FedUpUSA

Archive for February 15th, 2012

(February 15, 2012)

If the conventional econometric model based on metrics like forward price-earnings ratios and a declining unemployment rate is so accurate, then why did it fail so completely, totally and utterly in predicting the 2008 meltdown?

A certain flavor of econometric model dominates conventional portfolio management and financial analysis. This model can be paraphrased thusly: seasonally adjusted economic data such as the unemployment rate and financially derived data such as forward earnings and price-earnings ratios are reliable guides to future economic growth and future stock prices.

Here is an excellent example of econometric analysis, which (surprise!) concludes that the Dow Jones Industrial Average is headed for 15,000 as skepticism over economic growth and rising profits diminishes. Time to Reconsider the Upside for Stocks?

As always, there are abundant charts presented to support the econometric call for steady growth in economic activity, corporate profits and stock indices.

The same approach–that standard metrics of growth are not only accurate but they’re all that’s needed to accurately assess risk and gain–is on display here in the house organ of bullish bias, Barrons: Enter the Bull (Dow 15K or 17K).

If this model is so accurate and reliable, why did it fail so completely in 2008 when a visibly imploding debt-bubble brought down the entire global economy and crashed stock valuations? Of the tens of thousands of fund managers and financial analysts who made their living off various iterations of this econometric model, how many correctly called the implosion in the economy and stock prices? How many articles in Barrons, BusinessWeek, The Economist or the Wall Street Journal correctly predicted the rollover of stocks and how low they would fall?

Of the tens of thousands of managers and analysts, perhaps a few dozen got it right (and that is a guess–it may have been more like a handful). In any event, the number who got it right using any econometric model was statistical noise, i.e. random flecks of accuracy.

The entire econometric model of relying on P-E ratios, forward earnings, the unemployment rate, etc. to predict future economic trends and future stock valuations was proven catastrophically inadequate.

The problem is these models are detached from the actual drivers of growth and stock valuations. If you want to predict market action, the better model is to “follow the money” as Gordon Long does in Why Does The Market Keep Rising? (via U. Doran). This analysis is refreshingly cognizant of the fact that forward earnings, new unemployment claims and all the rest of the econometric spectrum are not predictive tools, they are merely perception management, i.e. justifications for current price action.

Even worse, econometric models are all polishing the rear view mirror as a means of looking ahead, i.e. they are all based on the belief that recent action is a predictably accurate guide to what will happen next.

This is another reason why the econometric models of forward earnings, unemployment rates and all the rest failed so utterly and completely: these metrics are incapable of predicting the next “credit event,” “loss of risk appetite” or secular downturn.

While the econometric models are all predicting renewed growth, rising corporate profits and an uptrend in job creation, consider this chart of the Ceridian Index.Does this chart reflect an expanding economy, or does it share all the traits of a contracting economy? (Chart courtesy of longtime correspondent B.C.)

Indeed, an objective analysis (i.e. one not driven by the desperate need to paint a positive picture via propaganda and perception management) would find it obvious that the “real economy” rolled over in May of 2010, and that the market’s recent ascent is nothing but Federal Reserve/central bank manipulation/intervention (see Gordon Long’s analysis above for a full account of this dynamic).

And what about energy consumption? (It’s Not Just Gasoline Consumption That’s Tanking, It’s All Energy).

And what about the vaunted employment resurgence? Where is it in this chart of actual employment, as opposed to unemployment rates, new claims, and other non-factors trumpeted by the cargo-cult witch doctors of econometrics as “proof of growth”?

Clearly, the number of people with actual jobs is declining, not rising. All manner of lipstick can be applied to the employment pig–weekly claims are dropping!, etc.–but the only number that actually matters is the number of people with jobs, and more narrowly, those with full-time jobs.

In other words, laying off 10 million full-time workers and hiring back 10.1 million part-time workers with no benefits is a completely deceptive measure of employment income, as total compensation (wages and benefits) fell more or less in half and so did the income available for consumption and investment. Such a precipitous decline in income and resultant economic activity would be completely masked by a studiously coarse measure of employment.

As for forward earnings–I have often described the dominant causal factor in the rise of U.S. corporate profits– the decline of the U.S. dollar. In a nutshell, here’s the story of rising profits: 40% of all U.S.-based corporate revenues are generated overseas, and a majority of profit increases result from these rising sales overseas.

When these profits earned in euros, renminbi, yen, etc. are restated in U.S. dollars, then the profits magically rise. For example, 1 euro earned by a U.S.-based corporation in 2002 yielded about $1 when converted to dollars in the company’s financial reports. In 2008, that 1 euro ballooned into $1.60 of profits due to the currency exchange rate of 1 euro=$1.60.

Fully 35% of that profit was a result of dollar depreciation, not an actual increase in profit margins or goods and services produced. The Fed’s campaign to destroy the nation’s currency generated fabulous (and phantom) “growth” in corporate profits at the expense of every holder of the currency.

Now that the U.S. dollar is in a secular uptrend, the Fed’s shadow strategy to boost phantom corporate profits and thus the stock market is in trouble. Now all those phantom gains are threatening to vanish as the dollar strengthens.

As I have noted many times, the vast majority of standard-issue financial pundits (SIFPs) are absolutely convinced that the Fed’s $1 trillion expansion of its balance sheet will drive the dollar ever lower in the years ahead. I disagree, on a simple “follow the money” analysis: given that there is around $60 trillion in financial assets sloshing around an increasingly risky world seeking some sort of safe haven, the pressing goal of not losing what I have makes parking assets in U.S. dollar-denominated assets a risk-averse strategy.

Recall that it’s difficult to temporarily “park” a rather modest $1 trillion in, say, renminbi, bat guano or gold, because the entire global market for these assets is small or restricted (the RMB is not yet a floating currency that can be bought in virtually unlimited sums). For example, the gold market is around $8 trillion, of which 19% is held by central banks and 52% is in jewelry. It’s difficult to locate $1 trillion of gold to buy. In contrast, it is comparatively straightforward to “park” $1 trillion in U.S.-denominated assets such as Treasury bonds, corporate bonds, stock funds, etc., and these assets have the additional benefit of being liquid, i.e. you can unload your position in relatively short order without destroying the global market for the asset. (Try that with bat guano or copper.)

This need to park collateral-impaired financial assets in something that won’t crater tomorrow or the next day is a powerful reason for some of that $60 trillion sloshing around to find a temporary home in dollar-denominated assets. Compared to the pool of digital money seeking safe haven, the Fed’s $1 trillion expansion is simply not big enough to move global markets when the “risk-off” trade explodes.

Meanwhile, the cargo-culters gathered around the econometrics campfire are staring at the glowing embers, entranced by forward P-Es of 14.6 and a 11K drop in new unemployment claims (now 366,000, soon to be adjusted upward by 12K when nobody’s looking) or whatever runes painted on rocks they’re looking at this week.

Charles Hugh Smith – Of Two Minds

Do you want to know what the future of America is going to look like?  Just check out what is happening to Detroit.  The city of Detroit was once one of the greatest industrial cities in the history of the world, but today it is a rotting, decaying, post-apocalyptic hellhole.  Nearly half the men are unemployed, nearly half the population is functionally illiterate, more than half of the children are living in poverty and the city government is drowning in debt.  As economic conditions have gotten worse, crime has absolutely exploded.  Every single night in Detroit there are frightening confrontations between desperate criminals and exasperated homeowners.  Unfortunately, the police force in Detroit has been dramatically reduced in size.  When the police in Detroit are called, they often show up very late if they even show up at all. Detroit has become a lawless hellhole where violence is the currency of the streets.  If you want to survive in Detroit, you better be ready to fight because there are hordes of desperate criminals that are quite eager to take literally everything that you have got.  But don’t look down on Detroit too much, because what is happening in Detroit will soon be happening all over America.

The following are 20 things we can learn about the future of America from the death of Detroit….

#1 People don’t want to live where the stench of failure and decay is constantly in the air.  Back in the 1950s, Detroit was a teeming metropolis of approximately 2 million people.  According to the 2010 census, only 713,000 people live in Detroit today.  The U.S. Census Bureau says that Detroit lost a resident every 22 minutes during the first decade of this century.

#2 When the economy falls apart, desperate people will do desperate things and many homeowners will fight back.  Justifiable homicide in Detroit rose by a staggering 79 percent during 2011.

#3 In major cities where people are scrambling just to survive, any confrontation can quickly escalate into a life or death affair.  The rate of self-defense killings in Detroit is currently 2200% above the national average.

#4 When there is not enough money to go around, a lot of local governments will choose to cut back on police protection.  Ten years ago, there were approximately 5,000 police for the city of Detroit.  Today, there are less than 3,000.

#5 The essential social services that you are enjoying today will not always be there in the future.  Officials in Detroit recently announced that due to budget constraints, all police stations will be closed to the public for 16 hours a day.

#6 Economic decay is a breeding ground for chaos and violence.  Last Friday and Saturday, a total of nine shootings were reported in the city of Detroit.

#7 More Americans than ever are realizing the benefits of self-defense.  The following is what 73-year-old Julia Brown recently told the Daily….

The last time Brown, 73, called the Detroit police, they didn’t show up until the next day. So she applied for a permit to carry a handgun and says she’s prepared to use it against the young thugs who have taken over her neighborhood, burglarizing entire blocks, opening fire at will and terrorizing the elderly with impunity.

#8 When crime gets go bad that the police are powerless to stop it, vigilante groupsbegin to form….

In fact, crime has gotten so bad and the citizens are so frustrated by the lack of police assistance that they have resorted to forming their own organizations to fight back.  One group, known as “Detroit 300″, was formed after a 90-year-old woman on Detroit’s northwest side was brutally raped in August.

#9 When criminals become desperate, they will steal literally anything that is not bolted down.  In Detroit today, thieves have stripped so much copper wiring out of the street lights that half of all the lights in some neighborhoods no longer work.

#10 As things fall apart, eventually a time comes when it is not even safe to drive down the road in the middle of the day.  100 bus drivers in Detroit recently refused to drive their routes out of fear of being attacked on the streets.  The head of the bus drivers union, Henry Gaffney, said that the drivers were literally “scared for their lives“….

“Our drivers are scared, they’re scared for their lives. This has been an ongoing situation about security. I think yesterday kind of just topped it off, when one of my drivers was beat up by some teenagers down in the middle of Rosa Parks and it took the police almost 30 minutes to get there, in downtown Detroit,” said Gaffney.

#11 One of the clearest signs of decline in America is the state of our education system.  Only 25 percent of all students in Detroit end up graduating from high school.  Many other major cities will soon have graduation rates similar to Detroit.

#12 When local governments run out of money they are forced to make tough choices.  After already shutting down dozens of schools, officials in Detroit have announced plans to close down 16 more schools.

#13 A growing percentage of Americans cannot even read or write.  This is a very frightening indication of what the future of America could look like.  According to one stunning report, 47 percent of all people living in the city of Detroit are functionally illiterate.

#14 Sadly, child poverty is absolutely exploding all over the United States.  Today, 53.6 percent of all children that live in Detroit are living below the poverty line.

#15 The employment situation in America is a lot worse than the government is telling us.  An analysis of census figures found that 48.5% of all men living in Detroit from age 20 to age 64 did not have a job in 2008.

#16 When a major city becomes a hellhole, home prices fall like a rock.  The median price of a home in Detroit is now just $6000.

#17 When crime and looting become commonplace, homes in an area can become absolutely worthless.  Some homes in Detroit have been sold for a single dollar.

#18 When depression-like conditions exist in an area for a number of years, large numbers of people will move on to greener pastures.  As of a few years ago, there were more than 40,000 vacant properties in the city of Detroit.

#19 Just because we have a high standard of living today does not mean that will always be the case.  Detroit is just a rotting shell of what it once was, and what is happening to Detroit will happen to much of the rest of America very soon.  The following is what one British reporter found during his visit to Detroit….

Much of Detroit is horribly dangerous for its own residents, who in many cases only stay because they have nowhere else to go. Property crime is double the American average, violent crime triple. The isolated, peeling homes, the flooded roads, the clunky, rusted old cars and the neglected front yards amid trees and groin-high grassland make you think you are in rural Alabama, not in one of the greatest industrial cities that ever existed.

#20 When government finances collapse, politicians look for things to sell off and “privatize”.  Unfortunately, the Detroit city government is so broke that it is now considering selling off some of its most famous assets….

Now, the city of Detroit’s most venerable assets — from Belle Isle to the Detroit-Windsor Tunnel — could end up on the auction block as the city fights for its financial life.

Facing mounting debt and the prospect of a state-appointed emergency manager, the city is looking at all options to shed expenses and raise revenue. If city officials can’t come up with a viable budget plan, an emergency manager would have the power to sell assets as part of a financial takeover of Detroit.

But Detroit is not alone.

Lots of other cities all over America are flat broke and out of options.

For example, just check out what is happening in Scranton, Pennsylvania….

Mayor Christopher Doherty is blunt when asked about a court order forcing his Pennsylvania city to pay about $30 million in wages withheld from police and firefighters under a state-approved fiscal recovery plan.

“I don’t have the money,” said Doherty, 53. As for the chance of borrowing the cash, more than half of the city’s projected general-fund revenue, he added, “there’s no financial institution that’s going to give me $30 million to pay it.”

The U.S. economy never recovered from the last major financial crisis, and now another one is on the way.

As the economy crumbles, so will the fabric of our society.

The American people are terribly spoiled and they do not possess the character to handle depression-like conditions with grace and dignity.

In the years ahead, we are going to see rampant rioting and looting in our major cities.  The crime sprees that we will witness in future years will be absolutely unprecedented.

Things did not have to turn out this way, but unfortunately the consequences of decades of really bad decisions are starting to catch up with us.

So what do you think the future of America will look like?  Feel free to leave a comment with your opinion below….

The Economic Collapse

We’ll see whether this gets any positive mentions – anywhere. (Hint: It won’t)

Europe’s economy contracted in the fourth quarter for the first time in 2 1/2 years as the region’s debt crisis undermined confidence and forced governments fromSpain to Greece to toughen budget cuts.

Gross domestic product in the 17-nation euro area fell 0.3 percent from the prior three months, the first drop since the second quarter of 2009, the European Union’s statistics office in Luxembourg said today. Economists forecast a drop of 0.4 percent, the median of 42 estimates in a Bloomberg News survey shows. In the year, the economy grew 0.7 percent.

Europe is facing its second recession in less than three years and Moody’s Investors Service cut the ratings of six of the region’s countries on Feb. 13, saying policy makers haven’t done enough to restore investor confidence. Euro-area finance ministers today will hold a teleconference to prod Greece to do more to clinch an aid package needed for a March bond payment.

Note carefully that nice embedded sentence.

This is elmementary mathematics, but nobody wants to deal with it.

GDP = C + I + G + (x – i)

That is, Consumption (by consumers) + Investment + Government Spending + Net Exports

Well, guess what — when you deficit spend you create false demand that does not really exist in the economy, and that makes GDP larger than it really is.

When you stop deficit spending then GDP must, mathematically, contract.

This is not bad, it’s good.  It forces out the malinvestment, the excess production, the companies that survive on the basis of producing goods and services for which there is no actual demand.

The common mantra that “growth is always good” is in fact false.  Growth is only good if it is actual growth in organic demand – that is, if there is both ability and desire to buy what is produced by real consumers using their economic output.

Government, in turn, has two means (and only two!) by which it can spend — it can either tax people in the here and now or it can dishonestly steal the funds to spend by borrowing.

The latter is dishonest because deficit spending inherently causes the monetary supply (money and credit) to increase.  And since the value of a unit of currency (in terms of goods and services) is determined by the simple relationship of the number of units of production divided by the units of currency and credit in the economy all such borrowing inherently causes the value of every unit of credit and currency in the economy to fall.

It thus has the exact same effect as if everyone using that currency were taxed in the exact amount that is “printed” through that borrowing!

It does not matter if your unit of currency is pieces of eight, scraps of linen-laced paper with dead Presidential visages upon them, stones of peculiar dimension and shape or sticks of wood.  All that matters is the number of them and those markers used to represent them, which is what credit is, compared to the number of units of goods and services produced.

Recession, once one understands this, is good, not bad.  It clears the excess production from the system and by doing so takes the weakest borrowers and lenders out to the woodshed and bankrupts them both.

We, and the rest of the world, must accept the fundamental truth of mathematics.  It’s not complicated; we’re talking about arithmetic and algebra here, not calculus.  Simply put, compound growth of anything is unsustainable over the longer term, and that which relies on it is therefore impossible.

This does not mean that for some period of time growth cannot happen.  It most-certainly can, and in many cases should.  But all such projections and expectations must have a “use by” date at which the presumption ends, and those political and social policies that follow must also take into account that “use by date.”

It is the refusal to do this that has led us to where we are in Europe with budget deficits and unsustainable fiscal policies.  The same refusal is what plagues us here in the United States, and what will result in financial, social and political ruin right here at home unless we choose instead to face reality.

The Market-Ticker

Discussion (registration required to post)

Passing a Federal Budget is a rarity, especially under the administration of a committed Marxist. The Democratic Senate’s strangle hold on bringing up legislation, particularly a budget, goes without saying. What makes this new budget for 2013 any different? This time the day of reckoning hits hard the first of the next year. The recent interview with David Stockman on the Fox Business channel with Neil Cavuto is an extraordinary analysis why the economy will absorb a frightful tax increase all at one time. The fallout to commerce could become the real end of the world scenario. Take the time and watch the insightful observations from a courageous number cruncher who served this nation with distinction during the Reagan Presidency.

BATR