Monday, September 15, 2014

How to protect your portfolio against a Scottish exit

By Sara Sjolin

NEW YORK (MarketWatch) — With less than a week to the Scottish independence referendum, investors have started to assess the risks of a breakup of the United Kingdom. The pound has already been flirting with a 10-month low, the FTSE logged its first weekly slide in five weeks on Friday and according to analysts at Société Générale more weakness in U.K. assets could be on the cards.

In a note on Monday, they laid out three ways to best protect your portfolio against a “yes” vote for Scottish independence at the referendum on Thursday.

1. Stay away from U.K. equities: There is a major risk that a breakup of the 300-year union would trigger a substantial political crisis, which is expected to greatly hamper stocks in the U.K., the Société Générale analysts said. One of the concerns is that a Scottish exit would reduce the number of pro-European members in the parliament, raising fears that the U.K. could vote to leave the European Union.

Another key fear, is whether Prime Minister David Cameron will be forced to resign and call a snap election. Such a move could bruise growth and economic confidence in the U.K., which had finally started to rise in 2014.

2. Stay away from Scotland-related assets: It already looks like investors holding Scotland-exposed equities have been hurt in the run-up to the vote: SocGen’s Scotland-related basket of 20 European stocks has underperformed the FTSE 100 UKX, -0.04% by 8% year-to-date and a “yes” vote would trigger another bout of underperformance. A lot of unanswered questions would hover over the companies, such as which currency will Scotland get and under which tax regime would the firms pay taxes.

Among major companies in the Scotland-exposed basket are BAE Systems BA., -0.20%  , Lloyds Banking Group LLOY, -1.39% LYG, -1.53% Royal Bank of Scotland Group RBS, -0.86% RBS, -1.61% Diaego DGE, +2.23% DEO, +2.01% Pernod Ricard RI, +0.50% J Sainsbury SBRY, -1.01% Tesco TSCO, -0.07% Technip TEC, -0.97%  and Next NXT, +0.36%

3. Buy pound-sensitive stocks: Some companies are poised, however, to benefit from an independent Scotland, mainly because an exit is expected to accelerate the recent slide in the pound GBPUSD, -0.29% SocGen pointed out 13 U.K. stocks that are sensitive to the sterling exchange rate, with this pound-exposed basket since January 2013 showing a 90% correlation with currency movements. In short, when the pound falls, the basket outperforms the FTSE 100.

Among the companies that could perform well after a Scottish “yes” vote are Barclays BARC, -0.26% BCS, +0.10% HSBC HSBA, +0.12% HSBC, +0.00% Standard Chartered STAN, -0.60% SABMiller SAB, +9.82% SBMRY, +9.02%  Unilever ULVR, -0.15% UL, +0.02% Burberry BRBY, +0.13% BURBY, +0.30% WPP WPP, -0.94% ARM Holdings ARM, -1.73% ARMH, -1.73%  and British American Tobacco BATS, +0.11% BTI, +0.14%

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The Two Scariest Charts in the World

by Erico Matias Tavares

There are plenty of things to worry about these days. A cursory look through today’s (13 Sep 14) sets the tone: the Pope says WWIII is underway; a senior Democrat accuses the Republicans of endangering civilization; drones are invading the privacy of citizens; militias are blocking traffic in the Mexican border; Feds run a US$589 billion budget deficit; the UK might fall apart; the Ebola epidemic is getting serious in Africa; a mystery virus spreads to NY and CT (and we could not resist adding this one: Hillary Clinton is doing yoga).

With all of this in our minds it is easy to forget, or at least put in proper context, the extraordinary progress that mankind has achieved over the centuries against remarkable odds. World population has steadily increased, proving Malthus wrong. Serious diseases like polio and smallpox, which affected even monarchs and presidents over the centuries, have been eradicated. We can crisscross the planet in less than 24 hours and put satellites in deep space. The baby boomers and their offspring are the most prosperous generations the world has ever seen.

This shows that with enough intelligence, political will, common sense and perseverance most challenges we face as a species can be overcome. This should provide a decent amount of hope that we can tackle whatever we are facing right now.

So why worry?

Well, what will happen if we start losing those qualities and values as a global society? Which is why we believe that the following graphs are the scariest in the world today:


Source: MailOnline, University of Hartford.


Source: SIPRI.

(a) Based on NATO expenditures (in 2011 constant US$), the longest data series publicly available.

The average world citizen is getting dumber while our means of doing harm are increasing. This trend is clearly not our friend.

Consider the following.

Countries around the world today spend over US$1.7 trillion on weaponry - more than the total global investment in energy supply. Beyond the manufacturers and suppliers downstream, this produces zero economic benefits (weapons become obsolete very quickly and do not generate any returns; on the contrary as, well, they blow stuff up) and the associated costs add to already bloated government debt levels. And that’s US$1.7 trillion less available each year to improve world education, food and fuel availability, the environment and shifting global demographics, all critical issues of the 21st century.

Also concerning is the fact that control over these weapons can be quickly lost, creating the prospect of blowbacks, never ending conflicts and major tragedies.

Prior to 1991, the Soviet Union had more than 27,000 nuclear warheads and plenty of weapons-grade uranium and plutonium to triple that number. While there have been no confirmed reports of missing or stolen former-Soviet nuclear weapons (astonishing given all the political and economic turmoil since then), there is ample evidence of a significant black market in nuclear materials. How long before someone in that rapidly expanding pool of idiots gets a hold of some is anybody’s guess.

Note: accidents can happen as well, adding to the unease of handling this type of firepower. For instance, in 1961, a B-52 carrying two nuclear bombs broke up in mid-air, dropping its nuclear payload very close to Goldsboro in North Carolina. Five of the six fuses designed to prevent a detonation failed in one of the bombs, with only the last one averting a nuclear explosion. That was an unbelievable close call.

And now turmoil is spreading across the Middle East yet again. With all the conflict going on, anyone showing up and volunteering to fight for one of the sides will be given free food and weapons, courtesy of the associated regional and international powers. Will those weapons stay there, concerning as that might already be for local populations, or will they be used elsewhere, even if the conflict is contained or resolved? As we all know fundamentalists – probably the most idiotic of the bunch – are ready to do anything.

Humanity cannot risk its future falling into the hands of increasingly lethal buffoons. The stakes are just too high now. Hopefully our leaders are paying attention, but this should concern us all. Let’s try to be smart about it – while the smart is still going.

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Argentina’s US Dollar Reserve Is Declining To Dangerously Low Levels

by Big Picture

Gold, Inflation/Deflation, Sprout Money

Christina Fernandez Kirchner

President Christina Fernandez Kirchner


Argentina has announced new measures to reduce the demand for US Dollars on the official foreign exchange market. Whereas the purchase of dollars was limited to people with a monthly income of 7,200 pesos per month, this amount has been increased to 8,800 pesos per month which means that Argentina is once again forbidding its ‘poorer’ citizens to hedge against the ever-increasing inflation in Argentina.
USDARS Exchange Rate

The USD/ARS exchange rate

Source: Yahoo Finance

This move was necessary to safeguard the dollar reserve of the Argentinean central bank, as according to the Wall Street Journal , in excess of $1.5B has been drained from the central bank by the Argentinean citizens. As the government devaluated the currency by 20% earlier this year, a lot of people don’t trust the government anymore and with an accelerated level of buying the US Dollar (in the first 4 days of September, Argentinean citizens bought $147M in US Dollar which is a clear acceleration from the $260M in the month of August). The central bank is doing everything it can to keep the official exchange rate low, as on low-volume days, traders are able to see some obvious dollar-dumping on the market by the central bank.

At this point in time, one US Dollar costs about 10 Argentinean peso’s on the official market, but the exchange rate on the black market (which is firing on all cylinders as the people who don’t meet the minimum criteria also want to buy dollars) is closer to 14/15 peso’s per dollar. The main reason for this run to the dollar is the fact that the inflation rate in Argentina is approximately 40% which means the value of the Peso is going down the drain fast. Additionally, there still hasn’t been reached an agreement on the debt situation in the USA, which means Argentina technically has defaulted on a part of its debt.

Should the regulations become even tighter, the supply of US Dollars could dry up and the question will then be whether or not the Argentinean citizens would consider to buy precious metals as a safe haven.

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The Ghost of Hirohito

by Eri Hotta

NEW YORK – The completion by Japan’s Imperial Household Agency of the 61-volume record of the life of Emperor Hirohito (1901-1989) has generated much interest and attention in Japan. The entire formidable work was recently opened to limited public viewing, with a plan to publish it over the next five years. But it is already clear that the new record inadvertently reflects Japan’s continuing inability to address some fundamental questions about its past.

Having taken a quarter-century to compile, the project relied on some 40 new sources, most notably the diary and notes of Saburo Hyakutake, an admiral who served as Court Chamberlain from 1936 to 1944. But, while acknowledging the enormous scale of the undertaking, specialists seem to agree that the new account offers no earth-shattering findings or innovative interpretations concerning Hirohito’s many and changing roles in the most tumultuous period of Japan’s modern history.

Perhaps this is not surprising, coming from a conservative imperial institution’s official team of editors. The record takes to new lengths the idea that the historian’s task, as Leopold von Ranke put it in the nineteenth century, is to show “what actually happened.” It is said to be an excellent chronicle of the court’s day-to-day goings-on, revealing, for example, that the emperor celebrated Christmas as a boy, that he had nose surgery in his youth, and how often he met with whom.

To be fair, such tidbits can be interesting and useful. But the new account fails to explain or analyze crucial events of Hirohito’s reign. Readers will be disappointed if they want to learn more about Japan’s entry into the Pacific War, its defeat, the Allied occupation (especially Hirohito’s relationship with General Douglas MacArthur), or Hirohito’s later reluctance to visit the Yasukuni Shrine, where Imperial Japan’s war dead, including Class-A war criminals, are honored.

What is already known about Hirohito is sketchy. That he was a tragically conflicted man is not news. As a young sovereign (imperial regent at age 20; emperor at 25), he had to assume contradictory roles: divine pater familias of the Japanese state and Supreme Commander of the imperial armed forces that were colonizing Japan’s Asian neighbors. He could not have been the bravest or most decisive man, given that he was unable to resist rising militarism. But to say that he was powerless (and thus blameless) or did nothing to oppose it would also be wrong.

The conflict between Hirohito’s divine and secular roles became most acute in the autumn of 1941, when Japan’s leaders debated whether to go to war with the United States and its allies. On September 6, an imperial conference was convened to approve a timetable for war mobilization in the event of a breakdown in US-Japanese diplomatic talks. As was true of all imperial conferences, Hirohito was expected to remain silent and approve a policy that already had been decided.

Breaking with protocol, however, Hirohito cautioned against giving up on diplomacy too soon, and then recited his grandfather Emperor Meiji’s poem from the beginning of the Russo-Japanese War, in 1904: “Beyond all four seas, all are brothers and sisters/Then why oh why these rough winds and waves?” Thus, Hirohito might have been seeking to express his view that Japan should avoid a war with the US, especially given that the country had been fighting a savage and unsuccessful war of conquest in China for more than four years.

But, whatever Hirohito’s true intentions (which we cannot know for certain), the larger fact remains that he went along with the war mobilization. And, while the new official record depicts this well-known episode in some detail, it sheds no new light on how Hirohito understood his own action.

Just as he dithered over going to war with the US, Hirohito was hopelessly ambivalent about how to end it. The new record reports that Hirohito told his closest adviser, Privy Seal Kōichi Kido, on September 26, 1944: “If one could come to a peace without the question of disarmament or war responsibility, I don’t care [if] our conquered territories [are taken away].” This is reportedly the first indication in the new account about Hirohito’s desire to end the war.

But, whatever his true desire, his subsequent actions were – once again – not those of a man actively trying to find a path to peace. For months, he told himself and others that first “Japan must have another brilliant military gain” over the US, so that it would have a modicum of diplomatic clout in negotiating a postwar settlement. Needless to say, many Japanese and non-Japanese lives were lost during those months of indecision.

Indeed, the very existence of the Japanese nation was endangered, as most cities were bombed, Okinawa was invaded, and atomic bombs were dropped on Hiroshima and Nagasaki. In the end, Japan was disarmed, postwar trials were held, and most of the country’s imperial conquests were reversed. And yet Hirohito still managed to sidestep the question of his own responsibility in a war that was so obviously fought in his name. Amid the postwar devastation, he became a symbol of peace.

The most important lesson of the new imperial record, then, might be quite different from what its compilers had intended. Japan’s notorious collective inability to come to terms with its past is deeply entwined with its inability to understand this emperor.

Admittedly, the new account makes only selective use of primary sources, quite a few of which have not been declassified in their entirety. It is possible that more revelations will emerge in the future. But, for now, Hirohito remains a singularly unfathomable and isolated character who defies common understandings – alas, to the detriment of a better understanding of “what actually happened.”

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Warnings From Deutsche Bank

by Big Picture

deutsche bank

There is plenty of uncertainty in the world at the moment. Turning on the television is enough to get flooded with disasters and conflicts that are impacting our societies right now. These conflicts also make sure that an increasing amount of policy makers are getting worried and the International Monetary Funds recently underlined that the global economy is under pressure.

It is definitely also important as an ianvestor to know what kind of news influences the markets. It is clear that investors are mostly focused on the words and deeds of the Federal Reserve and the European Central Bank at the moment, since both central banks hold the power to change the future on the markets.

A Warning From Deutsche Bank

deutshe bank risks

On the chart above you can see a number of risks and how big the risk actually is. One of the things that jumps out is that the risk of another crisis in Europe is quite high. Deutsche bank believes in other words that the ECB, under the leadership of Mario Draghi, will not be able to help the European economy. Next to that, Deutsche Bank also is worried about a sell-off on the markets.

Policy makers at Deutsche Bank are still taking into account a potential rough landing for the Chinese economy and all the geopolitical tension that is going on around the world. It is clear that these risks are not great for the bulls and the question is how long they can hold the bears back from a comeback.

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Corn's sharp slide

By John Caiazzo

Interest Rates: The 30-year Treasury bond closed Friday at 135 29/32nds, down 1 12/32nds as better than expect U.S. retail sales data indicated consumers are willing to spend. The uptick in spending could portend economic growth. U.S. retailers reported an increase in sales for August of 0.6% which was in line with expectations. Also the preliminary University of Michigan/Thomson consumer sentiment index rose to 84.6, it’s highest reading since July of 2013. A concern when better economic data is reported is that the U.S. Federal Reserve may consider moving up the end of it’s stimulus program and that could cause an increase in rates. We do not believe the Fed will act upon one or two sets of positive data so after this week’s decline in price and increase in yields, we moved from neutral to positive for bonds.

Stock Indices: The Dow Jones industrial average closed Friday at 16,987.51, down 61.49 points while the S&P 500 (CME:SPZ14) lost 12 points closing at 1,985.55 and for the week gave up1.1%. The tech heavy Nasdaq closed at 4,567.60, down 24 points or 0.5% and for the week lost 0.3%. Concern that the U.S. Federal Reserve may consider raising interest rates sooner that was previously expected. This weeks Federal Reserve meeting will be a determining factor but for now, as in prior weeks market letters, we strongly suggest taking profits and implementing risk hedging strategies for holders of large equity positions.

Energies: October crude (NYMEX:CLV14) oil closed at $92.27 per barrel down 56c or 0.6%. For the week crude lost 1% and has been down for 10 of the last 12 weeks. While some concern over the Russian/Ukraine situation and the ISIS control over some Northern Iraqi oil fields, our overall view of a declining global economy persists and we remain overall bearish towards crude. in our bearish posture. October natural gas seems to have "weathered" the storm and closed Friday up over 3c or 0.9% to close at $3.8570 per MBTU. For the Nat Gas gained 1.7%. We continue to favor the long side of Natural Gas.

Grains and Oilseeds: December corn (CBOT:CZ14) closed at $3.38-½ per bushel, down 2 1/2c on continued selling pressure since trading at $5.14 in May. The sharp slide was attributable to supplies and demand prospects. However, some talk of an early freeze could change the dynamics for both corn and soybeans (CBOT:ZSX14) so we would start "nibbling" at corn. December wheat (CBOT:ZWZ14) closed at $5.03 per bushel, down 6 1/2c since its May trading highs around $7.60. The downtrend and momentum keeps us out of wheat. November soybeans closed at $9.84 ¾ per bushel, up 3 1/4c and could be forming a technical base as well as tied to concerns of an early frost even though no particular information is available for now. According to Texas A&M University we could experience temperatures in the 30s and "crop is behind normal in maturity." That could prompt us to once again look at the long side of soybeans. Buying a few calls may be in order.

Precious Metals: December gold (COMEX:GCV14) closed at $1,231.50 per ounce, down $7.50 or 0.6% as confidence in the economic outlook for the U.S. increased tied to the data reported. Gains in retail sales as well as consumer confidence also a factor but the recent dollar strength the main consideration for gold’s weakness. December silver managed a gain of one cent to close at $18.55 per ounce but for the week lost 2.8%. At current levels I continue to prefer silver over gold for those that "must have" a precious metal in their portfolio. January platinum closed at $1,370.00, down $2.40 while December palladium gained $2.35 to close at $835.55 per ounce. Once again our preference here is palladium over platinum. The similarities of applications for these two white metals do not warrant the price disparity in our opinion.

Currencies: The December U.S. dollar closed at 84.405, down 5.4 points but ws up 2.11% against the Japanese yen for the week. The Japanese yen closed at 0.09323c, down 24 points. Gains were posted Friday for the Euro 21 points to $1.2954, the Swiss Franc 17 points toi $1.0714, and the British Pound 35 points to $1.6242. The gains were a correction from weakness against the dollar during the prior sessions. Losses were realized in the Canadian dollar 27 points to 89.98c, and the australian dollar 48 points to 89.87c. We have favored the dollar for some time and see no reason to change our opinion. The continuing concern related to Russian and the Ukraine could further impact energy to Europe should the situation deteriorate. Hold the dollar.

Coffee, Cocoa and Sugar: December coffee closed at $1.8420 per pound, down 1.25c on light long liquidation but some concern over Brazil’s production after the drought could keep prices from falling further and establish a base for another move over $2.00. We like coffee but use stop protection. December cocoa closed at $3,053, up $25 on shortcovering. The International Cocoa Organization had recently indicated that the previous concern over a production deficit may have been mitigated in West Africa and we could see some liquidation of forward contracts emerge. Stay out for now. March sugar closed at 16.33c per pound, down 30 points and remains solidly on our "no interest" list.

Cotton: December cotton closed at 67.91c per pound, down 18 points but shortcovering brought prices back from the recent lows around 62c. We could see further price gains tied to the USDA monthly crop report which downgraded its domestic cotton harvest. The tighter U.S. inventory situation could be offset to some degree by improved forecast for the Indian harvest. We would buy calls from here or in the case of futures, use stop protection.

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CTAs exit nat gas according to COT data

By Naureen S. Malik

Funds reduced bullish wagers on natural gas to the lowest level in more than nine months as U.S. shale production surges to an all-time high.

Speculators lowered their net-long position across four benchmark contracts by 12% in the week ended Sept. 9, the third consecutive drop, U.S. Commodity Futures Trading Commission data show. Short positions, or bets on falling prices, increased to the most since December.

Goldman Sachs Group Inc. and Barclays Plc cut their gas price forecasts for the fourth quarter and next year as the jump in shale production outpaces government estimates. Output from the Marcellus in the eastern U.S. is forecast to top 16 billion cubic feet a day for the first time in October. Futures gained 2.4% in the week of the report before tumbling 3.2% through Sept. 12.

“Last week we had another failed rally because we continue to get weekly verification that we have ample supply.” Teri Viswanath, director of commodities strategy at BNP Paribas SA in New York, said in a Sept. 12 telephone interview. “As the industry transitions into the heating season we experienced a bit of premature buying.”

Natural gas (NYMEX:NGV14) advanced 9.4 cents to $3.984 per million British thermal units on the New York Mercantile Exchange through Sept. 9 and settled at $3.857 on Sept. 12. The futures rose 7.1 cents, or 1.8%, to $3.928 at 8:51 a.m. today.

Stockpiles Increase

Gas stockpiles expanded by 1.979 trillion cubic feet from an 11-year low in March to 2.801 trillion on Sept. 5, the quickest pace in Energy Information Administration data going back to 1994. Supplies that rose faster than the five-year average for 21 consecutive weeks cut a deficit to the average to 14% from a record gap of 55%.

The EIA sees supplies rising to 3.477 trillion by the end of October as new wells come online at shale deposits, such as the Marcellus in the Northeast, according to its Sept. 9 Short- Term Energy Outlook. Marketed output will jump 5.3% this year to 73.93 billion cubic feet a day, up from 73.89 billion in the previous month’s estimate and reaching a record for the fourth straight year.

Goldman Sachs cut its gas price forecast for the fourth quarter and for 2015 to $4 per million Btu from $4.25, Daniel Quigley, a London-based analyst with the bank, said in a Sept. 12 note to clients. Barclays reduced its outlook for the fourth quarter to $3.95 from $4.50 and for 2015 to $4.01 from $4.24, Christopher Louney, an analyst with the bank in New York, said in a Sept. 12 report.

Milder Forecasts

Forecasts for colder air sweeping the Midwest turned milder for mid-September, signaling some weaker overnight heating demand, according to Commodity Weather Group LLC. Readings will return to seasonal norms or higher across most of the lower 48 states from Sept. 16 through Sept. 25.

Gas demand slumps in the so-called shoulder season between the summer months, when hot weather drives power-plant consumption to run air conditioners, and the heating season.

“If we weren’t in the middle of the shoulder season you would see a little more confidence,” Gene McGillian, an analyst and broker at Tradition Energy in Stamford, Connecticut, said by phone on Sept. 12. “We probably have six to eight weeks” of moderate weather, he said.

In other markets, hedge funds raised bullish positions on West Texas Intermediate (NYMEX:CLV14) from a 17-month low, adding 8.3% to 186,612 contracts. WTI declined 13 cents to $92.75 a barrel on the Nymex in the period covered by the CFTC report.

Gasoline Bets

Bullish bets on gasoline (NYMEX:RBV14) dropped 775 contracts, or 4.3%, to 17,125, the lowest since September 2010. Gasoline futures rose 0.2% to $2.5484 a gallon on the New York exchange in the report week.

Regular gasoline at the pump, averaged nationwide, fell to $3.395 a gallon Sept. 13, the least since Feb. 21, according to Heathrow, Florida-based AAA, the largest U.S. motoring group.

Net-short positions in ultra low sulfur diesel increased 13% to 20,146 contracts. The fuel dropped 0.2% to $2.7915 a gallon in the report week.

Net-long positions on four U.S. natural gas contracts declined by 15,463 futures equivalents to 115,986, the least since Nov. 19. The measure includes an index of four contracts adjusted to futures equivalents: Nymex natural gas futures, Nymex Henry Hub Swap Futures, Nymex ClearPort Henry Hub Penultimate Swaps and the ICE Futures U.S. Henry Hub contract. Henry Hub, in Erath, Louisiana, is the delivery point for Nymex futures, a benchmark price for the fuel.

Long positions slid 2.1% to 422,414 contracts, the least since Aug. 12, while short positions rose 2.1% to 306,428, the most since Dec. 3.

“The rally was fueled by the market focused on the forecast that we would go from a period of high cooling demand to a period of high heating demand,” said Viswanath. “That didn’t happen.”

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Is bull market on dollar menu?

By Jeff Greenblatt

Last week we explored the growing divergence between the housing index HGX (see chart) and the rest of the market. You’ll recall something similar may be brewing albeit on a smaller scale from the bad old days of 2007.  Latest news from the industry is new mortgage applications are now at a 14-year low.  It shouldn’t be too hard to figure out. We have a new world when it comes to the rate environment; cluster that with rising home prices and stagnant wages. It is what it is. Despite the better economic news compared to several years ago now fast food workers are starting to become militant about the $15 per hour minimum wage.

If you really analyze that situation, why it is that fast food workers are demanding such a pay hike. Back in normal times, it was only Ray Kroc, Ronald McDonald and a few thousand franchise owners who expected to build a career with the golden arches. But in this new era it was just a few short years ago McDonalds decided to hire 50,000 new workers and people from all walks of life showed up. When I was a kid, I remember my older cousin Davey got his first job at McDonalds. I marveled at his uniform and figured it was time to go get a paper route because I was too young.  But here you have thousands of misplaced people who haven’t been able to find work elsewhere demanding more money. McDonalds is a ‘starter’ job and people used to seem to realize they either had to go to school or improve their skills to move up the ranks to get paid more. Be of greater value to others in order to bring greater value to yourself. For some reason that is getting lost. For whatever reason people can’t seem to be able to afford training or can’t find the work to move on from McDonalds. Why am I going on and on about this? Because mortgage applications are at a 14 year low and this is the reason. Before I get emails about this, there is nothing wrong with working at McDonalds. I’m not pointing my finger at the good folks trying to make a living, rather indicting an economy that does not deserve the complacency we’ve seen over the past year.

Complicating all of this is the fact the BKX (Banking index chart below) just woke up out of its slumber. Last week it broke to the upside and long term readers of this column know one market altruism is when the BKX goes up nothing bad happens to the market. So how is it the BKX is going up while the HGX is losing ground? Honestly, I couldn’t tell you. It doesn’t even matter because it is what it is.

On tap for this week is the major quarterly Fed announcement tied together with Janet Yellen’s press conference. Last week the market had a hissy fit when it was either leaked or speculated they would remove the phrase ‘considerable time’ when it came to raising interest rates. Janet Yellen and company are studying whether the employment problem is structural or not. They probably shouldn’t strain too hard. All they need to do is look who is working at McDonalds these days.

Giving everything I’ve mentioned it would be the height of stupidity for the Fed to raise rates now or anytime soon. But perhaps they’ll take the phrase out for an entirely different reason. Has it occurred to anyone this would be a convenient way for Janet Yellen to attempt to pop the complacency bubble without mentioning it by name? Last week we talked about how this year is shaping up to resemble 1937 which just so happened to be a year the Fed raised rates and Congress attempted to balance the budget. The results were disastrous as it spawned Great Depression II. With the growing military threat we can’t afford any more missteps with the economy right now. There are hawks inside the Fed who would actually choose to raise rates this week. It’s not going to happen but the mere thought of it shows how these people have not learned from history. Thankfully, Janet Yellen sat on Bernanke’s kneecap and will hold off for at least six months, after the end of tapering (most likely after October meeting).

That gets me to the BKX which reversed course last week and actually put in a buy signal when polarity flipped as they tested the cluster of red power bar and that last gap down which represented the final thrust. It’s hard to say how far this can go but for right now that’s on a buy signal. The other part of the market still doing reasonably well is the Transports which is still making new highs. So if nothing bad happens when the BKX is going up, nothing really bad happens when the BKX and DJTA (Dow Jones Transportation Average) goes up along with it. But we still have that nagging bearish divergence to housing. Since the folks at McDonalds are not likely to change jobs anytime soon it’s still going to be a concern for this market as we hit late September and early October.

My final consideration for today is the dollar. I heard Dennis Gartman on CNBC proclaim the dollar is in a new bull market and by that he must mean secular. He might be right, but the technicals don’t support him yet. Here’s a chart exclusive (below) to readers that I’ve shown you periodically for the past five years and I haven’t had to change it one iota. The greenback has been driven by the long term Andrews mid line bus.

As you can see it has strategically touched it several times and repelled every time. So here we are again and for a bull market to confirm not only does this have to take out the line but somehow technically flip polarity to breakout to such a point it does not fall back below it in order to confirm a secular bull market. There is one technical case against it. They’ve come to this point in parabolic fashion and it’s hard to imagine it will do going forward what it’s done in the past. Does anybody think it’s going to stay parabolic?

So our views have not changed. We are still looking at the big cycle point come October. Right now the plot thickens as on the one hand banks and transports push higher, keeping Wall Street complacent at the switch and the non-confirmation of the HGX keeping smart traders on their toes.

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Dollar hotter than ever

By Rob Verdonck

The dollar strengthened to a 14-month high and commodities declined to the lowest level in five years after data added to evidence China’s economy is slowing. Russia’s ruble weakened to a record after the European Union and U.S. imposed new economic sanctions.

The Bloomberg Dollar Spot Index rose 0.1% at 8:33 a.m. in New York. The Bloomberg Commodity Index fell 0.4% as oil declined 0.9% and copper slipped 0.4%. Emerging market stocks dropped for an eighth day, the ruble (CME:R6V14) weakened for a third day and U.K. natural gas (NYMEX:NGV14) advanced the most in two weeks. Standard & Poor’s 500 Index (CME:SPZ14) futures and the Stoxx Europe 600 Index were little changed.

Royal Bank of Scotland Group Plc cut its 2014 estimate for Chinese economic expansion to 7.2% from 7.6% after August industrial output growth was the weakest since the global financial crisis. Investors assessed regional manufacturing data in the U.S., where the fastest rise in retail sales in four months bolstered speculation the Federal Reserve will signal moves toward interest-rate increases and reduce its quantative easing program of bond purchases at a meeting this week. U.S. Secretary of State John Kerry is scheduled to meet Russian Foreign Minister Sergei Lavrov today.

“The strength of the dollar is something we’ve been anticipating, knowing that we have QE finally ending,” Dan Morris, a global investment strategist at TIAA-CREF Asset Management, said in an interview on Bloomberg Television’s “On The Move” with Jonathan Ferro in London. “You do see a negative reaction on the part of emerging markets when those currencies do start to weaken against the dollar, with cash flowing back to the U.S.”

U.S. Treasuries

Speculation that a strengthening U.S. economy will prompt the Fed to bring forward its timeline for raising borrowing costs is pushing down Treasuries and boosting the allure of the dollar (NYBOT:DXZ14). The U.S. 10-year note (CBOT:ZNZ14) yield was at 2.60% after touching 2.62% today, the highest since July 7, and the Bloomberg Dollar Spot Index advanced to its strongest level since July 2013.

Spain’s bonds rose, pushing 10-year yields three basis points lower to 2.32%.

Australia’s dollar (CME:A6Z14) fell below 90 cents for the first time since March and South Africa’s rand slid for a sixth straight day today. Malaysia’s ringgit led losses in Asia as it fell by the most since March and a gauge of emerging-market currencies slid to the lowest since 2009.

The krona (CME:SKZ14) was little changed at 9.2365 against the euro today. The three-party Social Democratic opposition bloc won 43.6% of the vote in an election, versus 39.5% for the government’s coalition, with 97% of ballots counted. The Social Democrats must now garner support from other parties to form a majority.

Unprecedented Stimulus

Unprecedented stimulus by central banks helped swell investments in emerging markets to $1.4 trillion as of May, raising the risk that those markets may destabilize when interest rates rise or their exchange rates fall, the Bank for International Settlements said in a report yesterday. The Fed has created a committee led by Vice Chairman Stanley Fischer to monitor financial stability, reinforcing its efforts to avoid the emergence of asset-price bubbles.

The Bloomberg Commodity Index declined as much as 0.4% to the lowest since July 29, 2009. West Texas Intermediate oil (NYMEX:CLV14) dropped to $91.40 a barrel and Brent crude (NYMEX:SCV14) fell to $96.80 a barrel. Copper retreated to $6,812.25 a metric ton. China is the biggest buyer of energy and industrial metals. U.K. natural gas for October gained as much as 4.6% on concern an escalation of fighting in Ukraine may disrupt flows from Russia to Europe.

The MSCI Emerging Markets Index slid 0.8%, extending its longest run of losses since a 10-day rout ended Nov. 13.

The ruble weakened as much as 1.3% to 38.23 per dollar. Ukraine’s July 2017 Eurobond fell for a second day, sending the yield 27 basis points higher to 13.09%.

Paris Meeting

Kerry will meet with Lavrov at a conference on Iraq that will take place in Paris. Russia still has more than 3,000 soldiers inside Ukraine and about 25,000 troops along the border, according to the nation’s government. The U.S. and other NATO countries are commencing military exercises in the country today.

The U.S. on Sept. 12 expanded sanctions against Russia to include OAO Sberbank, the country’s largest bank, because of the fighting in eastern Ukraine. The EU added 15 companies, including Gazprom Neft, OAO Rosneft and OAO Transneft, and 24 people to its own list of those affected by its restrictions.

The Hang Seng China Enterprises Index of mainland companies listed in Hong Kong slid 1.6% to a five-week low. The Shanghai Composite Index added 0.3%.

Industrial Output

Industrial output rose 6.9% from a year earlier in August, the statistics bureau said on Sept. 13, down from 9% in July and the slowest pace outside the Lunar New Year holiday period of January and February since December 2008, based on previously reported figures compiled by Bloomberg. Retail sales gained 11.9% and fixed-asset investment in the January-August period climbed 16.5%, both missing analyst estimates.

The Fed Bank of New York’s Empire Manufacturing gauge manufacturing index jumped to 27.54 this month from 14.69 last month. Economists estimated the reading would be 15.95, according to a Bloomberg survey.

A separate report may show U.S. industrial production, which includes mines and utilities, rose 0.3% in August compared with 0.4% the previous month. Figures may also show factory output increased 0.2% last month, according to the median estimate of economists surveyed by Bloomberg News.

The MSCI All-Country World Index fell after sliding 1.4% last week, its first drop since the period ended Aug. 8.

Oil and gas companies led declines on the Stoxx 600, following a 1% drop last week. The U.K.’s FTSE 100 Index was little changed before this week’s Scottish referendum. Lloyds Banking Group Plc dropped 1.1%.

Air France

TDC A/S lost 7.2% after Denmark’s largest telephone company agreed to buy cable-TV provider Get AS and said it will cut its dividend. Nobel Biocare Holding AG dropped 5.5% after Danaher Corp. agreed to acquire it, paying less than its share price at the last close.

Air France-KLM Group slid 3.8% after saying it expects its most disruptive strike since 1998.

SABMiller Plc and Heineken NV both advanced more than 2% after the U.K. brewer was rebuffed in an attempt to buy the Dutch company. Micro Focus International Plc jumped 15% after agreeing to buy business-software provider The Attachmate Group Inc.

Hennes & Mauritz AB climbed 2.6% after Europe’s second-biggest clothing retailer reported a 16% gain in third-quarter sales.

Futures on the S&P 500 expiring in December fell as much as 0.4% today after the index posted its first weekly decline since the period ended Aug. 1.

Alibaba IPO

Yahoo! Inc. rose 2.4% in early New York trading after people with knowledge of the matter said Alibaba Group Holding Ltd. will increase the size of its initial public offering amid strong investor demand.

The MSCI AC Asia Pacific Index fell 0.6% today for an eighth consecutive day of declines, the longest streak since January 2010.

Phones 4u Ltd. filed for administration and will close its mobile-phone stores across the U.K. after failing to secure contract renewals with mobile carriers EE Ltd. and Vodafone Group Plc.

Its 430 million pounds of bonds maturing April 2018 plunged 26 pence on the pound to a low of 10.4 pence, according to data compiled by Bloomberg. The 9.5% bonds were quoted at 102 pence on Aug. 29.

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Under down under

By Lucy Meakin and Kristine Aquino

Australia’s dollar fell below 90 U.S. cents for the first time since March, and Sweden’s krona declined after elections as prospects for U.S. interest-rate increases next year boosted the greenback’s allure.

The Bloomberg Dollar Spot Index rose to a 14-month high. Australia’s currency (CME:A6Z14) extended this month’s drop to 3.4% after data showed the weakest growth in Chinese industrial output since the global financial crisis. Emerging-market currencies slid. The krona (CME:SKZ14) declined as Sweden faced the prospect of a hung parliament.

The risks now are building for the Australian dollar, not just from the U.S. higher yields but from the Chinese angle as well,” said Ian Stannard, head of European foreign-exchange strategy at Morgan Stanley in London. “We’ve seen the Aussie already moving below 90, giving quite a bearish signal. It’s an important week for global risk-assessment.”

Australia’s currency fell 0.2% to 90.23 U.S. cents at 8:36 a.m. New York time and earlier touched 89.84 cents, the lowest level since March 12. The krona depreciated 0.4% to 7.1464 versus the U.S. currency and reached 7.1571, the weakest since June 2012.

The U.S. dollar (NYBOT:DXZ14) strengthened 0.4% to $1.2916 per euro (CME:E6Z13) and was little changed at 107.24 yen. The euro fell 0.5% to 138.51 yen. Japanese financial markets were shut today for a national holiday.

China Production

Chinese industrial output rose 6.9% from a year earlier in August, the statistics bureau said Sept. 13. That was down from 9% in July and the slowest pace outside the Lunar New Year holiday period of January and February since December 2008, based on previously reported data compiled by Bloomberg. China is Australia’s largest trading partner.

Before the slide in the Aussie, the median forecast in Bloomberg surveys of analysts for the currency’s end-2014 level had climbed to 92 cents at the beginning of this month. That was the highest projection since July 2013 and the first time in more than a year that the Aussie’s spot level had fallen below the survey estimate.

The krona depreciated as the three-party Social Democratic opposition led by Stefan Loefven won 43.7% of the votes, versus 39.3% for the government of Prime Minister Fredrik Reinfeldt, with all the votes counted. The nation’s political establishment was thrown into turmoil as backing for the anti- immigration Sweden Democrats more than doubled, to 12.9%, making them the third-largest party.

Reinfeldt’s Loss

The result marks an end to eight years of rule by Reinfeldt’s conservative-led coalition. The premier said he will hand in his resignation today as the responsibility of forming a new government falls to the Social Democrats, which won the most votes.

“The krona has weakened in response to the Swedish election result,” BNP Paribas SA analysts led by London-based Steven Saywell, wrote in an e-mailed note. “The market’s concern is over the time it may take for a government to be formed, but we would highlight that the current weak levels of the krona limit the scope for a selloff.”

The Bloomberg Dollar Spot Index, which tracks the greenback against 10 major currencies, increased 0.1% to 1,051.55 and had touched 1,052.14, the highest since July 2013.

A gauge of manufacturing in the New York region rose more than forecast, climbing to a reading of 27.54 for September, from 14.69. A Bloomberg forecast called for 15.95.

Best Performer

The dollar has risen 3.6% over the past month, making it the best performer of 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted indexes. Signs of a strengthening U.S. economy have boosted speculation the Federal Reserve is moving closer to raising interest rates as it tapers its program of quantitative easing.

There’s a 78% chance the Fed will raise its target for overnight lending between banks from a range of zero to 0.25% by its September 2015 meeting, fed funds future data compiled by Bloomberg show today. Policy makers begin a two-day gathering tomorrow.

The strength of the dollar is something we’ve been anticipating, knowing that we have QE finally ending,” Dan Morris, a global investment strategist at TIAA-CREF Asset Management, said in an interview on Bloomberg Television’s “On The Move” with Jonathan Ferro in London. “You do see a negative reaction on the part of emerging markets when those currencies do start to weaken against the dollar, with cash flowing back to the U.S.”

A Bloomberg index of 20 developing-nation currencies slid 0.3% to 88.97 and touched 88.90, its lowest level since 2009.

Copyright 2014 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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What happened to the volatility?

By Daniel P. Collins

Every time it looks like we are heading back to a “regular” market environment we are reminded just how extraordinary an event we went through in 2008. Perhaps there is no going back — at least not for a long time. The key factor is that nearly all major currencies are wallowing in a near zero-interest rate environment and central banks across the globe are keeping a tight handle on monetary policy (see “Not much to trade over,” below). The result has been historic low volatility in currency markets.

“Obviously with monetary policy and yield differential being a big catalyst for currency direction the whole world seems to have come to a standstill,” says Interactive Brokers Chief Market Strategist Andrew Wilkinson. “Risk was set in neutral gear and nobody has a good handle on what comes next for the dollar.”

Or for anything else for that matter. An odd component of the recent low volatility environment is that it is happening with the world awash in geopolitical risk. We have the Russia/Ukraine situation, a hot war in the Gaza strip, the Islamic State of Iraq and Syria (ISIS) gaining a strong foothold in both those countries and an Ebola outbreak in Africa. 

“I have never seen anything like it in terms of complacency,” says Marek Chelkowski, principal of advisor MDC Trading. “There are a lot of volcanos.”

“We are setting records for most narrow average daily ranges,” adds Michael Aronovitz, portfolio manager for Gables Capital Management. “The average euro range is 30 to 40 pips a day; we were used to seeing 120 pips a day a few years ago. That is not going to change until interest rates begin to rise in the United States and there is more variation between (rates in) G10 countries.”

The situation compounds itself because with most central banks wallowing between zero and 50 basis points there is not a wide range of potential moves. “In a normal environment people would be looking at a larger potential range in movement of interest rates, but with it frozen that range is 25-50 basis points instead of perhaps 400 basis points,” Aronovitz adds.  

Dollar ready to soar?

There is a consensus that the dollar rally, which began in July, will continue, though the range of conviction is wide. 

Dean Popplewell, director of currency analysis and research for Oanda, sees numerous factors supporting the dollar. The taper, set to be complete by Q4, low inflation and the current low volatility all are adding to dollar strength according to Popplewell.

He points out that the European Central Bank is concerned with deflation as the U.S. Federal Reserve argues over when to begin raising rates.

Wilkinson is also positive on the dollar but more by default, and is cautious. “We had a lot of false starts with the dollar,” he points out. “Currency traders have been tripped up by that so many times. Ultimately it left a lot of people nursing wounds and sitting on the sidelines.”

He points out that economic data is still tepid and while the Fed should be the first mover, it could take another year. “The problem is that at the moment that move is thought to be way off into 2015.  And for the spot currency market that is a lifetime away,” Wilkinson says.

Erik Tatje, market strategist at RJO Futures, says, “We will see some weakness out of the Eurozone and a strengthening of the dollar by year end. I don’t foresee the fed changing anything. The dollar will continue to rally.”

Aronovitz is also bullish and cautious. “The dollar will continue to strengthen though there will be hiccups along the way,” he says. “We are at an historical low in currency volatility and that is the bigger story. Dollar strengthening is expected but the pace of the move is historically very slow.”

Expectations for the dollar range from slightly higher, following a correction, to testing the 2013 highs.

The summer rally took out some short-term resistance and the greenback faces a series of resistance areas in the narrowing ranges of the last few years (see “Squeezing the dollar,” below).

“What we are seeing now is a bit of a fear trade where people want to be long the dollar because stock markets are looking vulnerable to correction,” Wilkinson says. “And for the first time in a long while we are seeing the dollar feed off of those. The dollar is looking clever at this point in time but as [summer turns to fall] once again the same fears that are driving the dollar higher may end up receding.”

Popplewell sees the dollar breaking out of its narrow range and eventually testing 85. However, there is close-in resistance that must be challenged first.

“The first [resistance] level is 81.75, which was a 161.8 Fibonacci retracement from a previous zone,” says Tatje. “We really started to break above some key technical levels (in August); 81.50 to 82 will see a little resistance. If we can break above 82, I don’t see a whole lot of resistance. The next level of real resistance is 82.80-83.”

Wilkinson is less confident. “It might try and break through 82, but I see it between 82-81 for the remainder of the year,” he says. “I am not really looking for a substantial move in either direction. If we go off, we don’t go too far and if the dollar comes back, it won’t turn into a dollar rout.”

Chelkowski says, “I would buy the dollar but at a little better level because there is some pain coming.”

Tatje adds, “The dollar just looks the strongest relative to other currencies at this point. We are seeing a shift in strength to the dollar and that momentum will persist. By October, the market may test [the 2013 high]. We could see 83 anywhere from October to November. The key is when the market starts to trade above 82, because there will not only be near-term profit taking from this most recent rally but also longer-term resistance.”


The euro is not looking nearly as strong as the dollar and that has folks cautious as well. “When it looks too easy it is usually the wrong trade,” Chelkowski says. “Everyone hates the euro here. Everyone is short the euro, but I am a contrarian at heart.” He notes that the euro may make a comeback, but adds, “If euro prints 135, I would be a seller.”

“The euro is weakening because of the geographic proximity (to Russia) and the likely impact on Germany (from sanctions) and therefore the Eurozone as a whole,” Wilkinson says. “But I don’t think the euro will continue to slip. I can see 132 by September but I would not predict anything much lower.”

At that point, Wilkinson would turn bullish. “You can make the argument that the euro would be quite attractive at that point. On the other side of the financial crisis the euro could probably go to 150 but I would not put a time on that.”

Popplewell says it should be an intriguing end to the year. “The equity correction at the beginning of August provided some well-needed volatility and holds out hope for a more normal market. The euro will underperform the dollar and the dollar will outperform the yen.” Popplewell targets 131-129 for the euro.

Where things could get very interesting, judging from our experts, is with the Japanese yen. That is where we have seen the widest variance in opinion.

“There is nothing to cheer for in the yen,” Chelkowski says. “But markets don’t work like that. I would buy yen against Aussie.”

And he is not alone. Popplewell says the low volatility has pushed more traders to the carry trade, which he says is oversubscribed already. “The Aussie and kiwi (New Zealand dollar) benefit from the low rate environment. Those trades are overcrowded [and] will come under pressure by the end of the year.”

Specifically he is talking about a lot of traders long the Aussie and New Zealand dollars and short the yen.

While Popplewell sees an unwinding in the carry trade, Chelkowski has more ominous reasons for supporting the yen.

“I would sell risk, that means you sell the Aussie, you sell the kiwi and you buy yen and you have to buy the dollar,” Chelkowski adds.

He says the problems with the Chinese economy are not over, despite the rhetoric from Chinese leaders and that the correction in equities this August may just be the beginning. “I don’t believe in a global economic recovery. I am bearish on the stock market. We are in a serious scenario. I say 95 on dollar yen.”

“The yen is interesting,” acknowledges Wilkinson. “There was a view that things were getting better—the sales tax had created a whiff of inflation and the economy was staring to move. It was starting to act like a better risk arbiter than the dollar. It even was advancing against the euro, and now it seems to be [under pressure]. It may be ready to resume a march to 105 or 110 on concerns the Eurozone [problems] will roll over to the United States.”

The China wildcard

One of the reasons analysts have varying opinions on the yen, particularly vs. the Aussie, is because that trade is highly dependent on China (see “Wide breadth,” below).

China appears to have weathered its recent economic storm but like all things Chinese, the details are sparse.

“The Chinese economy seems to have turned the corner, which is good for the Aussie,” Wilkinson says. “It is difficult to predict that [the Aussie] is going to suffer when its biggest customer continues to grow at 7% to 7.5%.”

That is if you believe those numbers. “Six to nine months ago everybody was talking about how China was falling apart, now you are hearing that China is turning the corner,” Chelkowski says. “I don’t believe the Chinese numbers; the worst is yet to come. Obviously you would want to sell the Australian dollar.”

Aronovitz agrees that the Chinese data is questionable. “We expect our GDP to come out at 4% and it is flat—they expect GDP at 7.5% and it comes out at 7.5%.”

The larger question is if China will move further to float the yuan.

“The Chinese economy has suffered at the hand of a strengthening exchange rate,” Wilkinson says. “It is a long journey to bring it in line with where it should be. They just don’t want to do that too quickly. Perhaps in an era of stronger global growth they make that transition faster but we are still not clear of the financial recession.”

It’s all about rates

What is clear in the forex world is that there is very little volatility and that is not likely to change until interest rates change, which is why everyone has their eyes on the Fed. “It is really difficult to make currency projections because conventional monetary policy is perhaps dead,” Wilkinson says. “Even though interest rate increases appear on the horizon, there are a lot of “ifs” on the way that [could] actually provoke the fed into tightening. I’m quite concerned that we are going to be in an era of unconventional monetary policy going forward.”

Aronovitz says the one thing that can change expectations is if the economy begins to fail or we see an uptick in inflation. “Inflation is what central banks are paying attention to,” he says.

And after six years of a zero-rate environment it is unclear what tightening will bring or look like.

“The very action of pulling interest rates up will retard economic growth significantly. We have eight years since [U.S.] monetary policy was last tightened, so I don’t know how the economy is going to respond to it,” Wilkinson says. “The traditional catalysts for currency movements are almost redundant because we keep on getting these pushes in yields and we end up pushing back.”

It is unclear how quickly the Fed will move when they do move sometime in 2015. Tatje expects any move to be gradual. “It will be a slow gradual increase in the rates as opposed to a big jump of a whole percent.”

Judging by the Fed fund futures, it will be slow and not come until the end of the third quarter (see “The long wait,” below). It is important to remember that this unwinding has been continuously pushed back. “The long wait,” shows that a year ago Fed fund futures had priced in an interest rate of roughly 1.75% by the first quarter of 2016, now it indicates a rate of less than 1% for that period.

Of course those expectations can accelerate, particularly if the economy improves at a faster pace and if inflation spikes. Nothing lasts forever and that will hold true for the low volatility currency environment.

“The forex market had been handcuffed by the central banks,” Popplewell says. “When the market is quiet for a number of years, there tends to be an upshot in volatility and opportunity. Something we have been craving for a long time.”

While change is inevitable, the question on everyone’s mind is when.

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The Return of the Currency Wars

By David Wessel

When a country’s economy grows too slowly, the standard short-term remedies are to increase government spending, cut taxes or reduce interest rates. When none of those options is available, governments often resort to pushing down their currencies to make their exports more attractive to foreigners (and, these days, to push up import prices and thus bring inflation back up to desired levels).

When the world economy is sputtering, and every big country increases spending, cuts taxes and reduces interest rates, the global economy  benefits from the increase in demand.   That’s the story of 2009.

But when individual countries lean heavily on pushing their currencies down, that tends to shift demand from one place to another rather than increasing the total.  That is a “currency war.”  And we may be on the verge of one. Last time, the emerging markets were doing the complaining; this time, it may be the U.S.  (OK, I’m oversimplifying, but only a bit.)

Japan has already managed to depreciate its currency. The yen is at a six-year low against the dollar.  There is a fine line between pursuing expansionary monetary policy which works (in part) by reducing a country’s currency, and making currency depreciation a primary goal. The U.S. and Europe have tolerated the sinking yen largely because they saw it as part of Prime Minister Shinzo Abe’s broader effort to resuscitate the Japanese economy.

Now the spotlight is shifting to Europe.  Europe is growing painfully slowly, if at all.  Unemployment in the countries that share the euro is 11.5%. Among the under-25 crowd, nearly one in four is out of work.

Standard economics, the sort pushed by the International Monetary Fund, among others, suggests that while Europe addresses its much-discussed structural impediments to economic growth, it also pursue low taxes, more government spending and more expansionary monetary policy. And since short-term interest rates are already at zero, that means something akin to the Federal Reserve’s quantitative easing, the purchase of huge amounts of assets by the central bank to get more money into the economy, rekindle inflation (now at 0.3% in Europe) and nudge investors into private-sector loans, bonds and stocks.

But what appears to be economically necessary is not politically possible. Germany is the heavyweight in the eurozone.  It wants to keep the pressure on southern Europe to reform labor and other regulations, to work harder and to reduce their debts so it won’t bless more expansionary fiscal policy. And for those reasons, plus its historic anxiety about inflation no matter what the circumstances,  it appears opposed to more aggressive European Central Bank action – or, at the very least, it is slowing the ECB’s efforts to move in that direction.

The politics are treacherous.  As Europe leaders fumble and struggle to reach consensus, the public backlash against austerity and slow growth is building.  Euro-skeptic Marie Le Pen (“I don’t want this European Soviet Union,” she told der Spiegel Online in June) has a shot at becoming the next president of France.

So what’s the ECB to do? Push down the euro to try to juice the eurozone’s exports.  That appears to be one of ECB President Mario Draghi’s current objectives, and it’s one he can achieve with words even if he can’t get his policy council to agree on printing a lot of euros.  It certainly is appealing to the French, who’ve long seen the currency as a useful economic instrument.

And the markets are getting the message. The euro, which was trading above $1.38 for most of the spring, has fallen below $1.30 – and Goldman Sachs economists predict it’ll fall to $1.15 by the end of 2015.

For now this isn’t a big threat to the U.S. economy.  The U.S. dollar has been strengthening for some time, initially because nervous investors were looking for safety and more recently because markets expect the Fed to begin raising interest rates from rock-bottom levels next year, well before the ECB does.

Although there are always manufacturers complaining that the dollar is hurting their exports and there are long-standing complaints about China’s manipulation of its currency to favor its exports, the dollar hasn’t really been a big political or economic issue in the U.S. lately.

Perhaps because there has been so much else to worry about; perhaps because the dollar’s attractiveness has helped the U.S. Treasury lure foreigners to lend billions of dollars at very low rates.   U.S. exports have been growing; they contributed 1.3 percentage points to the 4.2% annualized increase in gross domestic product in the second quarter. But that could change if Japan and Europe continue to nudge their currencies down as a substitute for economic policies more friendly to global economic growth.

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Tesla & Bio Tech near short-term support

by Chris Kimble



Tesla and Bio Tech have been great performers over the past 24 months. Earlier this year both of them gave back some of there gains and then started another impressive rally.

Both are making attempts to make strong closes above highs hit 6 months ago, as they both are facing short-term support at this time.

Kind of interesting to see how much these patterns look alike since the first of March this year! How these stocks handle short-term support could have some influence on the future of NDX 100 index.

-See the original article >>

The Illusion Of Permanent Liquidity

by Lance Roberts

AFP (Agence France-Presse) recently printed an interesting piece about the current illusion of permanent liquidity.  To wit:

"Loose monetary policies have created an 'illusion of permanent liquidity' that is spurring investors to make risky bets and push up asset prices, the Bank for International Settlements said Sunday.

This "illusion" has not only been driving investors to make risky bets across the entire spectrum of asset classes; it has also led to the illusion of economic stability and growth. For example, financial analysts have started pushing the idea that the current earnings and economic backdrop will last for another decade. Such an expansion would rival the longest previous period on record (119 Months) from March of 1991 through March of 2001 during the "technological revolution." A repeat of such an expansion would be quite a feat if it were to occur. However, the drivers of declining inflation, interest rates and increasing leverage are no longer available to support such an expansion in an economy driven 70% by consumption.


This idea of "infinite liquidity," and the belief of sustained economic growth, despite slowing in China, Japan and the Eurozone, has emboldened analysts to push estimates of corporate profit growth of 6% annually through 2020. Such a steady rise in earnings per share would push levels to more than $183.00 per share. The problem, as shown in the chart below, is that such an earnings expansion has never occurred in history as it completely disregards the course of normal business and economic cycles.


(Note: The dashed lines show that earnings have a strong history of ranging, due to the business cycle, between 6% peak to peak and 5% trough to trough.)

It is unlikely given the current scenario of sub-par economic growth, excess labor slack globally and deflationary pressures rising, that such lofty expectations will be obtained. Importantly, it will be the consequences of such a failure that will be the most important.  As the BIS states:

"The longer the music plays and the louder it gets, the more deafening is the silence that follows," Claudio Borio, who heads the BIS's monetary and economic unit, told reporters.

'Markets will not be liquid when that liquidity is needed most,' he warned, urging 'sound prudential policies (and) extra prudence on the part of market participants themselves.'

Many central banks have kept their rates at record lows and pumped their economies full of liquidity first to stave off recession during the financial crisis and then to boost recent anaemic economic growth."

There is a rising realization by Central Banks that these excess liquidity flows have failed to work as anticipated.  The Bank of Japan entered into a "quantitative easing" program nearly 3x the size of that of the Federal Reserves most recent endeavor, or a relative basis, with nothing gained but a near 7% drop in economic growth. Domestically, the Federal Reserve's program has boosted asset prices that has inflated the wealth of the top 10% but left the bottom 80% in a worse financial position today than five years ago. (see "For 90% of Americans There Has Been No Recovery")

"Borio stressed that 'a common mistake is to take unusually low volatility and risk spreads as a sign of low risk when, in fact, they are a sign of high risk-taking. The illusion of permanent liquidity is just a prevalent now as in the past.'

Borio pointed out that years of 'unusually accommodative' monetary policy has left investors feeling secure low interest rates would continue or only be gradually tightened. That confidence has also spread to the international banking industry, where claims rose by $580 billion between January and March, BIS said. That marked 'the first substantial quarterly increase since late 2011.'"

The complete lack of "fear" in the financial markets can be seen in the levels of volatility across virtually all asset classes. The chart below, from Todd Harrison at Minyanville, shows volatility near their lowest levels on record for currencies, equities, and interest rates.


As Todd stated:

"Per the chart below, currency volatility, interest rate volatility, and S&P 500 volatility are compressed across the board. That makes sense in a world where liquidity is artificially infused into the financial fabric -- volatility is the opposite of liquidity -- but not so much as the punch bowl is being taken away. And it is clearly something that is on the radar of Federal Reserve officials given the interconnectedness of the global financial machination."

The illusion of liquidity and complacency, or should I say over-confidence, in the Federal Reserve has driven an unprecedented "yield chase" and an excessive disregard for underlying investment risk. The mistake that is currently being made by the vast majority of Wall Street analysts is two-fold. The first is the assumption that the Federal Reserve can normalize interest rates given the underlying deterioration in global growth currently. The second is that increases in interest rates will have ZERO effect on future earnings or economic growth.

As I discussed recently in "Don't Fear Rising Interest Rates, Really?" there has been no previous point in history where rising interest rates did not only slow the economy, but eventually led to an economic recession, market dislocation or both.

"While rising interest rates may not "initially" drag on asset prices, it is a far different story to suggest that they won't. I addressed this issue previously in "Why Market Bulls Should Hope Interest Rates Don't Rise" wherein I pointed out twelve (12) reasons why rising interest rates are a problem, particularly when those rate increases are coming from a period of very low economic growth.

What the mainstream analysts fail to address is the "full-cycle" effect from rate hikes. The chart and table below address this issue by showing the return to investors from the date of the first rate increase through the subsequent correction and/or recession."


The BIS is correct, the "Illusion of Permanent Liquidity" has obfuscated the underlying inherent investment risk. The belief that Central Banks will always be ready to jump in to avert a dislocation in financial or credit markets has emboldened investors to take on an incredible amount of risk.

The problem is that these excessive liquidity flows have only impacted the economic surface. Eventually, the underlying malaise will likely overwhelm the small beneficial effects of liquidity and a mean-reversion will occur. It is only then that investors will come to understand the gravity of the "risks" they have undertaken as the illusion of permanent liquity fades.

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Growth Debt And Secular Stagnation - Implications For The S&P 500

by Lance Brofman
Last October we published "A Very Long-Term View Of Government Finances - Implications For The S&P 500". The forecast extended to 2088 based on macroeconomic data forecasts from the Congressional Budget Office (CBO). From these we developed alternative economic scenarios, and we forecasted profits, the S&P earnings multiple, and thus an index value for the S&P 500 (NYSEARCA:SPY).
The conclusions from that analysis were both negative and potentially positive. On the one hand CBO data forecasts revealed a very negative equity market outlook because the CBO projected that current law would result in a huge increase in government outlays relative to GDP. But on a brighter and more hopeful note we showed that the outlook could be much more positive if GDP growth were just 0.2% per year higher than the baseline CBO forecast.
In July-August this year CBO updated its budget outlook for the 2014-2024 period. We applied this updated outlook to the long term, enabling us to update near and distant budget forecasts and forecasts for profits, the earnings multiple, and the S&P index. As part of this exercise we are integrating issues raised by Dr. Lacy Hunt of Hoisington Capital Management in his recent podcast entitled "The World Economy's Terminal Debt Sclerosis".
Our accompanying Table I shows a comparison between the most recent CBO ten year budget outlook and the outlook it published last year for the same ten year period. As usual the period is forecast on the basis of current law, and the forecast assumes no recession or any meaningful externality. In its update CBO has downgraded its ten year forecast for nominal GDP from an average of 5% per year to 4.5% and for real GDP from an average 2.8% per year to 2.5%. Implicitly it has therefore downgraded its estimate of future inflation as well.
The expectation of slower economic growth weighs on government finances. While the federal budget deficit in 2014-2015 is lower than CBO's year ago forecast, the cumulative ten year deficit is now about $600 billion higher. Because GDP growth is slower and the deficit is higher, by 2024 publicly held debt as a % of GDP is at 74% versus the 70% level that was forecast in last year's report. Finally, CBO forecasts that net interest as a % of GDP is about steady relative to last year's forecast. This is owing to a lower interest rate forecast that is a by-product of slower growth and lower inflation.
This revised CBO outlook is consistent with the mosaic of the U.S. and global economy described by Lacy Hunt in his recent podcast. Lacy argues that the economy is in a vicious self- reinforcing environment of stagnation (a liquidity trap) which is an outgrowth of excess public and private sector debt. In this environment excess debt inhibits economic growth which in turn exerts downward pressure on inflation. Weak inflation in turn depresses aggregate demand, adversely affecting nominal GDP and public sector revenue growth even as the monetary authority drives down interest rates to combat slow growth and low inflation.
From Lacy's vantage point the guts of the problem is the economy's growing inability to service its debt and the fact that interest rates have not fallen sufficiently to alter the sclerotic demand environment in which the U.S. and global economy is immersed. To illustrate this conundrum Lacy utilizes a relationship codified by the Austrian School of Economics wherein the BAA interest rate is related to nominal GDP growth such that as long as the interest rate is higher than nominal GDP growth, the economy is unable to adequately service its debt, thus prolonging sluggish business activity.
The accompanying Chart I shows a coincident history between the BAA bond rate and nominal GDP growth and a five year moving average of the two for the post World War II period. Coincident data is very jagged because of periodic business expansions and contractions. The five year average smoothes this and makes the trend in the relationship more vivid. On the chart zero is the line of demarcation for debt service with a favorable level being above zero and a worsening debt service climate represented by a below zero reading. On balance whether it be coincident or smoothed data the chart shows that until 1980 the BAA rate was consistently below the GDP growth rate which is a positive for debt service. Since 1980 the opposite has prevailed even as the general level of long term interest rates declined. The debt service proxy hit a low point in 1987 and from there it improved steadily with faster economic growth in the 1990s. But even during the 1990s the economy's ability to service debt deteriorated, and of course it worsened significantly with the onset of recession in 2008-2009 and throughout the past five years of recovery.
One could identify many channels through which debt service might affect the overall economy. Its impact on business investment would be one such channel so to test this we correlated net domestic investment (the domestic capital spending of domestic companies) with the five year moving average of Lacy's debt service variable. In fact the relationship is direct, meaning the better able that debt is serviced i.e. GDP exceeds the interest rate, the more positive it is for capital spending. The accompanying Chart II shows the historical fit. The relationship is statistically significant, explaining 18% of the variation in capital spending.
The BAA bond rate seems as good a proxy as any for the economy-wide business cost of funds. It works better than the ten year treasury rate in correlations with business investment. Yet it was not as useful as the ten year treasury rate in forecasting the market multiple. We surmise this reflects the presumption that borrowing costs for 90% of S&P 500 companies are close to the ten year rate. Moreover, almost all BAA corporate bonds are callable whereas treasuries are not callable. This gives investors an asymmetry whereby if rates drop, bonds are called but if rates rise, they would most likely not be called.
With this in mind our use of the ten year treasury rate in our short and long term forecasting models of the market multiple seems quite valid. And you will recall that this variable and a forward looking moving average of federal outlays to GDP are the prime ingredients in our forecasting model of the market multiple. Our model for estimating profits includes nominal and real GDP growth and a lagged moving average of unit labor cost in manufacturing.
Last year when we estimated this model to the 2080s we found that eventually the market multiple would fall into the single digits beginning in 2034 and to zero in 2067. With newly revised input data the news is less bad as the model now shows that 2039 is when the multiple swings into single digits.
The prime factor driving down the multiple is an explosion in government's share of the economy beginning in 2025. And in the context of Lacy's analysis this explosion makes it ever more difficult to service debt. This makes a dollar's worth of earnings less valuable, leading to weaker equity prices, a rising cost of equity capital and thus ever slower investment and economic growth.
To date Central Banks have been attempting to improve the GDP-interest rate relation. Their direct method has been zero short term interest rates and quantitative easing. The goal of low interest rates and monetary expansion has been to boost aggregate demand and price inflation, implicitly in this country and explicitly in the case of Japan and more recently Europe. Lacy would argue that while these Central Bank policies are effective intermittently, the effect is transitory and they are doomed to fail.
We are sympathetic to this argument as we have long argued that the U.S. and the global economy is caught in a liquidity trap. Of course Central Bank policies would be more effective if fiscal policies were in sync. But the fact is that over regulation, and tax and spending policies have often been countervailing. Given this we have also long argued that what is needed to break the debt spiral is some new innovation that would spur demand independently of public policies. Growth was facilitated in the 1950s and 1960s with the construction of the interstate highway system and the space race. Thus, the economy was very able to service the debt that was incurred during World War II.
Growth was facilitated in the 1990s by the advent of the internet and advances in computer technology. The 1990s was a rapid growth era even though Lacy's debt service ratio was consistently below zero. This implies that while debt service may be an impediment to growth it certainly is not the only factor affecting economic growth. The same is implied by the correlation between debt service and capital spending. The relation is significant but not conclusive.
The problem is that as debt service is negative and it is allowed to fester, the impact eventually becomes debilitating. This becomes clear when examining the very long term outlook to the 2080s. As noted earlier, upon running our models for the very long term we found that federal outlays to GDP rose to such a degree that it drove the earnings multiple to zero in the 2060s. With newly revised data the news is slightly less bad in that it is not until 2074 that the multiple falls to zero. This we would describe as providing cold comfort at best.
The accompanying Table II shows this and accompanying CBO macro forecast data to 2089. Various measures remain at tolerable levels until the middle of the next decade when they begin to explode. For example, the federal deficit would reach 12.7% of GDP at the terminal date versus about 3% currently and 14.7% in CBO's earlier analysis. Debt held by the public would reach 229% of GDP by 2089 versus 74% currently and 245% in the analysis done last year.
The major drivers of future deficits have not changed either in size or in order of importance. Federally financed health care and interest payments on the federal debt are the two most significant with social security outlays coming in a distant third. Federal health care spending is shown to rise from roughly 4.9% of GDP this year to 14% at the end of the forecast period in 2089. Of the total, spending on Medicare is shown to rise from 3% to 9% of GDP while spending on medical, child health insurance, and Affordable Care Act subsidies rise from 1.9% to 4.7% of GDP.
Net interest payments rise even as interest rates are lower than initially forecast by CBO. Interest payments are projected to rise from 1.3% of GDP currently to 10% of GDP by the end of the forecast period. Of course this increase parallels the rise in the amount of debt held by the public. Net interest payments are untouchable-the obligations have to be met-and there certainly does not and probably will not be any political will to halt the rise in federal health care spending as the population continues to age.
Ominously one cannot convincingly argue that this is even a worst case. Indeed, CBO projects that all federal spending excluding health care and net interest will actually decline from 14.2% of GDP currently to 12.6% of GDP eventually. This is actually a sharper decline than CBO forecast for this category in last year's document. Moreover, considering that social security is in this catchall category and is projected to rise from 4.7% of GDP to 6.9%, the reductions elsewhere are even sharper. Defense is in this category and it is hard to convincingly argue that the world has become a safer place.
Finally, regarding tax policy CBO projects a revenue rise from 17.6% of GDP currently and in the vicinity of the long term average to 23.9% by 2089 or considerably above the long term average. Raising the ratio above the 18.5% average seems very difficult to accomplish in the short term and very likely the long term as well. If Dr. Lacy Hunt is currently fearful of the consequences of the economy's current debt service predicament, he has to be absolutely terrified at the long run outlook that is forecast y CBO under current law.
But a financial disaster is not inevitable. We demonstrated in last year's Very Long Term Outlook how significant an economic growth path that was merely 0.2% per year higher than the CBO forecast could be. Indeed the federal budget deficit would disappear by the mid-2080s and the debt to GDP ratio would shrink to a very manageable 45% in a permanently slightly faster growing economy. With CBO newly revised estimates budget balance could be achieved ten years earlier. Thus, the secular stagnation thesis of Dr. Larry Summers would prove transitory as opposed to secular and Lacy would sleep better at night as the economy's ability to service its debt improved.
Achieving faster economic growth through some combination of faster real activity and higher inflation may be easier said than done. The optimal vehicle for achieving a faster GDP growth path will continue to be a matter of acrimonious debate. But while action seems elusive there does seem to be an emerging consensus that the tax and regulatory apparatus needs to be overhauled and spending needs to be more efficient. This will not be easy or quick and in the meanwhile incentives for growth oriented innovation need to be emphasized in order to boost aggregate demand and propel the economy out of its liquidity trap.

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Chart II Actual and Predicted - Net domestic investment: Private: Domestic business as a ratio of GDP 5-year moving averages 1964-2013 as a function of the difference between GDP growth and Baa corporate bond yields
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Source: Growth Debt And Secular Stagnation - Implications For The S&P 500
Additional disclosure: Please note that this article was written by Dr. Vincent J. Malanga and Dr. Lance Brofman with sponsorship by BEACH INVESTMENT COUNSEL, INC. and is used with the permission of both.
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