Quick! Get out the green spray paint and cover this up: “Durable Goods Orders in U.S. Unexpectedly Decreased“.

Orders for goods meant to [last] several years dropped 2.4 percent, the worst performance since January, the Commerce Department said today in Washington. Excluding transportation equipment, orders were little changed. Restrained consumer spending and near-record excess capacity mean companies will probably not boost investment in new plants or equipment in coming months. The report indicates the jump in auto sales from the Obama administration’s $3 billion trade-in program may not give other industries a jolt, raising concern any factory rebound will be uneven.

No problem, the banks will still be able to game the stock market and give the government their share, so all is well…

In essence, the government has passed the baton on to the banks so they can keep the party going.  This phenomenon has been most evident in bank earnings.  Banks are in the business of lending, but an odd thing has occurred while bank earnings soared – they were doing no lending!   Banks have been hoarding record amounts of cash as the government floods their balance sheets via various programs and bailouts.  Many assume that the banks are either attempting to loan the money or simply letting it sit on their balance sheets earning nothing.  But Moonraker’s analysis raises a more nefarious possibility – the banks are effectively creating a ponzi run stock market in which they use the bailout money to drive various market prices higher and thereby juice their own earnings.  It’s quite brilliant when you think about it – until the music stops.

Who’s in charge of the music?

There is debate (and confusion) over whether the average American has actually increased his saving rate or whether this is a mirage.  Ha!… Felix Salmon points out that some economists actually think that buying stocks and bonds is consumption – not saving.  Much of the confusion arises from the need to distinguish between “investors” and “savers”. There is a legitimate need for theory to take into account the possibility that the investor and the saver are not the same person, but some then go on to describe investors as “wealthy” and savers as non-wealthy, as if this is the chief issue.  If a saver puts his savings in any other financial instrument besides cash, has he become an investor as well as a saver?  Do only “rich” savers buy bonds, while non-rich savers put their savings in their mattress?

In my doctoral program, I took a class called “Capital Formation”.  It was all about understanding how and why real productive capital assets were created.  Investing is a real phenomena.  That is, we should think of investment as increasing the supply of physically productive capital in the world.  When a saver buys a bond, that does not necessarily mean that the total supply of real capital has grown. In fact there’s no reason to expect that it has.  It’s really another issue. The difference between the supply of financial assets in the world and the supply of real income producing capital in the world can be vast. More on real investment in another post.

For now, let’s get back to saving…  Typically, freshman economics texts suggest that higher interest rates (i.e. higher returns on bonds and stocks) encourage people to buy those financial instruments and, thus, save more.  This “income effect” is accepted wisdom, but does it cover all the bases?  Answer: only partly. The Theory of Consumer Choice says we have to consider the effect of higher interest rates on wealth too.  The wealth effect is opposite in direction from the income effect, so that as Greg Mankiw says in his Principles of Economics text, “Unfortunately, research has not led to a consensus about how interest rates affect saving”.

OK…so when the Federal Reserve reduces the interest rate it charges member banks ostensibly to “stimulate the economy”, what does that do to consumer saving?  Answer: WE DON”T KNOW! A saver might have a goal that involves saving each year for 20 years to be able to retire and live on (say) $50,000 per year after that.  With now near-zero interest rates available, that saver now needs to save more to achieve his goal, than previously.  And this ignores the increased amount of precautionary saving needed to offset the recent rise in general uncertainty about potential job losses, etc.  Has the saving rate risen lately? The government says it has, at least in aggregate. But even if it hasn’t, we can surely see why people might want to save more.

Famed Elliot Waver, Bob Prechter is “quite sure the next wave down is going to be larger than what we’ve already experienced,” and take major averages well below their March 2009 lows.

The Pragmatic Capitalist has a great post about the recent behavior of the VIX:

“The VIX is currently 34% from its 50 day moving average.  In the last two years since the recession began we have seen three other instances  where the VIX traded 30% from its 50 day moving average on the downside.  The first occurred in late September and early October of 2007.   The second occurred in May of 2008.  And the third occurred in mid-December 2008.   All three moves foreshadowed large equity sell-offs.  The first one in September of 2007 marked the top of the market.  The second market an intermediate top in the market after Bear Stearns went down and the third occurred just before the market sell-off in early 2009.

Clearly, three data points is not a comfortable amount of data with which to form a trading strategy, but there is no doubt that the sharp decline in the VIX represents a high level of complacency and comfort in high risk assets.  Considering the quick rise in the equity markets and the questionable underlying fundamentals and we might just be staring at a market that is ripe for a sharp decline.”

Bill Luby in VIX: How Low Can It Go? at SeekingAlpha (5/8/09) ventures that the VIX would not fall below 25-27:

For the record, the lowest 10, 20 or 100 day historical volatility level recorded in the past six months was a 10 day HV of 20.38, which translates into a VIX of 26.69. For anyone looking for the lowest possible extreme in the VIX in the near future, 26 would be a good bet. This is also consistent with my earlier prediction that the VIX is not likely to breach a floor of 25-27.

As of 11:55 Eastern on Wednesday, VIX was trading at 27.75 ish with a low for the day so far of 26.57.  If TPC and Luby are right, we will see a market top just around the corner…how big the correction may be is another question…

John Maldin at Investor Insight has Niels C. Jensen‘s letter  this week.  Here are some clips:

The problems are not over yet. Not by a long stretch. It will take longer than 18 months to unwind the excesses of the past 25 years. Analysts at Morgan Stanley reckon that the 15 largest banks which between them have shrunk their balance sheets by about $3,600 billion so far in this crisis, will shed another $2,000 billion in 20091. If you do not share my pessimism, please take a quick look at chart 3 below. The US financial sector debt load (as a % of GDP) is now 117%. In the early days of the great bull market in 1982, the same number was 22%. Households are not much better off with total household debt now at 96% of GDP vs. 47% in 1982.

Reinhart and Rogoff offer a more realistic approach (see chart 8 ) [to estimating the cost of crisis].  Using their least costly case study (Malaysia 1997) as our best case scenario, the true cost comes to $15 trillion. If one uses the average of 86% instead, the cost jumps to a whopping $33 trillion. I didn’t even bother to produce a worst case scenario – it all got too depressing!

Chart 8: The Cost of the Banking Crisis (Reinhart & Rogoff estimates)

Obviously, governments may buy a portion of these bonds themselves, but they cannot afford more than a fraction of the total unless they want to challenge Mugabe as the ultimate master of illusion. Neither should investors hold out for sovereign wealth funds to do the dirty work. As is clear from chart 9, the total amount of wealth accumulated in these funds is pocket money when compared to the projected bond issuance over the next few years.

Hence it comes down to the price at which governments can attract sufficient demand from people like you and me. One of two things may happen. Either this crisis will ignite such a bout of deflation that investors will happily own government bonds yielding 2-3% or the deflation scare goes away ultimately, the global economy recovers and bond investors demand much higher yields for taking sovereign risk. I am not yet sure which scenario will prevail, but I do know that both are quite bad for equities longer term. Take your profits!

For a while, Swamp Report  thought we were the only ones who thought it possible that the government might need to actually engineer a crisis as a way to sell all the Treasury bonds it needs to sell.  No we find several others of the same opinion.  For example, in another related post to Jensen’s, Clive Maund argues just that:

“The storm that is threatening to break is the combined collapse of the bond market and the dollar, which are joined at the hip. Late in April the bond market crashed important support and it dropped significantly again late last week. The dollar finally succumbed this past Friday, crashing important support. They both look set to plunge together – a scenario that will require immediate and drastic action to avert. What is the best way to rescue them? – why, to create another vicious cycle of deleveraging of course. The idea is to get the rabbits to flee out of commodities and the stock market and into the perceived safety of the Treasury market, just like last year, which will require them to buy dollars with which to buy Treasuries.”

It’s a wild world we live in…

Hans Wagner at tradingonlinemarkets.com has a straight forward piece at Market oracle that makes a simple point:  Standard & Poor’s estimates reported earnings for the S&P 500 in 2010 will be $39.59.  At even a conservative estimate of $50.00 and a generous PE ratio of 15, the S&P would be valued at 750.  The S&P 500 closed today at 851.92. The market is pricing in future earnings that can not be achieved.  Duh…

Bespoke Investment Group has several nice charts showing the current percent of stocks trading above their 50 day moving average. Here’s the one for the S&P. Kinda looks overbought to us…


Here’s an updated chart ( through 4/3) showing the correlation of the 10 day exponential moving average of $Tick compared to SPX.  Please see our previous post about this.  There still appears to be a correlation and a possible top.  We never give investment advice on the Swampreport, but it is interesting that the Pragmatic Capitalist’s “Ultimate Indicator” is also showing a possible top.


Bloomberg reports one-month treasury bill rates went negative today:

One-month bill rates turned negative today for the first time since Dec. 26 as investors sought the debt approaching the end of the quarter. At that time, banks prefer to carry securities on their balance sheets instead of cash, driving demand for bills, according to Donald Galante, chief investment officer and senior vice president of fixed income at MF Global Ltd. in New York. He expects rates to rise again by mid-April.

“We’re in a funds rate range of between zero and 0.25 percent,” said David Glocke, who manages $65 billion of Treasuries at Vanguard Group Inc. in Valley Forge, Pennsylvania. “If you keep rates this low, you’re going to end up having periods, especially in the Treasury bill market, where the yield goes negative.”

The rate on the one-month bill touched negative 0.0152 percent in New York, compared with 0.03 percent yesterday. It was last negative on Dec. 26, when it reached minus 0.05 percent.

We are not so sure that the implications of another few days of negative treasury yields are so benign.  As the article says, the last time the one-month yield went negative was Dec.26.  Take a to see what the S&P did then:


In a Seeking Alpha post on March 19, Great Trades described how the Tick 10 day exponential moving average was, of late, serving to warn of market pullbacks:

The below chart of the Tick 10-day EMA readings shows that extremely high positive readings have previously preceded sharp selloffs:

The current level of the Tick 10-day EMA is extremely high, increasing the likelihood of a strong pullback very soon.

We have tried to update this chart through today’s (March 24) trading, below.


As can be seen, the salient feature of the updated chart is that the Tick 10-day EMA is still very high – indicating a possible retreat from the recent 7% gain.  However, technicals like these are just that – technicals. With the government likely involved in a variety of manipulative actions, some overt, some clandestine, technicals can break down even more than normal…

Next Page »