Mr. Blanchard says policy makers need to consider radically different approaches to deal with major banking crises, pandemics or terrorist attacks. In particular, the IMF paper suggests shooting for a higher-level inflation in “normal time in order to increase the room for monetary policy to react to such shocks.” Central banks may want to target 4% inflation, rather than the 2% target that most central banks now try to achieve, the IMF paper says.

Australian Finance Minister Says More Stimulus Needed

Feb. 7 (Bloomberg) — Australian Finance Minister Lindsay Tanner said the nation’s economy remains fragile and that it will require more stimulus this year.

Australia’s long-term debt, accumulated through the global financial crisis, is also a serious matter, Tanner said on Network Ten’s “Meet the Press” program.

Read More…

G-7 Vows to Keep Economic Stimulus Even as Budget Deficits Grow

Feb. 7 (Bloomberg) — Group of Seven finance ministers pledged to press ahead with economic stimulus measures even as investors intensify their focus on mounting budget deficits.

Read More…

In conclusion, I’d like to accentuate the following analysis of the Japanese experience with private sector de-leveraging. I feel these issues are at the very center of the problems facing our markets…

Richard Koo’s book about the lessons from Japan’s balance sheet recession: The crux of his analysis is that governments have no option but to stimulate aggressively all the while the private sector is de-leveraging. ANY attempt at fiscal cuts simply results in renewed recession and a further loss of confidence, thus making it even harder and more costly to sustain any subsequent recovery and hence the budget deficit ends up bigger than before.

Tags: equity markets, euro, gold, Greece, IMF, Inflation, QE, Quantitative Easing, Stimulus, US$

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The equity and commodity markets get rocked as Sovereign debt woes resurface.

The burning question: Will the dramatic widening of credit spreads in Sovereign debt, beginning to resemble the CDS collapse of 2008 in the private sector, lead to a revisit of a 2008 type credit crisis and all the fallout associated with it?…

Greece, Portugal woes intensify – WSJ The Wall Street Journal reports the cost of insuring the debt of euro-zone members with large budget deficits against default rose Thursday, dashing hopes that the European Commission’s qualified endorsement of Greece’s budget plan would calm investor fears. Greece, Portugal and Spain were in focus, with their five-year sovereign credit default spreads moving sharply wider. Greece’s five-year sovereign credit default swap spreads were recently at 4.14%, compared with Wednesday’s closing level of 3.97%, according to to CMA DataVision. Portugal’s five-year sovereign CDS spreads were at 2.09 basis points—their widest level ever—after closing Wednesday at 1.96%. Spain’s sovereign CDS spreads widened to 0.12 percentage point to 1.64%. The moves followed news Wednesday that the European Commission had put Greece under more pressure to cut its deficit; that the Portuguese government sold only EUR 300 million of treasury bills at an auction, compared with an indicative offer of EUR 500 millon; and that the Spanish government had raised its budget deficit forecasts for 2010 through 2012. Spanish and Portuguese stock markets fell sharply for the second consecutive day, with banks leading decliners on sovereign debt worries.

…The jury is still out on the above question but market participants are voting today.  As usual, voting like this is detrimental to long term investment decision making.  I would suggest all take a step back relax and reassess after the smoke of today’s battlefield clears. In the meantime, tomorrow’s employment report may shed some light on the absurdity or validity of  today’s flight into the US$. I stress the word, may, because government released employment numbers are notoriously manipulated.  For those who wish to debate this manipulation issue and wish to cast aspersions about conspiracy theorists please view the following story…

Explaining The Government’s 1.8 Million Job Overestimation In Pictures

Last October the BLS announced it would revise historical payrolls lower by 824,000 on February 5 (this Friday’s NFP release). While this number will not impact the actual January NFP report (a loss of nearly one million jobs in a month would probably even take out the persistent SPY algo that has been hugging the bid for the past 10 months), it will be prorated across all months in the 2008-2009 reporting period. The reason for this adjustment has to do with a huge glitch in the birth-death model, which is exactly the same problem that the rating agencies faced when housing prices plummeted: the birth/death model assumes, in the long-run, jobs are created, not destroyed. Any period of excess volatility in the stock market therefore translates into major prior downward revisions to already disclosed payrolls. And while we know what the current revision will be, the scarier prospect is that the next historical adjustment, due out in early 2011, will be even larger, at least 990,000. This means that the government has overrepresented running payroll data by over 1.8 million jobs over the past 20 months. Read More…

Today, world equity markets suffer, the “risk” trade is reduced and scared investors run into treasuries and the US$.  Meanwhile, the underlying fundamentals of the US$ continue to deteriorate….

Zerohedge: It’s Official: Congress Passes Debt Ceiling 231-195; All Republicans, 20 Democrats Vote Against Raise.  Congress Democrats have just signed off on the US hitting 100% debt/GDP.  About 140% if one adds GSE liabilities which also should be on the budget.

Initial Claims 480K vs 455K consensus, prior revised to 472K from 470K

Continuing Claims rise to 4.602 mln from 4.600 mln

NY Fed’s Dudley says “nothing is on automatic pilot” when asked about ending MBS purchases in March, according to AP – Reuters (The expected end of Q.E. in March has been a major factor in the strong US$ theory since Dec.. Now we see, at the 1st sign of trouble, S&P500 down 3%+ today, the Fed begins to backtrack – surprise, surprise.)

Tags: CDS, commodities, credit markets, credit spreads, employment report, equity markets, Fed, Greece, initial jobless claims, sovereign debt

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