Friday, December 12, 2008

Bad News

It's said that bad news, like late night buses, comes in bunches. That certainly seems to be the case this week, where a few days of lethargy have been punctuated by a firestorm of fresh Armageddon-fodder over the past twenty-four hours.

Where to begin? Macro Man has to confess that he may have overestimated the market nous of equity punters, given that news of the auto bailout failure served to catalyze a jump lower in stocks. Is it really the case that a Big Three bailout was supporting the market? It boggles the mind, given a) the small size of both the bailout and the market cap of the auto sector, and b) the abject failure of the TARP to buoy stocks since its eventual passage in October. Crikey, if $350 billion for the industry at the heart of the economic and financial maelstrom has failed to support Spoos, why did these donuts expect $14 billion to Obsolescence-R-Us to be a rationale for buying stocks?

More sinister is the Bernard Madoff situation, which serves as another poisoned dart striking at the heart of financial system credibility. Now, Macro Man had never heard of Mr. Madoff until a few hours ago, and neither had just about everyone that he speaks to. But the staggering size ($50 billion) and nature (bald-faced fraud) of Madoff's failure serves as a timely reminder that there are still plenty of rotten apples in the market's fruit basket. Then again, Madoff's sin- taking a relatively small amount of investor capital and levering it up via an investment strategy that had no prayer of long-term success- sounds awfully similar to the investment banking business model of the last few years. Perhaps Madoff should convert to a bank holding company and apply for a bit of sweet TARP lovin'?

More prosaically, the economic dataflow remains uniformly awful. Yesterday's jobless claims data suggests the labour market continues to deteriorate, which probably shouldn't come as a surprise to anyone with Internet access and a fifth-grade reading level. More troubling, however, were a couple pieces of bigger-picture data that have helped guide Macro Man's core views.

The US flow of funds data were released yesterday, and they were a shocker. US household wealth is now falling at the sharpest rate in the history of the series (which covers most of the postwar era), superseding the collapse of the dot-com bubble. Unlike 2002, however, there are no further bubbles to inflate to save the consumer's bacon. The confluence of collapsing wealth and a terrible labour market form the crux of what has been Macro Man's base-case view for the past couple of quarters- a bone-crushing, consumer-led recession.
A natural outcome of this view has been an expectation that US savings rates would rise (which they are starting to), global trade volumes would decline (which they are), and that the US trade deficit would contract sharply, thereby supporting the dollar. Here's where we run into a spot of bother.

While it's not Macro Man's style to jettison a core view on the basis of one data point, he must confess to being troubled by yesterday's US trade figures. Rather than narrowing, as he expected, in October, the trade deficit actually widened slightly, despite the collapse in oil prices. Indeed, exports declined more in dollar terms than imports, despite being a much smaller percentage of overall trade. That's not what Macro Man wanted to see.

Indeed, the deficit excluding petroleum seems to be widening back out thanks to the drop in exports. Could it really be the case that US exporters failed to hedge any futures receivables when EUR/USD was above 1.50? Macro Man isn't sure what to make of this, but it wasn't part of the game plan.
Nor, indeed, was a smooth money-market passage into year-end. Instead of squeezing higher, as has been the case over the past few quarter-ends, LIBOR rates are actually coming in hard.

Hmmmm. If the US trade deficit fails to narrow and there is no further funding pressure, two of the major supports for the dollar will have been taken away. Certainly the market is rendering this interpretation, as EUR/USD appears to have broken out of its little trading range of the past couple of months.
Of course, an alternative explanation is that it is December, liquidity is appalling, and some punters have decided to have a go at pushing the dollar lower with little to no opposition. Macro Man requires more data before he can render judgment on whether the dollar bull case has evaporated (though he remains highly dubious of the notion of EUR as a store of value), but he's seen enough to encourage him to flatten what modest exposures he's got.

Some of the moves he's seeing make little sense to him, and he's happy to run very little FX directional risk until the new year. No news is sometimes good news, as they say...especially when it comes on the stop-loss front.


cfarley said...

MM -- a few of your charts are very Edward Tufte. That's a compliment.

Anonymous said...


I am not an accountant but I believe that US Accounting rules frown upon corporations changing hedging policies based upon market fluctuations. This would appear to be speculation rather than hedging to the accounting community.


Mr.Sparkle said...

MM - Might the reaction to the bailout rejection be due to the volume of CDS floating around on the Big 3's debt? Isn't that one of the reasons why AIG got money?

Anonymous said...

yes, 'terribly thin' seems to be what's been happening this week...

last friday the SP shorts didn't want to hold over the weekend for fear of govt. intervention, fomc decision in the 'quad witch' expiration week on deck

did gold know the auto bailout would fail...

thursday crude oil high almost precisely the 11/21 former low, was it pricing in an auto deal


drchaos said...

Crikey, if $350 billion for the industry at the heart of the economic and financial maelstrom has failed to support Spoos, why did these donuts expect $14 billion to Obsolescence-R-Us to be a rationale for buying stocks?

How about this:

There is a much larger world outside the financials. The true real-world economic influence of automotive manufacturing is far larger than the market cap of GM. (multiplier effect in manufacturing is much larger than other industries, even if the final industry is far less profitable.)

Banks get created every year, and are easily replicable. In the medium-long run, extinguishing banks with extractive and deceptive business models (many of them) will be a good thing for the U.S.

Unfortunately, such is not true with GM+F. Killing them will result in less wealth creation in the U.S., even though they have enormous problems. Even a bad GM is better than no GM in total economic value.

Not so with automakers. Has the U.K. ever started up new one of significant scale?

Anonymous said...


The EUR/USD has been pushed up mostly by the ECB (yes, your favourite whipping boy) announcement that there wasn't much space for further rate cuts ...

Anonymous said...

"It boggles the mind, given a) the small size of both the bailout and the market cap of the auto sector"

Can't understand why the loss of millions of well paying working class jobs is of no concern to the real economy and to the discounting mechanism of the markets.

Never heard of Bernie Madoff, doesn't know anyone who has even heard of Bernie Madoff.

The word 'parochial' comes to mind, one of the more polite.

Macro Man said...

drachos and Mr. Parochial,

Rest assured, I have no doubt that the Big 3 will limp on in some form. However, to think that a mere $14 bio divides them from solvency and oblivion, and thereby should exert a meaningful impact on stock prices, is just silly.

Any resolution that does not involve immediate job losses for a lot of auto-affiliated workers now will mean that the ultimate resolution will entail even more auto-related job losses later.

For the fundamental problem of the Big 3 is not lack of funding, or even the globally uncompetitive cost of manufacture.

It's that their products are shit.

And when the automakers receive their dose of sugar (or nationalization. or whatever) in January, their products will still be shit and globally uncompetitive.

So by all means, make financial decisions on whether the Big 3 get their medicine in December or January, as if the distinction matters. There are plenty of words for thinking that it does...and none of them are polite.

prophets said...

MM -

quick q - what service/site do you use as a data source for your PPP calcs? thx & happy holidays.

Anonymous said...

so you´d rather have dollars than euros? it seems to me too risky, us dollar is doomed to fail , now investor realize that is not a problem of exchange rate taken as a cost of opportunity but a matter of credit risk,for teh next two years us gdp will fall much larger than that of europe. US is printing money franctically trying to foster its economy at expense of the rest by monetizing that debt sooner or later. Iam invested in euros,gold, and short term german bonds.

livingston said...

Couldn't it be that while longer term deficit will go down, it first widens and then contracts...the exports are far more economic growth driven than imports and thus react faster...eventually the imports catch up as well..Higher dollar first due to lack of dollars worldwide; next lower dollar due to slowdown in global growth; finally higher dollar as us imports go down with US consumption which impacts imports with a lag due to seasonality..

Anonymous said...

I am surprised to hear that so many people have never heard of Mr. Madoff. Working as an equity portfolio manager back in the days of six cents per share commissions (about fifteen years ago), we used their firm as an alternate source of liquidity (at much lower costs). I met one of the principals (Peter, I believe) when getting everything set up.

I knew he had developed and maintained a big chunk of the off-exchange trading, although I did not know about his "investment management" business.