Hussman's Hard Negative

I keep looking for something I can't get
Broken hearts lie all around me
And I don't see an easy way to get out of this
--Cutting Crew

Another weekly letter by John Hussman that contains several nuggets of insight. Right off the bat, he makes it clear that conditions have turned decisively negative, in his view.

The current situation is "characterized by an extremely unfavorable ensemble of conditions across valuations, sentiment, economic factors, and other conditions. Current conditions cluster with periods such as May 1962, October 1973, July 2001, and December 2007, all of which produced 10-20% market losses in extremely short order."

Dr J notes the increasing disparity between the leading indicators that his firm and ECRI tracks, which now signal an extremely high probability of US recession, and the prognostications of mainstream forecasters and pundits.

He notes some exchange between a Bloomber interviewer and ECRI's, Lakshman Achuthan:

Bloomber interviewer: [ECRI recently made] a recession call. What happened?
Achuthan: It's happening.

Suggests some serious cognitive dissonance out there regarding recession chances.

He also notes that the EU summit last week did (and can do) little to avert the central condition of credit crisis: solvency. Solvency is a shortfall between money owed and the resources needed to credibly repay it. Emphasis on 'credibly.' Printing money to pay back debts in devalued currency is not a credible strategy--at least in the eyes of creditors...

John suggests that perhaps one credible means for relieving stress in the EU is for countries to issue convertible sovereign bonds as they roll debt. The bonds would be convertible into the currency of the issuer at the option of the issuing government. Those countries with shaky fiscal houses would be required to pay a significant premium in order to compensate bond buyers for the commensurate risk.

Over time, John suggests, convertible debt might relieve the acute pressure that has built in the EU system. EU members would need to achieve sufficient financial credibility to remain in the EU system, lest they be subject to huge premiums on debt issued. The need for questionable bureaucratic enforcement mechanisms would be reduced. John suggests, "If the system can be saved, it will be saved" under such an arrangement.

One problem, of course, is that the significant discount that many EU countries currently enjoy by issuing debt under the implicit backing of the EU umbrella would vanish. Those countries would be forced to pay up and/or get their fiscal houses in order.

Market forces hate moral hazard...

position in SPX

Brexit

"Think they know something we don't?"
--Major General Urquhart (A Bridge Too Far)

On Thursday, the British people will vote on whether the United Kingdom should remain a member of the European Union (EU) or whether to exit. A 'Brexit' result would signify a no confidence vote for the viability of the EU and would roil financial markets as the house of cards propping up Greece and other failing EU members depends on complete solidarity.

Stated differently, Brexit would severely weaken the viability of the EU.

Why is Britain tempted to withdraw? Because, like other big players such as Germany, it paying more into the collective than it is getting out. Moreover, its sovereignty is being restricted by EU rules and regs.

Britain would have an easier go at it than others because it never surrendered its currency to become an EU member. It kept the British Pound while countries like Germany ditched the Deutsche Mark.

Nonetheless, if Brexit happens, expect Germany to commence dialogue on Gerexit.

Oxi

Relax said the night man
We are programmed to receive
You can check out any time you like
But you can never leave
--The Eagles

This weekend Greek people overwhelmingly voted 'no' on a referendum requiring Greece to accept EU policy demands oriented toward fiscal 'austerity' in exchange for a restructuring of Greek sovereign debt which is now technically in default.

EU policymakers faces two primary choices. Agree to sit down once again with Greece in yet another round of Groundhog Day-like negotiations. This option makes Greece look like a winner in this battle. Plus it emboldens other EU countries teetering on default (e.g., Italy, Spain) to ignore future EU demands for fiscal policy reform.

The other choice is to boot Greece from the EU. Absent some sort of ECB bailout (which of course is possible), this option will eviscerate holders of Greek bonds.

Greece, on the other hand, in the throes of capital controls, is pondering the prospects of outright printing of euros to pay obligations. This, of course, would eviscerate the Euro and spark Big Inflation.

After futures markets sold hard over the weekend, investors have been putting on their brave faces once again this am, erasing nearly all red ink since the 'oxi' vote came in yesterday. Conditioned by previous bailouts, market participants obviously believe that policymakers will once again ride to their rescue.

Paper Late

It's too easy to talk about rocking the boat
Making changes and changing track
But you better not lock that door
'Cause you'll be coming back
--Genesis

I remember 9/19/2008 well. I recall the jovial happy b-day greeting sung by my mom and brother when I walked thru their door. It was grandparent's day at St Columban, and I proudly escorted Mom as my niece and nephew showed us their hallowed halls. We were still reeling from an inland hurricane the weekend before, and many homes were still without power.

It was also the day that the US government declared martial law on financial markets. Among other things, this entailed banning short sales on financial stocks--to curb the actions of 'speculators.' The Dow was at about 8000 at the time. After a voracious multi-day short covering rally that took the Dow to 9500ish, the selling returned with a vengeance. The Dow bottomed six months later at 6500 in the midst of an additional Shock and Awe campaign of stimulus.

This past weekend, the EU rolled out its own version of Shock and Awe in the form of a $1 trillion bailout package of Greece and other week EU members. Essentially, this involves Germany, France, and the IMF (read: the US) tossing in funds and printing money to prop up the debt of other EU members. The rhetoric included rationale aimed to curb 'speculators' against the euro and EU sovereign paper. Markets around the world are partying today, with world indices up anywhere from 4-12%.

Once again, the world is trying to paper over a debt problem w/ more debt.

Perhaps the end game is pushed out once more. But my sense is growing that the paper chase is getting long in the tooth.

position in SPX

Ponzi de Jour

If I'm losing control would you turn me away?
Or touch me deep inside?
And before this gets old
Will it still feel the same?
There's no way this could die
--Pat Benatar

The idea de jour in the EU crisis is to have governments borrow money from the ECB to buy assets (such as Greek bonds) from struggling banks. The vehicle for doing this is the EFSF (European Financial Stabilization Facility), which is a special purpose vehicle (SPV) established in 2010 and backed by EU country guarantees. The EFSF provides assistance to eurozone states in financial difficulty. The EFSF would essentially borrow using their country's assets as collateral.

The size of the borrowings necessary? Perhaps $1-2 trillion...

If this sounds like a version of TARP, then you'd be somewhat correct since the focus would be buying 'troubled assets.' In the case of TARP, however, government funds bought troubled assets from private sector banks. Under the latest EU plan, government money would be levered up with ECB money (more government money) to buy bonds from the same governments on the hook for the EFSF and ECB money to begin with.

How long before Mr Ponzi enters this discussion?

The only way such a program could be marginally effective is if Germany and France absorb an outsized share of the risk--well beyond what they have currently committed to contribute.

Which brings us back to the conclusion we've been reaching for months (here, here). Should Germany decide not to participate, then it all crumbles, cookie.

For today, anyway, markets were willing to look at the glass half full side of the story, with domestic markets up a couple of percent or so on the prospect of a $trillion EU bail out.

position in SPX

Peace Prize Sham

In violent times, you shouldn't have to sell your soul
In black and white, they really, really ought to know
--Tears for Fears

Three years ago the Nobel Peace Prize was awarded to President Barack Obama. The fact that this president had only been in office for months raised more than a few eyebrows. More importantly, his actions before and since have been oriented toward division and violence rather than toward unity and peace.

This president has sought to expand the role in government in both domestic and foreign affairs. Government is force--violent intervention in people's lives. When government's scope grows beyond that necessary to protect people's liberty and property, social capacity for voluntary cooperation decreases.

In domestic affairs, this president favors policies that employ the strong arm of government to forcefully take from some for the benefit of others. In foreign affairs, this president has prosecuted numerous illegal wars that have killed thousands, provided arms to various militant groups, and presided over the ongoing expansion of US military power. He boasts of the assassination of Osama Bin Laden during his administration.

This is a man of peace? A true peace-loving president would be shrinking government to remove this mechansim of force-- the single most powerful mechanism of force in the world, in fact--from peoples' lives as much as possible.

This year's Nobel Peace Prize has just been awarded to the European Union for 'promoting peace, democracy, and human rights for over six decades.' While countries have not been forced to join the EU, plenty of dissenting individuals in each member country were forced to play along. Indeed, 'promoting democracy' is promoting violence--violence exerted by the many on the few.

Now, individuals inside the EU are subject to increasingly greater force as EU officials desperately enact policies designed to 'preserve the union' (wink from Lincoln). For example, people are being robbed of their wealth through policies of suppressed interest rates, higher taxes, and devalued currency.

How can anyone pobjectively look at the EU currently and see a union of peace?

It seems the Nobel committee needs to consult a dictionary.

EU Discounting Mechanism

I don't want to wait for our lives to be over
I want to know right now what will it be
--Paula Cole

There is some belief that the European situation has been so broadly reported that markets have factored in most of the outcomes. Thus, when some 'resolution' actually occurs, it may largely be a nonevent for the markets.

Perhaps, but efficient discounting requires certain conditions to be present. One is that the information available can be interpreted as to its meaning. Stated differently, available information must permit various possible outcomes and their values to be forecast. Not sure this condition is present for the EU. Each day I read new interpretations of the Greek crisis alone. The leveraged, interconnected nature of global economies and financial systems make it difficult to grasp what will happen.

Another condition that must be present is the understanding of risk and reward associated with the decision. Market partipants must understand the penalties associated with being wrong, and the benefits associated with being right.

Through their past interventions, policymakers have skewed the risk/reward relationship far away from the one present in free markets. Poor decisions have largely been bailed out.

To the extent that market participants expect another round of bailouts, then they may be prone to take on more risk than they would in unhampered markets.

Stated differently, moral hazard may be impairing the discounting mechanism, causing unwise decisions to be made in front pending EU outcomes.

Yes for Brexit

V: Would you...dance with me?
Evie Hammond: Now? On the eve of your revolution?
V: A revolution without dancing is a revolution not worth having.
--V for Vendetta

In a dramatic vote that took many pollsters and experts by surprise, the British people voted yesterday by substantial margin to leave the EU. While what Britain does with its increased sovereignty remains to be seen, this is clearly a blow to statism worldwide and calls future solidarity of other EU members into question.

The news has roiled financial markets worldwide, as interventionary policies designed to hold the EU ponzi together suddenly appear less likely to work in the eyes of investors. Domestically, equity markets opened down 2%+. Banks in particular have been splattered, with many domestic names down 6% or more. British bank Barclays is off a cool 23%.

We'll see what happens after the bulls attempt to bounce 'em, which appears to be in process now. If they can't, then...

As my friend Toddo tweeted this am, markets rarely mark significant bottoms on Fridays. One reason: margin calls go out over the weekend.

Should also note that gold was up about $80 at one point but has since pulled back some. Still, it remains above the $1300 resistance level that has turned the metal back several times recently.

position in SPX, gold

Credit Default Swap Round II

Look around everywhere you turn is heartache
It's everywhere that you go
You try everything you can to escape
The pain of life that you know
--Madonna

John Mauldin shares analysis suggesting that, while Euro banks stand to lose big time in the event of sovereign debt defaults in the EU, US financial institutions are likely to fare just as poorly. This is because US institutions have been primary sellers of credit default swaps on EU sovereign debt.

Of the approximate $1.2 trillion in sovereign debt issued by Greece, Ireland, and Portugal, US institutions have indirect exposure via CDS of about $120 billion.

Hopefully you can connect the dots. Big EU bond 'restructurings' (a.k.a. defaults). CDS owners files claims w/ US insurers. US insurers lack capital to cover claims. FDIC steps in. US citizens fund another bailout--this one arguably on foreign soil.

position in SPX

Euro Bureau

"I think it's safe to say that this party is about to become a historical fact."
--Duncan (Some Kind of Wonderful)

A couple months back the ECB and EU were beings hailed as 'different' from the US. Europe is more fiscally prudent, it was said, and EU members were willing to swallow austerity in place of money printing and bailouts.

It should now be clear that there is no difference at all. Over the past couple of days, the ECB has signaled that they will go 'all in' if necessary to avoid an EU collapse.

Central banks are the same all over the world. Their actions are uniform and predictable.

position in Treasuries

Another EU Party

"On any other day, that might seem strange."
--Cameron Poe (Con Air)

Huge lift today in risk assets as the current EU shrimpfest revealed new plans about using the ESM facility to bail out banks sans 'austerity' measures and WITH Germany's support. Right now the plan remains a bureaucratic brief but it certainly fostered much market hope today.

The SPX was up 2.5% and closed at its highest level since early May. Commodities joined the party as well. Crude led the way--up 8%!

I took this opportunity to peel off some peripheral commodity exposure, some of it bought in the hole last week. Just tradin' 'em...

Right now, it's hard to discern whether this EU plan is for real, so it is difficult to discern how durable this rally could be. What I do know is that the solutions being discussed (borrowing, money printing, no deep spending cuts) have next to no chance of righting this situation.

Stated differently, I'm currently of the mind that this rally should be sold. And I plan to do just that if prices continue to march higher. Am particularly interested in shedding some more commodity exposure prior to the Next Time Down.

position in SPX, commodities

Cyprus Swamp

Hey now, hey now, don't dream it's over
Hey now, hey now, when the world comes in
They come, they come, to build a wall between us
We know that they won't win
--Crowded House

This weekend Euro-area finance ministers and officials of the Cyprus government reached tentative agreement on a rescue plan for the country. As has been the case in past EU bailouts, the focus is on bailing out insolvent banks and sovereign bondholders. The eye-opener of the plan is a proposed levy of 6-10% on depositors.

Needless to say the proposal has not sat well with Cypriot citizenry. Depositors have been hitting the ATMs to drain their bank accounts. Local media are cranking it up too:

There is also growing doubt about whether there are enough votes in Cypriot parliament to pass the plan. The specter of a thumbs down vote certainly has major banks around the world a wee bit nervous.

Perhaps this is much ado about nothing. After all, the tiny Cyprus economy is just a fraction of a percent of EU GDP.

On the other hand, it is straightforward to conjure a path to EU contagion. After all, how much money would you keep in a European bank if you know that there was potential for government to skim 10% off your balance at a moment's notice?

Did Germany Capitulate?

It ain't no use, we're headed for disaster
Our minds say 'no!' but our hearts are talking faster
--Donnie Iris

Many view yesterday's EU agreement as a capitulation by Germany. Essentially, risk was re-syndicated from the balance sheets of banks lugging euro sovereign debt onto the backs of German taxpayers.

Germany has essentially signalled the loss of its individual sovereignty in for of the EU collective.

Peter Atwater cautions against this conclusion. Yesterday's events bring into ever greater focus Germany's continued willingness and capacity to support the rest of Europe.

Many view yesterday's events as Germany's willingness to write giant blank checks to the rest of the EU. Atwater disagrees, and suggests instead that Germany will likely make future funds contingent on specific and prehaps tortuous preconditions.

If Peter is correct, then markets are nowhere close to figuring this out.

position in SPX

The EU's Circularity Problem

Into the blue again, after the money's gone
Once in a lifetime, water flowing underground
--Talking Heads

Kyle Bass thinks that the EU is engaged in a game of chicken with Greece right now. Greece is broke and running deficits, and they are certain to default. A nice point here that countries that commit more to bailout facilities jeopardize their own sovereign debt ratings, since they are now on the hook for more liabilities.

Bass concludes that the math simply doesn't work. Even Germany is a debtor nation. No matter how one looks at the magical faclities being erected to contain/bailout EU members, the bottom line is the 'solution' being offered is adding more debt to a sovereign debt problem. More leverage.

KB suspects that many people have yet to think the circular nature of this plan thru.

I think he's right. Right now, markets seem relieved that 'something' is being done. Once the euphoria lifts, however, they will likely see the same old problem staring at them.

What solves a debt crisis? Paying the debt down or restructuring (a.k.a. default). Either way, standard of living will go down.

What brings this 'solution' about faster? Germany decides not to participate. Bass thinks this to be likely, based on his firm's analysis, which includes on-the-ground polling of influential Germans.

no positions

Dublin Down

Confusion that never stops
Closing walls and ticking clocks
--Coldplay

Ireland becomes the latest recipient of EU bailout funds. Credit spreads of Spain and Portugal blow out more, suggesting stiff competition for next position in the Continental bailout parade.

There is increasing evidence that 'forced austerity' is not sitting well with sovereigns. Those inside bailout countries don't like being told what to do by outsiders. Moreover, ECB suggestions that everyone must share the pain will be distasteful among those who made prudent choices in the past.

Textbook behavior that can be under the heading 'why socialism doesn't work.'

Also, seems like sovereign pushback constitutes deflationary forces against central bank inflationary forces, no?

Hard not to sense that we're a couple steps closer to a collapse of the EU after the wkend activities.

position in TLT

Spill and Spoil

Watching I keep waiting still anticipating love
Never hesitating to become the fated ones
--Berlin

US markets gapped higher this am on more optimism over a resolution of the EU situation coupled w/ a brighter than expected payroll number. About mid-day, however, stocks started leaking and sovereign bonds spreads begans blowing out.

The culprit: chatter that Congressional Republicans were at work to block IMF bailouts of EU countries.

Wow. Should that be true and come to fruition, it would be the first responsible action this group would have taken in some time. Using US taxpayer dollars to bail out the excesses of other countries is clearly unconstitutional.

But I'm not holding my breath...

position in SPX

Sovereign Stop Payments

She's the dollars, she's my protection
Yeah she's the promise in the year of election
Oh sister, I can't let you go
Like a preacher stealing hearts at a traveling show
--U2

Peter Atwater suggests that perhaps Ireland et al will decide it is in their best interests to default rather than get bailed out. Indeed, "countries don't have friends, they have interests."

Should a string of sovereign defaults ensue, this will surely add additional stress cracks to the already weakened EU infrastructure. Moveover, hard to see how voluntary defaults do not send country borrowing costs higher worldwide.

Meanwhile, pressure has not come off the system even after the EU bailout announcement. And, based on its spreads blowing out this am, Spain has jumped ahead of Portugal as next in line.

position in Treasuries, XLF

Lockdown Stringency Analysis

Neal Page: He says we're going the wrong way.
Del Griffith: Oh, he's drunk. How would he know where we're going?
--Planes, Trains & Automobiles

Although Twitter can devolve into a cesspool of negativity and ad hominem back biting, the CV19 situation has revealed that Twitter provide a platform for an army of analytical talent to share exceptional work. Here's another example, this one studying the relationship between lockdown stringency among EU nations and CV19 morbidity. I've pulled some of the graphics from the thread for viewing here.

First, the cumulative stringency index estimated for various EU countries. There are several stringency indexes floating around. All of them involve scales aim at rating the intensity of authoritarian measures implemented. This particular scale sums daily stringency ratings to get a cumulative total that can be applied against measures of dependent variables summed over the same time period.

Next, CV19 deaths/million population for each country. If lockdowns were 'working,' then one would expect a negative relationship between lockdowns and virus deaths. Here, not only is the relationship not negative, it is weakly positive, suggesting that more intense lockdowns result in more deaths. R-squared clocks in at 0.138, which not all that bad for a 'macro' study. This result echoes findings from other work discussed on these pages.

Finally, stringency vs change in GDP. Here we find a negative relationship as expected (i.e., the more stringent the lockdown, the larger the decline in GDP). Solid R2 of about 0.487.

Would be interesting to see this analysis applied to US states.

EU Cesspool

Clark Griswold: There's the Left Bank, kids. Russ, bet you can't guess which bank is on the right.
Rusty Griswold: The Bank of America
--European Vacation

Hard not to see a growing cesspool of Ponzi and moral hazard when looking at the EU situation. Germany's resolve on austerity/no inflation appears to be weakening. All other countries seem all in on money printing strategy.

If a confetti fest is pending, then why is gold not reacting violently to the upside? The yellow metal continues to mark new lows daily.

position in gold

Lollipop Guild

"You have no power here. Begone, before somebody drops a house on you too!"
--Glinda, Good Witch of the North (The Wizard of Oz)

Another sage letter by Dr J. In the front half he makes a compelling argument for a recession given the position of his forward looking indicators.

In the back half he discusses the EU situation given last week's 'coordinated' move by central banks. He reminds once again that the issue is one of solvency rather than of liquidity. Last week's coordinated dollar swap program is a short term measure aimed at boosting liquidity.

To remedy the solvency problem, it is likely that either banks fail or non-bank holders of EU debt must take haircuts. Thus far, no one wants to do that.

John ends with a section called "We represent the Lollipop Guild." His thoughts here are so wonderfully collected that I want to capture them here in their entirety:

"Frankly, I am concerned that Wall Street is becoming little more than a glorified crack house. Day after day, the sole focus of Wall Street is on more sugar, stronger sugar, Big Bazookas of sugar, unlimited sugar, and anything that will get somebody to deliver the sugar faster. This is like offering a lollipop to quiet down a 2-year old throwing a tantrum, and expecting that the result will be fewer tantrums.

"What we have increasingly observed over the past decade is nothing but the gradual destruction of the ability of the financial markets to allocate capital for the benefit of future growth. By preventing the natural discipline of the markets to impose losses on the poor stewards of capital, and to impose interest rates high enough to force debtors to allocate the capital usefully, the world's policy makers are increasingly wrecking the prospects for long-term economic growth. The world's standard of living (what we can consumer for the work we do) is intimately tied to its productivity (what we can produce for the work we do). That productivity requires scarce savings to be allocated to productive physical capital, and to productive human capital (primarily education).

"Nietzsche famously said, 'What does not kill me makes me stronger.' The corollary is 'What constantly rescues me makes me weaker.' The world will only stop looking for bailouts when policy makers stop handing them out."

Re-read until you understand.