The Emperor’s Clothes Are In Plain Sight

We all know the naked truth that it's up to you, the politicians, to strengthen the weak/high-risk fiscal and economic environment...the Fed really can't do your job ad infinitum/ad nauseam as it can't fix the economy by monetary policy alone, as re-iterated by Ben Bernanke today in his speech at Jackson Hole:

     "As I have discussed today, it is also true that nontraditional policies are relatively more difficult to apply, at least given the present state of our knowledge. Estimates of the effects of nontraditional policies on economic activity and inflation are uncertain, and the use of nontraditional policies involves costs beyond those generally associated with more-standard policies. Consequently, the bar for the use of nontraditional policies is higher than for traditional policies. In addition, in the present context, nontraditional policies share the limitations of monetary policy more generally: Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly cannot fine-tune economic outcomes."

It's time for politicians to wake up, get out of bed, get dressed, and own up to your responsibilities by acting for the good of those whom you purportedly serve.


Guest Post: The End Of The Euro: When Will It Happen?

Submitted by Tim Staermose of Sovereign Man blog,

My 2-year old nephew in Australia loves getting postcards.  He already associates me with frequent traveling.  I’m referred to as “Tim Hong Kong jet plane.”

So before leaving Italy today, after a fantastic week in the Umbrian countryside with our Sovereign Man Total Access members, I set out to mail him some postcards. What I got, among other things, was a useful lesson in Italian bureaucracy.

In Hong Kong, on the rare occasion I need to mail a letter, I put a few coins in the vending machine on the outside wall of the post office. Space is a prized commodity that costs a lot of money in Hong Kong, so post offices are small and efficient.

Here in Rome, the main post office at Piazza San Silvestro is in a majestic old building with imposing architecture.  There were acres of cavernous space inside that could have been much better used by high-end retail shops earning a profit. Instead it goes to Italy’s famously slow, inefficient, loss-making postal service.

It was a procession just to buy a few stamps. Stand here, stand there. Take this ticket, fill out this form, print that form. What should have taken 10 seconds took 10 minutes. I finally got what I needed, but the process it took to get there was a real eye opener.

They have all these fancy IT systems—the mail clerk was in a clicking frenzy moving from screen to screen with all sorts of dropdown menus and product codes. But I get the sense that this ‘technology’ just gives the post office a veneer of modernity and sophistication without actually being necessary or adding any value.

This is typical of bureaucracy: take a simple task, make it unnecessarily complicated, then spend a bunch of money on technology that makes it even more complicated.

Given my experience this morning, Italy has clearly mastered the art of unnecessarily complicating the simple. It’s no wonder they have serious problems paying the bills.

Moreover, the country’s demographic challenges indicate the country’s fiscal situation cannot improve.

Robust economies are productive… and productivity is typically not associated with the elderly. Italy has one of the world’s oldest populations concurrent with one of the lowest birth rates.

This trend drives an unsustainable fiscal quandary: bloated public sector bills with lots of old people to pay pensions to, coupled with a rapidly shrinking population devoid of young workers to pay taxes.

At this point, Simon and I both agree there can be little doubt that Italy will exit the eurozone… most likely voluntarily. A return to the lira means the Italian government (probably to be headed by Berlusconi once again) would be free to print currency at will. This is the only reasonable solution remaining.

(Simon thinks they’ll probably even make up some silly patriotic-sounding name like ‘new strong lira’…)

When will it happen? Probably sooner than we think. Look at the European bond market— making a loan to the Italian government for three years yields just 3.642%… an absurdly low figure given the country’s untenable finances.

screen capture 1 1 300x140 The end of the euro: When will it happen?

Meanwhile the same loan made to the German government yields less than one one-hundredth of that amount (0.034%…) Yields on shorter duration bonds (2-year and below) are all negative.

screen capture 2 300x141 The end of the euro: When will it happen?

In other words, you lose money loaning to the German government for up to two years.  This is the period of time that the bond market is sensing maximum risk, and it may be worth considering as a final window for the euro’s demise.

Wacky Email of the Month: Obama to Rejigger DJIA

Since its the Friday before a 3 day weekend, let me share with you the goofiest email I have received this month, from somewhere in the Netherlands. The full email (which is all over the Internet in its original language) is reproduced below, immediately following my response.


My response:

That is hilarious. I presume you are joking.

The editors of Dow Jones (WSJ, Barrons etc.) manage the Dow Index — not the US president, who has nothing to do with how its calculated (its based on component prices, not market caps). The Dow today consists of 30 stocks, not 12. The WSJ/Dow Jones is now owned by Rupert Murdoch — who also owns Fox News — and last i checked, has not deferred any of his editorial choices to the President. There are some people here who even think that Murdoch does not care for either President Obama or his political party. (Perhaps Google can give you some color on this).

Indeed, anyone with access to Google can figure out how the Dow is composed. Do you know the author of this piece? Has he recently suffered a severe blunt head trauma? That is the only thing I can think of that would explain what he wrote . . .


Original Email:

Obama: “Truth, from fiction to reality”

Dow Jones Index to 58 points

After intensive consultation with his advisors, President Obama has decided to modify the formula used for calculating the Dow Jones Index. On January 1, 2013 the Dow Divisor will be changed to 30. The result of this change will be that the Dow Jones Index drops from the current 13,124 points to about 58 points. The underlying value of the 30 component stocks of course remains unchanged. With this modification to the formula Obama aims to make the large Dow fluctuations of recent decennia a thing of the past, and hopes that this will bring stability to the stock market. Banks, major investors and pension funds welcome this change in the Dow Jones Index formula.

To understand Obama’s proposal we must go back in Dow Jones history. The Dow was first published in 1896. The Dow was calculated by dividing the sum of the 12 component company stocks by 12:

Dow-index_1896 = (x1 + x2+ ……….+x12) / 12
In 1916 the Dow was enlarged to 20 companies; 4 were removed and 12 added:

Dow-index_1916 = (x1 + x2+ ……….+x20) / 20

The shares of a number of companies were split in 1927, and for those shares a weighting factor was introduced in the calculation. The formula is now as follows
(x1 = American Can is multiplied by 6, x2 = General Electric by 4 etc. )

Dow-index_1927 = (6.x1 + 4.x2+ ……….+x20) / 20

On 1 October 1928 the Dow was further enlarged to 30 stocks. Because everything had to be calculated by hand, the index calculation was simplified. The Dow Divisor was introduced. The index was calculated by dividing the sum of the share values by the Dow Divisor. In order to give the index an uninterrupted graph the Dow Divisor was given the value 16.67.

Dow-index_Oct_1928 = (x1 + x2+ ……….+x30) / Dow Divisor
Dow-index_Oct_1928 = (x1 + x2+ ……….+x30) / 16.67

Since then the Dow Divisor has acquired a new value every time there has been a change in the component stocks, with a consequent change in the formula used to calculate the index. This is because at the moment of change the results of two formulas based on two different share baskets must give the same result. When stocks are split the Dow Divisor is changed for the same reason.

In autumn 1928 and spring 1929 there were 8 stock splits, causing the Dow Divisor to drop to 10.47.

Dow-index_Sep_1929 = (x1 + x2+ ……….+x30) / 10.47

After the stock market crash of 1929, 18 companies were replaced in the Dow and the Dow Divisor got the value 15.1.

Table: Changes in the Dow, stock splits and Dow Divisor

The table above makes it clear that the Dow Jones formula has been changed many times and that the Dow Divisor in the period 1980-2010 has actually become a Dow Multiplier, due to the large number of stock splits in that period. Where in the past the sum of the share values was divided by the number of shares, nowadays the sum of the share values multiplied by 7.5. Dividing by 0.132 is after all the same as multiplying by 7.5. (1 / 0,132 = 7,5). This partly explains the behaviour of the Dow graph since 1980.

Figure: the Dow Jones since 1896

The proposed change on 1 January 2013 restores the formula to what it originally was: the sum of the share values divided by the number of component shares.

Dow-index_Jan_2013 = (x1 + x2+ ……….+x30) / 30

The aggregate current value of the 30 component stocks is 1736 dollars. By changing the Dow Divisor from 0,132319125 to 30 (a factor 227 larger) the index will, at current values, change from 13124 to 58 points (a factor 227 smaller).

The emotional factor in the current formula, the nervousness or euphoria of investors resulting from large fluctuations in the Dow, will be greatly reduced by this change (227 times) and so rationality should gain the upper hand in investor’s decisions.

Obama’s proposed change must still be approved by House and Senate. Both Republicans and Democrats have told Obama they support his proposal. Politicians, irrespective of political colour, desire stability in the stock markets. For the investor however it will take some getting used to: the Dow Jones at 58 points.

China, Germany to Settle More Trade in Yuan, Euros; What’s That Mean for Gold, the Dollar?

Inquiring minds note China, Germany Plan to Settle More Trade in Yuan, Euros.
Germany and China plan to conduct an increasing amount of their trade in euros and yuan, the two nations said in a joint statement after talks between Chancellor Angela Merkel and Chinese Premier Wen Jiabao in Beijing on Thursday.

"Both sides intend to support financial institutions and companies of both countries in the use of the renminbi and euro in bilateral trade and investments," said the text of the statement.

It also said that both parties welcomed investments in China's interbank bond market by German banks and supported the settlement of business in the yuan by German and Chinese banks and the issuance of yuan-denominated financial products in Germany.
Announcement Mean Anything?

That's the announcement, and I have no doubt people who do not understand trade math will trump this up as if it's news of big significance.

Well, it's not. The announcement is a common sense function of math.

There is more bilateral trade between Germany and China, so fundamentally it makes sense that this agreement would be worked out. Indeed, mathematically, the markets would eventually force such an agreement.

If Germany goes back to the Deutschmark, then one should expect bilateral trade between the countries to be in Deutschmarks and Yuan.

The only relevance to the dollar is if Germany is taking away US trade with China. If not, the announcement is a meaningless function of math.

Mike "Mish" Shedlock
Click Here To Scroll Thru My Recent Post List

Gold Soars To Near Six Month High As Silver Overtakes Stocks In 2012

A very noisy gappy day with much larger volume than in recent days (which all dried up in the afternoon session until the close - for the heaviest volume day in a month) in US equities. European comments lifted us early in a correlated-risk-on manner until Bernanke's speech which hit markets like a meteor - stops were run up and down - but by the close equities and the USD ended fractionally lower from pre-Ben (notably up on the day to save the month for the Dow), Gold considerably up from pre-Ben, Treasury yields down notably from pre-Ben. Near six-month highs in Gold and five-month highs in Silver were the real movers today - with their largest gains in two months. VIX ended marginally lower at 17.5% (-0.3vols); credit was very thin today and tracked stocks in general (though less volatile); USD ended the week -0.5% which matches Oil's +0.5% on the week as Copper underperformed. Silver has overtaken Stocks as the Year-to-date winner once again...

Gold vs Stocks vs USD vs Treasury yields... (arrows from pre-Ben to close)...7Y closed under 1%


left Gold and Silver at multi-month highs...


Leaving Silver the winner YTD...


Stocks were a mess all day post-Ben - especially the afternoon noise...but closed at VWAP - amid very heavy volume (month-end and all) but seemed to echo the last Friday buying. We closed at the low volume node (left hand distribution) of the recent range - having auctioned up early on, suspect we test back down by Sunday night...


It's month-end and the need to exit sizable positions was clear above but the last few minutes were quite fascinating in terms of the Algos In Action. Someone needed to dump a lot so they emplyed the 'tickle' algo to lift on low volume but higher block size, gradually wiping out the stack of orders encouraging a trend, getting followers to buy-in (as the crowd sees rising block size into and above VWAP - though not massive volume we should note), then flush their big block well above the start of the startegy - with any luck somewhere around VWAP...


Dow Transports end the month down 1.6%, The Dow managed to creep off unch todayt to make another green month but the NASDAQ was the big winner (thank you AAPL) as it ended the month up almost 5%...


Charts: Bloomberg


Bonus Chart: Facebook Is Barely Legal...

LPS: Mortgage delinquencies decreased in July

LPS released their First Look report for July this week. LPS reported that the percent of loans delinquent decreased in July from June.

LPS reported the U.S. mortgage delinquency rate (loans 30 or more days past due, but not in foreclosure) decreased in July to 7.03% from 7.14% in June. The percent of delinquent loans is still significantly above the normal rate of around 4.5% to 5%. The percent of delinquent loans peaked at 10.57%, so delinquencies have fallen over half way back to normal.

The following table shows the LPS numbers for July 2012, and also for last month (June 2012) and one year ago (July 2011).

LPS: Percent Loans Delinquent and in Foreclosure Process
July 2012June 2012July 2011
In Foreclosure4.08%4.09%4.12%
Number of loans:
Loans Less Than 90 Days1,960,0002,012,000NA
Loans 90 Days or more1,560,0001,590,000NA
Loans In Foreclosure2,042,0002,061,000NA

The total number of delinquent loans, and in foreclosure, dropped about 100 thousand in July from June.

The percent of loans less than 90 days delinquent is close to normal, but the percent (and number) of loans 90+ days delinquent and in the foreclosure process are still very high.

The ECB ‚Compromise‘ Cheat-Sheet

With Bernanke leaving the door open, but not pre-committing, in a check-raise to Draghi next week, market focus remains almost exclusively on the bond-buying program to support Spain. Credit Suisse expects markets to be mildly disappointed by Draghi's words and deeds as they question how far he can go, and in terms of near-term market moves, how much is said at next week's meeting versus said at later occasions or indicated through actions (e.g. once Spain asks for help). Draghi has already started to manage expectations with his Die Zeit comments (pitched at the German populous) but in order to get a handle on what the various scenarios are - and what the implications could be - here is Credit Suisse's matrix of compromise.


Credit Suisse: Analysing the ECB scenarios

Exhibit 6 below shows the main scenarios we consider possible. Our central scenario is the Compromise Scenario where the ECB cuts the Repo Rate to 50bp, keeps the Deposit Rate at 0% and revises the collateral framework. We expect little new material information on the front end SMP bond buying program. To us, this will underwhelm market expectations and will lead to a modest rally in core markets.


But the fact that the ECB meeting may well disappoint on bond purchases at this meeting does not change our constructive view on 1y Spain and Italy. In fact, any disappointment-led widening in 1y Spain would ultimately provide an opportunity to add to longs in 1y (and longer if it is clear that there will be buying) bonds; i.e., the commitment to do something is clear enough, it’s just a question of timing.

In developing these scenarios, there are three main axes to consider. We delve into these in more detail below:

  • Front-end bond buying: the degree of detail we get next week will determine the tone of the market in the near term. The question of seniority remains key.
  • Revision to the collateral framework: we are expecting changes to the collateral framework. Reducing haircuts will effectively act as a Repo rate cut.
  • Policy rate cuts: we do not expect negative Deposit Rate in the near future. We expect the ECB to cut the Repo rate by 25bp to 0.5%.

Disappointment. Under this scenario, the ECB does not provide any new material information on the front-end bond buying program. The ECB does not cut the Repo Rate but only announces the revised collateral framework. We expect the lack of detail on the bond buying to support a rally led by the Bund. The front end can sell off (5-10bp) as the market readjusts expectations for a Repo Rate cut. Spain and Italy 2-3y are likely to underperform in this scenario.

Compromise. Our most likely scenario. We expect little or no new information on bond buying. We expect a modest rally in core markets and wider peripheral spreads. To us any sell off in the front ends of Italy and Spain are a buying opportunity as we expect the ECB to reinforce their willingness and ability to address current market fragmentation.

Positive. In this scenario, we expect a meaningful revision to the collateral framework, and specific details on the maturity and countries that will be included in the front-end bond buying program. We would also expect the ECB to convincingly address the issue of seniority of bond purchases. To us that would be positive for the periphery. We expect tighter soft core and peripheral spreads. German yields would shift higher. We would position for this scenario by being short core yields.

Extremely positive. The least likely outcome. This scenario involves revision to the collateral framework that is immediately positive to the periphery (e.g. reducing haircuts on government bonds to a flat structure). The ECB cuts the Repo rate to 50bp and keeps the Deposit rate unchanged at 0%. Additionally, the ECB announces yield caps on the SMP program and addresses the seniority question convincingly. The immediate reaction is expected to be bearish steepening of the German 5s10s curve and tighter ASW, soft core and peripheral spreads.

1 2 3 178