The [Recovery] Has No Clothes

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” I believe that there have been repeated attempts to influence prices in the silver markets. There have been fraudulent efforts to persuade and deviously control that price. Based on what I have been told by members of the public, and reviewed in publicly available documents, I believe violations to the Commodity Exchange Act (CEA) have taken place in silver markets and that any such violation of the law in this regard should be prosecuted.”

– Bart Chilton, Commissioner, U.S. Commodity Futures Trading Commission (CFTC), October 26th, 20101

What a difference a month makes. Now that Greece has been papered over, the bulls are back in full force, pumping up the equity markets and celebrating every passing data point with positive exuberance. Let’s not get ahead of ourselves just yet, however. Very little has actually changed for the better, and it’s certainly too early to start cheerleading a new bull market.

Take the latest US unemployment numbers, for example. There was much excitement about the latest Bureau of Labor Statistics (BLS) report which announced that US unemployment remained unchanged at 8.3% during the month of February.2 The market was particularly enamored by the BLS’s insistence that non-farm payrolls increased by 227,000 during the month, as well as its upward revision of the December 2011 and January 2012 jobs numbers. Lost in all the excitement was the Gallup unemployment report released the day before, which had February unemployment increasing to 9.1% in February from 8.6% in January and 8.5% in December.3 Granted, the Gallup methodology is slightly different than that used by the BLS, but even if Gallup had applied the BLS’s seasonal adjustment, they would have still come out with an unemployment rate of 8.6%, which is considerably higher than that produced by the BLS.4 We all know which number the pundits chose to champion, but the Gallup data may have been closer to the truth.

For every semi-positive data point the bulls have emphasized since the market rally began, there’s a counter-point that makes us question what all the fuss is about. The bulls will cite expanding US GDP in late 2011, while the bears can cite US food stamp participation reaching an all-time record of 46,514,238 in December 2011, up 227,922 participantsfrom the month before, and up 6% year-over-year.5 The bulls can praise February’s 15.7% year-over-year increase in US auto sales, while the bears can cite Europe’s 9.7% year-over-year decrease in auto sales, led by a 20.2% slump in France.6, 7 The bulls can exclaim somewhat firmer housing starts in February8 (as if the US needs more new houses), while the bears can cite the unexpected 100bp drop in the March consumer confidence index9, five consecutive months of manufacturing contraction in China10, and more recently, a 0.9% drop in US February existing home sales.11 Give us a half-baked bullish indicator and we can provide at least two bearish indicators of equal or greater significance.

It has become fairly evident over the past several months that most new jobs created in the US tend to be low-paying, while the jobs lost are generally higher-paying. This seems to be confirmed by the monthly US Treasury Tax Receipts, which are lower so far this year despite the seeming improvement in unemployment. Take February 2012, for example, where the Treasury reported $103.4 billion in tax receipts, versus $110.6 billion in February 2011. BLS had unemployment running at 9% in February 2011, versus 8.3% in February 2012.12 Barring some major tax break we’ve missed, the only way these numbers balance out is if the new jobs created produce less income to tax, because they’re lower paying, OR, if the unemployment numbers are wrong. The bulls won’t dwell on these details, but they cannot be ignored.

Then there are the banks, our favourite sector. Needless to say, the latest Federal Reserve’s bank stress test was a great success from a PR standpoint, convincing the market that the highly overleveraged banking system is perfectly capable of weathering another 2008 scenario. The test used an almost apocalyptic hypothetical 2013 scenario defined by 13% unemployment, a 50% decline in stock prices and a further 21% decline in US home prices. The stress tests tested where major US banks’ Tier 1 capital would be if such a scenario came to pass. Anyone who still had 5% Tier 1 capital and above was safe, anyone below would fail. So essentially, in a scenario where the stock market is cut in half, any bank who had 5 cents supporting their “dollar” worth of assets (which are not marked-to-market and therefore likely not worth anywhere close to $1), would somehow survive an otherwise miserable financial environment. The market clearly doesn’t see the ridiculousness of such a test, and the meaninglessness of having 5 cents of capital support $1 of assets in an environment where that $1 is likely to be almost completely illiquid.

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