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Mark's Market Blog

6-23-13: Bernanke announces his endgame.

By Mark Lawrence

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Friday was a triple-witching day, and the entire world sold off. Government bonds everywhere dropped, meaning interest rates went up for every government on earth. Essentially every currency dropped against the dollar - imports to the US just got cheaper by a few percent, and it got harder for the US to export anything. Stocks everywhere sold off, especially in Asia where fears of a Chinese recession are increasing quickly. Gold and silver dropped 5%. All this apparently in reaction to Bernanke announcing that over the next 12 months QE would be slowly reduced to zero. It seems even the threat of refilling to punch bowl more slowly is enough to dampen the party. It was pointed out to me by several of my readers that my new-found bullishness was probably a strong bearish indicator, and it seems perhaps it was. However, the US economy remains reasonably strong - at least for the half of us that actively participate in it. I expect market volatility for a time, but not a clear trend either up or down. It's noteworthy that markets are correlated again: they're all going up and down together, stocks, gold, commodities, interest rates. This is not a healthy sign.


S&P 500 December 27 2012 to June 21 2013

America - the greatest nation on earth. The CDC reports that in 2010 there were 33,687 deaths from motor vehicle crashes, and 38,364 from suicide. Out of 222 nations the US ranks #51 in life expectancy, and our child mortality rate is worse than Cuba's. We do rank #1, however, in obesity (30.6%), diabetes, and heart disease.

The Japanese have ranked many of the countries in the world for surveillance. Who's out of control? See the map below, draw your own conclusions.

French president Hollande assured us a couple weeks ago that the European crisis was over (I'm never going to get sick of quoting him). Now Cyprus is asking for new bailout terms, correctly saying the current terms are destroying their economy; and Greece shut down their public TV broadcaster which has thrown the country into political chaos and brought the stability of their government into question. Greece is not meeting their targets, Eurozone banks are refusing to roll over Greek debt, and Christine Lagarde, the president of the IMF, says unless the situation in Greece improves the IMF will supply no more funds for the bailout.

More than a million people flooded the streets in Brazil protesting the government spending mega dollars to host the 2014 World Cup and the 2016 summer Olympics. The people think this money needs to be spent on education and transportation, and also think their tax code is unfair and their government corrupt. Brazil is often said by their people to have "France's taxes but Somalia's services." Meanwhile the Brazilian stock and bond markets are crashing as foreigners take their money out of Brazil and return it home.

Obama basically stated that Bernanke will be replaced when his term ends this January: "he's already stayed a lot longer than he wanted or he was supposed to." You would have to presume that the replacement will be a dove, that is someone who will be even looser with monetary policy than Bernanke. The current front runner is Janet Yellen, a long time Fed vice-chairwoman who is on the record as favoring about 2% inflation in our economy, and will certainly be happy to see inflation rise a bit further from today's levels. If Yellen becomes chairwoman, I think we can presume 2.5% inflation is no longer a cap, it's a goal. There will be mid-term elections a bit after this appointment, and Obama will not want his guys campaigning in the middle of a stock market "event." Bernanke finds himself squeezed a bit: he obviously wants to talk down the markets a little bit while keeping interest rates low, to avoid the possibility of building another bubble. But his president has just sent him a rather strong signal of displeasure. What to do? Bernanke had a press conference Wednesday, and came out guns blasting: "If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year."

The interest on 10 year treasury notes is increasing, and that seems to suit Bernanke just fine: "Yes, rates have come up some. That's in part due to more optimism I think about the economy. It's in part due to perceptions of the Federal Reserve. The forecasts that our participants submitted for this meeting, of course, were done in the last few days, so they were done with full knowledge of what happened to financial conditions. Rates have tightened some, but other factors have been more positive increasing house prices, for example. If interest rates go up for the right reasons that is, both optimism about the economy and an accurate assessment of monetary policy that's a good thing. That's not a bad thing." Bernanke will make sure his legacy includes an exit strategy, whether Obama likes that or not. Today I'm proud of him.

Of course a side effect of this interest rate surge is that the 30 year mortgage rate is also surging, hitting a 2 year high in the last week. The refi rush of the last few years is now officially over. As mortgage rates continue to normalize, that is rise to more historically normal levels, you have to think house prices will stop going up, as what most people pay isn't the house price but rather the monthly payment. In the short term this could be good for home sales as it sends a clear signal that houses are likely to only get more expensive from here. In the long term, Bernanke specifically mentioned house prices in his statement, and letting the 10 year rate increase to beyond 3.5% or so is not consistent with a housing rebound. Mr.Bernanke will be walking a very fine line for his last six months. It's noteworthy that many experienced Wall Street types believe this can never work, and we will be on QE for the foreseeable decades.

Chinese overnight inter-bank lending rates were skyrocketing, just as US and European rates did during the crash of '08. No one in China trusts any other bank. It seems the tide is going out and everyone wants to stand back to see who's swimming naked. The US/European interbank lending rate is called LIBOR; the Chinese equivalent is called SHIBOR. In the graph below we see that mostly Shibor has a slightly chaotic semi-regular rhythm to it, like a heart beat. Until the last few days. If that were a chart of your heart beat, your doctors would be yelling for the paddles. Shibor has gone exponential in the last few days, and everyone is holding their breath: when this happened to Libor in '08, a few weeks later we got Lehman Bros and then we suddenly found ourselves staring into the abyss. The Chinese central bank injected $8 billion into the banking system for short term liquidity on Friday, and the overnight Shibor dropped 4%. But the 14 day and 1 month Shibor rose a bit. The real problem is still alive and well, but now swept under a rug. Is China weeks or months away from their own Lehman moment? Stay tuned. . .

The Chinese shadow banking system, an unregulated portion of China's economy, is growing exponentially. This is a millennium old system where Chinese loan money to loan sharks, who then loan the money to businessmen in dire need who can't get money from the traditional banks. It's been estimated that this entire system has over $2 trillion outstanding right now. Below we see the "wealth management products" being created weekly in China.

Sherwin Smith, deputy director of Tennessee Department of Environment and Conservation's Division of Water Resources, said Thursday, "You need to make sure that when you make water quality complaints you have a basis, because federally, if there's no water quality issues, that can be considered under Homeland Security an act of terrorism."

Although the growth in health care spending in the US has slowed, we're still at a wholly unacceptable place. Our public spending is already in line with the most socialistic countries in Europe, and they cover their entire populations for what we spend on medicare and medicaid. Add in private spending, and we spend half again more than our nearest competition. What's the problem? Drug companies. Hospital pricing. Lawyers. Insane doctor payments. It's not a simple problem and it doesn't have a simple solution. But it must be solved before we bankrupt ourselves.

Hedge fund manager Stan Druckenmiller answered a question about whether or not investing had become more difficult in recent years: "It has become harder for me, because the importance of my skills is receding. Part of my advantage, is that my strength is economic forecasting, but that only works in free markets, when markets are smarter than people. That's how I started. I watched the stock market, how equities reacted to change in levels of economic activity and I could understand how price signals worked and how to forecast them. Today, all these price signals are compromised and I'm seriously questioning whether I have any competitive advantage left.

"Ten years ago, if the stock market had done what it has just done now, I could practically guarantee you that growth was going to accelerate. Now, it's a possibility, but I would rather say that the market is rigged and people are chasing these assets, without growth necessarily backing confidence. It's not predicting anything the way it used to and that really makes me reconsider my ability to generate superior returns. If the most important price in the most important economy in the world is being rigged, and everything else is priced off it, what am I supposed to read into other price movements?"

Many states have laws that cars may only be purchased from an independent 3rd party, that is a car dealership. Tesla motors has no dealers; like Apple they prefer to sell directly to their customers. Tesla has dealership networks up in arms for this behavior. New York is considering a new law that new cars not sold by dealerships cannot be legally registered. The law also prohibits issuing or renewing any registration of any car dealer in which a car maker has a controlling interest.

California has a new law: boys are allowed to shower with girls in the public schools if that is more "consistent" with their gender identity. PE is already almost dead, and showering at school has become quite rare. This should put a stake through its heart.

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