There has been far too much concentration on the form, the type of taxation, and not enough on its total amount.
Submitted by Lance Roberts of StreetTalk Advisors
The Fed And Goldilocks Economic Forecasting
Beginning in 2011 the Federal Reserve begin releasing its economic forecast for the present year and two years forward covering GDP, Unemployment, and Inflation. The question is after 18 months of forecasting - just how good has the Fed at forecasting these economic variables? I have compiled the data from each of the releases for each category and compared it to the real figures and used a current trend analysis for future estimates.
When it comes to the economy the Fed has consistently overstated economic strength. Take a look at the chart and table. In January of 2011 the Fed was predicting GDP growth for 2011 at 3.7%. Actual real GDP (inflation adjusted) was 1.6% or a negative 56% difference. The estimate at that time for 2012 was almost 4% versus 1.8% currently.
We have been stating repeatedly over the last 2 years that we are in for a low growth economy due to the debt deleveraging, deficits and continued fiscal and monetary policies that are retardants for economic prosperity. The simple fact is that when an economy requires nearly $5 of debt to provide $1 of economic growth the engine of prosperity is broken.
As of the latest Fed meeting the forecast for 2013 and 2014 economic growth has been revised down as the realization of a slow-growth economy has been recognized. However, the current annualized trend of GDP suggests growth rates in the next two years that will roughly be half of the Fed's current estimates of 2.85 and 3.4%. A recession in 2013 is a strong likelihood given the current annualized trend of economic growth since 2000. A recession followed by a rebound in 2014 would leave economic growth running at annual rate close to 1%-1.5% versus the current estimate of nearly 3%.
What is very important is the long run outlook of 2.6% economic growth. That rate of growth is very sub-par and, over the longer term, does not sustain the level of incomes and employment that were enjoyed in previous decades.
The Fed is as overly optimistic about the level of unemployment as they are about economic growth. One of the Fed's mandates is "full employment." At the beginning of 2011 the Fed predicted the unemployment rate for the year would be 8.7% for 2011, 7.8% for 2012 and 6.95% for 2013. The unemployment rate for 2011 was 9.1% and is currently at 8.2% currently likely to rise in the coming reports ahead as the economy again weakens.
The Fed sees 2014 unemployment falling to 7% and ultimately returning to a 5.6% "full employment" rate in the long run. The issue with this full employment prediction really becomes what the definition of reality is.
Today, even the average American has begun to question the credibility of the BLS employment reports. Recently even Congress has launched an inquiry into the data collection and analysis methods used to determine employment reports. Since the end of the last recession employment has improved modestly but mostly centered around temporary and lower paying positions.
Since mid-2011 there has been a fairly sharp decline in the unemployment rate from 9.1% to 8.2% currently. The main driver of that decline has come from a shrinkage of the labor pool versus substantial increases in employment. In our past employment reports we have discussed the increasing number of individuals that are moving into the "Not In Labor Force" category where they are no longer counted as part of the labor pool. For the Fed the reality of "full employment" and statistical "full employment" are two entirely different things. While the Fed could be very correct at achieving "full employment" of 5.6% in their longer run scenario - it certainly doesn't mean that 94.4% of working age Americans will be gainfully employed.
When it comes to inflation the Fed's outlook, for the most part, have been below reality. In January of 2011 The Fed's prediction for 2011 inflation was 1.5% which was 2% lower than what inflation turned out to be.
As of the latest meeting the Fed's 2012 inflation prediction is 1.6%. With current deflationary pressures pulling headline inflation down from 3% at the beginning of this year to 1.7% currently the Fed's prediction appears to be fairly accurate. The question, however, is how long can inflation remain suppressed at or below 2% which is the long run prediction of the Fed?
The Fed has much more control over inflationary pressures in the economy than they do at stimulating economic growth or increasing employment. By increasing or decreasing interest rates, using monetary policy tools and coordinated actions the Fed has historically been able to influence inflation. Unfortunately, their actions in this regard can also be directly linked to economic and market booms and busts.
What the Fed has much less control over are deflationary pressures. We have discussed that the threat of deflation in the U.S. economy is currently a much greater than inflation. It is also the primary concern of the Fed. However, there are two things that are likely occur that could drive headline inflation higher than the Fed's current long run estimate of 2%. The first is further stimulative action which expands the Fed's balance sheet known as "quantitative easing." The direct impact of these programs, as liquidity is injected into the financial system, has been higher commodity prices which translates to an increase in headline inflation.
The second, and more importantly, is that an organic economic recovery will eventually take hold. During real economic expansions where demand is increasing, wages are rising and the velocity of money is accelerating - real levels of higher inflation take hold. However, an organic economic expansion is likely some years away as the balance sheet deleveraging cycle continues globally.
Why The Fed Forecasts Like Goldilocks
Is the Federal Reserve really as bad at predicting future economic conditions as it appears? The answer is no. The Federal Reserve faces a severe challenge, when communicating to the financial markets and the media, which is the creation of a self-fulfilling prophecy. Imagine that following an FOMC meeting Bernanke stated: "The policies and actions that we have implemented to date have done little to curb economic weakness. The economy is in much worse shape that we have previously communicated as the transmission system of Fed policy through the economy, and the financial markets, is obviously broken."
The immediate reaction to such a statement would be a complete collapse of the financial markets. Such a collapse in the financial markets would negatively impact consumer confidence which would subsequently throw the economy into a recession. Conversely, an overly optimistic outlook would lead to an increase of inflationary pressures and asset bubbles. Neither situation is healthy for the economy in the longer term. Therefore, communication from the Federal Reserve must be very guided in its approach - not too hot or cold. This "goldilocks" appoach works to create a "glide path" to the Fed's destination while giving the financial markets and economy time to adjust to the incremental adjustments to forecasts.
Let me be clear. I am not making a case for the relevance of the Federal Reserve or its policies. That is another article entirely. What I am stating is that the communications from the Federal Reserve should NEVER be taken at face value. Since the Fed can not communicate its real position at any given time, due to the immediately excessive postive or negative effect on the economy and financial markets, as investors we must read between the lines. The problem for the financial markets, and the mainstream media, is that they tend to extrapolate current estimates indefinitely and generally in an upwardly biased manner. This is not the Fed's objective nor have they been able to repeal the economic and business cycles.
The Fed has been slowly guiding economic forecasts lower since 2011. The reality is that 2.6% economic growth is not a boon of economic prosperity, corporate profitability, increasing incomes or a secular bull market. It is also not the "death of America" or the return to the stone age. What is important to understand, as investors, is the impact on investment portfolios, expectated real rates of returns and the realization that higher levels of market volatility with more frequent "booms and busts" are here to stay.
Confused as to how to position your equity portfolio? Need to BTFD? Unsure of what is going on now that Bernanke has left you alone in the dark with reality? Have no fear. These simple three charts, that perfectly describe the process top-down for arriving at a view on US equities, will allay all your fears of missing the next great bull market leg. Equity Prices track Earnings Estimates; Earnings track ISM; and Real-Time Surveys indicate ISM going down. @Not_Jim_Cramer provides this clarifying confirmation of what we noted yesterday with regard to oil prices and slowing global growth (or a lack of printing) - equities appear alone in their hope for now.
1) Price Tracks Earnings
2) Earnings Track ISM
and 3) ISM Is Going Down...
With every passing day, we learn that those pesky socialists in charge of the "Evil Empire" were right all along:
- HOLLANDE SAYS THOSE WHO BENEFITTED MOST IN PAST 5 YRS WILL PAY
- HOLLANDE CALLS ON `PATRIOTIC' FROM WHO EARNED MOST TO CONTRIBUTE
In other words, Obama's "Fairness Doctrine" has just gone airborne. And judging by history is very contagious. Only this time the "other people's money" has run out as the ECB's announcement of condom wrappers as collateral, showed us this morning.
Today's EURO 2012 quarter-final between the diminutive (in stature and in economic might) Greeks, who surprisingly made it to the knock-out rounds - 'giant-killing' Russia on the way, and the hulking football genii Germans, promises to be as packed with prowess as it is punch. Don't write Greece off too soon though as they won the whole thing in 2004, and we can only imagine there is more than a little 'payback' in mind as they walk onto the field today. While we assume the entertainment will be a little less comedic than Monty Python's famous Philosophy International between the two nations, it is must-see viewing if for nothing else to watch Frau Merkel's face as she ducks and weaves the crowd's abuse. Will there be a little friendly wager between Samaras and Merkel? Santorini perhaps in exchange for four-more-years?
GREECE - Sifakis, Torosidis, Tzavelas, Papastathopoulos, Papadopoulos, Maniatis,
Makos, Katsouranis, Samaras (we thought he was injured this morning?), Salpiggidis, Ninis (new boy).
GERMANY - Neuer, Boateng,
Lahm, Bastuber, Hummels, Khedira, Schweinsteiger, Ozil, Schurrle, Reus, Klose. Sitting the top 3 forwards?
Perhaps this William Banzai inspired vision will conjure some captions...
Monty Python's International Philosophy Football Match...
ESPN3's Slightly less entertaining Germany vs Greece EURO 2012 Quarter-Final (no embed so click here for link)...
Odds are that Germany wins 2-0 (with 33-to-1 odds on a 5-0 win) as the Greek defense won't cope with Klose first to score. For the long-shot the odds of a Greek win is 9-to-1 - about the same chance they have of staying in the Euro.
For those with doubts after a nine-month correction in gold (and especially over the last few days), Brent Johnson of Santiago Capital reminds us that 'nothing has changed'. Starting from the three propositions that: 1) Money is extremely misunderstood; 2) 'Fiat' money is a poor store of value; and 3) Gold is an excellent store of value, Johnson provides, in a little under 10 minutes, a succinct summary of all the reasons to remain long the shiny yellow stuff. As it reverts to being 'the most marketable commodity' once again, with the 'good-as-gold' USD continuing to lose its purchasing power over time, Johnson provides some thoughts on the periods of deflation and how gold plays into that end-game: "If gold were not a good store of value, why do all the central banks of the world store it and hold on to it - even when crises abound?"
While this morning saw a rumor of junior bank bondholder haircuts (and burden-sharing) rapidly denied by Spain's de Guindos, it appears the country's smarter individuals are realizing that perhaps a 'bail-in' (a la Citigroup in 2009) is the better way to go than an unending 'bailout' when it comes to the problem banking system. As the WSJ noted last week "consider the grim fact that even €100 billion may not be enough to put Spain's banks back on their feet, as they could easily face losses of perhaps three times that amount" confirmed in yesterday's Oliver Wyman reality check.
The bigger issue is not the insufficiency of the loan but the fact that such a relatively small loan was impossible for the sovereign to raise itself as no private investors believe their solvency - implying Spain has reached its debt saturation point. Neither government nor taxpayers can afford to take on more debt (which is what the bailout is).
The solution, a precedent set by the good ol' USofA with the Citi preferreds, is to cram-up bond-holders. A compulsory debt-for-equity swap for the subordinated and senior unsecured liabilities, "whereby investors bear the vast majority of the cost of their own mistakes, without liquidating the banks and without pushing the Spanish economy into bankruptcy" may initially cause some turmoil in the interbank lending markets (which would need to be supported by the ECB in the interim as it is already) may be extremely painful for shareholders (who will see massive dilution) and bondholders (arguably rightfully so) but would offer hope for improving market belief in solvency.
A Senior-Subordinated spread decompression trade in credit would seem to make sense - given the considerable hit taken to the subordinated class (whether it triggered CDS or not) and sets up to be the macro trade for the coming months.
especially given the following 'math' from the WSJ's story:
Converting into equity 100% of the €88 billion of subordinated liabilities, and 40% of the €160 billion of senior unsecured debt, would generate more than €150 billion of loss-absorbing equity for the Spanish banking system. Together with the estimated €25 billion in expected operating profits for 2012, before loss provisions, that would yield about €175 billion in new bank equity, without increasing the debt burden of the Spanish taxpayer or requiring a loan from Brussels.
Many investors would no doubt complain about the rough justice of a regulator-imposed reorganisation. To preserve value, officials would have to move very, very quickly, leaving little time to fine-tune various claims or observe normal procedures. The new structure would be based on bankruptcy reorganisation principles, allocating value in accordance with investors’ seniority and ensuring that each class of investors would be better off than in liquidation. The process would not be pretty but overall, investors should be relieved by the result.
Why can’t the bankruptcy code do this today? To an insolvency professional, this restructuring looks somewhat like a “prepackaged” bankruptcy, in which creditors agree to a new, less leveraged capital structure negotiated over a period of months. But a lengthy, voluntary process is impractical in the panic surrounding the failure of a very large, complex financial institution.
As Juan Ramon Rallo notes in the WSJ article last week:
Instead of a bailout, the Spanish state should force a "bail-in," in which much of the banks' debt is converted to equity. This would reduce the banks' leverage and increase the capital available to absorb the coming losses... and after some time, short-term credit would flow again inside a country with much more robust and solvent financial institutions.
Perhaps the 'bail-in' is best summarised by a comment from the WSJ story:
Essentially, this is a proposal for financial restructuring (aka bankruptcy) without bothering to go to the courts. Its cleaner, less disruptive, and less expensive than where we are headed otherwise. The money has already been lost. Someone has to book it.
Seriously, when should investors in the debt of financial entities take a loss if not now? Never?
Submitted by Charles Hugh Smith via ChrisMartenson.com,
If we pursue the line of inquiry established by Chris Martenson’s recent call to Buckle Up -- Market Breakdown in Progress, we come to these basic questions: When will the market reflect the fundamental weakness of the global economy? And when will the market finally hit bottom?
First, we have to stipulate that the correlation between the real economy and the stock market is tenuous at times. According to the National Bureau of Economic Research (NBER), the widely recognized designator of recessions, the most recent recession began in December 2007 and ended in June 2009. Fully six months into the downturn (June 2008), the S&P 500 stock market index was still resiliently hovering around 1,400. The market did not break down until September 2009, the tenth month of recession.
A mere three months after the market bottomed in March 2009, the recession ended (as determined by the NBER).
Clearly, the correlation between market action and the underlying economy is weak. While many would declare the stock market to be a “lagging indicator” of recession, even that may be overstating the connection. If we have learned anything in the past three years, it’s that weakening the dollar to foster the illusion of rising corporate profits, central bank monetary easing (QE), and central state borrow-and-spend stimulus can goose the market higher even as the underlying economy remains weak or recessionary.
Properly inflated with cheap liquidity, the stock market could continue rising even as the real economy (as measured not just by profits but by employment, household earnings, and tax revenues) sags into recession.
Indeed, some have argued that the emergence from recession in June 2009 was largely illusory, the consequence of counting debt-funded spending as part of GDP. (By this thinking, all we need to do to avoid recession is borrow and spend $10 trillion a year forever. That this course is artificial and unsustainable doesn’t enter into the calculations.)
If recessions were defined by real household incomes (i.e., adjusted for increases in the consumer price index), then the real economy is clearly still recessionary: household incomes slipped 3.2% in the December 2007 - June 2009 recession, and then fell another 6.7% in the two years from June 2009 to June 2011. This drop in inflation-adjusted income is almost 10% (9.8%), a staggering decline in a supposed “recovery.”
The point here is that the real economy could slip further downhill while monetary/fiscal “juice” keeps the stock market buoyant.
Another line of thought suggests that Global Corporate America has effectively decoupled from the American economy. Corporate profits could continue rising, powering the stock market higher, even as most of America stumbles along in declining-income recession.
The conventional thinking, however, is that eventually the stock market will have to reflect economic reality, both domestically and globally, regardless of how much juice the Fed injects into the market.
That possibility becomes intriguing when we consider the Economic Cycle Research Institute’s (ECRI) call on September 30, 2011 that the U.S. was entering another recession. The ECRI reiterated their position in March of 2012. The ECRI argues that the U.S. is entering an era of more frequent recessions as a result of 1) declining trend of economic growth and 2) increased cyclical volatility.
Though the mainstream financial media has treated the ECRI call as an outlier, this following chart (courtesy of frequent oftwominds.com contributor B.C.) suggests that the call may well be as prescient as ECRI asserts:
This chart displays the current post-recession Weekly Leading Index (WLI) -- the ECRI’s proprietary measure of economic activity -- with seven other postwar recessions, all plotted from the start of each recession. This enables us to examine the history of each recession from an “apples to apples” time perspective.
While each recession occurs in a unique set of circumstances, it is nonetheless striking that the current recession (WLI 2010, in solid red) tracks the sharp 1973-75 downturn, the 2001-02 “soft patch” and the 2007-09 recession rather closely in time if not in amplitude.
If history offers scenarios rather than predictions, it is interesting to note that if the current downturn follows the timeline of the relatively modest 2001-02 recession, the ultimate bottom lies out another 15 weeks.
If the present weakness tracks 1973-75, the bottom might be roughly 30 weeks ahead, while the 2007-09 recession offers a pattern that suggests the final low in the WLI might be reached about 20 weeks out.
The next chart displays the annual change in the WLI over several recessions. Since the present so evidently tracks the three recessions noted above, these downturns are the ones displayed:
Once again, we see that the final troughs in previous recessions are still ahead by between 10 and 30 weeks.
The ECRI famously reports that they have never missed identifying a recession nor made a false positive (i.e. called 10 of the last five recessions). While it is certainly possible to question their reports or challenge the validity of the WLI as a useful indicator, their record is nonetheless impressive and should not be dismissed as an outlier.
The substance of these charts is clear: The U.S. economy is rolling over into another recession, and the bottom of that recession lies 10 to 30 weeks in the future.
What About the Stock Market?
As previously noted, the stock market’s tops and troughs do not correlate closely with the peaks and valleys of the underlying economy, as depicted on the above charts by the WLI.
Since the closest modern analog we have to a deflationary, deleveraging economy supported by massive central bank and central government intervention is Japan between 1989 and the present, let’s turn to B.C.’s chart of the Nikkei stock index between 1985 and 2003 overlaid with the S&P 500 (SPX) U.S. stock index starting from 1995 to the present.
To make the comparison “apples to apples,” the indices have both been plotted as a percentage of their highs, and each index has been adjusted against the trade-weighted currency (yen and dollar). To insure that currency fluctuations haven’t skewed our understanding of the index’s history, the Nikkei has been plotted adjusting to both the yen (red line) and to the dollar (blue line).
In adjusted terms, the Nikkei index topped in 1989, while the SPX peaked in 2000.
Plotted in this fashion, we see that the two indices, though based in different economies, have traced uncannily similar histories from their respective peaks.
We can see the sharp recoveries in the SPX in 2010 and 2011 when the Federal Reserve responded to market declines with massive quantitative easing (QE) programs.
Will the Fed continue to support the U.S. market with QE programs every time it sags? Will QE always work as well as it did in 2010 and 2011? If the history of the deflationary-era Nikkei is any guide (and we should recall that Japan’s central bank has provided unprecedented monetary easing while the central government has borrowed and spent unprecedented sums on fiscal stimulus), the bottom could be a year away.
In Part II: Predicting the 'When?' & 'How Far?' of the Next Market Decline, we will explore in depth the technical indicators of both the U.S. and global markets that support the probability that a lot of downward motion lies ahead before we see the ultimate bottom in both the economy and the stock market.
Update 3: they are making it up as they go along:
- TURKISH PM SAYS HAS NO FIRM INFORMATION ON ANY APOLOGY FROM SYRIA, WILL MAKE FURTHER STATEMENT AFTER SECURITY MEETING
- TURKISH PM SAYS CANNOT SAY WHETHER TURKISH WARPLANE SHOT DOWN OR CRASHED, NO NEWS ON PILOTS - TURKISH TV
Looks like everyone is trying to position appropriately.
Update 2 from Syria: Oops, sorry.
Turkish Prime Minister Tayyip Erdogan said on Friday that Syria had admitted it shot down a Turkish warplane in the Mediterranean and that Damascus had apologized.
The two pilots of the Turkish F-4 fighter jet are alive, Erdogan had earlier said, before holding a press conference in Ankara.
“At this moment the air force and navy are conducting search and rescue operations in the western Mediterranean and luckily our pilots are alive, we have just lost a plane,” he told journalists while travelling back from Brazil.
Earlier, the Turkish army said it lost radar and radio contact with one of its aircrafts on the Mediterranean near neighboring Syria, and a television station said it had crashed in Syrian territorial waters.
But Lebanon’s Hezbollah-owned Al-Manar television station said that Syrian air defenses shot down the Turkish military aircraft, quoting Syrian security sources.
“Syrian security sources confirmed to a Manar correspondent in Damascus that Syrian defense forces shot down the Turkish fighter jet,” the Hezbollah-owned channel said.
Turkey, which had drawn close to Syria before the uprising against Assad, became one of the Syrian leader’s fiercest critics when he responded violently to pro-democracy protests inspired by popular upheavals elsewhere in the Arab world.
Ankara has previously floated the possibility of setting up some kind of safe haven or humanitarian corridor inside Syria, which would entail military intervention, but has said it would undertake no such action without U.N. Security Council approval.
Turkey said it had lost contact with one of its military aircraft off its southeastern coast, and a television station said it had crashed in Syrian territorial waters.
The plane took off from Malatya airbase in the southeast at 0730 GMT and lost communication with the base at 0858 GMT in the southwest of the Hatay province bordering Syria, the military command said in a statement posted online.
“Search and rescue efforts have started immediately,” it said.
Update from Al Jazeera: Turkish PM says cannot say whether Turkish warplane shot down or crashed, no news on pilots.
Just when the geopolitical tensions in the middle east appeared to be abating, and Brent was on a gentle glideslope to whatever price will greenlight the NEW QE now that fears of an Iran war have been very much silenced, things change. Reuters reports that Syria shot down a Turkish warplane on Friday, according to Lebanon's al-Manar television reported, "risking a new crisis between Middle Eastern neighbours already at bitter odds over a 16-month-old revolt against Syrian President Bashar al-Assad." "Syrian security sources confirmed to a Manar correspondent in Damascus that Syrian defence forces shot down the Turkish fighter jet," the Hezbollah-owned channel said."
Here is the rub: Turkey is a NATO member, and by definition the alliance will have to come to Turkey's aid if requested. Syria, however is not just any country as has been made quite clear over the past several months of UN impotence: it is a critical staging ground for both Russia (which has a very critical regional naval base in the city of Tartus) and China, and according to the Jerusalem Post, the three countries are in preparation to conduct the "largest ever" war game. As such Syria, already gripped by fierce local fighting, where just like in Egypt and Libya the presence of US-based flipflop on the ground can be smelt from across the Atlantic, is merely a symbol. The real implication is how far can little escalations push until finally the showdown begins, with NATO on one side and Russia and China on the other?
Turkey, which had drawn close to Syria before the uprising against Assad, became one of the Syrian leader's fiercest critics when he responded violently to pro-democracy protests inspired by popular upheavals elsewhere in the Arab world.
Ankara has previously floated the possibility of setting up some kind of safe haven or humanitarian corridor inside Syria, which would entail military intervention, but has said it would undertake no such action without U.N. Security Council approval.
Turkey said it had lost contact with one of its military aircraft off its south-eastern coast, and a television station said it had crashed in Syrian territorial waters.
CNN Turk television said Turkey was in contact with the Syrian authorities to get permission to conduct a search for the airmen, although there was no immediate official confirmation.
Turkey's military said a search and rescue operation was under way. It lost radar and radio contact with the plane after it left Erhac airport in the eastern province of Malatya.
Two crew were aboard the F-4 jet, Turkish state news agency Anatolia said, citing Malatya governor Ulvi Saran.
Hurriyet daily newspaper reported that the plane had gone down in international waters and that the two airmen had been found alive and well by Turkish forces.
Be on the lookout for the official Turkish response: it may not happy. Especially if this is merely the latest variation on a very old false flag theme, or merely media manipulation seeking to inflame tensions and incite a Syrian invasion.
And for those wondering, yes, the F-4 still exists, and more shockingly, it still flies.