http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
INSIDE
Listening In
Hoisington Nails
Bond Market;
Here’s Its Take On
The Economy
PA G E 1
Guest Perspectives
Bill Hester
Global Risks
To Monitor In 2012
Anatole Kaletsky
The Euro’s Woes &
Germany’s Blame
Themis Trading
SEC Gags
The Exchanges
Chart Sightings
John Hussman
Recession Evidence
Kate Mackenzie
Property Prices
In China Drop
John Kosar
Strong Energy =
Stocks Up In U.S.
Dave Rosenberg
NY Fed Survey’s
Good News
Talk Back
Acute Observations
Comic Skews
Hot Links
ALL ON WEBSITE
RESEARCH
DISCLOSURES PAGE 17
listeningin
Face The Music
Road Back To Prosperty Is Through Shared Sacrifice, Says Lacy Hunt
Last time Dr. Lacy Hunt, the chief economist at
Austin, TX-based Hoisington Investment
Management was interviewed in these pages, in
July, 2009, the rebound in stocks from their crisis
lows was only months old — yet he remained firmly in the bull camp – on bonds. As it turns out,
Lacy, and the entire portfolio management team
at Hoisington, led since the firm’s founding by Van
R. Hoisington, couldn’t have been proven more
right: Rates, which “couldn’t go lower” have continued to sink. Much to the benefit of Hoisington’s
institutional clients and investors in the WasatchHoisington U.S. Treasury Fund, which the firm subadvises. When I gave Lacy a call earlier this
week, he — always a gentleman and a scholar —
patiently explained not only why he’s still bullish
on long Treasuries, but why there’s simply no easy
exit from the debt morass in which the whole economy, public and private, is trapped. Listen in.
KMW
Happy New Year,
Lacy. And thanks for
sending all those
charts to background
me for our conversation. I have to say
the first one stopped
me — showing debt
as a percentage of
U.S. GDP all the way
back to 1870? What
data goes back that
far?
Dr. Robert Gordon at
Northwestern University
has been very helpful to
me, recreating a lot of
welling@weeden
JANUARY 20, 2012 PAGE 1
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Charts Courtesy
Hoisington Investment
Management Co.
data. The National Income and Product Accounts
(NIPA) from the Bureau of Economic Analysis
(BEA) only start in ’29. But NBER (the National
Bureau of Economic Research) funded two studies, one by Christina Romer and the other by
Robert Gordon, to estimate the nation’s GDP
back to 1870. So we have those data sets. They’re
not identical, obviously, but what most economists do, including me, is use an average of the
Romer and the Gordon estimates, which seems to
work out pretty well.
fine your analysis to post-war period, you only
have one major debt-dominated cycle and that’s
the one we’re currently in — and have been in
for a number of years. But if you go back far
enough, you have three more. You have the
1820s and 1830s. You have 1860s and 1870s
and then you have 1920s and their aftermath.
Sometimes it’s essential to take your analysis
back as far as you possibly can.
Sure. Doesn’t your second chart, on the
velocity of money [page 4], show how
Still, I suspect most folks looking at a line none other than Milton Friedman was misled
on a chart interpret it as “historical fact”
into thinking that it was a constant
instead of as an
because he only
estimate based on
looked at post-war
spotty data on the
data?
“Fisher ... is saying
workings of a very
That’s correct and, in
different economic
something entirely different. fact, I was misled
environment.
along with him
He’s saying that
Well, what the profesbecause I was also
sion is saying is that
doing analysis based
economic propositions the insufficiency of aggregate on the post-war data.
need to be tested and
Friedman’s period of
demand is a symptom
verified over as comestimation was basicalplete a sample as possiof excessive indebtedness ly from the 1950s to
ble. Admittedly, some
the 1980s. Well, if you
of these earlier perilook at the velocity of
and what you have to do
ods, you didn’t have a
money in that time
central bank; you didto contain a major debt event — period, it’s not a conn’t have an income tax;
stant, but it’s very stasuch as the aftermath of
you had various politible around 1.675. So if
cal regimes; someyou tracked money
1873, the aftermath of 1929, supply growth then,
times you were on the
gold standard, someyou were going to be
the aftermath of 2008 —
times you were off.
able to get to GDP
The point is, most peogrowth very well. Not
is you have to prevent it
ple feel that these
on an individual quarinstitutional differahead of time. You have to terly basis, but even
ences shouldn’t
the individual quarterobscure the verifiable
prevent the buildup of debt. ly variations were not
observation of basic
that great. Until veloceconomic relationity broke out of that
ships. So you want to test this over as much
range after we deregulated the banking system.
time as you possibly can and I think that’s a rea- Now, velocity is breaking below the long-term
sonable proposition. Anyway, that’s my
average and it’s behaving exactly like Irving
approach, and that’s increasingly the approach
Fisher said, not like Friedman said, absolutely.
in the profession.
What a perfect example of the difference
I was just noting that what we actually
your frame of reference can make.
know about the economy in days gone by
Yes, Friedman even said Fisher was the greatest
is lot squishier than terms like “data
American economist, and I think that is corsets” or lines on charts seem to imply.
rect. Fisher had a broader understanding of the
But clearly, observations over short times economy in a very, very critical way and in a
can be misleading.
way that I don’t think either Friedman or John
Absolutely. Take the subject of debt. If you con- Maynard Keynes understood it, and even a lot of
”
welling@weeden
JANUARY 20, 2012 PAGE 2
contemporary economists, such as Ben
Bernanke. Keynes and Friedman both felt that
The Great Depression was due to an insufficiency of aggregate demand and so the way you
contained a Great Depression was by your
response to the insufficiency of aggregate
demand. For Keynes, that was by having the
federal government borrow more money and
spend it when the private sector wouldn’t. And
for Friedman, that was for the Federal Reserve
to do more to stimulate the money supply so
that the private sector would lend more money.
Fisher, on the other hand, is saying something
entirely different. He’s saying that the insufficiency of aggregate demand is a symptom of
excessive indebtedness and what you have to do
to contain a major debt depression event — such
as the aftermath of 1873, the aftermath of
1929, the aftermath of 2008 — is you have to
prevent it ahead of time. You have to prevent
the buildup of debt.
And that your goose is cooked if you don’t
you cut off the credit bubble before it
overwhelms the economy?
Yes, and Bernanke is thinking that the solution
is in the response to the insufficiency of aggregate demand. That was Friedman’s thought.
That was Keynes’ thought and most of the economics profession has traditionally thought the
same way. They were looking at it through the
wrong lens. Fisher advocated 100% money
because he wanted the lending and depository
functions of the banks separated so we couldn’t
have another event like the 1920s.
You’re saying that Fisher argued against
fractional reserve banking?
Yes, and so did the people that more or less followed in Fisher’s footsteps, principally Charles
Kindleberger and Hyman Minsky. Minsky felt that
the way you prevented a major debt deflation
cycle was to keep the banks small.
Prevent them from ever becoming too big
to fail in the first place?
Right. Don’t let them merge. You don’t want
them to get big. I actually gave a paper with
Minsky once, in 1981, in which he advocated
that position. Kindleberger was very precise in
“Manias, Panics, and Crashes,” when he said
that when you have a small credit problem, or
many small problems, some say, you don’t want
the Federal Reserve to respond. Because if the
central bank comes in and bails out a small
problem, then that will be a sign to those who
want to take more risk that they don’t need to
be cautious — they can always count on the central bank to come in and bail them out. If they
do, Kindleberger said — and this was in ’78 —
then the future crisis will be even greater. “A
free lunch for speculators today means that
they’re likely to be less prudent in the future.
Hence, the next several financial crises could
be more severe.”
Too bad nobody paid attention.
So we came along and we bailed out Long-Term
Capital Management in the late 1990s.
Not to mention the banks that got in trouble in Latin America in the early ’80s, the
entire S&L sector in the early ’90s —
Absolutely. You could even include the bailout
of Chrysler in 1980, because that was a signal
to the automobile companies and to their
unions: “Do what you want. If you get in trouble, the U.S. taxpayer’s behind you.” But the
Chrysler bailout and the LTCM bailout were
very small. I mean, LTCM was a $3 billion
problem. That’s a quaint number today. Yet the
Fed came in with all its big guns blazing. They
used monetary policy to ease the pain. A debt
buildup was already underway, but the Fed
greatly facilitated it and encouraged it. So, it
seems Fisher and Kindleberger and Minsky
were right. The only prudent way you can deal
with these huge debt problems is to prevent
them from building up in the first place. The
response after the fact matters some, but it’s
not the route you should go.
That’s great, in theory. Except that it is
the route we went. Once again, we didn’t
prevent the excessive buildup of debt, so
welling@weeden
JANUARY 20, 2012
PAGE 3
Over-trading?
That was the old-timey term that Kindleberger
used. He said there are three phrases of behavior as you move toward manias, panics, and
crashes. The first phase is over-trading, where
you start buying assets at prices far beyond
their fundamentals. People enjoy this phase,
because initially it boosts income and raises
wealth and so forth. So it becomes very irrational. Then you get to what he called the discredit phase, where the smart people start
pulling their funds out. Then you get what he
called revulsion. The classical economists used
those terms: Over-trading, discredit, revulsion.
As I said, I got the impression from
Kindleberger that once you get into that overtrading phase, there’s no one who is going to
stand in the way of it.
now we have to deal with pressing deflationary forces.
That’s why Fisher wanted to segregate the lending and deposit-taking functions of the banks.
Does that sound a mite like Paul Volcker,
daring to suggest banning the banks’
speculative proprietary trading activiPolicy Responses:
ties — and getting
Letting It Burn Out & Others
nothing but grief
from the industry
The moral hazard problem is that policy
for his efforts?
measures undertaken to provide stability to Well, that’s right.
the system may encourage speculation by Fisher couldn’t get it
those who seek exceptionally high returns done, either. And
and who have become somewhat convinced warned that we would
that there is a strong likelihood that
do it again. I had a brief
government measures will be adopted to
acquaintance with
prevent the economy from imploding — and Kindleberger; I didn’t
so their losses on the downside will be
know him well, but I
limited. A ‘free lunch’ for the speculators
knew him and he was
today means that they are likely to be less helpful to me. He
prudent in the future. Hence the next
taught Ken Rogoff. And,
several financial crises could be more
in fact, “This Time, It’s
severe. The moral hazard problem is a
Different” is really a
strong argument for nonintervention as a quantification and verifinancial crisis develops, to reduce the
fication of a lot of the
likelihood and severity of crises in the
qualitative themes that
future. Will the policymakers be able to
Kindleberger
devise approaches that penalize individual expressed. My sense
speculators while minimizing the adverse was that Kindleberger
impacts of their imprudent behavior on the thought that once the
other 99% of the country?
economy got into overtrading, there was no
Charles P. Kindleberger (1978). Manias, Panics, one who was going to
And Crashes: A History of Financial Crises, stand in its way.
pages 204-205.
welling@weeden
JANUARY 20, 2012
Why stand in front of a freight train?
Especially when it doesn’t seem to be in anyone’s interest to stand there. Regulators,
banks, companies, investors, everybody’s having a good time; profits are being made,
employment is strong.
So we’ve just seen.
No one dealt with the credit excesses in the subprime market, until the crisis hit. And no one
dealt with the excessive speculation in the
financing of the railroads in the middle of the
19th Century, or in the financing of the canals
and turnpikes and steamship lines in the 1820s
and 1830s. Nor did anyone step in to try to stop
the foolishness that was going on in the 1920s.
Kindleberger took it all the way back to
the tulip mania, and I’d venture that wasn’t the first time in human history when
an auction market got out of hand.
That is correct. Absolutely. You push things
beyond their fundamental value. But this isn’t
the conventional economic view of debt and it’s
important. I sent you some quotes contrasting
conventional wisdom with this newer understanding.
I noticed you picked something Bernanke
wrote to illustrate conventional wisdom —
I chose that Bernanke quote [box page 9]
because Bernanke addressed the Fisher Kindleberger theme in the early part of this
century — and that’s when we really needed
Bernanke to say something and to do something. But as you can see, Bernanke rejected
Fisher and Kindleberger in his book, “Essays
PAGE 4
on The Great Depression.” And notice that he
doesn’t reject Fisher because he says Fisher’s
data is flawed. He doesn’t reject Fisher because
Fisher’s argument is flawed or Kindleberger,
either. He rejects them because an excessive
buildup of debt implies irrational behavior.
Well, hello!
That’s the world I live in. You, too, probably.
To mention that what can seem rational
on an individual level can be irrational
when an entire economy does it.
We see it all the time, every day of every week.
And yet Greenspan’s rejection of the danger of
an excessive buildup of debt in his book put
him in a different mindset, not just in evaluating the events of the 1930s, but when it came to
understanding what was going on in the early
part of this century, up to 2006 and ’07.
Because he thought he could respond to a debt
problem and contain it. But that was not at all
what Fisher taught. Fisher said you have to prevent a debt deflation ahead of time. That’s a
very powerful, critical, difference. What Fisher
is saying is that once you get into this extremely
over-indebted situation, and the prices of assets
begin to fall, these two “big bad actors,” those
are the terms he used, control all or nearly all
other economic variables. Then, if you attempt
to respond to the problem by leveraging further, it’s counterproductive. That’s the term
Fisher used in one of his letters to FDR expressing concerns about deficit spending.
One of the newer quotes I sent [page 9] is from
Stephen Cecchetti, a former director of research
for the New York Fed. A Cal Berkeley Ph.D., a
very serious economist. It’s from a paper he
gave at Jackson Hole shortly after Bernanke
spoke about holding a special two-day meeting
of the Fed. Here’s what Checcetti said, “Debt is
a two-edged sword. Used wisely and in moderation, it clearly improves welfare.” In other
words, when banks engage in their traditional
business and consumer lending, it improves.
There’s no question about that. But when they
lend imprudently in excess, the result can be a
disaster for individuals, households, firms. And
“Over-borrowing leads to bankruptcy and
financial ruin for a country. Too much debt
impairs the government’s ability to deliver
essential services to its citizens.”
And the level of government debt he specifies is
consistent with what Carmen Reinhart and
Rogoff wrote in their paper for the NBER called
“Growth in a Time of Debt.” They found that
after you get above 90% of debt to GDP that you
lose 1% off the median growth rate, and even
more off the average growth rate. So it’s clear
that debt plays a major role in the economy.
Most of the time, it is a benign factor, but you
get these irregular intervals in which debt
builds up excessively. And, once it has built up
excessively, it’s a controlling influence for a
long time. Plus, you cannot solve that overindebtedness problem by getting deeper in
debt. That’s the problem.
True, but you can postpone it a while —
The point is that it doesn’t really matter
whether you’re using the Federal Reserve’s
I noticed that Cecchetti even specified
how much debt becomes cancerous.
That’s right. I like his use of that medical term.
welling@weeden
JANUARY 20, 2012
PAGE 5
monetary tools to get the private sector to
leverage up or whether you’re engaged in
deficit spending at the federal level to try to
address the insufficiency of demand. Both tacks
take you in the wrong direction. Now, what
we’re beginning to understand — at least with
regard to governments, because we have known
this is true for the private sector for a long
time — is that there comes a point in time at
which additional debt is no longer available.
That’s where a lot of countries in Europe are.
And that is probably where we’re going in a
number of years. We’re not there now, but
that’s where we’re headed. We spent $3.6 trillion last year at the federal level. We borrowed
around 35% of that and we had tax revenues to
cover around 65%. Some of the European governments are trying to borrow more than that
ratio, and it’s being denied to them. Reinhart
and Rogoff call that the “bang point.” When
that happens, your spending levels then have to
fall back to your tax revenues. That’s where
we’re headed unless we correct the problem.
It’s obviously going to get greater, because we
have built-in guaranteed increases in our obligations under Social Security and Medicare.
That’s why I also sent you a passage [box, page
11] from “Exorbitant Privilege,” by Barry
Eichengreen. He’s a Yale Ph.D., taught at
Harvard many years, Cal Berkeley. In the last
three years, federal outlays have averaged 25%
of GDP, which is the highest three-year period
since 1943 - ’45, when we were in a multi-continent war. What Dr. Eichengreen is saying is
that federal outlays are going to go to 40% of
GDP within 25 years, without major structural
reforms.
Just based on the programs in place and
demographics?
Yes. To him, that means that the current laws
cannot remain unchanged and I agree with
him. I don’t think you can transfer an additional
15 percentage points of GDP to the government. There’s no practical way that we can do
it. But the political process doesn’t seem to
want to respond in advance, so it’s very difficult
to see how this is going to work out in any salutary way.
Let’s put some numbers on this. The first
chart you sent me [page 1] shows total
public and private debt in the U.S.
approaching 400% of GDP.
Yes, that’s the conventional approach, using publicly held federal debt as the measure of govern-
welling@weeden
JANUARY 20, 2012
PAGE 6
ment debt. But that, in my opinion, is really not
appropriate. The more appropriate measure is
really gross federal debt. [chart page 5].
And the difference is that the gross figure
includes debt held in intra-government
accounts?
That’s correct. But what Dr. Eichengreen is saying, and I agree, is that even that gross debt
number is not really sufficient because we’ve
also got $59 trillion, at present cost, of unfunded liabilities in Social Security and Medicare.
We have about $52 trillion of current debt,
public and private, the way I measure it. We
have about $15 trillion in annual GDP. So if you
substitute the gross government debt for the
privately held debt and if you use the IMF’s projections for the increase in gross government
debt going forward and you assume private
debt-to-GDP stays flat, well, we’re going to new
peak debt levels in the next several years.
And we’re not the only nation in this fix.
The situation in Europe is worse. I put together
some charts that are interesting; took a lot of
effort, anyway. If you look at U.K. debt, public
and private [chart, page 6] it’s 100 percentage
points higher than in the U.S. The Japanese
debt [chart, page 6] is approaching 150 percentage points higher. The Eurozone, just the
countries in the Euro currency zone, have got
about $62 trillion in current debt equivalence
(chart, page 6). They only have $14 trillion of
GDP equivalent. So they’ve got about $10 trillion dollars more of debt than we do and $1 trillion less of GDP. I have another little piece of
information on that score that’s interesting:
Their unfunded liabilities also appear to be
greater than ours. A study published in 2009,
but really based on data from 2006, called
“Pension Obligations of Government Employer
Pension Schemes and Social Security Pension
Schemes Established in EU countries,” by
Freiburg University, which was commissioned
by the European Central Bank, showed that the
unfunded pension liabilities of the EU member
countries studied amounted to about five times
their GDP. And the report only covered unfunded liabilities in 19 of the 27 EU member countries — 11 members of the Euro currency zone
and 8 non-currency zone countries. Now,
Europe had a big recession, too, in 2008, which
opened the gap further. So their unfunded liabilities are about five times their GDP, whereas
in the U.S., they are about four times. The debt
problems in Europe are at an advanced stage
relative to where they
China’s Potential Debt Woes
are here. Also, their
demographics are
China's model has produced super
much worse than ours.
growth, lustrous office towers,
So we’ve got this situamassive
and grand new airports and
tion, if you accept what
other
visible
signs of wealth and success.
Fisher said about debt
But, beneath this
controlling all other
glamorous veneer, the growth model is
economic variables in a
flawed and fragile. Substantial and
debt deflation, then
unknowable risks
the levels of indebtedare accumulating in the Chinese banking
ness in the U.S. and
Europe are also playing
system. “The fact that it
a heavy hand in the foris well-insulated from outside
eign exchange markets.
markets does not mean that China's
How so?
While there’s nothing
salutary about the U.S.
situation, we’re not in
as an extreme position
as are some of the
other major areas of
the world, Europe,
Japan, the U.K.
You’re implying that
the dollar is like the
best house in a
lousy neighborhood?
Yes, if you think of foreign currency movements being determined like a beauty
contest, if you’ve got
10 ugly contestants,
the least ugly wins.
This tends to support
the value of the dollar
for no meritorious reason; it’s simply comparative valuation.
finances are crisis-proof. The
system can be disrupted by purely
internal factors, as it clearly
has been in the past.“
Red Capitalism: The Fragile Financial
Foundation of China's Extraordinary Rise
by Carl E. Walter and Fraser J.T. Howie
(John Wiley, 2011), page 207.
Utilizing micro- and
macroeconomics as well as
psychology, biology (contagion),
and politics a model is developed
to identify booms that bust. This
framework applies to recent as well as
distant boom/busts. "Although China
appears to be in the midst of an unsustainable boom, the timing of a bust is
extraordinarily difficult to predict."
Boombustology by Vikram Mansharamani
(John Wiley and Sons, 2011), page 237.
True, and not terribly good news for U.S.
companies trying to compete on a global
basis.
No, especially not because this recovery — such
as it is — since the middle part of ’09, has been
heavily influenced by exports.
The percentage of GDP growth attributable of late to exports is really eye-popping.
It is. While exports have been growing at 10%
per annum, consumer spending has been growing at only 2% per annum.
welling@weeden
JANUARY 20, 2012
PAGE 7
that he wrote to FDR. But he was our best and
he was just so wrong that people could never
look at him the same way after the Crash. It
probably was frustrating for him. But, Fisher
actually was a very modern guy, in some ways.
Richard Thaler, the co-founder of behavioral
finance, wrote an interesting paper a decade or
so ago called “Irving Fisher: Modern Behavioral
Economist.”
That’s positively un-American!
Export growth has been just under 50% of the
cumulative gain in GDP. It really has been the
driving force. But now, income is trending down
overseas. And, in international trade flows,
income is four or five times more powerful than
price effects. So the spreading recessions in
Europe and Japan and elsewhere are going to
knock down the demand
for our exports — and
The Delevering Process:
the fact that the dollar is
rising serves to worsen
Four Archetypes
that trend.
1. “Belt Tightening”. The most common delevering
path. Episodes where the rate of debt growth is
slower than nominal GDP growth, or the nominal
stock of debt declines. Examples are Finland ’91’98, Malaysia ’98-’08, U.S.’33-’37, S. Korea ’98-’00.
2. “High Inflation”. Absence of strong central
banks, often in emerging markets. Periods of high
inflation mechanically increase nominal GDP
growth, thus reducing debt/GDP ratios. Examples
are Spain ’76-’80, Italy ’75- ’87, Chile ’84- ’91.
3. “Massive Default”. Often after a currency crisis.
Stock of debt decreases due to massive private and
public sector defaults. Examples are U.S. ’29-’33,
Argentina ’02- ’08, Mexico ’82- ’92.
4. “Growing out of debt”. Often after an oil or war
boom. Economies experience rapid (and off-trend)
real GDP growth and debt/GDP decreases. Examples
are U.S. ’38- ’43, Nigeria ’01- ’05, Egypt ’75- ’79.
McKinsey Global Institute. Debt and deleveraging: The global credit bubble and its economic consequences, page 39. December 2010.
welling@weeden
Wonderful. I can’t
help but note,
though, that it’s
pretty ironic that
we’re talking about
Irving Fisher’s reputation as an economist being rehabilitated now, when he
destroyed it himself
by being so wrong
about Crash in 1929.
True, but that in itself
is instructive. He did
make some outrageous
statements that were
totally incorrect and it
greatly damaged his
stature. No one was
really willing to listen
to him, although his
work was there and so
were a series of letters
JANUARY 20, 2012
PAGE 8
I’ll have to dig it out. [link]
It’s an interesting paper. In economics, there
are two conditions: Equilibrium and transition.
The economics profession mainly teaches equilibrium economics; the general presumption is
that we’re at equilibrium most of the time.
Transition, we know it occurs, but transition is
considered the short, uninteresting phase.
Equilibrium is the long, interesting phase.
That’s the way it’s taught. But in actuality, what
we’re learning is what Fisher understood long
ago: The transition is long and equilibrium is
short. We move toward equilibrium, but usually
we achieve equilibrium only on the way to
another transitional phase of disequilibrium.
The economics profession has used the analogy
of an airplane. When it’s on the tarmac, it’s in
equilibrium. Then, as it takes off and climbs to
an altitude of 40,000 feet, it’s in transition, relatively uninteresting. Then you’re at equilibrium again at 40,000 feet, until you return to the
tarmac. So conventionally, you’re at equilibrium most of the time, either at 40,000 feet or on
the tarmac. But for Fisher, the equilibrium
phases were short and the transition phases
were long. I think that’s where the profession
is headed, certainly the way I’m thinking about
it.
In other words, economic equilibrium is
not a very stable state?
No, we hit equilibrium on the way to another
disequilibrium. If you’re looking, for example,
at my velocity of money chart [page 4], you can
see that one period, from the early ’50s to the
early ’80s when it hovered around 1.67. But in
most of the other instances shown, we’re either
moving above it or we’re moving below it. We
cross it, but we don’t spend much time there. I
think the reason we had that post-war period of
stable velocity is that there was not a really substantial buildup of debt and we had a heavily
regulated banking system. Once we deregulated
the banking system and allowed the massive
buildup of debt, the velocity of money started
taking off. But then it turned down in ’97, just
as it had turned down in the early 1920s.
Debt and Economic Activity
Conventional View
Why? We certainly kept borrowing —
Beginning with Irving Fisher (1933) and A. G. Hart
It wasn’t that we weren’t taking on more debt. We were, but the debt that
(1938), there is literature on the macroeconomic
we were taking on was becoming more and more counterproductive. We
were getting less bang for the buck. The downturn in the velocity of
role of inside debt. Hyman Minsky (1977) and
money after 1997 was actually a signal that we were in a potentially trouCharles Kindleberger (1978) have in several places
blesome period. One of the things that Fisher specifically cited was that
argued for the inherent instability of the financial
when you get into this highly over-indebted situation, one of the variables system, but in doing so have had to depart from the
that is controlled by that debt overhang is the velocity of money. The Fed
assumption of rational economic behavior.
has been able to increase money supply growth but their efforts at simulat- Footnote: I do not deny the possible importance of
ing GDP — except during some brief intermittent episodes — have been
irrationality in economic life: however, it seems
thwarted because the velocity of money is trending down. It’s now falling
that the best research strategy is to push the ratiobelow the 111-year average.
nality postulate as far as it will go.
And when you look at velocity on your chart going back to 1900,
it sure looks like the time it spent in equilibrium was the outlier,
not the norm.
It does, and Fisher understood that.
Ben S. Bernanke (2000). Essays on the Great
Depression, pages 42-43.
Vs. New View
What little reading I’ve done about Fisher says he was unusually
The U.S. economic recovery has been weak. A
talented and energetic, despite some weaknesses typical in the
microeconomic analysis of U.S. counties shows that
period, like being a fan of eugenics.
this weakness is closely related to elevated levels
Very true. Paul Samuelson, who disagreed with a lot of what Fisher had to
of household debt accumulated during the housing
say, said that Fisher’s doctoral dissertation was the greatest one ever writboom. The evidence is more consistent with the
ten — and it was on transition and equilibrium. Fisher gave us the formulas
view that problems related to household balance
for all the price indices we’re currently using. People forget that. James
sheets and house prices are the primary culprits of
Tobin said he was our leading expert in index numbers. He invented the
the weak economic recovery. King (1994) provides a
distributed lag. Joseph Schumpeter said that Fisher had the keenest inteldetailed discussion of how differences in the marlectual mind of anyone he ever met. Schumpeter was no slouch, in his own
ginal propensity to consume between borrowing
right. Fisher even invented the Rolodex. But he didn’t see The Great
and
lending households can generate an aggregate
Depression coming. By the way, neither did Keynes.
True enough, and he lost a bundle. So what did Fisher miss?
Why Fisher missed the Depression call is instructive. It was because at
that point he assumed that the U.S. economy was dominated by cyclical
forces. As we went through this business cycle, we’d have a brief period of
bad times followed by an extended period of good times. Yes, the period of
bad times could be a little unsettling, but it didn’t last too long and then
we would have another extended period of good times. But what Fisher
later wrote was that once an economy becomes extremely over-indebted,
this normal business cycle model that everybody believes to be what controls the situation really becomes inoperative in the traditional sense. The
business cycle attempts to work, but it can’t, against the strong secular
forces of excessive indebtedness. Like Keynes, Fisher was a big investor
and, of course, he was wiped out by the events of the late 1920s, early
1930s. But he later made that statement that the extreme over-indebtedness controls all or nearly all other economic variables. It appears to control the risk premium, too, as that table [page 5] I sent you shows. We’ve
now had three 20-year periods: 1874 to 1894, 1928 to 1948, and the last
20 years, in which the risk premium stayed negative. I didn’t have the
final official numbers to include last year’s Q4, but it doesn’t change the
picture, I’m pretty sure.
So you’re saying investors get risk-averse in severe downturns?
My point is that we know that, over the long run, you have to have a posi-
welling@weeden
downturn in an economy with high household leverage. This idea goes back to at least Irving Fisher’s
debt deflation hypothesis (1933).
Federal Reserve Bank of San Francisco Economic
Letter January 2011. Atif Mian University of
California Berkeley, Haas School of Business and
Amir Sufi, University of Chicago Booth School of
Business.
Debt is a two-edged sword. Used wisely and in moderation, it clearly improves welfare. But, when it is
used imprudently and in excess, the result can be a
disaster. For individual households and firms, overborrowing leads to bankruptcy and financial ruin.
For a country, too much debt impairs the government's ability to deliver essential services to its
citizens. Debt turns cancerous when it reaches 80100% of GDP for governments, 90% for corporations and 85% for households.
The Real Effects for Debt by Stephen G. Cecchetti,
M. S. Mohanty and Fabrizio Zampolli. September,
2011. Bank for International Settlements, page 1.
JANUARY 20, 2012 PAGE 9
true in 2009. The debt-to-GDP ratio peaks a
year or so after the panic, because you’ve got
the denominator in this ratio. But what’s interesting is that after the 1875 peak, you don’t go
above it until 1916. You don’t go above the
1933 peak until 2003. So once you get these
periods of extreme over-indebtedness, it takes a
very long time to resolve them.
tive risk premium, stocks have to outperform
bonds, because investors must be rewarded for
holding riskier assets. But after the extreme
buildup of debt in the 1860s and the early
1870s, risk-taking was not rewarded. After the
extreme buildup of debt in the 1920s, for 20
years risk-taking was not rewarded. And for the
last 20 years, it hasn’t been rewarded either. So
my table may be instructive. We don’t know,
because we don’t have a lot of experience, but if
Fisher is correct, and if we try to solve our current problems by getting deeper in debt, then
what Fisher is saying is the additional indebtedness doesn’t make us stronger, doesn’t increase
our options. It makes us weaker, reduces our
options. So risk-taking may not be rewarded
going forward. This is where we’re hamstrung
by our lack of sufficient data to evaluate. But
what data we have suggests that if we proceed
along the path of over-indebtedness, risk-taking will not be rewarded because the economy
is going to perform very poorly.
Is there perhaps a glimmer of hope in the
fact that the earlier instances you cite
lasted roughly 20 years, and this one is
already 20 years old?
Well, they all came after major buildups of
debt. The panic years were 1873, 1929 and
2008, but if you go back and look at my first
chart [page 1], in the first instance, we had this
massive buildup of debt that was complete by
1873. The panic year was 1875. The debt-toGDP ratio peaked in 1875 because the denominator, GDP, collapsed. Then in the second
instance, the debt buildup was complete by ’29.
The debt-to-GDP ratio peaked after the fact in
1933, because GDP declined. And the same was
welling@weeden
JANUARY 20, 2012
And it’s usually not a lot of fun.
No. That’s why I sent you those quotes from a
great study by the McKinsey Global Institute
Study [page 8], listing what they call the Four
Archetypes of the Delevering Process. What it
boils down to is that austerity is required in
about 75% of the cases. Either you do it yourself
or it’s imposed upon you. They do address the
possibility of “growing out of debt” and they
cite the case of the U.S. in World War II and a
couple of other instances. But to my way of
thinking, the U.S. during WWII was also an
austerity case. If you look at my chart of the
personal savings rate back to 1929 [page 8],
you can start to see that what really brought us
out of the Great Depression were our exports.
Our allies’ countries were being disrupted by
actual fighting and they had manpower shortages. So we were selling them everything that
we could produce — but meanwhile, our people
could not spend the income we were receiving.
Right, there was rationing and tremendous
austerity on the home front. So the only
thing that people could do with the money
they were making was buy war bonds.
That’s correct. And that’s what they did — look
at the personal saving rate. We’re not getting
that same response here. The saving rate went
up for a while, but it’s now back to 3.5%. We’re
essentially back where we were when the recession started.
It’s more than a little perverse to pull for
another world war to pull us out of this
mess. Wasn’t the debt deflation in the
19th Century simply cured by the passage
of time?
In the earlier case, the excessive indebtedness
just burned itself out. That was the title of
Kindleberger’s chapter on policy responses:
“Letting It Burn Out and Other Devices.” I
sent you an excerpt from that, too. [page 4] You
might do better to just let it burn out.
Everybody rejects that as being too harsh;
“How could you possible advocate that?” But it
might be better.
PAGE 10
Sure, like a forest fire. But that argument
isn’t very strong in today’s highly interconnected economy. We’re not facing any
isolated conflagration.
Well, you hear that argument, but I’m not sure
that I buy it. I think the world was very interconnected in the 1920s and I really see a lot of
parallels. We don’t have good data outside the
United States, but we do know that a lot of the
commodities-producing countries took on a lot
of debt to finance commodities production
back then.
So vendor financing wasn’t invented during the internet bubble.
Not at all. And the problems in the late ’20s
started, I believe, in the commodities producing countries. The first country to devalue in
the late ’20s was the Dutch East Indies, a huge
commodities producer. Then it was Australia.
Both had expanded very substantially with
debt. Then there were a number of other devaluations and, finally, in ’31, the British devalued. In the meantime, we stayed on the gold
standard and so everybody that was devaluing
against the U.S. dollar. Their incomes were
declining, which undermined our exports and
then the price considerations went against us
so we started losing our exports. Then, between
April of ’33 and January of ’34, we had about a
60% devaluation. That helped us, compensatorily, to regain some of the markets that we had
lost, and everybody stood still for that, because
we were still sort of operating under the rules of
the gold standard game. But then, in ’37 and
’38, the gold bloc countries finally devalued;
we lost some of the gains we had made and the
economy fell back. So there was a great deal of
international interconnectedness in that period. But what this also shows is that the markets
deal with the serious problems first and then
they move on to the next most serious and so
on. So this whole process could be much longer
and more persistent than many people believe.
Particularly because, if we continue to try to
solve the over-indebtedness problem by taking
on more debt, that ultimately creates more
problems than it solves.
That’s sure what’s going on in Europe.
The Europeans have two problems. No. 1,
they’ve been financing themselves short. They
have an enormous rollover problem and a lot of
the folks who have lent to them don’t want to
extend those loans. In addition, the folks that
don’t want to extend
Federal Outlays Heading
their loans are being
Toward 40% Of GDP?
asked to make even
bigger loans and so, the
borrowers are not real- Dr. Barry Eichengreen of the University of California
ly responsive. Do you
at Berkeley estimates that after 2015 federal outknow John H. Cochrane?
Haven’t had the
pleasure —
John Cochrane is at the
University of Chicago,
a very serious economist.
lays as a percent of GDP are headed to 40% over
the next quarter century without major structural
reforms in Social Security and Medicare. For Dr.
Eichengreen this means that the current law cannot
remain unchanged in spite of the lack of political
will to deal with the issue.
“The United States will suffer the kind of crisis that
Europe experienced in 2010, but magnified. These
events will not happen tomorrow. But Europe's
experience reminds us that we probably have less
time than commonly supposed to take the steps
needed to avert them. Doing so will require a combination of tax increases and expenditure cuts.” He
goes on to point out that, “At 19% of GDP, federal
revenues are far below those raised by central governments in other advanced economies with spending on items other than health care, Social
Security,defense and interest on the debt having
shrunk from 14% of GDP in the 1970s to 10% today,
there is essentially no non-defense discretionary
spending left to cut. One can imagine finding small
savings within that 10%, but not cutting it by half
or more in order to close the fiscal gap.”
He has the AQR
Capital Chair, if I’m
not mistaken —
Yes. He was president
of the American
Finance Association, a
very serious academician. What he has
pointed out is that the
real value of government debt must equal
the discounted value of
the stream of future
surpluses. If you think
about that, any asset
has to be equal to the
discounted value of its
future revenue stream. Barry Eichengreen, Exorbitant Privilege: The Rise
and Fall of the Dollar and the Future of the
So, what you’ve got in
International Monetary System, Oxford University
the present value formula is the discounted Press, 2011
stream of future flows
and then your discount rate. Well, Cochrane’s
argument is that at the point in time that the
markets lose confidence that there is a future
stream of revenues to pay off the debt, to service the debt, then the discount rate will move
up sharply. It doesn’t matter what monetary or
fiscal policies are, the discount rate explodes.
That’s what’s really happening in Europe. The
investor cannot see a viable revenue stream to
service the existing debt levels. I don’t think
that we’re at that point here yet, but we could
be. I hope we have some time. Perhaps, because
Europe is in a graver situation, indebtednesswise than we are, it’s buying us some time. But
we don’t seem to be willing or able to, we don’t
seem to have the political will to deal with our
problem.
Certainly not if you listen to what we’ve
welling@weeden
JANUARY 20, 2012
PAGE 11
heard so far in terms of campaign
rhetoric.
Part of the problem is that these are serious
matters and to solve them, it’s going to require
a lot of sacrifice by a lot of people. That’s why I
really like that Eichengreen quote. The thing
is, no one wants to have austerity. We all enjoy
the good life. We don’t want to have to raise
taxes; that’s unpleasant. We’re going to have to
change the benefits tables for Social Security
and Medicare. We’re going to have to cut discretionary spending — even though it has
already been cut substantially. Right now, the
four main components of the federal budget are
Social Security, Medicare, Defense and interest
payments on the debt. By the end of this
decade, if market rates are unchanged —
Quite an assumption.
Yes, but at these rates, by the end of the decade,
the three top components of the budget will be
Social Security, Medicare, and interest; that’s
according to the Congressional Budget Office
projections. If you hold market interest stable
through 2030, by then interest payments will
absorb 35% of the budget. If the market interest rates go up by two percentage points, that
adds about $300 billion a year to our deficit. By
the way, that’s why you hear it said often that
one of the solutions is to inflate our way out.
That’s supposedly the easy alternative, at
least politically.
But I don’t think you can do that because your
debt is 350% of GDP. If you get an inflationary
process going, interest rates will rise proportionately with inflation. So, if inflation goes up
1%, in time, interest rates will go up 1%. But
your debt is 350% of GDP. If the inflation rate
goes up, you will not get an equivalent rise in
GDP, because what we’ve learned is that in
inflationary circumstances, a lot of folks can’t
keep up. In fact, most of your modest and moderate income households will not keep up.
Not good, considering that “the 99%” are
already restive with reason.
That’s correct. We saw this in a microcosm in
2011. The Fed engaged in quantitative easing;
they got the inflation rate up temporarily, but
the main effect was to reduce real income. So, if
you try the inflationary route, you’re not going
to be able to inflate your way out of debt trouble. This other variable, your interest expense,
is going to rise proportionately with inflation,
and your GDP won’t keep up. Many will lag
behind and that will worsen the income or
wealth divide. So inflation is really not a potential savior in the current situation. Which then
forces you back to the conclusion that the only
viable way out is austerity, although no one
wants it.
Suppose one of Europe’s Hail Mary passes
actually miraculously works, and the
Chinese decide to lend them a ton of dough?
I’m not an expert on China. But I did spend
some time there earlier in my career, and I
don’t think the situation is that stable. I sent
you a quote from the book, “Red Capitalism” by
Carl Walter and Fraser Howie [page 7]. Carl
Walter is a pretty serious observer, Stanford
Ph.D., has lived in Beijing for about 20 years,
speaks Mandarin. His basic point is that the
government has forced the banks, which they
welling@weeden
JANUARY 20, 2012
PAGE 12
control, to make loans to the provincial governments for all of these expansion projects.
There’s now a great deal of excess capacity and
the projects are not generating sufficient cash
flow to service the high levels of debt that the
banks have extended. We’re reaching the point
at which the banks will have to be recapitalized.
We had an episode of that in the late ’90s when
the Chinese banks needed to be recapitalized
and the government had to shift expenditures
into bank recapitalization. That caused the
Asian economic crisis. Now there’s some evidence to suggest that China will have to recapitalize the banks again and when it does that, it will
produce economic weakness in China that will
reverberate around the world. So the Chinese
may be more of a problem than a solution.
I suppose all this means you expect a
recession this year?
Well, consumer spending will slow this year
very dramatically from a very weak base. We
had a decline in real disposable income in 2011.
GDP rose, but GDP measures spending, not
prosperity. In 2011, as is often the case, when
inflation rises, households initially try to maintain their standard of living. So in the face of rising inflation and trailing wages, which was the
story in 2011, families resorted to increased credit card usage or to drawing down their saving. But
in addition to a decline in real disposable income
in 2011, we also saw a net decline in net worth
[lower chart, page 13]. And a year-over-year
decline in net worth has been associated with the
start of all the recessions since 1969.
It’s certainly not a good thing, in terms of
consumers’ ability to spend —
Exactly. Consumers need to bring their savings
back up into alignment with more normative
levels, which suggests a severe headwind to consumer spending this year. Exports, we’ve
already talked about; there’s not a good outlook
there for what has been our most dynamic sector. Capital spending, I think, is going to be
extremely weak this year. We’re going to see a
net decline, principally because the accelerated
depreciation rules, which were in effect,
expired on Dec. 31. Up until then, you got 100%
depreciation. Since Jan.1, you only get 50%.
We’ve seen this happen many times in the past.
Firms look as far as they can into the future and
move those expenditures forward in order to
take advantage of the accelerated depreciation.
So it’s reasonable to believe that we’re going to
see a considerable falloff in capital spending
this year. Then you’ve got the government sec-
tor. We’ve got a $1.3 trillion deficit according
to the latest projection from the CBO. In real
terms, government purchases of goods and services will decline slightly this year, mainly
because of defense cuts. Non-defense, at best,
will be flat. How could we have a worse situation than with a $1.3 trillion deficit and a
decline in real government purchases of goods
and services at the federal level? It’s hard to
imagine how it could be worse.
Well, toss this in: State and local spending
isn’t going to fill that gap.
No, you probably saw the statement from New
York Gov. Andrew Cuomo that the situation has
deteriorated in New York. About half of the
state governments either have deficits that they
must address for the remaining six months of
welling@weeden
JANUARY 20, 2012
PAGE 13
tion over the next several years, that’s saying to
us at Hoisington Management that the long
Treasury will eventually get to 2%.
the current fiscal year, or they’ll have deficits in
the new fiscal year. Now, that’s an outward
improvement. But the state budgets do not
include the unfunded liabilities of their pension
plans. Last year was another in which their
investment returns did not match their actuarial assumptions, so those pension plans are in
worse shape now than they were a year ago.
How is that problem going to be rectified?
Either you have to cut the benefits, or you have
to get additional funds from the state and local
governments. The only way that can be
achieved is by cutting other programs or raising
taxes. So the state and local governments will
remain a drag. Guess what? We are looking at a
recession in 2012.
And that means what, for the markets?
Let’s look at the last chart in the package I sent
you, the long-term Treasury rate going back to
1871 [page 14]. We had 10 or more years in the
late 19th Century and early 20th Century when
long Treasuries got to 2% or less; those were in
the aftermath of the huge buildup of debt in the
1860s and 1870s. In 1941, as you can see on the
chart, long Treasuries were at 2% again, then
Pearl Harbor came along. Another way of looking at this is that, since 1871, long Treasuries
have averaged about 4.3%. The inflation rate
has been about 2.1%, 2.2%; so you had a real
return of about 2%. Notice, too, that in the
period from the rise of the Iron Curtain to its
fall, interest rates averaged about 6% and the
inflation rate was 4%, so you had a real rate of
2%. In the earlier global market period from
1870, the interest rate was around 2.9% and the
inflation rate was 0.9%. So your real rate gravitates towards 2%. If we go towards zero infla-
welling@weeden
JANUARY 20, 2012
All the way down to 2%?
Rates have done that in Japan for a lot of the
last 15 years. Getting there will not occur in a
straight line. It will be in a very frustrating pattern. We’ll see a lot of volatility and there will
be some episodes where it will look like the
trend toward lower rates will be interrupted. It
may well be interrupted for intermittent periods of time. To put this in another way, if you
asked me to write down all of the reasons why
interest rates could rise, I couldn’t list them all.
There are a lot of reasons why interest rates
could rise over the short run. In this generally
poor economic environment, there will be some
time periods when the data will get a little bit
better. There may be massive portfolio selling
from time to time. There may be expectations
that problems in Europe or elsewhere are being
solved. There are a whole host of seasonal and
other factors that can intervene. But as long as
the United States is confronted with these various structural factors, interest rates can rise —
but they really can’t stay up for very long. They
ultimately have to go back down. We’re in a
gradual process toward lower rates. Five or 10
years down the road, we will end up thinking
about is this as a period of low interest rates.
And its volatility won’t seem too important after
the fact. But I can assure you it will be important during the interim.
Especially if you have to worry about little
things like portfolio returns —
Absolutely, because as you go lower in yield,
each basis point has a larger and larger price
effect.
The math is pretty plain, although it
escapes a lot of people.
It is. Of course, this is our bread and butter. Did
you see the returns in our fund last year?
How could I miss them? You did blindingly
well, not just against your peers, but the
universe. Up well over 30%.
The mutual fund that we sub-advise, the
Wasatch-Hoisington Treasury Bond Fund, actually
is up over 41%. The institutionally managed
account was up slightly in excess of 40%. It was
a volatile process, a nerve-wracking process,
getting there and I don’t anticipate going forward it will be any easier.
PAGE 14
What are you doing?
We’ve basically been long, but we’ve gradually,
over the last several years, increased the percentage of our portfolio in zero coupons.
They’ve performed very handsomely. They’ve
had volatility, but they’ve done very well and if
rates go lower, it’s clear that the best performance will come from the zero coupon bonds,
because they don’t entail the reinvestment risk.
That couldn’t have been more of a contrary position a year ago. And it still is.
Yes. “Rates are going higher. They can’t go any
lower; they’re at all-time lows.” Or so they say.
Well, that depends on how far back your
chart goes, as you’ve demonstrated.
That’s exactly right. All you have to do is look
back to 1941. But it specifically boils down to
the following situation. The critical thing for us
is that the economy’s extreme indebtedness is a
deterrent to growth. It’s not a positive for
growth. What the classical economists said is
true: What creates prosperity is the hard work,
creativity and ingenuity of individuals and businesses. Your prosperity does not come from
governmental financial transactions.
Nor, from highly leveraged purely financial
transactions, no matter how many transpire per second in the private sector.
Absolutely. I agree with that. I don’t know
whether you ever read David Hume’s essay written in 1752, “A Public Credit.”
I believe I did, but a very long time ago.
Hume is among the 10 greatest intellects of
mankind. His treatise on human nature, of
course, is what he’s remembered for the most;
Adam Smith said that Hume was the greatest
intellect that he ever met, and Smith knew all
the great figures of the Enlightenment. At any
rate, the point Hume makes in “A Public
Credit” is that when a government has mortgaged all of its future revenues, the state lapses
into tranquility, languor, and impotence. And
he discussed various historical situations.
Hume died in 1776, not long after reading
Smith’s “Wealth of Nations”, which was also
published in 1776. What we are seeing today is
that Hume was correct — and some of the intervening smaller thinkers were not. I’ll tell you
another little thing. Immanuel Kant said that it
was Hume that opened his eyes to the reality of
the world.
Turning back to interest rates. Why do you
suppose real rates have gravitated to 2%
for so long?
I suspect, and I don’t know this, but I suspect
it’s because that may be the very long-term
average increase in productivity or real income.
I’ve tried to verify that, but it’s only a guess.
Excellent question. It may be that the factors of
production in the long run earn about the
same, but I don’t know. We do know that productivity is in that range, over a very long period. Whether they exactly equilibrate or not, I
don’t know. But they seem to be pretty similar
over the long haul. They’re certainly not similar
over the short run. I don’t want to give anyone
that impression.
Maybe the short-term volatility is telling
us something about the capriciousness of
human nature —
Absolutely. Maybe it’s a sign that there are very
significant emotional elements in our decision
making process. We try to be rational and to make
considerate judgments, but in the final analysis
may have limited time. We may have to make
decisions based upon rules of thumb or generalizations. Decisions are overly hasty, emotional.
Your charts also show that ideas about
how low rates can go depend on perspective. What period you are looking at.
Yes. If you came into the market in 1991, these
rates are extremely low. If you came in in 1971,
they’re even lower. If you look at the sweep of
history in both the United States and around
the world, these rates are low, but not at all-time
lows. That’s an important consideration. It’s
equally important to understand the conditions
that produce the low rates as well as the condi-
welling@weeden
JANUARY 20, 2012
PAGE 15
tions that produce the high rates. For the time
being, the trend in rates is still downward. We
are approaching the point at which long
Treasury portfolio maturities will have to be
changed, but we’re not there yet.
So what will it take to make you shorten
maturities?
That’s a very great question. We need to see a
fundamentally different policy response. There
are things that could be done in the realm of fiscal policy to change the outcome, if we were to
use our knowledge correctly. Now, before I
describe what we could do, let me say that it’s
hard to visualize how this could happen right
now, but maybe that could change going forward. So what do we know? Well, No. 1, we
know that the government expenditure multiplier is, at best, zero and maybe slightly negative. By that I mean if we increase deficit spending, although you can get a transitory boost in
GDP for a few quarters, at the end of 12 quarters, there’s no gain in GDP. But you do shrink
the private sector, increase the government
sector, and you take on a higher level of debt,
which makes the economy still weaker. So the
deficit spending, if we continue that, that will
continue to weaken the economy. If we could
reduce the deficit spending — although it would
reduce economic growth over the short run —
over the long run it would revive the private
sector. The tax expenditure multipliers, however, are quite large. They’re between -2 and -3.
By that I mean, if you raise the marginal tax
rate by a dollar, you will lower GDP by $2 to $3
after about three years. If you cut the marginal
tax rate by a dollar, you will raise GDP by $2 to
$3 at the end of three years. But there is also a
third component of the federal budget — the socalled tax expenditures, or what are more commonly called the loopholes.
Or the root of most the evil in the tax
code —
Well, in the ’86 legislation, as Martin Feldstein
at Harvard pointed out, we had a revenue neutral bill in which we lowered the marginal tax
rates and eliminated the loopholes. We brought
the tax expenditures down from 10% of GDP to
6%, which is where they are today. But yet, the
economy responded more to the reduction in
tax rates than to the elimination of loopholes.
Now, I don’t know of any studies that confirm
this, but it suggests that the multiplier on tax
expenditures is considerably less than the multiplier on tax rates.
welling@weeden
JANUARY 20, 2012
Which stands to reason, since they benefit
only specific minorities.
It probably is because in some cases these loopholes especially in the corporate code, can go to
a very few. But let’s take the biggest tax loophole on the household side, which is the mortgage interest deduction. We’ve done a lot to
stimulate housing in the United States — and
what we’ve gotten is overproduction and clearly
a negative multiplier. To move forward, it’s
clear that we need a program of mutual sacrifice. There are going to have to be tax changes
and expenditure changes. It seems to me, the
better thing to do is to start scaling back as
rapidly as possible the future promises that
have been made under Social Security and
Medicare. To have shared sacrifice, we should
eliminate the loopholes. I, personally, am in
favor of elimination of all the loopholes in both
the personal and corporate tax codes. But I
don’t know how that could be achieved — there
are so many beneficiaries and the whole system
is designed to support those loopholes.
Not to mention all the tax attorneys you’d
be throwing out of work.
True, but to keep the economy growing, we
need some reduction in the marginal tax rates.
And it could be done, while lowering the
deficit, because of the higher multiplier on tax
rate changes, in a way where the cuts in spending and the elimination of loopholes are greater
in terms of dollar volume than the reduction in
the marginal tax rates. So we could deal with
the debt situation. We don’t have the option
that John Kennedy had in the early 1960s or
Ronald Reagan had in the early 1980s, where we
had sluggish growth and just responded by cutting the tax rates, so the economy improved
over time. We don’t have that option because
we’re so heavily indebted. We’ve got to do it in a
comprehensive sense in which we lower the
budget deficit initially, and we achieve that by
cutting spending, eliminating the loopholes,
and then we provide some offset through a
reduction in the marginal tax rate. If we move
in that direction, then ultimately the economy
would begin to work out some of these difficulties. I haven’t seen the political will to move forward. But this basic approach is very similar to
some of the provisions in Bowles-Simpson, and
this is the direction in which we have to go.
And we probably need political campaign
finance reform first, so good luck!
Everyone is a special interest. But we don’t
want the tax codes to incentivize investments
PAGE 16
that are not consistent with the most productive
use of capital. What we really want is tax codes
that are neutral in terms of the allocation of the
country’s goods and resources. That would produce a better net result, but there are many who
benefit from the existing structure and they’re
going to fight the changes as hard as they possibly can. This is not a case where we lack the technical knowledge to deal with our problems.
There’s a lack of political will or political cohesiveness to deal with the problem.
What about the private sector? You mentioned earlier that Minsky wanted to keep
banks small. We’ve only let them grow
larger. We’ve made no real progress in
delevering the private sector since the crisis—
No, and we’ve got to deleverage. I don’t think it
really matters whether we deleverage in the private sector or the government sector. The fact
is, we’re going to have to deleverage in both in
order to clear the way for prosperity. After all,
isn’t that in the final analysis what we want to
achieve? But we’re not doing that. The real
median household income right now is where it
was in the late 1990s. We’ve had no improvement in the standard of living, even though the
debt-to-GDP ratio has risen about 100 percentage points. The problem is not solely in the government sector. It’s not solely in the private
sector. It is the aggregate problem, the aggregate over-indebtedness, which is the key.
Have you adjusted your portfolio positions
at all for this year?
Not yet, we still have a very long duration portfolio. If the situation changes, we hope to be
able to be flexible enough to react to it and
we’re prepared to react. But we don’t think that
situation is immediately at hand, though nothing can be taken for granted. In economic
analysis, there are two things that are important. First and foremost, you have to have some
understanding of how the world works and then
you have to evaluate the incoming data in terms
of the way in which the world works.
Responding to the individual indicators, at
Hoisington Management, we don’t think that
works. The indicators have to be interpreted in
light of a more fundamental structure. What’s
very difficult about bond management is that
the short-term trading is really dominated by
these whole hosts of psychological and behavioral characteristics, which are very difficult to
sort out. But the bond market, in our opinion,
does move toward equilibrium, though the
process is slow and torturous. To know when
you’re moving toward equilibrium and in which
direction the equilibrium exists, requires this
broader understanding of the fundamental economic relationships. That’s what we try to do.
You’re saying you try to stay focused on
the big picture? Not react to each blip in
the data?
Yes, and the thing about it is, it’s counter-intuitive. You might assume that we’d have greater
knowledge about the short run and less knowledge about the long run. But in our approach,
the only knowledge that we think we have pertains to these longer term fundamental considerations, not to the short-term trading. So we’re
looking at the world through an entirely different prism.
So short term moves are just noise?
Yes, and trying to sort out the short-term noise
is an impossible task. Our approach at
Hoisington Management is that you cannot
react to these short-term swings. If you do that,
you’ll generally be buying at the wrong time and
selling at the wrong time.
Words to the wise. Thanks, Lacy.
W@W Interviewee Research Disclosure: Dr. Lacy Hunt joined Hoisington Investment Management Company as chief economist in 1996. This interview is not in any sense a solicitation or offer
of the purchase or sale of securities. This interview was initiated by Welling@Weeden and contains the current opinions of the interviewee but not necessarily those of Hoisington Investment
Management. Such opinions are subject to change without notice. This interview and all information and opinions discussed herein is being distributed for informational purposes only and
should not be considered as investment advice or as a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources
believed to be reliable, but is not guaranteed. In addition, forecasts, estimates and certain information contained herein are based upon proprietary research and should not be interpreted as
investment advice, or as an offer or solicitation for the purchase or sale of any financial instrument. No part of this interview may be reproduced in any form, or referred to in any other publication, without express written permission of Welling@Weeden. Past performance is no guarantee of future results.
welling@weeden
JANUARY 20, 2012
PAGE 17
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http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
guestperspective
INSIDE
RESEARCH
DISCLOSURES PAGE 6
guestperspective
By Bill Hester, CFA
Charts To Watch
Five Global Risks To Monitor In 2012
As we’re all a bit forecast weary by this point in
the year, here’s a list - not of prognostications but rather of potential risks that may come into
even greater focus this year. These risks –
whether they intensify or pass – will likely play
an important role in driving the performance of
global stock markets in 2012.
1) The Persistence of Wide Spreads Among
European Debt – Even if Bond Holders are
‘Rescued’
There are two components of the European
credit crisis - debt levels and economic growth
prospects. While the conversations to this point
have leaned mostly toward reducing debt levels,
economic growth prospects and the overall viability of a common currency will likely get a
closer look this year, especially as Europe heads
for recession.
During this two-year crisis investors have continually called on the ECB and euro area leaders
to ‘fix’ the debt issue: by wiping out half of
Greece’s debt, by protecting Italy’s access to
debt markets through bond purchases, or by
suggesting a levered EFSF, the euro area’s rescue vehicle.
But even if the ECB does bend to the will of the
bond markets this year, and begins to buy sovereign debt directly, the single currency is left
with all of the same weaknesses that existed
prior to the crisis: the inability to tailor interest
rate policy for each individual economy, the
lack of foreign currency adjustment needed to
offset differences in competitiveness, and
growth-limiting trade dynamics throughout the
area.
welling@weeden
Martin Feldstein, a long-time euro skeptic, in
this month’s Foreign Affairs magazine made
the point this way: “During the past year,
Germany had a trade surplus of nearly $200 billion, whereas the other members of the eurozone had trade deficits totaling $200 billion. A
more comprehensive measure that factors in
net investment income reveals that Germany
has a current account surplus of nearly five percent of GDP, whereas Greece has a current
account deficit of nearly ten percent of GDP.
Put another way, Germany can invest in the rest
of the world an amount equal to five percent of
its GDP, whereas Greece must borrow an
amount equal to nearly ten percent of its GDP
to pay for its current level of imports”.
One of the strongest benefits at the introduction of the common currency was that investors
priced government debt similarly across the
euro area. During this period investors thought
of the euro area as a group of countries that
would not only share a currency, but also share
economic performance and long-term outcomes. Smaller countries and those of southern
Europe experienced the greatest amount of
benefit from converging yields. Yield on Greek
debt fell by more than half in less than 10 years.
Even stock market valuation ratios converged.
The spread between the countries with the
highest and lowest PE ratios dropped by more
than half during the period.
While this period could have been used to
improve some of the issues surrounding productivity, competitiveness, and trade dynamics
among countries, what occurred instead was
that governments took on larger amounts of lia-
JANUARY 20, 2012 PAGE 1
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bilities, and as interest
rates fell, housing bubbles formed. With that
period passed, it’s difficult to imagine that
investors will soon
return to the mindset
that Portugal, Ireland,
or even Italy, will soon
again converge materially – in either economic performance or
level of credit risk with Germany.
I highlighted this risk
and the graph above
early in the European
credit crisis (The Great
Divergence). At that
point the sovereign debt of Portugal was priced
at 200 basis points above German bunds, compared with 1100 basis points today. Updated
graph, right, top.
There is a long history prior to the period of the
shared currency where spreads among countries and with Germany were dramatically and
persistently wider than even today. This was
because expected economic growth rates, inflation expectations, and the real rates required by
investors differed. Now that investors have been
reminded of the structural weaknesses of a
common currency – even outside of the discussion of high debt loads - persistently high
spreads may be here to stay. Those spreads will
surely play a role in the potential long-term
growth rates of
economies and euro
area stock market valuations.
accounting didn’t add up. And how Ireland’s
bad bank debt was turned into sovereign debt –
which tripled its debt to GDP ratio in just three
years. It will also cover the trajectory of peripheral sovereign bond yields in the face of
investor uncertainty, where yields were first
pushed above seven percent, and then eventually to much higher levels, forcing a rescue program.
The second part of the story will be about Italy
and Spain, and potentially France, and how
they were either pulled into the fiscal debt
maelstrom or whether the ECB and euro area
leaders were able to ring-fence them from the
more troubled smaller euro countries. It will
cover whether investors pushed these core
2) Sovereign Debt
Rollover Risks
When the history of
the European Credit
Crisis is written, it’ll
likely be in two parts.
The first part will
cover the debt crisis of
the smaller European
countries – mainly the
woes of Greece,
Portugal, and Ireland.
It will cover Greece’s
admission that its
welling@weeden
JANUARY 20, 2012 PAGE 2
countries from liquidity concerns to solvency
concerns. While these chapters are still being
written, the outcome may very well be available
to historians (and investors) much sooner than
many are expecting. One reason is because of
the vast amount of sovereign and bank debt that
is due to mature this year, all of which will
needed to be rolled over because of existing
budget deficits. The two countries that pose the
greatest risks for rolling over this debt are Italy
and Spain.
The chart on page 1, bottom gives some sense
of the relative importance of Italy – and to a
slightly lesser degree Spain – in meeting its
rollover demands this year versus the smaller
euro area countries. The graph shows the
cumulative amount of debt that will mature this
year in the countries listed. (These totals count
all government debt coming due – including
shorter term notes – and are therefore larger
than estimates of only long-term debt.) The
graph shows the limited bond market needs
(and therefore rescue funds needed) of Greece,
Portugal, and Ireland, relative to those of Italy.
Also, notice how steep the line is for Italy’s
maturing debt during the first four months of
the year – when almost half of this year’s total
debt will mature.
It will be important to watch bond auction
demand in Italy and Spain in the beginning of
the year. The recent bid to cover ratio – a measure of the eagerness of bond investor to participate in an auction – for Italy’s 10-year notes
has mostly been in line with results from early
last year. Of course, the level of yield will also
matter. The chart nearby shows the weighted
coupon of the existing debt outstanding for
each country (in blue) versus the current yield
(using the weighted maturity of existing debt)
of its bonds (in red). For many years during the
Euro’s first decade, borrowing costs continued
to fall versus the average cost of the existing
debt of these countries. This trend has now
changed for most of Europe, except Germany
and France. This will likely continue to further
widen economic divergences among countries.
This is one more benefit Germany is deriving
from the crisis. In addition to a weaker euro,
which helps fuel its export-oriented economy,
the cost of financing its sovereign debt relative
to its existing debt continues to fall while the
smaller countries struggle with rising financing
costs.
3) The Depth of Italy’s Recession
It would be difficult to overemphasize the
importance of Italy retaining access to the bond
markets, and mitigating further losses in its
sovereign bonds. According to the Bank for
International Settlements, foreign claims on
Italian debt total $936 Billion – that’s larger
than the combined foreign claims on the debt of
Portugal, Ireland, and Greece. And core
Europe is long a mountain of Italian debt.
French banks, for example, hold 45 percent of
Italy’s liabilities. Much more is at stake than
France losing its Triple-A rating if Italy moves
from a liquidity concern to a solvency concern.
What eventually would force that shift is if
investors come to believe that the country’s
ability to handle its debt load over the long term
is compromised. Those concerns can be partly
alleviated if Italian Prime Minister Mario Monti
delivers a balanced budget by 2013, which he
promised this week. Unfortunately, near-term
economic risks could make these goals difficult
to meet in practice.
This year economists expect the Italian economy to contract only slightly – by 0.3%. The
graph below shows the year-over-year change in
the OECD composite leading indicator for Italy
(lagged by six months) versus the year-over-year
change in Italian GDP. The change in the leading indicator is currently -9.8 percent. That’s
suggesting a much deeper contraction in the
Italian economy than current forecasts.
Following any decline of greater than 5 percent
in the year-over-year change of the leading indicator has led to an average contraction in the
welling@weeden
JANUARY 20, 2012 PAGE 3
decline in Italy’s economy this year that pushed
debt to GDP ratios materially higher would
likely catch bond investors’ attention, and then
ultimately the attention of global stock
investors.
4) The ECB, LTROs and European Bank
Funding
Will the ECB’s three-year long-term refinancing operations (LTRO) work as a stealth quantitative easing program? Will banks borrow longterm funds from the ECB and turn around and
buy sovereign debt? That’s the hope. But there
are strong tides of data pushing back against
this idea.
Italian economy of about 3 percent six months
later.
Even assuming austerity measures might ease
some of the country’s debt load, it would be difficult to offset this steep of a decline in output.
Hold debt levels static, and that rate of economic decline would force Italy’s debt to GDP ratio
to rise to 122% from 118% – clearly the wrong
direction if the hope is to ease long-term solvency concerns.
Investors in Italian stocks may have moved
some distance toward pricing in a deeper recession than what is currently expected by economists. The FTSE MIB Index declined 40 percent peak to trough last year (the index fell 25
percent on a calendar basis). But a deeper
While there was much fanfare last month after
the ECB loaned 523 banks 489 billion euros,
the actual amount of new funds was a more
modest number. This is because two earlier
loan programs expired on the same day as the
three-year LTRO was held, and banks probably
rolled these funds into the three-year operation. The earlier operations included a 3-month
loan of 141 billion euros offered in September,
and a net 112 billion euros of overnight loans.
The ECB also allowed banks to shift 45 billion
euros from an October operation into the 3year LTRO. Of the 489 billion Euros operation,
that left about 191 billion euros of fresh loans.
(See this link for ECB euro operation results.)
Will this smaller figure be used by banks to buy
sovereign debt? Any purchases will probably
not in be in large amounts. That’s because, as
Bloomberg Economist David Powell recently
pointed out, the 191 billion euros of new loans
are less than the value of bank debt scheduled
to come due this quarter alone. And with the
unsecured debt markets essentially closed to
many of these banks, the ECB loans will be
needed to fund existing assets.
Up to 700 billion euros of European bank debt
comes due this year, with about 200 billion
euros coming due the first quarter, according
to Bloomberg data. The financing needs coming due in the first quarter “imply that euro
area banks will not have extra money as a result
of the three-year auction to purchase European
sovereign bonds, using a carry-trade strategy,
because the amount of fresh cash is less than
the amount of bank debt that will mature during the quarter”, Powell wrote recently.
Meanwhile, the ECB’s balance sheet continues
welling@weeden
JANUARY 20, 2012 PAGE 4
to grow. At 2.7 trillion euros, it’s now levered
33 times to its own capital, versus a leverage
ratio of 25 back in September. For investors
holding out hope that the ECB becomes more
involved in the debt crisis, it’s clear that the
central bank is already deeply involved.
As the size of the ECB’s balance sheet grows,
the quality of its collateral is declining. Open
Europe, a Brussels-based think tank, estimates
that through government bond purchases and
liquidity provisions to banks, the ECB’s exposure to Greece, Portugal, Ireland, Italy, and
Spain has reached 705 billion euros, up from
444 billion euros in early summer - a 50 percent increase in six months (their note was published prior to the December 21 three-year
LTRO, which likely further boosted lower quality collateral). They also remarked, “the number
of banks which are becoming reliant on the
ECB is alarming and hopes that the functioning
of the European financial markets will ever
return to normal are diminishing – creating a
long-term threat to Europe’s economy.”
5) Widespread Global Slowdown
Risks exist outside of Europe, too. Leading
indicators suggest that the risks of a synchronized global downturn are building. (See John
Hussman’s recent discussion on this topic:
When “Positive Surprises” Are Surprisingly
Meaningless.) The year-over-year changes in
the OECD’s Composite Leading Indexes for the
United States, the United Kingdom, Japan, and
Europe have all turned negative to varying
degrees. Of these, the OECD’s index that
tracks Europe’s major economies is declining at
the fastest pace (-6.5), with the 12-month
change in the US index falling just below zero
in the latest release of the data.
Now that negative leading indicator readings
for these four major regions of the world are in
place, stock market risks have climbed considerably. The graph below is one way to show the
typical outcome when all of these leading indicators are negative. The red bars (right scale)
represent drawdown – or the decline from each
prior peak - in the MSCI World Index. The blue
bars (left scale) are just a sum total of the number of regions where the year-over-year change
in the OECD leading indicator is positive. The
large blocks of blue areas reaching the top of
the graph represent periods of widespread economic growth, such as the late-1980’s and 1990’s, when the leading indicators for all four
regions were positive. The large blocks of white
space represent those periods where economic
contraction was widespread – such as in 1974,
the early 1980’s, in 2000, and in 2008.
Importantly, the sum of positive leading indexes has dropped to zero once again.
Probably the best way to summarize this chart
is that when the majority of developed
economies have negative leading indicators on
a year-over-year basis, investors should at least
allow for large stock market declines. The
declines beginning in 1974, 1990, 2000, and
2007 all began from periods when the leading
indicators of all four regions had – or were
about to - turn negative. The worst of those 1974, 2000, and 2007 also began from very rich
market valuations. The stock market collapse in
1987 is the only example of a large decline
without at least some notification from the
OECD’s leading indicators of oncoming weakness. The 1980-1982 period, where global
stocks fell more modestly, can be explained by
the extremely low levels of valuation during
that period, unlike today’s higher levels.
The above global composite of OECD leading
indicators also does a surprisingly good job of
providing a coincident signal of US recession.
Here are the dates where all four indicators first
turned negative along with the actual month a
US recession began in parenthesis: December
1973 (November 1973), February 1980
(January 1980), December 1990 (July 1990),
December 2000 (March 2001), and November
2007 (December 2007). The indicator warned
5 months into the 1990 recession, and 3
welling@weeden
JANUARY 20, 2012 PAGE 5
months early in 2001, but within a month of
each other recession (missing only the 1981
recession). This composite indicator turned
negative with the October data.
William Hester, CFA is a Senior Financial
Analyst at Hussman Funds and author of
Investment Research & Insight.
Debt loads and economic growth vulnerability
probably sum up this list of risks best. While
these were topics investors focused on in 2011,
this year will raise the stakes. Large quantities
of debt will need to be rolled over and coincident indicators are likely to follow the currently
downbeat leading ones. Both will need to be
watched closely.
Reprinted with permission of Bill Hester and
Hussman Funds’ Investment Research &
Insight, January 2012.
W@W Contributor Research Disclosure: William Hester, CFA is a Senior Financial Analyst at Hussman Funds and author of Investment Research & Insight. This Guest Perspective is reprinted
with permission of Hussman’s Investment Research & Insight, January 2012. All rights reserved and actively enforced. Except for articles hosted from the web domains hussman.net or hussmanfunds.com, linked articles do not necessarily reflect the investment position of the Funds.
**Full Disclosure: Kate Welling owns shares in the Hussman Strategic Growth Fund and Hussman Strategic Total Return Fund.
welling@weeden
JANUARY 20, 2012 PAGE 6
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
guestperspective
INSIDE
RESEARCH
DISCLOSURES PAGE 2
guestperspective
By Anatole Kaletsky
Pointing Fingers
The Euro’s Woes and Germany’s Culpability
The world watched with horror and fascination
this week as investigators sought the cause of
an entirely avoidable shipwreck in Italy that
could have cost as many as 40 lives. Meanwhile,
the cause of a much greater wreck – that of the
good ship euro – is heaving into view. As Greece
moves towards default, as France, Italy and
Spain suffer credit downgrades, and as negotiations on last month’s fiscal treaty reach deadlock, the euro is heading for the rocks. And the
negligent captain is neither Greece, Italy nor
France. It is Germany.
ing” and that the German-inspired fiscal compact agreed to over British objections at last
month’s European summit would “not supply
sufficient resources or operational flexibility”
to restore euro zone stability. Yesterday, Mario
Monti, the German-appointed Prime Minister
of Italy was more explicit, warning that
Germany would suffer a “powerful backlash” if
it persisted in opposing measures that could
relieve financial pressures on other euro members, such as the issuance of jointly-guaranteed
bonds.
Germany has been responsible for almost all
the misguided policies implemented by the
euro zone. And if the euro fails, the reason will
be that Germany adamantly opposed two of the
three conditions necessary to save the common
currency. The German government consistently vetoed the only policies that could have
brought the euro crisis under control: collective European guarantees for national debts and
large-scale intervention by the European
Central Bank. To make matters worse,
Germany pushed for last year’s crazy interest
rate hikes by the ECB, as well as the excessive
demands for austerity and bank losses that now
threaten Greece with a Lehman-style chaotic
default.
The dawning recognition that the odd man out
in the euro zone is Germany, rather than any of
the Mediterranean countries, aids understanding of the baffling twists and turns of the crisis.
As euro-skeptics have argued since the early
1990s, there are only two possible outcomes for
the single currency. Either the euro will disintegrate or the euro zone will transformed into a
full-scale fiscal federation and political union.
This dichotomy, controversial before the Greek
crisis two years ago, is now widely acknowledged.
German culpability – or, to put it more politely,
the inconsistency of Germany’s actual policies
with the ostensible goal of the euro’s survival –
has been highlighted by a series of recent public
statements, starting with last week’s downgrade announcement from Standard & Poor’s.
S&P stated that “a reform process based on fiscal austerity alone risks becoming self-defeat-
welling@weeden
The key question is what exactly “fiscal federation” means. The answer reveals the full extent
of German culpability. For the euro to survive
three conditions must be satisfied. The firstinsisted on by Germany - is the imposition of
budgetary discipline, which can only be
enforced by centralized EU control over the tax
and spending policies of national governments.
The second is a substantial degree of collective
European responsibility for national government debts and bank guarantees. This mutual
support is the flip side of the fiscal federalism
JANUARY 20, 2012 PAGE 1
coin, as Mr. Monti made clear. But it is a quid pro quo that the Germans
have refused even to discuss.
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Published exclusively
for clients of
Weeden & Co. LP
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
Jean M. Galvin
Business Manager/
Webmaster
(203) 861-9814
[email protected]
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
Greenwich, CT 06830.
Telephone:
(203 ) 861-9814
Fax: (203) 618-1752
The third condition for the euro’s survival is support for the fiscal federation from the ECB, comparable to the monetary support provided for
government debt markets by central banks in the US, Britain, Japan,
Switzerland and all other advanced economies. It is because of this central bank support for their government bond markets that the US,
Britain and Japan have managed to finance much larger deficits than
France or Italy without any problems or serious worries about credit
downgrades.
The euro’s fundamental problem is that Germany refuses to acknowledge these three conditions for the currency’s survival. Instead, it concentrates entirely on the first. It forces other governments to adopt ever
more draconian and unrealistic austerity targets, while vetoing consideration of the things that would make such austerity possible and productive: collective debt guarantees and central bank intervention.
Consequently the new euro treaty supposedly agreed to last month is like
a three-legged stool with only one leg. Clients have asked us if the finalization of the fiscal compact text, expected in March at the latest, will
boost confidence. Our answer is that if the German government sticks to
its present position then the final text will not matter: the treaty will
never be ratified.
Excerpted and reprinted with permission of Anatole Kaletsky & GaveKal
Research Checking The Boxes, January 18, 2012.
Anatole Kaletsky is the Chief Economist at GaveKal Research.
Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
for such infringement.
welling@weeden does not
license or authorize
redistribution in any form by
clients or anyone else.
However, clients may print
one personal copy and limited
reprint/republication permission may be made available
upon specific request.
Copyright 2012,
K.M. Welling.
All rights reserved.
W@W Contributor Research Disclosure: Excerpted and reprinted with permission of Anatole Kaletsky & GaveKal Research Checking The
Boxes, January 18, 2012. GaveKal is an independent research firm, offers institutional investors advisory services on tactical asset allocation, and which has a number of sister companies.. The information and opinions expressed in this GuestPerspective are based on research
from sources believed to be reliable and credible, but no guarantees are expressed or implied. This piece is in no way, shape or form an
offering of interests or solicitation of an offer to purchase interests in any security or fund or any investment of any sort. For more details,
please go to www.GaveKal.com.
welling@weeden
JANUARY 20, 2012 PAGE 2
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
guestperspective
INSIDE
RESEARCH
DISCLOSURES PAGE 2
guestperspective
By Joe Saluzzi and Sal Arnuk
SEC Gags Venues
Losing Faith In Arms Merchants
Over the past few years, we have tried to help
investors understand how the equity markets
have changed. In addition to highlighting a
“few” problems with high frequency trading,
we have often set our sights on the stock
exchanges. We have referred to them as “arms
merchants” who will sell sophisticated weapons
like colocation space and data feeds to the highest bidder. Often, we feel like we are just yelling
into a forest and no one hears us. But finally it
appears that our regulators have caught on to
the conflicts of interests that exist at our
nations stock exchanges.
ing, according to a person familiar with the matter, suggesting the SEC’s leash will grow tighter
this year. This time around, sources said, the
SEC’s focus has shifted to issues such as data
feeds and whether certain market players
may get an information advantage, as well
as adequate investments by exchanges into
technology and infrastructure.”
Based on this Reuters article, the SEC appears
to have finally realized that the exchanges are at
the center of many problems with today’s equity
market. It appears that the SEC no longer
trusts the stock exchanges. They had to step in
and slap gag orders on them because they knew
if left to their own devices that they would do
what’s best for their bottom line and not what’s
best for the market.
In an article titled, “SEC tightens leash on
exchanges post ‘flash crash’”, Reuters has
unveiled some information about what is ahead
for the stock exchanges:
“Shortly after the flash crash, regulators pushed
NYSE Euronext, Nasdaq OMX Group and other
market operators to craft new trading rules to
avoid future breakdowns. Reuters has learned
the SEC took the unprecedented step of serving those exchanges with non-disclosure
agreements, effectively muzzling them to prevent further public bickering and to get the fierce
competitors to work together.”
“People who knew of the agreements, and spoke
on condition of anonymity, said they were
intended to compel exchanges to leave their differences aside for the good of the public markets.
Some said they were also meant to stop leaks to
the media about the preliminary, and sometimes
patchy, plans for new rules.”
“More cases involving stock exchanges are pend-
welling@weeden
In 2000, NASDAQ demutualized and six years
later, the NYSE did the same. Demutualization
altered the structure of exchanges from member owned facilities to private corporations. At
the time, the SEC did not seem to have a problem with this switch. In a 1999 speech, Arthur
Levitt, then Chairman of the SEC, said: “In the
wake of this heightened competition from ECNs,
Nasdaq and the NYSE are pushing forward
with their plans to demutualize. The
Commission has no intention, whatsoever, of
standing in the way of a movement towards forprofit status.”
The SEC now seems to see the damage that this
for-profit exchange model has done to the market. Unfortunately, it took a flash crash to wake
them up and hopefully it doesn’t take another
flash crash for them to act.
JANUARY 20, 2012 PAGE 1
Reprinted with permission of Sal Arnuk and Themis Trading, Themis
Trading Blog, January 13, 2012.
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Sal Arnuk and Joe Saluzzi are co-heads of the equity trading desk at
Themis Trading LLC (www.themistrading.com), an independent, no conflict agency brokerage firm specializing in trading listed and OTC equities for institutions.
Published exclusively
for clients of
Weeden & Co. LP
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
Jean M. Galvin
Business Manager/
Webmaster
(203) 861-9814
[email protected]
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
Greenwich, CT 06830.
Telephone:
(203 ) 861-9814
Fax: (203) 618-1752
Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
for such infringement.
welling@weeden does not
license or authorize
redistribution in any form by
clients or anyone else.
However, clients may print
one personal copy and limited
reprint/republication permission may be made available
upon specific request.
Copyright 2012,
K.M. Welling.
All rights reserved.
W@W Contributor Research Disclosure: Sal Arnuk and Joe Saluzzi are co-founders of Themis Trading, LLC. This Guest Perspective from
Themis Trading Blog January 13, 2012 is reprinted with permission from Sal Arnuk and Joe Saluzzi and Themis Trading, LLC. The information
and opinions in this report constitute judgment as of the date of this report, have been compiled and arrived at from sources believed to be
reliable and in good faith (but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness) and are subject to change without notice. The information should not be construed as investment advice and is provided only for
informational purposes. For further information, Phone: (973) 665-9600 / Web: www.themistrading.com.
welling@weeden
JANUARY 20, 2012 PAGE 2
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
chartsightings
INSIDE
RESEARCH
SEE
DISCLOSURES PAGE 2
chartsightings
By John P. Hussman, Ph.D.
Capturing A Syndrome
Examining Evidence Pointing Toward Recession
Recession evidence is best measured by capturing a syndrome of conditions that reflects broad
deterioration in both real activity and financial
indicators. What’s perplexing to me is that the
recession concerns we’re seeing are evident
even in composites of very widely tracked economically-sensitive indicators. For example,
the chart above is simply the average of standardized values (mean zero, unit variance) of
the following variables: 6 month change in S&P
500, 6 month change in nonfarm payrolls, 12
welling@weeden
month change in nonfarm payrolls, 6 month
change in average weekly hours worked, ISM
Purchasing Managers Index, ISM New Orders
Index, OECD Leading Indicator - total world,
OECD Leading Indicator - US, ECRI Weekly
Leading Index growth, Chicago Fed National
Activity Index - 3 month average, credit spreads
(Baa vs 10-year Treasury), Industrial commodity prices - 12 month and 6 month change, and
New building permits 6 month change.
JANUARY 20, 2012 PAGE 1
The current average is at levels that have always and only been associated
with recession (and at about the same level where most recessions have
started), though there was a brief dip nearly approaching these levels in
2002, just after the 2000-2001 recession.
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Published exclusively
for clients of
Weeden & Co. LP
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
Jean M. Galvin
Business Manager/
Webmaster
(203) 861-9814
[email protected]
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
Greenwich, CT 06830.
Telephone:
(203 ) 861-9814
Fax: (203) 618-1752
Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
for such infringement.
welling@weeden does not
license or authorize
redistribution in any form by
clients or anyone else.
However, clients may print
one personal copy and limited
reprint/republication permission may be made available
upon specific request.
Copyright 2012,
K.M. Welling.
All rights reserved.
While we prefer to construct discriminator variables (similar to our
Recession Warning Composite , which helps to capture interactions and
minimize “outlier” effects), we should be reluctant to casually dismiss
the downturn we observe in a whole range of economic measures here.
Of course, it’s possible that the downturn we’ve observed to date will
quickly reverse to a new growth path, but we should keep in mind that
GDP is just the sum of consumption, real investment, government
spending, and net exports, and then ask what will drive that reversal.
Have the credit strains in Europe been durably addressed? Can European
economies presently be expected to expand? Is there now less need for
fiscal restraint in the U.S.? Has the overhang of troubled mortgages in
the financial system been worked out? Have savings rates rebounded or
pressure on household budgets eased? Is consumer demand is sustainably rebounding? Is there pent-up demand for capital goods despite having drawn spending forward due to expiring tax credits last year? Are
exports to the rest of the world expected to accelerate? Are profit margins likely to expand from already record levels in order to accommodate
growth in corporate profits? Do companies expect demand to be strong
enough to commit to large-scale or multi-year investment projects? Not
all of these factors have to reverse in order to have a sustained expansion, but the headwinds don’t appear light.
My intent isn’t to go to battle on the recession side of this debate, but
rather to share what I’m looking at, and the concerns I have about continuing economic risks - particularly since the implications for the stock
market are lopsided. If we are destined to have a recession, I would prefer for us to correctly anticipate it, but I don’t hope for one, and my preference would be not to observe the kind of data we’re seeing here at all.
Rather than overstating the case or dismissing the risks, we’re willing to
dwell in uncertainty by acting in proportion to the data we observe and
its implications for the financial markets. At present, the data strongly
implies recession risk, though with less than 100% certainty. The problem is that with overvalued, overbought, overbullish market conditions,
the loss implications for the market in the event of a blindside recession
are far more hostile than the possible gains in the event of a recovery
that is already anticipated.
Excerpted and reprinted from Hussman’s Weekly Market Comment,
“Dwelling In Uncertainty”, January 16, 2012.
John P. Hussman is the founder and president of Hussman Investment
Trust and manager of the Hussman Funds.
W@W Contributor Research Disclosure: John P. Hussman is the founder and president of Hussman Investment Trust and manager of the
Hussman Funds. This Chart Sighting is excerpted and reprinted from Hussman’s January 16, 2012, Weekly Market Comment. John’s Hussman
Weekly Market Comment is published weekly by the Fund Manager, Hussman Econometrics Advisors. All rights reserved and actively
enforced. The investment manager has sole discretion in the measurement and interpretation of market conditions. Except for articles
hosted from the web domains hussman.net or hussmanfunds.com, linked articles do not necessarily reflect the investment position of the
Funds. For further information please visit www.hussmanfunds.com.
**Full Disclosure: Kate Welling owns shares in the Hussman Strategic Growth Fund and Hussman Strategic Total Return Fund.
welling@weeden
JANUARY 20, 2012 PAGE 2
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
chartsightings
INSIDE
RESEARCH
SEE
DISCLOSURES PAGE 2
chartsightings
By Kate Mackenzie
Prices Drop
China’s Property Sector: From Bad To Worse
More…Remember all that stuff we’ve been saying about Chinese property? How it’s really,
really important? We’re hardly the only ones,
either.
Bloomberg View’s Michael McDonough has
done another of his handy charts on the latest
city-by-city sales price data. The green is nearly
all gone in December:
n’t tell us various important things such as
sales volumes or the numbers offered for sale,
which could be particularly revealing regarding
whether those who already own investment
apartments are beginning to sell. Or how fast
the central government’s much-touted social
housing expansion might be progressing.
A whole stack of official data has taken care of
(most of) that, however.
Of course that’s just one slice of data, and does-
welling@weeden
JANUARY 20, 2012 PAGE 1
Statistics published on Tuesday showed growth in real estate investment
in December slowed to its lowest rate in a year; actually falling year-onyear during that month. From Reuters:
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Property investment grew 12.3 percent from the same month a year earlier, down from an annual rise of 20.2 percent in November and 25.0 percent in October and September, according to Reuters calculations based
on official data released on Tuesday.
And then, aggregate new home prices:
Published exclusively
for clients of
Weeden & Co. LP
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
Average new home prices across China dropped 0.3 percent in December
from the previous month, deepening from a decline of 0.2 percent in both
November and December, according to Reuters weighted house price
index based on official data released on Wednesday.
Again from Reuters,
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
“If they build the same amount (in 2012) that they did last year, which is
still a phenomenal rate of construction, then it would take GDP down to
6.6 percent,” said Patrick Chovanec, an economist who teaches at
Tsinghua University’s School of Economics and Management in Beijing.
Jean M. Galvin
Business Manager/
Webmaster
(203) 861-9814
[email protected]
That would be a dramatic slowdown from 2011's 9.2 percent growth,
and it doesn’t even include potential indirect impacts that typically come
with a housing slowdown, such as falling demand for building materials
or a rise in banks’ bad debts.
China’s property sector goes from bad to worse
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
Greenwich, CT 06830.
Telephone:
(203 ) 861-9814
Fax: (203) 618-1752
Posted by Kate Mackenzie on Jan 18 09:08.
http://ftalphaville.ft.com/blog/2012/01/18/838191/chinas-propertysector-goes-from-bad-to-worse/
Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
for such infringement.
welling@weeden does not
license or authorize
redistribution in any form by
clients or anyone else.
However, clients may print
one personal copy and limited
reprint/republication permission may be made available
upon specific request.
Copyright 2012,
K.M. Welling.
All rights reserved.
welling@weeden
JANUARY 20, 2012 PAGE 2
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
chartsightings
INSIDE
RESEARCH
SEE
DISCLOSURES PAGE 2
chartsightings
By John Kosar
Bull Case
Strong Energy = Strong U.S. Index
In our January 6th Commentary entitled
Recent Strength In Oil Prices, Energy Sector
Bode Well For U.S. Stocks In Q1 2012, we
pointed out a January 3rd breakout higher in
the AMEX Oil Index (XOI) from two months of
sideways trade, and said that the upcoming rise
in energy-related assets prices that it implied
should bode well for a coincident rise in the U.S.
stock market.
Since that report the S&P 500 has risen by
welling@weeden
32 points or +3% while the bullish chart pattern in the XOI (a triangle, indicating temporary investor indecision as shown in Chart 1
below) remains valid and continues to target an
initial +8% rise to 1350.
This chart shows that, in addition to XOI breaking out from the upper boundary of the pattern
early this month and at the same time rising
above its 200-day moving average (orange highlights, a widely-watched major trend proxy), the
JANUARY 20, 2012 PAGE 1
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Published exclusively
for clients of
Weeden & Co. LP
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
Jean M. Galvin
Business Manager/
Webmaster
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[email protected]
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
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Telephone:
(203 ) 861-9814
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Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
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welling@weeden does not
license or authorize
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However, clients may print
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Copyright 2012,
K.M. Welling.
All rights reserved.
index has also risen above overhead resistance at its March 2011 benchmark low at 1261 (blue highlights).
This clears the way for a rise to at least meet our 1350 initial upside
target, which will remain valid as long as the apex of the triangle pattern
at 1218 contains the index on the downside as underlying support.
Chart 2 plots daily bar charts of XOI (red) and the S&P 500 (black) since
2000 and shows that these two series have maintained a tight and stable
positive correlation to one another for the past two decades.
Per the correlation, as long as energy-related asset prices as represented by the AMEX Oil Index continue to rise as Chart 1 suggests is
likely, then the U.S. broad market is likely to extend its October 2011
advance — which thus far has been +22%.
Excerpted and reprinted from John Kosar and Asbury Research LLC,
What We’re Watching Today, January 19, 2012.
John Kosar is the proprietor of Asbury Research LLC, a technical research
service for institutional investors based in Crystal Lake, IL.
W@W Contributor Research Disclosure: Excerpted and reprinted from John Kosar and Asbury Research LLC, What We’re Watching Today,
January 19, 2012. John Kosar is the proprietor of Asbury Research LLC, a technical research service for institutional investors based in
Crystal Lake, IL. The material in this Chart Sighting is for illustrative purposes only and for your private information, and Asbury is not
soliciting any action based upon it. This material should not be redistributed or replicated in any form without prior consent of Asbury
Research LLC and Welling@Weeden. The material is based upon information that we consider reliable, but we do not represent that it is
accurate or complete, and it should not be relied upon as such. Nothing in this interview should be interpreted as an offer to sell or a solicitation of an offer to buy a security, or an interest in any fund. Mr. Kosar’s views are subject to change without notice. Nothing herein
should be construed as specific investment advice. For more info, see www.AsburyResearch.com.
welling@weeden
JANUARY 20, 2012 PAGE 2
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
chartsightings
INSIDE
RESEARCH
SEE
DISCLOSURES PAGE 2
chartsightings
By David Rosenberg
Empire Strikes Back
A Bit Of Good News In NY Fed Survey
Well, we have had two January reports so far –
both of them in survey form via the University
of Michigan consumer sentiment index that
came out on Friday and the NY Fed Empire
manufacturing index that was released yesterday. And both managed to advance to their best
levels since last spring. Not too shabby.
The NY Fed Empire index rose for the third
month in a row after the bleeding stopped last
welling@weeden
October in terms of negative readings, to stand
at 13.48 in January (was 8.19 in December).
The components were equally impressive to
boot with orders and backlogs both improving
smartly. In fact, the weightings of the components point to a 55 reading on ISM for January
(it was suggesting 52.5 for December this time
last month). This is more fodder for the bulls,
to be sure.
JANUARY 20, 2012 PAGE 1
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Published exclusively
for clients of
Weeden & Co. LP
The forward-looking ‘six-month’ outlook component also jumped to
54.87 from 45.61 to stand at this highest level since January 2011 – nearly a two-year high. It is absolutely incredible when you look at the economic turmoil overseas that American businesses can be this optimistic
– but it is what it is.
Hiring intentions rose to its best tally since last April from 24.42 to
28.57 – it was flat last September. Capex plans also improved, and none
more than for tech spending where the outlook rose for the third month
in a row to 19.78 from 15.12 in December; the highest reading since May
and augurs well for a part of the stock market that has basically been a
market performer.
Excerpted and reprinted from Breakfast with Dave, January 18, 2012.
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
David A. Rosenberg is the Chief Economist & Strategist at Gluskin Sheff +
Associates Inc.
Jean M. Galvin
Business Manager/
Webmaster
(203) 861-9814
[email protected]
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
Greenwich, CT 06830.
Telephone:
(203 ) 861-9814
Fax: (203) 618-1752
Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
for such infringement.
welling@weeden does not
license or authorize
redistribution in any form by
clients or anyone else.
However, clients may print
one personal copy and limited
reprint/republication permission may be made available
upon specific request.
Copyright 2012,
K.M. Welling.
All rights reserved.
W@W Contributor Research Disclosure: David A. Rosenberg is the Chief Economist & Strategist at Gluskin Sheff + Associates Inc. Gluskin
Sheff + Associates Inc. is a Canadian wealth management firm. This Chart Sighting is excerpted and reprinted from Breakfast with Dave,
January 18, 2012 and Gluskin Sheff + Associates. Neither the information nor any opinion expressed constitutes an offer or an invitation to
make an offer, to buy or sell any securities or other financial instrument or any derivative related to such securities or instruments (e.g.,
options, futures, warrants, and contracts for differences). This report is not intended to provide personal investment advice and it does not
take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investors should
seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed
or recommended in this report and should understand that statements regarding future prospects may not be realized. Any decision to
purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information
in the prospectus or other offering document issued in connection with such offering, and not on this report. This report is prepared for
the use of Gluskin Sheff clients and subscribers to this report and may not be redistributed, retransmitted or disclosed, in whole or in part,
or in any form or manner, without the express written consent of Gluskin Sheff. Gluskin Sheff reports are distributed simultaneously to
internal and client websites and other portals by Gluskin Sheff and are not publicly available materials. Any unauthorized use or disclosure
is prohibited. Copyright 2012 Gluskin Sheff + Associates Inc. (“Gluskin Sheff”). All rights reserved. For more information or to subscribe to
Gluskin Sheff economic reports, visit www.gluskinsheff.com
welling@weeden
JANUARY 20, 2012 PAGE 2
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
acuteobservations
INSIDE
RESEARCH
SEE
DISCLOSURES PAGE 7
acuteobservations
exchanges have tried to raise their take fees.
NASDAQ’s PHLX exchange proposed raising
their customer take fees from $0.29 to $0.31
per contract. And BATS proposed increasing
their customer take fees from $0.30 to $0.44
per contract...
Top 10 Traded Options
Contracts for 2011
Underlying Security
SPY
SPX
IWM
QQQ
BAC
AAPL
C
VIX
XLF
LV
Dec. YTD,
2011 Volume
%
729,478,419
197,509,449
167,040,702
137,923,379
114,362,369
108,586,176
102,526,010
97,988,951
81,871,564
79,433,438
15.99%
4.33%
3.66%
3.02%
2.51%
2.38%
2.25%
2.15%
1.79%
1.74%
Source: OCC
“As volumes continue to plummet in the equity
market (down 18% already this year), the HFT
parasites have started to look for new markets
to ravage. Last year, over $130 billion was
withdrawn from domestic equity mutual funds.
Each one of these lost dollars represents fewer
opportunities for the HFT parasites to feast.
So, they have moved on. One market they have
moved to is the options market. According to
the OCC, over 4 billion contracts cleared in
2011, a 17 percent increase over the prior
year. Options on the S&P 500 ETF (SPY) represented a whopping 16% of the total amount of
contracts traded. One big beneficiary of this
explosion in options volume has been the
exchanges. The exchanges employ a very similar maker/taker model in the options market.
That is to say, they pay rebates for adding liquidity and charge for taking liquidity. Business
has been so good for them that some of the
welling@weeden
Looks like the options market has the same
problems that we have in the equity market.
Conflicted for-profit exchanges who are looking to maximize revenue and payment for order
flow schemes which are corrupting smart order
routers. Best of luck to our friends in the
options industry. Let us know if we can help.”
Joe Saluzzi
Themis Thoughts
Jan. 18, 2012
www.themistrading.com
“Lobbyists for U.S. banks say a proposed ban on
proprietary trading will cost companies and
investors more than $350 billion. Some economists and fund managers say the claim is greatly exaggerated.
The impact of the so-called Volcker rule on
markets and the economy is being debated at a
congressional hearing today, a month before
the Feb. 13 deadline for comments on a 298page plan by regulators to implement the ban.
The proposal, championed by former Federal
Reserve Chairman Paul Volcker, 84, would constrain the largest banks from betting on investments that could produce big losses.
Lobbying groups, including the Securities
Industry and Financial Markets Association,
JANUARY 20, 2012 PAGE 1
Kathryn M. Welling
Editor and Publisher
[email protected]
(973) 763-6320
Published exclusively
for clients of
Weeden & Co. LP
Noreen Cadigan
Institutional Research Sales
(203) 861-7644
[email protected]
say the narrow definition of what’s allowed
under the proposal will curtail the role of
banks as market-makers, preventing them
from purchasing securities clients want to sell
without first finding a buyer. That would
reduce liquidity and increase transaction costs
for companies, according to an industry-funded study.
‘Their fears are greatly exaggerated,’ said
Simon Johnson, an economics professor at the
Massachusetts Institute of Technology scheduled to testify at the House Financial Services
Committee hearing. ‘The industry’s claim
ignores the fact that when the largest banks
stop doing this kind of trading, somebody else
will step in to do it. And we have to weigh those
costs against the risk of banks blowing up.’
Andrew B. Van Ogtrop
Institutional Research Sales
(617) 757-8730
[email protected]
…Even if the Volcker rule does reduce trading
in some markets, that might not be so bad,
MIT’s Johnson said.
Jean M. Galvin
Business Manager/
Webmaster
(203) 861-9814
[email protected]
‘There’s probably excessive trading anyway,’
he said. “Do we need all this trading for the
objective of efficient allocation of capital? Not
really. They publish these studies saying the
Volcker rule could hurt social interest, but
since when did the banks start caring about
social interest?”
Yalman Onaran
Attack on Volcker Rule Seen Exaggerating
Cost of Disruption to Bond Market
Jan. 18, 2012
http://www.bloomberg.com/news/2012-0118/attack-on-volcker-rule-seen-exaggeratingcost-of-disruption-to-bond-market.html
Distributed biweekly,
usually on Friday
mornings, by
welling@weeden,
and
Weeden & Co. LP.
145 Mason Street
Greenwich, CT 06830.
Telephone:
(203 ) 861-9814
Fax: (203) 618-1752
Copyright Warning and Notice: It
is a violation of
federal copyright law to reproduce all or part of this publication or its contents
by any means. The Copyright
Act imposes liability
of up to $150,000 per issue
for such infringement.
welling@weeden does not
license or authorize
redistribution in any form by
clients or anyone else.
However, clients may print
one personal copy and limited
reprint/republication permission may be made available
upon specific request.
Copyright 2012,
K.M. Welling.
All rights reserved.
“HFT shrinks spreads and provides liquidity.
You’ve heard it all a thousand times, and more.
It’s good for you; take your Soma! Honestly,
today when investors hear those words, they
are wise to the propaganda, and they discount
it appropriately. The only ‘defense’ thrown up
by the for-profit exchanges’ catering to HFT at
each and every turn, is that they have done so
for our collective good. Because of that platitude!
But what if it weren’t true? I mean like really
not true; like what if an academic study came
out and stuff? What if such a study came out
and demonstrated that HFT did NOT shrink
spreads after all, because when you take trade
sizes into account, effective spreads are in fact
welling@weeden
quite similar to the past!
We introduce into evidence: The Impact of
High Frequency Trading on Stock Market
Liquidity Measures, by Soohun Kim and
Dermot Murphy. They have examined a somewhat liquid instrument, the S&P 500 ETF, SPY
during different time periods. Using four independent models
Glosten and Harris (1988), Sadka (2006),
Huang and Stoll (1997), and Madhavan,
Richardson and Roomans (1997)
that each calculate the effective spread, all four
models underestimate the spreads from 20072009 by 41 – 46%. Stated differently, spreads
between 1997 and 2009 are actually quite similar when you account for size of trades. [See
Hot Link.]”
Sal Arnuk
Themis Trading
Jan. 19, 2012
www.themistrading.com
GaveKal’s Checking The Boxes
January 19, 2012
www.gavekal.com
“Rather than just pumping liquidity into
clogged pipes, countries can and should do
more to build a more effective network of compensating conduits. In doing so, their main
objective (indeed, the test for effectiveness)
JANUARY 20, 2012 PAGE 2
would be the extent to which new private-sector
investment is “crowded in.”
It is high time to move on five fronts, simultaneously:
•
•
•
•
•
Countries such as Spain and the U.S. need
to be more forceful in unblocking the housing sector by making overdue decisions on
burden sharing, refinancing, and conversion of idle and foreclosed housing stock.
Countries with excessive debt, such as
Greece and Portugal, need to impose sizeable ‘haricuts’ on creditors in order to have
a reasonable chance to restore mediumterm debt sustainability and growth.
In several Western countries, public-private partnerships should be formed to
finance urgently needed infrastructure
investment.
Regulators should stop bickering about the
future configuration on key financial institutions, and instead set a clearer multi-year
vision that is also consistent across brokers.
Finally, governments should inform their
electorates explicitly and comprehensively
that a few contracts written during the
inadvisable ‘great age’ of leverage, debt,
and credit entitlements cannot be met, and
must be rewritten in a transparent way that
strikes a balance between generations,
labor and capital, and recipients and taxpayers.
Such policies would allow healthy balance
sheets around the world, both public and private, to engage in a pro-growth and pro-jobs
process. They require leadership, focus, and
education. Absent that, plumbing problems will
become more acute, and the repairs more complex and threatening to virtually everyone –
including both the ‘one percenters’ and those
who worrisomely are struggling at the margins
of society.”
Mohamed A. El-Erian
PIMCO
Jan. 19, 2012
www.project-syndicate.org
“The latest batch of data from China confirms
both that the economy is steadily slowing and
that the feared ‘hard landing’ remains elusive.
The extent of the slowdown is so far less than
we and most others expected: official GDP
growth was 8.9% YoY in Q4, barely lower than
welling@weeden
the 9.1% in Q3. The slowdown was however a
bit more obvious in the NBS’ estimate of QoQ
growth, which slowed to an annualized 8.2% in
Q4 from 9.5% in Q3. Full year growth came in
at 9.2% after 10.4% in 2010.
These figures confirm our long-held view that
China is basically undergoing a substantial, but
nonetheless cyclical, economic slowdown.
Thanks to the big stimulus delivered from late
2008 through 2010, the country has not seen a
cyclical slowdown in some time, and many people may not remember what one looks like.
This may be why stories about how China is
now entering terminal economic decline have
become so popular. But most economic indicators do not support this scenario, and we are
still comfortable with our call for GDP growth
of around 8% this year.”
Andrew Batson
[email protected]
Rosealea Yao
[email protected]
Janet Zhang
[email protected]
GaveKal Dragonomics
January 18, 2012
www.gavekal.com
“Keep in mind that the U.S. generated 17%
earnings growth off of 1.6% real GDP growth
last year—margins exploded again in 2011. This
goes to show how much of the earnings
momentum was derived by drawing loan loss
reserves in the banking system, the prior global
economic boom, a weak U.S. dollar giving a
huge boost to currency translation with respect
to foreign-sourced earnings, reduced interest
expense, tax benefits (accelerated depreciation
allowances). These are unlikely to recur this
year and some of these will actually pose as serious headwinds.
If there was a broad asset allocation shift afoot,
which would lead to a more lasting rally,
Treasuries would be selling off, however, they
are actually rallying despite what are usually
poor seasonal and despite the recurring ‘risk
on’ trade for the better part of the past three to
four months. So the bull case for the economy
at least is not seeing much validation here, if
any.
Sentiment remains a worry – for all the talk of
the market being positioned ‘bearishly’, that is
JANUARY 20, 2012 PAGE 3
not evident in the data. The CBOE put/call
ratio at 0.74 is at its lowest level since last May
as the market was peaking out and tipping
over. Most sentiment surveys like AAII,
Investors Intelligence and Market Vane
showed a degree of bullishness not seen since
last summer. Short interest has fallen to a ninemonth low of 168.8 billion shares on the NYSE
and Nasdaq. The last time we were here was in
March 2011 – just ahead of the market peak for
last year. The share of AAII respondents
expecting the market to decline in the next six
months was 50% last August, when the major
averages hit an interim low, and that number
has since dwindled to 17%.”
David Rosenberg
Breakfast With Dave
January 18, 2012
www.gluskinsheff.com
“The global environment is very complicated.
On the one hand, the Federal Reserve has
taken a much-needed break from quantitative
easing (at least for the moment). Accordingly,
inflation in oil and food has abated, providing
relief to the U.S. economy. Bearish forecasts
that the U.S. was headed back into recession
proved wrong for the third time since the end
of the last recession.
On the other hand, Asia appears to be in much
worse shape than it was at this time last year
and could be a drag on the world economy
going forward. Very few people trust any of the
economic data coming out of China, making it
difficult to gauge the situation there. Some of
the smartest people we know have very dim
views. The Chinese have been a leading growth
engine for the last two decades and are largely
credited with leading the world out of the
recession in 2009. A change in their economic
circumstances could really upend things.
Finally, the European currency crisis has continued to worsen…The cycle looks like this:
Time passes and the crisis deepens. Markets,
eternal creatures of habit, begin to reflect the
ensuing fear. Then, just as things appear ready
to unravel, there is a reprieve, as red headlines
race across the screen: ‘Sarkozy and Merkel to
Meet at Deuville’, ‘Obama Phones Cameron’,
or ‘Christine Lagarde Waves From Bus’. The
market jumps, You’d think the media would
quit falling for this charade, but having run out
of clever headlines to describe the impending
welling@weeden
doom – ‘Eurogeddon’ Really? – They herald
every briefing, meeting, assembly, and conference call.
The market embraces these announcements as
eagerly as the media, behaving as if any and all
communication is equally constructive, and
likely to yield a solution. The market continues
to rise until the day of that summit, as all ears
await a Grand Communiqué. Within minutes
of any proclamation, the market may cheer
with a final, celebratory spike. Upon evaluation of the actual statement, it becomes clear
that either nothing has truly been agreed
upon, or that the plan is insufficient, impractical or just won’t work. The market sells off and
the crisis deepens some more. Lather. Rinse.
Repeat.
Nonetheless, everyone is looking to these leaders for a solution. And it’s understandable that
speaking and meeting are necessary steps. Yet,
despite the endless telephone calls and summits, all we hear are repeated promises to ‘do
whatever it takes,’ which seems to include
everything except making the necessary sacrifices that might actually resolve the crisis.
The latest solution is a work-in-progress treaty
being heavily negotiated that, in its current
incarnation, will only need to be ratified by a
subset of the Eurozone countries. While the
leaders have committed in principle, there is
significant risk that once the details emerge
(and the necessary electorates are consulted),
we will discover that some leaders pledged
with their fingers crossed and, as with prior
efforts, this too will fail to get the job done.
2012 may be the year in which the currency
crisis will no longer be kept at bay by politicians buying time with empty promises. Maybe
the fall of the Euro will be the 2012 catastrophe that the Mayans predicted.”
David Einhorn
Greenlight Capital Letter
January 17, 2012
“Carried Interest Debate Flares Anew With
Romney Disclosure: The ‘carried interest’ tax
debate that has raged in Congress and on Wall
Street over the past half decade took center
stage in the presidential race on Tuesday. Mitt
Romney, speaking at a campaign stop in
Florence, S.C., revealed that his effective tax
rate was about 15 percent. Mr. Romney’s dis-
JANUARY 20, 2012 PAGE 4
closure is sure to reignite complaints that private equity executives – among the nation’s
wealthiest individuals – get preferential tax
treatment. Private equity executives are taxed
at the capital gains rate of 15 percent on most
of their earnings, a rate well below the 35 percent tax on ordinary income. Certain hedge
fund managers, real estate investors, and venture capitalists also earn much of their pay in
the form of carried interest. A White House
spokesman said Tuesday that the 15 percent tax
rate reveals unfairness in the tax code.”
NY Times Dealbook
Jan. 17, 2012
www.nytimes.com
“At present, our own recession ensembles, as
well as ECRI’s official views, remain firmly
entrenched in the recession camp. This feels
more than a little bit disconcerting, as the
entire investment world appears to have the
opposite view. My problem is that the data
don’t support that rosy ‘U.S. leads the world off
the recession track’ scenario. Leading data
leads. Lagging data lags. Weak data is weak
data. To anticipate a sustained economic
upturn here would require us to place greater
weight on weak, lagging data than we presently
place on strong leading data. It’s really that
simple. If the evidence turns, we will shift our
view - and frankly with some amount of relief.
At present, though, we continue to expect a
concerted economic downturn.”
John P. Hussman
Leading Indicators and the Risk of a
Blindside Recession
Jan. 9, 2012
www.hussman.net
“With most analysts dismissing the likelihood
of recession, I have been vocal about ongoing
recession concerns not because I want to align
myself with one side, but because the investment implications are very asymmetric. A slow
but steady stream of modestly good economic
news is largely priced in by investors, but a
recession and the accompanying earnings disappointments would destroy some critical pillars of hope that investors are relying on to support already rich valuations. We’re always open
to shifting our investment stance and outlook
in response to new evidence, but the ‘optimistic’ evidence that many observers are using
to discard recession concerns is generally based
welling@weeden
on coincident or lagging data…
Of course, it’s possible that the downturn we’ve
observed to date will quickly reverse to a new
growth path, but we should keep in mind that
GDP is just the sum of consumption, real
investment, government spending, and net
exports, and then ask what will drive that reversal. Have the credit strains in Europe been
durably addressed? Can European economies
presently be expected to expand? Is there now
less need for fiscal restraint in the U.S.? Has the
overhang of troubled mortgages in the financial
system been worked out? Have savings rates
rebounded or pressure on household budgets
eased? Is consumer demand is sustainably
rebounding? Is there pent-up demand for capital goods despite having drawn spending forward due to expiring tax credits last year? Are
exports to the rest of the world expected to
accelerate? Are profit margins likely to expand
from already record levels in order to accommodate growth in corporate profits? Do companies expect demand to be strong enough to
commit to large-scale or multi-year investment
projects? Not all of these factors have to reverse
in order to have a sustained expansion, but the
headwinds don’t appear light.”
John P. Hussman
Dwelling In Uncertainty
Jan. 16, 2012
www.hussman.net
“Greece and the other peripheral countries
face a difficult choice. Do we stay in the euro
and pay as much as we can, and watch our economy drop; pay nothing and watch our economy
drop (as we get shut out of the bond market); or
leave the euro and go back to our own currency
and watch our economy drop?
They have no choices that allow them to grow
and prosper without first suffering (for perhaps
a long time) some very real economic pain. As I
have written in previous letters, leaving the
eurozone has severe consequences; but the economic pain of leaving would go away sooner
and allow for quicker adjustments, than if they
stayed. However, the initial pain would be
worse than the slow pain they’d suffer by staying in the euro. Their choice is, simply, which
pain do they want – or maybe, which pain do
they think they want? Because whatever they
choose, they are not going to like it.”
John Mauldin
JANUARY 20, 2012 PAGE 5
The End of Europe?
John Mauldin’s Weekly E-Letter
Jan. 14, 2012
www.johnmauldin.com
“The woes of Europe, however ameliorated,
are, to put it mildly, still of considerable
moment. Which doesn’t seem to have fazed
investors, to judge by the market’s buoyancy
and the latest sentiment figures. On the latter
score, Investors Intelligence shows over 51.1%
of the advisory services are optimistic, the most
since early last May, while the American
Association of Individual Investors survey
showed 49.1% of its responding members were
bullish, versus a mere 17.2% bearish.
Comstock ventures that with the lull in foreclosures poised to end, a new surge of houses will
be pouring onto the market. It cites Ned Davis
Research’s estimate that the overhang of houses
is close to 10 million. And prices, which haven’t
exactly set the world on fire for four or so years
now—some 11 million mortgages are underwater—are due to decline further.
So, we’re sorry to say, all those folks who have
been putting their hard-earned bucks into
home-building shares in anticipation of a revisit
to housing’s glory years could be in for a big
and expensive disappointment.”
Alan Abelson
Up And Down Wall Street
Jan. 14, 2012
www.barrons.com
Big and small, then, investors are prepared for
everything but a bit of bad news.
As you may have gleaned, we’re not especially
sanguine about the outlook for equities until
there’s some evidence that the Old World has a
firm handle on its problems, which are apt to
get worse before they get better. We also would
like to see some concrete signs that our own
recovery, which is hardly immune to what’s
happening in Europe and, for that matter, the
rest of world, turns more muscular.
To repeat what we’ve said many a time and oft,
it’s tough to conceive of a really vigorous recovery with housing still pretty much in the
dumps. Yes, yes, we’re aware that the home
builders are upbeat (so what else is new?) and
that investors have been bidding up the housing shares for quite a spell now.
The S&P home-building index is up more than
60% since hitting a low in October. But here,
too, we think investors’ reach exceeds their
grasp. For as Comstock Partners points out in a
special report, a soft jobs market and a freshly
enhanced inventory stack up as daunting barriers to any upswing in housing.
Thus the decline in foreclosures has a heck of a
lot to do with the robo-signing scandal, which
prompted lenders to go easy on delinquent
mortgage holders lest they further incite the
public’s wrath. That, of course, ate into the
backlog. But the banks, having read the etiquette book on how to toss people out of their
homes gently, are poised to try again.
welling@weeden
“I am frankly amazed when I read commentators saying that Japan’s interventions to stop
the yen rising are doomed to fail. They are not.
An economy can always stop its currency rising.
Just look at China. But you have to be prepared
to intervene in unlimited quantities on the FX
markets and then be prepared for the economic
consequences – these are likely to be runaway
domestic money supply growth, a credit bubble, and unsustainably rising asset prices – most
especially property prices. These are things
that most Japanese can only dream of. It is time
for the Japanese authorities to make a stand
against the U.S. Treasury and make that dream
a reality. The time to act is now.
Footnote: A weak yen would of course put yet
more upward pressure on an uncomfortably
strong Chinese yuan. It would almost certainly
hasten the Chinese authorities agreeing to the
demands of the U.S. and allow market forces to
determine the yuan’s next move. And that
would involve a yuan devaluation as China is
currently seeing a decline in its foreign
exchange reserves.
A hard landing in China would put this policy
option definitely into play, especially as the
authorities would likely seek to placate a restive
workforce with rapid wage rises as they did last
year in the face of rapidly rising price inflation.
Rapidly rising wages would further re-emphasise the loss of competitiveness by tying the
yuan to the U.S. dollar, especially while so many
other emerging market competitors were
devaluing so aggressively last year.
JANUARY 20, 2012 PAGE 6
Human capital or ‘hand’
Such resentment is not completely new. It bears
some resemblance to the hostility towards profiteers after the First World War, which prompted Keynes to remark: ‘To convert the business
man into the profiteer is to strike a blow at capitalism, because it destroys the psychological
equilibrium which permits the perpetuance of
unequal rewards. The businessman is only tolerable so long as his gains can be held to bear
some relation to what, roughly and in some
sense, his activities have contributed to society.’** On that basis, no one can be surprised
that the legitimacy of capitalism is currently in
question. And it would be wrong to call it a
‘winner takes all’ form of capitalism, because
privileged losers appear to be making off with
the prizes too.
A step up in the ‘currency wars’ may well
become the surprise theme of 2012.”
Albert Edwards
Soc Gen Global Strategy Weekly
January 12, 2012
[email protected]
“What, then, is different about today’s outbreak of disaffection? Perhaps the most important difference is that it is not the product of
despair. The people in Manhattan’s Zuccotti
Park and on the steps of St Paul’s Cathedral in
London had no need of soup kitchens and took
to their tents out of choice, unlike many in the
1930s U.S. who slept in cardboard box colonies
– Hoovervilles – out of necessity.
If there is no proliferation of soup queues, it is
because in all the economies of the developed
world capitalism has been humanised to a
greater or lesser degree by forms of social
democracy and by bank bail-outs.
Unemployment in the U.S. has gone nowhere
near the 25 per cent rate that prevailed in 1933.
While there are exceptionally high rates of
youth unemployment, especially in southern
Europe, there is more of a safety net for the victims than in the Depression. And if today’s protesters articulate no coherent programme, it
seems clear that underlying frustrations are to
do with perceptions of unfairness, not immiseration.
Much of that frustration relates to the banks. In
contrast to the 1930s, when banking was about
deposit-taking and lending, modern bankers
engage in complex trading that they themselves
do not always understand and whose social utility is not apparent to ordinary mortals – or even
to the likes of Lord Turner, head of the U.K.
Financial Services Authority, who famously
declared that many parts of the banking business had ‘grown beyond a socially reasonable
size’. Many have shown a disregard for their
customers, while fiduciary obligation has
become a casualty of deregulation and the
shareholder value revolution. There is a widespread conviction that these bankers constitute
a protected class who enjoy bonuses regardless
of performance, while relying on the taxpayer
to socialise their losses when they have taken
excessive risks. At the same time, the public is
aware that top executive rewards more generally are poorly related to performance and tend to
go up even when profits fall.
welling@weeden
What is unquestionably novel is the ferocity
with which U.S. business sheds labour now that
executive pay and incentive schemes are more
closely linked to short-term performance targets. In effect, the American worker has gone
from being regarded as human capital to a mere
cost, or what was known in the 19th century as
a ‘hand’. Yet this pursuit of a narrowly financial
conception of shareholder value may destroy
value for the ultimate pension beneficiaries –
because of the disruption that slashing and
burning causes, and the cost and time involved
in hiring and retraining when conditions
improve.
That underlines the ‘agency problem’ at the
heart of the banking and boardroom pay sagas.
The accountability of management – the agent
acting on behalf of the highly dispersed beneficiaries of equity ownership – is fundamentally
flawed. While the public may not be aware of
the details of the weak chain of accountability,
or the growing number of investors such as
high-frequency traders or hedge funds that have
no interest in playing a stewardship role, it sees
the outcome, which contributes to the wider
inequality story.”
John Plender
Capitalism in crisis: The code that forms a
bar to harmony
Jan. 8, 2011
http://www.ft.com/intl/cms/s/0/fb95b4fe3863-11e1-9d0700144feabdc0.html?ftcamp=rss&ftcamp=crm/
email/201219/nbe/Analysis/product
JANUARY 20, 2012 PAGE 7
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
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relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
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appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
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or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
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http://welling.weedenco.com
VOLUME 14
ISSUE 2
JANUARY 20, 2012
comicskews
INSIDE
RESEARCH
SEE
DISCLOSURES PAGE 16
comicskews...
Our World, Refracted For Grins
Super PAC, Republican Race, Oil Tug Of War...
Super PACs
© R.J. Matson,
St. Louis Post-Dispatch.
All rights reserved.
Huntsman Flip Flops
© R.J. Matson,
Roll Call.
All rights reserved.
welling@weeden
JANUARY 20, 2012 PAGE 1
Kathryn M. Welling
Editor and Publisher
Bully PAC
[email protected]
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Arizona Daily Star.
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welling@weeden
JANUARY 20, 2012
PAGE 2
MO Twisted Budget
Priorities
© R.J. Matson,
Roll Call.
All rights reserved.
Occupy Romney
© R.J. Matson,
Roll Call.
All rights reserved.
Romney Road Trip
© Pat Bagley,
The Salt Lake Tribune.
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welling@weeden
JANUARY 20, 2012 PAGE 3
Strait Of Hormuz
© Osama Hajjaj,
Abu Mahjoob Creative
Productions.
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Guantanamo 10 Years
© Paresh Nath,
The Khaleej Times, UAE.
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Haley Barbour Shop
© Adam Zyglis,
The Buffalo News.
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welling@weeden
JANUARY 20, 2012 PAGE 4
Hostess Bankrupt
© Rick McKee,
The Augusta Chronicle.
All rights reserved.
Huntsman Fan
© Eric Allie,
Cagle Cartoons.
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Huntsman Quits
© Pat Bagley,
The Salt Lake Tribune.
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welling@weeden
JANUARY 20, 2012 PAGE 5
Iran Nuke
© Rick McKee,
The Augusta Chronicle.
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Jurassic Pac
© Bill Day,
Cagle Cartoons.
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Kardashian Economics
© Pat Bagley,
The Salt Lake Tribune.
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welling@weeden
JANUARY 20, 2012 PAGE 6
Library Fine
© Paul Zanetti,
Australia.
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Meh Romney
© Jeff Parker,
Florida Today.
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Missouri Budget Cuts
© John Darkow,
Columbia Daily Tribune.
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welling@weeden
JANUARY 20, 2012 PAGE 7
Mitt Is Number One
© Adam Zyglis,
The Buffalo News.
All rights reserved.
Mitt Occupied By His Past
© John Darkow,
Columbia Daily Tribune.
All rights reserved.
Mitt Romney, The Front
Runner
© Patrick Chappatte,
Int’l Herald Tribune.
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welling@weeden
JANUARY 20, 2012 PAGE 8
Mitt’s Money Problem
© David Fitzsimmons,
The Arizona Daily Star.
All rights reserved.
MLK Dream Update
© Pat Bagley,
The Salt Lake Tribune.
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More Free Speech
© Daryl Cagle,
MSNBC.com.
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welling@weeden
JANUARY 20, 2012 PAGE 9
Newt Occupies S.C.
© Rick McKee,
The Augusta Chronicle.
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Not Mitt
© Eric Allie,
Cagle Cartoons.
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Oil Tug of War
© Luojie,
China Daily, China.
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welling@weeden
JANUARY 20, 2012 PAGE 10
Pee
© Luojie,
China Daily, China.
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Phony Baloney
© John Darkow,
Columbia Daily Tribune.
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Press Puppets
© Eric Allie,
Cagle Cartoons.
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welling@weeden
JANUARY 20, 2012 PAGE 11
Re-Elect Capt. Obama
© Rick McKee,
The Augusta Chronicle.
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Romney & GOP Doggie
© Daryl Cagle,
MSNBC.com.
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Santorum
© Milt Priggee,
www.miltpriggee.com
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JANUARY 20, 2012 PAGE 12
Santorum & Pork
© John Cole,
The Times-Tribune.
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Signs Of A Recovery
© Tom Janssen,
The Netherlands.
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Slam Dunk II
© John Cole,
The Times-Tribune.
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JANUARY 20, 2012 PAGE 13
Someone Better
© Larry Wright,
The Detroit News.
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Stinking Campaign
© Olle Johansson,
Sweden.
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Super PAC
© Mike Keefe,
Cagle Cartoons.
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welling@weeden
JANUARY 20, 2012 PAGE 14
Super PACS
© John Darkow,
Columbia Daily Tribune.
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Tea Party, Join, Or Die
© Adam Zyglis,
The Buffalo News.
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Tebow Mania
© Nate Beeler,
The Washington Examiner.
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welling@weeden
JANUARY 20, 2012 PAGE 15
Weeden & Co. LP’s
Research Disclosures
In keeping with Weeden & Co. LP’s
reputation for absolute integrity in its
dealings with its institutional clients,
w@w believes that its own reputation
for independence and integrity are
essential to its mission. Our readers
must be able to assume that we have
no hidden agendas; that our facts are
thoroughly researched and fairly presented and that when published our
analyses reflect our best judgments,
not vested pocketbook interests of
our sources, colleagues or ourselves;
w@w’s mission is strictly research.
Twinkie Defense
© John Darkow,
Columbia Daily Tribune.
All rights reserved.
This material is based on data from
sources we consider to be accurate
and reliable, but it is not guaranteed
as to accuracy and does not purport
to be complete. Opinions and projections found in this report reflect
either our opinion (or that of the
named analyst interviewed) as of the
report date and are subject to change
without notice. When an unaffiliated
interviewee’s opinions and projections are reported, Weeden & Co. is
relying on the accuracy and completeness of that individual/firm’s
own research disclosures and
assumes no liability for same, beyond
reprinting them in an adjacent box.
This report is neither intended nor
should it be construed as an offer to
sell or solicitation or basis for any
contract, for the purchase of any
security or financial product. Nor has
any determination been made that
any particular security is suitable for
any client. Nothing contained herein
is intended to be, nor should it be
considered, investment advice. This
report does not provide sufficient
information upon which to base an
investment decision. You are advised
to consult with your broker or other
financial advisors or professionals as
appropriate to verify pricing and
other information. Weeden & Co. LP ,
its affiliates, directors, officers and
associates do not assume any liability for losses that may result from the
reliance by any person upon any such
information or opinions. Past performance of securities or any financial
instruments is not indicative of future
performance. From time to time, this
firm, its affiliates, and/or its individual officers and/or members of their
families may have a position in the
subject securities which may be consistent with or contrary to the recommendations contained herein; and
may make purchases and/or sales of
those securities in the open market
or otherwise. Weeden & Co. LP makes
a market in numerous securities., but
none are featured herein. Weeden &
Co. LP is a member of FINRA, Nasdaq,
and SIPC.
Twinkies
© Cam Cardow,
Ottawa Citizen.
All rights reserved.
Vultures
© David Fitzsimmons,
The Arizona Daily Star.
All rights reserved.
welling@weeden
JANUARY 20, 2012 PAGE 16