Planet Yelnick

Skip Danger Forum

As I wind this blog down, I recommend readers check out the Skip Danger stock forum. Frequent readers of the comments know that it is a place to continue the sort of dialog that made this site worthwhile.  If you do go check it out, drop back and let me know what you think. 

Broken Pattern, Token Risk

I appreciate all the concern in the comments on my transit back through Narita, but it came and went and I still have my hair. I spent about an hour in transit, and the food on the return was worse than normal, telling me that it was not sourced from Japan. 

The risk I took was very low. I wrote about it in my other travel blog: Bananas Are Radioactive Too. The risk I took was about the risk of a daily commute. You guys who commuted for the six working days I was gone were taking on much more risk.

Investing trades in risk and investors get it wrong all the time. Right now the bet is not to fade the Fed, to believe QE Infinity will continue to pump this market. The calls to end both QE and the zero interest rate policy (ZIRP) are increasing. Andy Kessler just explained in the WSJ how ZIRP crushes capital formation and stifles the recovery. Risk on.

The other bet is that the four-year re-election cycle will pump the market. This is the most predictable cycle, and its causation is clear. Yet Obama shot this bullet early, right away in fact, and the Stimulus is already fading to the point it is acting as a drag on GDP. He is facing political headwinds from the grumpy Republican House, and if he loses QE, he is left with only a war to pump the economy. Libya? Yet another Middle Eastern war threatens to keep oil prices high, acting as a bigger drag than war-spending. 

You can see the impact of this in this chart showing the current market vs. the normal re-election market. Now, "normal" here is an average of many years, so we should not expect any one market to actually match the curve; also, the curve is not combined with statistical variability (eg. Bollinger Bands), so cannot we easily assess if this one is still within the bands of "normal". The key, though, is the extent the recent dive has taken this market off the normal pattern. Broken pattern betokens bigger risk.

Skip Danger

The news over here in Asia about Japan is not as strident as Americans see back home on CNN. My family keeps urging me to skip danger and fly some other way home than through Narita, but there is no evidence of radiation floating down towards Tokyo. Of course, winds may change. 

A more immediate danger I have been facing is to my pocketbook & digital lifestyle: Internet at my hotel sucks. To skip that danger, I scored a great deal on a 3G SIM in Singapore, and wrote about it in my travel blog. Just a few years ago we marveled at going hotel to hotel around the world and staying connected, but now the expense and limitations of hotel Internet are glaring. Rather than suffer $150 during my stay for lousy connectivity, I found a way to pay $15 and get complete 3G nirvana. If you travel, you might take a look. The wireless world is rapidly eclipsing the wired. 

For you traders, it has been a big week. Some of you are dog tired. Time to lay back and enjoy the weekend! Your favorite indicator, one way or the other, the STU, expects a bigger slide next week. So far this correction has fallen in three waves, and today's reversal has all the earmarks of a wave 4. If instead it pops on Monday above 1294, something else is going on. Better news on oil (Libya) and my flight home (Japan nukes) could spur the pop.

Of course, if the global winds shift, all bets are off. The G7 intervention is already fading, with the USD down to new lows. The toxic Dollar cloud may drift over Tokyo, too. Japan may begin to swap Treasuries for Yen, bringing the wealth back home, and unbalancing the Fed's QE plans. 

Another site you might want to check out is Mamma's new Skip Danger stock forum. Frequent readers of the comments know that it is a place to continue the sort of dialog that made this site worthwhile.  

If you do go check it out, drop back and let me know what you think. 

Transiting Through Narita

I just posted on Narita, the Nukes and United over in my travel blog. Take a look. If typepad asks for a sign-in, cancel and you will be in. It is a glitch on their site. Feel free to continue the discussion in this post.

Special Bulletin

It is with great trepidation that I post this, given my prior post, but the comments are overflowing & I wanted to give frequent readers a forum before you jump (or not jump) to "Mamma's" new place. Have at it, and as a treat a little technical analysis below the fold.

New Blog Platforms

Planet Yelnick began as an email exchange and then a private newsletter after the dot-com bubble burst. Been a great ride but I am changing focus. A new tech boom is on and my attention is there. My new blog platform is: http://bullpencap.com/.

For fun I will occasionally blog about travel and cultural issues. In a week or so the travel blog becomes the new Yelnick start page. 

Employment Brackets the Over/Under

The over/under is a betting level: the predicted points in a game. Last month employment disappointed, but it was blamed on weather. After that report, the catch-up level was 260k jobs in this report. We missed that by a mile. The catch-up number was lowered since then down to 196k by those mysterious "they" who set expectations. (At least in Vegas we know who the bookies are.) This report came in bracketing the over/under:

• 192k new jobs, below 196k expectations
• 222k private sector jobs, above 200k expectations

Stocks are down today, possibly reacting to an under. More on that below. The spinmeisters are out in full force, however. Just before the report the herd expected the over (60% thought it would beat). After the report the consensus of opinion appears to be this comment from CalculatedRisk:

This wasn't a great report. Heck, it wasn't a "good" report. But it was a little better than most recent reports.

At this stage in the business cycles, upward revisions are more likely going forward, so this report should improve with more data. What is less clear is if new jobs will ramp up, or just remain steady - the average between January and February is only 127K new jobs, below what is needed to keep up with new entrants to the workforce. The 192k number is a catch up from a dismal January number of 36k, which was revised up to 63k. 

The market reaction has been mixed. Bonds improved but reflect a reasonable chance of a rate increase later this year. Stocks may be reacting to a modest recovery, which makes QE3 less likely, and would remove the speculative pump under markets. On the other hand, the report shows no surge in wage inflation, meaning QE has not yet spilled over into wage inflation:

The below-the-surface issue with the report is a continued detrioration of the overall employment picture. While the unemployment rate is down, the rate of participation and the ratio of employed to population continue to fall even faster. This means statistically the unemployment rate has dropped not because of more jobs (numerator) but because of fewer workers (denominator). Without those dropouts, the unemployment rate would be 11%. 

Chinese Curse Bewitches the Dollar

Be careful what you wish for; it may come true - Chinese curse

China made a bold currency move Wednesday, and it barely registered in the West: it is encouraging the Yuan to be a reserve currency, to be used to settle transactions in and out of China, instead of the Dollar. For all those pundits and politicians pressuring China to float their currency, they just got their wish. 

This marks a shift from an export-driven mercantilist economy, to a consumer-led capitalist economy. The internal pressures from mercantilism eventually create their own contradictions:

• inflation from laundering the currency conversions
• unrest by people who wish to cash in and enjoy the good life
• lost wealth from capital trapped in forced savings that act as a sinkhole of productive investment
• lost profits from excessive competition & multiple me-to factories

The curse is that it removes one of the largest borrowers of Dollars, and reduces demand for Dollars for international settlement. This has led the WSJ opine that the Dollar's role as the one reserve currency is coming to an end:

1. Technology is undermining the scale and depth of Dollar trading by allowing rapid cross-cirrency comparisons without translating in Dollar terms
2. Rivals of enough scale are emerging, especially the Euro and the Yuan
3. US fiscal policy (such as QE and huge deficits) are undermining confidence in the Dollar as a safe haven that is a stable store of value 

Asked rhetorically, can the Fed continue infinite QE (indefinite Dollar debasement) as the foundations for Dollar strength (oil trade, international settlement, safe haven) crumble?

The Fed has become the biggest buyer of Treasuries, which has worried Bill Gross to ask the question: who buys Treasuries when the Fed exits?

His answer: Treasury rates will have to go higher to attract investors. This could scuttle an incipient recovery, especially with higher oil prices. It would, however, be good for the Dollar - but it is months off until QE2 ends, and expectations of QE3 are increasing as fast as GDP fades. 

The Dollar, then, remains on edge. It has traded below the trendline of support that has held for the past three years. The longer down below, the more likely it begins to lose support and possibly crash. 

When measured in the Dollar Index, as shown in the chart (with the key trendline), the so-called crash would like more like slip-sliding away; but when measured against metals or commodities, it would look like gold and silver shooting north & commodities heading up parabolically - which is how they have begun to look recently. You can scan the blogosphere and pick up all sorts of predictions on silver ($130!) for example. It is pretty clear that Dollar weakness since last summer has led to commodities strength (Dollar in green, using the UUP instead of the DX; commodities in blue):

Another leading indicator of a Dollar collapse would come from the commodity currencies - the CAD, AUD and NZD, which indeed have been showing recent strength. You can scan the blogosphere and pick up all sorts of predictions on the CAD (Fifteen reasons to love the Loonie!) as well as the AUD. 

A further (but in this case misleading) indicator is oil, which is undergoing a dramatic spike - up 15% in five days. Such a spike is rare and almost always fades back quickly (the one recent exception being the invasion of Kuwait in 1990, which led to the first Gulf War). Such an event-driven spike gives little guidance on the direction of the Dollar since it is likely to be temporary; indeed it may be the primary explanation of why the Dollar Index has fallen below the support trendline and stayed below. When the immediate Libyan crisis abates, oil should fall, and the Dollar recover. 

Bullishness on the Buck is below 10%, according to the STU. This is what happens around a Dollar low, so they wait for it to bounce, but add that the wave structure is unsettling. The bounce that began at the QE2 announcement has now faded more than 78.6% off its peak in November, and the wave structure is ambiguous. Normally a fade beyond 78.6% means it is going beyond 100%, but they expect the opposite. Again, the explanation for the ambiguity may be the temporary oil spike. 

In the longer term, the Chinese move should be good both for China and the broader world, as China rebalances toward a more Western-style economy, which will come with opening it up more for imports. The move will put pressure on the US to get its economic house in order, also a good thing in the long term. Also, the multiplicity of reserve currencies may smooth a transition to a different form of reserve currency, one not tied to any domestic set of policies, what Keynes called the Bancor. This frees the reserve currency from the tyranny of domestic policies, and lets all currencies float against a standard. 

In the near-term, with turmoil in the oil-bearing countries and a painful adjustment domestically to get off the drug of stimulus and back into a sound economic foundation, the US may have to live through the other Chinese curse: "interesting times."

This Time the Tech Boom is Driven By Reality

Last time, the dot-com boom was driven by a frenzy over gaining eyeballs. Valuations went through the roof well before revenues.

This time the hot companies are growing real revenues remarkably fast. The WSJ noted how much faster the leaders like Groupon and Zynga have raced towards $1B in revenues, much faster than in prior tech booms and perhaps the fastest in history:

Groupon’s revenue in 2010 rose more than 22 times to $760 million in its second full year since its daily deals site launched, up from $33 million in 2009. Zynga, the maker of online social games like FarmVille scored revenue of $850 million in its third full year in 2010, more than triple the year before, and Facebook’s revenue rocketed to as high as $2 billion in 2010, its sixth full year.

Their ridiculous revenue growth rates actually rival those of the four largest Internet companies–Google, eBay, Yahoo and Amazon.com ... 

Compare all of this with the software industry. [L]ess than one-third of the nation’s top software companies reached $50 million in annual sales in six years or less – and the fastest to $50 million, Novell, took three years. Microsoft crossed the $50 million barrier in eight years; Oracle, 10 years.

It should be no surprise, then, that Facebook has crept back to a $70B market cap in private trading, and JP Morgan just raised a $1B fund to buy into the private market of shares for high-fliers, beginning with Twitter.  Something big is brewing, and the smart money is leaping in.

The tech trade press is beginning to figure out that these valuations fit within normal metrics, assuming the incredible growth continues.

It is not 1999 all over again. Not yet. 

It is too facile to knee-jerk and call it a bubble when we have revenue growth of this magnitude by the leading social companies. 

The Fed on Commodity Inflation: What, Me Worry?

Is it inflation or speculation? The Fed Chairman spoke very plainly today, but what he left out is important. Coincidently, he spoke right after the ISM Report on expectations. Good news: manufacturing expectations are booming. Bad news: inflationary expectations are also booming.

These CPI expectations (the blue line) do not predict inflation, but a lot of folk are worried. Not Ben. He said commodities price increases are NOT a concern. 

His comments have been picked up by the punditsphere, and you can get a quick read from Barry Ritzholz thinks ("I disagree") and Cullen Roche at PragCap ("totally oblivious"). Here is Ben's view of surging commodities:

[T]he increases in commodity prices in recent months have largely reflected rising global demand for raw materials, particularly in some fast-growing emerging market economies, coupled with constraints on global supply in some cases.

Commodity prices have risen significantly in terms of all major currencies, suggesting that changes in the foreign exchange value of the dollar are unlikely to have been an important driver of the increases seen in recent months. 

The rate of pass-through from commodity price increases to broad indexes of U.S. consumer prices has been quite low in recent decades, partly reflecting the relatively small weight of materials inputs in total production costs as well as the stability of longer-term inflation expectations.

I think all three assertions are true, but hide the truth: his QE2 policies have driven up speculation, and that has driven up commodities across the board. Let's look at his assertions:

• demand and shortages have driven up prices - ok, but why would all commodities be going up in lockstep due to weather here or there, or other local causes of shortages? And why up so much when the great demand generator, China, is slowing down? As Cullen Roche opines: "There is nothing normal about cotton prices rising 200% in six months."
• prices have risen across all currencies - ok, inflation is the result of weaker currencies, and normally the whole world does not weaken at the same time in much the same pace. Also, QE2 does not 'print money' in the way people casually toss out. Still, his core assertion is too loose: prices have gone up faster in Dollar terms than Euro or Yen, bespoking Dollar relative weakness since QE2. Still, the inflation argument would have more weight if the Dollar were falling faster than it is, given how much commodities have risen. 
• commodity price rises are not being passed through - ok, so far anyway. I see blogosphere comments about official stats hiding the real inflation going on, but it is pretty clear that other than food and energy, where costs have an easier time being passed through, most industries are having a terrible time passing on the rise of input costs. This is why corporate earnings are about to run into a margin squeeze. 

Under the New Austrian School of Economics, interest rates are mechanisms to adjust business investment behavior. Normally low rates speak to longer investment horizons, but in the deflationary depressive aftermath of a credit bubble, keeping rates artificially low as the Fed is doing has the opposite effect: it spurs short-term, speculative investments over the long term. You could think of low rates as destroying the returns on sunk capital, leading to low replacement of existing plant - pretty much what has been going on during the Great Recession. 

BTW Bernanke let out his own estimates of how much he has lowered longer term rates - 75 bp. ZeroHedge extrapolated his formula across all his various QE measures:

The sum of QE 1, QE lite (the top off of QE1) and QE2 is $2.35 trillion. Using Bernanke’s formula you get a range of 4% to 5% as the approximate interest rate consequence of QE. 

That is an extraordinary number. The Fed’ ZIRP policy set interest rates at zero. QE has brought that to -4.5% (average) based on Ben’s numbers.

I don’t think that this has ever happened before in the USA. The examples I can think of in history outside of the US all ended badly. Ben has set monetary policy so that interest rates are 5-6 % below inflation. There can be only one possible result. Inflation of everything we use is going to explode. 

Maybe. The ISM reports are clear in seeing price increases on inputs across the board, and maybe American industry will not accept the margin squeeze and will try to pass it on. If so, prices should begun to push up in the next six months, and while this might make GDP tick up (see chart), it could just as well depress consumer spending:

The other explanation than coming inflation is that the speculative fervor is about to cool. We will likely see this first with oil and the Dollar. A strong Dollar reversal will unwind the speculative positions (priced in Dollars), and a break in oil will remove the biggest driver of cost-push seen by the ISM managers. 

Dollar Double Tests the Trendline

At the start of February, on Groundhog Day, the Dollar came down and tested a trendline that has provided resistance since Bear Stearns Day in 2008 (the day Bear went under). Apparently the Dollar saw its shadow when it bounced last Groundhog Day, and has remained in the winter of its discontent - it is now back to that level, a double-test in less than a month.

This trendline has provided resistance since March 2008, at lows in August 2008 as we began the great slide down, in Nov 2009 as the Hope Rally appeared to stall, and more recently in Nov 2010 at the kick-off of QE2. It is now Groundhog Day all over again for the Dollar, as it once again has come down to the critical support level (chart courtesy EWTrends):

If it does not hold these levels, it is poised for a fall based on technical, fundamental and cyclical considerations. PIMCO even put out a comment today that the Dollar was about to lose its status as the reserve currency. SImon Black added that "the Dollar is finished."

The primary basis for these assertions is the oil trade, which has been primarily in Dollars since a deal was cut in 1973, after Nixon went off gold. Given the Brent Crude market, an increasing quantity of oil is being bought directly with Euros, which suggest that the world's reserve currency is moving to a basket of at least the Dollar and the Euro. 

Still, these pronouncements seem grossly overblown. Sentiment is very bearish against the Buck, at similar levels to the Nov 2009 and Nov 2010 bounces, and according to the STU, the total net positions against the Dollar are at the extremes of the Bear Stearns low and the Nov 2009 low. This suggests another bounce is imminent. 

A lot of folk are watching for a first-day stock bounce as we march forth to a new month. I suggest watching the Dollar instead for an indication of what is to come.