Wednesday Market

US debt issues are now front and center. What is clear is that the two parties have no ability to work together (which isn’t a bad thing actually) and their battle lines for 2012 are clear. Republicans will not raise taxes under any circumstances and they may or may not actually cut spending. Democrats will not cut actual spending under any circumstances and they will twiddle around with irrelevant class-warfare taxes. The Dems have won this round of PR/spin — but I think both of them (as is the media) are truly clueless as to the tsunami that is on its way. If congressional districts are already so broken and gerrymandered – or if the 2012 electorate does not resolve this with a convincing win for one side or the other – things will go from really pathetic and corrupt to downright violent.

Market technicals deteriorated today to full-out bearish – both short and intermediate term. And the breadth of the bearishness is pretty ugly. There will be a bounce when the debt ceiling legislation is passed and it will be important to monitor it. That will occur within a week. But for the first time, markets are really contemplating the problems with public debt and a AAA rating for the US. The chances that the US will be downgraded from AAA by the end of the year are probably 90%+ — regardless of what happens with the debt ceiling — and that will freeze up some aspects of the market and cause serious problems.


AAA Credit

What the US debt kerfuffle is revealing is an interesting end game re true AAA debt. Even if the US successfully kicks this current can down the road, US sovereign debt can no longer be considered truly AAA safe. Which raises a serious problem for the global credit markets. If US Treasuries aren’t AAA, what bond issuer on Earth IS? And what will happen to such AAA bonds if/when the US gets formally downgraded?

As to the first question, the list is teeny. The universe can only be sovereign bonds of sovereigns who have very comfortable total debt limits and who are also comfortable with their currency skyrocketing in value relative to other fiat currency issuers who may debase their currency in order to pay off debt. And companies that are both financially strong enough to merit a AAA and are also global enough to avoid getting hammered by confiscatory taxes in those countries that may confiscate their way to a balanced budget or debt reduction. Among the sovereign issuers — Australia, Denmark, Finland, Luxembourg, Norway, Sweden, and Switzerland. Followed at the true AA+ level by Netherlands, Austria, and perhaps Canada and Germany. Chile would be AAA as well except that it has no government debt. Among corporate issuers — Johnson and Johnson and KfW (a German bank). That’s it.

AAA rated bonds — accurately rated AAA — are the core of global credit markets and credit creation. Anyone who is issuing credit to anyone needs some “riskless” asset against which they can measure/rate the risks of the credit to someone riskier. Riskless bonds also serve as the collateral/reserve for, literally, the entire global economy. The countries I’ve listed above are teeny. The US’ current AAA rating – along with the UK and the core Eurozone – have provided that credit foundation for the growth in the global economy for decades. If those sovereign bonds become less than AAA, then “globalization” itself loses its foundation.

That’s the real deflation we face. Global trade/finance becomes much riskier because it is based on less-than-AAA credit. The bubbles, crashes, panics, liquidity injections (resulting in commodity inflation), etc are merely the manifestation of that riskiness. If global trade/finance instead becomes based on a smaller pool of true AAA credit (countries above plus AU), then it will shrink dramatically. And until time passes and large economies can delever and become truly AAA again; then nothing CAN fundamentally change. It is why this sort of deflationary “cycle” can last so long – think decades.

What will happen? Globally, those AAA credits (and gold – as an asset with no liability risk attached) will rise in value. They are the “last man standing” – under any and all investable scenarios and so will attract whatever credit needs a riskless foundation. The only true “sleep at night” credit. Their value is NOT going to be merely the “price” or the “income yield” of the asset. Rather, their value is that they are the only source of riskless credit/leverage. That value will not be apparent most of the time – but when it does become apparent it will become glaringly apparent. To the degree that that pool of AAA credit is simply too small to support a global economy, then investment will overflow to riskier credit – but that will be erratic and depend on news flow and such.

For more details – read Nicolai Kondratieff, Joseph Schumpeter, Irving Fisher, Hyman Minski, Melchior Palyi, Antal Fekete. This is not mainstream economics. Then again, mainstream economics has been a colossal screw up for a few years — and everyone knows it.

On edit: After close of business today, the Chicago Mercantile Exchange issued a new set of guidelines re margin collateral. Short-term Treasuries will from now on get a “haircut” (0.5%) when used as collateral. This haircut will get larger over time. Which will in turn reduce the amount of leverage that is possible and the amount of credit that is made available. It will affect margin credit, bank credit, derivatives credit, trade finance credit, everything. This particular move is small but the direction and future moves are inevitable.

Weekly Summary

Short-term: Neutral
Intermediate-term: Neutral

Technical indicators are saying nothing about the market. The US debt kerfuffle is now coming to the fore again. That will likely drive markets all next week – creating a huge problem for the dollar and Treasuries and a huge tailwind for gold, swissies, yen.

Other markets – commodities, equities, etc – should be far less affected since this news event is most likely a very temporary one and will be reversed whenever the debt ceiling is raised. However, the trading will likely provide a bit of an indicator as to which direction those markets go once the summer ends. If commodities and other cyclical assets do well, it likely means that we have another leg up. If bonds do well, then watch out come Labor Day. If our politicians are truly so incompetent as to default on US debt ( a fiat currency over which govt retains a legal production monopoly), then the only assets that matter are bullets and beans.

Weekly Market Summary

I’m changing my summaries to weekly. It’s a bit less noisy than the daily indicator summary. And a weekly summary allows for a slightly different view and a better investment plan.

Short-term: Slightly negative
Intermediate-term: Neutral

Last week’s pullback turned out to be, generally, more healthy than indicative of something worse. That said, roughly 2/3 of equities still look like this is a false rally overall for them. Like last year, it looks like we are in summer noise mode and have established a trading range for the Memorial Day to Labor Day timeframe.

Strongest currencies last week were the two safe-havens – yen and swissie. US$ isn’t a safe-haven until debt ceiling argument is resolved. Weakest currencies last week were euro, A$, and emerging currencies. The swissie is the only currency that is a bit overbought over the last month. It could be vulnerable to either a “risk on” move or a short-term resolution of the US$ “safe havenness”. No currencies are oversold. Longer-term, the barbell currency trade (A$ and swissie) that has performed well over the last year looks overbought – while the US$ looks oversold. Overall, currencies are not indicating a direction for other markets.

The healthiest looking equity markets look to be (in no order): Canada, Japan, HK, Singapore, Taiwan, Malaysia, and Mexico

July 13, 2011

Short-term: 1 green, 2 yellow, 1 red
Intermediate-term: 3 green, 1 red

Market is sitting on a fence. And Moody’s put the US on a credit watch for possible downgrade if the debt ceiling isn’t raised. I don’t think there is a single competent person living in the entire city of DC. Too bad they are in power and Americans don’t give a clueless crap.

Country Rankings

An assessment of country risk rankings over the foreseeable future. International investing is tougher than domestic simply because the context within which companies operate is not embedded in an investors mind as “normal”. What is “normal” is what we experience here in the US. That doesn’t mean other countries are either the same as here or the same as what the media/financial headlines might imply. Nor does this ranking imply that solid economies are actually growing or that investments there are attractively priced/valued. This is true out-of-the-blue risk – banking system collapse, currency collapse, sovereign default (via whatever method), revolution, etc.

Stable and solid investment environments (risks are lower than the US):
Hong Kong

Solid environment except for euro currency risks (slightly better than US)

Marginal/borderline (multiple risks – I put the US in the higher end of this category)
New Zealand
Czech Republic
South Africa
South Korea

Every other big country is basically junk. I would need a huge discount to invest. However some are definitely on their way up and others on their way down. Not really worth trying to pick them though given what is happening in the major Western markets

July 12, 2011

Short-term: 2 yellow, 2 red
Intermediate-term: 1 green, 2 yellow, 1 red

Nothing remarkable. Some deterioration. Gold popped. I think the markets are going to price in resolution of a debt ceiling deal here in the US over the next week or so. It will leave markets vulnerable to either a low-probability of no deal or a “sell on the news” of a deal. In the interim, it is positive for equity markets because the big liquidity pumps that are occurring now are funding the high-frequency quant traders who are responsible for 80% or so of daily trading volume.

Europe is unraveling

fast and overnight it seems. This could get really ugly if bank runs start. Banks do not have to reserve their holdings of sovereign debt. One of the globalizing regulations put in by the Davos crowd over the last two decades. Akin to mandating that all AAA-rated collateralized mortgage debt be considered top-tier capital – which caused the 2008 crisis to be a global one. Do these clowns force Mr Magoo to write all their regulations or is Mr Magoo just the brightest mind in the room when they write them?

The euro dropped and dollar rose by 0.7% in a whoosh after Christine LaGarde new head of the IMF didn’t rule out anything re Greece and said “the IMF is not a cash machine”. Equity markets will drop the same %. Most commodities will drop more. Short-selling will likely be banned again soon – not that that is a wise thing to do. Get liquid – not leveraged.

I do think I know why the market rose in the tail end of June. That’s when the Fed and central banks started pumping more liquidity into the system. Gave their buddies and pals a two-week heads up to clear out positions before the SHTF and before they have to head off to the Hamptons and St Tropez for August.

One advantage of being a minnow. It doesn’t take as long to clear out positions

Currency Move Coming

The US dollar looks like it is poised for a significant multi-month move.

On a daily chart, it has been forming a bottoming wedge for a few months and it broke out to the upside today. That wedge – lower highs and higher lows converging to one point (roughly 75 on the US$ index) at around the end of the month – ie just when the debt limit/default politics stuff is resolved.

On a weekly chart, the dollar index has been cycling between roughly 74 and 88 since 2006. It is near the lows of that range. The two sharp upsurges since then have been the liquidity crunch of late 2008 and early 2009 and the first euro/Greece crisis of 2010. Both of which were panic safe-haven surges – reversed by the Fed implementing a QE program to trash the dollar. I think this rebound will be a bit different from the last two. Don’t know how.

The key currency pair is dollar-euro. Both have serious problems and news events are likely to drive both – and thus the dollar index and equities/commodities. Swiss franc is in turn going to key off the euro zone but it looks very overbought and could be subject to intervention by the Swiss central bank.

July 11, 2011

Short-term: 1 yellow, 3 red
Intermediate-term: 2 green, 1 yellow, 1 red

Big deterioration on both volume and bad news from Europe. Now it is Italy that is having difficulty financing its excessive spending. Greece/Ireland/Portugal are one thing. Italy/Spain – and soon Belgium/France – are quite another. The eurozone is showing all the dysfunctionality that everyone predicted. Germany imposed a strong currency zone to protect its export sector. And now, it will pay hundreds of billions per year to keep it together. There is never a free lunch.

More on currencies in next post. For now, get liquid or short equities and junkier bonds. We’re going down to test the June lows. This rally since then was bogus. I would guess that the SPY will zig zag down to about 117-122 for now.