Americans are not saving enough for retirement, which is a bigger issue than tax policy, Fink said.

The taper worms are still driving things this am.

To the taper worms, tapering equals ‘bonds’ higher in yield and stocks lower in price.

Fundamentally, however, the Fed only tapers if the economy is strong which is good for stocks.

And no tapering means the economy is weak, which is fundamentally bad for stocks and bond friendly (lower yields).

That is, the Fed uses the taper message to signal its economic forecast, and it’s that economic forecast that is fundamentally meaningful for stocks and bonds.

But in this thin/illiquid May market the whims of global hedge funds and portfolio managers rule.

From: JJ LANDO
At: May 14 2013 07:41:14

Consider the following thought experiment. These are the scenarios:
A. The Treasury decides that it will fund itself 30% more in Overnight Bills and reduce issuance across the curve.
B. The Fed announces it will increase QE by 30% (it will remit the net income of this activity back to the Treasury like taxes)
C. Congress announces a new tax on all passive income from USTs, to holders both at home and abroad (ie Central Banks), for all new-issue USTs
D. Lew pre-announces that we will ‘selectively default’ and apply a haircut of on all future Treasury coupon payments of new issues.

Here’s what’s funny. Most intelligent market participants will say things like:
A. Stocks down a few percent on fear of downgrade. Economy slightly weaker or unchanged.
B. Stocks up 5-10% and economy grows another 1% for 1-2yrs; monetary stimulus.
C. Stocks down 5-10% on tax hike (like last year) that maybe corrects. Economy slows 1-2% for a year or so because it’s a tax hike (ie fiscal consolidation).
D. Stocks down 80% and we go into a great depression on steroids. All investment dollars flee the US. I can’t tell you what happens next because my Bloomberg account gets shut down. They might even declare an Internet Holiday.

Here’s what’s craziest: THESE ARE ALL THE SAME THING. The name and the process is different, the OPTICS is different, but the net is the same. There’s the government and there’s everyone else. The government either pays more out – in interest payments or transfer payments or vendor payments, or it takes back more in taxes or default or interest ‘savings.’ Everything the government net gets in ‘revenue’ the rest of the world loses in income. Everything the government dissaves (deficits) the rest of the world saves. Equal and opposite.

[You need to further get around the idea that reserves are overnight bills and there's no such thing as 'monetary base' - just interest rates; that lower discount rates are lower no matter how you get there; that rate cuts are taxes are austerity, even considering the benefit to risk assets from 'lower riskfree discount rates'... it's all basically true if you think abt it long and hard].

Here we are, almost 550 rate cuts into this thing, and inflation everywhere with QE is basically falling (see chart), and incomes are falling everywhere but in the top brackets (see page 9 here for a TRULY SOBERING CHART)… let us never forget that the goal is TO IMPROVE PEOPLE’S QUALITY OF LIFE NOT TO JUICE GDP . Thus economics as a whole also has some major shortcomings. Exporting your way to prosperity is the same as turning your entire population into servants to foreign masters. Disinflation due to lower input costs or better goods or technological gains are good things. HOWEVER if suddenly 20-somethings find social currency in free online friend status rather than cars and houses and weddings – if it makes them happy that’s great but it is also a downward shift in the demand curve that if isn’t replaced leads to someone somewhere being unemployed. These are different issues that shouldn’t all be swept under the ‘disinflation’ rug.

But I digress. Where am I going with all this?
Let’s pretend risk is now in the last 6m-18m phase where everything rallies, everyone in the pool, everyone chases any risk premium to sell, and the underlying income trends are irrelevant. Since I also will posit the Fed isn’t hiking in the next 18 months, I now believe the Fed will entirely miss this risk cycle. Which means they are on hold beyond any trading horizon. So what triggers the end of the cycle? Most would argue – the fear that they ‘tighten’ or ‘hike’ or ‘aren’t on hold anymore.’
To that I disagree…the income and earnings just isn’t there and QE is hurting…in fact the reason the consumer is now tracking +3-4% has been due to a decline in the savings rate (1-handle in q1 as tax hikes hit) that is prone to reverse…it’s MUCH more likely is what triggers the end is that the world starts to understand that QE is a lot like a tax (+ some ‘Richfare’) rather than a stimulus…and that lower rates do raise asset prices for the asset rich but lower incomes and the net to the median person is not what it appears…I see progress on this day every front…TBAC is starting to get it…the inflation markets are starting to get it… we’ll get there … low rates forever…buy blues..

A number of people have inquired about this morning’s front page article in the WSJ by Jon Hilsenrath, “Fed Maps Exit from Stimulus.”

This seems constructed by Jon in a way that is very much reminiscent of the three-day inflation scare and talk of early exit he created last year. Note four points:

1. Jon does not have access to policy makers in the way the WSJ beat reporter once had. The days of Wessel and Ip are over. Bernanke was very reluctant to provide informal guidance to begin with, and the practice virtually ceased with the report of the Subcommittee on Communications at the beginning of last year. Essentially, they decided to speak authoritatively in FOMC statements and everyone was free to offer their own view in the public record after that, but not off camera.

2. The first two paragraphs are an extended, bloated, version of the single sentence in the statement that said “The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes.” Those paragraphs don’t say anything more than the Fed has a plan to do its job. This reminds me of the CNBC banner yesterday morning while Bernanke was giving his speech on financial stability. It said “BREAKING NEWS: THE FED IS MONITORING FINANCIAL STABILITY.” It would have been just as informative to run the banner “BREAKING NEWS: THE FED IS STILL IN BUSINESS.”

3. Note that the only two on-the-record, active voices are Charlie Plosser and Richard Fisher. Those two are probably last on the list of reliable co-conspirators for the core of the Committee that makes policy. But those quotes, plus the older Williams’ one, allows Jon to write “Fed officials” to make it sound like he has access to the second floor of the Board. It also lets him bring out the stale dealers survey.

4. Note the inconsistencies in the story. Fed officials want to put more volatility in the market by conveying that QE is a flexible, smoothly adjusting instrument. The problem is that this makes more sense if the effect of QE was on flows, not stocks, which they have studiously denied for four years. By the way, if those conspiring officials want to make clear it won’t be a slow, steady retreat of accommodation, than they better tell Janet Yellen to stop showing the optimal policy path. Good luck to that.

I believe the central message, which is what I have described in earlier notes: Fed officials want to put as much volatility as possible back into the market before starting to raise rates, provided financial conditions otherwise remain supportive to sustained expansion. They’ll take opportunities to do so on the back of an equity market rally. But Jon Hilsenrath is not the means they will do so.

Vincent

Karim writes:
RETAIL SALES

Though a bit old, this March release is yet another indicator that shows signs of rolling over.

With the tax hikes and spending cuts, it’s up to private sector credit expansion to rise to the occasion. Should the lost income and lost jobs cause it instead to roll over, we’re looking at negative GDP.

How well do stocks forecast this risk?
Note, for example, the last time private sector credit expansion went into reverse, the S&P rallied to an interim peak of over 1,400 mid May of 2008, in front of a 50%+ sell off.

Not at all that it will happen again, but that markets aren’t all that good at forecasting private sector credit acceleration going into reverse.

As previously discussed, financial placebos like QE do cause market participants to alter behavior out of either a misunderstanding of the actual fundamentals, or in anticipation of reactions by others presumed to be misinformed. And while the effects of these activities get reversed, however sometimes the effects are more lasting.

And there are also first order and second order effects. For example, a QE announcement could unleash misinformed fears about ‘money printing’ and ‘currency debasement’ and subsequent portfolio shifting that drives down the currency in the fx markets and drives up the price of gold. And the same misguided fears could cause bond yields to go higher in anticipation of a stronger/inflationary economy, even with the Fed buying bonds in an attempt to take yields lower.

So right now the QE/’monetary policy works if large enough’ placebo is at least partially driving things in both Japan and the US, and today’s announcement of the possibility of the ECB buying asset backed securities is now also at work.

And along the same lines but with a different ‘sign’ is the ideologically driven idea that cutting govt spending in the face of a large output gap- the sequester- is a plus for output and employment. Same for the year end tax hikes.

The underlying fundamental I don’t see discussed is whether private sector credit expansion can continue to sufficiently ‘overcome’ the declining govt deficit spending and satisfy the ‘savings desires’/demand leakages.

The main sources of private sector credit expansion are housing, student loans ($9 billion increase in March), and cars. Since 2009, the private sector credit expansion has managed to stay far enough ahead of the declining govt deficit, which has fallen from about 9% of GDP to about a rate of 6% of GDP by year end (mainly via the ‘automatic fiscal stabilizers’ of higher tax receipts and moderating transfer payments) resulting in about 2% real growth.

The question now is whether the private sector credit expansion can survive the 1.25% of GDP shock of the FICA tax hike and sequesters- which reduce support from the govt deficit to only maybe 4.5% of GDP- and still continue to sufficiently feed the (ever growing) demand leakages enough to generate positive GDP growth.

The stock market is often the best leading indicator of the macro economy, but it has ‘paused’ for two double dips that didn’t happen over the last few years, and it is subject to influence from placebos. Additionally, valuations change as implied discount rates change, and so in this case P/E’s shifting upwards may be discounting interest rates staying low for longer, due to an economy too weak to trigger Fed rate hikes, but strong enough to keep sales and earnings at least flat.

Placebo Surgery Shows Surprising Results

By Kate Melville

Research by Doctor Cynthia McRae of the University of Denver’s College of Education provides strong evidence for a significant mind-body connection among patients who participated in a Parkinson’s surgical trial.

Forty persons from the United States and Canada participated to determine the effectiveness of transplantation of human embryonic dopamine neurons into the brains of persons with advanced Parkinson’s disease. Twenty patients received the transplant while 20 more were randomly assigned to a sham surgery condition. Dr. McRae reports that the “placebo effect” was strong among the 30 patients who participated in the quality of life portion of the study.

“Those who thought they received the transplant at 12 months reported better quality of life than those who thought they received the sham surgery, regardless of which surgery they actually received,” says Dr. McRae. More importantly, objective ratings of neurological functioning by medical personnel showed a similar effect. In the report, appearing in the Archives of General Psychiatry, Dr. McRae writes “medical staff, who did not know which treatment each patient received, also reported more differences and changes at 12 months based on patients’ perceived treatment than on actual treatment.”

One patient reported that she had not been physically active for several years before surgery, but in the year following surgery she resumed hiking and ice skating. When the double blind was lifted, she was surprised to find that she had received the sham surgery.

Although patient perceptions influenced their test scores, when the total sample of patients was grouped by the actual operation they received, patients who had the actual transplant surgery showed improvement in movement while, on average, patients who had sham surgery did not.

Professor Dan Russell at Iowa State, the study’s co-author, says the findings have both scientific and practical implications. “This study is extremely important in regard to the placebo effect because we know of no placebo studies that have effectively maintained the double-blind for at least 12 months. The average length of placebo studies is eight weeks,” according to Russell. Dr. McRae notes that similar results related to the placebo effect have been found in other studies with patients with Parkinson’s disease. She says that there is a need for placebo controls in studies evaluating treatment for Parkinson’s as the placebo effect seems to be very strong in this disease. Dr. McRae also reports that although the sham surgery research design is somewhat controversial and has raised some ethical concerns, the results of this study show “the importance of a double-blind design to distinguish the actual and perceived values of a treatment intervention.”

Knee Surgery Proves No Better Than Placebo

By Katrina Woznicki

July 10, 2002 (UPI) — For individuals suffering from osteoarthritis in their knees, a common type of knee surgery has been found to be no more beneficial than a placebo, a new study revealed Wednesday.

Researchers at the Houston VA Medical Center and at Baylor College of Medicine came to this surprising conclusion after comparing various knee treatments to placebo surgery on 180 patients with knee pain.

The patients were randomly divided into three groups. One group underwent debridement, in which the damaged or loose cartilage is the knee is surgically removed by an arthroscope, a pencil-thin tube that allows doctors to see inside the knee. The second group received arthoscopic lavage, which flushes out the bad cartilage from the healthier tissue. A third group underwent a placebo surgery. They were sedated by medication while surgeons simulated arthroscopic surgery on their knees by making small incisions on the leg, but not removing any tissue.

During a two-year follow-up, researchers found no differences among the three groups. All patients reported improvement in their symptoms of pain and ability to use their knees. Throughout the two years, patients were unaware whether they had received the “real” or placebo surgery.

However, patients who received actual surgical treatments did not report less pain or better functioning of their knees compared to the placebo group. In fact, periodically during the follow-up, the placebo group reported a better outcome compared to the patients who underwent debridement.

Seems like this ‘quasi’ govt type of thing is often later shown to be behind ‘difficult to explain’ ‘liquidity driven’ equity moves.

Norway oil fund makes big move from bonds to stocks

By Richard Milne in Oslo

April 29 (FT) — Norway’s oil fund has reduced its bond holdings to their lowest ever level as the worlds largest sovereign wealth fund signals its discomfort with the effects of western central banks money printing.

The fund held just 36.7 per cent of its $726bn assets in bonds at the end of the first quarter, the lowest proportion since it first received money in 1996. Its equity holdings were close to a record high, accounting for 62.4 per cent of the total.

Yngve Slyngstad, the funds chief executive, told the Financial Times there had been a significant change in rhetoric away from its previous comments that it was comfortable with a high level of equity holdings.

Now it is that we are not so comfortable with the low returns in the bond portfolio. It is not enthusiasm for the equity market but a lack of enthusiasm for the bond market, he said.

The worlds biggest sovereign wealth fund by some distance, Norways oil fund has for some time been concerned about the low level of government bond yields and what that will mean for fixed income return.

But Norges Bank Investment Management, as it is also known, is reluctant to comment about money printing, known as quantitative easing, by the US Federal Reserve, Bank of England or Bank of Japan as the fund is part of the Norwegian central bank.

Still, Mr Slyngstad said unconventional actions were riskier than normal measures, signalling his unease. Unconventional in this context means untried. Things that are untried have a different risk profile than things that have been tried, he added.

The fund has been shifting both its bond and equity holdings away from dollar, yen, euro and sterling assets to those of emerging markets . But the fund is noticeably more positive on US Treasuries than other western government bonds with Mr Slyngstad saying they serve [a] double purpose of being a haven and highly liquid.

Mr Slyngstad said the fund could take several courses of action to reduce the risk of a sharp fall in bond prices, including buying real assets such as property and diversifying into new currencies. It has also reduced the average duration of its bond holdings from about six to five years.

His comments came as the fund delivered its biggest ever quarterly increase in its market value of NKr366bn. It posted a 5.4 per cent overall return with equities gaining 8.3 per cent and fixed income just 1.1 per cent. Apple, Santander and BHP Billiton were its worst-performing investments while BlackRock, Nestl and Novartis were the best. The oil fund also formally unveiled its plans to become a more active investor , as first revealed by the Financial Times. Mr Slyngstad has joined the nomination committee of Swedish truckmaker Volvo , the first time the fund has formally participated in the selection of board directors.

Some very interesting trends/divergences emerging:

1. Staples/Tech or cyclicals/defensives or low vol or correlations all falling completely off a cliff in spectacular fashion.

2. Forward P/Es in Japan vs in China and Korea massively diverging (fx-driven earnings drain, effectively, but only affects fwd PE this much if street is dramatically dramatically underestimating the fx impact on earnings)

3. You all know, Apple, GE, IBM vs S&P, etc.

Meanwhile consider the backdrop:

1. GE was a ‘shoot the messenger’ situation where their own ‘global growth market share’ looks fine but they say global leading indicators are poor so the market takes them down 5% and everyone else untouched

2. Weak USD, Strong commodities, China, and MOST IMPORTANTLY A MASSIVE US DEFICIT were fundamental drivers for US Equity performance for a long time. All are now pushing the opposite way. I am seeing ppl forecasting just 400+b for deficit within 2 yrs. Ppl still had 1T for this year a few months ago. It’s a STAGGERING, stealth development. It’s bad for stocks even if it’s from good growth. People thought the Fed was pumping stocks with ‘liquidity.’ There might have been some weak-USD effects but the FEDERAL BUDGET DEFICIT was the big driver. **Much of the deficit was winding up as corporate earnings the past few years rather than household income** Thus median incomes were flat, overall were up small, overall growth was small, and equity free cash flow and earnings growth has been chugging along at 7,8,9%. Where do you think that came from? Not from the Fed. That was blogoshpere nonsense. IT CAME FROM THE DEFICIT.

The biggest issue of course, is that free cash flow yields still make equities look dramatically cheap to bond-like alternatives… but they also are much more sensitive (over-sensitive) to turning points in things. If only as a punt on reactionary-ism stuff, I don’t like them here. Short for a trade. G’LUCK!

Not that the presumptions will turn out to be right, but just based on the presumptions:

The presumption is that the BOJ’s action will weaken the currency, stocks are up due to the weaker yen, which is presumed to support exports and restrain imports, and help with earnings translations

So the presumed increase in exports/higher stocks is not about total global sales/profits increasing. The presumed increase in exports is just about Japan gaining market share.

Which means the same presumptions lead to the further presumption that the equity gains in Japan from increased exports are at the expense of the ‘rest of world’s’ sales/profits/equity valuations/etc.

In other words, the equity rally in Japan is not based on the presumption that Japan will be an ‘engine of growth’ for the rest of world. Quite the opposite, in fact.

Not that a stock market is ‘necessary’. And not to forget that a 30% corporate income tax, as in the US, is at least as good as owning 30% of all taxable enterprises. If govt, want’s a larger share of corporate profits, it can just hike the tax rather than buy the stock.

If govt cares about stock prices, the question has to be why. If it’s because lower stock prices cause people to spend and consume less out of fear, you’d think cutting taxes on people working for a living would be more attractive than the govt buying stocks? If it’s due to an attack on a fixed fx currency, like HK, I’d rather float the currency than buy stocks.

CSRCs Guo Says Intervention in Stock Market Necessary

January 22 (Bloomberg) — China Securities Regulatory Commission Chairman Guo Shuqing said at the national securities
and futures supervision meeting that its necessary to intervene in Chinas stock market at key moments, the official Xinhua
News Agency reports.

* Chinas stock market is not mature, Guo was cited as saying

So just like Japan, as soon as the economy starts doing a bit better we hike taxes. Still too early to say how the FICA hike will impact sales and profits, but it will. And spending cuts are on the way, though they may be delayed.

Not to forget the debt ceiling thing about to be kicked 3 months down the road as it stands guard to ensure ‘meaningful’ spending cuts.

Oil firm, but can still go either way. WTI converging to Brent indicates the seaway pipeline capacity increase may be enough to drain the surplus at pad 2, bringing wti up to brent, but too soon to tell for sure. And looks like the demand for saudi crude is dropping some, but not enough to dislodge them from being
swing producer/price setter.

Looks to me like the whole world is becoming ‘more competitive’ so it all cancels out. Bad for people, ok for stocks, with profits running at record highs as a % of GDP. Meaning the federal deficit has to be that much higher, all else equal, to fill the output gap.

The yen keeps going down. Looking more and more to me it’s off the radar screen intervention by the likes of insurance co’s, pension funds, and other quasi govt agencies got the note to buy fx denominated bonds in size. Not sure how far they will take it, but they have a serious herd instinct that has formed serious multi year bubbles in the past.

Europe? They fixed the solvency issue, sort of, and now just have the economy thing to deal with. Problem is the ECB grants solvency only with conditionality. Good luck to them.

Please click here to listen to a conversation with Warren Mosler. We did an audio call with Warren in late June and he was spot on. So I thought it was a good time to circle back with him. Topics include: US stocks (they look good…deficit to GDP in US a support for market/econ), US rates, Europe and China.

Stocks down again yesterday but interestingly bond yields up a tad, dollar down a tad, oil and metals up, and even long BMA ratios holding steady, etc.

The cliff isn’t nearly as large and threatening as the debt ceiling cliff would have been in 2011 if that thing hadn’t been extended, and we’d gone cold turkey into an immediate and forced balanced budget. But that event is the stock market’s ‘recent memory’ of stock market reaction functions.

And this time GDP is being supported by a private sector credit expansion/housing expansion, with private debt service ratios substantially lower due to cumulative federal deficits adding to nominal ‘savings’. And the federal deficit remains well above 5% of GDP, which historically has been more than enough to reverse a recession.

And then there’s the election factor. Post election I’m hearing (anecdotally) distraught Romney supporters thoroughly convinced the President is a ‘socialist’ bent on destroying capitalism, taxing the rich ‘job creators’ and giving it to what Romney called ‘the 47%’ dependent class, etc. etc. etc. Merits of this ‘belief’ aside, it looks to me it’s driving portfolios to shift out of equities. However, if not supported by an actual decline in earnings, which is how I see it, it’s all a case of ‘pushing on a spring’.

Yes, the euro zone is a problem, with Q3 GDP just reported at -.1%. But that’s an ‘improvement’ from q2′s -.2% as larger deficits are acting counter cyclically to cushion the austerity driven decline. And Rehn was just quoted on Spain favoring not adding to austerity measures, perhaps indicating a move to ‘let it be’ for a while, which will allow GDP to stabilize at modestly positive levels.

And China is no longer going backwards, so that negative has been reversed as well.

Back to the cliff, in fact letting tax rates go up for high income earners should have little effect on GDP, as the marginally propensity to spend for that segment is reasonably low. (of course that means there’s no point in taxing that income in the first place, but that’s another story). Nor does it mean investment or employment will suffer since investment is driven by sales prospects. And with higher tax rates, and business expense tax deductible, the after tax cost of investment goes down with higher tax rates. For example, in the 70′s, when my tax rate was around 70%, I clearly recall making very high risk investments figuring it was better than giving 70% to the govt. Point is, taxing income and savings that isn’t going to be spent is about social engineering, and not ‘funding the deficit’ or altering aggregate demand, and is intellectually honestly framed as such. So point here is, I score the effect of raising the highest tax rates at 0 regarding aggregate demand.

This all supports my take that the stock market has over discounted the cliff, partly for ideological reasons, partly due to the recent memory of what stocks did during the debt ceiling debacle, and partly from fear of what’s going on in the rest of the world.

So as we get through it all with modest top line and earnings growth continuing, I’m looking for valuations to quickly return to at least where they were before the election.

I’m thinking it’s about that time for portfolio managers to buy stocks and go play golf for a few years,
with the following very caveats.

1. A serious spike in crude oil/gasoline prices that undermines consumption
2. The euro zone could break down socially under the stress of continued austerity
3. Congress opting for ‘meaningful’ proactive deficit reduction

But apart from that it looks like relatively clear sailing to me

The Republicans are now softening on revenue increases to get past the fiscal cliff.

And in any case the fiscal cliff may already be up to 50% discounted, as business has slowed due to delayed contracts, etc. with top line growth still remaining modestly positive as the cyclical housing ‘recovery’ begins its multi year upward grind, providing a powerful ‘borrowing to spend’ force for growth. I call it a drop in ‘savings desires’ as borrowing is in fact ‘negative savings’.

This is fundamentally supported by continuing federal deficit spending that, while down from the peak, is still looking more than high enough to support a growing credit structure.

And the 4 years of ‘larger than ever’ federal deficits have added exactly (to the penny) that much in dollar net financial assets to the global economy, with much of that being added here domestically. This is evidenced by the full recoveries, and then some, of macro debt service ratios of all types. In short, ‘savings’ has been, for all practical purposes, more than sufficiently restored for a ‘normal’ recovery.

This kind of underlying strength will quickly cause the Fed to reevaluate policy as unemployment drops towards 7%, leading to a ‘normalization’ of policy, which means a fed funds rate at a ‘normal’ premium over ‘inflation’ for a ‘neutral monetary policy.’ In fact, as this happens, the higher rates from the Fed further support the expansion via the interest income channels.

The output gap is wide enough for this to go on for a long time without excess demand issues, again with the caveat of crude oil.

Growth has already caused the federal deficit to come in lower than expected, which is helping put off proactive deficit reduction efforts.

Yes, eventually, the automatic fiscal stabilizers will bring the deficit down too far for it to support the credit structure, and serve to end the cycle. But this is WAY down the road.

The first Obamaboom came from the ‘stimulus’ which wasn’t nothing, but was far too weak to remove the sudden drag on demand from the private sector credit contraction.

The ‘crime against humanity’ was not implementing the likes of my proposed ‘payroll tax holiday’ in mid 2008 to support demand at full employment levels at that time.

Instead, the govt allowed demand to collapse/output gap to widen. This did not have to happen. It was a total failure of govt.

Also, timing is also important, so mind the technicals!

Karim writes:

Not to overlook the increase in the labor force participation rate from 63.6 to 63.8!

And Q2 gdp talk still about 2%.
Still looks to me good for stocks, not so good for people, though lower gasoline prices good for consumers as is weak consumption overseas.

Venice video link here.

Also, Trichet Friday, the German elections, and G8 reports seem to be setting the tone for the euro zone to do something about the solvency issue. This is very good for equities and the rest of the credit stack.

At the same time it does not seem likely that any growth proposals will include fiscal relaxation, so the euro zone will have to get by the best it can with the deficits it has, which I’d guess should mean flat GDP, +/- 1% or so.

The US should also continue to muddle through with modest top line growth, and inflation low enough and the output gap wide enough to keep this Fed from hiking any time soon.

US economy muddling through, growing modestly, particularly given the output gap, but growing nonetheless.

Lower crude prices should also help some.

I had guessed the Saudis would hold prices at the $120 Brent level, given their output of just over 10 million bpd showed strong demand
and their capacity to increase to their stated 12.5 million bpd capacity remains suspect. And so with the Seaway pipeline now open (last I heard)
to take crude from Cushing to Brent priced markets I’d guessed WTI would trade up to Brent.

But what has happened is the Saudi oil minister started making noises about lower prices and when ‘market prices’ started selling off the Saudis ‘followed’ by lowering their posted prices, sustaining the myth that they are ‘price takers’ when in reality they are price setters.

So to date, contrary to my prior guess, both wti and brent have sold off quite a bit, and cheaper imported crude is a plus for the US economy. Which is also a plus for the $US, as a lower import bill makes $US ‘harder to get’ for foreigners.

But the trade for quite a while has been strong dollar = weak US stocks due to export pricing/foreign earnings translations, and also because US stocks have weakened on signs of euro zone stress, which has been associated with a weaker euro. So when things seem to be looking up for the euro zone, the euro tends to go up vs the dollar, with US stocks doing better with any sign of ‘improvement’ in the euro zone.

It’s all a tangled case of cross currents, which makes forecasting anything particularly difficult.

Not to mention possible dislocations from the whale, which may or may not have run their course, etc.

And then there’s the news from Greece.

First, they made a full bond payment yesterday of nearly 500 million euro to bond holders who did not accept the PSI discounts. This is confounding for the obvious reasons, signals it sends, moral hazard, credibility, etc. etc. But it’s also a sign the politicians are doing what they think it takes to keep the euro going as the currency of the euro zone. Same goes for the decision to fund Greece as per prior agreements even when there is no Greek govt to talk to, and lots of signs any new govt may not honor the arrangements.

Even if that means tricking private investors out of 100 billion, rewarding those who defy them, whatever. Tactics may be continuously reaching new lows but all for the end of keeping the euro as the single currency.

It also means that while, for example, 10 year Spanish yields may go up or down, the intention is for Spain, one way or another, to fund itself, even if short term. Doesn’t matter.

And more EFSF type discussions. The plan may be to start using those types of funds as needed, keeping the ECB out of it for that much longer, regardless of where longer term bonds happen to trade.

As for the euro zone economy, yes, growth is probably negative, but if they hold off on further fiscal adjustments, the 6%+ deficit they currently are running for the region is probably, at this point, enough to muddle through around the 0 growth neighborhood. The upside isn’t much from there, as with limited private sector credit growth opportunities, and substantial net export growth unlikely, and strong ‘automatic stabilizers’ any growth could be limited by those automatic fiscal stabilizers. Not to mention that this type of optimistic scenario likely strengthens the euro and keeps a lid on net exports as well.

And sad that this ‘bullish scenario’ for the euro zone means their massive output gap doesn’t even begin to close any time soon.

For the US, this bullish scenario has similar limitations, but not quite as severe, so the output gap could start to narrow some and employment as a percentage of the population begin to improve. But only modestly.

The US fiscal cliff is for real, but still far enough away to not be a day to day factor. And it at least does show that fiscal policy does work, at least according to every known forecaster with any credibility, which might open the door to proactive fiscal? Note the increasing chatter about how deficits don’t seem to drive up interest rates? And the increasing chatter about how the US, Japan, UK, etc. aren’t like the euro zone members with regards to interest rates?

Same in the euro zone, where discussion is now common regarding how austerity doesn’t work to grow their economies, with the reason to maintain it now down to the need to restore solvency. This is beginning to mean that if they solved the solvency riddle some other way they might back off on the austerity. And now there is a political imperative to do just that, so things could move in that direction, meaning ECB support for member nation funding, directly or indirectly, which removes the ‘ponzi’ aspect.

They have certainly had their ups and downs:

Click here for larger version

>   
>   (email exchange)
>   
>   Warren, what do u think stocks do here?
>   

Been bearish all along from mid March and still thinking same.

Euro zone still melting down.

US coming off Q4 rebuild of Japan’s pipeline.

And now unemployment benefits expiring in 9 states with more to come?

State and local cutbacks are ‘high multiple’ and actual state and local deficit spending coming down as well?

Housing not picking up enough to add meaningfully to aggregate demand/GDP.

With ‘real productivity’/technology and management advances’ continually reducing labor needed per unit of output, recent declines in productivity in line with softer employment?

Global austerity = global slow motion train wreck?