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All eyes will be focused on the weekly jobless claims to be released by the Department of Labor at 8:30 AM EST on Thursday.
You may recall that investors did not exactly run the last two weekly reports up the flagpole and salute them, which showed sharp increases in unemployment claims. At this point the bulls are being comfortably complacent, blaming the bad numbers on? ?random noise? and short term statistical anomalies. This was the final data series to turn negative, and the last of a recent plethora of downshifting economic reports.
Get two more high or higher jobless numbers, and the four week moving average will turn up. That will be enough to set the cat among the equity holding pigeons, and turn a modest 5% correction into a much scarier one that is 15% or greater. All of a sudden it is d?j? vu all over again, with 2012 turning into a carbon copy of 2011, 2010, and 2009, and a big summer sell off in the cards.
I have been warning about the likelihood of such a development all year. After every company in the US hired one person, they again slammed on the brakes and quit returning e-mails. Corporate management these days are playing defense, and don?t see any increase in consumer spending as sustainable. Why add overhead in front of the next slowdown? There are also not a lot of companies that want to expand the workforce going into the summer, which normally sees a seasonal slowdown.
This sudden downgrade of one of the most important data streams is occurring just as a whole flock of black swans are getting clearance for landing. The French elections are signaling that we have at least two more weeks of ?RISK OFF? on the table until the run off on May 6, and possibly much more. Last night, the HSBC Chinese purchasing managers index came in at 49.1 for April, below the crucial boom/bust level of 50 for a sixth month. That means a Chinese hard landing is still on the table, although I think that it is unlikely.
The timing of all this couldn?t be worse, or better, if you happen to be short, as I am. The charts for virtually every risk asset, from Apple (AAPL), to the (SPX), (IWM), (USO), (CU), (FXY), (FXE), (GLD), and (SLV), are either showing textbook head and shoulder tops, or are already in clear down trends. I include an ample sampling below.
Anyone who believes that the ?RISK ON/RISK OFF? model is dead works in a profession where they can be consistently wrong and still stay in business, like in journalism. Give it two more weeks, and expect the media to start wringing hands about ?double dip? or ?triple dip? recession. Last year risk assets peaked on April 29. This year, April 29 came early, on April 2.
The Black Swans Have Been Cleared for Landing
It would be easy to ignore what is happening on the other side of the world, especially when they involve the French. But to do so today in this interconnected and interdependent world would be extremely hazardous to your wealth. When a butterfly flaps its wings in Brazil, the tsunami hits Japan.
That is exactly the extreme sort of weather event we are witnessing today with the French presidential election results. This is how they came out:
Socialist Fran?ois Hollande? 28%
Conservative Nicolas Sarkozy? 26%
Right wing Marine Le Pen 18%
Communist Jean-Luc M?lenchon 11%
Other parties and uncommitted? 17%
To say this is a disaster for Sarkozy is an understatement of the highest order. It is the first time in more than 50 years that a sitting president lost in the first round. The odds of the socialists winning again in two weeks have moved from 50:50 to more like 80:20. For Sarkozy to pull things out of the fire from here would require nothing less than a miracle.
The socialist economic policies will require an increase in government spending, growing budget deficits, an extended retirement age, and a far heavier reliance on sovereign borrowing by France. It makes a complete hash of the careful progress made by German chancellor, Angela Merkel, made towards steering Europe to live within its means. More debt issuance means higher interest rates, falling stock markets, and a continuation of the European crisis. Message: bombs away for risk assets.
The only way that Sarkozy could keep his job is to do some sort of a deal with the right wing National Front to create a coalition government. And what would be their price for such an arrangement? The immediate withdrawal of France from the Euro to recover national pride and sovereignty. Message: more bombs away for risk assets.
Needless to say, this is all hugely positive for the dollar (UUP), the yen (FXY), and US Treasury bonds (TLT), and very negative for US stocks (IWM), the Euro (FXE), oil (USO), copper (CU), gold (GLD), and silver (SLV). That house you think you recently bought at the bottom just fell in value by 5%. If you have been reading this letter in recent weeks, you already have all of the right positions and are sitting pretty. If you don?t, you better start reading.
As a long time analyst of the American political scene, I have to laugh at the results broken out by prefecture on the map below. The conservatives dominate the cities, while the socialists control the countryside, which is the complete opposite found in US election outcomes. Similarly, college grads vote conservative while the uneducated vote liberal, which again is the polar opposite of American results. No wonder I have such a hard time digesting frog legs.
The Next Prime Minister of France?
I ran into Minxin Pei, a scholar at the Carnegie Endowment for International Peace. Who imparted to me some iconoclastic out of consensus views on China?s position in the world today.
He thinks that power is not shifting from West to East; Asia is just lifting itself off the mat, with per capita GDP only at $5,800, compared to $48,000 in the US. We are simply moving from a unipolar to a multipolar world. China is not going to dominate the world, or even Asia, where there is a long history of regional rivalries and wars.
China can?t even control China, where recessions lead to revolutions, and 30% of the country, Tibet and the Uighurs, want to secede. All of Asia?s progress to date has been built on selling to the US market. Take us out, and they?re nowhere. With enormous resource, environmental, and demographic challenges constraining growth, Asia is not replacing the US anytime soon.
There is no miracle form of Asian capitalism; impoverished, younger populations are simply forced to save more because there is no social safety net. Try filing a Chinese individual tax return, where a maximum rate of 40% kicks in at an income of $35,000 a year, with no deductions, and there is no social security or Medicare in return. Ever heard of a Chinese unemployment office or jobs program?
Nor are benevolent dictatorships the answer, with the despots in Burma, Cambodia, North Korea, and Laos thoroughly trashing their countries. The press often touts the 600,000 engineers that China graduates, joined by 350,000 in India. In fact, 90% of these are only educated to a trade school standard. Asia has just one world class school, the University of Tokyo.
As much as we Americans despise ourselves and wallow in our failures, Asians see us as a bright, shining example for the world. After all, it was our open trade policies and innovation that lifted them out of poverty and destitution. Walk the streets of China, as I have done for nearly four decades, and you feel this vibrating from everything around you. I?ll consider what Minxin Pei said next time I contemplate going back into the (FXI) and (EEM).
?They got us into this mess, they?ve gotten great credit for getting out of this mess, and now they are creating even a bigger mess,? said the former chairman of Morgan Stanley International and a colleague of mine, Steve Roach.
My Apple April $450-$480 call spread expired deep in the money at the close on Friday. Legally, these expire at midnight on Saturday night, so your broker won?t take these off your statement until the following Monday. The position should be zeroed out and you should receive a cash credit. You will also find that the margin requirement has disappeared.
Your net profit on this position should be $1,855, or? $1.86% for the notional $100,000 portfolio. Well done. Here is how the profit is calculated in detail:
Execution
March $450 call cost?????... $97.60
March $480 call premium earned?-$70.25
Net Cost???????.........?. $27.35
Profit Calculation at Expiration
Expiration value???????..$30.00
Purchase cost ?..??????. . $27.35
Net Profit????????.??.$2.65
Total profit = ($2.65 X 100 X 7) = $1,855 = $1.86% for the notional $100,000 portfolio.
I will go back into another position like this in the future, but only after a substantial dip in the share price. I still think that Apple will continue on its march to $1,000 a share. Coming down the road we have Apple TV and the iPhone 5. Of far greater importance will be the adoption of Apple standards by corporate America, which has long avoided Steve Jobs? creations. This is going on everywhere, and is being hastened by the demise of Blackberry (RIMM). But it is a trip that will take years, not weeks or months.
Thanks, Steve
With all of the handwringing about the zero return on US equities for the last decade, I thought I'd better take a look at the long term charts. It's very clear that we have been trading in a gigantic sideways narrowing wedge for the last 18 years, defined by 14,000 on the upside and 6,000 on the downside.
The clever investors out there, like hedge funds, have been selling every big rally and buying every dip, laughing all the way to the bank and leaving your average Joe pension fund beneficiary, 401k owner, and mutual fund investor holding the malodorous bag.
What's more, I believe that this state of affairs is going to continue for another few years. You get what you deserve. This view is consistent with an economy that isn't inventing anything new, spends more than it borrows, and lets foreigners take the technological lead through sheer indolence and complacency. We aren't going to Twitter our way to prosperity.
It also fits with 80 million baby boomers withdrawing wealth from the system, downsizing their homes, and plopping everything into the Treasury market. This means that we are much closer to the end of this run in equities than the beginning.
If you have any doubts, take a look at the chart below showing that stocks are more expensive now than at any time in the last nine decades. Should one of the world?s? more structurally impaired economies be commanding one of the highest PE multiples? I think not. This is why I have been using my electric cattle prod and my kangaroo skin bullwhip to herd investors to the sidelines.
The Sidelines Are a Good Place to Be
Thanks to China's ?one child only? policy adopted 30 years ago, and a cultural preference for children who grow up to become family safety nets, there are now 32 million more boys under the age of 20 than girls. Large scale interference with the natural male:female ratio has been tracked with some fascination by demographers for years, and is constantly generating unintended consequences.
Until early in this century, starving rural mothers abandoned unwanted female newborns in the hills to be taken away by ?spirits.? Today, pregnant women resort to the modern day equivalent by getting ultrasounds and undergoing abortions when they learn they are carrying girls.
Millions of children are ?little emperors,? spoiled male-only children who have been raised to expect the world to revolve around them. The resulting shortage of women has led to an epidemic of ?bride kidnapping? in surrounding countries. Stealing of female children is widespread in Vietnam, Cambodia, Laos, and Mongolia.
The end result has been a barbell shaped demographic curve unlike that seen in any other country. The Beijing government says the program has succeeded in bringing the fertility rate from 3.0 down to 1.8, well below the 2.1 replacement rate. As a result, the Middle Kingdom's population today is only 1.2 billion instead of the 1.6 billion it would have been.
Political scientists have long speculated that an excess of young men would lead to more bellicose foreign policies by the Middle Kingdom. But so far the choice has been for commerce, to the detriment of America's trade balance.
In practice, the one child policy has only been applied to those who live in cities or have government jobs. That is about two thirds of the population. On my last trip to China I spent a weekend walking around Shenzhen city parks. The locals doted over their single children, while visitors from the countryside played games with their three, four, or five children. The contrast couldn?t have been more bizarre.
Economists now wonder if the practice will also understate China's long term growth rate. Parents with boys tend to be bigger savers, so they can help sons with the initial big ticket items in life, like an education, homes, and even cars. The end game for this policy has to be the Japan disease; a huge population of senior citizens with insufficient numbers of young workers to support them. The markets won't ignore this.
?The US has repositioned itself better than any of its global competitors. Americans are doing what they do best. They?re adapting, they?re moving, they?re finding good, and they?re surviving. That?s where we need to be,? said Tom Barrack, CEO of Colony Capital, and a former principal of the Bass Group.
After spending all of this year ignoring the fiscal disaster that the US is facing at the end of 2012, markets are finally taking off the blinders. That might explain why the S&P 500 has dropped 4.3% so far from its April 1 peak and why it may have more to come.
Remember the debt ceiling crisis of the summer of 2011? You know, the one that triggered a 25% collapse in US stock prices? The compromise that was struck required major progress in deficit reduction by November, or drastic measures would automatically kick in.
Well guess what? Zero progress has been made. None can be expected until after the November 6 election as long as both parties expect to win. That allows just eight weeks for the president and congress to repair some of the most serious fiscal damage ever to strike the country, three of which will be vacation weeks.
Add up the numbers and the potential impact on the economy is particularly grim. If congress takes no action by year end, a series of tax increases and spending cuts will automatically take effect that will squeeze the life out of the economy. Think Austerity with a capital ?A?. Think Spain with a capital ?S?. Even Federal Reserve Chairman, Ben Bernanke, a man normally disposed to making cautious, taciturn statements has described the problem as ?A massive fiscal cliff?.
Here is the forbidding breakdown in terms of their effect on annual GDP growth:
-0.2%? Expiration of unemployment benefits
-0.8%? Automatic spending cuts required by sequestration
-0.8%? Expiration of payroll tax cuts
-1.0%? Expiration of Bush tax cuts
-2.8%? Total
The big problem is that the economy doesn?t have much economic growth to give away. My own forecast for GDP for 2012 is still at 2%. But that is based on the assumption that corporate earnings would bring in 5% growth, down from last year?s torrid 15% growth. My calculator tells me that 2% -2.8% = recession. Danger! Danger! Current stock prices are not reflecting this reality.
It gets worse. The 15% of companies that have reported Q1, 2012 earnings so far have delivered a much more modest 1% growth, well below my own minimal expectations. That is with the earnings cycle front loaded with the most profitable companies in technology. It also reflects a lot of business pulled forward into Q1 from Q2 and Q3 by the warm winter. Yikes!
It?s hard to see how this ends happily for the stock market. The best case scenario would be for a lame duck president and congress, no longer worried about reelection, to cobble together a deal in December. Some sort of resuscitation of the ?grand bargain? that was on the table last summer, but suffocated in its crib by the Tea Party because it included tax increases, might work. Alternatively, if one party or the other sweeps the election, it could ram through something. But that outcome is unlikely. A divided country gets the dysfunctional government it deserves.
The headache for equity investors and risk investors in general is that even the mere discussion of the weighty matters triggers a huge ?RISK OFF? trade. Confidence withers, business and consumer spending slows, and the economic data takes a hit. That?s what happened last summer, when the markets discounted a full blown double dip recession that never actually happened. It?s a given that our representatives in congress don?t understand this.
Is This Our Fiscal Policy?