PIMCO’s open letter to “President Obama” is not going to be answered. Not through any reluctance to deal with correspondence but simply because the odds are against Obama getting the nod on November 4th. An old racing axiom has it that the odds are not always right, but that is the way to bet. Markets are often credited with the ability to look through current events and posit a position roughly six months into the future. If that querulous assumption is true, markets are betting that all will be fine by February 2009 and that means McCain will at last have the Presidency that was ruthlessly denied him eight years ago.
The US is such a huge and uninformed market that campaigning comes down to political advertisements and sound bites. In the country that invented mass marketing, political mass marketing is an art form. To get the message across to the marginal voters who always decide elections, the tool of choice is a blunt instrument. Not for the masses are the niceties of actually funding campaign promises or detailing policy initiatives too clearly. Instead the political election process boils down to a simple caricature of the candidates’ profile, so that a mental image is established in the minds of voters rather than the minutiae of policy aspirations. In this arena each candidate plays not only to his strength but also the others perceived weakness.
For McCain his memorable feature is his military service and internment in Vietnam. A genuine war hero and seriously tough guy, McCain personifies the Commander-in-Chief role for which he has been made. His prescience in warning against leaving US Marines in Beirut and defying his party to vote against the motion is simply a hallmark of courage. His acknowledgement that “economics is not my strong point” reflects his life and interests but that’s what cabinet and public servants are for. It is not a must know specialty for the leader of the free world.
Obama, without the cloak of honour that distinguished military service bestows in all societies, perforce needs to focus on social issues and change. To an outsider, the magnitude of the changes that Obama seeks are staggering. From his background as a labor lawyer and an alien to the “wealth” establishment his proposals to socialise America are entirely in keeping with the road he has travelled. But the changes to the tax base that his proposals imply are enormous.
Like most areas of public policy, the tax figures can be made to say whatever you want and childish sniveling by the all pervasive media where the cult of celebrity is imposed, nay grasped by journalistic hacks and shrills posing as people of quality, simply restates ad nauseum their entrenched positions which may reflect their own bias or their networks’ bias. The end result is that air space is filled, entertainment on some level is provided to the uninformed and ignorant and the guy with the microphone wins. The sauce of the argument has been simply stated by Warren Buffett who is on record as acknowledging a tax system gone wrong, where he pays a lower tax rate than his secretary. America may be the land of opportunity but it is undoubtedly also a land of privilege.
Into this simplistic positioning we can cull the issues down to these: If Americans are primarily concerned with security and America’s position in the world, and not the economy then McCain will win. If social issues are paramount to more than the beneficiaries (highly unlikely in our hedonistic society) or the levers of wages and quality jobs become pivotal, then the pendulum swings to Obama.
At present US markets are holding for McCain. A savage drop in broad markets would disclose the obvious, that the Emperor has no clothes, but to date at least markets are hiding that recognition commendably. The subtext of our market readings is that the Fed and US Treasury (and ECB) are in control and have done enough to quarantine market damage to the banking sector. Whether this is true or only perception is irrelevant. We are concerned here with what equity markets are saying and whatever else may be said, markets if not sanguine are certainly not fearful. The belief in market security spreads across the Atlantic.
When faced with Imminent Disaster
Eventually S&P and other major indices will all succumb to the asset and pricing bubble. None will be immune. Long ago in another place and another time I was in the Sydney Equity (Commercial) Court waiting my turn to defend another rogue who had plundered his shareholders more than the acceptable norm, when Tony Bellanto, the father I presume, of the present silk, wandered into the Court in the historic St James building at the end of Philip Street. This was a shock for the assembled lawyers as Tony was the leading criminal Barrister (Attorney) in Sydney, if not Australia and contrary to popular fiction, there is a decided pecking order amongst the legal fraternity. Criminal lawyers are the bottom of the pile. As such the Equity Courts were a long way from the criminal Courts, then in a rather seedy area downtown that was Bellanto’s usual stamping ground.
Bellanto’s brief was to defer a winding up (corporate bankruptcy) petition against a company whose directors were obviously old clients who had needed his forensic criminal defense skills on more than one occasion. Not being versed in the niceties of the Equity Court, and more accustomed to the rough and tumble of the lower Courts, Bellanto simply stood up and said “Your Honour, my clients would like an adjournment” (US continuance).
The Judge looked horrified. “Mr Bellanto” he intoned, “In this court we require reasons for an adjournment. Has your client any reasons why this matter should not proceed today. Has your client a valid argument against this winding up petition?”
Bellanto was unfazed. For a man used to fighting for his client’s personal liberty, mere corporate bankruptcy was no big deal. “Well” replied Bellanto to the much younger Judge “I have had many years of experience at the law as you know, and it is my considered view that faced with the prospect of imminent and unavoidable disaster it is always wise to adjourn it for 90 days!”
The Courtroom burst into laughter as the Judge granted the adjournment. Like Bellanto, the Republican administration needs an adjournment. For them, they only need 67 days. At all costs the economic bag of worms must be kept in check or at least quarantined to the banking sector so that the voters don’t get spooked and pay heed to the Democrats’ lament that the ills have been caused by the present administration and that McCain will continue those policies. Markets are helping them in that cause.
Cognitive Disassociation (means they don’t get it sport)
Here is where the damage has been done. Below is the monthly chart of the S&P Banking Index. You have seen this chart before when I explained the significance of the black Danielcode line at 138.80 and the fate that a monthly close below that number implied. As we see so often, this market well knew where its nemesis lay and having slipped through the crucial number it reversed sharply from the next Daniel sequence number to avoid giving the signal that Le Deluge was upon us! It has spent the past 40 days grimly holding on to the old DC number at 174.
Given the high weighting of financial stocks in both the Dow and S&P indices we would expect to see considerable impairment in those indices and undoubtedly we are seeing a correction, but at this stage it is only a correction as the S&P index made landfall at its ordained DC number and has held on imperiously. These are early days as the following chart makes clear, and we know the fate that awaits a conclusion from an incomplete chart pattern as we are now just 10 months from the highs.
BUT- If the banking/quasi originator/leverage sector is being fed a stiff dose of reality, then where is the strength coming from?
Surprisingly, the answer is the small caps sector as demonstrated by the Russell 2000 which remains fully 25% above its 2000 closing high:
And the NASDAQ index which is only 16% off its 2007 highs! Not even a bear market in this index sport.
The smaller cap stocks should be more reliant on consumer spending. With less emphasis on branding and marketing budgets as the sample moves wider in its travels down the pyramid of marketing power, we would expect to see much more damage in these indices if consumers were truly tapped out. It hasn’t happened.
Price and Earnings
NEW YORK (AP) - Standard & Poor's Index Services on Monday said preliminary figures show second-quarter operating earnings for the S&P 500 companies fell 29 percent, the fourth straight quarterly decline for the index of large companies. With data available from 96 percent of the companies in the index, S&P said the aggregate results show operating earnings at .08 per share, compared with .06 per share for the 2007 second quarter.
"As reported" earnings, which reflect results that are not adjusted for special charges and gains, fell to .32 per share. That's down 39.1 percent since hitting a record of .88 per share in the first quarter of 2007. The financial sector was the only sector to have a negative result for operating earnings, showing a loss of 4.1 percent. A year ago, the financial sector contributed by far the largest percentage to operating earnings, at 28.4 percent. Excluding the financials, S&P 500 operating earnings rose 3.2 percent for the quarter. There are 88 financial companies in the index. 08/25/08
It is wise to treat earnings announcements with a deal of skepticism or more practically a well developed sense of humour, but this modest quarterly snapshot buttresses the argument. Let’s just take the statement from S&P Services and assume they are telling the truth, at least as they know it. “As reported” earnings are down 39.1% from the record first quarter of 2007. On a linear basis assuming constant yield valuations, the index should have been down about that much also and with a decline of only 17.4% (high close to 06/30 close) pricing is still optimistic. If we isolate the financial sector which showed a loss of just 4.1% we have a year-on year turnaround of reported earnings in that sector of minus 32.5%. Yet the S&P Banking Index dropped almost 60% from its closing high to 06/2008 close.
I know that the Banking Index and S&P categorizations of “financials” are not aligned and that the reported earnings are a farce but such are the designated results that US securities legislation empowers the great and mighty to issue in the interests of keeping the market informed! In any event we can see as the simplest conclusion that if financials have borne more of investors wrath on the disclosed information then the corollary must be that other stocks have borne less. Optimism, even bullish exuberance has not been killed in these markets.
The U.S. Federal Deposit Insurance Corp. said on Tuesday that its "problem list'' of banks increased 30 percent in the second quarter to the highest total in five years as more commercial real-estate loans were overdue. The list had 117 banks as of June 30, up from 90 in the first quarter and the highest since mid-2003. FDIC-insured lenders reported net income of .96 billion, down 87 percent from .8 billion in the same quarter a year ago. The BIX and the Dow rallied.
For all these imbalances there is a compensating mechanism, the exchange rate. Here too markets are telling us the exact opposite of what commentators and economists have believed. The Euro is having a fit of despair on the EUR-USD cross. This month’s price action is nominal on the macro view but it is the biggest bar on this long term chart. Something bad is happening in Euro land. Or is this simply belief that as contagion spreads god is with the big battalions? The US Dollar is the biggest battalion by far. Has USD become the safe haven bet. That would be a change of considerable proportions.
The UK Telegraph sees real problems in Scandinavia and the Baltic states: Almost the entire region of Western Europe, Scandinavia and the Baltics is on the cusp of fully fledged recession, raising fresh fears about the health of Europe's banking system. Germany's IFO confidence index of future business crashed in July to levels last seen in the post-unification bust of the early 1990s. The dramatic downturn in Europe's core economy appears to have taken the currency markets by surprise. The euro has plummeted by almost 10pc against the US dollar since early July, inflicting heavy losses on hedge funds with big "short" positions on the greenback. In Denmark, the credit boom has pushed household debt to 260pc of disposable income, the highest level in the world. This is worse than Britain (159pc) and America (135pc). The property boom has now turned to bust. House prices have fallen by 10.7pc over the past year in Copenhagen.
Leaving aside the obvious comment that house prices down 10.7% after running up 100% plus in five years is not a “bust”, there is open anxiety at the highest levels. On Tuesday the Germans said they haven't seen a domestic economy this bad in 15 years. On Monday, the world's central bankers were wringing their hands at their annual meeting in Jackson Hole, Wyoming. Stanley Fischer, governor of the Bank of Israel, told the meeting: "There is an enormous amount of uncertainty about where we stand at the moment, we are in the midst of the worst financial crisis since World War Two."
Charles Bean, deputy governor of the Bank of England, agreed: "There are periods when markets look like they are getting better. Then another grenade explodes, another bout of fear of sustainability of some financial institutions, perhaps more intervention by the authorities."
Is this dire news? This is pretty stern stuff from the heavyweights. The market either doesn’t hear them or doesn’t believe them This is the German DAX index below. It is off 20.8% from its all time high. Barely edging into bear territory. Hardly reflective of the worst financial crisis since the War!
Traditionally Gold should signal out of control inflation and real financial risk. It is having a bet each way at the moment (the jury is still out). Well off its March highs, Gold is still holding an historically strong position.
On the weekly chart Gold has only corrected a minor swing and a weekly close above 849.20, basis Comex Gold December contract is required to negate the current weekly sell signals in Gold. You can follow along with Gold and HUI’s buy and sell signals at the Danielcode website where the Gold Trend Charts and their specific signals are free for Financial Sense readers and updated before the US open every Monday.
For those of you interested in forex and particularly system trading, we have a model account of one aspect of the trading signals generated by the Danielcode that you can view at our website
For Republicans, you can relax over the holiday weekend, and tune out replays of the Democratic Convention, sure in the knowledge that US markets think McCain is a good thing to win the Presidency.
For Democrats, the weekend will not be so joyous as despite Hillary’s words that “Most of all, I ran to stand up for all those who have been invisible to their government for eight long years,” Democrats have failed to make the public aware of the economic imbalances facing US and the World.
Joe Average has no idea what is coming down the track. Most apparent US consumer problems are blamed on gas prices in the firm belief that a gallon petrol is the end of the world and the sure cause of whatever consumer tension is apparent. The fact that Britain, Europe and the lands Down Under have been paying near and above per gallon for years without any ill effects to the economy or apparently the consumer, has not been considered. Same cars down here (GM, Fords and Toyotas), same commute, same mileage. Gas is just another household cost and hidden sales tax, but it is not the problem.
Living beyond your means is the problem. That is a mindset in the western world that has become ingrained in less than a generation. Public policy will not change that mindset. But what is unsustainable must eventually fail. That is more than a law of economics; it is the law of nature.
The acute fiscal anxiety that should be orchestrating this Presidential election and causing the economy to be the essential topic is just not there, in the swing voters, where it matters. For this, Democrats must take the blame. It was their game to win.
Whatever your political affiliations, I bid you a restful and enjoyable break over the Labor Day weekend. Traditionally, equity markets return to life from the Summer doldrums, after this weekend so there is much to look forward to.
Copyright © 2008 John Needham