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Mark's Market Blog

8-10-14: Debt.

By Mark Lawrence

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The market was flat this week on high volatility. Why? There's always reasons after the fact. Ukraine. Russian threats to European oil. Germany falling towards recession. Money moving out of bond funds. In a little while I expect the market to resume moving upwards, and then all these reasons will be forgotten.

S&P 500 February 15 2014 to August 8 2014

Is the buill market over? Not in my opinion. We hit the top edge of our long term channel. You might expect a 10% or 15% correction due to this, but about 4% is all this market could manage to drop. I expect we'll trade sideways for a time until we're comfortably below the channel limits, then resume marching upwards. I'm already on record, we're heading for 2100-2200 S&P and I've seen nothing to change my mind. We do have a short term ceiling of about 1950, and I expect we'll stay below that until we break through, then 1950 will change from ceiling to floor.

At her last public announcement Yellen said interest rate hikes "likely would occur sooner and be more rapid than currently envisioned." Dallas Fed President Richard Fisher was asked why, as a hawk, he hadn't dissented at the last meeting. Fisher said the committee "is coming in my direction, so I didn't feel the need to dissent." If the FOMC "doesn't keep moving in that direction, I will dissent," he promised. "But it's more important, I think, here, to really work with the group, and make sure we achieve a consensus, and we're all behind a certain direction. And I think we ’re moving closer to my direction, but time will tell." Meanwhile, some on Wall Street like Jeff Gundlach don't believe it. He thinks 10 year notes will continue to trade between 2.2% and 2.8%, with the risk that it goes below 2.2%. He's basically claiming Yellen is either (a) lying or (b) has lost all control. Bernanke agrees with Gundlach.

US District Judge Thomas Griesa threatened a contempt-of-court order on Friday if Argentina did not stop issuing false statements about having made a required debt payment on restructured sovereign bonds. In rare circumstances, US judges have held foreign governments in contempt and imposed monetary penalties. But such sanctions can be difficult to enforce, and federal appeals courts have split on whether foreign governments can be held in contempt at all. Federal law largely protects the assets of foreign governments held in the United States, said Michael Ramsey, a professor of international law at the University of San Diego. "You can't put Argentina in jail, so I'm not sure what he'd have in mind besides monetary sanctions. Argentina has refused to pay a valid judgment and I don't see why it wouldn't also refuse to pay a valid contempt order."

Germany appears to be stalling out and headed for a recession. Factory orders are contracting and inventories are building up. Germany's flag ship company, Volkswagen, is losing sales and market share as their models are a bit behind on the update cycle and their marketing strategy of selling upscale cars to the middle class is failing as the middle class loses purchasing power. And the Ukraine thing is screwing with energy prices and exports to Russia. If Germany catches a cold, Europe will be bedridden with pneumonia. Absent Germany, Europe's economy has been contracting for six years - the EU economy is about 3.2% lower than it was in 2008. Germany, the only bright spot on the continent seems headed for recession. And somehow we're envious and want to make our economy more like Europe's.

Japan's economy also appears to be shrinking even in the face of Abenomics, their own program for printing money and taking on massive new debt.

Malaysian Air, which has had about a generation worth of bad luck this year, has had trading in their stock halted. There continue to be questions if the airline can survive.

After WWI Britain drew the lines in Arabia. They drew the lines to reward people who had helped them, to divide the people who had not, and to make a bunch of countries with a very mixed population that would be significantly ungovernable. They did not want a regional power to emerge, a successor to the Turks. The Brits are pretty smart and they did a good job, given their goals. Today I think we're seeing those lines being challenged. ISIS wants to carve out a Sunni country from northern Iraq and northern Syria, leaving the Kurds to the Turks and Iranians and the southern Shi'ites to find their own way. Does it make sense? It does to them, which, since we claim to want to export democracy should be good enough for us to want to stand back and let a certain amount of this happen. Will the resulting states be friendly to us? Probably not, but then neither are the existing states. Meanwhile because of the ragged way we pulled out of Iraq these people are all very well armed. They could not challenge our army, but they certainly would make quick work of any other group that was not well armed and trained. I think our job here is to identify our interests and promote them. Perhaps ten years ago our interests were best served by stability even if it was brought on by despots; but those days are behind us now and it's time to plan for a new reality. Unfortunately I have no confidence in Obama's ability to think strategically, so instead of nurturing the parts of this process that suit us I think our reactions will be pretty much random, driven by how the White House feels about this week's news. I think perhaps it's time for another Arab council, not unlike the one at the end of Lawrence of Arabia, where we help them find new boundaries that allow for homelands for Christians, Shi'ites, Sunnis, Jews, Kurds, Baha'i, Druze, Yazidi and Zoroastrians. And I can't help but note that Arabia is a place where everyone is everyone else's cousin dating back 50000 generations or more, separated by a bit of religion, and multiculturalism is failing there spectacularly. Their Shi'ites and Sunnis, roughly comparable to our Catholics and Lutherans, each want the other dead; they can only get along long enough to first kill off the Christians, Jews and Kurds, whom they hate even more than each other. I have no idea why some here cling to the idea that we can make multiculturalism work with peoples imported from vastly different civilizations, relying primarily on TV, food stamps and school busing as our most significant mixing programs.

Money is fleeing bond funds at a record rate. No mystery there: the Fed is likely to raise interest rates in the near future - Yellen has been warning us - and raising interest rates means lower bond prices. In a normal economy all that money would have to live somewhere so you would expect it to move to the stock market, raising stock prices. Nothing has been normal for at least 15 years. These days the bond and stock market move together more often than they move oppositely. I'm not prepared to predict a 50% drop in the DOW, but it won't stun me if it happens in the next 18 months.

Deleveraging - since the crash, we're all doing it, right? Nah, no such thing. Before 2002 US household debt never exceeded 100% of disposable income. Today it's at 103%, pretty much at the pre-crash levels. Banks more or less won't write mortgages anymore, so now it's auto loans and student debt. Corporate debt is increasing at 9.5% per year, well above our GDP growth rate of about 2%. And of course the Feds, who have added $7.3 trillion of non-social security debt under Obama. Keynesians would have us believe that the level of government spending determines the economy; if so then why aren't we growing at 15% per year? Or perhaps we're to believe that absent the drunken sailor spending the economy would be shrinking at 15% per year. Well, anyway, the banks made out like bandits in the last crash and they're getting all set up to do it to us again. Want to see the future? Just ask yourself one question: what happens if interest rates rise 3% or so to their normal pre-crash levels.

Household spending on motor vehicle sales is flat, showing zero growth. But car sales are increasing. How is this possible? Leasing (renting) cars is increasing at 20% per year. 20 years ago 95%+ of all Mercedes Benzs were leased, mostly by businesses. Households bought cars with leases running at more like 16% for Chevrolets. Today it's more like 26% of Chevrolets are leased (rented) - Ford is selling an F150 pickup truck every 46 seconds, but Ford's lease rate is only 15%. GM is loving this, their sales are growing at about 15%. TOyota is growing at 20% and Honda at 25%. Only Volkswagen is failing to participate in the feeding frenzy - their sales are contracting. The real growth is in vehicles where the lease (rent) payment is $199. But the sales are to banks, not households, then the loans are bundled up and sold as high interest bonds on Wall Street. Sound familiar? Don't worry, This Time Is Different.

Renting houses is also more popular than buying these days. Since WWII mortgages have been how the middle class saved money - your 30 year loan may have meant you wound up paying $300,000 total for that $100,000 house, but at least after 30 years you owned it. Now you pay slightly less for rent instead of a mortgage, but after 30 years you own zilch. Banking was a really great idea 40-50-60 years ago, by lending (creating) money banks made our economy grow at a very pleasing rate. For a couple generations the slogan was a rising tide lifts all ships. But since 2000 our economy basically hasn't been growing in spite of taking on enormous new debt. We have a lot of theories about this: we need population growth so let in a bunch of illegals. Household debt is maxed out so have the government be the borrower of last resort. Consumers can't afford car payments, so turn corporate leases into an instrument for the unwashed masses. If everyone had a bachelor's degree we would hit escape velocity, so loan out $50,000 to each 20-something kid to get a BA degree in Oppressed People Studies from the University of Liberal Indoctrination (ULI). None of it is working, energy is still expensive, growth is still elusive, debt keeps piling up. Historically the result of huge unpayable government debt is inflation and war, but This Time Is Different.

On thursday Russia announced a ban on food imports coming from the EU, the US, Canada, Australia and Norway. The foods that will become most scarce in Russia are butter, pork, chicken and cheese. I have no idea what they think they're going to eat - beets and potatoes, I suppose. Not BBQ Chicken or Pulled Pork Pizzas, that's for sure. We're having a drought in this country so exporting less food seems like a good thing for us. This will likely stoke inflation in Russia and put pressure on the Russian people, resulting in a change in government next time they get to vote. Ok, I couldn't resist writing that, but of course Putin will continue to lord over the People's Republic of Putinia.

And now, from the people who brought us the sub-prime mortgage crisis, we have a new idea: trading water futures to promote "water security." I have no idea what this means. Suppose China buys a lot of futures. Does that mean Ireland will have to deliver water to them? Basically Wall Street's idea is that water will soon get very scarce, prices will skyrocket, and they want a piece of that action. Somehow Manhattan making money on LA's water will benefit LA, by promoting "water security." How long will we tolerate these people messing up our economy?

Google routinely scans all emails. Recently they found an explicit picture of a child in a man's email; Google notified the National Center for Missing and Exploited Children. They notified the Houston police, who obtained a warrant. The man in question was a registered sex offender, convicted of sexually assaulting a child in 1994. Police found several more images in his possession. No one knows what to think of this. A registered sex offender keeping child pornography? We all want him off the streets. Google fighting child pornography? Yah, I suppose that sounds ok. Google watching our emails and reporting on us? I dunno about that part. Anyways, if you have a gmail account, you should presume that any and all federal and state agencies are looking at your stuff.

Everyone's talking about Ebola, the virus that makes your body melt. Is it coming to America? A health worker caught it and flew here for treatment, but basically no. Ebola spreads only by blood contact, like HIV, so if you don't want to get it don't be around the blood of people who have it. For completeness I note there are those in Canada's version of the CDC that say there is evidence Ebola spreads by air. Ebola is currently only in three countries, so don't go to them either. About 700 people have died of ebola so far this year, all but a handful of them in these three African countries.

Want to read a forecast for US politics by a pretty well-informed redneck? This country is being split in half. Something is going to happen, not just yet, and it won't be pretty at all.

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