Notes From Underground: Let The Markets Reveal Their Resolutions

The “MARKET” will resolve to test the GRIT of traders and investors as the mysteries of politics and economics collide to make the daily lives of traders difficult, to say the least. In 2011, the markets left traders and various investors sleeping like babies as we were relegated to getting up every hour to cry. We must remember that the market’s “JOB” is to  cause as much heartache and pain to as many people as possible as money seeks to attain a positive return Last year the market was in its full glory as it caused some of the world’s foremost global macro investors to be humbled in a capacity not seen since the credit market debacle of 1994-95. This year seems to be of a similar ilk as the travails of the EUROPEAN UNION will continue to weigh upon the flows of global capital.

In a piece in the weekend’s Financial Times, columnist Gregory Meyer brings to my attention the fact that UBS has launched an ETF that tracks the dynamic of the RISK-OFF trade. Its symbol is OFF and it sells OIL, THE EURO and STOCKS, and BUYS TREASURIES, YEN and GERMAN BUNDS .The one thing we can be sure of as 2012 proceeds is that the RISK-ON/RISK-OFF PARADIGM will break down. As the readers of NOTES FROM UNDERGROUND know full well, this BLOG firmly believes in the DYNAMIC NATURE OF ALL INVESTMENT RELATIONSHIPS and that what correlates well today does not guarantee synchronicity tomorrow.

When 2011 came to a close, the markets continued to track the RISK-ON/RISK-OFF profile but some cracks had already begun to show. It is mind numbing to think that the U.S. TREASURY market was the star performer unless of course one happened to be short emerging market and European EQUITIES. Many are pointing to further U.S. equity strength as the U.S. and North America outperforms the rest of the world; if this is to be so then it will be difficult for U.S. DEBT to continue to be the outstanding investment. Yes, there are many reasons why the TREASURY market performed so well:

1. The FED’S intervention has left the BOND VIGILANTES financially wounded and forced to the sidelines … for the moment

2. The lack of good collateral in EUROPE has meant that U.S. sovereign debt is a needed instrument to continue the functioning of the REPO market

3. Of course the amount of global uncertainty has pushed global investors and central banks to find the most liquid haven

Will the U.S. continue to benefit from the confluence of these elements? Will investors maintain accepting real negative returns on their investments as 10-year yields are lower than inflation and that is before taxes?

As I argued at the beginning of last year, large-cap stocks with a 4% dividend yield were a better place for investment capital. The DOW’S outperformance certainly lent credence to that view but it seems that the trade is now all the rage as FUND MANAGERS have stopped chasing the high fliers as stocks such as NETFLIX, ZIP, SODA and many others were ravaged. Until the ALL-CLEAR is given in Europe and other areas of financial concern is sound, STRONG DIVIDEND PAYERS ARE THE SAFEST HARBOR. It is important to be aware of when the changes in the popular paradigm begin to breakdown. With hard work, good analysis and the use of technicals, let’s identify the sea changes and profit from preparation. OK MR. MARKET, let’s get to work.

***DOLLAR/YEN is the proverbial RIDDLE, MYSTERY, ENIGMA as the YEN strengthened against all currencies, even the U.S. DOLLAR. The YEN has befuddled more traders than even the U.S. debt markets. Japan is saddled with a huge GDP/DEBT ratio, declining population,a nd being a dominant exporter in a slowing global economy. The Japanese stock market was down 17% on the year as the STRONG YEN proved a drag on corporate, industrial Japan.

The release of the IMF COFFER data made the YEN strength that much more intriguing as the YEN’S appreciation cannot be blamed on Japan’s role as a RESERVE CURRENCY. Total international reserves of YEN are 3.8%, which is a rounding error compared to the use of EUROS and DOLLARS in that capacity.

The YEN certainly has haven status and that helps explain some of its relative strength but its eroding fundamentals means that the MOF cannot allow YEN APPRECIATION to continue. If Japan suffers under TOO STRONG A YEN it will be time for corporate Japan to go on an international spending spree so as to buy cheaper global assets to assure its market share of high-quality, well-engineered products. The rise of the GERMAN AUTO INDUSTRY in the last few years is becoming a significant problem for the Japanese car makers. The outflow of investment may be able to weaken the YEN in a way that BOJ intervention hasn’t succeeded–looking for the resolution of a great RIDDLE.

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2 Responses to “Notes From Underground: Let The Markets Reveal Their Resolutions”

  1. john brady Says:

    As today’s trade may be slower, we thought we would take a closer look at yesterday’s Dec 13 FOMC Minutes, and the key sentence from the Minutes may have been:

    “With regard to forward guidance to be included in the statement to be released following the meeting, several members noted that the reference to mid-2013 might need to be adjusted before long”

    The politics of the season are beginning to heat up.

    There has been and will be a focus on the evolving Fed communication policy, which aims to add clarity and transparency to Fed policy. We are not as surprised as others, as Chairman Bernanke suggested this very idea early and often in his nomination testimony of November 15, 2005. The story here is NOT the increased transparency of policy; rather it is the timing of the move towards increased “transparency”.

    On Friday, December 23 2011 the Bureau of Economic Analysis released Personal Consumption and Expenditures data for November. Buried in the minutia of the data was a very disturbing trend that FOMC policymakers did not directly reference in yesterday’s meeting, but was most likely discussed:

    Personal Savings Rate:
    Q3, 2010: +5.6%
    Q4, 2010: +5.2%
    Q1, 2011: +5.0%
    Q2, 2011: +4.8%
    Q3, 2011: +3.9%

    In considering these numbers, we tend to think that equities have been mostly flat over the last year, while home prices have failed to steady in a meaningful way and maintain a modest downside bias. Household wealth is continuing to decline in sync with the savings rate. Moreover, we think a more important sentence from yesterday’s minutes is:

    “Revised estimates indicated that households’ real disposable income declined in the second and third quarters, and the net wealth of households decreased in the third quarter (of 2011)”.

    So, in short–and we haven’t touched on the slowing in non-defense capital goods orders (excluding aircraft) nor on the risks posed by the ongoing European financial crisis–deflationary pressures are intensifying here domestically and the FOMC is getting very nervous. Strong Q4 economic growth/consumption will most likely not be sustainable, given an already declining savings rate, declining disposable income, and declining household net worth. Recall that YOY inflation measures are set to drop shortly as high monthly readings from early 2011 are scheduled to drop out of the data set. So what is the Fed to do, especially with the zero-bound already achieved and three injections of quantitative easing already used to debate-able success?

    …Change Communication strategy!?!? It is not overly-tricky and rather convenient in a year where the political climate is due to get very dirty and ugly. Fiscal policy debate regarding payroll tax cut extensions will begin a-new in the coming weeks, while Dr. Bernanke has already been singled out by Republican primary candidates as performing his job poorly. With the savings rate (savers are punished with zero rates! Einstein’s power of compound interest is null-and-void!) dropping, with real incomes dropping, with total household net worth dropping, and with an election 10 months away, something has to be–and will be–done. That’s a Nixon legacy, and better to do something sooner-rather-than-later as the election nears.

    Individual members of the FOMC will soon issue their own individual forecasts for rate policy, and thus–in changing “communication policy”, the politics of monetary policy are going to shift away from the Fed Chairman and create lots of debate and noise over whose policy forecast is more/less accurate. The noise of public forecasts will shade and cover the Fed’s worst nightmare coming true: intensifying deflationary pressures addressed through politically-charged and additional quantitative easing. Thus, the new key members of the FOMC as it specifically regards monetary policy in 2012 are going to be Vice-Chairwoman Janet Yellen AND her successor at the San Francisco Federal Reserve John Williams, a noted dove and supporter of additional qe. The Fed set the table at the December 13th meeting.

    Why Yellen and Williams? Bernanke is already too well-known and now needs to avoid the limelight in the political arena. Dudley is radio-active to the 99% (Goldman Sachs, NY Fed, etc…). Most importantly, most voters don’t know of Janet Yellen or John Williams by name or appearance. Their communications and forecasts will represent and drive the deliberative (dovish) majority of the FOMC in 2012. No disrespect meant towards Sandra Pianalto, Dennis Lockhart, and Jeffrey Lacker, but John William’s September 23, 2011 speech in Zurich, Switzerland and the October 3, 2011 FRBSF Economic Letter suggests that this specific topic has already been researched pretty thoroughly by the SF Fed:

    http://www.frbsf.org/publications/economics/letter/2011/el2011-31.html

    There was additional hints of this policy at the SFFRB conference of February of 2011, though this paper is quite technical (Paper enclosed).

    http://www.frbsf.org/economics/conferences/1102/agenda_content.php

    “The expectations channel is crucial for the effectiveness of optimal forward guidance policy. If the public has an imperfect understanding of the central bank’s intended policy path, then forward guidance may not work as well as adverstised. Therefore, a key challenge for forward guidance is communicating the intended policy path to the public.”

    In short, Dr. Williams may have emerged as the Fed’s lead-person on communication and forecast policy, specifically with Fed policy already at the zero-bound. Funny enough, Mr. Williams is scheduled to speak at an Economic Forecast Breakfast in Vancouver, Washington on Tuesday, January 10, following the December employment data and ahead of the 2-day FOMC meeting Jan 24/25. Forecasting may be more art than science, but with the science of recent economic data and with domestic deflationary headwinds set to perhaps intensify as the Eurozone crisis intensifies and the US Dollar heads higher (see enclosed), we think the QE table is set. Dr. Williams and Yellen are the key policymakers this year. John Brady and Todd Colvin

  2. yra Says:

    John and Todd—good add to last night’s discussion on the FED and its new communication techniques—some reason this was posted to the wrong day’s blog but again a greta add to the discussion and the new dynamic of politics into the fed

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