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3 CREDIT BUBBLE
BULLETIN A
glass no longer half
full Commentary and weekly
watch by Doug Noland
Friday's payroll data
were dismal. The unemployment rate jumped back
above 9% (to 9.1%), while the 54,000 gain in
Non-farm Payrolls was the weakest increase since
last September. Most alarming, the manufacturing
sector lost 5,000 jobs during May. This was the
first decrease since November 2010, providing
added confirmation that the recovery is not on
solid footing.
Between November 2007 and
December 2009, manufacturing jobs dropped 2.3
million (1.15 million during the worst six month
period). So far, the recovery has engendered a
return of only 238,000. It is worth noting that
the current 11.694 million employed in
manufacturing compares to 17.637 million back in
March of 1998. Not surprisingly, recent incredible
fiscal and monetary stimulus has demonstrated
minimal support for our
country's much needed
industrial renaissance. Worse yet, the massive
expansion of government debt is backed by little
in the way of added wealth-producing capacity.
This is a dangerous ("bubble") dynamic both from
an economic and financial stability perspective.
Sentiment is shifting. Optimism in the
sustainability of the recovery is dimming, as
analysts come to better appreciate that key
sectors remain unhealthy and immune to government
stimulus. While the export sector remains robust,
its relatively diminished stature limits the
overall economic impact. During the past decade,
much of our atrophied productive capacity was
directed to supplying the housing and related
consumption boom. It is now becoming clear that
the (post-mortgage finance bubble and housing
mania) recovery will be a protracted and arduous
process. Boom-time malinvestment ensures that the
value of too much of our productive capacity is
impaired in the current economic landscape.
Meanwhile, the state and local government sector
faces heightened austerity headwinds.
Talk
will now likely shift from "soft-patch" to
possible "double-dip". Either way, such weak
economic performance in the midst of
double-digit-to-GDP (gross domestic product)
deficits is disconcerting. The booming federal
government sector is anything but transmitting
"animal spirits" to the private economy. So, the
argument that Washington is sucking energy
(incentives, real resources, investment and
finance) from the rest of the nation's economy
becomes more difficult to disregard by the week.
The Federal Reserve's second round of
quantitative easing (QE2) stoked equities and risk
asset prices - along with energy and food costs.
Some gained, some lost, while the marketplace
turned highly speculative. With markets now
levitated and the inflation outlook further
clouded, uncertainty is a greater issue these days
than it was pre-QE2. Meanwhile, the freakish
nature of Washington's fiscal and monetary
management creates a powerful disincentive for
long-term productive investment. Myriad atypical
financial and economic factors impede the
formation of a sound and sustainable recovery.
Alan Greenspan had another hour on CNBC on
Friday morning. As an antagonist of historical
revisionism, I take special interest in comments
from the former Fed chairman. I find it ironic
that he assails "a whole structure of [government]
activism that has occurred in the aftermath of the
crisis". After all, the so-called "free market
economist" Mr Greenspan is the father of
"activist" central bank planning. The current
predicament is a direct consequence of more than
20 years of misguided Federal Reserve market
intervention.
Not surprisingly, Mr
Greenspan presses ahead with his focus on
post-bubble policy mistakes - regulatory and
fiscal, in particular. I'll not back away from
placing primary responsibility on the errors and
misconceptions from the bubble years. The history
of booms and busts is rather clear: major credit
booms are precarious in large part because they
will eventually lead to strident political
responses in financial regulation, spending
profligacy and excessive government control over
the real economy. The flaws in the notion held by
Greenspan and his successor Ben Bernanke of
ignoring asset bubbles - while being ready to
implement aggressive "mopping up" strategies when
they burst - should now be readily apparent.
Another Greenspan comment piqued my
interest: "We're dealing with a fiat money system;
you have to regulate it in some form or another."
He then stated that "the ideal regulation is
capital adequacy", while brushing off the issue of
off-balance sheet finance. "We could have
prevented all the nature of the crisis if we had
adequate capital... It would solve 'too big to
fail' because they wouldn't fail." If he really
believes this, Mr Greenspan fails to grasp the
essence of this historic credit bubble.
The fiscal situation worries Mr Greenspan,
although his analysis never links previous credit
excesses to today's fiscal "activism" and runaway
deficits. The so-called "fiat money system" failed
spectacularly in the private-sector credit boom,
yet the role this dysfunctional system is now
having in perpetuating a government finance bubble
remains unaddressed.
Somehow, there is no
mention of how loose monetary policy incentivized
systemic excesses throughout the mortgage/Wall
Street finance bubble - and how even looser
"money" is today complicit in profligate federal
borrowing and spending. It is incredulous to
suggest that "capital adequacy" is somehow going
to resolve the issue of unfettered non-bank
("fiat") credit expansion. The basic problem
remains the unchanged: a malfunctioning
marketplace cannot effectively price, intermediate
and regulate marketable debt.
Last week,
the stock market took more seriously the weak
economic data that it had been content to
disregard. Until recently, disappointing economic
reports were viewed as holding any tightening move
by the Fed further at bay. Besides, a somewhat
weaker economy would pressure the dollar lower, a
process that bolstered the global "risk on" trade.
US equities last week seemed to decouple with
other risk assets. US stocks and the dollar
declined in tandem. Meanwhile, Treasury yields
sank and German bund yield rose - as global
speculators faced markets moving in all different
directions.
The US stock market and
economy are now increasingly vulnerable to a
self-reinforcing confidence problem. QE2 effects
boosted stock prices, and a strong market
bolstered confidence. Policy led the markets which
then lugged the real economy. Today, the soundness
of economic underpinnings is increasingly in
question, while QE2's weeks are numbered.
Fiscal and monetary policies have little
left to offer a marketplace that has luxuriated in
policy largesse. And, as always, market direction
tends to dictate the tenor of the news/analysis.
For about a year now, the bias has been to
disregard the bearish and focus instead on the
more optimistic interpretation of things. I would
not be surprised if last week's stock market break
proves an inflection point with respect to a more
"glass half-empty" view of our structurally
challenged economy and policy framework.
WEEKLY WATCH For the week, the
S&P500 dropped 2.4% (up 3.4% y-t-d), and the
Dow fell 2.4% (up 5.0%). The broader market was
weak. The S&P 400 Mid-Caps fell 3.0% (up
6.0%), and the small cap Russell 2000 dropped 3.5%
(up 3.1%). The Morgan Stanley Cyclicals fell 4.0%
(down 0.6%), and the Transports declined 3.6% (up
2.2%). The Morgan Stanley Consumer index lost 3.6%
(up 0.6%), and the Utilities declined 1.4% (up
4.4%). The Banks were hit for 4.3% (down 8.7%),
and the Broker/Dealers sank 4.4% (down 9.6%). The
Nasdaq100 declined 1.9% (up 3.4%), and the Morgan
Stanley High Tech index fell 3.0% (down 0.5%). The
Semiconductors were down 3.5% (up 1.6%). The
InteractiveWeek Internet index lost 2.4% (up
0.7%). The Biotechs added 0.5% (up 13.2%). With
bullion up $6, the HUI gold index declined 2.4%
(down 6.3%).
One-month Treasury bill rates
ended the week at 2.5 bps and three-month bills
closed at 3 bps. Two-year government yields
declined 5 bps to 0.42%. Five-year T-note yields
ended the week down 10 bps to 1.60%. Ten-year
yields dropped 8 bps to 2.99%. Long bond yields
declined 2 bps to 4.23%. Benchmark Fannie MBS
yields declined 5 bps to 3.89%. The spread between
10-year Treasury yields and benchmark MBS yields
widened 3 to 90 bps. Agency 10-yr debt spreads
were little changed at negative 4 bps. The implied
yield on December 2011 eurodollar futures was
little changed at 0.395%. The 10-year dollar swap
spread increased 2.75 to 12.5 bps. The 30-year
swap spread declined one to negative 26 bps.
Corporate bond spreads were wider. An index of
investment grade bond risk rose 4 bps to 95 bps.
An index of junk bond risk jumped 21 bps to 474
bps.
Investment-grade issuers included
Applied Materials $1.75bn, John Deere $850
million, Union Bank $700 million, Camden
Properties $500 million, Coventry Health Care
million $600 million, Whirlpool $300 million, and
Airgas $250 million.
Junk bond funds saw
outflows of $237 million (from Lipper). Junk
issuers included Vulcan Materials $1.1bn, AES Corp
$1.0bn, W & T Offshore $600 million, Puget
Energy $500 million, Southern Natural Gas $300
million, Cinemark $200 million, Sunstate $170
million and International Wire Group $100 million.
I saw no converts issued.
International dollar bond issuers included
ING $2.5bn and Asian Development Bank $1.5bn.
U.K. 10-year gilt yields slipped one basis
point last week to 3.28% (down 23bps y-t-d), while
German bund yields rose 7 bps to 3.06% (up 10bps).
With an agreement on additional eurozone and IMF
assistance, two-year Greek yields sank 245bps to
22.17%. However, Greek 10-year bond yields
declined only 48 bps to 15.74% (up 328bps).
Spain's 10-year yields declined 9 bps to 5.22%
(down 22bps). Ten-year Portuguese yields rose 23
bps to 9.59% (up 301bps). Irish yields declined 27
bps to 10.58% (up 153bps). The German DAX equities
index slipped 0.8% (up 2.8% y-t-d). Japanese
10-year "JGB" yields added a basis point to 1.135%
(up 1bps). Japan's Nikkei slipped 0.3% (down
7.2%). Emerging markets were resilient. For the
week, Brazil's Bovespa equities was little changed
(down 7.2%), while Mexico's Bolsa dropped 1.9%
(down 8.9%). South Korea's Kospi index gained 0.6%
(up 3.0%). India's equities index rose 0.6% (down
10.4%). China's Shanghai Exchange increased 0.7%
(down 2.9%). Brazil's benchmark dollar bond yields
dropped 8 bps to 4.16%, and Mexico's benchmark
bond yields fell 9 bps to 3.99%.
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