Dantes Outlook

Explaining the Euro Deal

2011-12-13T03:24:00.002-05:00

The Euro Group delighted us all late last week with hints of progress. The plan expands the scope of the European Financial Stability Fund (EFSF), European Central Bank (ECB), and International Monetary Fund (IMF). It also includes strict measures to enforce fiscal stability, but is gridlocked at the will of member country politics. The proposal places more hope in the ECB and Central Banks to liquidate our way out of the mess, but does nothing to solve structural issues, and places a heavy burden on the IMF. It is essentially a transfer of responsibility (the bad bank(s) method). It could work, but it involves a lot of risk. Let's step back and understand how the system works.

The two videos accurately explain the European capital markets.

The ECB strategy is to become a lender of last resorts. There is clearly an imbalance between surplus central banks like Germany and deficit central banks like Ireland and Greece. Too many Euro-zone countries riddled in financial misery have a high dependency on stronger countries to provide liquidity. The strong national central banks loan money to the ECB, which in turn loans to the deficit central banks in greater amounts than received. The new strategy is to tap the inter-bank market and borrow just enough funds from private banks in strong countries like Germany. These borrowed funds are then loaned to the private banks in deficit countries. The hope is to sure up the private banks, while reducing exposure to the deficit national central bank.

Solving the Collateral Crunch comes in when surplus national central banks loan to the IMF. The IMF then buys sovereign debt from the private banks in deficit countries. Euro group system lending by the surplus national central banks is also acquired by the IMF. Again, the hope is that the private banks, with cleaner balance sheets, will sure up the system. The trash held in the IMF and ECB will then regain value, and the IMF will now be equipped with collateral that was purchased by the surplus national bank sellers.

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Now, structural issues still remain. Public trust is not evident in Europe as savers deposit less money into banks. These banks have less cash on hand to make loans; the hope is that the IMF and ECB can offset this. With new cash on hand, will private banks lend? Not quite. Just like int he US with QE, banks know that there is greater risk of default among borrowers. Austerity and further slowdown is a big factor, and growth is still nowhere in the agenda.

In the UK, Prime Minister Cameron chose to veto the decision to join in the Euro Group proposal. The plan calls for tougher fiscal surveillance and high standards; if the UK does not perform up to par it faces the risk of financial sanctions. London is all it's got at this point, with finance being its economic life-support.

Bottom line - we still have major work to do. But, the plan makes sense. It just lacks the structural gut to make sure that it is executed as planned, and that the private banks realize the economic uptick to actually perform. That economic uptick is unfortunately political.

The US markets turned soar on Monday as the Dow dropped 162 points. The Euro declined as well, as the dollar strengthened giving rise to Gold and Crude Oil. Gains from last week Friday were virtually lost. Moody's warned that the EU Summit does not decrease the chances of a downgrade - citing political and structural constraints as the big factor (the European culture). S&P raised a red flag again as it now looks to review Germany and France.

Central Banks Prepare for Greater Risk

2011-12-03T13:48:00.001-05:00

A hell week full of European bond sales, bank downgrades, and government response indicates that greater risk is ahead. All participants in the global capital markets from governments to investors are taking necessary steps to protect themselves against further downturns.

The events of this week displayed the true colors of market participants. Finally, for better or worse, governments have come to the realization that fiscal policy will accomplish very little. Efforts to correct this fiscal grid-lock places pressure on central banks to perform. With monetary stimulus essentially exhausted (certainly in the US), central banks seized this opportunity to protect themselves against foreseeable risks.

This report is lengthy, but feel free to skip sections. If you care less about the reasoning behind the downgrades, you might want to just skim straight to the Central Bank response section.

Ratings Agencies Draw their Red Flags
S&P presented a string of bank downgrades which included Bank of America, Citigroup, Morgan Stanley, Wells Fargo, and other major players. At face value, people were quick to either panic or brush this off. The panic came from those who saw this as confirmation of a deepening crisis. Others viewed the downgrades as useless; the problems are obvious, and we saw this coming. However, both groups share the same belief that the global capital markets are entering further misery. We cannot be arrogant and place the downgrades aside without looking deeper into the reasoning behind it.

The math explains the underlying worries about further risk. Once we understand this, everything else begins to fall in place.

The ratings result from a calculation comprised of a weighted average of significant variables. These variables measure the strength/weakness of a banks' financial structure.

The Stand Alone Credit Profile (SACP) is comprised of preferred stock evaluations, combined debt ratings, and basic levels of government support. This portion of the formula is all about the bank's ability to pay back debt to stock and bond holders based on its balance sheet of deposits, returns on lending, government guarantees, etc. Bottom line - this is the overall health of the bank.

Extraordinary Support is the next variable. Simply put, this measures the bank's access to government support on extraordinary levels such as capital injections and other sorts of "bailout-style" measures. This also includes support by a group - if a bank is part of a major bank, it will receive support from greater levels.

SACP + Extraordinary Support = ICR

Issuer Credit Rating (ICR) is the result of this calculation. This is what we see as investors; the combined rating of the bank. It is important to note that the ICR takes into consideration of potential for additional direct support from the parent bank or sovereign government.

All math aside, this all shows that government support is a major component in the model used to rate banks. With the current turmoil, there is intense pressure on governments to perform. If there is uncertainty, it is reflected in the rating.

Patterns of boom/bust indicate likely government support. However, history shows that government support never solves the underlying problems. Banking crises will happen again, and these rating will continue to take this fact into account.

The recent S&P report is revised for modern times. The truth is that government support is uncertain. Governments are less able to support a range of banks because of its own balance sheet constraints. However, we are given more certainty for groups of banks with shared problems, as systemic risk on the entire system is more important for Central Banks to perform their role of ensuring price stability in the economy.

Supporting the system is one thing, but direct support will make less impact. Liquidity and capital injections are unlikely to raise SACP because of the underlying internal cash difficulties of that specific bank. There is execution risk of utilizing government funds effectively, and managing the flight back to independence is very difficult.

History shows that banks almost never reach back to a level of independence. Government support is a drug that never leaves the system. It causes market distortions that raises false expectations, creating an environment in which a completely independent bank will not be equipped to operate in (hence the fall of regional banks in the US). Depositors are propped up with artificial fiscal and monetary measures such as stimulus and low interest rates. The most striking part of government support is that banks are pressured into providing loans to industries and companies that support the growth mission of that nation. These are usually high risk loans (a repeat of the housing crisis), but the certainty of government support is priced in to these models, so it does not look as bad.

We are operating in a world of powerful zombie banks (a fancy way of saying Government Related Enterprises - GRE) that are in desperate need to become independent and correct these market distortions - thereby saving the public from underlying misery.

Central Banks to the Rescue

Market distortions aside, the Central Banks (well, the US only) seem to be saving themselves as they work to calm the financial crisis.

Eurogroup ministers held a press conference to discuss their progress in expanding the capacity of the European Financial Stability Fund (EFSF). The ministers appeared exhausted and less hopeful; but there might be good reason behind this attitude. The thought is that even if the member countries do not cooperate in getting its fiscal house in order to pay back debt, the ECB and partners would have hedged against this.

The frustration is certainly directed towards the politicians in the member countries. As Megan Greene (Economist Meg) strongly advocates in her blog, Central Banks need to protect themselves against losses on these relief funds. The use of Special Drawing Rights (SDR's - a combination of currencies), or implementing her 'Big Bazooka' plan is a way for these Central Banks to play defense amidst the political bickering. This is business!

Notice the large amounts of swaps used during the '08 crisis

Fortunately, the US Federal Reserve understands this. Calling for global cooperation to increase access to US Dollars through currency swaps will strengthen the safety net of global banks in seek of liquidity. The idea is that a foreign bank or firm will pay their currency in exchange for borrowed dollars from the US Federal Reserve. At the end of the contract, the foreign firm or bank is obligated to repurchase their currency from the Fed at the same exchange rate. The foreign firm also pays a market based interest rate to the Federal Reserve for the liquidity swap protection. The US stands to gain from this move.

The interest rate paid to the Fed after the swap agreement (usually ranging from overnight to 3 months at most) is determined by the market, on average. The US Fed sets the Federal Funds Rate, but swap rates are left for the market to decide upon agreement between banks and firms. To influence a lower rate with the liquidity swap program, all the US Federal Reserve has to do is simply announce that their swap window is open for more business. Banks run back to price in a lower interest rate in their models, and by doing so, future liquidity increases in the entire market. Rates are expected to decrease to 0.645% from 0.805% as of Tuesday. Now, rates are hovering around 0.523%.

The Federal Reserve is artificially increasing the demand for dollars at its swap window, which will eventually send the dollar exchange rate higher. As foreign firms and banks extract greater value from our dollar, the Fed moves closer to inflating our way out of debt (paying back interest to our debt holders with a higher valued dollar is more affordable). The inflation is seen in the value of commodities such as corn, with future prices rising consistently.

Preserving Wealth Against Higher Volatility

2011-11-27T16:45:00.001-05:00

Too many times, the imagination of constant behavior has led us down a path of financial ruin. The thought that housing prices will always rise or the belief that dot com companies will continue a path of infinite valuation growth, propped up bubbles that left everyone involved (directly and indirectly) in a world of hurt.

The focus of this post is on those that are indirectly involved - the pension holders, mutual fund investors, hard working individuals wanting to secure their wealth. Often times, these people just go with the flow and fail to take full control over their investments. For example, pension schemes are designed to make gains during bull markets, and remain steady during down-times largely through the hope that people will continue paying into the system. Volatile times call for greater optimization of portfolio returns to get out of the rat race of traditional investing.

Stop being a blind investor. It's time to take charge.

Buy and Hold is a common term in portfolio management. An investor picks an asset or a basket of assets with the intention of holding on to it for a long period of time. This is a gamble. You hope that your due diligence conducted now will grant you time without worry in the future. Sometimes this works. Investors stick with major companies like WalMart and even Apple for long periods of time and make significant gains in their portfolio. However, those that actively re-balance their portfolio are one step ahead, and are more secure than the buy and hold investor.

A portfolio should be diversified by industry (or asset type) and time of investment. Investors should have a mix of assets that have various time frames associate with the trade. One might invest in Apple for two years (with periodic check-ins and adjustments), but also invest in Oil and Gas only during specific conditions such as storage reports. The former involves less transactions with a clear eye on maintaining value, whereas the latter calls for a trading approach to handle long term uncertainty with short term gains.

This is an ongoing balancing act. Simple diversity in asset classes will only go so far. Investors need to look at the snapshot scenario. If an investor is focusing on a particular market condition - say the European debt crisis, correlation between assets must be managed properly. A naive investment -- placing large bets in the US equities markets hoping that this will protect your portfolio from European exposure.The problem here is that US companies have great exposure to Europe as it is a major trading partner; better hope you're not holding financial stocks that have a balance sheet full of Greek debt.

Investors need to understand that investing in Mexico is parallel to investing in the US. Placing money in Asia does not guarantee safety from the economic woes of the West as trade and financial dependence is evident. Investing in Australia without understanding Asia can be fatal (when China demands less, Australia suffers). The bottom line is that your portfolio needs to take a constant pulse of various conditions inside and out of your asset classes.

Another naive approach is to give up and avoid the global recession by investing in Gold for the long haul and be completely blindsided to scenarios that may play out. Investors can only prop up Gold prices for so long as the demand for liquidity to cover risky positions in equities will cause periodic moments of declining Gold prices. In the long run, gradual price rises may correct this, but based on your financial position, a margin call might drain your portfolio in its entirety. Short term speculation in smaller amounts will allow investors to cash in where they see opportunity. It requires more time and awareness, but your money deserves some attention. A lazy investor receives lousy returns.

The video above is from the video bar provided by Merrill Lynch Wealth Management. The panel of experts speak to this point very well.

Markets Prepare for an Italian Size Problem

2011-11-11T20:20:00.001-05:00

Italy was tested this week as bondholders sent yields rising near 7%, increasing the cost of borrowing for the country. The timing was perfect as the markets realized the growing risk of an Italian size problem for the Euro zone. We realized that the European Central Bank (ECB) is not capable of artificially buying enough Italian debt to push yields down, thus decreasing Italy's borrowing costs despite market based movements. We also saw a win situation for investors as they were able to use their selling power to force the incompetent Prime Minister of Italy, Silvio Berlusconi, to pledge his resignation after a budget bill is passed, paving the way for structural reform and cooperation with the ECB over debt issues.

It all started when two major European clearinghouses raised collateral amounts for investors wanting to borrow Italian bonds. By doing so, the clearinghouses sent a message that Italian debt is deemed too risky, and therefore requires more money up front to protect against losses while dealing with Italy. Not wanting to take on the extra costs while anticipating a sell-off, more banks began reducing exposure to Italy. This lead to the sell-off that sent yields rising near 7%, the dreadful levels reached by Greece, Ireland, and Portugal during the height of their debt panic. The Financial Select Sector SPDR Fund dropped 5.4% on Wednesday - further proof of the sell-off by banks with exposure to Italian debt.

The worry is whether or not Italy can sustain the high cost of borrowing. If not, will the country be on a path to default? Not quite.

Again, the timing is perfect. Italy has time to make the necessary reforms. If it does not, it will certainly be a major blow to the region, causing an eventual break-up or break-down of the Euro zone. With Greek troubles, Spanish structural issues, and Germany becoming financially exhausted, economic leaders are not prepared to tackle another problem. Not to mention that nothing has been solved for the current mess that's becoming worse, except mere agreements among leaders to meet.

The scariest part of this situation is that the ECB does not have enough market power to artificially decrease yields. The Central Bank desperately tried to purchase Italian debt to decrease the burden on the country's borrowing, but this hardly placed a dent in the sell-off.

Italy can get this right, and Berlusconi made the right decision to resign as the markets pressured him out of his role as Prime Minister. Now the hope is that the Italian Senate approves the budget deal (which it did) so that Berlusconi will officially resign, and the new government under Mario Monti, the man touted as the next Prime Minister, will move forward with reforms.

The Italian government will need to implement the budget plans which includes spending cuts and tax increases, but must also focus on growth.

In a world of high growth or high inflation, those interest costs would be manageable. Either income covers the outlay or inflation erodes the debt burden.
But Italy has neither to look forward to. The International Monetary Fund forecasts Italy to grow by less than 1% a year over the coming three years and for Italian prices to rise by little more than 1% over the same period. -WSJ

This will result from incentives for investments and productivity; the economy needs to produce enough revenue to pay the increasing costs of debt accumulation. Investors particularly find Italian debt attractive because it is very liquid. Italy is the world's fourth largest borrower, and is a magnet for European bondholders. This is why Italian leaders must present a plan that focuses on growth in order to calm the markets and eventually send yields lower to comfortable levels. Even if the plan is not implemented properly, at least borrowing costs will be lowered so that the expectations for economic growth are reasonable.

The political shake-up in Greece and Italy are good first steps to calming the markets. Getting rid of incompetent leaders is always reassuring. It is not a complete reset though - this will only come in the form of default and a completely new government. Realistically speaking, new politics and budget plans have already proven to calm markets in the short term. The Euro currency and US stock markets gained some ground after Berlusconi made his pledge to resign, and the Italian Senate approved the budget bill on Friday.

Don't think Europe is off the hook yet. There still needs to be drastic changes. Getting rid of incompetent leaders is only the start.

Keystone Pipeline Delayed Until After Election Year

2011-11-10T16:17:00.001-05:00

The Obama Administration delayed approval for the Keystone XL pipeline extension from Canada to the US Gulf Coast. Yet another move to play it safe and place political strategy ahead of real economic due diligence. The administration decided to play it safe and dismiss any decisions on moving forward until 2013, one year beyond the 2012 presidential elections.

The current Keystone pipeline starts in Hardisty Canada and extends down the US mid-west belt to St.Louis. The proposed Keystone XL pipeline project will push westward, passing through the borders of Nebraska's Ogallala aquifer to reach the southern tip of Houston Texas and Port Arthur Louisiana. The estimated $7 billion project has been in talks for decades, and the US government was supposed to follow a schedule of 12-18 months of logistic, economic, and environmental studies.

Instead, the delay will decrease optimism among US shippers and refiners, Canadian oil sands producers, and job hunters from both sides of the border. Gulf Coast refineries need certainty about their supplies; delaying their scheduled deliveries one year out (along with the time needed to build), is enough reason to forget the idea of getting oil sand crude altogether.

Aside from the fact that the US clearly does not have an energy plan, it's also puzzling as to why the government allocates so much time for review and political strategy, but does nothing in preparation for new projects. It would be logical for the US to beef up safety precautions such as engineering barriers and enhanced filtration to make way for a project that is sure to develop some ROI for the neighboring states. Issuing a municipal bond to bring the infrastructure project into fruition, while paying back those bondholders with revenue generated by industry productivity is a solution that makes sense. We need a collaborative approach to work around constraints to maximize capital, labor, and productivity resulting from the pipeline project. Canada deals with the production, the neighboring states deal with optimizing economic gain from the pathway, and Houston and Port Arthur deals with the inflow of oil sand crude and delivery to the nation.

Another year of bickering does nothing when no one is willing to get serious. Canada must be laughing in a field of oil sands right about now. We can't blame them.

America Needs More Engineers

2011-11-01T23:02:00.001-04:00

The quality of America's labor supply is low. Most politicians don't understand education reform. It's the backbone of the economy, and doesn't do much if it is given conventional treatment. We need a complete overhaul as to how we get people equipped for the labor market. The constant rhetoric of increasing graduation rates and improving test scores is just more pussyfooting. We need to re-instill the passion for math and science to produce the next generation of engineers from all disciplines: financial, environmental, mechanical, software, medical and more.

The proof is in the Beveridge Curve to the bottom right. Even as we extend emergency unemployment compensation, job vacancies continue to increase. As the plots move further away from the regression line, more jobs are left unfilled. This could mean that with unemployment benefits, the recipients don't utilize the time to acquire more skills.

Since I was a child, I've always questioned why people drift away from science and math. Up until fourth grade, children have great curiosity in the sciences. We all wanted to know how things were created - it was like explained magic. I remember at age seven I told my parents I wanted to be an astronaut. My Mom, always realistic, would tell me that that plan involved lots of work and heavy academics, but I replied that my back-up plan was to be an astronomer. Little did I know that that too involved the same level of math and science, coupled with hard work and determination. As I grew older, my elementary school had us play with LEGO blocks and introduced shapes and basic geometry with some math. I then wanted to build things. I came home and replicated cities with my building blocks - I wanted to become an architect. By fourth grade, something happened and all of my friends put aside their scientific dreams and wanted to be rock stars and athletes. This was where trouble began.

Some may argue that every child can be what they want, and there is nothing wrong with being a rock star and athlete. However, there is a lot wrong with this. The spillover effects on the economy are somewhat toxic. Glamorized careers produce little advancement to the economy as a whole. These rock stars do not contribute to the prime industries that utilize the nation's resources to effectively compete in the global economy. They often establish charities with little understanding of economics, causing more harm than good. The odds of being the next rock star and athlete are so low that the probability begs children to protect their human capital at all costs. Being an educated rock-star with some skills to fall back on is fine. An engineer who has a side band is also great.

Sadly, the damage has already been done. More Americans are entering the workforce with little skill and 9-10% unemployment rates are worrisome (not including the underemployed and those who stopped searching for jobs). Interestingly, Americans with just a High School education are evenly distributed among professions. This means that the less educated are still starting businesses and becoming productive managers. As support, these low skilled entrepreneurs need the expertise of skilled workers to expand. As lending declines, more entrepreneurs are relying on savings and personal credit to start ventures. The savings need to come from somewhere - a job. That job that can provide sufficient start-up income is hard to come by if you lack the necessary skills that are in high demand.

According to Manpower, 46% of senior human-resources executives surveyed in the company’s latest global annual survey said that their talent gap was making it harder for their firm to implement its business strategy. Only 27% said they felt their business had the talent it needed. And the shortage is likely to get a lot worse because of the imminent retirement of a generation of seasoned workers with sought-after skills in the rich economies. In 2008, one in four workers in America with a degree in science, technology, engineering or mathematics was 50 or over. Lockheed Martin, an aerospace firm, expects nearly half its science and engineering workforce to retire by 2019 and will have to hire a total of 142,000 engineers. Currently only 60,000 engineers a year graduate from American universities. -The Economist

There is intense pressure on the younger population to replace the old. Jobs require more skills and experience. Young graduates might obtain the skills but lack experience. Older workers have the experience, but lack skills. The solution is to work on getting the young population experienced while receiving a skillful education. At the same time, we must get the older workers into skilled programs, certainly before they give up and seek early retirement placing a strain on the near bankrupt benefit schemes of the nation. We need to act fast.

The problem is not just American, and we can actually learn from other nations. Russia faces an exodus of skilled people who have the income to venture away from the nation. This creates a problem as President Putin plans to rely less on energy exports and more so on human capital and innovations in technology and banking. Germany has comparative advantage in manufacturing, but its youth are shying away from math, science, and technical skills. Also, women are intimidated by the stigma of technical work being a man's job. The Arab World is probably the most interesting example of a plan that could have worked. Governments in the Middle East did well at educating the youth by creating great institutions and pushing its large population of young people through school. The problem was when most of them graduated, jobs were nowhere to be found. The management of most companies are run by a group of foreign educated elite and to some extent controlled by the State leaving managerial powers at the hands of the autocratic ministers. Little room is left for the recent grads to utilize their skills. Great opportunity for America.

We need a plan to leverage the shared problems of the world. It starts with labor. US companies should continue to recruit the skilled graduates from foreign lands, and the government should relax its immigration policies in certain respects. An Indian student who graduates from a US school looking to work in the US should be welcomed because it contributes to our economy; strengthening our comparative advantage against the home country of that student. We are placed one step ahead. Currently, it is very expensive to go through the immigration process with Visa issues and such, so US companies give up and wait for the few skilled US grads to apply.

While they wait, we should help them craft the incoming applicants to their liking. Organizations such as the National Math & Science Initiative (NMSI) are doing a great job at addressing this issue. NMSI sponsors advanced quantitative curriculum in schools across the nation. Exxon Mobil recently helped to spread the word with a series of commercials. This again is an opportunity for companies like Exxon to continue.

New York City has an adopt-a-school program that works wonders. Although it has been gradually dismissed throughout the years, some High Schools that are career focused create partnerships with companies such as Citigroup and grant internships to students. Students have a resume with skills already taught by the curriculum of their High School and sponsor company before entering college! Companies should team up with schools from as early as Middle School to guide a matriculation of well skilled applicants. It's cheaper than implementing a training program.

Research in Motion has a great collaboration with the nearby University of Waterloo in recruiting highly skilled graduates in the fields of engineering and management. The national physics center and think tank founded by the company's two CEOs strengthens the relationship with Canada and its future generation. That is truly a great example of how corporations can best utilize regional human capital.

Bottom line is that we need to produce more engineers of various disciplines to effectively compete.

Inside Operation Twist: Trading like the Feds

2011-10-09T06:06:00.000-04:00

Here's a quote from a past article featured on this blog:

The treasury bails out troubled banks, while the Fed funds these bail outs by purchasing attractive treasury bills. The return on interest and added bank fees for insurance serves as revenue for the Fed, in which about 80% is given to the Treasury. So, I beg to question the motives of these politicians. I support Bernanke's fight to keep the Fed independent. -Dantes Outlook

Trading like the Fed during these times might involve something more sophisticated than an average FX position. The dollar is busy saving investors from Europe, and in the long run the effects of Operation Twist will probably not be evident in the FX markets as conditions change frequently.

Look towards the financial futures market. Second in size to the global foreign exchange market (FX), the financial futures market trades at such massive scale equal to about 1/2 of US GDP. It is expensive to participate here (thousands of dollars) but positions are generally longer term and only trade about 4 times per week.

Here's a strategy: (NOTE -- currently studying this for my degree)

Implied yield on T-Bond contract is around 5.66%. Implied yield on Eurodollar CD is around 2.62%. Let's aim for the T-bond to get 50 basis points above the Eurodollar CD rate.

For this 50bp spread to occur, this needs to happen:

3.12% - 2.62% = 0.50% long term (or 2.62 + 0.5 = 3.12)
5.66% - 5.16% = 0.50% short term

Thus, the T-bond futures contract will need to rise enough for the implied yield to fall to 3.12% as operation twist should command. Using a spreadsheet model, you can play around with the prices to find a comfortable yield that will move the price closer to present value. Refer to the chart below for a visual breakdown.

*Check out the brochure to learn more about custom strategies (FX trading for now) in the Research & Advisory Section.

Markets Prepare for Downside Risk

2011-09-24T17:12:00.002-04:00

The markets experienced lots of turbulence this week following Fed Chairman Bernanke's plan for more easing. However, that alone was not the major worry among investors. It's the growing concern that rescue initiatives are exhausted, leaving everyone forced to make key decisions that avoid risk.

As IMF Chief Lagarde accurately puts it, "[there are] downside risks on the horizon, they are piling up." Everyone knows this, but it seems that investors are the only ones making the necessary bold moves, sending shocks throughout the financial system. As more rhetoric fills the airwaves from political officials, the more investors and common folk lose trust in the system. At this point, it's actually good. These officials have got us into more economic trouble, and perhaps it's best they continue to talk and not act. Let the markets do the work.

For sure, we always expect more of the same to come out of these talks - things like QE3 or more bailouts. Bernanke's long awaited speech and FOMC decision did not live up to the hype. The markets expected a grand program of more quantitative easing (heavy purchases of treasury debt to encourage more lending and spending). Instead, Bernanke did not come to the rescue, and proposed a lighter adjustment to the Fed's gradual withdraw of monetary stimulus. There will be more purchases than planned, but still less as the months go on. The Fed is exhausted, and Bernanke is pressuring Congress to take responsibility for the fiscal problems in the US.

These grand expectations caused investors to scramble for liquidity. As Gold prices rose in anticipation of QE3, it declined following the announcement of Bernanke's 'operation twist' as investors sold gold positions for cash to cover losses in risky assets like stocks. These margin calls require more cash on hand to cover greater risk. There is also an opportunity cost for holding gold (storage), so during cash-strapped times, it makes sense to just sell this liability and seek hard cash coupled with income generating assets like treasury bonds. The dollar was also heavily bought for added security as Europe faces heightened risk of a Greek default. Italy's downgrade added more fuel to the fire. Here's a breakdown of the market's reaction:

Gold dropped 5.7% on Friday, down 9.6% for the week to 1,638/ounce
Silver down 18% on Friday (was highly overbought before 'operation twist' announcement..also industrial use of silver is more of a hassle to hold).
Dow down 6.4% this week, but up 37 points on Friday to 1,0771 (cash from gold/silver sell-off put back to cover equity positions).
Euro down 6% this month, ended week at 1.35

The markets show the flow of dollars in response to the economic politics of the world. It's the strongest indicator that we have.

Europe is still examining ways to lend Greece more money. 15 billion euros ($20 billion) has already been allocated to Greece until 2013. The request for more euro's comes at a cost -- the country must enact tougher austerity measures. The problem with this is that austerity will cause a slowdown as more financial pain is placed on the people of Greece, and crucial services that have the potential to revive the economy are receiving cuts. Transit workers recently staged a massive strike in protest of cuts, grinding the system to a halt. Greece will need an investment plan coupled with incentives making full use of its resources.

China is not coming to the rescue of Europe, especially Greece. It knows that the bailouts and political dithering are clouding the structural reforms so desperately needed. China is in seek of return on investment if it does provide some assistance; Europe is not in the right position to provide a return. A free check will not come from China; the IMF, G20, and European Stability Fund handle the unsustainable flow of aid.

China is busy handling its own problems - withdrawing stimulus which caused domestic problems such as a construction boom, 6%+ inflation, 7% growth targets (lowered from the 8-9% trend), and local debt issues which call for tighter lending standards going forward.

The world can no longer depend on China, bailouts, stimulus, etc to solve its problems. The markets need to be accepted as a sustainable alternative. The Australian dollar has been on a decline recently as weak economic data out of Asia spread fears about trade volume between China and Australia due to lack of demand for natural resources. Leaders need to fess up and provide sufficient returns for capital injection.

What's Ahead for US Foreign Policy

2011-09-11T17:00:00.001-04:00

Immediately following the horrific events on September 11th, the US acted on impulse and embarked on what now marks a decade of war on terror. The pre-9/11 mentality was full of optimism (despite the burst of the internet bubble) mainly in part of government's meddling in the housing and credit markets. The silently orchestrated debt crisis was inevitable despite the talk of pundits correlating the war with current economic slowdown. The terror attacks made conditions worse as it gave government more reason to prevent immediate recession. The decision to destroy the enemy was clear, but the motivation was filled with too much emotion and not enough reason.

Even as a child coming home from school to see the aftermath of the World Trade Center collapse on television, and knowing that my mother worked a few miles north still within the vicinity of lower Manhattan was too much to bear. The drive that I took with my Dad from the Bronx to a bridge way to wait for Mom was the worst ride of my life. The radio was filled with words of war, and I was convinced that everything I appreciated about my city was under attack by evil. I wanted to get even. That mindset of an 11 year old boy was shared by many on that day, but forgotten at the time of battle. The purpose of war is to protect the crucial assets that make up a strong nation (land, people, resources, etc). Emotion propels action, but the basis of the fight should never be forgotten at home.

As the war on terror progressed, we forgot to maintain what we were fighting to protect. The World Trade Center towering over the financial capitol of the world, was a beacon of capitalism, only to be destroyed. Since then, the motive of war has gone off point and the US is slowly having less to show for our world might. The logic discussed here makes further sense as troops fighting overseas would want to return home to a stronger economy, seeing first hand the result of hard work. Instead, often times the dream turned reality is subsidized with failed promises. Veterans are faced with an unsustainable pool of funds for rehabilitation services and other structural issues.

Congress allocated $1.3 trillion (adjusted for inflation) towards the war on terror. The Afghanistan invasion costed us about $450 billion, and the Iraq invasion $800 billion. The cost of the externalities of war stand at an estimated $900 billion which is mainly veteran services (not including the ripple effect of other related spending).

According to Washington Post's Top Secret America Investigation, the defense industry expanded to about 2,000 private contractors mainly for IT & Support and military personnel. The alarming observation here is that security and defense contractors have moved away from production to services, responsible for the overwhelming bureaucracy of 1,300 facilities and 850,000 security clearance officials. Many of these agencies have sub-agencies, with a web of other agencies under the same umbrella often performing the same task. With a defense industry of massive scale, the US government created yet another critical asset in need of protection at all costs.

The bottom line is that our assets are under attack and must be strengthened while protected. The threats are not just physical. China should be of main concern given the astronomical amount of attempts by Chinese hackers to tap into US government intelligence and private industry to mimic or destroy us in our tracks. The Middle East is an obvious threat, yet we still depend on the region for a large share of energy supplies instead of ramping up our own production at home and fighting to protect our resources like Russia is doing. With a defense budget of $650 billion between now and 2020 (small scale compared to the US), Russia is investing heavily in defense while it makes record discoveries of natural resources and maintains its regional power through distribution of natural gas deemed critical by smaller neighbors and the not so mighty Euro-zone.

So much potential to get it right. Let's not wait any longer.

Bank of America, Buffet, and Army of Analysts Shut Down Crooked Henry Blodget Sell-Off

2011-08-24T16:02:00.007-04:00

Warren Buffett's Berkshire Hathaway will invest $5 billion in Bank of America

News broke out this morning, pushing BofA higher after this blog post was published yesterday afternoon, encouraging investors to hold on despite what the pundits say.

Henry Blodget is the CEO and Editor-In Chief of Business Insider and a familiar pundit on Wall Street who loud mouths for or against tech companies depending on his investment objectives. Now banned for securities trading following some questionable predictions during his internet and e-commerce analyst positions at Prudential and Merril Lynch. Gaining popularity, Blodget offered good calls particularly on Amazon.com hitting his price target of $400 per share, and bad calls in which he labeled eToys as a good long term buy back in 1999 - which eventually tanked two years later and had assets acquired by KB-Toys; perhaps a move to prop up share prices to leverage a sell through indirect trading accounts pointing back to his personal stake. Now ousted from the industry, Blodget remains active - with a new target on Bank of America.

Tech guy turned bank guy, Blodget had great power leveraging his platform at Business Insider and connections with big heads on Wall Street to spread fears about Bank of America being under capitalized with great risk exposure. The fears rippled throughout the blogosphere and investors began shorting heavily. A rumor was sparked about JP Morgan preparing to purchase Bank of America with government cash support. Especially at a time when everyone is worrying about economic slowdown leading to a double-dip, negative attention towards US banks is sure to spark big fear -- another 2008-type crisis? No. Take a breather.

The fundamentals are worrying, but not as scary as Blodget and friends make it seem. On July 19th of this year, Bank of America reported a net loss of $8.8 billion ($0.90 per share), largely due to charges resulting form a recent agreement to resolve Country-wide liens on Residential Mortgage-Backed Securities (RMBS) involving a line of $900,000 worth of loan modifications, repurchase exposures, and other related costs. The bank's core business performance this past quarter was held back from higher costs as management absorbed more mortgage issues. With losses canceling out gains and draining cash, investors have good reason to be cautious.

However, Bank of America continues to experience a good inflow of deposits and revenues gained from those holdings. The bank reported $147 billion of new extended credit in the second quarter, an increase in consumer deposit balances by $44 billion (4% from previous year), and more small business accounts equipped with the support of new branch locations and local loan specialists. An increase in Global Wealth clients contributed to $1.6 billion in investment banking fees, the bank's highest since the Merril Lynch acquisition.

Tangible Book Value (TVB) essentially measuring the net-worth, has decreased by about $1 to $12.65 per share from the first quarter of this year. Since the bank is balance sheet driven, investors can use TVB as a rough estimate of its liquidation value - apparently being low. This is a problem; consistently lower TVBs shows that too much of the banks' interest earning assets are covering interest bearing liabilities. Again, the costs on the liabilities side coming from mortgage loan problems.

The financial short-fall is a natural consequence of addressing the mortgage problems head-on, an organic approach taken on by the new CEO. Brian Moynihan is doing a good job with cleaning up the mess from former CEO Ken Lewis who grew a troubled bank. The fact that this is going on internally is great news for the long term investor. Given no immediate disaster in the economy, Bank of America is preparing a sustainable path for itself.

The big worry among investors is that Bank of America may dilute its shares for immediate cash. Not quite. The internal operating overhaul will provide sufficient liquidity for Bank of America to remain solvent. Moynihan is looking at what works, and what doesn't work. More clients, depositors, fees, liquid interest-earning assets, and sales are working well. A sell-off should not be shunned upon; so far 20 assets have been sold under Moynihan's leadership including the Canadian card unit, plans to exit UK and Irish card units, and write downs of credit cards and mortgage units. The power of a write down - reducing the book value because the asset is deemed overvalued - will help Bank of America adjust to reality and manage its operations better. As with most banks, Bank of America is overstaffed with toxic paper pushers, not value creators. The 3,000 layoffs recently marked a significant move to restructuring operations. Shifting labor from what doesn't work, to what works (hence more local loan officers to monitor small business credit lines during economic uncertainty) is a result of good management.

Trusting Moynihan is tricky, but moving forward will hurt in the short term. The rumors will continue, but those who stick to the fundamentals will gain. The JP Morgan merger is unlikely as Bank of America already has $62 billion in market cap with enough on its plate. External moves will hurt the company, and it knows this -- investors are voicing their opinion that the company should continue internal restructuring, or else risk a sell-off (with a stock price so low, there's not much room to risk such a blow in equity value).

The risk of being undercapitalized is important, but debatable. Basel III capital requirements will force Bank of America to raise $25 billion, according to JP Morgan (not $200 billion according to Blodget). Here's what the army of analysts say:

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Bank of America (BAC) got a new supporter on Wednesday, as analyst Meredith Whitney told Bloomberg Radio that the hemming and hawing over the bank’s need to raise billions in new capital is overdone. “I don’t think that there’s a mad dash to raise capital immediately,” she said. --Barron's

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"There is no impact whatsoever on Bank of America's balance sheet, based upon the price of its stock in the open market. If the price of the stock goes to a penny a share, it has no impact on the balance sheet of Bank of America. Bank of America sells the stock to the public, it takes in the money, and that is the end of the transaction as far as Bank of America is concerned. If you're going to break a bank, you're going to have a run on its deposits. That's not happening. Exactly the opposite is happening…Deposits are pouring into Bank of America."
"Or, as in the case of the fourth quarter of 2008, you've got to bust a bank by making it repay all of its short-term debt immediately. Bank of America has so much cash on its balance sheet that it can pay back all of its short- term debt, it could pay back a big chunk of its long-term debt and still have excess cash on the balance sheet. You can't break the bank by driving the price of the stock lower, particularly if the bank is as cash-rich as this one is with deposits pouring in as fast as they are." --Bank Analyst Dick Bove

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Core Portfolio - Prime mortgages 30 days or more past due increased to 1.98% from 1.67%.
Legacy Asset Servicing Portfolio - Subprime mortgages 30 days or more past due increased to 46.7% from 46.6%.
Commercial – Commercial loans 30 days or more past due decreased to 2.01% from 2.55%.
Credit and Consumer – Loans 30 days or more past due decreased to 3.38% from 3.93%.
Also, 90% of the loan portfolio is paying in a timely fashion.
And 8.5% of the loan portfolio is 90 days or more past due or was purchased credit impaired.
If all of these loans default with no recovery rate, BAC would be looking at $75 billion in future write-downs. With $37 billion already allotted to loan loss reserves, the bank would be looking at a decrease of $38 billion from tangible book value, which held steady near $130 billion. That would still leave the bank with over $90 billion in tangible book value and selling for just 75% of tangible book value. Currently, the bank only sells for half of tangible book value, an unprecedented valuation.
For Bank of America to become insolvent, 14% of its loan portfolio would have to default with no recovery rate. With only 8.5% of loans currently 90 days or more past due and/or purchased credit impaired and almost assured to have some recovery rate, this would mean defaults would have to at least triple for the bank to become insolvent, a level much worse than the depths of the recession in 2009. -- Matt Blecker

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This is nothing like 2008, says CEO Brian Moynihan. "Simply put, we have twice the capital we did back then," he said on a recent conference call. B of A currently has twice as much capital as regulators require. New international banking standards called Basel III require large banks to hold 9.5% Tier 1 common equity, phased in between 2013 and 2019. B of A says it will already exceed 8% next year. Seven years to raise less than two percentage points of capital is hardly onerous, particularly since B of A isn't paying dividends to shareholders. As for aneverending stream of lawsuits caking the bank in uncertainty, Moynihan said he isn't going down without a fight. --Motley Fool

Historic US Downgrade Adds Pressure to Liquidity Trap, Markets Signal Trouble

2011-08-06T16:41:00.007-04:00

This past week, the markets have provided useful indication that trouble is brewing. The private sector has gone rogue, and the message is clear that enough is enough. The economy has been poisoned by political dithering and government crowd out, and now it is time to fess up with the consequences. In the midst of a liquidity trap, safe haven depletion, structural problems, fiscal insanity, and now a historic downgrade of the used up global superman (that is the US), the world sits to drown in worry about what will happen next.

The United States debt ceiling debacle completely missed the golden opportunity to introduce a complete overhaul to reverse the years of folly that got us into this mess. Lawmakers failed to realize the underlying problem - the US has been abused, and it is time to heal it for good. A while back, this blog reported that talks were in progress to craft SDRs (a basket of currencies) to replace the US Dollar as the world's reserve currency. My analysis of this was that the US was beholden to the world's demand in spite of its domestic issues. Issues that included fiscal woes following the decision to leave the gold standard and accumulate an unsustainable supply of dollars to fuel world demand for more US debt. The cycle continued as the world progressed (case in point: the emerging economies off the back of US pain -- China, the biggest holder of our debt). Congress, given the constitutional power of the purse, has yet to realize that we are being played continuously. Recently, Russia's Putin stated that the US is a parasite to the world. China continues to lecture us on how to reverse our addiction to pleasing the world with debt, because it is no longer sustainable for their country as it moves past our problems. And now, our own private markets have raised the alarm. Standard & Poors steps into the debate.

The downgrade from AAA to AA+ is primarily because of the deficit deal reached by lawmakers one day before the debt ceiling deadline. It was merely a band-aid approach to calm markets, and shifts responsibility to a committee that must use politics to decide what government program will receive a cut. With something so nonsensical, a downgrade is inevitable, no need to be shocked. The structural problems have yet to be addressed.

Lower GDP, and what seems to be better jobs numbers at face value, sent lawmakers reassuring the American people that this is just a short term thing, and the economy will get better...in their hands. Almost laughable to watch this play out. A deeper look into the data shows that the labor market has continued to decline, and because of our messy approach to employment statistics, a drop in the labor market means that the troubled Americans in search of work have left the pool, and the active few (some of whom successful in finding employment) provide a boost to the data. This is correlated to a structural problem, in which the supply of labor is due to an unskilled workforce. Businesses need skilled thinkers to cut through the problems created by the government, and pave the way to recovery. Instead, we have many Americans who are the result of failed government programs with no where to go. And now lawmakers must accommodate for this weird skew with budget shifts.

The structural problem is not entirely American. The European Union continues to struggle with a way to balance the needs of constituents and bond holders. EU's Rehn recently urged everyone to stay calm and breathe deeply as officials try to craft a plan for Greece to continue borrowing at low costs, with less fiscal burdens due to austerity measures, all while making sure that current bond holders receive their fair share. It's a complex mess that will take time to correct. The markets are not impressed.

Italy rushed through an entire austerity package in one week, under pressure by the EU to make sure that the country is in good shape in case of contagion disaster. Italy is a major route for European debt, so there is big internal worry that they remain solvent. Yields on Italian debt surged as investors panicked and withdrew money from its bonds. The backroom deals sent a message that there are more problems to come. There is hope in Spain as yields decreased with an improving stock market. But, these spreads between Italian, Spanish, and German yields show that the movement of cash within Europe is due to uncertainty.

US markets experienced a significant decline this week, as the Dow Average moved into the red for this year. Safe havens are now at risk of a price drop too. Margin calls were a major factor in the drop in Gold and Silver prices as investors needed to exit positions in commodities for liquid cash to cover riskier investments in stocks, all to maintain a balanced portfolio. The intense movement of cash to Switzerland caused the Swiss Franc to rally. However, the Swiss Government saw this as too cumbersome a risk to foreign banking demand; thus in an effort to remain stabilized, its Central Bank cut rates to calm the markets.

US Treasury bills are still in hot demand, and this is somewhat problematic. Investors have no where to go, and Treasuries will continue to be a safer alternative. However, with the US now on "negative outlook" by S&P, the supply and demand of Treasury Bills at auction is uncertain. States have already started buckling up with less debt accumulation. The lower supply of municipal bonds are good for the state's sustainable budget goals, but leaves investors hoarding more cash.

The Financial Times accurately calls this a liquidity trap - the 2011 deposit crisis. Banks like BNY Mellon are charging more for services that are costing them. The service of hoarding depositor cash in savings is not feasible. Banks have the duty to utilize your savings to provide interest returns. However, with no utilization of cash because of global uncertainty, they rather avoid having to be pressured into risk.

So, what can be done? The government should shift from spending to investment. As much as there is a spending problem, governments are in desperate need of revenue to please bondholders. Taxes should not be the only source of revenue. Government services need to be measured by its affect on producing a good supply of labor, which will in turn utilize the assets created by government (infrastructure, education, etc) to enhance their well-being. Every project must have ROI in mind. States are in a better position to do this well by making sure that each municipal bond issued must have a plan of repayment with ROI instead of new debt. We desperately need to send a signal to the markets that the US is back in business.

Investors Finding Safety in the Swiss Franc and US Debt

2011-07-25T16:20:00.004-04:00

Out of all the general safe haven investments during US troubles, the Swiss Franc has performed the best this year. Whether it be the threat of Mid East oil supply disruptions during the Arab Spring, or the continuing worries of a messy budget situation in the US, investors have shifted to the franc as their safe haven currency. As we see further in the post of charts; investors may not want our currency, but they still like our debt.

The first chart on top shows the US Dollar's 3 month decline against the Franc.The bottom chart shows a fast increase in volatility in the EUR/CHF (euro to swiss franc) pair, against the decline in volatility in Gold. This is quite interesting. Investors seem to be demanding more franc than Gold during the US deficit mess.

FT Alphaville has a nice feature today on this topic. The article states that mortgage borrowers in Poland and Hungary held Swiss Franc denominated debt taken out prior to the 2008 financial crisis, as an extra hedge. Even Central Bank policies have centered around the Franc.

In a world of uncertainty, investors are realizing that during times of crisis, you must reserve your spot in the haven where the frantic crowd heads. At that point, you'll be prepared to collect what essentially is a rent-seeking cost. The funds from this strategy can eventually offset the losses from bad exposure.

Now this is where it gets interesting. Treasury yields (which basically signal the inverse movement to and from T-Bills, as T-prices rise with demand, yields fall) have risen throughout the latter part of 2010 as investors got out of treasury bills. Now, so far this year, yields have been on a decline as investors are buying back more T-Bills. Is this confidence? Or are investors busy fleeing riskier investments and settling for the somewhat safer US debt? More so of the latter. There's no risk free rate here, but given the intense measures taken (hence the high publicity and frantic government), this shows that the US is concerned about bondholders, and will probably continue issuing more debt which is apparently in demand. No talk about how we pay for it until the next debt ceiling date (see the cycle?) Sad, but true. US debt will always be in the mix of a safe haven portfolio, until that time comes -- when someone with a stiff spine paves a correct path towards fiscal sanity at home, in which bondholders are paid back with ROI instead of debt, and spending is on a sustainable level.

Another Chance to Get it Right - The US Debt Ceiling

2011-07-11T17:22:00.010-04:00

A deficit deal must be reached before the August 2nd deadline. In a press conference this morning, President Obama stated that he will meet with his budget team, Vice President Biden, and House Speaker Boehner. The US is in desperate need of a strict budget overhaul, and this could be its chance to do so. In an ideal, somehow unrealistic situation, the debt ceiling will remain and the US will agree to make the necessary cash adjustments to remain solvent in both the current and long term. The US needs a strict force to whip it into shape; the debt ceiling is that force.

White House officials, economists, and pundits in the media use scare words like catastrophic consequences, disaster, the end of the US - if the debt ceiling is not raised. President Obama even lashed out against those that disagreed with him on the debt ceiling issue as irresponsible. Laughable that the ones who were irresponsible are now clinging for political and economic survival. The blame game, and further dithering is not the heart of the matter, as some in the media cleverly make apparent. As daunting as it might be, the numbers deserve more light.

Keeping the debt ceiling at its current level will force us to make serious sacrifices, and operate within our limits, for once. Now is our chance to reverse the status-quo and allow the nation to freely grow without the strangles of debt and bad budgetary practice. Let's delve deeper into what's at stake.

US default is not as scary as the media makes it out to be. It's nowhere close to what Argentina experienced, or what we see now in Greece. The US simply does not have enough cash to cover its debt payments, which fuels the government machine behind the economy. There have been 16 consecutive occasions since 1993 in which the debt ceiling was raised. The decision to open up allow a little more debt to keep up with unsustainable government services adds up, and now we find ourselves at what should be the debt peak. The argument rests in the decision of whether or not to default on bond interest or the principle. We seldom hear of the debate to stay within the set limit and introduce a budget overhaul to correct the mistakes we clearly made after budget plan that came out of the previous debt ceiling lift. Now that's irresponsible.

Here's an option on the table. The not so scary default could be tamed if the Treasury department rolls over maturing issues, so long as the overall stock of outstanding debt does not rise. The term rollover means that the Treasury uses money from the sale of new T-Bills to fund the rollover of maturing debt. It's essentially replacing debt due with new debt, instead of paying for it in cash (which we don't have). The treasury already does this every Monday -- $30 billion worth of T-Bill due for payment are rolled over with the issuance of new debt. See the cycle? It's all virtual faith. The safe haven is made more of an idea every Monday, when the underlying asset is clouded. The continuing pattern after the gold standard (in which every dollar was backed by gold).

According to ICAP data made public by The Economist, interest payments can be covered. In August of 2011 (the debt ceiling deadline), the US will have an estimated $185 billion in cash receipts, $37 billion in interest due, and $340 billion in other outlays, equating to a ($192 billion) deficit. If the government fixes its budget so that these outlays (which fund government services, bank transfers, bond payments, etc) decreases to allow cash to cover interest, we can avoid less harm. The Prompt Payment Act enforces penalties on late interest payments - yet another expense to worry about. This is a clearly unbalanced position, and the ICAP estimates see a continuing deficit problem with outlays becoming an increasing burden. The problem is obvious - the US is not using its cash receipts in a responsible manner. Giving out more than we have, while creating more of what we don't have is just nonsensical, and it must stop.

If we are forced to default, Treasury will use less scare rhetoric and will explain what we are defaulting on exactly. T-Bills come in periods, so we still have some room to get our act together, broken up by each issuance and disbursement of debt. But a grand overhaul to orchestrate each minuscule (billions are actually big) payment is essential. The US will be forced to create a strategic game play in which the Treasury is held responsible for a balanced budget of inflows to outflows, which means that the government must act with what's given. If the requester of Treasury funds needs more, then they should create more through revenue generation. That will help the budget of each municipality, state, and in a broader sense, the federal government. Creating $3 with $1 requires innovation, and better use of the private sector. Allowing people to do what they do best (create value), will increase cash receipts. It's up to the local politicians to get this right.

The government must be forced to balance its budget. Austerity is painful, but it's clear that the economy needs a step back to leap forward; the US recession needed that J-Curve. If the debt limit does not provide this force, the economy will naturally seek responsible action. And this is exactly what bond investors are thinking. Let's tap into the thought process of the investor.

Are the bond markets really worried about default? So far, there is no demand for higher interest rates to compensate for default. Yields are lower, while treasury prices rise, signaling increased demand for T-bills as a safe haven. Investors are not fleeing the bond markets, because the general picture is still sluggish growth (again, the economy will naturally push for responsible leadership). The safe haven is still viewed as a risk-free asset.

However, the number of Credit Default Swap (CDS) contracts are up from 600-1,000 so far this year. The one year to 15 year spread has tightened, as it is now more expensive to insure a one year bond compared to a fifteen year bond against US government default. Even though investors are buying more Treasuries, they are insuring against default by relying on CDS. Playing it safe. China is also diversifying its reserves outside of US Treasuries.

The Economist interviewed a bond strategist about the patterns she sees in the markets:

Priya Misra, head of US rates strategy at Bank of America Merrill Lynch, says anyone who thinks America might default for several weeks this summer should sell a bond with interest due on August 15th and buy one with interest due on November 15th, which would result in the price of the first bond falling relative to the second. But, she says, neither market pricing nor the chatter of clients shows such a trend.

The debate should focus more on a budget overhaul, and the debt ceiling issue will follow these standards.

What to do about Greece

2011-06-27T14:47:00.144-04:00

Greece isn't so much of a headache as it an opportunity for traders. It allows us to step back and think like an economist; evaluating the what ifs of contagion and speculating the fate of the Euro. The task list is complex.

Last week, the Prime Minister successfully passed a confidence vote, but voters outside his elite backing remained angry. Protesting outside government buildings continued, spreads on Greek/Spanish yields widened, and traders sold off on the Euro sending the currency on a decline. The markets are one step ahead, as the value of the Euro rises ahead of key meetings and votes just to show that expectations are rising, only to increase fears about the next step.

The fact is that Greece is and will continue to be a burden on the Euro zone - lower GDP per person coupled with higher government debt as a percent of national GDP. The country is in desperate need of a 12 billion euro life-line loan by mid-July. This, along with a plan for further austerity measures will be the next task for Greece. The Prime Minister and his cabinet must balance the interest of pleasing bond holders and pleasing voters. This battle is essentially the same, as voters, who want to continue life as it once was (living beyond their means) are the major holders of Greek debt.

Contagion is based mainly on fear rather than the actual. Although the euro zone is becoming entangled in the mess of Greece through its Central Bank (a bad bank of debt) and the flows of bail out cash extending a line of dependency, the risks are greater at home. Greek banks will ultimately feel the pain in the event of a default. The National Bank of Greece, Piraeus Bank, and Eurobank EFG, all have 6-8% of capital tied up in Greek government bonds. However, outside banks such as BNP Paribas and Dexia group, have 2-5% of capital in Italian and Spanish bonds. This is a big problem.

Banks within the euro zone and around the world don't have to be tied up in Greek debt specifically. If the balance sheet has Italian, Irish, and Spanish bonds, it is indirectly affected by Greek default or other types of restructuring. Yields will fluctuate in response, as investors display emotion with their dollars. Banks around the world that have holdings in funds that are exposed to European debt face risk. Similar to the financial crisis, in which investment banks struggled to determine counter-party risk -- who the heck owns the stuff? Eventually, the knot becomes too tight to untangle, and we end up with a Lehman style collapse. Not so much the case here. Transparency is much greater with government debt, but still, exposure and contagion fears remain.

Investors are already evaluating exposure. Shares of Dexia Group, a Belgian bank with major holdings of euro zone debt, have declined significantly (down 24% YTD). However, banks like Dexia are insured through credit default swaps. Back in June, Dexia joined other banks to rollover a combined 30 billion euros of Greek debt for an emergency package. On the other hand, taxpayers and public workers have savings in Greece, and they should worry. The people of Greece can begin with tightening their belts so that the government can get on with tackling its fiscal woes.

So, what are the options.

A second bail out will continue the spiral of dependency and will only succeed if its backed by strict austerity measures. Voters even see a second bail out as a continuing problem. Investors will see this as some certainty, but only short term.

In the long run, the euro zone will continue to funnel money through a stabilization fund (essentially a little IMF of their own). Countries need to get away from this. The money just stalls time.

Default will ripple the markets, but will force people to get serious. If this happens, Greece should think about a gradual exit from the euro zone to focus on creating an organic model that will be more sustainable.

Restructuring is the best bet. First, greater privatization should be considered. Already, Greece is selling shares of its ports and an immediate sale of state assets. Second, a private 'bail-out' focused on restructuring debt should occur. Give Germany and the rest of the euro zone a break, and consider this:

SWFs [Sovereign Wealth Funds] have the might and the risk appetite, but do they have the interest? China has repeatedly pledged support to Europe’s periphery, motivated by the prospect of currying favour with Europe in order for its domestic firms to gain greater access to the European markets.
Norway’s sovereign fund—the world’s second largest—also has an interest in the euro area’s speedy recovery, given its home country’s proximity and links to the euro zone. Although the fund largely tracks public equity and bond indexes, it leaves some room for active management. Recent statements from government and fund officials suggest that the fund may use its discretion to buy more euro area peripheral debt. As of the third quarter last year, Norway’s SWF held US$3.9bn in Spanish sovereign debt, its seventh-largest individual bond position. -- Economist Meg, SWFs: the euro zone's white horse? (May 2011)

For now, we wait. Honestly, I enjoy the buzz among my Twitter and Facebook friends as we frantically try to make sense of this mess. Traders will continue to monitor these events, taking pulse of the Euro. In the meantime, the US should prepare for a shift of interest and get its budget deficit under control to show investors that the country is serious about becoming solvent.

The Future of Toxic Assets

2011-05-20T18:17:00.001-04:00

Once again, a Facebook discussion inspired me to think further. The banking idustry will face many challenges ahead, as outlined in last week's Special Report in The Economist. The culprint behind it all are "toxic assets". It's not as toxic when viewed in the long run, but for now bankers and regulators are still trying to find a place for it. The US went through this, and is slowly recovering with cleaner balance sheets. Europe is starting to experience similar troubles, especially Spain with its housing bubble. The question remains, what's next for these troubled assets (troubled is a better term than toxic).
In general, it is still too early to forecast the future of the banking system. The US, the source of the financial crisis, is still in the idea phase. The Dodd-Frank Bill is essentially a long list of proposals on what regulators intend to accomplish. Once a specific action plan full of regulations is introduced, analysts will surely weigh the pros and cons. We are starting to see the plans leak out, begining with consumer protection, and regulations on small things such as debit card transaction fees. The industry as a whole will be tightened, with higher capital and reserve requirements, cutting into profits. This might also force banks to venture into new exotic investments, and spill over risk from the shadow banking system - financial dealings with investment banks and other non-deposit institutions.

The initial plan, and what remains to be the first resort, is to set up a bad bank. The government purchases troubled assets and places them in a 'bad bank' where they sit and wait to be bought at a higher value. The government also collects payments in the form of a core capital ratio from the banks. The tricky part is valuing these assets and figuring out book values. The market for troubled derivatives is essentially dead, and there is little transparency, no source of ownership, and no demand pressure to set an actual price. The government has actuaries who assume the price, and we have some faith in this value. I think that the cost of the lump sum of purchases should equal to the amount of cash desperately needed to free up the bank's balance sheet.

The underlying asset that sets the value of these derivatives such as credit default swaps and mortgage baked securities are mainly consumer debt and homes, respectively. Currently, the US housing market is sluggish, as many homes remain vacant, foreclosed, and on a tightrope amidst mortgage loan restructuring. Some banks are desperately extending loan terms to help buyers by decreasing mortgage payments, in hopes to hold on to income producing properties. Other banks have lost hope and started a wave of short-sales, accepting small losses, but still face low demand from buyers. An empty home is...an empty home, and the derivatives that are fueled through the payments of borrowers are empty too, dead, or as some like to call it - toxic.

Fast forward a decade into the future. By this time, these troubled assets will be worth something. Governments can sell them off for profit, but I feel like there is a better way for banks to deal with this on their own. Consider this:

Banks establish a bad bank of their own and bear the costs involved in doing so (no initial sale, no cash). The government is artifically valuing the assets, when given some time, these instruments can arrive at a fair market value. These bank owned 'bad banks' will be managed by a team in charge of re-structuring the assets for a gradual launch throughout the recovery years. The assets are already structured for a good economy with cash flows from income generating properties and debt accumulation. The problem that caused systemic collapse was when the economy went sour, these instruments became toxic because they were not created to yield positive results during default. No matter how many parties insured the risk of default, the process of capital payment to borrowers and faulty ratings trumped all other pre-cautionary measures. Also, the web of insurers grew to large, that a collapse was inevitable, because no one could pinpoint the source of risk.

When these assets are structured, they need boundries. These derivatives should perform similar to options. It must come with a start date, and most important, maturity. The maturity period should arrive when the economy gives signals of exhaustion. Next, the assets should be split into groups of investors so that transparancy can flow easily. This is a better alternative because it is re-structured to be sustainable. Sitting on the government's books does nothing, and will only leave the new investors in more pain.

The Coming Health Care Collapse: Balancing the Costs of Supply and Demand

2011-04-29T16:35:00.002-04:00

The health care industry is the fastest growing employer in the United States. According to the Bureau of Labor Statistics, the industry is estimated to contribute 3 million additional jobs between 2008 and 2018, adding to the 14.3 million wage and salary workers as of 2008. The labor growth in health care is a result of increasing demand. The pace of hiring is greater than the pace of lay-offs, which makes me wonder if this is sustainable. During the recession, the health care industry maintained its standing as a major employer, despite short term lay-offs. A high skilled medical professional at a struggling hospital is able to relocate to another hospital that is busy expanding to fulfill increasing demand. However, patient demand places a strain on capacity and costs. The short-term layoffs, weaker job growth, and increasing costs expose the reasoning behind the coming health care collapse.

Hospitals are struggling to break even, and the results are painful. In April 2010, St.Vincent's Medical Center, a major hospital in downtown NYC, closed its doors. With approximately $750 million in debt, and no way of controlling increasing costs, St.Vincent's reached its shut down point. A major blow to NYC, as the last Catholic General hospital after 160 years in operation left the entire lower West Side of Manhattan without a hospital. St.Vincent's had a 6 month struggle with a budget deficit, and suffered an earlier bankruptcy prior to its closing. The bankruptcy apparently did nothing to restructure the financial model of the hospital. The State of New York issued $9 million in emergency loans to cover payroll, but this too was not enough. The community fought tirelessly to keep the hospital open, and a glimmer of hope arrived as Continuum Health Partners and Mount Sinai Hospital came on board to bid on a buy-out. However, a team of accountants deemed St.Vincent's an unsustainable investment. Also, there is word that state government chose to shy away from helping to structure a bidding process. Previous employees in the billing department have spoken up, stating that the St.Vincent's was very generous in providing care to poor patients. There was a lot of missing reimbursements for Medicare and Medicaid, and accounts receivables grew too cumbersome to manage. Sadly, this is true with other hospitals across the country.

Last year, President Obama, while promoting his health care plan, praised Cleveland Clinic and Mayo Clinic as the model hospitals that work to reduce costs. Weeks later, Cleveland and Mayo refused to serve Medicare patients in its Arizona locations; citing many missed reimbursements - and even the payments that were received did not cover the full cost of care. This coming from hospitals that are a model for cost reduction is a huge blow to the government who can not keep its promise. What about the many hospitals that are in worse shape, that didn't get the pleasure of being hailed as the model clinic? Government continues to make promises that it cannot keep.

The Pennsylvania Health Care Cost Containment Council has kept record of its growing list of hospitals that have closed or merged. University Medical Center, the hospital that treated Congresswoman Giffords after her gunshot wound to the head in an attempted assassination, decided to use this opportunity sue the US Department of Health and Human Services over Medicare reimbursements. Also, Congresswoman Giffords worked hard to keep the trauma center open amidst budget constraints; the one which saved her life. In my area, Our Lady of Mercy Hospital in the Bronx faced bankruptcy and was on the brink of shutdown. Fortunately, weeks before the birth of my little sister, the hospital was rescued by Montefiore, a huge conglomerate of failed medical centers in the North Bronx. Hospital mergers have formed a strong pact to pressure government to pay its fair share of promised reimbursements. Benefiting from economies of scale, these large hospital conglomerates are closely tied with politics, funneling campaign cash, and doing whatever is necessary to cover costs. The US health care industry is in a desperate situation.

The cost of serving the poor is an issue. Media tends to be biased in exposing the faults in Medicare (government health care for the elderly) opposed to Medicaid (government health care for the poor). My mother worked as a medical biller throughout the 1990's, and she recalls many situations in which Medicaid patients were not reimbursed. After several attempts, the billing department is then instructed to contact the patient for payments, with the excuse that Medicaid is not able to cover the visit. Patients have the choice to enroll in a payment plan, or pay all up front and deal with the local Medicaid office themselves; thereby transferring the reimbursement burden on the patient rather than the hospital. Also, a lot of government programs have strings attached. For all of the blame that private insurers receive, it's almost laughable that government fails to realize that Medicare and Medicaid operate the same way. They all cover certain services, while refusing to cover others. The only difference with government plans is that the insurance pool receives a large percentage of its funding from the government via taxpayers. Increasing demand through government funding does nothing to bend the cost curve from the supply side.

Hospitals need to improve their responsibility based cost measurement systems. Overhead is the continued expense to operate the hospital, and the costs are either direct (equipment) or indirect (administrative and miscellaneous). The hospitals budget these expenses based on the past and future expectations of demand. The goal going forward should increase under applied overhead - spending less than budgeted in order to cover funding gaps such as missed reimbursements. Next, hospitals must do a better job at tracing indirect costs and match it up with specific procedures. Capacity is strained with increasing patient demands; more occupied space comes with additional costs such as paperwork, additional staff responsibilities, food, etc. Operating leverage will be the make or break portion in this game-plan. Fixed costs that go directly into any service is usually uncontrollable; the procedure equipment, softwares, building services etc are there to stay. The variable costs are controllable - often indirect that naturally come about with an increase in patient demand. Operating leverage is made up of the ratio of fixed costs to total costs -- if this number is high, it means that the hospital is at high risk. We're trying to avoid shutdown when costs are greater than revenue. The problem is that indirect costs are often brought about when the hospital places extra effort in recovering reimbursements, which in turn don't cover variable costs, cancelling out the overall funding of the increasing demand from patients who think they are being covered. This is the danger in the health care system.

Solutions to this problem are open for discussion. Leave a comment.

US Internet Poker Shutdown Leave Gamblers and Traders Worried

2011-04-19T10:47:00.000-04:00

The following article appeared in the Babson College Financial Report:

April 15^th is a day to remember. Friday night, a prime time in the online poker world, is when players of all walks of life gather in a virtual space void of true identity. At one corner, there’s a die-hard Texan who’s been strategizing all day in hopes of winning the pot to pay the rent. He virtually sits beside a housewife whose alias is a bearded cowboy demanding authority. The group, joined by occasional college students making quick bucks to buy books, has formed a friendship – broken by the regulatory web holding the internet poker industry hostage to the moral judgment of pure losers.

Instead of gaining access to their accounts, and the diverse table offerings, poker players were welcomed with an FBI message stating that the domain has been seized as an arrest warrant is being pursued for illegal gambling commerce. The four leading poker sites: PokerStars.com, FulTiltPoker.com, AbsolutePoker.com, and UltimateBet.com (UB.com), were all shut down, affecting a large share of the fifteen million Americans who bet online.

The Manhattan US Attorney’s Office confirmed that eleven people, including owners of the poker sites were linked to gambling-related crimes based on “payment processing operations…a criminal fraud scheme involving massive money laundering and bank fraud…funds passing undetected through US banks, by law.” Seventy-six bank accounts remain frozen, along with player cash. The wire fraud gives the Feds reasonable evidence to seek $3 billion from the companies involved.

Although the terms used in the US Attorney’s statement blatantly seem like a vast ponzi scheme, sounding as if this is the next Madoff-Poker scandal, the law backing the charges is laughable when connected to the illegal matters. In 2006, Congress passed the Unlawful Internet Gambling Enforcement Act, banning the transfer of funds from and through US banks for gambling purposes. In short, poker players are not allowed to use their banks for cash management and transfers during games; almost all use money orders and credit cards independent of banks. The internet poker companies are banned from using US banks entirely for funding and management of the operation. This then created a mini-bank in all online poker sites. Poker players will deposit and use cash held in their accounts on the poker sites.

Abiding by the law created lots of confusion and made the internet gaming process less efficient; holding back the industry’s expansion. The four leading poker sites decided to take matters into their own hand and hired Daniel Tzvetkoff, an Australian based entrepreneur. Daniel was skilled in reverse engineering money transfers, and set up fronts to spread cash through US banks for ease of management. Through the process, Daniel ended up pocketing cash for himself, and when the poker sites sued him, the entire process raised a red flag with the FBI. A dumb move yes, but inevitable under a nonsensical law created to promote unsustainable cash logistics to bring down an entire industry.

The Unlawful Internet Gambling Enforcement Act (UIGEA) has the penalty of 30 years in prison and $1 million fine (or twice the gross gain/loss from the internet operation). It was set up to protect individual losers and compulsive gamblers. Gambling and trading share the 90/10 rule – that is 90% losers, 10% winners. The 90% call for protection, and everyone must bear the brunt. This industry is not for everyone, and the objective is to weed out the losers. All odds are against the 90%, and when there’s an external force that interrupts the game theory, the entire process is artificially destroyed.

Like the UIGEA, the Commodities and Futures Trading Commission poses a threat to the unconventional online trading industry. In an attempt to decrease the number of speculators, there have been many laws put forth that give hedger’s preference in trading, despite the need for a diverse exchange. Currency traders might be limited to the amount of leverage used, as many freshman traders lose large sums due to poor risk management. If you want to trade options online, you must have years of experience trading traditional equities. So many regulations that cause many to wonder what the future holds for internet based trading and gambling.

-Damanick Dantes

Sources:

“Online Poker Sites Shut Down.” Internet-Poker.co.uk . April 15,2011

“The Boy Genius Who Took Down the Online Poker Industry.” Business Insider. April 15, 2011

“Why The Unlawful Internet Gambling Enforcement Act is a Bad Bet.” Duke Law. June 30, 2008

US Treasury Dilemma Could Spur Dollar Gains For All the Wrong Reasons

2011-04-10T20:17:00.002-04:00

Another opportunity is in store for the US to lure investors by boosting expectations and preparing for growth. Just as the European debt crises began in the first quarter of 2010, history is repeating itself in 2011. This time, with Portugal and Ireland. Despite some signs of life with strong manufacturing and employment wages, the ECB will not hike rates for a while, and instead focus on structural issues. With inflation on our back, the US Dollar has the potential to reverse on speculation...for all the wrong reasons.

The era of cheap money is over, right? Not quite. There are still many underlying problems in which rate hikes will flirt with systemic danger if continued. Pay close attention to treasuries. Notes have declined recently as traders begin to factor in inflation. Yields have risen on 10 year treasuries: 14 basis points (0.14 percentage point) to 3.58% from 3.44% in March.

The inverse relationship - drop in treasury prices and rising yields - was brought upon by lower demand for treasuries in recent auctions. Investors expect greater returns as higher interest rates begin to direct the flow of cash out of government safety and into various asset classes, hopefully lending. This type of activity usually provides a boost for the US Dollar as investors become optimistic, preparing for growth, but current conditions paint a different picture.

The Dollar has consistently dropped against other currencies. One obvious reason is inflation being the immediate concern in the Euro-zone and Britain. Second, is the spike in commodity prices. Oil is up to $113 per barrel and food prices continue to rise. This is not the right type of inflation that signals growth.

Commodity prices are volatile, and this is based on supply/demand and global imbalances. The chart above shows core CPI having a steady increase along a comfortable path, but when energy and food prices are added it looks troubling. This is because food and energy are volatile, and the sharp increase back to where we were before the recession seems painful. We've been too comfortable at the dip, but still ask for reasonable prices. Perhaps we can't fight supply and demand, or it could just be a volatility problem due to global conditions. Either way, the pain of paying for the stuff is a direct result of our currency's manipulation to calm the recession.

Money supply is a major factor that influences purchasing power. Fed measures such as quantitative easing increased the money supply which gradually reduced the value of the dollar. Today's prices seem more expensive because it has absorbed the amount of money in the system deemed to measure demand for the good. Not the case when it's been tempered with. Lower purchasing power plus what seems like higher prices, coupled with a global imbalance gives us excessive inflation.

US employment has picked up with manufacturing showing a strong recovery. This is a great start, but leaves out important fundamentals. The employment rate leaves out a lot of people, especially those who have dropped out of the labor force. Many Americans lack the skills demanded by employers after years of working in one sector without a diversified skill-set. Those who continue to get denied have either accepted lower paying jobs, or have enrolled in college or trade programs. These people are not counted in the unemployment statistic. The labor force is smaller, and the remaining individuals are the ones who are confident that their skills are up to par, weighed their options, and joined the working population.

Housing is still sluggish, and is not in the right position to be bothered with a rate hike. This will transfer interest on to mortgage holders - a main concern in the Euro-zone, which is why Trichet warned that the decision is not one to last.

Government debt is also a major issue. Investors are fleeing treasuries to hedge against further government misery. PIMCO recently dumped all treasury holdings, and even decided to place shorts on government debt. The Fed, the main buyer of US treasuries pushing down the yield and raising asset prices, is thinking of starting a monetary stimulus withdrawal. This will push treasury yields even higher and create an air of optimism. The hope is that investors are blind sighted into seeing this as real supply demand of capital. Price transparency is now questionable.

Bottom line for the dollar: CPI numbers at the end of this week will increase inflation chatter. At the same time the EU will release price data, but interest rates are exhausted now, so no expectations. Expect further Portugal mess and strong US data -- consumers can afford retail goods..it's part of core inflation after all.

Fixing the US Budget. Here we go again.

2011-04-06T11:19:00.000-04:00

Yesterday, a Norwegian classmate told me that the US may go bankrupt by 2020 and has 5 days to avoid a shut down...I should consider moving now. I chuckled and chose to shy away from the conspiracy, but deep down I knew there were problems that needed to be addressed. It is true that a budget needs to be signed to avoid shut down, and our fiscal path is unsustainable. Here is some background information, and alternatives to avoid the unthinkable.

On Tuesday, House Republicans proposed their budget plan for the 2011 fiscal year. It is projected to spend $3.5 trillion, $179 billion less than President Obama's plan. The goal is to balance the budget as soon as possible - Obama plans to do so by 2015. The budget proposed by the Republicans calls for a repeal of Obama-care and includes sharp cuts in Medicaid and the gradual phase out of Medicare. The WSJ provided some specific details:

People who retire after 2021 would no longer have access to Medicare, the government-run fee-for-service health-insurance program. Instead, Medicare for them would be converted into a "premium support" system, meaning beneficiaries would choose from an array of private insurance plans, with government helping pay the premium. People 55 and older would not be affected.
Medicaid would be converted into a block grant for the states. The GOP budget estimates it would save $771 billion on Medicaid over the next 10 years. It would also turn the Food Stamp program into a block grant system.

Pundits think the House Republican budget is a lost hope. It must be approved by a Democrat ruled Senate and signed by President Obama. Despite its projected decrease in government spending from the current 24% of GDP level to 22.5% next year, the specifics will be debated. It's a better alternative on paper, but politics will surely rip it apart with the possibility of putting us back on an unsustainable path - stalling the process for sake of re-election. Let's face it, people are not ready for strict austerity measures. Both budgets lack qualitative support. The programs that are cut or eventually phased out remain inefficient. Any thought as to what drives the cost? Some programs pose great externalities, where one cut may have a ripple effect on greater economic conditions. The structure of government services needs to be efficient - using less to serve more. The demand for a smarter government trumps the argument for a mere decrease in size.

President Obama called an eleven hour meeting to fix the budget and avoid government shut down. The current goal is to cut $33 billion for this year. House Republicans argue that this is not enough. The pressure is on to make bold moves, not little cuts here and there, we need a complete revamp of social programs. The focus needs to be on costs more so than revenue. A sustainable plan will need to bend the cost curve instead of just increasing revenue to pay for something that doesn't work. This calls for better talks with the private sector who provide the services in which we subsidize. Fueling demand for costly services does nothing to solve the problem - the government can make the necessary investments to create a more efficient social services market.

There are talks of raising the debt ceiling from $14 trillion to $15 trillion for the seventh consecutive year. Nonsensical to do so as it continues the problem. We need to work within tight standards to force responsible action. Treasury Secretary Geithner argues that if the debt ceiling is not raised, there will be substantial negative effects. This coming from the guy who is in charge of selling US debt. There is an underlying interest here. The Dollar's stance as the reserve currency provides the US with the ability to run deficits and acquire more debt. But with the increasing prospects of Dollar reserve alternatives, the US needs to start taking precautionary measures to prevent a collapse. A good indicator of market jitters is the slowing demand for municipal bonds. The WSJ reports that last week was the slowest quarter for municipal bond issuance in eleven years. Local government is in fiscal disarray and its not flattering to borrowers. Continuing low interest rate levels is also a contributing factor to low demand for government debt, as borrowers don't see economic improvement by Fed standards in the near term. Most importantly, private sector borrowers don't see the possibility of greater gains through interest rates, and thus shift focus to savings or foreign investments (emerging markets anyone?). However, there are improvements as the savings rate recently declined, and employment picks up.

Private investment needs to be at the forefront of the US recovery plan. The WSJ reports:

When private investment is high, unemployment is low. In 2006, investment—business fixed investment plus residential investment—as a share of GDP was high, at 17%, and unemployment was low, at 5%. By 2010 private investment as a share of GDP was down to 12%, and unemployment was up to more than 9%. In the year 2000, investment as a share of GDP was 17% while unemployment averaged around 4%. This is a regular pattern.

The article goes on to say that historically, increased government spending crowds out private investment. The government has the responsibility to encourage productivity by getting the economy back on track so that investors will fuel growth. Not necessarily a rate hike to create the false image of recovery (as this can do a lot of harm messing with the emotions of investors). We need to create a productive environment that will stimulate expectations of rate hikes and further economic growth. Employment, housing, smaller and smarter government that spends less, and business growth are among the many variables that will contribute to our comeback.

* Above charts from WSJ. See links for full articles.

Modeling the Real World. Quants: The Alchemists of Wall Street

2011-03-31T19:38:00.000-04:00

I came across this insightful documentary today entitled Quants: The Alchemists of Wall Street. It explores the problems with financial models and how certain assumptions were made that did not account for fluctuating risks of human behavior. A striking point that many in the financial world fail to realize is that the world does not operate in a linear fashion; most certainly asset prices, given its volatility. The fact is that things change, and big firms that relied on these models failed to adapt during times of diminishing returns.

This is one reason why there's beauty in trading that many continue to bash. Ask an economist or large investor their outlook on the economy. Chances are you get a fixed prediction, something linear. They might say that the Japanese Yen is at risk to any natural disaster (prior to its rally following the recent earthquake..didn't see that one coming), or look in their little historical calendar book and say now is the time for the Dow to rally because it did so on this day for the last two years. We learn in school the difference between opinion and fact, and professionals exploit this to making any argument a fact so long as its backed by a number, no matter the reliability. Trading allows us to speculate on the given. Dantes Outlook's Global Fund (starting this April) may have an outlook, but it's constantly adjusted as it measures the mood of the marketplace. With that thought, take heed to what's explained in this short film. Enjoy.

What's Next For Japan

2011-03-18T22:57:00.001-04:00

While on vacation this past week, major news about the horrific earthquake, tsunami, and emergency nuclear leakage in Japan filled my news-feed. Constantly checking in via my BlackBerry, even besides the calm shores of the Caribbean , knowing that the waves to the West were crashing with intensity. The destruction in Japan is a terrible situation, but one that the country will leverage well.

Japan's natural disasters bring about mixed consequences. The major talk now is the Yen's rally against the dollar. Many were confused about why a currency will appreciate during such a grave disaster. The opposite being reminiscent of the New Zealand earthquake a few weeks ago. It's usual to draw this nieve comparison without a closer look into the specific fundamentals behind the Japanese economy. Government and businesses in Japan have huge savings in US Dollars, which they have to sell in order to buy Japanese Yen to spend on reconstruction. The spending will directly target sectors that require a lot of labor - construction and cleanup. The economic indicators following this disaster will be important. Employment, capital flows, and productivity are the main factors that will formulate Japan's recovery. Despite Moody's tough stance on Japan just before the earthquake; stating that the country is at a fiscal 'tipping point', its savings will give it a boost. Japan is a wealthy nation in terms of its portfolio of savings, in which its opening gave birth to a now powerful Yen to aid in recovery.

A negative consequence of a rising Yen is obvious. Exports define Japan's economy, and with its goods being expensive in international trade, there is little hope for constant demand. Japan's exports are now on a tightrope. Will partners purchase at a higher Yen and be willing to factor in the opportunity cost for higher quality goods? Technology from Japan is innovative and gives it advantage along the supply chain. Japanese automakers like Toyota will experience a decline in sales as their vehicles become more expensive for countries like the US to import. This gives US automakers like GM and Ford a slight advantage. However, key parts from Japan are delayed in shipment to major plants such as GM's Louisiana pick up truck production center. A major bottleneck in the supply chain could cripple industries that rely on Japanese parts.

The initial sell off of US Dollars in exchange for Yen was acceptable. However, a continued rally will hurt the Japanese economy. To solve this problem, the Bank of Japan intervened earlier today to sell massive amounts of Yen. This devalues the currency and makes more Yen available. The circulation of Yen will do well for reconstruction spending now that the savers have converted currency for their own recovery plans. The G-7 pledged to intervene to sell more Yen.

Japan is a unique economy, which is why the well calculated monetary actions must be followed by similar fiscal responsibilities. I don't see massive amounts of debt needed, being that the domestic capital flows seem sufficient enough in allocating monetary resources to aid in redevelopment. The Japanese government, if it continues a responsible path, will hopefully get off that tipping point and prove a lot of pundits wrong. The lesson of smart leadership brought about through crisis.

There is one major concern lurking behind the optimism. The radiation levels from nuclear plants damaged during the earthquake are dangerous. The government and scientists behind the plant are criticized by the international community (especially the US) about its cover up. Many believe that the radiation levels are far worse than reported by the Japanese government. Parts of Tokyo have been evacuated due to uncertainty. This problems needs to be a top priority, because the long term effects on the people of Japan will not be pretty.

The Yen's volatility is uncomfortable for trade entry. However, I do see a trend reversal as the G-7 prepares its intervention. There is risk that speculation will continue to push the Yen higher despite these sudden spikes of devaluation. At this point, there is more information about the monetary game plan to provide some short term trading strategy. The large US Dollar purchases will probably do well in other dollar base pairs. Follow my live trades here.

What Should the US Do About Rising Oil Prices?

2011-03-08T12:19:00.000-05:00

Unfortunately, this question seems of high importance when energy prices rise. However, people tend to forget about the problem when prices decline to normal levels. The fact of the matter is that high energy prices are a good signal to whip us into shape. The longer we wait to correct the problem, the more susceptible we are to volatility.

The truth is that oil is in low supply, and in high demand; thus reflected in its price. If the supply was of comforting amounts, 8% threats would be of little concern. Too much of the world is dependent on the Middle East for its oil imports, and too many in the west fail to realize the impacts of continued demand for the stuff. Does it not seem odd that most of our foreign relations and wars are focused in the very region that fuels our economy? We need a comprehensive energy plan - an all of the above approach. This is one sector of trade in which some degree protectionism works. Energy production for domestic consumption trumps the status quo. America is abundant in natural gas, solar and wind corridors, and more.

We can leverage this opportunity even more by utilizing NAFTA to operate what I call a strategic North American Energy Alliance (NAEA): tapping into onshore and offshore drilling areas, contributing to our strategic oil reserves, natural gas exploration and development, incentives for cleaner and sustainable drilling innovation, expanding the wind and solar corridors to power grids that connect the North American continent. Canada is already skilled in extracting oil from tar sands, most of which exported to the US. Mexico's control of most of the Gulf region contributes to their comparative advantage in oil, exporting to the US. Our contribution needs to be significant. We need to produce enough for domestic use, and then some for the export advantage to China and India. If anything, we need to act fast on a plan like 'NAEA' before China does.

There are many ideas on the table. Bowing down to the Saudis should not be one of them. James Cramer, the energetic host of Mad Money on CNBC made this statement:

First, Cramer said the government needs to sell oil futures contracts against our strategic reserves to stop the jump in oil prices. Second, the U.S. government must be vocal about its support for Bahrain and Saudi Arabia, which will help prevent unrest from spilling over into these regions. Finally, Cramer said Congress must pass the natural gas act to subsidize 18-wheelers converting from oil to natural gas.

The government and US based oil companies already sell oil futures. But, apparently its not a fix all solution. The price we pay at the pump could be so much more if it were not for the futures market. The fact that there is so much panic over near $4 at the pump means we are in serious trouble if the 'real' price comes to light. I'm in support of the Natural Gas Act, and of course for the US having its two cents about peace in the Middle East. However, the massive amounts of aid and imperialist like influence in the region is disturbing. We are disliked because of our influence, no matter how much we try to mask this with a message of peace. The aid flows stir violence to create an unstable society for the US to offer a promise of modernization ("a human right?"), all for the control of what lies beneath the sands of Arabia - that is oil. It's a long term agenda that will leave us in a world of hurt. It's better to hone in some domestic strategy opposed to meddling with so called buddies who play us blindly.

Here's a video of former Vice Presidential candidate Sarah Palin. Her remarks on the need for energy independence are spot on. Our abundance in resources are clear, and its about time we use this.

I'm also a strong supporter in an all of the above approach. T Boone Pickens also has a plan that will reduce our reliance on foreign oil.

Oil Prices Expected to Soar, Stifling US Growth

2011-03-06T18:21:00.000-05:00

Last week, data showed that the United States is picking up slowly. However, there are still some areas of concern. The Beige Book reported moderate expansion with solid manufacturing but rising input costs because of inflation. Home sales and construction continued to decline; especially in Atlanta and Kansas City. As productivity increases with higher costs, businesses might hold back on hiring.

However, the unemployment rate dipped below its 9% range to 8.9%, its lowest level since April of 2009. ISM numbers increased to 59.7 in February from 59.4 in January; readings above 50 signal expansion. Initial jobless claims fell by 20,000 to 368,000 last week, the lowest since May 2008. Consumer confidence was also given a boost with personal income up from 0.4% to 1%. Personal spending and consumption remained flat at 0.8% and 0.1% respectively.

Its not yet time for cheers of a recovery. Construction spending fell to -0.7% from -1.6% Pending home sales are up from -3.2% to -2.8% but still not acceptable. The initial release of positive data caused investors to break free from the safety of US bonds as 10 year Treasury prices fell 16/32 to a yield of 3.531%

Fed Chairman Bernanke voiced concerns about the fiscal conditions on the state level. At the Citizen's Budget Commission's annual dinner event, Bernanke stated that the Fed will continue to monitor the municipal bond market closely, and that states need to stabilize revenue streams. This comes after several economists raise concern about the risk of state debt defaults. Meredith Whitney, and now Roubini Global Economics report that states face major issues in repaying debt and maintaining sustainable budgets. Defaults are likely to occur from small projects deemed unimportant, but will add up. States like Wisconsin are starting strict austerity measures by tackling unions and other forms of unsustainable spending. Like states, US manufacturers are set to experience the pains of high costs as oil is expected to continue to rise in the weeks ahead.

Oil and other commodities will continue to be the topic of discussion this week.US manufacturers will notice higher input costs, and struggle to gain foot. Zerohedge reports that the United States is reviewing the option to tap into its strategic oil reserve to cool prices. However, at the same time China is looking to buy more oil to keep in reserve for their own future use as a hedge against high prices. Tricky situation for the US, but more confirmation that China's demand will continue to raise oil prices. With this in mind, a long position in the Canadian dollar will provide some speculative gains this week.

Meanwhile, the European Central Bank kept key lending rates unchanged for the second straight month. ECB President Trichet expressed his worries about inflation and overheating in Germany and other Eurozone countries. "An increase in the next meeting is possible" he said. The ECB will probably not raise the key lending rate, but revert to some other light monetary tightening. This prediction is backed by the recent warnings by the IMF that the ECB should not pursue aggressive tightening. Employment and housing are still sluggish. There seems to be more concern about the periphery instead of the major countries at hurt. Mortgage holders will bear the brunt of a rate increases in countries such as Spain. Europe is in a similar position as the UK, which kept rates unchanged despite 4% inflation. They too should refrain from tightening. Expectations of a rate hike next month sent the euro and bond yields higher.

This week is light on data releases, so oil will be in play. Also, New Zealand will make an interest rate decision. Analysts expect New Zealand to cut rates after hefty spending to recover from earthquake damages. There was also the fear of its credit rating to decrease as the country struggles to balance its fiscal position in the wake of the natural disaster. Overall, the economy is still growing like its sister country Australia. I predict rates to remain unchanged, but investors should be prepared for a rate cut. Either way, the Kiwi will continue a decline.

Stark Choices Ahead for America's Future Concerning Education

2011-03-02T10:55:00.000-05:00

It's clear that the United States is on an unsustainable path. A major threat that I blogged about last month is the fear of an alternative to the US Dollar reserve currency. After decades of running budget deficits to retain the flow of dollars around the world, handling debt without global demand will leave us in serious pain. Structural issues such as sluggish employment and trade imbalances pose a great threat as well. The US economy depends on high skilled labor to produce its industrial exports.

Roughly 80% of the US population's highest source of education is high school. Only a few go on to college, and at most take on skilled education using special programs to become certified or community college. However, the demand is high for the highly educated, yet unemployment is at its highest among those with lower education. This means the supply of high labor is low. The most interesting statistic is the distribution of occupation as it relates to education attainment in the United States. Most highly educated individuals are employed in the professional-managerial field, whereas people with just a high school education are employed evenly in various fields such as management, service, construction, to farming. So, is higher education really that much of an importance? With a glut of highly educated individuals, the pay rate will probably decrease. Look at China, generally low per-capita income, but highly educated population which lacks domestic innovation with structural problems of its own.

The major factor involved in skilled labor starts out with education, but in the long run it's all about experience. People with low education are trained with incentive to elevate. Eventually, some return to school, or become the innovators and managers employing foreigners with high skill. Education in the United States is a problem because it lacks choice. If students learn about choice and competition at a young age, imagine the possibilities of the next generation to tackle the inherited problems of such massive scale. Americans need to be independent and choose their education needs based on demand. A high school educated entrepreneur should not be looked down upon in statistics, so long as they are productive in whatever they do.

Reducing choice forces people into a system in scarce supply. For people who have accumulated living expenses paid for by a good job income - once they lose that job, they demand another job equal to or greater than previous pay. Meanwhile, jobs that require very low skills are available for less pay - those forced through a system without choice rather just stay unemployed and wait it out.

We need to reform education from the start. Here's a revised post about the education game plan:

Experience is the best teacher. For this reason, I look back at how I tackled problems in the education system to get to where I am today. I now realize that the start of my success began in elementary school, thanks to a solid local education system gone rogue.

I received a great education at my elementary school, P.S. 103 in the Bronx. I also had parents who were involved and had the mindset that education does not end outside of the classroom. My mom always pushed me to study hard and master the material from school so that I could go anywhere for college and become successful. I was trained to excel in education so that college finances will be covered through merit based rewards. When I entered fourth grade, New York issued standardized exams that judged your understanding of reading and math and ultimately decided your promotion to the next grade. Exams were a wake- up call to stay on track with my education. Class sizes in elementary school were average (about 20 students per teacher), but this number gradually increased as the neighborhood population soared and more children attended the school. In fifth grade we were given the option to attend a Prep School or Arts School for Junior High. Some applied for the Prep School and attended with financial aid awards, while others remained in P.S. 103 where they were given another chance to apply with the same options for Junior High School. A large number of students were accepted into the Arts and Prep schools, whereas the few remaining students went on to the local public Junior High School. This was when I began to understand the workings of the public school system.

As I progressed through High School, the issue of over-crowded, poor quality schools became intense and I always remembered how my elementary school in the undiscovered corner of the Bronx tackled the issue very well. If this strategy were implemented on a state or even national scale, imagine the outcome. More students will be concerned and motivated about their education with hopes of advancing to greater schools that were once thought of as financially impossible. Best of all, parents and students are given the choice to make their education work. Through my research, I discovered that this system exist across the nation. It is called the Voucher System and it’s a popular topic in Utah (referendum 1). Statistics show that Utah taxpayers spend about $7,500 to educate each child; 50% comes from state funding, 34% from property taxes, and 8% from federal funding. With overcrowding on the rise, government is faced with a serious economic problem of allocating enough funding to accommodate these extra students. The quick solution could be to simply raise taxes, but why should residents suffer when the problem lies within the individual student.

There is a conflict between struggling, average, and gifted students. No Child Left Behind (legislation put forth by President Bush) provides additional funding for struggling schools in order to help students who are behind according to national standards from state exams. I am confused as to how this helps the overcrowding issue and places attention on helping students. This is a bill that needs serious reform. No child should be left behind on a choice; give students and parents the power in deciding what is the best alternative for their education. Also, throwing money at the problem does very little to tackle the quality of the supply – teachers. We continue to reward all teachers on an equal playing field despite wide performance variations. Does a poor teacher whose students continuously perform below standards need more federal money? Children have no voice in the process. Integrating all levels under one public umbrella is shifting focus and resulting in poor results. This leaves our nation’s students behind. The students who want to go elsewhere should use a portion already allocated for them through public education funding for a private alternative. After all, the lump sum of funding already given by the public is a free voucher. Why not issue a voucher with choice to students who wish to advance their education and leave a system that is failing them. When these students are aware that this option exists they will try hard to receive the best education they can. Students will then scrutinize poor teachers, and command equal education quality compared to their hard work. Students will demand a fight to the top, score well in admission to specialized public schools, charter schools, private schools, (judged on merit, not lottery).

Greater choice will reduce class sizes in public schools and increase funding for the remaining children in the public schools by using the left over amount unused by the student going elsewhere. This will also increase teacher salaries in both sectors of education and provide them with the resources they need to help students advance so that they can try again and put their vouchers to use.

Studies show that the remaining students in smaller class sizes will do well in a focused environment dedicated to educating everyone on a personalized level. Some, including myself were concerned about private expenses (wondering if the voucher is enough to cover these students). On average, tuition for grades one through three is around $15,000. In Utah, the individual student will be given $3,000 out of their allocated $7,500 public fund for tuition aid (voucher). This of course will be backed with extra government grants, private aid, merit based scholarships, etc. As for the public system, schools will keep the extra 4,500 unused by this student to help the remaining students on a smaller scale get to the same position in education and ultimately advance from that point on.

This is how I see No Child Left Behind working – we increase choices. The focus should start with preventing the spoiling of our nation's children each year. We fail a generation each time we continue to use this same system of failure.

Global and US Energy Report

2011-02-28T23:45:00.000-05:00

The following article appeared in the Babson College Financial Report's Energy Section, by Mr.Dantes

Global Energy Conditions:

For the week ending February 25^th, Crude Oil price rose to a 29-month high. Its 8.4% gain is the largest since March of 2009. The spike in prices is due to the recent unrest in North Africa and fears of chaos spreading throughout the Middle East region. The major concern is the risk of Libya’s crude supplies falling short to meet demand. According to the Oil and Gas Journal, Libya boasts 46.4 billion barrels of oil reserve holdings as of this year. A weekly report by Futures Pros states that suspended operations in Libya’s oil fields are escalating. Among the top companies placing a halt on supplies are French Total SA, Norwegian Statoil, Chinese Petro China, Italian Eni SpA, and Royal Dutch Shell.

The New York Mercantile Exchange (NYMEX) reports Light Sweet Crude ending the week at USD $98.20 per barrel. However, prices were given a slight boost as Saudi Arabia and the IEA made a pledge to fill the region’s supply chain gap by releasing crude oil supplies.

Libya is not all about oil. This is one fundamental fact that speculators must realize. According to the Energy Information Administration (EIA), Libya has 55 trillion cubic feet of natural gas – much of it is used domestically, accounting for 45% of the country’s electricity needs. In the export realm, natural gas is more productive than oil in the make-up of Libya’s trade advantage. Libya’s oil exports reached its peak in the late 1960’s, and since then natural gas exports have risen dramatically; increasing the spread between gas exports and domestic consumption. The country’s energy wealth is enough to make it a sustainable trading participant in the North Africa region. The pipelines that link Africa with Southern Europe, flowing west into the Middle East and Asia, then converted to LNG en route to the West on tankers, all start with the natural gas abundance in countries like Libya. The fears about supply constraints are mainly speculative.

United States Energy Watch:

Crude Oil supplies in the United States are struggling to gain foot after declines from December through February. The EIA projects a rise in oil production to 5.6 million barrels per day in March, while imports fall to 8.5 million barrels per day. However, projected weekly inputs are down, while monthly projections are up. The spread here shows a forecasted short term boost in domestic production, but a longer term squeeze.

An area of importance is the WTI Brent Spread – a particular type of Crude Oil. Brent prices have been relatively flat this past week, while other crude oil prices rose. This spread signals excess supply of Brent that will eventually run low, as hedgers buy more in anticipation for higher prices later; a natural market correction. So long as the spread lasts, speculators will gain through arbitrage – selling Brent while buying other Crude Oils. Brent did tighten due to supply problems and maintenance in the North Sea – its source of production. There are also maintenance issues in the Gulf region, a main arrival artery in the West for Brent.

Meanwhile, natural gas storage is down to 1,830 billion cubic feet in the United States. Rig counts are down by one, and transport conditions are weak. A recent eruption in northern Ontario and maintenance in the Gulf are placing pressure on supply.

Sources:

“Crude Oil Futures – Weekly Review.” Futures Pros. February 27, 2011

“Natural Gas Weekly Update.” EIA. February 24, 2011

“This Week In Petroleum.” EIA. February 24, 2011

“Libya Country Analysis.” EIA. Las Updated: February 2011

Libya's Butterfly Effect on the Global Economy

2011-02-25T21:26:00.002-05:00

According to Wikipedia: The butterfly effect is a metaphor that encapsulates the concept of sensitive dependence on initial conditions in chaos theory; namely, a small change at one place in a complex system can have large effects elsewhere

The world is a complex system, and the shake up in Libya has a large affect on international business. The flow of money is experiencing a wave of volatility reminiscent of the paper currencies floating about through the storms of global politics. This is the essential theory behind the butterfly effect; applied to the economics behind resource and capital constraints.

Libya is an energy rich country sharing the pains of freedom fighting protesters as seen throughout North Africa and the Middle East (especially Egypt, Algeria, Tunisia, and now Iraq). It's much hated dictator Moammar Gadhafi has no intention of stepping down. His first video announcement in response to the protests only denounced rumors that he has fled to Venezuela. Gadhafi stated that he will remain in Libya and 'die a martyr'. The protesters raised their voices in response to the stubborn dictator. Ghadhafi then opened fire on the streets of Tripoli, only to increase the violent conditions throughout the region.

The unrest in energy rich North Africa and the Middle East created panic in dependent industries. For one, the rich dictators and members of the North African elite quickly increased their cash base in Switzerland, causing the Swiss Franc to soar against all other currencies. However, as Switzerland remains a nation of secrecy in terms of banking, they have a responsibility of transparency as a 'neutral' country. Switzerland's Federal Department of Foreign Affairs placed a freeze on Gadhafi's assets in the country in support of the world's calling for his resignation.

Why not the US Dollar as the desired safe haven? Too many structural issues in the West and the risk of it's depreciation in value as oil rises, makes it less attractive as it stands aside the Swiss Franc. This week, US economic data did little to support our standing in the world to attract foreign holdings amidst unrest. Consumer confidence, durable good orders, and housing all came below expectations. This moment supports the reasoning behind the world's lost hope in the reserve currency.

The US Dollar/Oil spread widened throughout the protests. Oil hit $100, only to slide back a bit, but remains flirtatious in a worrying price range. Libya is a main producer and exporter of energy (mainly to southern European countries like Italy). The country has 46 billion barrels of oil reserves; the largest in Africa. Libya also has 55 trillion cubic feet of natural gas, and boasts 1.8 million barrels of oil per day (2010 figures). Despite large oil reserves, production peaked in the late 1960's as natural gas exports grew strong. 45% of Libya's electricity is from natural gas; and the country has enough left over to export. This data shows that Libya's energy is sustainable for domestic consumption and exports to support itself. However, the dictator calls the shots - the resource wealth is essentially in the hands of Gadhafi - and energy plants have decreased production throughout the political unrest.

It's important to realize that the world does not circulate around Libya. Certainly it's butterfly effect has gone rampant, but the supply chain can adjust. Mathematically, the theory shows chaos in steps - starting from a simple move creating waves of response that bring about bangs of opportunity. Opportunity because these new events become the nucleus of a new orbit, given leverage to other spirals of wings. Good only comes from bad. Thus, Saudi Arabia, a key link the region's energy supply chain, pledged its support to fill exports of gas to southern Europe and the rest of world. OPEC nations are surely strengthening their models, and southern European nations like Italy are tapping into their own rainy day reserves of energy. This is not the end all, it's just the beginning..hopefully a realization about dependency.

Meanwhile, Libya's energy conditions are much like the US. Having large oil reserves, and natural gas productivity, the US sits on a wealth of energy resources put aside for the sake of strengthening foreign relations. Libya has a greater energy export economy, but holds a lot of energy in reserve to cater to the gas demands of its neighbors (most pipelines carry natural gas in the region). The US and Canada have a productive partnership in the same industry. We need to realize the butterfly of Libya, and strengthen our energy markets at home. It's enough of a blow that our reserve currency was put to shame by the Swiss Franc. The US Dollar is under the command of oil, when it has the clear opportunity to break away from the fray.

Strong US Consumer Confidence, Europe Inflation Talks, Libya Protests, and New Zealand Earthquake

2011-02-22T22:25:00.000-05:00

Today was an active day in the markets; which means the Global Fund ended up positive. After dropping on risk aversion, the Euro rallied after ECB member Yves Mersch said that the central bank may warn of upside inflation risks at its next meeting on March 3rd. Meanwhile, protests in Libya contributed to oil's 7.63% gain, while gold slipped 0.56%. The US dollar gained some foot afterwards as investors looked to protect their holdings. Consumer confidence in the US rose to its highest in 3 years, beating expectations to a reading near 70. All the wile, fear rose about New Zealand's potential credit rating cut because of the government's continual spending on disaster relief - most recently the Christchurch earthquake.

The Euro will have two scenarios this spring. The first being more realistic - the ECB crafting a bailout fund, and inflation being a main point of concern, especially as good manufacturing numbers continue to show in Germany and countries along the periphery. Second scenario - ECB and IMF realize that Spain and Portugal will not be able to fulfill its debt obligations as yields continue at unsustainable levels (7%), and attempt to usher in a bailout to end the PIIGS, sending jitters across the markets. However, the swift move might work to the Euro's advantage. ECB officials should pay close attention to the housing and labor markets - both sluggish - before they attempt to tame inflation.

BOE minutes will come out tomorrow, and analysts expect more support for a rate hike given UK area inflation. So far, two members voted in favor back in the January meeting.

The US is continuing to show improvements, but unemployment and housing remain a serious problem. Inflation is a great concern as it cuts into business margins.

Data Shows China Can Withstand Droughts

2011-02-17T12:05:00.000-05:00

FROM OUR FACEBOOK PAGE: As world commodity prices continue to rise, all eyes are on China's supply constraints due to the country's worst drought in decades. However, China ramped up imports of wheat prior to the drought, and can use some stockpiles to ease price pressures and keep exports stable. The main importer of wheat is Egypt, and many analysts are concerned that lower shipments of wheat to a nation in turmoil will not help the revolution as agriculture prices surge, picking the pockets of the those millions of protesters. Quite an extreme scenario, but I project conditions to stable out. View the entire Facebook Note here.

Chinese wheat dynamics, 2009-10 (annual change) according to USDA

Production: 114.5m tonnes (+1.8%)

Imports: 800,000 tonnes (+67%)

Use: 103.0m tonnes (+0.5%)

Year-end stocks: 60.0m tonnes (+23%)

Dangers Ahead for the US as IMF Plots Dollar Alternative

2011-02-11T16:01:00.001-05:00

On Thursday, CNN Money confirmed that the IMF is in fact determined to seek an instrument to replace the dollar as the world's reserve currency. Sources say that the IMF prepared a 30 page report, much like its usual annual report, giving strong support for SDRs to be used as the world's reserve instrument.

Special Drawing Rights (SDR) was created by the IMF in 1969 and is based on a weighted basket of various currencies. The collapse of the Bretton Woods system raised a red flag in the international funds market, supporting the need of a more diversified system. Today, SDR is the typical IMF lending product to countries. It's a less volatile alternative weighed heavily by four main currencies: Euro, Yen, Pound Sterling, and US Dollar.

The goal is to diversify the world currency system. The IMF wants to reduce its dependency on US Treasuries by using SDR-denominated bonds. Pricing gold and oil in SDR terms instead of the US Dollar is expected to decrease volatility. Analysts say IMF nations should agree to create $2 trillion in SDRs over the next five years. The actual structure of reserve type SDRs will be difficult to craft and will take time, effort, and high costs for central bankers and global trade participants to adjust. And for the US, this will place us in terrible shape as the realities of years of economic folly at international will come to light.

As the chart in the right picture displays, the purchasing power of the US Dollar declined 94% in the 76 years of child-like economic discipline from 1933-2009. Under the Bretton Woods system, countries had to back their currency by gold reserves (the gold standard). This ensured stability and actual trust during the exchange of money between governments. However, around the 1930's following the US Great Depression, the Federal Reserve decided to exit the gold standard to stimulate growth. Being a reserve currency strengthened our reason for doing so - borrowing more money by issuing US Treasuries increased global circulation of US Dollars. Running deficits allowed the US government to increase global power, creating this image of structural strength as the world's reserve currency. Since then, the gold standard was abolished, and the US rapidly increased spending in defense, social entitlements, and foreign policy in terms of aid - all funded through debt. However, economists cite the Triffin Dilemma - the imbalance in the current account of the balance of payments; the fundamental conflicts of interest between short-term domestic and long-term international economic objectives.

The US was used as a pawn by the international community. Within the next decade, the US will struggle to return to fiscal sanity as we try to correct our debt burdens. SDR is a clever instrument that will leave the US in serious pain. The IMF is in the business of forecasting economic declines, and it secretly knows that the US is on an unsustainable path as we maintain the reserve currency only to continue domestic hardships. As the demand for Treasuries decrease, how will we fund the operations that are we hold dear to our culture? The spending spree became a footprint of US norms after the gold standard - we always borrowed our way out. The spirit of our independence from British rule was completely forgotten. Washington warned us about meddling in international affairs, and the spirit of American ingenuity was that of structured growth. We borrowed from the British to fund the industrial revolution, but payed it back in full - an actual investment with ROI.

Meanwhile, like the IMF, China is diversifying its currency holdings. The world will soon depend on China to consume and assemble; and for the US, our debt will increase China's presence on our soil as they seek leverage to gain power.

With or Without Justice, US Health Care Remains in Serious Trouble

2011-02-08T12:43:00.000-05:00

FROM OUR FACEBOOK PAGE: In today's New York Times, Laurence H. Tribe has an opinion piece entitled On Health Care, Justice Will Prevail - citing some legal similarities between the US health care law and the current social security system. Tribe is a constitutional law professor at Harvard. However, his op-ed is debatable.

Tribe states that since the social security system taxes all US workers to combine revenue in a disability insurance pool for everyone's qualified use, it is legal. This is correct. He then goes on to state that by this logic, the health care law, which has voluntary participants operating in interstate commerce within a shared insuance pool is legal. This is correct. Building on these facts, Tribe sees it as correct to state that since social security relies on everyone to pay in (an impossible opt-out since the tax is an automatic deduction from wage pay), the health care law's mandate is legal. Not quite.

View the full Facebook Note here.

Hushed Data Shows China's Rapid Demand for Agriculture

2011-02-06T18:17:00.002-05:00

DATA WATCH: Reputable organizations in the US and China provided expectations backed by secretive data that suggest China's shift in trade strategy. During the country's expansion, much focus is placed on industrial demand. Although this sector of trade remains strong, much of China's demand will consist of agriculture.

China's January PMI readings dropped to 52.9, below forecasts of a moderate decline of 53.9, signaling a slight drawback in manufacturing. However, PMI numbers were kept within a tight 51-55 range throughout 2010. Industrial orders are expected to remain in this range because of a domestic pullback as the Chinese government controls industrial expansion. Meanwhile, the strategy is to leverage inflation and fuel the agriculture markets even more.

Fifty years of history show sufficient supply of corn to meet domestic demand in China. As time passes, imports tend to increase. According to the Financial Times, from 1978-79, China imported 3m tonnes of corn. From 1994-95, imports increased to 4.3m tonnes. The US Grain Council released data from unnamed sources that show China's shortage of 10m-15m tonnes of corn. Usually, the Chinese government keeps 30% of corn in stock, but sources say that that the government will only demand 5% in corn holdings. This means that China will need to tap the trade market for 9m tonnes of corn.

The strategy will surely increase the world's dependency on Chinese demand. As inflation increases their purchasing power, which will then fuel domestic demand, China will continue to be a strong trade participant. The game shift to agriculture is expected to prevent future economic shocks of inflation, which many investors worry about. Increasing imports of agriculture will increase supply, and thus decrease food prices in China. The current large demand for food in all developing countries places heavy pressure on production - but supply constraints brought on by weather, raise prices. China realizes this, but has a plan to make it work.

Remember, the 5% corn stock is just an estimate. There is probably a bigger story behind the statistics. China is known for keeping extra supplies by offering subsidies to hoarders. This extra stock kept within China will offer more opportunity for price control as food imports add to the increased supply of agriculture.

China's demand for corn is a great opportunity for the US. Corn is to America what oil to is to Saudi Arabia. The US will need to ramp up production to fulfill both domestic and Chinese demand. The US is a major consumer of corn, being a prime ingredient in almost all foods. An increase in production will be a strain, but subsidies will most likely help.

Some analysts worry that the currency appreciation of the US Dollar and Aussie will affect trade with China. But, the Yuan is also rising, increasing China's purchasing power. Australia and the US have farm subsidies to help offset this risk.

Expectations of wheat imports are up because of the worst drought in 60 years in the Shandong region of China. According to China National Radio, unnamed sources provided data that suggest China's imports of wheat to exceed 114.5m tonnes. Dantes Outlook reported our findings of a recent order from China to the tune of 150kt in feed wheat from Australia - 3 cargos of shipment from March-April. The demand is intense, and the opportunities for investors are clear.

All eyes are on Australia, with stronger growth forecasts. The RBA stated that economic activity is expected to expand at an annual pace of 4.25%. The increase in industrial and agricultural production will fuel employment, which will then equate to stronger household spending. Traders are busy factoring in their expectations for an RBA rate hike sometime this year - chances are after the natural disaster damages ease.

AUD/USD Daily Chart. Clear point of entry for a long term trade considering the due diligence of this post.

Global Manufacturing Leads the Recovery

2011-02-02T11:06:00.000-05:00

The manufacturing sector suffered the worst decline throughout the global economic slowdown. However, recent economic data points to a pick up in activity - but areas of caution remain.

Let's start with Australia. The country's prime location and export dependency make it a key indicator for the projected trade activities of Asian giants. Australia's manufacturing sector is off to a slow start in 2011 with PMI largely unchanged and below 50 - indicating a contraction in activity. Firms remain cautious, resulting in inventory declines and lower ordering numbers mainly in construction. The cautious attitude comes amidst a 'fading' resource boom. China's demand for Australian resources is falling off a bit, below expectations of its assumed positive sloping demand curve. We'll get back to China later in this post.

Here in the US, the manufacturing sector is rising at its fastest pace in seven years. The ISM report shows employers' positive outlook on future hiring. ISM numbers are currently at 60.8, well above the critical 50 mark, indicating strong growth. The Fed will continue its $600 billion in asset purchasing (QE II), but ease down in the long run, so long as employment and manufacturing follow an upwards path.

Another important indicator is the housing market, which is still on the decline. The US Commerce Department reports that construction spending fell 2.5% in December 2010 - its lowest level in this decade of convex activity.

There is good news on the corporate front. US companies are reporting stronger financial standings, with positive earnings forecasts for the early quarters of 2011. The picture looks even better in the small business sector. According to Thompson Reuters/Pay Net Small Business Lending Index, borrowing by small businesses is up for five months straight. The auto industry is led by General Motors (GM) and Ford, reporting an increase in sales by 22% and 13% respectively. A remarkable comeback for GM after its tumultuous financial standing. The US auto companies are expected to pick up hiring (especially in the Detroit area; currently facing near 12% unemployment). GM and Ford have since re-focused strategy towards lower costs and more fuel efficient innovation, equating to a demand for talent.

The US economy is up 3.2% on an annual basis - from the last quarter in 2010.

Europe manufacturing is also booming, mainly led by Germany. For a candid visual analysis of January PMI graphs in the Euro-zone refer to my colleague Edward Hugh's Facebook blog.

Despite strong ISM numbers in the US and Europe, there are still slight problems ahead. For one, Australia remains sluggish, which is not a good sign about direct demand from emerging markets. It's clear that something is up in the East.

Here's the problem. The global wave of inflation = higher input costs = pressure on profit margins. Businesses will need to find ways to absorb this before domestic consumers start to heavily economize. The high input costs begin in Asia. China has some structural problems - domestic inflation and a shortage in young factory workers. The Asian giants that specialize in the physical manufacturing of export goods to the west (such as Thailand and Vietnam) meet a block in the supply chain when the first batch of goods arrive in China. The lack of factory workers who are demanding higher wages to fend off inflation, create this inevitable input cost on the finished product. This in turn creates higher priced goods in the US and Europe.

On the other side of the trade equation, the Chinese government plays the game well. Domestic inflation is sending the Yuan higher, which means greater purchasing power for more imports. However, the rising value of the Australian Dollar makes resources goods down under less attractive. So, we can give Australia some slack in our model that measures the direct conditions of Asian demand.

I say this is a short term problem that has a lot of room for correction. Latin America also has a problem of rising currency values, but governments have worked to push the value lower to make export goods attractive for Chinese demand (hence the currency war). And to fix China's input cost problem with its shortage of young factory workers - look towards India. A nation with a large population of young workers, mainly working in outsourced industries from the West, but also capable of picking up factory work to keep the Asian supply chain network in tact.

European Rate Hike? Close, But No Cigar

2011-01-30T22:10:00.000-05:00

The European Central Bank (ECB) will meet later this week...and not raise rates, contrary to popular belief. Inflation is now the center of attention in the global economy. It's certainly supported by some measures of quantitative easing (QE) by the large economies. Inflation is seen clearly in the surge in commodity prices; partly from supply disruptions in oil and agriculture. Bond markets responded with higher yields, and the currency market sent the Euro to its highest levels following past months of declines from debt woes.

The Euro-zone is still risky, and now is not the time for a rate hike. Trichet continues to press for better fiscal sanity, while Sarkozy and Merkel work on more monetary support for struggling countries. Portugal will host another round of treasury auctions at the same time of the ECB interest rate meeting - strategic time slot, say if the auctions go bad or credit agencies voice concerns again, hopefully some positive remarks by ECB heads will help the Euro -- or if rates are kept unchanged, a successful bond sale will lighten the mood. The bottom line is that the foundation is still being built, let's not get ahead of ourselves.

However, the UK is one to watch. With inflation above target, and 2 votes for a rate hike back in the January meeting, there's some cool jitters about a spunk in the economy. But, the expectations are high, and the UK hasn't delivered what the markets want yet. 4Q GDP came out low, and Governor King states that he wants wages to go up, and better determine risks.

Overall, the markets don't forget about risk. The risks of a double dip or deflation. The big economies are still in a tight fiscal condition. The US is under threat with debt levels reaching its ceiling, and tough lash outs from Moody's about a possible slight credit rating devaluation if we don't get our act together. The Euro zone still has problems with debt, unemployment (especially Spain near 20%). All of this should press Central Banks to support more inflation. Remember, even the US Fed continues to set high targets on inflation because they have factored in slight up-tick moments like the present situation. It's simply not the right kind of inflationary condition for a rate hike.

The markets are rallying up because they are increasing their expectations, but I predict it's a build up of excitement. Countries have a long road ahead, and a lot to prove. Also, where's the talk on the housing markets - a key indicator for any possible rate hike. It's still in the ruts, and a rate hike in the Euro zone will severely hurt Spanish mortgages. The US is in no condition either to afford rate hikes amidst mortgage modifications. It's simply absurd to not even include employment - a major problem in all major economies.

We will have to wait this one out. Investors will have a close eye on these upcoming series of economic data, and expect currency values to drop back to previous levels.

Terrorism Doesn't Stop Russia - Being Optimistic in a Violent World.

2011-01-26T18:34:00.001-05:00

Below is an interesting video that sums up the effects of the recent terrorist attack in Russia. Terrorism definitely places a dent on any economy, but it also provides leverage for speculation. Entering at a dip in an existing strong economy can be a good thing for some businesses. Some speculators place bets on Russian security stocks. Others, like Dantes Outlook, keep an eye on violence, but see the long term conditions in Russia as stable - especially since the oil industry is booming.

Violent attacks cause everyone to raise a red flag about a country, but it also provides a window into the existing economic conditions of a particular country, which can unearth some investment opportunity. By now, the world is used to violent acts, but the opportunities are still unique. For example, the recent uproar of protests in North Africa, gives us more information about Egypt's unsustainable fiscal path - the shouts of protesters are well heard amongst global economists for sure. In light of this, there is new investment opportunity in South Sudan, even during some violent episodes. South Sudan's vegetation and oil fields provide untapped opportunity that can potentially yield greater returns to overpower economic affects of violence, which by now is a given. As always, the greatest potentials come with more risk.

Chart of Note: Aussie Lower on Weak Trade Data, but Hope Lies in Agriculture

2011-01-20T20:24:00.000-05:00

Just now, the Australian import and export prices were released: export prices fell 8.1% from a quarter ago, while import prices fell 3.8% from a quarter ago. This illustrates lower yield from trade for Australia.

A month ago, I raised great concern about Australia's trade sustainability with China. This mainly because of China's rapid expansion that is set to cool down a bit as the country tackles domestic problems such as inflation.The demand for goods abroad will remain high, but sluggish based on its known buying frenzy trend. Weak reports like this don't mean well for Australian investors; most notably the Aussie.

I also suggested that Australia make stronger ties with India. However, the Indian government expressed concern over its widening trade gap with Australia:

In 2009-10, India's exports to Australia stood at just USD 1.38 billion, while imports amounted to a whopping USD 12.4 billion, translating into a trade deficit of about USD 11 billion for New Delhi.

Krishna "urged greater flexibility and requested for early action on issues that impacted India's exports to Australia, especially in service exports (IT) and products such as pharmaceuticals, mangoes and table grapes," it said.

However, Australian Foreign Affairs Minister Kevin Rudd said Australia has an open market and welcomed Indian trade and investment, it said. - The Economic Times

However, there is hope - a great opportunity actually. The demand for agriculture is sure to grow as China's domestic inflation needs to be tamed - most importantly, food prices. Reuters reported yesterday that China purchased 150kt of Australian feed wheat (3 cargos of wheat shipment for March/April).

In 2010, China imported 1.23 million tonnes of wheat, 36 percent more than in 2009, which saw a big shift from net exports the previous year. China normally imports to meet demand for high quality bread and cakes at the top end of the market, but it is under no pressure to import because it holds large reserves. - Reuters

Food prices in China have shot up by about 11%. Raising the supply of agricultural products will work to decrease the price burden on Chinese consumers so that they can continue to demand other goods to keep China's economy kicking. I hope traders realize this opportunity for Australia.

Debating Michel Barnier on Bank Bonuses

2011-01-18T16:40:00.000-05:00

Today, Michel Barnier, EU's financial services commissioner proposed that "banks use moderation in setting bonuses while the economy suffers." The problem with this, as raised by The Economist, is that taxpayers now hold such a high stake in the banking system from bailouts. Retaining top talent to innovate our way out of this mess will provide a good return:

The right approach towards bonuses has three struts. First, the value of the state-owned stakes should be maximised. That means paying for good managers to clean up these firms: the boss of RBS, though pilloried for his pay packet, is making a decent fist of things. About a third of RBS’s value sits in its investment bank. To maintain its worth it must compete to retain staff against foreign banks that are not subject to pay limits. A ban on high pay would thus leave taxpayers poorer. -The Economist

However, Barnier and others can argue that at this point, top talent is lucky to even have a job in finance; and with knowledge of job cuts, it makes sense for employees to step up anyway. In support of the contrary to bank bonuses, The Financial Times paints bankers as gamblers who operate in a system in which 'profits are privatized and losses are socialized':

High bonus payments are a symptom of a problem, not its cause. The banking settlement was deficient because it did little to address the asymmetries in the universal banking business model. This model causes investment banks to jeopardise global financial stability in bad times whilst allowing bankers to cream off film star compensation in the good times. The global reforms have done a bit to improve financial stability but almost nothing to constrain the profitability that produces the bonuses. That profitability arises from a business model that gives banks in general and investment banks in particular the best possible view of global economies and markets. They are able to use this information advantage to load the dice and generate super-profits. This is where the bonuses come from and this is why the banking lobby worked so hard and so successfully to defend the model. -FT

It's important to note that Barnier was just appointed by French President Sarkozy as the European Commissioner of the Internal Market - including the financial system. The UK and France have crammed down on bank bonuses the hardest in the EU with a tax on extra pay, and rhetoric supporting public distrust in the banking system.

Barnier is described by his previous colleagues as a lightweight, having the charisma of an oyster, and not well respected - perhaps some reasoning why Dantes Outlook features him on our first debate series.

What's your stance on bank bonuses? Leave a comment.

Source: Bloomberg

Charts of Note

2011-01-17T19:30:00.001-05:00

Euro weakened against the US Dollar ahead of the European Finance Ministers Meeting in Brussels this morning. As more leaders placed pressure on the quantity and quality of the Euro-zone 'bailout fund' the Euro rose back to its initial height. The markets want security, but we can see the cross on the MACD, and the double top on EUR/USD clearly showing some weakness. Take note of the Portugal bond auctions last week - at around 7%, IMF is cautious about the country's ability to re-pay the debt. Spain will soon be an issue, and Italy too. Economists are sounding the alarm for the next of the PIIGS to fall this spring. Something to keep an eye out for. In the short term, speculation will define the movement of Euro.

I found this one funny. Apparently, news all over the web has been bearish on the Aussie during the 'biblical' floods in northern Queensland. However, us traders saw the opposite. The Aussie has maintained a strong uptrend throughout the floods, despite some dips of retracement. It's important to note that natural disasters do not have a significant affect on a country's exchange rate, unless it's of massive scale. This did not disrupt trade, and economic data flowed uninterrupted. Zero Hedge did an analysis of this here. Strange how the media fails to look at the charts sometimes.

Obama-Care is Unconstitutional and is in Jeopardy of Failing to Perform as Legally Intended

2010-12-16T21:36:00.000-05:00

From Our Facebook:

Earlier this week, Richmond, Virginia Judge Hudson ruled the individual mandate portion of the U.S. Health Care Reform Bill (H.R. 3962) unconstitutional. However, the rest of the law does not breach any constitutional standards, according to Judge Hudson. Accessibility to quality health care, while bending the cost curve, should be the objective of Health Care Reform, instead Obama-Care is set to do only one of the three. Judge Hudson's ruling is a major micro-economic blow to Obama-Care, which should send lawmakers back to the drawing board to legally economize and bend the cost curve.

Click here to view the full note on Dantes Outlook's Facebook Page.

China's Upcoming Rate Hike and its Ripple Effects

2010-12-12T16:39:00.001-05:00

The official numbers coming out of China show that the economy is rapidly expanding. Consumer prices are up 5.1% for the year. CPI excluding food is up by only 1.9%. Higher food prices are fueling China's inflation. For the period, food prices have shot up by 11.7%. The Chinese government is attempting to implement price controls on grains, edible oil, and sugar. Analysts are expecting the Chinese Central Bank to hike interest rates sometime this week. This has created a ripple effect of economic balance in commodities, Chinese trading partners, and the US.

China's growth did not derive directly from trade; the problem is domestic. The country's lax monetary policy, tax code, and currency manipulation have contributed to the current property boom.

Rapid construction fuels Chinese demand for commodities, boosting imports, and adding to export productivity in Australia and Brazil. China's trade surplus narrowed by $22.9 billion in November. A drop from 16% in October, then facing a $27.2 billion surplus. Since then, exports are up by 34.9%, while imports remain higher at 37.7%.

China's trade deals with its South Pacific friends have contributed greatly to the regions trade productivity. So much so, that the Australian dollar basically mimics China's economy; the value of the Aussie essentially being dependent on China's demand for natural resources. Brazil is also a hot bed of commodities, and recent deals with China have accelerated South America's export growth. However, China's domestic problems have spread to its trading partners.

Australia and Brazil have property booms of its own. On a much smaller scale, Australia's expansion is almost a mirror image of China's. Much of Australia's property boom is located in urban areas like Melbourne and Sydney. However, the inverse with China is that much of Australia's property boom is in developing cities like Perth. Western Australia holds a large sum of the country's mineral deposits, and the mining industry contributes to job growth, heavy construction which adds value to land, new homes to house the influx of workers, and now a population glut with immigrants flocking to Australia to capitalize on its growth. Because of this, Australia was among the first to raise rates, and continuing to do so.

In China, much of the growth is in-equal. The housing boom is on the eastern shore in the tightly enclosed urban areas. The western part of China remains sluggish, with a large elderly population.

The US almost seems isolated from this. Not so much. Our trade gap has narrowed with China, with exports up around 8%.

With expectations of a Chinese rate hike, Gold prices are down 2% on the week. US Crude Oil Futures are down 1.57%. The Australian dollar, despite having a nice rally, is set to decline - rate hike lowering the value of the Yuan, thus decreasing China's purchasing power for commodities. If the Chinese government shifts focus to domestic issues, they will need to demand less and tighten monetary policy to cool the housing market. This will also ease trade productivity. In sum, expect the Aussie to decline when markets open.

How the US should handle the Bush Tax Cuts

2010-12-09T01:31:00.003-05:00

Under pressure from Republicans to extend the Bush tax cuts, and Democrats lobbying for government to support the poor and middle class, President Obama reached a compromise. The proposal calls for an extension of the Bush tax cuts, coupled with decreased payroll and social security taxes, and extension of jobless benefits for another year (13 months to be exact). The main problem is that the formula for an ideal proposal is unbalanced. What this means is that there is no plan for revenue generation or spending cuts to counteract the increasing deficit - an inevitable consequence of Obama's current proposal.

One can argue that lowering taxes will spur productivity, and thus provide the government with needed revenue to fill the deficit through taxes on business revenue and new individual income and consumption. This is a mighty forecast, that has proven to be a failure with the Bush tax cuts. Times have changed, and expectations are low. The expiration time should have allowed us time to adjust the formula, not worsen it.

There is a high level of inequality in the United States. Roughly, 38% of people fall between the median - poverty line; with incomes at $43,000 - $18,000 respectively. The top 20-10% are the richest in the country; making $300,000 and above. The rich have more money to acquire wealth. Generally, their income is taxed more, which provides incentives to transfer income to wealth. Acquiring wealth through investments which have low capital gains taxes (thanks to the Bush tax cuts), caused their income to rise, while the 38% poor and middle class have experienced a decrease in dollar income. The thought was that the rich will stimulate through investment. Instead, they acquired wealth through savings. Wealth increased to about 90% of the income for the rich. Consequently, there was little job or consumption growth.

The current crisis added to the economic slowdown. The US government continued hefty entitlement spending on Medicaid, Medicare, Social Security, spending projects, etc. Government grew with less revenue because of a failed tax incentive model. With that, we contributed to the estimated $5 trillion federal deficit, and $445 billion budget deficit, fueled with treasury bonds. If you don't have it, you borrow, right? But, how long will we borrow for the forecast of revenue growth alongside economic productivity comes into fruition. Accumulating more debt increases the time period as the government adjusts the model, allowing more time for revenue to cover debt. In short, the revenue curve will continue to decline as the debt curve increases.

The US government needs to hedge against a potential loss of revenue. If these tax cuts fail to stimulate growth, there needs to be a budget balance to correct the model.

The argument against the federal government proposal fades as I realize that this is more of a state issue. States need to rise up and take a stiff approach their own tax system, while bridging budget gaps. Each state should incentivise job creation by encouraging training for demand industries with subsidies and/or business tax breaks to encourage job creation (only issued if they hire workers). Instead, the federal government proposes to disincentivise employment with jobless benefits extending for another year, with no concern for the Beveridge Curve, which clearly shows a decline in labor market quality.

US Hints at Austerity, while Europe Rescues the PIIGS

2010-11-29T21:47:00.005-05:00

On my Facebook, I posted "Line up the PIIGS". I think this is what the higher ups like Angela Merkel must be thinking. The IMF and ECB are giving bail outs to high debt countries - so far Greece and Ireland. Europe is a domino effect in the midst of an unfortunate crisis. What's important is to not lose focus on Europe's externalities.

The Irish bailout sent the Euro higher, only to fall back to record lows as investors anticipated more fallout. Spanish yields opened the day higher, and bond spreads widened across the Euro zone. There is much signal that more will come. I suspect Portugal to be the next country of focus, followed by Spain, then Italy. Europe is now struggling to pick up the pieces by implementing strict austerity measures. Just as the people of Greece lined the streets in protest, Irealand received its fair share of angry citizens, and so has Germany, bearing much of the financial brunt behind the packaged bailouts. There's also the concern that EU funds meant to stimulate the economy are being wasted, so there's the effect of moral hazard or just mismanagement on the government's part. The UK is also scaling back government spending. This is the consequence of years of failed policy, a comforting relationship based on government dependency, and the accumulation of debt to form the foundation of the free rider system. It's inevitable that those who remained comfortable for so long will be the first to lash out against pressure to tighten their belts.

The same is true for the United States. This morning, President Obama proposed his plan for freezing federal employee pay for two years, hoping to save the government about $28 billion over the next five years. Some argue that there should be salary cuts of government workers; but either way this is a warning of more to come. Oh, there will be more. Monetary policy is soon to be exhausted; there needs to be tough fiscal measures, despite public unrest.

The US Dollar will continue to climb as European troubles escalate, so the pressure is on for fiscal action. The government should scale back spending, but be clever with taxes.

'Dantes Floating Tax'

Taxes should be used like a monetary weapon to scale down or stimulate the economy. State governments should approach problems with a basket of tax tools: consumption, property, income, miscellaneous, and business. Decrease the burden while also adjusting taxes for an increase where there is high consumption, but little effect on overall consumer spending. Businesses and individual incomes should be the most incentivised, while miscellaneous taxes will discover strategic opportunities for investment through subsidies and tax breaks, but also new taxes on exposed sources of untapped revenue. We need to be smart about this; if an econometric model is needed, so be it. Every state should conduct its own indicator on budget balances through the form of an average tax rate being a function of the various forms of taxes issued. During times of economic distress, the average tax rate should be low. When the economy is roaring, the average tax rate should be high.

To the east, we have China. The Yuan is likely to appreciate more as China experiences domestic inflation. This will help Australia, as China's purchasing power increases; hence the steady rise of the Australian dollar these past two weeks. China's PMI this week will be an important indicator to watch.

Overall, Europe's troubles provides opportunity for America to get it together.

Four Loko: Don't Ban It. Tax it!

2010-11-20T22:22:00.001-05:00

Four Loko is a popular drink containing the perfect blend of an estimated one cup of coffee and eight cups of beer. It's highly popular among college teens, even it's only sold to adults. Recently, the drink has been the subject of legal scrutiny, as law makers flat out banned the beverage in states such as New York, Massachusetts, and Washington, citing cases in which Four Loko was the cause of serious health damage.

When overly consumed, Four Loko causes one to lose sensation and a sense of the moment - a feeling set on a higher cloud than the typical drunk night out. Health officials fear the long term socital damage, as Four Loko drinkers may end up as night time drivers. But isn't this true of any strong substance? And for something consumed so greatly, should this not be considered as a revenue opportunity for cash strapped states?

Let's get to the first question. It is true that no one should drink and drive; but this also applies to being under the influence of any strong substance that impairs logic. Taking too many prescription meds, advils, too much red bull, coffee, or any other common stimulant or depressant, does not put you in a position to take on responsibility. This is the responsibility of the consumer; and knowledge of the consequences should persuade people to avoid any strong substance. Four Loko has been around since 2005, enough time to accumulate fatal cases or arrests resulting in its consumption; so far none. Recent hospitalization among minors who overly consume Four Loko - plenty.

The real problem is at the end of the supply chain. The neighborhood stores should not sell to minors, and Four Loko should not be consumed in excess, just as any alcohol beverage. A ban of this product makes matters worse.

Knowing that Four Loko will banned in several states starting in December, sales will dramatically increase as of now, as consumers stock up. By 2011, expect a thriving black market for Four Loko; one that has no limit, rules, or health concerns from the dealers. Best to keep this in the open, where there is responsibility of sale and consumption. The black market will drive up government's cos of enforcing the ban, drive away legal business, which will in turn equate to an opportunity loss in tax revenue.

Four Loko is based in Chicago. Manufacturing sites can move to 'banned states' to fuel the black market. States like NY lose manufacturing, distribution, and sales tax revenue. A Four Loko tax will cut supply and generate funds to help our budget woes and inform consumers about the health risks involved in over consumption of Four Loko.

With the tax, the price of Four Loko will increase above its current $3 level. This will force the company to sell the product in larger bottles to balance out the loss of recenue. An expensive, larger bottle will compete with the likes of Grey Goose - another popular party drink; one that is safer. Large groups of teens (who inevitably break the rules anyway), purchase Grey Goose with a sum of cash from all friends and the occasional designated adult. The bottle is then shared in small shots. These teens may be drunk, but they are well aware of their budget. There's always the case of going too far with any drink. The case is greater with Four Loko because of its cheap price, accessibility, and sense of bottle ownership of the consumer - opposed to 'shared shots' with a group.

Perhaps law makers should attend a local party and analyze the economics of teen consumption and make it work to better the state in which they reside. Instead, the price we will pay with a Four Loko ban will leave everyone needing a drink.

- Damanick Dantes

Once Again, European Debt Troubles Interrupt US Fed Strategy

2010-11-14T17:13:00.002-05:00

At the start of 2010, Greece debt woes sent the dollar higher against the Euro, not helping with our export boost strategy and inflation targets. Now, the Fed raised targets and expected QE2 to continue the dollar decline which returned during the latter part of this year. The hope is that a weaker dollar will push prices up, increase foreign demand, and help with the overall domestic business sentiment as the Fed works to cool down inflation with ultimately higher interest rates; producing good returns for the financially productive during these times of stress.

Unfortunately for us, the Europeans have raised another red flag with Ireland. The ECB is placing pressure on Ireland to accept aid, and the IMF is set to provide. However, Ireland has not made any official plead for assistance. Either way, the confirmation that Europe is not healed sent market volatility higher. The Euro is likely to continue its decline.

David Kelly, an Irish Economist explains that Europe must provide assistance to avoid a domino effect of default. Here's a video interview from Bloomberg:

Trading the QE2 Announcement - I'm Launching a Fund

2010-11-03T19:23:00.004-04:00

Today, the FOMC voted on a second round of monetary stimulus dubbed QE2. This will include $600 Billion of treasury purchases lasting until the end of 2011. This equals to about $110 Billion per month, with purchases of $850-900 Billion through June; this sum being reinvested in mortgage securities. It's a hefty sum that was well anticipated on this blog, going against some popular analysts who expected lighter Fed action. I say the pressure is on.

Bernanke is pressed for action, and he clearly laid out his expectations for economic growth. He stuck by his word, and together with the FOMC, QE2 was voted in. The hope is that this will continue to accompany low interest rates to encourage lending, boost asset prices, and spur inflation. The consequence is that if this doesn't work, there will be a confirmed asset bubble (which we are already in), and higher prices brought on by no real market demand, which can bring us down to deflation as consumers struggle to afford the price increases.

Following the waves of quantitative easing, one can almost feel exhausted for the Fed - the feeling is mutual. There is only so much the Fed can do, but fiscal policy is needed. Bernanke said that he will continue to monitor the economy and pursue further QE, if needed. If there is the much anticipated gridlock in politics, the US will be in serious hurt. I don't think politicians realize how serious this is. We keep continuing the same measure of stimulus, both monetary and fiscal, that failed us in the past. It's time for a new approach.

If you have followed this blog throughout the past two weeks, you were swamped with my projections for today's decision. I did the research, and came out correct. My practice forex account reached a $28,000 profit today as I shorted the US dollar, going against the expectations for a rally by some analysts. The difference in my approach is that elsewhere the news is just reported, but on Dantes Outlook I dig deeper to project the next move, and invest in that. The Fed wants a weaker dollar, and that's what they have accomplished today.

Trading on these events improves the economic skill of this blog. Being invested in information helps to provide clear cut analysis and economic forecasting. The community of readers receive this digest as a way to filter out the noise to get informed about the stuff that matters most. Profits have been consistent, but to do so, there is high leverage and risk. This is heavily managed with good discipline in asset allocation intra-day; and I'm present when the fundamentals clearly drive me to the trading room - that is during reports and announcements. The same approach has proved successful leading me to the final rounds of energy trading in New Orleans. Because of this, I plan on launching the Dantes Outlook Fund sometime next year so that readers can become invested in what moves the world.

The Bureaucrats Return to NYC. This Time to Prevent Foreclosures and Leaky Ceilings

2010-11-01T15:02:00.006-04:00

In the midst of all the busy news on the grand economic scale, I get an email from my hometown. NYC Council recently set up a Task Force on Financially Distressed Rental Housing. At first glance this alerted me as more city level bureaucracy touching on a complex subject that always reminds me of my distrust in government - that is the housing market. The purpose of this new task force is to hold banks and landlords accountable for proper maintenance of their properties in the event of foreclosure or financial distress.

Many real estate companies such as Milbank aggressively purchased properties during the housing boom, attracted to the easy lending spree, and now face the reality of affordability. Milbank is not necessarily unique, but the fact that their portfolio is occupied by high end properties and then a random inclusion of Bronx Collections I and II seems rather odd. The company's strategy was to target low income housing and aggressively seeking out past-due rents, proceed through the eviction process, and then revitalize the property and lure in new tenants and charge higher rent. Or in some cases, because of rent stabilization laws, tenants who have resided in the premises for a long time period are forced out so that the unit can be converted and charged at market rate. One method is to cut down on maintenance.

As buildings headed into foreclosure, landlords decided to make cuts in the maintenance budget to try to squeeze as much cash possible to pay back mortgage debt. Of course, this is not fair to the tenants, and the task force will help to hold landlords responsible to continue legally required maintenance to ensure stable living conditions despite any financial shortfalls. This should be a given, but it's sadly inevitable following failed government incentives.

The task force fails to get to root of the problem. There are still incentives to lend without proper appraisal, this good intention quantity over quality approach needs to stop. Unfortunately, the system doesn't work where tenants are given the tools to evaluate their landlord's debt holdings and ability to pay before they rent. Oh, if the tables were turned. Instead, we figure that stuff is already figured out; but rationality breaks down when government intervenes for a snapshot approach to sway results in political favor.

None of the members on the task force understand the cause of this crisis; because if they did, they would have put a stop to this. Instead we result to stalling - encouraging banks to reach a compromise when it's a clear failure. The council members are allowing the cycle to continue. It's OK to re-enforce the law about proper maintenance, but I'm afraid of these backroom deals between banks, politicians, and landlords. It's what got us into this mess, and it's certainly something to prolong it.

Dollar Rally a Fake or Inside Strategy? Busy Week Ahead

2010-10-31T20:47:00.007-04:00

As you can probably tell by now, the dollar has been a prime focus of this blog these past few weeks. Certainly as the currency war and Fed talk have occupied market reactions. Staying consistent with my view that expectations of a dollar rally are too high, there must have been some underlying reason for the sudden surge in the US dollar against other currencies as the global markets opened a while ago. Check out the screen-shots from DailyFX, including my own trend analysis of the dollar v market cross:

The drop definitely caught my eye. For a second, I thought the analysts were right, but the fundamentals always come to light. Moments later, the market corrected this rally and forced prices back to previous levels. Fellow trader, Kendall Huang provided a possible reason for the surge in volatility that pushed the dollar higher: big banks and hedge funds understand the fundamentals and are clearing the way for a short strategy. It makes sense to inflate the dollar to get in at a top, only to short as the market reacts to strengthen the artificial move. Now, the sudden correction probably interrupted this strategy, but certainly as the week begins, and as analysts anticipate a rally, the opportunity to short is ever more leveraged...just give it some time.

This week, the most important event will be Wednesday's FOMC meeting and Friday's Non Farm Payroll report for the US. Australia and Britain are expected to leave rates unchanged. Most important, China's PMI on Monday is likely to move the Australian dollar. Analysts expect no change, but watch this closely - it might drive the Australian dollar heading to the RBA announcement. If there's little movement, use the Aussie and Euro to combat the dollar (FOMC and payrolls). I anticipate the dollar to weaken, but if it does strengthen, you'll be able to spread your positions. I'll continue to blog throughout the week.

The Workings of the Fed Orchestrate the Dollar's Decline

2010-10-29T15:52:00.006-04:00

The expectations are still too damn high. I admit that I was wrong with predicting US economic data to come out below expectations this week.

Existing home sales (Sept MoM) greatly improved to 10% from a 7.3% decline, beating expectations of 4.1%

Consumer Confidence increased to 50.2% from 48.6%, beating expectations of 4.5

Durable Goods Orders higher at 3.3% from -1%, beating expectations of 2%

Initial Jobless Claims lower at 434K from 455K, beating expectations of 455K

GDP met expectations of 2%, up from 1.7%

Very good results, which shows that there is a slight comeback for the US. However, the dollar continued to decline despite a string of positive data. This is because the overall picture is still bleak. The expectations of a dollar rally are too high, and the fundamentals are clear that the improvements are not enough in the Fed's eye. The Federal Reserve wants more, mainly in terms in higher inflation.

On November 3rd, the FOMC is expected to announce a second round of asset purchases (QE2). The Fed language has been tough these past weeks, signaling heavy action. However, some analysts expect asset purchases to be lower at $500 billion. Seriously, that will do nothing, why waste the time. I'm comfortable with a projection of $2,000bn - $1 trillion. Now, this may be a bit much considering all of the good economic data this week - perhaps the Fed may scale down as the economy shows some signs of growth.

To stay consistent in their vision of a strong, immediate, economic recovery, the Fed will need to go all in with QE2. The Fed has clearly laid out their expectations; something we should heed well to if we want to invest properly. The inflation targets of 2-3% gradually will only be met with a falling dollar, below current levels. For the dollar to fall lower, more QE is needed. For now, just the mere expectations of increased asset purchases (heading up to November 3rd) will send the dollar lower against a basket of other currencies. If they opt for QE-lite (somewhere near $500 billion) there might be a slight rally only to be corrected with hitting comfortable lows, for the Fed that is. Either way, the dollar will fall. Gold and equities will continue to rise (more so stocks as we head into election season).

Will the Dollar Bounce Back? Expectations are too High.

2010-10-25T21:18:00.004-04:00

It's a busy week ahead in the FOREX market as economic reports of high importance will be released. Starting on Tuesday at 10AM EST, October Consumer Confidence for the US will come out; analysts expect 49.5%, higher than the previous 48.5%. I figured there must be some relationship between election season and the attitudes of consumers. Take a look at this data:Consumer Confidence and Elections

View more documents from NAR Research.

I ran a model to test for significance, which proved that there is no valid relationship, probably because I relied solely on election v consumer confidence data. However, this author argues that the positive changes in Consumer Confidence out-way the negatives during election season. Based on history, one can expect consumers to have more confidence in the economy, but there's a lot of room for error in this assumption. Therefore, I think it's safe to expect a slight rise in consumer confidence, but probably below expectations. I would better expect consumers to stay negative on the economy until November. Once we get the results, then we'll see what consumers really think based on an actual political shift, not just expectations.

On Wednesday at 8:30AM EST, US Durable Goods numbers will be announced. Analysts have continued to remain bullish on these reports, expecting durable goods to increase to 2% following a previous -1.5%. Manufacturing is sluggish, and ISM numbers are mixed, more so negative. Perhaps a lower dollar helped spur interest for US goods. Again, I expect a rise (being that the previous number was so low), but less than expected.

Know that if the dollar does bounce back up, there will be a negative affect on the Euro and Gold. Many say that the dollar has fallen to lows, and are able to technically forecast a rally based on the flurry of data coming out. Perhaps this is true, especially considering that home sales came out higher in September. This was mainly because of a decline in the median price of homes, according to realtors. However, with the foreclosure halts at major banks under government pressure, these home buyers may struggle trying to gain legal ownership of distressed properties.

Either way, the expectations and the real facts that will come out this week will support my view that the US economy will continue to move sideways given the shaky truth in economic reports. More specifically, in economic terms, the economy will increase at a decreasing rate.

------ outside the US------

The big announcement will be New Zealand's Interest Rate Decision. I agree with analysts expectations that the central bank will keep rates steady at 3%. One reason is because of the currency war. With so much devaluation, now is not the time to cause a major change in your currency led on by government decisions. Also, New Zealand is an export driven economy, so a steady interest rate will help to depreciate the Kiwi in the short term based on real facts. The hard data supports a steady interest rate decision. New Zealand reported lower CPI, stable GDP YoY, lower Q2 GDP, and the last interest rate decision was steady. The economy is not expanding to the point where it needs to be cooled with monetary policy.

Energy Trading Competition. Off to New Orleans!

2010-10-21T23:51:00.003-04:00

At the start of this month, I chose to participate in the annual Tulane University Energy Trading Competition. My team member and I entered the preliminary rounds and traded light sweet crude oil and natural gas contracts intra-day for two weeks. We were new to the energy markets, but research and due diligence ultimately prevailed.

Our largest gain followed a storage report a few days before the ending of round one of trading. I looked at previous crude oil storage data, demand, pipeline conditions, and technicals to make a prediction. There was high storage the past week, coupled with increasing demand heading into the winter season, and a pipeline leak in Canada was slowly being repaired - easing the flow of supply throughout North America. All of these fundamentals helped me formulate a trading strategy; one that is not complete or executed unless real data supports my forecast. The volatility was too high to enter the position based on a forecast, and for the sake of risk, I decided to wait until the official announcement. Turns out, storage came out low, and I immediately took on a long position, expecting crude oil prices to rise as low supply - high demand became the forces behind market movements.

My teammate and I made a combined profit of $29,000 with starting capital of $100,000 (roughly 20% gain in two weeks of trading). This took a lot of hard work and time dedication, and the learning experience was definitely worth while. We did take on some risk with the storage report trade, which placed us in 14th place based on a risk adjusted index. However, based on unadjusted profits, we hold the number one spot out of about 84 participants from colleges and universities around the country. Now, I will travel to New Orleans to compete in the final round in hopes of winning.

I will act as a hedger for simulated energy companies based on a given case. More information will be provided in the follow-up post.

This is an amazing opportunity, and it's one factor that lays out the path for Dantes Outlook. My passion for Economics, financial markets, and trading will surely become the business model behind this network. Our Facebook and Twitter groups of intelligent people from across the world, readers who comment and message me with ideas, and others who support the growth of my outlook keep me going. I learned to never back down, and to keep on pursuing the best. Your interest helps this mission, and together, the network on Dantes Outlook becomes stronger. Stick with me.

How A Lower Dollar Will Affect Productivity

2010-10-18T14:31:00.010-04:00

Click on each image link for a better view.
Source: WSJ article

Retailers Push CPI Down to Boost Sales

2010-10-15T09:05:00.004-04:00

Retail sales came out at 0.6% ahead of the expected 0.4%. A rise in sales for three months straight, as retailers slash prices and offer deals ahead of holiday season. Lower prices have set the CPI down to 0.1% v. expected 0.2%. This is an uncomfortable price level for Fed Chairman Bernanke who aims to keep inflation within a long term range of 1.7-2%. Clearly, the consumer needs incentive to buy considering weak employment numbers; it makes sense that pressure is placed on businesses to lower prices.

The dollar advanced against most major currencies this morning. Traders are bullish on the dollar for the time being, while Bernanke is scrambling through the Fed's toolkit. There is more talk of the Fed remaining committed to pursuing monetary policy aimed at boosting inflation at desirable levels to spur a recovery, and maximizing employment.

Michigan Consumer Confidence report came out lower than expected at 67.9 v. 68.9 and prior 68.2.

Planning For Economic Growth

2010-10-01T16:23:00.011-04:00

According to the American Planning Association, October is national community planning month. It's a time to encourage local economic development and celebrate the achievements of previous planning projects.

I truly believe that any design or infrastructure project should be planned for effective economic productivity. I consulted with rising planner, Zachary Aders who also believes that too many architects and designers lack necessary business skills to plan for a return on investment. Aders, who graduated from Columbia University with a Masters of Architecture, moved to Sao Paulo, Brazil to work with Cities Without Hunger, an NGO that develops urban community gardens.

Many architects team up with business professionals to add investment value to their projects. The externalities should encourage productivity which ultimately benefits the local residents. Almost every urban center has a bustling market place. In Boston, there's Quincy Market. In NYC, we have Union Square. Farmers from across the region transport their food to these centers - most of which are locally grown, healthy, and cheaper. Organizations such as Cities Without Hunger are the driving force behind stimulating local entrepreneurship while helping the less fortunate. However, looking at the bigger picture can provide a much greater return that could be re-invested to spur greater projects. This reminds me of the pressing nutrition initiative, a project of Michelle Obama, which might receive funding from budget cuts in the national food stamp program. This sparked debate of whether increased food stamp aid contributes to an unhealthy population - recipients making the wrong food choices. If this is the issue, it's a great opportunity for community farming projects. Linking food stamp aid to less expensive locally grown products will provide an incentive for regional farmers to boost production, and planners will have to increase access from farms to cities.

Local businesses embrace access to opportunity. That's where planners come in. When Aders designed a walkway and middle school campus system for the Highbridge community in the Bronx, he incorporated the ideas of many local residents and advocates. Railroads create pathways to better the supply chain for industrial businesses; it's better to have those entrepreneurs at the planning round table to ensure effective community investment. High speed trains transport the current unemployed in seek of jobs located in areas that were once unreachable given budget and time constraints. To do so, government needs to encourage not only employees transporting to and from these downtown areas, but also consumers who have a reason to travel and spend, supplying the funds that will eventually become the paychecks of those commuters, who then pay a fare to ride the commuter rails to supply income for the conductors, and a return for the developers, an incentive to further stimulate the efficient economic systems. There is an inherent link between planning and regional economies.

Unfortunately, many of the great design ideas never come into fruition because of underfunding. I think the issuance of bonds is a great tool to place pressure on bettering the bottom line for developers and bondholders. A clear business plan attracts investors, but many development projects shy away from the economic return. Aders stresses the importance of designing for frugality by using existing structures to cut costs not only for developers but local users of the new project.

The Soviet Union was destroyed through intense infrastructure spending just for the sake of producing surplus nuts and bolts to remain competitive with the US. However, the system lacked economic sense. Not like the US who borrowed from the British to fund a thriving industrial revolution, improving access to cities, which spurred manufacturing, jobs, homes etc. The British received a healthy return. That spirit of investment needs to return.

Carry Trading the Falling Dollar

2010-09-26T21:21:00.006-04:00

FUND STRATEGY: The latest FOMC statement contained specific language signaling prospects for more quantitative easing in the coming months. As always, Fed talk says if only necessary, but the report shows lagging data leading up to that moment of, well, necessity in their minds. The markets pretty much believe that there will more treasury purchases to keep borrowing rates low - as a monetary stall of stimulus. We see the Fed desperately trying their powers amidst midterm elections, where true fiscal policy is needed, but will have to wait, probably until early next year.

So, here's the opportunity. The dollar is decreasing against a basket of competing currencies, so a short dollar position in the FOREX market is the prime choice for traders. Ben Slotnick, one of our readers, messaged me about the advantage of using arbitrage through carry trades. This works by taking advantage of the interest rate spread between the US and emerging countries. Since borrowing costs are very low in the US, investors will naturally borrow but with the purpose to sell dollars in exchange for another currency with high deposit rates; thus pocketing the spread of cash exchange. The country that has high deposit rates is in the process of withdrawing monetary stimulus; countries like Australia and India. The risk is that exchange rates fluctuate, causing the value of the currency exchanged to possibly cancel out the purpose of profiting on a spread.

The current conditions show a trend that will likely continue throughout the rest of this year. The screen-shot from CNN Money shows the overall picture of bonds and rates. The recent uptick in yields is from better economic data (durable goods), but analysts say that yields are still in a zone of resistance.

Banks, who are adjusting investments during these times of government desperation, are profiting. As the Fed tries to crowd out the treasury market to encourage banks to transport cash away from government debt to borrowers, the banks will result to carry trades. This will place more downward pressure on the dollar, benefiting short dollar traders in the FOREX markets, and hopefully benefiting policy makers who are apparently wise enough to realize the externalities of their actions. On a quest to lower the dollar's value, policy makers are probably planning to export our way to recovery. Again, this doesn't work well for a reserve currency that's subject to high fluctuation. Germany may have benefited from a weak Euro, but it's not enough to help the entire Euro-zone escape its troubles.

But, think about it. Banks are sitting on a good amount of cash while the government tries to stimulate. Once we have better fiscal policies that effectively stimulates growth, and the Fed calms down, banks will feel comfortable to lend their excess cash. Also, if exports do pick up manufacturing will become more productive which will create jobs. Banks will lend, until Bassel III rules and financial regulation standards kick in. At this point, counter party risk will be an issue, so long as we sustain a recovery.

Obama's Bridge To Nowhere

2010-09-19T14:40:00.005-04:00

It's mid-term election season, and promises are in full swing. Talk is stirring of a second stimulus effort, even though politicians dare say the word. Instead President Obama is pushing for a $50 Billion infrastructure bank, in which the federal government will award grants and contracts to encourage construction to revamp highways, tracks, runways, airports, and building projects. Following the sluggish response of the first failed stimulus, there is little hope for this one. However, now is the best opportunity to correct the past mistakes.

If President Obama goes by the coined phrase of an infrastructure bank, the government should be focused solely on investment, seeking a positive return. Banks don't necessarily provide grants, but they surely will award a contract to a construction company to make their investment plan come into fruition - it's the creation of an asset in which the investment of a "grant" adds to the cost, in hopes of generating enough revenue to offset the expense of labor. A stimulus that runs by this mentality has a better chance of success.

According to the ProPublica Recovery Tracker, most of the stimulus money produced no jobs, and some states lost jobs. Now, it's not fair to make this correlation without doing heavy statistical analysis, but the data shows that the stimulus did not do enough to help boost employment.

I decided to zero in on the Bronx to craft an action plan. My home town is the only borough that is physically connected to the mainland of NY state. This means that it serves as a major transportation route, yet still faces a lot of economic problems. The public transportation routes that connected the city and upstate NY to the Bronx gave birth to the suburban feel of the north Bronx as many city dwellers chose to relocate and commute elsewhere to work. As time passed, the Bronx became host to many residents who chose to seek area employment, which was scarce and mainly consisted of small businesses. This gave rise to a major public housing development in response to a decrease in economic productivity.

Robert Moses helped revamp NYC after the great depression with major infrastructure projects such as the Tri-Borough-Bridge and Cross Bronx Expressway. He did so remaining in the private sector, using government contracts, and continued to reinvest revenue derived from tolls and real estate projects. It was an amazing re-birth for NYC, but critics worry that the focus on vehicle transportation took away from investments in public transportation. Also, many snub the Cross Bronx Expressway as an eye-sore that caused neighboring communities to turn into slums under the freeways. The externalities of NYC infrastructure can be corrected through better investment, using the assets that are already in place.

On Recovery.gov, the Bronx is shown receiving little stimulus funds compared to the rest of the city and state. Most of the funds were distributed to charter schools, churches, and hospitals. For example Montefiore Hospital, the biggest employer in my area, received $183,000 for medical research on Lukemia, but added zero jobs. It's certainly a failure of local representatives who were given the responsibility to invest stimulus funds. This money could have been used to encourage nursing training, day care centers at the children's hospital throughout the Montefiore campuses in the north Bronx. This would have eased the financial troubles for many single parents, most of whom I know back home, while providing an incentive to get back to work. Of course, a council member will know this if he/she took the time to survey the district you represent.

Let's look at infrastructure. The Cross-Bronx-Expressway is an eye-sore. Currently, no contract is awarded, not even a bidding request to improve this decaying transportation line. It's crumbling facade is in desperate need of a face-lift. Lanes to separate trucking from car traffic, along with ramps to the community below will provide an added bonus. Exits off of the expressway will contribute to the storage businesses already in the area, local trucking companies, warehouses, manufacturers etc. Easing the commute on cars, many of which bypass the Bronx completely during their commute from upstate into the city. Building the area community by converting empty lots to high-rises and commercial office space will attract businesses and residents looking to move closer to their employees. Bronx residents will actively be involved and become recipients of this investment process.

In sum, President Obama needs to seriously think about this second spending push. The construction is short term. Companies that are awarded a contract will first use the current staff (not boosting any new employment) or employ new workers, only to complete the task and return to handing out pink slips until they find a new project. If this money is invested, the long term growth of areas surrounding the improved infrastructure will become an engine of productivity.

New railroads are only good if utilized by the transportation companies, many of whom are struggling because of the unproductive economy. Get to the heart of the problem. Drilling activity, instead of moratoriums, will better the use of railroads transporting coal. Container shipments throughout the US using more rail lines, improving access, lowering cost, increasing revenues. These common sense ideas need the involvement of local businesses and government officials.

US Worries About the Trade Politics of Japan and China

2010-09-16T20:57:00.007-04:00

It's tough being the reserve currency. The US is stuck in the middle of a swarm of trade capital and currency swings that must pass our way, given that these countries help shine our appeal. It's only fair, right? But everything is artificial with fiat currencies as governments constantly try to stable their value to shift market interest. The two big players are China and Japan, as the US tries to create this master plan for growth. Here's the scoop.

First, the back story.

In June, China decided to break it's peg to the US Dollar. Possibly to break US pressure for a more "market valued" yuan that will allow our dollar to decline and add appeal in the trade market. The goal is to artificially control domestic data impacted by currency valuations. China did state that the yuan's appreciation will be gradual; so in the long run, this will lead to higher prices of Chinese goods. Given that most of the goods currently in the US come from China, the US expects this to cause some added inflation. Of course, if everything works out perfectly. This should also provide us with an advantage to boost production and exports, adding domestic jobs and a flow of foreign cash into struggling manufacturers. Perhaps China's greater purchasing power will steer them towards the US, creating a good relationship that will probably pull us out from economic misery. Yeah, right. The problem is that US companies will most likely shift their business to other Asian countries with low costs (Made in Taiwan, Vietnam, Korea..ring a bell?).

Even though China has since allowed its yuan to appreciate, they have found ways to stunt its growth. The largest banks in China are state owned, and most are busy buying up US assets and treasuries to keep the appreciation stable. Yet, they buy Japanese Yen to diversify their holdings. The US is sweating bullets. The Yuan hit a new high against the US dollar on Thursday, rising for 5 consecutive trading sessions. However, Treasury Secretary Geithner argues that the "pace of appreciation is too slow, too limited." A 1% gain in a week for the yuan is not enough; the US wants it to accelerate 20%, a more appropriate rate, sometime soon. China has decreased their holdings of US Dollars, but they're still not out of the game, with their sneaky manipulation. The plan was to create this shift away from US Treasuries so that investors will become more productive given the decreased expectation of return. All the while everyone stays quiet about Japan. Ah, yes, Japan.

China's neighbor guaranteed $300 billion in US bonds. This stabilized intervention is meant to decrease the value of the Yen, given Japan's heavy reliance on trade. The Bank of Japan can implement as much as 35 Trillion Yen of intervention capacity. It's not over. Japan wants to create liquidity, they foresee inflation, and want to reduce debt. The power of the Yen is extremely important for the Japanese economy. But, stabilized intervention isn't necessarily good for our plan in the US. The purchase of treasury is a gimmick that may last for a while. The weaker Yen also made the dollar appreciate, although not significantly much as all eyes remain on China. If anything, this raised our standards for the Chinese to push their yuan in response to global threats to the whole currency re-valuation plan.

The US doesn't want such a large injection to the Treasury pile. The Japanese intervention also helped to boost the value of Gold. The US is stuck - we want to follow the success of export driven countries like Canada and Australia who rely on the purchasing power of China. We look at the crisis in Europe and how Germany used the depreciation of the Euro as a way to boost exports and help fuel expansion to bring the region back on its foot. The hard truth is that we might have lost our opportunity, or was there one to begin with? The reserve currency doesn't have the advantage to prolong currency strategy to boost productivity. This, once again, brings us back to the domestic drawing board. A task that so many believe is nearly impossible to handle.

As for the FOREX market, expect the US dollar to advance for a few more days against the Yen. After that, fundamentals will return to play, and the dollar will continue its struggle.

Possible Effects of Basel III

2010-09-13T12:51:00.004-04:00

Central Bank leaders from around the world came to a consensus earlier today about new banking requirements. Basel III calls for an increase in common equity, which bank's use to absorb losses. In addition to that safety net, internationally active banks must hold levels of common equity equal to at least 7% of their assets. The current international standard is 2%, and 4% in the US - a significant increase.

The WSJ reports:

"Some changes will go into effect as soon as 2013, but others won't be in place until the beginning of 2019. Technical changes to the definitions of capital won't be fully in place until 2023.

Banks will be allowed to phase in these new standards over a period of years, so they will have more time to comply. By 2015, banks will have to begin building a 2.5% "buffer" of capital that must be fully in place by Jan. 1, 2019.
If banks fall below the buffer, regulators could force them to hold onto more of their earnings to augment their capital, which means the companies will have less money on hand to pay dividends or offer large compensation packages. Some analysts believe the new standards could essentially force banks to shrink their loan portfolios or shed other assets in order to improve their capital positions."

Despite the gradual implementation of the conservative requirements, banks claim that the costs will be transferred over to borrowers and employees. This will mean higher lending standards causing a decrease in loans, and higher fees. Employee bonuses, under intense media and shareholder scrutiny will likely decrease as an effect; although several analysts expect this to remain steady. Academics argue that according to past data, increased reserve requirements have little to no effect on lending productivity.

Although this is very much needed, there is still the risk of hazard. Knowing that there is a safety net, despite it being their own cash, banks will might continue risky investments. Surely, if they grow large enough, the state will provide additional funds lacking in common equity reserves - that being the mentality of the crisis. Whatever the case, banks will find themselves scrambling for cash. Interbank short term lending might pick up and banks will flock to more liquid investments - those that seem attractive, but pose risk. Banks will find a way to get the cash they need; governments might not be ready to tackle the new system that grants this liquidity, if it poses systemic risk that is.

Another risk is that banks might gradually decrease their stake in government debt. In the US, banks are utilizing bail out cash to purchase Treasuries and other forms of hedging. Since then, the Fed has been active in quantitative easing to try to crowd out the treasury market and encourage banks to transfer their cash to borrowers. So far, data shows that investors are leaving treasuries as yields fall - perhaps an entirely different case.

In sum, for the US, this still means we have more work to do. Basel III is an international standard meant to secure the banking system, but domestic responsibilities of each country still remains. Now that in the long run banks will have to reserve more cash, we need to figure out a way to encourage lending. That starts with a healthy economy of borrowers, consumers, and employers. Let's see if the election season full of tax cut promises will provide some short term boost, or a long term recovery to match the rate of bank capital available needed to stimulate free market productivity. Definitely worth a follow up in the next post.

Investing in Ground Zero

2010-09-11T14:32:00.002-04:00

Nine years ago today, the nation experienced the worst terrorist attack on our soil. It's certainly a day to never forget; feelings of sorrow and pain fill the souls of all Americans. However, beyond our gut emotions lies a spark of hope, one of inspiration to move on. And for this reason, I will never forget what lower Manhattan was and what it could be - something much greater.

In 2008, I blogged about reconstruction delays at Ground Zero. The rebuilding project became a part of my life. I always felt this pride of growing up in the financial district of the world. My business minded friends all planned to flock to Wall Street, work in the World Trade Center, and contribute to the spirit of New York. After the 9/11 attacks, the financial district became a ghost town. Businesses moved to neighboring New Jersey and Connecticut, and employees followed. The economic hit was not only short term, but since 2001, New Yorkers are continuing to leave in search of better opportunity. I wouldn't be surprised if most of the families who return to NY every year on 9/11 to pay respect have relocated since the attacks. The constant struggle to keep businesses in NY remains difficult as the state economy declines. Connecticut has embraced the influx of hedge funds with tax incentives that NY is not willing to provide because of budget cuts.

Either way, every year reminds of the duty we have to bring NY back despite economic barriers. The reconstruction of Ground Zero is picking up. The memorial site is almost complete, more buildings are rising above the shadows of the past. Silverstein Properties, the developers of the new site are in constant battle to ensure a fair and safe layout abiding to the interest of so many New Yorkers who want the best for our city. The surrounding area is booming as well. The rebirth of battery park is unbelievable. Walking through the blocks of the residential areas of the financial district instills a certain level of pride. The luxury housing to host the expected increase in corporate workers are beautiful with scenic water views, and green architecture. What's more remarkable is that the high end buildings stand side by side with affordable housing projects that have long kept their residence around Chambers Street where the iconic Stuyvesant High School still stands, giving hope to upcoming intellects of New York.

The video below makes a good point about the attractiveness of lower Manhattan. The area is accessible from all points as all transportation lines merge, similar to how midtown is designed. The new transportation hub near Fulton Street will definitely serve as an asset for the financial district. I expect a mix of businesses to call the new World Trade Center home. Big banks like Goldman are likely to move in, but given the state of the economy, the growth in start-ups that are correcting the mistakes of the fallen will surely flock to NYC once the project is complete. Small hedge funds, mom and pop retailers, and new security companies will play a bigger role in the economy of district 1.

US is Losing the Battle Against Unemployment. Here's a Gameplan.

2010-09-03T16:42:00.008-04:00

Following a happy toast to better manufacturing numbers from yesterday's ISM report, policy makers are back at the drawing board. Earlier today, non farm payroll numbers (NFP) were released. NFP rose by 54,000 in August; matching up with July's revision. This signals an overall loss in jobs for three months straight. Even though the NFP results were slightly above expectations, it still gave further confirmation that the labor market is weakening.

Adding to the employment pressure, the unemployment rate rose slightly to 9.6% after hovering at 9.5% for the previous two months. A move downward could be a taste of worse to come, or just a minor loss that will soon be corrected. Either way, unemployment is still high and should be of main concern for policy makers. Meanwhile, the private sector added 67,000 jobs in August mainly in education and health care. The government cut 121,000 jobs mainly due to decreasing state budgets. Some signs of hope from the private sector tells us that there is potential, but the market needs an extra push for employment to expand at a reasonable rate for recovery.

Expect a shift from monetary to fiscal policy. This will come in the form of tax cuts for small businesses; maybe not an extension of the Bush tax cuts, but some other crafted tax strategy by the Obama administration specifically designed for the current economic situation. However, we must be careful about how this should be implemented. The US doesn't need a jolt of incentive to artificially boost data only to return to previous levels or worse; as seen in the housing market following buyer tax credits. The tax strategy needs to float - start with significant cuts, but slowly ease stimulus as conditions improve. Now is the time for impressive strategy, one that must be accessible by businesses - one failure of the stimulus being that much of it remains unspent because it was planned poorly on both federal and local levels and didn't effectively reach the public. The government needs to encourage on the job training through tax credits. This could potentially be a long term strategy as a bulk of the labor market gets trained in accelerating industries that are hiring; especially as most economists explain that the quality of the labor market does not meet the demand of the private sector (which apparently is hiring).

As for now, the US economy is showing more signs of decline despite impressive ISM numbers. I do see a turnaround as industry expands, but for the time being conditions will worsen. Once policy makers craft a plan, the support of industry and government incentives will provide a much needed boost. Currently, I'm bearish on the US dollar, as the market loses trust in our economy following the poor jobs numbers.

Also, it's important to note that the ECRI indicator that tracks inflation and growth in major economies just dropped to -10.1%. Zero Hedge, a financial blog, reports that the indicator is entering double dip territory.

We're losing the battle, and unfortunately the main casualties are the unemployed.

Testimony on NY Natural Gas Drilling and Concerns about NYC Water Supplies

2010-08-20T16:26:00.006-04:00

Members of NY State and Local Government and EPA,

The long debated issue of natural gas drilling in upstate New York reached its peak earlier this year when state officials decided to temporarily disallow drilling near the pristine watersheds that serve a large supply of fresh, unfiltered drinking water to New York City to the south.

Concerns are understandable, given the risks involved in any type of exploration and drilling activity. The new norm is hydraulic drilling which optimizes natural gas extraction thousands of feet into the Earth, horizontally tapping the vast Marcellus Shale for an estimated 1.9 trillion cubic feet of natural gas. The pipes that are lowered under ground create a path deep into the rocky layers isolated by heavy coatings of cement, allowing large amounts of water and chemicals to boil at high temperatures adding pressure to blast areas along the rocks (process known as 'fracking') which will allow deposits of natural gas to flow freely. The danger is if there is an accident causing leaks of chemicals (most of which undisclosed) into the nearby water sheds used for public consumption.

This is a controversial issue, but I urge city and state governments to work cohesively in understanding the concerns of the public, industry interest, safety, and federal environmental protocols and regulations. I also hope that the EPA will pay attention to this matter sooner rather than later, as its been placed on the back burner for over one year.

First, the issue of safety should be of top priority. I applaud the New York City Council in representing our concerns and taking an active approach in displaying interest about the protection of our water supplies upstate. However, the fact that Catskill and Croton watersheds are unfiltered makes one worry about safety aside from any proposed drilling activity. There should have been a grand safety net on our water supplies given the evident increase in industrial activity upstate. I do know that NYC has taken a stand on safeguarding our supplies with the purchase of 1,124 acres of land for watershed protection. This land is marked for our reserve and is open to recreational activity such as hunting and canoeing, adding to area tourism. I urge us to utilize this land for setting up a filtration system for enhanced safety. Reports by NYC's Environmental Protection Department states that $1.5 billion has already been allocated towards investments in water protection - some of which was used in the purchase of land. Building a filtration system will come at a cost, but the benefits and return on investment should offset this. Perhaps the New York City Municipal Water Finance Authority could sell special bonds to provide any additional upfront funds. Even though federal law does not require large cities such as Boston, Seattle, San Francisco, and New York City to filter their water being that much of it derives from fresh sources, we should still do so given the increased industrial productivity within our lands.

The safe guarded approach will work to protect NY residents and allow the drilling industry to explore and develop. The natural gas industry will provide jobs and help boost the overall area economy along south western NY. The region of interest along the Catskill range will surely welcome the boost to employment. Drilling activities will sure up other industries such as trucking and manufacturing providing a bustling economic expansion, similar to what Pennsylvania benefits from now (owning a larger region of the Marcellus shale). Local and state government will benefit from taxes on productivity and the leasing of state owned land.

Also, reports indicate that as drilling productivity increases along the Marcellus shale, the existing pipelines will not be enough to adequately deliver natural gas to the public. This is further proof of the need to ramp up more pipelines in addition to water filtration methods in preparation and anticipation of more drilling activities. These pipelines will better deliver natural gas throughout NY state and even surrounding neighbors improving the Northeastern US market for natural gas. An even better leverage for NY to host the pipelines that will flow up north.

The opportunity to implement this strategy will be a great addition to our state economy. We must also remain focused on safety measures, and I'm proud of NYC for maintaining such great interest in our water reserves. I hope to see this come into fruition, and to know that we have prepared in advance will serve as an example for the rest of the country on how government and industry can work together.

-Damanick Dantes

Philadelphia Fed Survey, Jobless Claims and Treasuries All Bad

2010-08-19T13:08:00.015-04:00

A lot of data came flashing across my radar this morning. Here's the rundown:

Philadelphia Fed Business Outlook Survey (-7.7)

The survey measures the Philly region's manufacturing conditions. The diffusion index of current activity decreased from 5.1 in July to -7.7 in August. Analysts expected a reading of +7.0, but apparently the industry came out short. For the first time since July 2009, the index reached negative territory, marking a period of declining monthly activity.

23% of firms surveyed reported a decline in employment, and a bigger decline in the average employee work week from 1.7 in July to -17.1 in August. 70% of the firms surveyed reported no change in prices of their manufactured goods, while 19% reported a decrease in prices.
However, the industry remains optimistic. Future new orders index increased to 25.7 and shipments remained unchanged. Overall, the outlook on employment remains bleak as 22% of the firms expect further decreases in jobs.

Jobless Claims (+12,000)

Initial jobless claims increased by 12,000 to 500,000 according to the US Labor Department. This is the third straight week of increasing jobless claims. Analysts say that as state governments proceed with budget cuts, government workers will lose jobs. Also, because of a sluggish housing market, construction jobs are minimal. It's important to note that this figure does not include the nearly 5.6 million unemployed workers who are receiving extended unemployment benefits.

QE-lite Begins

The Federal Reserve bought $6.16 billion of Treasuries, using capital from maturing securities as part of its reinvestment program (QE-lite). The Fed now owns 7 of the 27 Treasuries listed for purchase; most of which are set to expire in November 2016 and May 2017.

This could possibly be the reason for the US Dollar's intra-day rally against a basket of currencies (except Yen). Perhaps something technical, but either way at the time of this post, a peak is clearly evident as fundamentals come into play pushing the dollar lower.

Stocks slide, Yields lower

The negative data returned fears of double dip across Wall Street, causing the S&P to drop nearly 20 points (as of now).

Yields on the 10 year treasury experienced a steep decline as the Philly report added to the bond market rally responding to the Fed's reinvestment. (below- intra-day chart)

Overall, once again negative news. I can't stress enough the need for a complete fight against unemployment. We need to get on the supply side and help firms increase productivity, and along with that employment. A floating tax strategy to provide some incentives to firms that are directly involved in the industries that have severe unemployment (manufacturing and housing). But then again, it seems that some incentives are already in place, but it clearly shows that we lack a stiff game plan to combat unemployment.

For example, US Mortgage Rates dropped to record lows for the ninth straight week. This makes it cheaper and more attractive to borrow and refinance homes. Mortgage applications rose 13% in the week ending August 13th, but unemployment has placed a damper on home sales. Consumers and producers are eager to be productive, but they need the right support from government to provide the much needed boost to the US economy.

The news comes a day after President Obama spent a day with a couple in their Ohio backyard to showcase how the success of stimulus efforts helped Americans. This is not a majority case, and the data keeps depressing.

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What's Goldman's Real Position on Gold?

2010-08-18T14:11:00.005-04:00

Zero Hedge, a popular financial blog, reports its finding that Goldman Sachs has advised clients to sell Gold (GLD) despite raising its price target on the soaring commodity. Goldman's reports are dated this month in its Market Pulse Asset Management evaluation and strategy. You can view the report and the Zero Hedge article here.

After reading through the flashy Market Pulse, it's difficult to understand what Goldman Sachs is advising in relation to their analysis. Overall, the investment firm does see some sort of U shaped recovery in the US running into 2011, but before that happens, the economy will slide some more. Most important, its strategy on gold:

"[Goldman] shifted our stance on gold after years of being long; see gold as vulnerable to central bank inactivity int he face of rising deflation risk."

True, the Fed has run out of ideas, but we see that they have not given up their fight against the economic slow down, especially with QE-lite (reinvesting capital in Treasury bonds). However, Goldman even states that they have moderated their view on deflation due to "increased prospects of quantitative easing." What are you really telling us Goldman?

I doubt the Fed will just sit back, even if they don't take monetary action, the words of Bernanke on the state of the economy are much significance to market volatility, and real data doesn't lie.

There are probably many reasons why Goldman's Market Pulse is cloudy, but my guess is that as a market maker, they are trying to buy at a dip, by causing a dip. GLD is in the midst of a secular bull market, and Goldman and pals want in. By pals, I mean Eton Park Capital Management, a hedge fund founded by Goldman's youngest partner, Eric Mindich. This firm joined Paulson and Soros in making GLD its largest common stock position at $800 million. Goldman is likely taking a similar position.

I reached out to my friend who's a trader to try and figure out what's really going on. He was quite frank in saying "Goldman is covering their butts. Remember, clients are sitting on paper assets so they are not in favor to push GLD." This also makes sense. Goldman can either use this as a cover or enter at a dip to offset some losses from their large client base invested in paper assets.

Either way, the takeaway is further confirmation that GLD is continuing its bull run.
*chart above is YTD GLD Bloomberg*

Geitner says Government will Play Active role in the Future of Housing Finance. But still no Plan.

2010-08-17T15:59:00.007-04:00

I'm still disappointed that it took so long to address the issues about Fannie and Freddie and the outlook on housing finance. Today, Treasure Secretary Geithner held a conference with notable folks from the department of Housing and Urban Development (HUD) and other experts of the like. His concluding speech was just plain rhetoric, again stating that something needs to be done, but whatever solution comes about, the federal government will continue to guarantee mortgages. I expected a plan, not a re-statement of the issue, but we'll deal with what we have now.

PIMCO's manager, Bill Gross, told Bloomberg News that he proposes a full nationalization of housing finance. Although, I agree with Gross to a certain extent, his proposal lacks substance just like Geithner. I too proposed that the Feds adopt Fannie and Freddie and supervise the mortgage security market that poses such systemic risk. The government can continue to guarantee mortgages; which will provide insurance and encourage affordable lending, but we must also be stern and manage our own risk as the insurer. This means setting guidelines for loans that serve borrowers who meet certain standards - as Fannie and Freddie had in place before the Community Reinvestment Act, thereby alleviating some risk on all parties in the financing scheme. Second, the government should not tolerate any political influence and get rid of the monetary incentives that act as a commission for banks to actively lend; let it be known that taking on the risk through insurance and securitization is enough of an incentive.

Message to the government: enough with the artificial masking, and do your job. Mortgage financing is a great service, but it should in no way blind the public. Decreased lending during bad times makes sense. The heart of the matter lies in the sluggish economy, which goes beyond the housing market, and in my opinion deals more with employment and production. The government has a responsibility to provide economic support to bring a healthy pool of borrowers into fruition so that bankers will realize that the new found beauty in their risk calculations and lend with the backdrop of government guarantees through a securitized insurance pool.

Currently, we must pay the price of our mistakes, but building a system that recognizes these faults is a must. The financial reform bill has done that, and I'm still waiting to see a solid plan for the housing market.

What's behind the US Dollar's sudden reversal

2010-08-17T13:56:00.008-04:00

Since June of 2010, the US dollar continued a downward reverse from the positive trend in the midst of European debt troubles. Attention has returned to the US, and our economic data consistently falls below expectations. Double dip concerns, recovery turned "unusually modest" in the words of Fed Chairman Bernanke, and lite quantitative easing have pushed the dollar downward against its currency counterparts. However, following through the negative trend comes an awkward bump that sparks some interest.

So, what's the reason for this sudden reversal? Perhaps some good US data and talks of a faster recovery? I tried to dig up some information, and was pointed to mixed news, this time about improved factory production, sluggish housing numbers, and producer prices (PPI) increasing 0.2% following a 0.5% drop in June. It usually takes time for the markets to react, and the data still isn't as stunning to spark a sharp turn upward.

Turns out the spike is simply a correction - lesson learned. All of the investors who were shorting the dollar along the downward slide have bought back and adjusted their positions; simply put - shorters running out of steam. Real buyers have stepped in to take advantage of this break. At the time of this post, the dollar points downward on the reversed bump, perhaps returning to its trend, or sustaining the break. More follow-through is needed, but its certainly something to pay attention too. Here we see technicals being just as important as fundamentals, as the voice of the markets reveals the direction of foreign capital, and ultimately the fate of the US dollar.

*comparing the dollar to a basket of currencies, as displayed in the 1yr ICE chart above. The dollar/yen is an exception due to it's intense volatility at the moment.*

Debt Buys Time. Speed up the Process by Reducing Personal and Government Debt.

2010-08-16T15:16:00.010-04:00

The Federal Reserve was quite confident of US economic recovery in the beginning of 2010. But now it is worried as in the first quarter of 2010, US national debt has reached $13 trillion. On the other side unemployment, increasing medical costs, marital separations, salary cutbacks and increasing education costs have led to an increase in consumer/personal debt. Millions of people are in need of debt help in 2010. This is certainly not a positive sign for the US financial market. US economy indeed requires a reduction in personal and government debt as soon as possible.

The Lowdown on Personal Debt.

According to the latest report released by the Federal Reserve, average Americans owe more on student loans than on credit cards. As per the report, Americans have incurred $829 billion student loan debt whereas the credit card debt is around $826 billion. This fact is not entirely surprising as the cost of higher education has increased manifold. Generally, student debts are regarded as a sensible investment as compared to credit cards in an individual’s life. The reason is, one can use student loans for ensuring a better future. But what most people tend to forget is that accumulated student loans can adversely affect them when they enter professional life after college. Sometimes, they’re even not aware of the amount of debt they have incurred.

Several unemployed youths have been compelled to complete post-graduate education. Most of the students take huge amount of loans thinking that they would pay it back after getting a job. But the worse part is, it doesn’t happen always. An increasing number of students are in need of debt help in USA. A good plan will be leading a frugal life, taking advantage of student financial aid programs and applying for scholarships.

As far as mortgages are concerned, an increasing number of people have failed to qualify for refinancing and loan modifications in 2010. As a result, around 300,000 homeowners have lost their houses to foreclosure. Although the Government has taken initiatives to control the situation, but things are not always working the way it should be. However, it’s not just the Government who needs to take some action in this scenario. Homeowners too must plan a good strategy such as taking out the right loan and making timely payments on it so they can avoid a mortgage default.

However, not all debts are bad. In fact, you can utilize as an investment and get better returns in future. Debts like student loans and mortgages are not bad as long as these are managed effectively with the help of a strategic plan. As far as credit cards are concerned, keeping a low credit-utilization-ratio (below 30%), making minimum monthly payments on time, and managing low interest cards effectively can help a person avoid debt problems.

The big issue is the shrewd mentality of taking on debt to eventually pay back in installments without proper financial planning. What happens now when borrowers don't have the support of a stable economy? Well, they take on more debt to pay the debt that they previously acquired. The cycle is all about stalling time, and when government intervenes to encourage lending to the masses who have this mentality, it goes to show that the problem is not only consumer based, but is sourced at the federal level.

Government Debt.

With the US national debt going up to 13 trillion dollars, publicly held national debt has reached around $8.5 trillion. Publicly held national debt is around $8.5 trillion. According to financial experts, the total federal debt is likely to reach 87% of USA’s GDP by 2020 and exceed 100% of GDP by 2025.

Supplying the Debt.

As part of the ongoing cycle, the Federal Reserve has decided to purchase government debts. The Federal Reserve will use their earnings from investment in mortgage bonds to buy the debts. It will utilize around $10 billion each month to purchase government debt. It is expected that this step will help shift the interest of bankers towards lending; thus supplying the debt that’s in such high demand. Apart from this, the government has sanctioned a $26 billion Bill in August, 2010 to guard 300,000 teachers, police and other employees from layoffs. These actions are likely to help the US economy grow faster, or just stall some time.

-Rose Anderson.

The FOMC statement and QE-Lite. Where do we go from here?

2010-08-10T16:59:00.005-04:00

Earlier today, the Federal Reserve issued their FOMC statement. All members, except for Hoenig, voted for a policy to keep interest rates near zero to 1/4 percent and "reinvest principal payment from agency debt and agency mortgage baked securities in longer term Treasury securities". In basic terms, the Fed realizes that the economy is moving at a snails pace, and will not allow its portfolio to decrease and instead keep the balance sheet steady at $2.06 trillion. Bernanke's talk of continuing monetary pullback has reversed; the Fed has simply run out of tools and will continue investing at a steady rate.

Many investors speculated a new QE2 (quantitative easing part two), but this seams more like a QE-lite - nothing big, but nothing small. US equities ended the day in a range as markets took a cautious approach to the Fed announcement. Meanwhile, the US dollar took a serious tumble intra-day against a basket of securities, but is now regaining strength. Investors are coming to their senses that this is just QE-lite, but the Fed's confirmation that the "pace of the recovery in output and employment has slowed in recent months" made investors a bit nervous. Gold inched up slightly in response to the panic. In the long run, the US is likely to experience very slow growth.

As I stated in the previous post, the Fed can go on with QE-lite, but it all comes down to employment and output, mentioned in the first sentence of the FOMC statement, highlighting its significance. The Financial Times has a really good point about the Beveridge Curve; proving that the labor market is experience a demand/supply issue. The public is lacking skills that are in demand, and the economy is not providing much of an incentive to boost employment. There needs to be focus on this while the Fed launches QE-lite.

Weak US Data sends Treasury Yields to Record Lows, back up ahead of FOMC meeting.

2010-08-09T15:37:00.010-04:00

These last two weeks have been depressing, but I will do my best to update more. It's just that my outlook has come true, but not for the best. I've long sounded the alarm here that the US is not recovering at a desirable pace for investors, consumers, and government. Jobless numbers fell slightly, and non farm payrolls came in less than expected. The labor market is pretty much stagnate, leaving many fearing that it can either go up or down from here - other economic data weighing heavily on the latter. Durable goods orders slid 1% as Dow Jones Newswire predicted a 1.1% gain; further evidence of a weakening manufacturing sector.

Treasuries rallied from this data sending yields to record lows (see UST2yr -10yr chart, source: MarketWatch). Even though foreign demand for US treasuries decreased, for the first time since August 2007, US investors own more treasuries than foreign holders. This is not looking good. The Fed will auction off $74 billion of 3-10-and 30 year securities starting tomorrow. The continuous decline of US treasury swap spreads show decreased demand, which may hurt the Fed's auction. Either way, the sale of notes sparks market anticipation that the Fed might announce further monetary stimulation in response to weak economic data through quantitative easing. This sent 2-year Treasury bonds higher breaking out of record lows; 10-year remains steady as the market awaits tomorrow's FOMC meeting. At this point, I'd whisper to Bernanke "here we go again".

Fed Chairman Bernanke did state at a recent Congressional hearing that monetary stimulus withdraw will continue. I'm not certain that he will stick to his word. US consumers are not confident because the economy is not ready to support spending. Producers are not confident, certainly as manufacturing data weakens and CPI remains sluggish. People are saving more, and banks are not lending. Banks are using this glut of savings deposits and transferring that over to US treasuries. This is nothing new. At the start of the crisis, just when banks received bail out funds to stay afloat, much of this cash was sent right back to the Treasury increasing the demand for bonds - decreasing yields, increasing prices. The Fed stepped up with quantitative easing to crowd out the treasury market so that banks can turn towards lending, but the economy does not support the consumer, leaving bankers skeptic about lending to risky borrowers. The Fed can beef up its portfolio by purchasing treasury bonds, but don't let this discourage you from paying attention to the economic perils that bankers are set to face.

At the moment of this publication, the San Francisco Fed stated that the chance of recession in the next two years is "significant" - reversal is unlikely in the next few months. Perhaps a warning that the Fed will revert back to more stimulus?

The US dollar is suffering severely since June 2010 against a basket of other currencies (see ICE US Dollar Index Chart); there is evidently no reversal from a long term (3 month-1 year) perspective, despite minor ticks from intra-day volatility. Investors should remain bearish on the dollar.

This will be a nail biting week as one of the most anticipated FOMC meetings is held tomorrow.

Financial Reform forgets about Fannie and Freddie, but I didn't.

2010-07-29T15:38:00.010-04:00

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So, the financial reform bill was passed, and now we can all breathe a sigh of relief. Well, not quite, because one of the prime causes of the financial crisis - the decline of the housing market, is still up in the air in terms of regulation. To be blunt about this, I ask the US government "what the heck's up with Fannie and Freddie."

For the most part, the financial reform bill seems like it will do good at identifying systemic risks, preventing it is another story. The genius of financial innovation always finds a way to create secondary markets. Either way, this is certainly a move to applaud. Among the plan of sweeping reform and regulations, a consumer protection agency will emerge, more disclosure, and government clearing houses for credit swaps. I especially favor the move to require banks and other financial players to take on some risk; for example, issuers of mortgage backed securities must retain a minimum of 5% of the credit risk associated with the underlying asset.

So, what to do about Fannie? For starters, here's some background info.

Fannie Mae and Freddie Mac actually provide a great benefit to homeowners and should not be fully blamed for the housing crisis. The bulk of Fannie and Freddie's portfolio holdings came from sub-prime borrowers in response to the Community Reinvestment Act. Providing affordable mortgage options to low income families who have the necessary means to qualify for such deals was able to continue because of institutions like Fannie and Freddie. Politicians wanted banks to serve the communities in which they operate, instead of taking deposits from the poor to finance the operations of the rich. However, the risk was that the residents in the community could not keep up with expensive mortgages. So, Fannie and Freddie helped to guarantee a portion of these mortgages by securitizing the asset to investors. These politicians who pushed hard for more sub-prime loans had good intentions that failed to make long term economic sense. As most loans had adjustable rates, borrowers began to struggle to make payments, and a default cycle rippled through the many markets that became the derivatives of the sub-prime investment scheme.

The systemic risk was caused by these secondary markets. Investors wanted to hedge, and sought more cash by sharing the pool of assets. With so many participants, and misleading ratings, and no real market value of these securities, the power of the home-owner is that much greater. The system was prone to collapse.

If we let Fannie and Freddie fail, a private player would have picked up the pieces, but the problem of politics will remain. For the many who sounded the alarm of regulating Fannie and Freddie by requiring reserves and oversight of their portfolio were dismissed in the Congressional chambers.

For a system so complex, I propose that the Federal Reserve adopt Fannie Mae and Freddie Mac. Now, this may receive some opposition from those who believe that the Feds have failed us. But actually, it's the fault of most politicians who place a gridlock on economic prosperity. The federal reserve is separate from politics for this reason, and for a system that provides affordability using such a complex framework, monetary experts should be involved. Home ownership and debt is crucial to our economic system, and with a grasp on this, the Federal Reserve will be better equipped on making better monetary decisions. Now, there's already a lot on the Fed's plate, but the work is best divided among their 12 regional branches. Picture a Fannie and Freddie board in each district with a specific grasp on community needs, reporting to the national Fed on the investment interest in the mortgage finance market, while adjusting the system for any type of secondary systemic risk.

The Treasury is set to hold a conference to discuss the outlook on the mortgage finance industry on August 7th. Clearly, they are undecided on what to do, so I hope some bright ideas come into play. I'll surely be listening very closely.

As for the housing markets -- the house price index posted a 4.6% increase in May, beating a forecast of a 3.9% rise. But the rise looks like a correction from the latest decline due to the expiration of home-buyer tax credits. Skeptics also say that home sellers are waiting for prices to rise, but then become desperate and offer bargains, causing a return to low home prices. There's also fears of a wave of pending defaults, certainly after 40% of home-owners dropped out of the HAMP program (government supported mortgage modification program).

The housing market got us into this mess, but a recovery can get us out.

Goldman settles and joins BP in the comeback race

2010-07-16T11:33:00.007-04:00

Goldman Sachs proposed a $550 million settlement with the SEC. The firm was trialed on fraud allegations after regulators found documents and emails which contained information that was never shared with investors. The settlement must be approved by US District Judge Barbara Jones in New York. So, it's not over yet - Goldman is still under criminal investigation.

Meanwhile, Goldman's stock (GS) experienced a rally in which a reversal is evident. After experiencing a major decline following the SEC announced its trial, Goldman is now experiencing a comeback. Investors are relieved that the company is able to move forward. Expect a bumpy reversal though, considering that the trial is not officially over. The chart featured in today's WSJ provides a great visual breakdown of GS stock performance during this debacle.

BP is also another underdog experiencing a comeback. The media has covered the massive Gulf Coast oil spill in great depths, and the company is faced with billions of dollars in cleanup charges and lawsuits. This caused a sharp decline in BP's stock, but as the issue subsides, investors are starting to realize BP's value. Engineers are getting closer to actually plugging the hole, the tests show that something is being done. Also, oil exploration and the energy sector as a whole is strong. Most important is the major investment interest in BP after the company's value tanked. Middle Eastern investors have their eye on obtaining a valued stake in BP; CEO Hayward even visited some partners in the region earlier this month. Investors are optimistic about BP's longevity, and cash from major holders is certainly needed.

In sum, these two important comebacks is something to learn from. Companies or any other investment in distress serves as a good bargain for value investors. It pays to follow the fundamentals, and enter at the reversal. Things are bound to turnaround, you just have to know when. Especially in the macro perspective, the global economic slowdown is the perfect time to start looking at the long run; even though a recovery will take much longer than micro investments like BP and Goldman. Either way, it's a good time for analysts and economists - heed well to their due diligence.

Opinion: Politics a Threat to Economics?

2010-07-12T20:13:00.006-04:00

Reform has always been a battle between politicians and economists. Both sides striving for progression and the greater good of society. However, too many times they have failed to reach a common ground, causing economic crises and in some cases an entire collapse. Politicians are plagued with good intentions and the worry of doing all they can to get re-elected. It's this mentality that causes the public to become dependent on government, and politicians to splurge without rational thinking to protect an image. However, the field of economics is based on assumptions and sometimes doesn't take into account the social affects of complex models. There needs to be a balance which calls for cooperation between politicians and economists.

The dependency factor causes many to believe that government will always be around to do what it does best - provide for the people. However, a system is bound to become exhausted; and this calls for political cooperation. This is evident in the Euro zone, as member countries (especially the PIIGS) scramble to cut back on spending in the middle of a sovereign debt crisis. Greece was one country that lived beyond its means, and when the time came to cut back, politicians were the ones to blame. Protestors flocked to the streets causing riots near government buildings in blatant hatred towards politicians. The economists who warned about soaring deficits and unsustainable debt were asked to help the IMF assess the financial sustainability of European countries.

The relationship between Central Banks and politicians is also important. In Argentina, President Cristina Kirchner decided to use some of the central bank reserves to fund deficits and continue spending. After the Central Bank Governor disagreed, he was ousted.

In China, its government is so hands on, that its actions are great enough to manipulate economic growth. When the yuan was pegged to the dollar, China bought US dollars to keep their currency stable, but also had a greater say in US economic policies. China's expanding interest in accumulating natural resources from developing countries is strengthening their diplomacy while balancing trade and increasing domestic productivity and output. When China vowed to gradually brake the dollar/yuan peg and allow the markets to set the value of their currency, some saw this as a loose policy of the Chinese Central Bank. However, the comfortable relationship with the Central Bank and politics worked to keep the yuan stable. Recently we've seen Chinese state owned banks buy up US dollars, and even the Agricultural Bank of China went public. Technically, it's not the Chinese Central Bank, but the expansion of their state banks to act as a derivative to stabilize the yuan despite the peg break is one impressive strategy. When the central bank bought record amounts of Japanese Yen, the world began to realize how important China's reserve holdings are. China will soon reach a point where its government will have great political impact on the world through its economic operations while others are busy trying to come back.

Chinese politics and economics is one mutual relationship that's tricky. The outcome is questionable, but it is clear that politics gets in the way of a lot of economic policy (for good or bad). However, in the United States, this problem is stalling a recovery. Monetary policy is exhausted, and the markets seem to be ready for a US reversal, but politicians have yet to fix employment, cut back on spending, and raise revenue. Several states such as California remain in a fiscal trap. New York desperately needs to balance their budget, but politicians have stalled the process. Republicans vote no for any taxes and spending cuts that will affect their constituents, while Democrats want to keep spending programs active to keep everyone happy. No one is willing to sacrifice for responsible governing. As deficits grow, new entitlements arrived as promised. A national health care plan came at the wrong time instead of adjusting the current programs that cater to the ageing population that will surely be a long term problem for all governments in the rich world.

Most politicians just don't get it. We need people who know how to work a budget with proper economic sense. Unfortunately government spending is not investment, and during slow economic times, investing is the better option to decrease dependency but ensure productivity.

All eyes are on the emerging markets, but politics poses a threat in those countries too. Africa is plagued by corruption, and Latin America sits on vast natural resources and has great potential, but its leaders are busy being dictators who stump innovation.

Stepping back and just analyzing global politics gives us great insight into where our investments are headed. Perhaps because of all of this turmoil, Keynes is right - "in the long road, we're all dead."

Dollar Demise Returns after weak US Economic Data

2010-07-06T15:27:00.017-04:00

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Last year, governments around the world rushed to save the economy. The immediate plan was to pass a stimulus package hoping to boost demand and provide incentives for businesses to increase productivity. This stimulus wave did some good; it kept us from experiencing something far worse, added some jobs, and fueled overall growth - at a snails pace. The main problem was that the stimulus came with an expiration. This forecast for pullback made the incentives more like handouts.

Tax credits for home buyers helped the housing market rebound, but as soon as the credits expired, home sales plunged. The National Association of Realtors stated that pending home sales index fell 30 percent survey to 77.6 percent based on contracts signed in May. Jobless claims increased last week to 472,000. This just after the government temporarily boosted employment with about 225,000 census jobs. Once the census ended, the job market was back on the radar. Congress is now hoping to extend unemployment benefits. Obama wants to extend George W. Bush's tax credits (but not for families above the $2K mark per year) which expire at the end of this year.

This proves that stimulus hand outs did not effectively boost aggregate demand. The forecast that set these expirations was supposed to allow government some time to come up with a long term plan, while working to push the stimulus (most of which unspent) to fuel the economy. Unfortunately, we are still behind, and now is not the time for a pull back. At the G-20, Obama urged other countries to keep spending. But does this mean more handouts? Governments need to change the way they incentivize.

Setting limits provides a goal for when the economy should recover, but these programs should be aloud to float. Unlike monetary incentives, political stimulus creates more of a public dependency on government. Interest rates float and can be adjusted; except when you're stuck near zero, but public incentives should do the same. A home buyers tax credit in response to a sluggish market should gradually increase and decrease according to market activities. A sudden withdraw does not help with the confidence of a recovery. If the public knows that they are given some help, without having to worry about buying before a deadline, aggregate demand will become sustainable. What we have now is artificial demand that responds to a shot of stimulus. Political gridlock in Congress does not help the issue, which is one reason why monetary stimulus is independent from politics.

Currently, investors fear a double dip approaching, but most economists see this as a temporary downturn. Former Fed Chairman Greenspan said that this is a normal pull back during a recovery. Perhaps all we need is more extensions, but there comes a point when government must show some concern for their own budget. The UK is introducing an emergency budget full of government pull back, and European countries are cutting back as well. Government needs to raise revenue and cut spending. By now, the economy should have been recovering smoothly so that government can step back and heal itself. Obviously something is wrong, it could just be a hiccup, but the pullback clearly shows that the public isn't ready. Famed Economist Nouriel Roubini thinks bond vigilantes will return as government ops to spend more.

Investors should avoid the US for now. Technicals don't show enough selling pressure to confirm a sustained downturn, but the Euro has rallied on the dollar's recent decline. And, well, there's always China.

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