1) These are key excerpts from Bill Gross's November newsletter at PIMCO. Go to the source if you want to read some of his introspection about being age 65 and staring into the grim reaper's face. This is one of several items today warning of our current stock market bubble.
2) Pesek, for Bloomberg, writes of Einhorn's ominous warnings about Japan's debt level.
3) Garth Turner has a blog in Canada called Greater Fool. This is always a great read and I don't read it often enough. This post has some good insights concerning baby boomers, their lack of savings, and what it means to the housing market (in Canada, but applies to the U.S., too).
4) This is just one paragraph from a longer article by Marshall Auerback, New Deal 2.0, concerning the new pay czar regulation. Well said.
5) Yves Smith, of Naked Capitalism, writes about China possibly experiencing 15% inflation.
6) Chris Mayer, from Daily Reckoning, posts a great chart and short read to remind us about the home loan mortgage resets time-line.
--Kalpa
Midnight Candles
by Bill Gross
....Let me start out by summarizing a long-standing PIMCO thesis: The U.S. and most other G-7 economies have been significantly and artificially influenced by asset price appreciation for decades. Stock and home prices went up – then consumers liquefied and spent the capital gains either by borrowing against them or selling outright. Growth, in other words, was influenced on the upside by leverage, securitization, and the belief that wealth creation was a function of asset appreciation as opposed to the production of goods and services.....Asset prices are embedded not only in our psyche, but the actual growth rate of our economy. If they don’t go up – economies don’t do well, and when they go down, the economy can be horrid.
....assets didn’t always appreciate faster than GDP. For the first several decades of this history, economic growth, not paper wealth, was king. We were getting richer by making things, not paper. Beginning in the 1980s, however, the cult of the markets, which included the development of financial derivatives and the increasing use of leverage, began to dominate.....This 100% overvaluation from recent price peaks of course is crude, simplistic, and unrealistically pessimistic. It implies that stocks should be at – gasp – Dow 7,000 – and that home prices – gasp – should be cut in half from 2007 levels, and that commercial real estate (Las Vegas hotels, big city office buildings that are 20% empty) should likewise face the delevering guillotine. Some of these price adjustments have already taken place, and to be fair, corporate and high yield bonds as well, should be thrown into this overpriced vortex more resemblant of a black hole than American-style paper wealth capitalism.
....support, of course, comes in numerous ways. Financial system guarantees, TARP recapitalization of banks, TAFs, TALFs, PPIFs – and in Europe and the UK, low interest rate term financing, semi-bank nationalizations, and asset purchase programs similar to the United States. In the case of the U.S., the amount of the implicit and explicit financial support given by policymakers totals perhaps as much as $5 trillion, which goes part way to support the $15 trillion overvaluation of assets theoretically calculated in the PIMCO model (100% of nominal GDP).....While the U.S. economy will likely approach 4% nominal growth in 2009’s second half, the ability to sustain those levels once inventory rebalancing and fiscal pump-priming effects wear off is debatable.
...Asset appreciation in U.S. and other G-7 economies has been artificially elevated for years. In order to prevent prices sinking even lower than recent downtrends averaging 30% for stocks, homes, commercial real estate, and certain high yield bonds, central banks must keep policy rates historically low for an extended period of time. If policy rates are artificially low then bond investors should recognize that artificial buyers of notes and bonds (quantitative easing programs and Chinese currency fixing) have compressed almost all interest rates. But while this may support asset prices – including Treasury paper across the front end and belly of the curve, at the same time it provides little reward in terms of future income. Investors, of course, notice this inevitable conclusion by referencing Treasury Bills at .15%, two-year Notes at less than 1%, and 10-year maturities at a paltry 3.40%. Absent deflationary momentum, this is all a Treasury investor can expect.
.....the risks outweigh the rewards at this point......the six-month rally in risk assets – while still continuously supported by Fed and Treasury policymakers – is likely at its pinnacle.
Einhorn’s Next Call Won’t Be as Easy as Lehman
by William Pesek
David Einhorn was right about Lehman Brothers being a house of cards. What about Japan? The New York-based hedge-fund manager who bet against Lehman Brothers Holdings Inc. says, “It is hard to see how Japan could avoid a government default or hyperinflationary currency death spiral” once borrowing costs increase. Lehman was one thing; Japan crashing is too frightening to contemplate.
Einhorn’s firm, Greenlight Capital Inc., has bought options that anticipate much higher interest rates. He is betting on a phenomenon many tried to time for a decade: a meltdown in a bond market with irrationally low yields. Talk of a default may be farfetched. Japan has defied such predictions for two decades and will continue to do so. It can always tap $15 trillion of household savings through higher taxes or sell state assets in a worst-case scenario. Officials in Tokyo really are crisis-management experts. Concern that yields will surge in 2010 is more justified. In the next 12 months, there will probably be a big increase in Japanese market rates.
....The mix of a falling birthrate and swelling debt is a key reason investors steer clear of Japan, or bet against it returning to prosperity. “Japan may already be past the point of no return,” as its debt burden worsens and the population ages, Einhorn said on Oct. 20 at the Value Investing Congress in New York. While that may be an exaggeration, the limits of Japan’s ability to borrow indefinitely will be tested in 2010. A strategy that has worked masterfully will bump up against fiscal realities the likes of which Japan has never seen before. Let’s hope it fares better than Lehman.
Terrorists
by Garth Turner (Canada)
......But I’m not normal. Especially compared to the bulk of people in my generation. The Big Generation. Big disappointment, as it turns out.
Those people have grown up in a time of almost constant inflation, endless economic growth, technological advance and wall-to-wall progress that seemed to obliterate the need for personal responsibility. Back when the public pension system was being set up, the Boomers were in grade school and the country was rocking. Growth was rampant, corporations expanding, private pension plans were being set up right and left, moms were streaming into the workforce as never before and workers were being given a cool new savings vehicle called the registered retirement savings plan. The future seemed obvious and the CPP was designed for just one function – to supplement other forms of retirement income, namely those corporate pensions and RRSP savings.
Never, ever, did policymakers dream fifty years ago the bulk of those kids teeming into the public schools would end up like this. Three-quarters without corporate pensions. Millions discovering they’d been cheated when pensions were underfunded. Two-thirds having missed most, of not all, of their available RRSP contributions. Only one kid per class proving to be serious about retirement savings. Most learning that at age 65 they couldn’t afford to retire in comfort, or retire at all.
How could they have envisioned in the Sixties that a generation born into such education, promise and prosperity would borrow so much, spend so carelessly, save so little, invest so reluctantly or fail so spectacularly that those tiny supplemental public pensions might become their only salvation?
Over the coming decade, the Big Generation will have absolutely no alternative but to try and turn real estate into cash. This money will be needed for immediate income, but also for growth, since life expectancy is catapulting higher. The average Boomer, at age 60 for example, has 25 years or more yet to finance – years often devoid of either earned income or meaningful pension payments. That means the money from a real estate needs to be turned into lifetime investment income. The consequences for equity markets are obvious – a 20-year infusion of capital which can’t help but propel assets higher.....
Clearly, there are no alternatives to a real estate fire sale. With Boomers now streaming into their sixth decade, it’s obvious time has run out to grow savings enough to finance the future. There’s no way stock market gains or secure fixed-income investments can make up for thirty years of new cars, Cuba, Nikes, flipping houses or affording your kids.....
Happy Halloween: Pay Curbs are a Trick on the Taxpayer, Not a Treat
by Marshall Auerback
....As Cane acknowledges, the curbs only apply to the newest wards of the state, the likes of AIG, Chrysler, GM, Bank of America, and Citibank. The more than 700 banks and other companies that have directly benefited from the government’s largesse are not affected - even those who are minting profits from credit markets propped up by trillions of dollars of the taxpayers’ money, and who continue to benefit as a consequence of the FDIC guarantees of their commercial paper, which substantially reduced borrowing costs at a time of uniquely high financial stress. Yet we’re still neither proposing any kind of serious regulation, nor any kind of resolution mechanism to deal with the problem of “too big to fail” banks.....
Inflation in China at 15%?
by Yves Smith
This tidbit, from a report on impressions of conditions in China, via a steel buyer who has been making the rounds in Asia (hat tip reader Michael) is more significant than it appears. High inflation levels in China (and the powers that be seem to get worried when it goes over 11%-12%) is consistent with the authorities having started to ease up on stimulus, particularly pushing banks to lend.
And high interest rates feed stock market speculation. Interest rates on deposits are low, so the routes for investors to preserve cash are stockpiling commodities (we’ve read various reports of both businesses and speculators going this route) and the stock market. But stocks often backfire as a store of value when too many people latch on to the same strategy.
I was at presentation a couple of years ago at the Asia Society on China, and one of the panelists observed that if you wanted to design a system guaranteed to produce hyperinflation, it would be hard to do a better job. The global financial crisis has provided a wee bit of a respite on that front for China; we’ll see, when world growth resumes, if this view proves correct....
The Eye of the Housing Storm
By Chris Mayer
This chart shows you it isn’t over yet:
These helped frame where we are in the mortgage crisis, which has been the main shark in the water over the past couple of years. You should know where that shark is and whether or not it is hungry…
Clearly, it is not yet safe to get back in the water: Years 2010 and 2011 face big resets in so-called Alt-A and Option ARM loans. What this means is more write-downs and more losses for banks and others who hold these mortgages.
The bounce in home building stocks looks ridiculous in light of what they have to look forward to. The T2 duo actually recommended shorting the home building stocks through the iShares Dow Jones U.S. Home Construction ETF (ITB)… I like the idea of shorting homebuilders. At the very least, I wouldn’t buy one.
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