Indian Time Bomb

A lot of ink has been wasted in the last few years about the BRIC countries (Brazil, Russia, India and China). While there is some truth there, I think that a lot of it is overdone. Russia is dying. There population is declining by almost 1/2 of one percent per annum. In 50 years, their population will decline 25%. That would be 30 million fewer Russians. China is growing about 0.5% which will produce a 30% increase to 1.7 B total. Not easy to handle, but possible for a country its size. Brazil is growing at a 1.2% rate, taking their current 200M population over 350M. Not a problem for Brazil. (There goes the Amazon jungle!). But worst of all is India. They are growing at 1.5% per year. They currently have a population of 1.1B. In 50 years, that will more than double! Not sustainable! Especially, since there is a serious imbalance between the sexes with 1.1 males for every female, currently almost 50M more men than women. Imagine 2B people crammed into a country the size of India with 100M men who have no hope of finding a mate. It isn't going to happen. India is going to collapse first. War, social calamity and poverty will continue to be the story of India in the coming decades, unfortunately.

US Monetary Tightening

This morning the Ten Year Treasury yield is 3.88%. That is up from 3.20% a little over a month ago. Since the US Government is trying to shift its borrowing out on the curve and since Federal stimulus is the only game in town when it comes to economic expansion since debt is being pared in the private sector, this is in effect a monetary tightening. I don't know why it is occurring and whether it will continue. It may be the bond vigilantes. It may end up being noise. But if it sticks for any period of time in 2010 (I think it will and I think there is a good chance of 4.50%) it will be destabilizing to the global economy. The US Dollar is the world reserve currency and it tightening occurs, the consequences of even a small fraction of the $50-150T sloshing around the world could be immense. [3.88% of $1T is $39B. Double that to $78B and you have the cost of financing the US debt to be issued next year alone, assuming it had a ten year duration, which is probably not true, but it is an indicator of the cost of the US Federal folly]. 30 year fixed mortgage rates are now above 5 1/4% and at this rate may be pushing up against 6% in a few months. No wonder the Treasury decided to make an open-ended commitment to Fred and Fan.

World Turned Upside Down

Or at least the S & P 500 Index...

One of my occasional twisted exercises is to look at a market from a different perspective. That is, from standing on my head! So I offer the following chart, as well as my musing that the current environment is similar to late 2006/early 2007. We have numerous non-confirmations and waning upside momentum. That era produced a fairly sharp sell-off followed by a recovery to new highs later in the year. Something very broadly along those lines could be in the offing for 2010. Of course, at that time, the stock market was not below the "water line", or its long term moving average. And of course, the world looked quite a bit different with falling real estate values, interest rates poised to rise and a pile of bad debts to be worked through... Now that I look at it again, the broad brush strokes may be painting a similar picture, but don't be surprised if it all takes shape much more quickly than it did before.

TNX Inverted Head and Shoulders?

I am personally not a big fan of head and shoulders formations. I think that people tend to see these formations all too often. Where the will and where they want. But in an effort to see all of the possibilities and be prepared, I humbly submit this chart of the the 10-year Treasury yield. It could be carving out the right shoulder of an inverted head an shoulder pattern. On one hand, this makes sense with Treasury issuance rising to the stratosphere with $2T federal budget deficits as far as the eye can see. On the other hand, with a stabilizing, if not rallying US Dollar, does it make sense that yields would rise? Plenty of times before the markets have done the unthinkable. And plenty of times before seemingly rock solid correlations have broken down and left as many traders as possible in the dust. Will this time be different? Who knows. But just in case, I am steering clear of the bond market. 4.50% seems like a real possibility in Q1. After that, it is anyone's guess, but it may hold important clues. My guess is yields up, followed by a sharp correction with an ultimate upside resolution down the road 18-24 months or so. With that, you at least know what is not likely to happen.

Dollar Devaulation?

I am posting this not because I have the answers, but exactly the opposite. I think that I have the right question. Find the answer to that question (or at least know the likely possible answers) and you will be half the way to success.

There is the ongoing debate regarding inflation versus deflation. Last year, deflation was in force, while this year we have seen a return of inflation, in a sense at least. (We haven't really seen a great expansion in credit and/or money, so the verdict is still out on that one.) But how is it ultimately going to end? Because it is not over. Not by a long way. The final denouement could come in nine months or nine years. It could be a deflationary collapse followed by a reflationary recovery. Or it could be a blow-off, bubble type top, followed by a huge collapse, leading to an era of higher inflation in a post-reserve US Dollar, floating exchange rate world with or without regional currency pegs or with shifting currency pegs as each nation attempts to jockey for competitive advantage without doing the hard work of restructuring while trying to work off the hangover of the last few decades' party. I tend to believe that it is not the latter, but that is not the point here. The point is that somehow, someway, the USA will have to get itself out from under the weight of its oppressive debt. It can default and throw the US Dollar to the wolves and cause a dramatic and traumatic adjustment of domestic priorities as revenues and spending must quickly be brought back into balance. Or it can devalue the US Dollar and effectively revalue its debt obligations to a level which can be managed.

First, a couple of premises. The overall debt levels during the Great Depression of the 1930's started that period just below 200% of GDP and peaked just under 300%. Currently total debt levels in the US are just below 400% and rising. This implies that the current situation is of a larger scope than the crisis of the 1930's. Bob Prechter of the Elliot Wave Theorist is convinced that this market top is of a larger degree than the 1929 peak. (And lest you are inclined to dismiss Mr. Prechter as a "perma-bear", he made this call in the 90's well before the scale of the current peak was clearly known.) That does not mean that his deflationary call is correct, but at least that it should be seriously considered. In 1933, FDR devalued the US Dollar (against gold) by 40%, by confiscating privately held gold at the price of $20 and then fixing the new international exchange rate of gold at $35. Of course, at the time, the country was on a gold standard, a somewhat flawed and flexible one, but a gold standard nonetheless. How would such a feat be pulled off today, since we are no longer on a gold standard? More on that later. The other way that the US Dollar could be devalued is against the other major currencies of the world. That would include the Euro, Yen, Chinese Yuan, British Pound, Swiss Franc, Canadian and Australian Dollars. What would the response from these seven countries (maintaining the fiction that the Euro Zone functions as a supra-national entity) be? In the 1930's, the world was much less interconnected and the four major powers (Britain, the US, France and Germany) collectively controlled a much larger share of world GDP and therefore could more easily agree to the terms and conditions of international trade. ( Those powers combined share of GDP has fallen from about 2/3 of world GDP to a little over 1/3 from 1913 to present.) Getting all of these competitors to agree would be a monumental challenge. Just keeping the EU in line is proving to be a major exercise, which by no means is guaranteed of success and could quite possibly break up, sooner rather than later. Witness Greece, Ireland, Spain and Portugal (the PIGS). If this is the model that is attempted it would seem more likely that their would be an Asian currency regime (either a single currency replacing the Yen, Yuan, HKD, Singapore Dollar, etc or fixed exchange rates among its members or some combination), the Euro Zone and then the Anglo group. It would not seem to be the most stable of situations, since a lot of this sort of fiat paper, floating rates monetary schemes have brought us to where we are today, but never put anything past the money interests and their servants in governments everywhere.

The rule of alternation would seem to imply that a return to some sort of hard money standard, gold, silver, bimetallism, etc would be demanded by a world spectacularly let down by paper money. It would also provide the cleanest and least painful path ( at least in terms of dispersion of the pain) among participants. Even if just the US and Euro Zone went back to the gold standard, a 50% devaluation would possibly bring debt levels back down to the 100-150% range where it would be feasible for these economies to grow out of the debt in 20-30 years.

Both devaluations would seem to suggest that purchasing gold as a "store of value" or an alternate currency would be the wisest path (and to some extent that will surely be true). But as the possible scenarios of a US Dollar devaluation against other paper currencies versus a return to the gold standard, could involve drastically different paths including gold confiscation, the answer is not yet knowable. But being prepared with right questions and the possible resolutions to that question could make the difference in a volatile and dynamic situation.

Greek Tragedy in January?

CDS costs for a Greek sovreign default are reaching record levels not seen since the depths of the financial crisis a year ago. With a federal budget deficit projection of almost 13%, a default of some sort is quite possible. Germany is trying to take a hard line as they are getting tired of bailing out the EU's poorer members, but they may push things too far and accidentally get more than they bargained for. But with the odds of default still around 25%, default is still not likely, but a lot can happen in the next month, when Greece will float an offering whose details are still entirely unknown.

Bernanke Withdraws Nomination!!!

Yes. I know. It has not happened. Yet. But it may. After the Senate Banking Committee vote of 16-7, "Helicopter Ben" is not a shoo-in for another term. Yes, it is likely he would be able to garner 60 or more votes if he and the administration pushed hard enough. But there are probably enough Democrats who would be comfortable with Janet Yellen and enough Republicans who would be happy with anyone but Bernanke. With Chris Dodd successfully moving the re-nomination through committee he can tell his financial handlers that he did what he could, but Ben was just too unpopular. Especially in an upcoming election year.

"Edelweiss, Edelweiss, Bless My Homeland Forever"

Unfortunately, it appears that the Edelweiss is actually German. How this does anything but shift the risk closer to the center of ECB and EMU authorities is beyond me. Of course, this is just a continuation of the actions that the FED and ECB authorities undertook last year. But the "crisis has past" supposedly, hasn't it? Look for another crisis next year (2011 at the latest) that is much broader in scope and scale as it will likely engulf all of the highly indebted sovreignties (which is just about all of them, at least in the Western world).

See: Austrian bank Hypo rescued.

Barings Goes Global

I recently finished reading Judith Rawnsley's book "Total Risk" about the Barings Bank collapse at the hands of Nick Leeson. While the book is good enough, although maybe a little too easy on Nick and Barings, it is interesting enough. A couple of illustrative quotes:

"... Khoo's trading operation created an unexpected dilemma because Heath's 'client is King' approach to the world was suddenly thrown into question as the proprietary trading ... began to draw complaints..."

"The only point at which both proprietary and agency broking business streams converge is on the exchange floor or dealing-room screen."

"... Peter Norris allowed Ron Baker to be charge of agency broking and proprietary trading, so the two sides of the Chinese Wall became fudged."

What strikes me about this story is that the destructive behavior which took down Barings only 15 years ago, is now being performed on an even larger scale. One could argue that it has gone global as the large money center banks are being fed inside information by Federal Treasuries. It should be no surprise when and if the result ends up being the same.

Consumer Tapped Out

The consumer is tapped out and has been for some time. Without the real estate fiasco, we would have been in trouble a long time ago. The 2001-2003 tech bubble collapse would have been much worse without the real estate bubble to paper over the problems. Consumer credit (excluding mortgages) has been growing at a steadily slower rate since the mid-90's. So either folks are wealthier or they have been increasingly unable or unwilling to take on additional debt. Look for yourself, these numbers are from the Federal Reserve, so they must be true!

By looking at this graph, you would think that consumers have been retrenching. But note that debt has been increasing, just increasing at a slower rate. Could that be because for the past fifteen years consumers have been finding it increasing difficult to make "ends meet"? Is this because it is not possible for the average US consumer to maintain their current lifestyles? Is there another "piggy bank" or ATM, like US housing equity, to borrow against to maintain that lifestyle? Nothing is impossible, but this graph implies that it will not be possible, at least not much longer. Watch out if the RATE turns negative and STAYS negative. This will be serious trouble for the reflationist camp.

Morgan Stanley by the eerrr....Envelope

Instead of analyzing Morgan Stanley's financials by the book, I am going to do it by the back of the envelope for the following two reasons:
1) I am not trained as a financial analyst.
2) All modern financial institutions, lie... uh, rather... use "good faith" to interpret accounting "standards". These figures were gleaned from the Sep. 09 10-Q filing.

First of all, MS has about $60B cash and equity, more or less equally divided. Total liabilites are in the range of $700B, with about $300B long-term debt. The asset side of the ledger includes over $87B of debt securities and $89B of derivatives including $25B of debt securities and $9B of derivatives classified as Level 3 assets. The total debt securites show unrealized gains of $937M whiled the derivatives display an unrealized loss of $1.251B. The debt securities included $17B of CDO's with unrealized gains of $670M. The L3 assets include RMBS and CMBS securities which showed unrealized losses of $41M and $442M, respectively. Better than last year when they declined $771M and $2.23B, respectively. So far, nothing seems too far out of line, with the possible exception that an institution which is leveraged about 12:1 would not seem inherently stable, but maybe I am just old fashioned.

More interesting is some of the off balance sheet items. One notes points out that there are QSPE's (Qualified Special Purpose Entities) which have a grand total of $56B in RMBS, $111B in CMBS and $64B in US Agency securities. I don't think the US gov't is broke...yet. So that last part is probably OK, for now. But the first two items are disturbing. Especially, with the recent news that one of Morgan Stanley Commercial RE funds is facing big losses. I think that it is reasonable to assume that 30% of both the Residential and Commercial MBS in these SPE's is impaired, although they may have begun to address this already, I am skeptical. My impression is that they have taken their hits for the stuff that is consolidated on the balance sheet that they have had to do, but there is a reason the off balance sheet is off in the first place. So in a worst case scenario where they take a 30% hit, $18B would be gone from RMBS and $34 from CMBS, leaving Morgan Stanley with $10B against $550B of liabilites. Or leverage of 55:1.

Also, they have an astonishing $21T, yes, Trillion notional value of derivative hedges in places. The fair market value is just over $1T. While this is hedged and theoretically would involve offsetting positions, $980B of this market value is said to be counterparty netting. I think this indicates why last Fall, financial authorities were basically panicked about systemic failure. With this kind of counterparty risk at one single company, the contagion effects of the failure of one significant player could easily be disastrous, as it would be difficult even for such a profligate printer such as Ben Bernanke to plug a $980B hole in short order, before it rippled through the global system.

I believe that we may see such a ripple next year due to CMBS. And Morgan Stanley may be at the heart of it.

Goodbye Method: A Sign of the Times

WSJ has an interesting commentary today about the end of the influence of the Method School of Acting. Represented by such staunch players as Marlon Brando and Robert DeNiro, the author suggests that it has yielded to a rebirth of the more classic "pretender" ala Cary Grant (my personal favorite) or Sir Laurence Olivier. My two cents is that, as "socionomics" theorists would suggest, the times have changed and consequently, our tastes have changed with the times. In a difficult, sometimes bleak world we want to "pretend" and we want a light, breezy style from someone like Matt Damon or George Clooney. In a more upbeat time, we have a little more spirit and good feeling to spare, so we look for something a little edgier, maybe like Brad Pitt. If I were Mr. Pitt's agent, I would take note.

Bears Stearns Redux?

WSJ has an article speculating that a MS CMBS Fund may default on its mortgage. Didn't something similar happen to an outfit called Bear Stearns back in 2007?

Reversals Everywhere

I could post a dozen more but I don't want to bore you anymore than you already are.

The first chart of BAC. Who really thinks that BAC giving back $45 B of cheap, gov't money and diluting shareholders is a great idea? Even the geniuses who bought the stock this morning at a 6% plus premium may be reconsidering this one. If the market is a big voting machine, this idea was just voted down! My previous post about shorting BAC is now a profitable position. I personally shorted this AM at 16.45 and covered at 15.95, which I am now regretting. I still see potential to below 14, with a stop at 14.75 first.

The second chart is the Dow Trannies. If these recent highs are not taken out soon, real soon, we will have a real Dow Theory non-confirmation, divergence or sell signal. Could this be related to the ISM survey showing that Healthcare and Finance were expanding while Real Estate Mgmt, Construction, Mining, Food Services and Transportation all declining. In other words, not much Transportation is required to knock people over the head and steal their wallet sending them to the hospital compared to digging something out of the ground, growing and preparing food, building something or maintaining that something you just built. Simply put, the phony economy is still growing while just about everything else in the real economy (with the possible exception of Retail, although most of that is phony and much of it is probably temporary and will evaporate soon after Santa head back to the North Pole) is shrinking.