Monday, May 27, 2013

Europe’s Clash of Generations

by Gene Frieda

LONDON – As Europe’s financial crisis goes from acute to chronic, the dispute over who will bear the costs of resolving it is fueling the emergence of a new generation of political movements. In the so-called periphery, political upstarts promise citizens an alternative to austerity. In the eurozone’s “core” countries, they purport to protect taxpayers from relentless demands for debtor-country relief. How Europe’s leaders respond to these new political challengers will determine whether the monetary union stabilizes or fractures.

This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Paul Lachine

Europe’s political elite have, for the most part, been strongly integrationist. Given that they are largely of the post-World War II generation, they are acutely aware of the benefits of a peaceful Europe. In the 1990’s, differing visions of European integration led to a problematic compromise. In order to secure France’s backing for German reunification, Germany agreed to create a monetary union – but not a fiscal union. Now, Europe is suffering the consequences of that Faustian bargain.

At the same time, Europe’s leaders are under pressure from a new generation of voters, who grew up in the shadow of the Berlin Wall’s collapse. The lifting of the Iron Curtain gave the West access to a vast supply of cheap labor in Eastern Europe. China’s subsequent emergence expanded that supply further, culminating with China’s entry into the World Trade Organization in 2001. As a result, many of Europe’s economies began to fall behind.

European leaders hoped that a monetary union would help Europe’s less competitive economies catch up to the richer countries of the north. And, during its first decade, the euro ostensibly delivered. Just as cheap mortgage financing papered over the cracks of growing income inequality in the United States, cheap capital from the north accelerated Europe’s apparent economic convergence.

The post-Wall generation seemed to have all the luck – at least for a while. But income inequality was worsening steadily in all member countries, with more highly educated citizens benefiting from the booming services industry, while the less educated suffered as manufacturing moved to cheaper locations. Then, the global financial crisis struck, income inequality rose sharply, and the post-Wall generation in southern Europe suffered the largest drop in living standards since WWII.

Unlike the US, which was founded on a political cause – opposition to British colonialism – that forged a common national identity, countries joining the European Union sought simply to avoid further warfare on the continent. While laudable, this cause was inadequate to foster a shared European identity. On the contrary, it allowed national identity to flourish.

The post-Wall generation, whose members are less than 40 years old and thus far removed from WWII, has little appreciation for this cause. For them, debtor and creditor countries’ increasingly divergent economic objectives are much more meaningful.

Citizens of debtor economies, who grew up complacent about economic convergence, have lost their savings and, in many cases, have run out of hope. Meanwhile, citizens of creditor countries are focused on protecting the gains made before the crisis; after all, it was their savings that financed their neighbors’ reckless spending.

Throughout the eurozone, rising income inequality has created an underclass that is increasingly suspicious of the monetary union. As the post-war generation ages – with most of its members now at least 60 years old and its leaders either in senior leadership positions or acting as senior statesmen – the remaining support for integration is waning.

Many post-Wall voters stand on the margins of established parties or are forming parties of their own, while a more pragmatic group is being pulled between the old order and new movements. The muddled, reactive response to the euro crisis reflects the compromises that traditional political parties have made in order to remain in power as generational differences have become increasingly extreme.

Political revolutions rarely arise out of brief periods of acute crisis. Rather, they follow one or more generations of chronic decline, when fear of economic loss gives way to targeted anger, and charismatic voices surface to orchestrate the response. This pattern has recurred throughout history, from the French Revolution all the way to the fall of the Berlin Wall. Although markets may have been cowed into submission for now, the cracks in the eurozone’s political foundations are beginning to show.

For now, the post-Wall generation lacks a clear focus for its anger. New populist parties in Italy, Greece, and Germany reflect the direction in which politics is moving, not the final destination. Their ability to win support from both the left and the right suggests a shared aspiration to rebuild the protective national barriers that the post-War generation demolished.

Against this background, most European leaders are afraid that their electorates will reject anything that seems to imply more integration. It is a classic prisoner’s dilemma: all countries are better off if they contribute to a common cause, but the pressure of national elections impedes politicians’ ability to champion that cause. The ultimate test of leadership will be a commitment to EU treaty reform, with all the thorny negotiations and referenda that this entails.

The post-war generation’s political leaders must respond promptly and effectively to the challenge posed by emerging political movements while they are still immature. If they wait too long, the old walls will be restored and the euro’s guardians will be left out in the cold.

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Misreading the Global Economy

by Ashoka Mody

PRINCETON – In April 2010, the International Monetary Fund’s World Economic Outlook offered an optimistic assessment of the global economy, describing a multi-speed recovery strong enough to support roughly 4.5% annual GDP growth for the foreseeable future – a higher pace than during the bubble years of 2000-2007. But, since then, the IMF has steadily pared its economic projections. Indeed, this year’s expected GDP growth rate of 3.3% – which was revised downward in the most recent WEO – will probably not be met.

This illustration is by Paul Lachine and comes from <a href=""></a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

Illustration by Paul Lachine

Persistent optimism reflects a serious misdiagnosis of the global economy’s troubles. Most notably, economic projections have vastly underestimated the severity of the eurozone crisis, as well as its impact on the rest of the world. And recovery prospects continue to depend on the emerging economies, even as they experience a sharp slowdown. The WEO’s prediction of a strengthening recovery this year continues the misdiagnosis.

European Central Bank President Mario Draghi’s announcement last summer that the ECB would do “whatever it takes” to preserve the euro reassured financial markets. But, as pressure from financial markets has eased, so has European leaders’ incentive to address problems with the eurozone’s underlying economic and political dynamics. Easy ECB liquidity is now sustaining a vast swath of Europe’s banking system.

The eurozone is operating under the pretense that public and private debts will, at some point, be repaid, although, in many countries, the distress now is greater than it was at the start of the crisis almost five years ago. As a result, banks, borrowers, and governments are dragging each other into a vicious downward spiral. Politicians have exacerbated the situation by doubling down on fiscal austerity, which has undermined GDP growth while failing to shrink government debt/GDP ratios. And no decisive policy action aimed at healing private balance sheets appears imminent.

Moreover, Europe’s problems are no longer its own. Europe’s extensive regional and global trade networks mean that its internal problems are impeding world trade and, in turn, global economic growth. In 2012, world trade expanded by only 2.5%, while global GDP grew at a disappointing 3.2% rate.

Periods in which trade grows at a slower pace than output are rare, and reflect severe strain on the global economy’s health. While the trauma is no longer acute, as it was in 2009, wounds remain – and they are breeding new pathologies. Unfortunately, the damage is occurring quietly, enabling political interests to overshadow any sense of urgency about the need to redress the global economy’s intensifying problems.

Against this bleak background, it is easy to celebrate the success of emerging markets. After all, emerging and developing economies are growing much faster than the advanced countries. But even the world’s most dynamic emerging markets – including China, Brazil, and India – are experiencing a sharp deceleration that cannot be ignored.

Consider India, where growth is now running at an annualized rate of 4.5%, down from 7.7% annual growth in 2011. To be sure, the IMF projects that India’s economy will rebound later in 2013, but the basis for this optimism is unclear, given that all indicators so far suggest another dismal year.

The emerging economies’ supposed resilience, which has buoyed economic forecasts in recent years, needs to be reassessed. Like the advanced economies, emerging economies experienced a boom in 2000-2007. But, unlike the advanced economies, they maintained high GDP growth rates and relative stability even at the height of the crisis. This was viewed as powerful evidence of their new economic might. In fact, it was largely a result of massive fiscal stimulus and credit expansion.

Indeed, as the effects of stimulus programs wear off, new weaknesses are emerging, such as persistent inflation in India and credit misallocation in China. Given this, the notion that emerging economies will recapture the growth levels of the bubble years seems farfetched.

Economic forecasts rest on the assumption that economies ultimately heal themselves. But economies’ powerful self-healing capabilities work slowly. More problematic, a misdiagnosis can lead to treatments that impair the healing process. Overly optimistic economic projections based on mistaken assessments of the global economy’s ailments thus threaten recovery prospects – with potentially far-reaching consequences.

In Europe, the banks’ wounds must be closed – weak banks must be shut down or merged with stronger banks – before recovery can begin. This will require an extensive swap of private debts for equity. For the global economy, the malaise reflected in anemic trade growth calls for coordinated fiscal stimulus by the world’s major economies. Otherwise, the risk of another global recession will continue to rise.

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The Cashless Society

By John Mauldin

The Underground Recovery
The Cashless Society?
Welfare and Incentives
Carlsbad, Tulsa, Nashville, Brussels, and Homeless in Dallas

But Mousie, thou art [not alone],
In proving foresight may be vain:
The best-laid schemes o' mice an' men
Gang aft agley,
An' lea'e us nought but grief an' pain,
For promis'd joy!

Robert Burns, To a Mouse, on Turning Her Up in Her Nest with the Plough

It is a common trope in science fiction novels. Economic transactions are handled seamlessly with a wave of a card or a physically imbedded chip, and whatever the author imagines money to be is transferred, far removed from the archaic confines of ancient physical monies. If you Google "cashless society" you get about 600,000 references in under a second, and 20 pages into the references there are still articles on a future world where physical cash is no longer needed. Some see it as a sign of the "end times," some as a capitalist plot, some as a frightening vision of socialists and ever-bigger governments, and some as a logical step in the evolution of a technologically driven international commerce.

And some of the "cashless society" references are showcase articles for the latest innovation that turns your phone or smart card into a functional wallet. I can attest it is quite possible to go for days without needing actual cash (as long as there are no kids around). The Bitcoin phenomenon (28 million sources on Google!) is a libertarian enthusiast's dream of not just a cashless society but a society with no need for fiat money and central banks.

Today we'll look at research suggesting that cashless future might be farther off than we either fear or hope. Not only is a cashless society farther away than some think, we are actually seeing an increase in the use of cash all over the world (and this is not just a US phenomenon). We will look at some interesting factoids that in themselves make for thought-provoking discussions, but when we couple them with research on the rise of the unreported economy (aka the underground economy) and the number of people who get some form of government assistance, we may find problematic consequences resulting from hidden incentives that work in unintended ways.

The Underground Recovery

In a recent New Yorker article entitled, “The Underground Economy,” writer James Surowiecki explores the import of a study by University of Wisconsin economist and professor emeritus Edgar Feige, who for many years has done research on the amount of actual cash in the US. Feige has recently updated his work.

What prompted me to follow up and then finally to discuss his work personally with a remarkably accessible Feige was his rather well-documented refutation of a common assertion I have long believed: that at least 2/3 of physical, printed US cash circulates outside the borders of the country. Indeed, you can find research on this topic at the San Francisco Fed and in serious economic journals, so this was not just some anecdotal belief I held from observing the impressively large number of dollars in use wherever I travel in the world. But no, this factoid was something "everyone" simply "knew." Well, everyone but a few people like Feige and evidently some people at the New York Fed.

And we are not talking about a small difference between perception and reality here. Feige asserts convincingly that only 23% of physical US dollars are outside our borders. The difference is $400-500 billion, not a small sum. He vigorously (and I think conclusively) dissects the assumptions in the research that has generated and promoted the larger number. (You can read his 28-page paper here. Let’s look at some of the more interesting parts of his research. (Emphasis mine, of course. This is an academic paper, after all, and polite academics do not use boldface for emphasis.)

The rapid growth of substitutes for cash, particularly debit and credit cards, has led economists to predict the advent of the "cashless society". Yet cash holdings in most developed economies continue to grow and in the U.S., per capita currency holdings now amount to $3000. This paper revisits the long-standing controversy concerning the whereabouts of U.S. cash. Specifically, we employ a previously confidential data source on net shipments of U.S. currency abroad to re-estimate the fraction of U.S. currency held overseas. Contrary to the widely cited figure that 65 percent of U.S. currency is abroad, we now find that direct evidence supports the notion that overseas holdings amount to less than 25 percent. With domestic cash holdings amounting to roughly $2250 per capita, we are far from a "cashless society".

He goes on to note,

Currently, the official figure for the percent of U.S. currency held abroad as published by the Federal Reserve in their Flow of Funds Accounts and by the Bureau of Economic Analysis in the U.S. Balance of Payments Accounts is 39 percent….

To put these figures in perspective, they imply that the average American’s bulging wallet holds roughly 91 pieces of U.S. paper currency, consisting of: 31 one dollar bills; 7 fives; 5 tens; 21 twenties; 4 fifties and 23 one hundred dollar bills. Few of us will recognize ourselves as "average" citizens. Clearly, these amounts of currency are not normally necessary for those of us simply wishing to make payments when neither credit/debit cards nor checks are accepted or convenient to use. Yet as shown in Figure 2, these surprisingly high U.S. per capita currency values were exceeded by per capita currency values for Europe ($3274); Hong Kong ($3963), Switzerland ($6335) and Japan ($7562).

(Very odd factoids for those of us currently obsessed with all things Japanese. Not only do the Japanese have the largest per capita currency in circulation, but surveys tell us that the Japanese people only admit to holding about 10% of that cash. This is indeed, as Feige first noted in research in 1989(!), a "currency enigma." Sidebar question with no immediate answer: Cash is by definition deflationary, and Japan has problems with deflation … and now Kuroda-san is going to crank up the electronic printing presses? I will pose that one to Kyle Bass and Louis Gave, among others, next week. If the answer is interesting, I will report back.)

As Feige noted, on average we are each holding 23 $100 bills. Wondering where your Ben Franklins are? Here, just for fun, is the new $100 bill, coming on October 8:

Interestingly, much of the cash outside the US is in $100 bills, so that may explain where some of the missing C-notes are. Here’s Feige:

Even a cursory examination of the growth and magnitude of the U.S. currency supply in circulation with the public reveals that predictions of the advent of the "cashless society" are unfounded. Despite financial innovations giving rise to convenient substitutes for cash, per capita cash holdings continue to increase and by the end of 2011, amounted to $3000 for every man woman and child residing in the U.S. While this figure does not comport with our common sense notion of how many dollars the average person holds in her wallet, we show that Europeans and Japanese citizens hold even larger amounts of cash. Two explanations are offered for these large cash holdings. The first posits that a large fraction of U.S. currency is held abroad, the second that large amounts of cash are employed to undertake transactions that individuals and firms prefer to hide from the government either to avoid taxes, regulations or punishment for illegal activities.

The Cashless Society?

Professor Feige soundly refutes the first theory. The second one is what is interesting here: there is a rather large cash economy in the US.

The above-referenced article by Surowiecki in The New Yorker was actually about another piece of research by Feige on the "underground economy." (Feige is at least in his mid-70s and is clearly still quite active for one with "emeritus" in his title. He has one very impressive, yea, intimidating resumé, with 80 publications to his credit. His first book was published 50 years ago, and he has been called "the father of underground economy analysis.")

In my conversation with him, Feige made it clear that he thinks it should be called the "unreported" rather than the "underground" economy. By whatever name, that economy apparently totals about $2 trillion a year in the US. And the "lost" tax revenue is in the neighborhood of $400 billion a year. That amount is downright puzzling if the cash in US circulation is only $250 billion (as would be indicated if 65% of US dollars really were outside the country). That would be pretty high velocity (the number of times money moves from one hand to another). But if cash is actually $750 billion, then that velocity becomes not so remarkable at all.

Surowiecki writes:

The percentage of Americans who don’t use banks is surprisingly high, and on the rise. Off-the-books activity also helps explain a mystery about the current economy: even though the percentage of Americans officially working has dropped dramatically, and even though household income is still well below what it was in 2007, personal consumption is higher than it was before the recession, and retail sales have been growing briskly (despite a dip in March). Bernard Baumohl, an economist at the Economic Outlook Group, estimates that, based on historical patterns, current retail sales are actually what you’d expect if the unemployment rate were around five or six per cent, rather than the 7.6 per cent we’re stuck with. The difference, he argues, probably reflects workers migrating into the shadow economy. "It’s typical that during recessions people work on the side while collecting unemployment," Baumohl told me. "But the severity of the recession and the profound weakness of this recovery may mean that a lot more people have entered the underground economy, and have had to stay there longer."…

The U.S. is certainly a long way from, say, Greece, where tax evasion is a national sport and the shadow economy accounts for twenty-seven per cent of G.D.P. But the forces pushing people to work off the books are powerful. Feige points to the growing distrust of government as one important factor. The desire to avoid licensing regulations, which force people to jump through elaborate hoops just to get a job, is another. Most important, perhaps, are changes in the way we work. As Baumohl put it, "For businesses, the calculus of hiring has fundamentally changed." Companies have got used to bringing people on as needed and then dropping them when the job is over, and they save on benefits and payroll taxes by treating even full-time employees as independent contractors. Casual employment often becomes under-the-table work; the arrangement has become a way of life in the construction industry. In a recent California survey of three hundred thousand contractors, two-thirds said they had no direct employees, meaning that they did not need to pay workers’-compensation insurance or payroll taxes. In other words, for lots of people off-the-books work is the only job available.

J.D. Tuccille, over at, responds to the New Yorker article with an interesting analysis pointing to tax rates as the issue, among other things:

Surowiecki bemoans the "damaging effects of this trend," but he should pay more attention to the damaging taxes and regulations that caused this trend by pushing people to work off the books. People aren't depriving themselves of legal recourse and traditional benefits because it's suddenly hip to do so – they're hiding in the shadows because red tape and taxes are strangling the legal economy.

These are concerns. People respond to personal incentives. If the incentive to make their life better in the short term is to work off the books – and that is the basic choice – then that is what they will do. But that is not where I want to go with this discussion today. Let’s focus on another incentive to move out of the reported economy.

Welfare and Incentives

I think almost everyone participates in the unreported economy in one way or another. Do you tip a waiter or waitress? Pay cash for taxis or tip the bellman at the hotel? The baggage guys at the airport? The guys who do your lawn? Even if you write checks for a service, does that mean that income is reported?

I and most other businesspeople try to pay for everything that is a business deduction with a credit card. That can be tricky during IRS audits, but it is just easier than keeping receipts and documenting expenses when you get homeand then trying to add up your cash payments. And you can use a credit card or cash card without problems almost everywhere.

(When I travel outside the US, I am sometimes frowned at if I try to use a credit card. Singapore? No problem. Across much of Europe a credit card is not an issue, but cash is clearly appreciated. Then again, there was the time I wrote about last January, when I tried to use a credit card at a taverna off the tourist paths in Greece, and they had to hunt for their credit card machine and it didn’t work after they found it. And gods forbid you try and use a credit card in Argentina. My point is that the unreported economy is hardly just a US phenomenon.)

But there is a part of US society where unreported income is a particular problem, due to unintended consequences of poorly designed incentives. That is the segment of the country on welfare.

Let me note up front that this is not an argument for or against welfare or helping the poor and needy. I am just noting the large cash economy and offering another reason why it might be as large as it is: misaligned incentives.

In the last few months, conservative news outlets cited a Republican Congressional survey that shows that welfare is about $1 trillion of the US budget, or $168 per day for those below the poverty line. When you dig into the data, you find that a very loose definition of "welfare" was employed, one that most Americans would not use for many of the programs the survey lists. It might argued that the money in question should not be spent, but the survey does not pass the smell test in identifying actual welfare.

According to the Center for Budget and Policy Priorities, even when one uses a very expansive definition of "welfare," only "13 percent of the federal budget in 2011, or $466 billion, went to support programs that provide aid (other than health insurance or Social Security benefits) to individuals and families facing hardship." (

The St. Louis Federal Reserve database shows an even smaller welfare number, at $273 billion (chart below), but you can add about $140 billion at the state level and that gets you closer to the $466 billion mentioned above. That is still a large number per day per family below the poverty line. But let me hasten to add that is NOT what an actual recipient gets; it is just the budgeted cost, which includes what it takes to run the government offices and pay welfare workers.

Let’s look at a few quick statistics, which taken out of context can be misleading, so don’t be misled or assume that I am. The total number of people on welfare is  about 4,300,000. The total number of people getting food stamps (the SNAP program) is 46,700,000. We just saw a new high for the number of families on food stamps:

In Texas if, as a single mother of two or three kids, you can figure out how to qualify for every type of assistance available, you can amass get the princely sum of about $980 a month (plus some healthcare). Other states are more generous. The popular meme is that 40 states pay more than $8 an hour to those on welfare, with seven paying more than $12 an hour. But if you work and make more than $1,000 a month (more or less, depending on the state) you will not likely qualify for welfare. The more you make the less you can get, until at some point you do not qualify at all. The theory is that benefits should decrease as your work income increases. (Source for some data:

Of course, there is the earned income tax credit (EITC), which is phased out once income reaches certain levels. To qualify for that, of course, you need to actually earn income. And WIC, housing subsidies, Medicaid, and other programs exist. (And we will not even get into disability payments. We have recently seen the number of people on disability rise faster than the number of people going back to work. Can a child or other member of a family get disability and another get welfare? Yes, the system can be gamed. Different letter.)

The following chart is from the generally liberal Urban Institute. Note that the maximum amount of total benefits is received by those who have the lowest levels of income, which makes a certain sort of sense. This chart is for a single parent in Colorado, a state that is middle of the road as far as benefits go. Benefits are considerably lower in Mississippi and far higher in Massachusetts and Alaska.

I am not arguing either for or against the level of payments or costs or the rationale for any particular program here. Different issue, different day.

No matter where you live, with few exceptions, being on welfare is not a pleasant lifestyle. Neither is living on $10 an hour, much less on minimum wage.

The point is that people on welfare have a clear need for more money than they get from whatever government check they receive. For most people, welfare is a temporary assistance program to help them out between jobs. But in the last decade, and especially in the five years since the beginning of the Great Recession, the welfare and disability rolls have simply exploded.

The clear incentive, it seems to me, is to work for extra cash in the unreported economy. If as a single working parent you make $10 an hour in the reported economy, you are going to lose most if not all of your welfare benefits (depending on the state); while if you work in the unreported economy, you keep your benefits.

You can view this situation several ways. For instance, perhaps the EITC should be higher, as in, the more you make the more you keep.

If you have a skill that pays you $20-30 an hour (closer to the median family income pay level) you are better off keeping the job and staying off welfare. But if you are minimum-wage labor or not far above it, the equation works out better if you work off the books for that extra income.

Is everyone on welfare working in the unreported economy? I would not suggest that for a minute. Obviously, they aren't.

While acknowledging that correlation is not causation, the parallel growth of the underground economy and the welfare rolls seem to me to be not entirely unrelated. The natural incentives are clearly there. What worries me most is that we are creating a generation of people who are getting used to working off the books, whether or not they are on welfare. They are outside the system and will come to see themselves as not being part of it. It becomes something "other" – except when they want medical care, which, with the advent of Obamacare, will now be available them even if they work in the unreported economy.

None of our kids, yours or mine, believe Social Security will be there for them when they retire. No need to be in the system for that.

There is a lot of controversial work in the economics profession, but I think pretty much everyone agrees that people respond to incentives. I wonder what message we are sending?

Carlsbad, Tulsa, Nashville, Brussels, and Homeless in Dallas

Next Monday I leave for Carlsbad and my conference, which starts on Wednesday evening; but there are lots of meetings and other things to attend to beforehand. Monday I will go to the Altegris office, where there is a lot to discuss, and then I'll meet with Jon Sundt and the other partners that night. The next day will see my Mauldin Economics staff show up for a long day of planning, as we try to deal with our rapid expansion.

And then when the meetings are over and the conference starts up, I get to enjoy again one of my favorite times of the year, when I get to see so many friends and have so many awesome conversations. I personally wish I could make it last for a week or more, as there is just not enough time to spend with everyone. But we take what we can get and savor it.

After the conference I'll be home for a bit before I make my way to Tulsa, where my daughter Abigail will get married May 19. (Her twin sister Amanda is doing fine with one-month-old daughter Addison!)

Later that week I'll fly to Nashville for a night, to speak at a meeting for Altegris, before returning to Dallas to write my letter and then head for Brussels for a week.

I am working on so many writing projects, plus my speech for next week, that I am quite busy. And there are just so many interesting things I come across that seem to demand my attention, not the least of which is working on the new-apartment design and contracting. But of course, we actually have to close the loans and make the purchase first. It seems like it takes forever, which is exactly what everyone told me to expect.

I am still "Homeless in Dallas," living in an extended-stay hotel. I don’t want to rent a temporary apartment until the new place actually closes, so that I can finesse the timing of everything. Therefore, most of my worldly possessions are in storage. It is an interesting experience, as I am finding out that I need far less than I have, and I'm sure I could cut even more. The important things, it seems, are the phone and computer, which are my lifelines to my kids and other family and friends and work. Those two possessions go with me everywhere. And with the new technology in hand, I am finding it easier to enjoy myself wherever I am – and to anticipate the next moment as well. Yes, there are always issues. Kids come with issues galore, and there are always things in the businesses that need tending to. Expenses pile up to more than I like. As do writing deadlines. And now I have to put up with a lack of air traffic controllers and a balky FAA. There is no end of things I could dwell on and stress over, if I wanted to.

There are also a lot of Big Things to worry about in this world of ours, but with an abundance of family and friends, the Small Things seem to work out just fine. You have a great week!

Your living in the moment analyst,

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Chart Of The Day: S&P 500 Now At Extremes

by Lance Roberts

Recently I have been discussing the direct connection between the Federal Reserve's Q.E. program and the market as well as putting you, my dear reader, to the task of answering the inherent questions regarding the sustainability of the current rally.

Today's chart of the day looks at the market from a technical perspective.  While there are a plethora of Wall Street analysts calling for much higher levels for the S&P 500; most of these calls are based simply on the belief that the current trajectory must continue indefinitely.  While you certainly cannot "fight the Fed" the underlying fundamentals and economics that support the markets long term are not present for the party.  What is very important to understand, and can be clearly seen in the chart below, is that despite repeated calls for "ever rising" stock markets in the past eventually left investors devastated.  Markets do not, and cannot, continue indefinitely in one direction.

Market prices are subject to gravity (the long term moving average) and the longer the duration of the moving average the greater the "gravitational pull" that exists.  One way to measure extremes of price movement is through the use of standard deviation.   One standard deviation from the mean (average) encompasses 68.2% of potential outcomes within a given distribution of data which, in this case, are market prices.  Two standard deviations encompass 95.8% of all potential outcomes while three standard deviations encompass 99.8% of all potential outcomes.

The chart below shows a MONTHLY chart, which is a very slow moving analysis, of the S&P 500 overlaid with Bollinger Bands which represent 2 and 3 standard deviations of a very long term (34 month) moving average.


At the peaks of the "Internet Bubble" and the "Credit/Housing Bubble" the market never got significantly above 2-standard deviations.  Today, we are encroaching well into 3-standard deviation territory.  Standard deviation analysis tells us that roughly 99% of the potential movement in prices, from the bottom of the correction in 2011, has been achieved.  Furthermore, the extension of the market above the long term moving average is also at levels that have previously been associated with major market tops.

The top graph is a very long term (150 month) measure of overbought and oversold conditions.  It is also warning that the current market environment is stretched very far and that further gains are likely to be limited without a correction first.

However, therein lies the potential problem.  Looking back at the markets during a bullish trend the market is usually contained between the long term moving average and 2-standard deviations above the mean.  However, when the extension is above the long term mean subsequent corrections are generally more associated with mean reversions.  A mean reversion is where prices fall an equal distance in the opposite direction or well below the long term moving average.

The current level of overbought conditions combined with extreme complacency in the market leave unwitting investors in danger of a more severe correction than currently anticipated.  A correction to the long term moving average (currently around 1350) would entail an 18.5% correction.  A correction to 2-standard deviations below the long term moving average (which is most common within a mean reversion process) would slap investors with 33% loss.

If you don't think a 33% loss is possible you should be aware that that is about the average draw down of the markets during a normal recessionary cycle.  Not only is such an event possible - it is probable when, not if, the economy slips into an eventual recession.

IMPORTANT:  We are currently invested n the market and I am not suggesting that you sell everything and move to cash.  What I am saying is that the market is very extended and the risk of a correction of some magnitude has increased significantly this year.   Therefore, if you are close to retirement, or simply just can't afford the risk of a major market correction, then you may want to start reducing some of your portfolio risk and begin to build in some hedges against an unexpected event.  Whatever eventually trips up the market will be "unexpected."

Currently, it seems that most of the world's concerns have been put behind us due to the massive injections of liquidity being injected by the Federal Reserve, BOJ, ECB and China.  The Eurozone crisis has disappeared, recessions in the Eurozone and weak US economic data are of little concern, declining revenue and earnings are readily dismissed as the primary driving force for investors is Fed interventions.  However, it is within this complacency, that an unexpected turn of events can pull the rug from beneath the markets and send money racing for the sidelines.  Unfortunately, for most individuals, by the time they realize what is happening it will likely be far too late to act.

See the original article >>

The Week Ahead: Volatility Rising?

by Jeff Miller

Eureka! Markets can move in both directions – even in a single day!

The relentless market rally since the fiscal cliff was averted has left everyone expecting a correction, looking for an entry point – or both. This came to a sudden end last week. We can see this readily from Doug Short's graphic summary of the week's trading (see the full article for more charts and helpful discussion).

Click on chart for larger image.
Doug Short Weekly Summary

Follow up:

As the chart shows, my prediction for last week's featured theme -- Fedspeak – was on the money. This week I expect continuing volatility. The unresolved Fed issues will be augmented by some important data in a holiday-shortened week.

The Key Viewpoints

How one views the prospects for various financial markets is linked strongly to one's viewpoint about the role of the Fed.

  • The popular view is that the economy is fundamentally weak. Financial markets will falter as soon as the Fed ends the current round of quantitative easing.
  • The Fed's own view is that the economy is improving, albeit sluggishly. Expert Fed watcher Tim Duy cites and interprets New York Fed President William Dudley:

    Dudley adds something that I think is important:

    "The important thing to recognize about the U.S. economy is that things are actually improving underneath the surface," Dudley said in the interview. "We don't really see that so much in the activity data yet because of the large amount of fiscal drag."

    Translation: Fiscal drag will weigh down the GDP numbers. Look underneath those numbers to building momentum in the economy. I think this means there will be extra weight on the jobs data rather than the GDP data as an indicator of the impact of fiscal policy.

Whichever viewpoint you share, get ready for action! This debate will not end soon, and markets are reacting (over-reacting?) to each statement and every nuance.

The discovery need not send you running naked through the streets as Archimedes did, but it can serve to enlighten your trading and investing.


We should expect an increase in volatility? If so, what is the best reaction?

I have some thoughts on volatility and investing which I'll report in the conclusion. First, let us do our regular update of last week's news and data.

Background on "Weighing the Week Ahead"
There are many good lists of upcoming events. One source I regularly follow is the weekly calendar from For best results you need to select the date range from the calendar displayed on the site. You will be rewarded with a comprehensive list of data and events from all over the world. It takes a little practice, but it is worth it.

In contrast, I highlight a smaller group of events. My theme is an expert guess about what we will be watching on TV and reading in the mainstream media. It is a focus on what I think is important for my trading and client portfolios.
This is unlike my other articles at "A Dash" where I develop a focused, logical argument with supporting data on a single theme. Here I am simply sharing my conclusions. Sometimes these are topics that I have already written about, and others are on my agenda. I am putting the news in context.
Readers often disagree with my conclusions. Do not be bashful. Join in and comment about what we should expect in the days ahead. This weekly piece emphasizes my opinions about what is really important and how to put the news in context. I have had great success with my approach, but feel free to disagree. That is what makes a market!

Last Week's Data

Each week I break down events into good and bad. Often there is "ugly" and on rare occasion something really good. My working definition of "good" has two components:

  1. The news is market-friendly. Our personal policy preferences are not relevant for this test. And especially -- no politics.
  2. It is better than expectations.

The Good

As expected, this was a light week for economic data. There was some significant good news.

  • New home sales are strong, especially considering revisions to prior months. Calculated Risk calls it a "solid report" providing an array of charts and supporting evidence. Here is a key example showing inventory back at pre-recession levels:


  • Initial jobless claims dropped to 340K, beating expectations and moving back to the lower end of the recent range.
  • Industrial production beat expectations, and was even better than the headlines (via Steven Hansen at GEI).

The Bad

The thin data week included a little bad news. Feel free to add in the comments anything you think I missed!

  • The world economy shows continuing weakness. RecessionAlert tracks both the GDP results (noting percentage of countries in one- or two-quarter recessions), and also composite measures of world economic activity. This is a compilation of data not found from other sources – well worth a look. Here is an interesting sample:


  • The Gang of Eight Immigration Bill is stalled in the Senate. Many do not understand the issue, but immigration reform is generally viewed as positive by economists of all stripes. See The Hill for news on the setbacks for this bipartisan effort.
  • Chinese manufacturing is contracting, according to the HSBC Flash Index, which registered 49.6 versus consensus estimates. The "official" estimates usually run better, but who knows for sure?
  • Investors turned more bullish according to the AAII poll (viewed as a contrarian indicator), reported with a typically great chart from Bespoke:

AAII Bullish Sentiment052313

The Ugly

Utilities. There is a growing awareness of the risk from the multi-year chasing of yield. See Tomi Kilgore's nice WSJ analysis of the break in trend and the latest measures of technical risk.


Expect other yield-based investments to join this trend soon.

The Indicator Snapshot

It is important to keep the current news in perspective. My weekly snapshot includes the most important summary indicators:

The SLFSI reports with a one-week lag. This means that the reported values do not include last week's market action. The SLFSI has moved a lot lower, and is now out of the trigger range of my pre-determined risk alarm. This is an excellent tool for managing risk objectively, and it has suggested the need for more caution. Before implementing this indicator our team did extensive research, discovering a "warning range" that deserves respect. We identified a reading of 1.1 or higher as a place to consider reducing positions.

The SLFSI is not a market-timing tool, since it does not attempt to predict how people will interpret events. It uses data, mostly from credit markets, to reach an objective risk assessment. The biggest profits come from going all-in when risk is high on this indicator, but so do the biggest losses.

The C-Score is a weekly interpretation of the best recession indicator I found, Bob Dieli's "aggregate spread." I have now added a series of videos, where he explains the rationale for his indicator and how it applied in each recession since the 50's. I have organized this so that you can pick a particular recession and see the discussion for that case. Those who are skeptics about the method should start by reviewing the video for that recession. Anyone who spends some time with this will learn a great deal about the history of recessions from a veteran observer.

I have promised another installment on how I use Bob's information to improve investing. I hope to have that soon. Meanwhile, anyone watching the videos will quickly learn that the aggregate spread (and the C Score) provides an early warning. Bob also has a collection of coincident indicators and is always questioning his own methods.

I also feature RecessionAlert, which combines a variety of different methods, including the ECRI, in developing a Super Index. They offer a free sample report. Anyone following them over the last year would have had useful and profitable guidance on the economy. RecessionAlert has developed a comprehensive package of economic forecasting and market indicators, well worth your consideration.

Unfortunately, and despite the inaccuracy of their forecast, the mainstream media features the ECRI. Doug Short has excellent continuing coverageof the ECRI recession prediction, now well over a year old. Doug updates all of the official indicators used by the NBER and also has a helpful list of articles about recession forecasting. His latest comment points out that the public data series has not been helpful or consistent with the announced ECRI posture. Doug also continues to refresh the best chart update of the major indicators used by the NBER in recession dating.

The average investor has lost track of this long ago, and that is unfortunate. The original ECRI claim and the supporting public data was expensive for many. The reason that I track this weekly is that it is important for corporate earnings and for stock prices. It has been worth the effort for me, and for anyone reading each week.

Readers might also want to review my Recession Resource Page, which explains many of the concepts people get wrong.

Our "Felix" model is the basis for our "official" vote in the weekly Ticker Sense Blogger Sentiment Poll. We have a long public record for these positions. About a month ago we were "neutral for two weeks." (These are one-month forecasts for the poll, but Felix has a three-week horizon). Felix's ratings stabilized at a low level and improved significantly over the last few weeks. The penalty box percentage measures our confidence in the forecast. When there is a high rating, it means that most ETFs are in the penalty box, so we would have less confidence in the overall ratings. That measure is relatively low at the moment, so we have greater confidence in short-term trading.

[For more on the penalty box see this article. For more on the system ratings, you can write to etf at newarc dot com for our free report package or to be added to the (free) weekly ETF email list. You can also write personally to me with questions or comments, and I'll do my best to answer.]

The Week Ahead

This week brings some important data and news in a holiday-shortened week.

The "A List" includes the following:

  • Initial jobless claims (Th). Employment will continue as the focal point in evaluating the economy, and this is the most responsive indicator.
  • Personal income and Spending (F). The consumer is still important, so income and spending are both crucial.

The "B List" includes the following:

  • Consumer Confidence (T). The Conference Board measure is a good concurrent indicator of the mixed effects of increased taxes, gas prices, political concerns, housing, and most of all – employment.
  • Michigan Sentiment (F). Just as important as the Conference board, but we already have a preliminary reading. The final versions have surprised recently.
  • Case-Shiller home prices (T). One of the regulars on CNBC said this was the most important data point for the week. I think that is silly, since it is the slowest of the housing price indicators. It is worth watching.
  • Chicago Purchasing Managers' Index (F). This is more important than usual since the nationals ISM index will not be out until next week. The Chicago Index is the best estimate.

I am not very interested in pending home sales or the revision to first quarter GDP.

We will also have more speeches by FOMC participants.

Trading Time Frame

Felix has continued a bullish posture. The trading positions have become more aggressive – financials and technology – rather than consumer staples and utilities. It is popular to predict a correction, but that has been true all year. Several readers questioned Felix's bullish stance a few weeks ago. I understand, since we humans all know that markets do not move in straight lines. Felix is especially good at sticking with a trend until there is clear evidence that it has broken. The method is excellent in helping to stay on the right side of big moves.

There will come a time when Felix is wrong, giving back some gains in a correction. It goes with the territory. There are many ways to trade and invest successfully, and many trading time frames. Felix is making a three-week forecast, but we monitor it daily.

Investor Time Frame

This is a time of danger for investors – a potential market turning point. I review this investor section carefully every week, although the general advice does not change as rapidly as it does for the trading time frame. The recent themes are still quite valid. If you have not followed the links, find a little time to give yourself a checkup. You can follow the steps below:

  1. What NOT to do

Let us start with the most dangerous investments, especially those traditionally regarded as safe. Interest rates have been falling for so long that investors in fixed income are accustomed to collecting both yield and capital appreciation. An increase in interest rates will prove very costly for these investments. I highly recommend the excellent analysis by Kurt Shrout at LearnBonds. It is a careful, quantitative discussion of the factors behind the current low interest rates and what can happen when rates normalize.

Other yield-based investments have a similar or greater risk profile. As David Kehohane of FTAlphaville notes, even junk bonds are now yielding less than 5%!

  1. Find a safer source of yield: Take what the market is giving you!

For the conservative investor, you can buy stocks with a reasonable yield, attractive valuation, and a strong balance sheet. You can then sell near-term calls against your position and target returns close to 10%. The risk is far lower than for a general stock portfolio. This strategy has worked for over two years and continues to do so. (If you cannot figure it out yourself, or it is too much work, maybe we can help).

  1. Balance risk and reward

There is always risk. Investors often see a distorted balance of upside and downside, focusing too much on new events and not enough on earnings and value.

Three years ago, in the midst of a 10% correction and plenty of Dow 5000 predictions, I challenged readers to think about Dow 20K. I knew that it would take time, but investors waiting for a perfect world would miss the whole rally. In my next installment on this theme I reviewed the logic behind the prediction. It is important to realize that there is plenty of eventual upside left in the rally. To illustrate, check out Chuck Carnevale's bottoms-up analysis of the Dow components showing that the Dow "remains cheaply valued."

  1. Get Started

Too many long-term investors try to go all-in or all-out, thinking they can time the market. There is no reason for these extremes. There are many attractive stocks right now – great names in sectors that have lagged the market recovery. You can imitate what I do with new clients, taking a partial position right away and then looking for opportunities.

We have collected some of our recent recommendations in a new investor resource page -- a starting point for the long-term investor. (Comments and suggestions welcome. I am trying to be helpful and I love feedback).

Final Thought

What are the implications of the debate over Fed policy and the resulting volatility?

I like to consider problems like this from three different angles.

  • The reality of the current policy is that the Fed is getting too much credit or blame for current asset prices. In my Fed as a Fig Leaf post I explain this in more detail. The basic idea is that objective analysis of fundamental economic and policy changes easily explains the change in market values over the last three years.
  • The most probable economic and policy outcomes. This is not what I or others would prefer to happen, but a realistic assessment of what is likely to happen. There will be a gradual reduction in Fed stimulus – a tapering of new purchases, the end of new purchases, and finally an increase in short-term interest rates. The stimulus will not really end until this process is complete. It might take years. Whether the end is timely will depend not upon the extreme voices on the Fed, but those at the center. See Prof. Mark Thoma's current analysis of Bernanke and the center to appreciate the significance.
  • The popular perception – which will be the short-term driver of stock prices. Despite increased communication and transparency, the Fed has failed to explain the rationale for QE and to convince the average market observer of the actual economic effects. This creates a climate of uncertainty.

Investment fundamentals will eventual prove out, so the first two points are most important. Meanwhile, perceptions drive markets as we have seen quite often in the last few years. I warn clients to expect a 15% market decline at some point, even in good years and even when not justified by economic fundamentals.

I do not see an imminent change in Fed policy, so there is still some time. For the moment, market volatility provides opportunity to establish new positions, as I was doing last week.

See the original article >>

Oil Market Manipulation Reaches Absurd Levels

By EconMatters

Markets & Manipulation: A long History

Most markets these days are manipulated to some extent, and this is nothing new if we look back through the history of financial markets. But there are some strange things happening right now in the oil market worth mentioning.

Brent-WTI Spread/Scam

Another scam in the Oil market is the Brent-WTI spread this has been one of the biggest scams over the years in the Oil market. Just to provide some data to the absurdity which is this much hyped about nonsensical spread Cushing Oklahoma has 49.7 million barrels in storage, it had 45.1 million barrels in storage a year ago. Cushing had 50 million barrels in storage at the start of the year. Moreover, in June Cushing will be adding additional supplies to storage due to current pipeline capacity going offline. So for all this talk about pipelines finally unlocking all the glut of oil supplies from the Cushing hub, and this being the reason for the impressive reduction in the Brent-WTI spread it is just a bunch of nonsense.

Cushing Oklahoma Supply Glut

So there is basically more oil trapped in Cushing Oklahoma then there has ever been when the spread was 25! So regardless if the spread is 25 or 8 it has very little to do with supplies residing in Cushing Oklahoma that is quite evident. Now there are a bunch of factors contributing to the nuances of the spread which I will not go into detail here but the takeaway is just to point out the absurdity which is the false and misleading rhetoric that encompasses this spread and Cushing Inventory levels.

400 Million Barrels & Climbing

While we are talking about inventory levels it is funny that WTI sits at $97 a barrel when the entire year we have had basically 3 minuscule draws in inventory supplies which stand at a record breaking 395 Million Barrels in storage. So the Dow keeps hitting new highs every week, and the US keeps setting new modern records for Oil in storage each week.

Weak Demand in an Artificial Economy

But it is not just the supply issues in an obviously oversupplied oil market with the US domestic production being the biggest culprit. The demand side of the equation has been equally bearish for the fundamentals with China`s actual economy slowing over the past 2 years, Europe being stuck in a perpetual recession, and the US being a mature market with higher fuel standards and a stagnant economy that requires $85 Billion of stimulus each month to keep from cratering. The demand side had been very underwhelming from the products side of the equation. For example, Gasoline supplies in the northeast are 10% higher than normal for this time of year.

Strong Dollar Bearish for Dollar Denominated Commodities

Finally the strong dollar is supposed to be bearish for commodities and oil, and with the US Dollar Index hovering around 84 and threatening to strengthen from these levels it is a wonder that the Oil market has barely noticed this strange occurrence in Dollar strength, unlike the Gold and Silver Markets.

Fundamentals: Are we talking about the Fundamentals Again?

The takeaway is that none of the actual fundamentals ever matter in the Oil markets. When you have a house style advantage that would make any Las Vegas Casino envious the fundamentals play little part in a manipulated Oil market. It is all about protecting the huge supply chain that is the oil market and everybody`s livelihood. When in doubt follow the money trail, and money is the biggest reason oil prices are where they are currently despite the bearish fundamentals of the commodity. Oil prices wouldn`t be at these levels if the powerful manipulators of the commodity were not making a whole lot of money as a result.

Oil Analysts Clueless

So the next time some Oil analyst tells you some hard studied reason why Oil prices are up it is all nonsense. Oil prices are up or down depending upon what the powerful players want oil to do, one week it can be at $86, the next $97, or $77, it is all about the money to these players, and they will do whatever it takes to make the money. And if it means being very creative with their methods then so be it, it is not like this is a regulated market!

See the original article >>

The Macro Story as Told by Gold, Copper and Oil

By EconMatters

Gold’s been on a wild ride.  After reaching a peak of $1,920 an ounce in September 2011, gold has tumbled 28% to the current ~$1,380 level forcing John Paulson to take a 47% loss in his gold fund during the first four months of this year, according to Bloomberg.

Unlike Paulson who maintained his positions in gold, other big players like George Soros and  BlackRock cut their gold ETF holdings, while Goldman Sachs issued a sell recommendation on gold right before the yellow metal plunged 13% through April 15, the biggest drop in three decades.  And by looking at the futures curve (chart below), market does not seem to expect gold to come back roaring any time soon.

Chart Source: S&P Capital IQ

QEs Not Hitting the Real Economy

Historically, gold is regarded as a good inflation hedge and store of value, typically thriving in an environment of high inflation, and/or weak U.S. dollar (currency debasement).  With U.S. Federal Reserve’s three rounds of QE, the never-ending debt crisis in the Eurozone, hyperinflation and dollar debasement seem inevitable and supportive of gold for the long run, right?   

Theoretically, Fed’s QE and near zero fed funds rate is supposed to encourage borrowing and spending from the private sector thus injecting money into the real economy.  However, theory and reality don’t always see eye to eye. 

Since the 2008 financial crisis, banks have significantly tightened the credit standard and are reluctant to lend.  On the other hand, corporations are making money mostly from “streamlined” headcount and structure, but instead of the intended wealth distribution effect expected by the Fed such as investing back to the economy, or increase employee pay which would in turn increase consumer spending, most corporations are hoarding cash or use profits for dividend, share buybacks, or mergers & acquisitions with limited impact on the real economy.    

Copper & Oil Indicating Weak Demand

The weak demand is also reflected in part of the commodity market fundamental.  WTI crude oil inventory climbed to 82-year high and copper inventory at LME hit a 10-year high in April, while Goldman Sachs cut its “near-term” outlook for commodities. 

Although some have argued oil and copper have lost their significance primarily due to increasing domestic oil production, and “temporary” excess copper supply.  While the abundance of domestic shale oil production may have distorted the historical supply and demand relationship, but with the U.S. becoming the world’s largest fuel exporter, the fast and furious oil inventory build is nevertheless still an indication of a weak world economy.  And I can’t imagine how the “temporary” buildup of copper inventory is not a sign of weak global economic condition?

Further Reading - Oil Market Manipulation Reaches Absurd Levels

Massive QEs, Limited Inflation?

On top of the overall weak spending and demand in the private sector, most of the developed countries are undergoing some shape or form of austerity with reduced government spending.  China, the growth engine of the world, is having some problems of its own.  The old-fashioned massive infrastructure building QE program got China through the 2008 financial crisis, and was the main driver behind commodity prices.  But Beijing can’t afford another QE due to inflation concern (plus China has probably run out of things to build).  Low wage levels means China consumers can’t really pick up the spending slack, coupled with bad credit problem (i.e., NPL: Non-Performing Loans), and recent capital flight, had many analysts worried enough to downgrade China’s growth prospect. 

The simultaneous pullback from both the private and government sectors in U.S. Europe, and China is a major factor why Fed's massive QEs have resulted in only limited inflationary pressure and increasing signs of deflation. 

Dollar and Carry Trade Kills Gold

Nonetheless, when compared with Europe, China or any other regions in the world, the U.S. seems relatively more stable, and has been able to retain the “safe haven” status despite its own debt problem.  With investors pouring money into U.S. equity and bond propping up the dollar, and weak demand suppressing inflation, two of the main conditions for a strong gold price -- high inflation and a weak US dollar -- are basically non-existent in the current macro environment.
Furthermore, there was already a bit of disconnect between gold and the other commodity prices such as copper, and oil.  So eventually, gold had to come to grip with the macro reality.    

Chart Source:

Another major factor against gold right now is that gold has no yield and is out of favor with the huge yield-seeking yen carry trade crowd (borrowing yen to invest in higher yield options) since bond and equity now are offering much better returns.  Unless there's a shock to the system such as a war breaking out in the Middle East, or an eventual debt crisis in Japan when people start seeking safety, there's not much upside momentum for gold.

Gold's Volatility Game

For now, the prevalent view is that the Fed will slow or exit QE3, and gold is out of favor under the the current macro trend.  For example, Lim Chow Kiat, the chief investment officer of the Government of Singapore Investment Corp (GIC), thinks gold still looks overpriced as the usage of gold for industrial or consumer products doesn't quite justify the prices.  GIC is one of the world's largest sovereign wealth funds.
As long as dollar maintain its strength and inflation remains tame, gold prices most likely will see considerable volatility swinging between rumors and speculation (e.g., some central banks may need to unload some of their holdings due to debt crisis), and Asia retail buying on the dip (South China Morning Post reported that many shops in Hong Kong were running out of the precious metal for the first time in decades.)
Technically speaking, gold's next support level should be $1,330 range with $1,320 as the major support when most physical retail buyers would rush in.  If gold breaks below $1,300 hard, expect a major liquidation when even Paulson could be forced to sell and everybody piles in.

See the original article >>

Economic And Employment Composites Indicate Further Weakness

by Lance Roberts

"The economy is amazing right now - employment is recovering, innovation is going and housing is reviving.  What's not to love?" This was a statement I heard in the media to justify the recent rise in the stock market.  In this past weekend's newsletter I went into significant detail in dismantling the bullish arguments with one point being the consistent weakness in the economic data.

The most recent release of the Chicago Fed National Activity Index (CFNAI) is the last of the components released each month that comprises the Economic and Employment Composite indexes.  The April data for the CFNAI was not good with the manufacturing component confirming what we had already seen in most of the regional Federal Reserve manufacturing surveys.  The overall CFNAI index plunged from to a negative 0.53 from a negative 0.23 in March.  In both months, manufacturing production fell, down 0.4 percent in April following a 0.3 percent decline in March.

However, as opposed to recent media headlines boasting of the strength of consumer spending and housing, the consumer & housing sector was the second largest drag on national activity in April dropping from negative 0.15 in March to negative 0.17 in April.  Employment also did not confirm the recent BLS report, which we suspected would be the case, as the employment component has fallen from a positive 0.35 in February to a positive 0.1 in March to ZERO in April.  This is certainly not a trend that supports the much hoped for job growth in the near future.

Let's take a look at the two composite indexes to see what they are telling us about the economy and the most likely direction of the data in the months ahead.   Both indexes are weighted average of the CFNAI, ISM, several Federal Reserve manufacturing surveys, the NFIB Small Business survey, Chicago ISM and the Leading Economic Indicators.  The only difference between the two indices is that the employment composite is comprised of the employment components of the above as opposed to the overall activity components.

STA Economic Output Composite Index (EOCI)

The EOCI index fell sharply to 26.08 in April from 30.35 in March as the brief surge in activity from "Hurricane Sandy" finished working its way through the system.  The chart below compares the EOCI index to real, inflation adjusted, GDP on a quarterly basis.


There are a couple of important takeaways with this index.  The first is that both positive and negative trends in the EOCI index track very closely to the ebb and flow of GDP.  The second is that historically when the EOCI index was below 30 the economy was either in, or about to be in, a recession.  Currently, the economy is not running in recessionary territory, as of yet, but the trend of weakness in the macro economic data is somewhat concerning.

The chart below shows these corollary trends a bit better with the EOCI index, smoothed with a 3-month average, compared to the annual rate of change in nominal GDP.


What is most concerning is that while the asset prices are inflated with artificial interventions that trend of economic data has clearly peaked for the current cycle.  Either the mainstream economists and analysts are correct and the economy is about to turn substantially stronger and play catch up with asset prices or asset prices will revert to catch up with the fundamentals of the economy.  The latter is much more likely the case from a historical perspective.

STA Employment Composite

If you strip the employment components out of the EOCI index and weight them into their own composite index we find that the hiring intentions of employers is clearly weakening.  The chart below shows the Employment Index smoothed with a 4-month average and compared to the annual rate of change in Total Non-Farm Employees.


As with the EOCI index above - employment activity clearly peaked in early 2012 and has begun to wane.  The recent uptick in the employment index, remember this is a 4-month moving average, is due to the effects from the uptick in economic activity from "Hurricane Sandy."  This index will turn down in the next couple of months as the recently monthly data points have declined.

What is clear from the two composite indexes is that the broad economy, and by extension underlying employment, has clearly peaked and has began to weaken.  This is well within the context of historical trends and time frames.  While the mainstream analysts and economists continue to have optimistic views for a resurgence in economic activity by years end the current data trends, both globally and domestically, suggest otherwise.

by Lance Roberts

See the original article >>

Stock Market No Confirming Signal for a Top, Yet

By: Michael_Noonan

There is a reason why the trend is the most important consideration when positioning in any market. The number of profitable shorts, as of last week, can still be counted on one hand, at least those who remain amongst the ranks of the devastated ones still trying to pick a top. The most money is lost picking tops and bottoms, but top-pickers are always at odds with that fact. Richard Dennis lost more money trying to buy sugar under 5 cents than he did buying at higher prices on previous occasions. He ranks as a poster child for money lost in bottom-picking, and he was a highly regarded professional player.

No matter. Top-picking egos have been clamoring for a top over the past several months. Like a stopped clock, one day they will be right. We prefer to let the markets reveal their message and respond to it, rather than front-run it.

What will be evident in viewing charts from over three time frames, monthly, weekly, and daily, is that the trend is unequivocally up, and that is a strong statement from the market.

Where many may have anticipated the possibility of a triple top, the Fed-driven market sailed right through what would normally be resistance. One has to remember that the anticipated resistance was just potential, and it had to be confirmed by market activity showing signs of weakness and reversal behavior. It never happened.

The failure of a triple top is a great example of why one should follow the message from developing market activity and not front-run and get run over in the process. The channel shows that there is still room to rally without being in an overbought condition. What may provide valuable information will be the location of the close by the end of the week. A strong close will mean continuation. A weak close could signal a possible turn, but it takes time to turn a trend, so one does not have to be the first one in.

The dashed portion of the channel represents future support/resistance, once the first three points are established, the two swing lows in 2009 and 2011, forming the bottom support line, and a line parallel to it using the swing high between those points, 2010.

What has many bears-in-waiting salivating is the weekly Outside Key Reversal [OKR]. Just like one swallow does not a summer make, nor does a single bar necessarily reverse a trend. It may lead to a trend reversal, but further proof of confirming market activity is required.

What is interesting about the weekly chart is the location of current price activity within the channel. It is not reaching the top of the channel. The OKR is occurring at the mid- point of the channel, generally a sign of a weakening trend. An important issue with that observation is the fact that price also failed at a similar mid-point back in September of 2012 and was still able to keep the trend intact.

It is simply a piece of information of which to be aware.

An OKR also developed on the daily chart, last Wednesday, 3rd bar from the right. The volume was exceptionally strong. Volume was also strong the next day, with a lower high, lower low, and lower close, but note the location of the close. It was at the upper end of the bar, and that is the market telling us that despite the increased volume and effort to drive price lower, buyers were in control by the end of the day.

If an OKR at a [potential] high is a sign of weakness, more weakness should follow. The exact opposite happened, as noted on Thursday. This reflects the power of a trend and how it takes a lot of effort to reverse it.

Friday’s close showed a drop in volume, and that equates to a lack of follow-through selling pressure. The upper end close shows buyers still in control. Unless and until weakness enters the picture, one has to respect the trend. If long, one would want to be moving up stops on all stock positions for protection, in case a turn does develop.

As for being short, it may be appropriate for individual stocks that have been under- performing the current market rally, but there is no reason for shorting the market at current levels. What can never be known in advance is how future price activity will develop. The trend, [and Fed effort], may not be over, and based upon how the market has been up, up, and still up since September 2011, it is a message not to be ignored.

If more weakness enters the market next week, or sometime soon after, there will be ample time to take a short position when a turn in trend says it makes sense, to then make dollars from that side of the market.

One interesting piece of factual information is the last two times the S&P traded at an all-time new high and reversed downward to close more than 1% below the high were at the March 2000 and October 2007 highs. Will the same hold true this time around? If it does, we will see market weakness to substantiate it.

Let the market be your guide. It never disappoints, unless its message is disregarded.

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Which Asset Class Is The Most Sensitive To a Fed "Taper"?

by Tyler Durden

Markets are starting to price the removal of the unprecedented policy stimulus provided by the Fed. Investors have faced this situation several times in recent years, but as Barclays notes, these prior episodes lacked broad consensus and proved short-lived as further risks to the global recovery quickly re-appeared. The edginess of markets to ebbs and flows in the data and Fed communications in recent months suggests this time is different. Market movements are saying the Fed’s exit is now more ‘when’ than ‘if’. Fed actions have led to some of the most extraordinary market moves on record. Nominal US bond yields are at historically low levels, and real yields have been negative for a prolonged time. Risky assets, by contrast, have rallied sharply, supported by central bank policy even in the face of poor economic data. If the Fed is preparing for an exit, these market moves may need to go in reverse...

Via Barclays,

Which asset classes are more vulnerable to Fed tapering?

We begin to tackle this question by constructing two indicators that seek to capture the sensitivity of various asset prices to Fed easing and the extent to which asset prices have responded to such easing. The explicit assumption here is that asset classes that have been most sensitive to Fed policy and appear most dislocated from historical norms are likely the asset classes at greatest risk.

Our first indicator calculates the beta of various asset classes to the Fed balance sheet expansion. In particular, we calculate the elasticity of asset prices to changes in the Fed balance sheet...

Our second indicator shows the (normalised) deviations of current asset prices from historical averages (z-scores). The idea is to gauge how Fed easing has affected prices relative to historical norms...

Investors who are concerned about the reversal of Fed easing should consider short positions in assets with high elasticities to the Fed and expensive valuations versus history. [ZH - European staples to the S&P 500 and US High Yield and US Healthcare stocks] appear vulnerable. Short positions on the latter make sense to protect risk portfolios.

The re-pricing has already started in safe havens

An earlier-than-expected Fed tapering has already been priced in to some markets, even before the events of this past week unfolded. Safe havens assets that benefited greatly from elevated global tail risks and central bank easing, such as gold, the Swiss franc and even the AUD, have suffered...

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Eyes On Income

by Tom Aspray

I have been following the bond market since 1982, which was just a year after the yield on the 30-year bond peaked at 15.20%. In the early 1990s, I was pleased to be noted by the Wall Street Journal as “one of the top bond market technicians.”

The decline in yields and the rise in bond prices over the past 32 years have been dramatic, but there have been other long-term trends in rates. In fact, the decline in yields was equal in time and price to the rise in bond yields and decline in their prices that took place from the early 1950s until 1981.

It has been my view since earlier in the year that the next two years are likely to be pivotal for the bond markets. Therefore, it will be increasingly important for income investors to keep an eye on rates as they will need to be a bit more active in the management of their income portfolio.

The outlook for both the 30-year T-bond and 10-Year T-note yields has reached an interesting juncture, so now I believe is a good time to formally introduce an income-only portfolio.

In the past, I have recommended high-yielding stocks for the Charts In Play portfolio that also had growth potential. However I have recommended selling them when nice profits were attained or if the technical outlook changed.

For the Eyes on Income portfolio, I will only sell the income holdings if there is a significant change in my outlook for rates. Let’s look at the key levels to watch.

Click to Enlarge

Key Yields to Watch: Though the yield on the 10-year T-note is more relevant for consumers, I still find that the 30-year T-bond yield (TYX) can provide valuable insight into where rates are headed.

  • The weekly chart of T-bond yields shows that in late 2011, yields declined to the 2.855% level before rallying to just over 3.47% in March 2012.
  • Then yields plunged over the next four months to a low of 2.517% in July, which is labeled as the head of a reverse head and shoulders bottom formation.
  • The rally from last summer’s low hit a high of 3.284% in early March before yields again dropped back to the 2.855% level at the end of April.
  • Over the past three weeks, yields have closed higher and as of May 23 look ready to close higher for the fourth week in a row.
  • The neckline of the reverse H&S bottom is just above this week’s high at 3.241% and a weekly close above 3.284% will complete the formation.
  • The upside target from the H&S formation is in the 4% area.

The chart of T-note yields (TNX) also reveals an apparent reverse H&S formation but the neckline level is less clear. The left shoulder (LS) was formed in September 2011 at 1.696%.

  • The initial rally hit a high of 2.407% before yields again dropped to the 1.800% level in early 2012.
  • The secondary high in March was at 2.363% before yields dropped to a low of 1.394% in July 2012, forming the head of the H&S formation.
  • The TNX yield reached a high of 2.064% the week ending March 12 before turning lower.
  • The decline in yields broke the uptrend but held above the November lows at 1.556%.
  • Last week, yields again rose above 2.00% and a weekly close above the March high (2.064%) will signal a rally to the major resistance at 2.390%.
  • This connects the prior twin peaks at 2.407% and 2.363%.

Click to Enlarge

The potential bottoming formation in the weekly charts of both the T-bond and 10-year yields must be viewed in the context of the longer-term trends. The daily and weekly trend in yields is currently up, but the monthly charts tell a different story.

  • The monthly chart goes back to 1990, and since 2000, the downtrend in yields, line a, is well established.
  • On the monthly chart, there is next major resistance in the 3.525-3.3563% area. This corresponds to the declining 20-month EMA and the lows from August 2010.
  • This long-term downtrend is now at 4.181%, which is just above the upside target from the reverse H&S formation on the weekly chart.
  • The monthly charts make it clear that yields have to move significantly higher before it is clear that the long-term trend has changed.

Featured Investment: For part of one’s income portfolio, I like a bond fund that holds income instruments with shorter duration (one-eight years) as it will provide more flexibility if rates move higher and also if they stay in a broad range.

DoubleLine Total Return Fund (DLTNX) has a current yield of 5.22%, which is paid on a monthly basis.

The fund details (from show that it has $40.7 billion in assets with an expense ratio of 0.76% and a minimal investment of $2,000. The expense ratio is a bit higher than some of the high-yield ETFs, but it is below average for the class of funds.

The weekly chart of DLTNX shows that it is likely to close the week below the 20-week EMA at $11.38 as it closed Thursday May 23 at $11.36.

The major price support is in the $11.25 to $11.34 area. In 2012, DLTNX had a low of $11.02 while it hit a low of $10.80 in 2011.

Income Strategy: The weekly OBV on two of the largest junk bond ETFs, SPDR Barclays Barclays High Yield Bond (JNK) and iShares iBoxx $ High Yield Corporate Bond (HYG) turned negative this week.

This action is consistent with my short-term view that rates will move higher as we start the summer. If the reverse H&S bottom formations are completed in either T-bond or T-note yields, then a new report will be released.

Portfolio Recommendation: Based on a $100,000 portfolio, invest $1,000 in DLTNX on May 28 and then $1,000 on the next three Mondays. If the fund has a daily close at $11.34 or lower, invest another $3,000. Then, if the fund closes at $11.30 or lower, add another $3,000 in the fund. The goal is to eventually invest $10,000 or 10% of your income portfolio.

Future investments for the Eyes on Income portfolio will be primarily focused on individual stocks or other income-producing instruments, including ETFs.

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