Friday, August 21, 2009

The Recession is Over

...according to a statement made by Ben Bernanke today.

That's great. I'm so glad to hear it. They were sounding somewhat more pessimistic at the FOMC last week but hey, I'll take it. Hopefully now, the bailouts will come to a close, the auction lending facilities will be wrapped up as soon as possible, quantitative easing will at least not be extended beyond where it is at now (if not stopped early), and further FOMC meetings will bring rises in the interest rate.

Or perhaps, maybe, current circumstances are supported by unsustainable easy credit from the government that will reverse once the bailout measures reach their natural endpoint of an exhausted tax base?

Monday, August 17, 2009

Squeezing the Shorts

This blog has presented a macroeconomic theory over the past year and a half, which examines money supply, bailouts, and equates inventory with money supply and considers the consequences assuming that relationship to hold true.

But in terms of day-to-day fluctuations of the stock market, and even sustained runs, my guess work has not been good, and were I playing a shorting game, even though I am as much a bear as anyone, my guesses as to when fluctuations were to take place have been so bad I’m sure I would have lost my pants.

Part of it is the activity of bailouts of the falling economy, which is at best kept discrete and at worst hidden from the public eye. Bailouts allow upswings to go on longer than they should. But shorting is another factor which allows a bear run to enjoy one last moment of triumph when all looks hopeless. Which I’d like to comment on today. So I propose three phases to a bear run to help predict or at least better understand the natural course of upswings during a generally down market (or “bear runs”):

1. The Run: all bear markets have reversals of course. In the panic of a down market the indices will overshoot, which will be followed by a reactive upswing. This results from the inevitable imprecision of market pricing, which worsens during strong or unexpected periods of change—in other words, sinusoidal amplitudes that surround mean pricing only worsen. To predict the course of the bear run, one guesses what the mean pricing of stocks should be at a given moment, and the degree that the fall went below that average. The rebound should overshoot the "true" value by a similar amount.

2. Doubt and Shorting: when that moment comes to pass, and indices start to level off, and we all think the run is over, then since many people are expecting reversals of the market, shorting will be prevalent.

3. Squeezing the Shorts: however, if many people short the market at the same time, a third dynamic comes into play. Prices of stocks are determined by what buyers are willing to pay, and what sellers are willing to accept. With many shorts in play, those who possess the stock know that shorters HAVE to buy stock at whatever price it is at when the short sale comes due. At that time, there will be intense demand for the stocks, and since shorters have no choice, an extortion game can be played where shockholders wait it out for excessively high returns. And so we see sudden spikes of stock prices at the end of “bear runs,” right after it has started to level off.

4. Recycling: now, seeing this uptick can potentially arouse confidence and produce another run, albeit smaller, until shorters are exhausted and the run loses all confidence.

Then and only then will there be a down swing in the market.

Thursday, August 13, 2009

"Agency Debt," Part 2

In the continuing mystery of "agency debt," for which the Fed intends to spend $200B (around $1500 T*Bux) as a part of its quantitative easing program—"agency" we think means the GSE's—but "debt" remains ill-defined other than it probably does not mean mortgage-backed securities since there is a separate $1.25T program for that.

On his blog, Mish showed a robust market for corporate debt over the past month which he attributed to fueling the S&P index.

If this is where the $200B is earmarked—toward buying, insuring, or somehow facilitating corporate debt—we have an explanation for the sustained comeback of U.S. stock indices in the setting of an otherwise deteriorating economy.

But I don't know of any GSE that invests in major corporations so, again, the term "agency" continues to remain non-specific.

Wednesday, August 12, 2009

Quantitative Easing through October

The Fed had an uneventful FOMC meeting today. The notes are pessimistic about the economy despite recent events in the DJIA and other economic indices. There is no suggestion of rate hikes from 0% as it stands now. They did extend the window of quantitative easing by a month from September to October, but the amount remains $300B for treasuries, and then around $1.5T in "agency" mortgage-back securites and "debt."

For the record, $300B equals $2175 T*Bux, and $1.45T is $10,512 T*Bux. In other words this round of bank bailouts runs close to $13,000 per taxpayer. But money isn't coming from taxpayers... it's coming from the printing presses of the Fed, and so the tax is more of a devaluation of existing currency than something taken from our income. Such devaluation will be reversed as the bonds are paid back. Treasuries will be repaid, but I'm highly skeptical about agency mortgage-backed securites and debt, and so much of that $1.5T would be pure monetary expansion handed to the bankers.

My guess is, money supply will be diluted by around $1T from this. This would be bad for anyone holding onto cash.

Cash supply now runs around $1T (discounting what is sitting idle in bank reserves), and fractional reserve debt runs around 9x that (with approximately $4T in mortgages and $1T in consumer debt)—and so I'm guessing a ball park money supply of around $10T from cash and credit.

In the current environment of tightening credit, we have 90% of the money supply that could potentially contract quite a bit, and if credit falls more than 15%, such would wash out any total monetary expansion from quantitative easing.

Monday, August 10, 2009

Trophy Houses

In the midst of this current economic resurgence since last March, where it is hard to discern any economic growth driving it but it keeps progressing and beating expectations, I’d like to comment on a clear pattern seen in the real estate market since declines began in 2006 (or 2007 in San Francisco). It is this: low-end properties are correcting toward fundamentals faster than the higher-end ones, with middle-range properties somewhere in between.

To me the explanation is straightforward: there is greater economic capacitance at the wealthier end of the spectrum, so more ability there to sustain a drain of wealth while waiting for a turnaround. (Those getting the bailouts enjoy a whole lot of economic capacitance.) Low economic capacitance has a snowball effect: inability to keep up with underwater mortgages leads to that many more properties on the market, which leads to further erosion of prices, which means more underwater mortgages and more homeowners with a motive to walk away, and less ability to buy in worsening economic times.

However, if low-end properties become a decent investment once you factor in the rent-to-mortgage ratio, whereas higher tier properties demand mortgages well in excess of rents, then the low-end market will draw interest from middle-range buyers, exerting a downward pressure on that market, which will eventually work its way to the top.

So goes economic theory. In actuality, upper-end properties in areas of high demand are declining in price very slowly, at best. I’m thinking of San Francisco. Which begs the question—might there be areas immune to economic factors, “trophy” properties in other words, which will maintain a strong market so long as there is an upper 5% of the population that controls 80% of the wealth, or so?

Now I’m all for redistribution of wealth, so long as it is voluntary, and trophy purchases of any kind—cars, boats, houses—have exactly that effect: a drain on wealth from those who have it. By “trophy” I mean a purchase which commands prices above and beyond fundamental value because of general desirability and status benefit which comes of it. So, is this trophy market sustainable? Could somebody get an upper tier house in San Francisco with the anticipation that wealth would at least be preserved and capital gains could even improve on the investment?

I suppose the only answer is: “time will tell.” It depends on how deep the pockets of the wealthy run. But one does not become rich or stay rich by losing money. In anything but a climate of compelling capitals gains, trophy properties are costly.

Sunday, August 2, 2009

What If...

For all of those now contemplating that the recent upswing of economic indices reflects a true turn around, I wish they would all pause for a brief moment to reflect on the following: imagine if all taxpayer underwritten government programs—the TARP, TAFs, the upcoming PPIP, and any other money the Fed, Treasury Department, and GSEs are now tossing around—what if it all suddenly came to a halt? Then what? Would you still anticipate the economy to continue growing and the numbers to keep rising?

All bear markets have bull swings. This one, in addition, has a lot of government backing. The Obama administration will do everything possible to keep the bubble economy in this disequilibrium state. As long as there are people willing to buy Treasuries, such money can be used indefinitely to keep easy credit flowing and the money supply high. The end point is where Treasuries become prohibitively expensive because nobody wants them or, hopefully sooner, the tax base increasingly comes to realize the fraud being perpetrated and takes a stronger stand against it.

Government bailouts can only stall the economic contraction. Eventually they will run out of money, and the return to fundamentals will continue. What is worse, the government money misapproprated in Wall Street bailouts now will be gone when it is truly needed for jobs, extended unemployment, food programs, and basic social supports.