A Screwed up World - And Investors Are Supposed to Invest How?

Chicago PMI number came out this morning and it was a very very bullish economic number. Came in at 60.4 versus expectations of 55.5 compared to a previous read of 56.7. The problem is the entire thing doesn't match up with any other September data. It doesn't even match up with the Midwest data as reported by the Fed. So what in the world is really going on and how is an investor supposed to know?

From the Wall Street Journal entitled: Chicago Fed: Cars Drag Down Midwest Manufacturing Activity.

Manufacturing activity slowed in the Midwestern U.S. during August, as automakers chose to stop building up inventories, the Federal Reserve Bank of Chicago reported Monday.

The Chicago Fed’s Midwest Manufacturing Index dropped 1.4% to a seasonally-adjusted level 79.9 in August, from a downwardly revised 1.9% in July. The July index stands at 81.0, down from the original estimate of 81.4.

What in the world? The inconsistencies continue. The new orders portion of the Chicago PMI. The regional Fed numbers that have come out the last week showed weak or declining orders. The most ridiculous part of the Chicago PMI was that prices paid (so input prices) came in at 55 versus 57.2. All the regional Fed indexes saw big increases in prices paid.

So the question is what in the world is going on? These things don't actually measure output. They are surveys. Does the Chicago PMI focus more on Catepillar (which is booming) and less on the general economy? What is the real picture?

One thing is for sure. The number this morning is bullish dollar and the stock market is one massive currency trade right now. If this reverses the dollar the market is going to have problems.

I tried to bet a friend $10 paying 2 to 1 that the market would end down today after this number was released. He wouldn't take it. It is going to be interesting. Bull runs often end in a burst of positive news. Like I said this number is bullish dollar which has been bearish stock market. Tomorrow the ISM number comes out. Will that match the Fed regional numbers or the Chicago PMI? Good grief we lived in a messed up world.

David Tepper - High on Hopium or Embracing a Ponzi?

David Tepper is a famed value investor who manages and is the founder of Appaloosa Management. An incredible fund who has had an incredible record. He is semi close to legendary status. He has been in the news lately for his comments last Friday on CNBC when he basically said the markets are a two headed coin. If the economy recovers the market is going to continue to boom. If the economy continues to falter the Fed will step in and perform some additional quantitative easing and the market will rise. These thoughts have been repeated numerous times in various market circles.

There is much ridiculous with Tepper's comments and to be fair I do not know in what context everything was said. On the surface it sounds absurd. Besides having a misunderstanding of what QE really is, he is basically admitting the entire system is a ponzi. All ponzi's initially implode. Last time the market was here heading up (back late last year) the chatter was about how this was going to be a V shaped recovery. WHEN WAS THE LAST TIME YOU HEARD THAT FROM A BULL? No longer is the argument that the economy is in great shape and going to be a great V shape recovery. Now the argument has shifted to the Fed will save us and won't let the market go down. How well did that work in 2008? In fact it is the same exact argument that emerged after the initial argument in 2007 failed. The initial argument in 2007 was that it was going to be a very shallow recession. After that argument failed than it became the Fed was ahead of the curve and going to save everything. After that it was the Treasury and John Paulson was going to save everything (remember the Paulson bazooka?) After that is was we are all going to die.

So now the prospects of a V shaped recovery are off the table but if you listen to Tepper there is no risk. The market will only go up. Ponzi 101 until the entire thing collapses.

A friend of mine sent me something else by Tepper which I actually really liked. However, the premise is completely wrong in the context of how he uses it.

“In 1898, the first international urban-planning conference convened in New York,” he said. “It was abandoned after three days because none of the delegates could see any solution to the growing crisis caused by urban horses and their output. In the Times of London, one reporter estimated that in 50 years, every street in London would be buried under nine feet of manure.”

He paused, allowing people in the crowd to snicker to themselves, then went on to recommend a handful of investments most would consider highly risky, among them debt in AIG and equity in financial companies like Bank of America and even some banks in teetering Europe. “I know, everyone hates the financials,” he said. “But the PIIGS”—Portugal, Ireland, Italy, Greece, and Spain, considered to be the most troubled European economies—“every single one has a deficit-reduction plan! The ECB—the Bundesbank—bought back government bonds!” He paused for dramatic effect. “Holy Christ. It’s like the chastity belt is off, and the girl is starting to play.”

The crowd tittered nervously. “On the way to work this morning, I got a headache because I was listening to one guy talking about how there’s gonna be hyperinflation. And then after him there was some guy telling me there’s going to be a depression and deflation. Neither—neither—is most likely going to happen,” he said. “The point is, markets adapt, people adapt. Don’t listen to all the crap out there.” - David Tepper

Like I said - I really like what he said above. It embraces capitalism. The market will solve the problems. HOWEVER, the market right now is not allowed to work. Furthermore, unlike other "problems" debt is inherently different. It is the millstone that holds you down. It cannot disappear unless it is paid off or defaulted on. Once you have to much debt the market is handicapped until that is resolved. If the problem was to much housing, I wouldn't worry about it. The market would fix it. If the problem was China wasn't consuming enough, wouldn't worry about it, the market would fix it. If the problem is to much debt, the market would fix it, it would be really painful, but if it isn't allowed to fix it, it can be catastrophic. Tepper is comparing not apples to oranges, but apples to asparagus.

He may be right though in one respect. It may be alot more ponzish than anyone would care to admit. In a ponzi it doesn't go down gradually. You wake up one morning and you lost 100% from the day before. It is possible that the government can keep everything together until over a very short time period - they can't.

Meredith Whitney - Tragedy of the Commons

Meredith Whitney was on CNBC yesterday talking about her new report which places a rating on all 50 states. She started looking at them a couple of years ago in her analysis on the banks and was startled to realize how similar things looked. She thinks a financial crises is coming within the states and that bond holders at the municipal level are going to be very disappointed. I would love to get my hands on this report. She did say Texas is by far the best positioned state. Not even close when compared to other states.

She also talked about how bad a quarter it will be for the banks and discussed some of her thoughts on the economic future.

Video below: (having trouble determining if the video is posting correctly - can be seen here http://www.cnbc.com/id/15840232?video=1602262513&play=1)

Friday's Follow Up

Well the market took the durable goods number and ran with it. Like I said, you needed to watch the market reaction. It wasn't a fundamental number. The market reaction said the rally is still on. As a result, as a bear, I continue to hide in the bunker, try to maintain my current shorts, and don't short anymore. Fundamentally, as mentioned, durable goods order is not a number I watch much anyway. Even the core number is incredibly volatile. If you want to find a bearish tilt to it you can look at the 3 month annualized rate. As David Rosenburg pointed out it has dropped from 39.3% in May, to 23.9% in June, to 11.5% in July, and 8.8% in August. Like I said, that is if you want to find a bearish argument. In general I think it is just better to ignore it fundamentally and take the cues on how the market reacts to the number to judge the mood of the market.

So the market loved that number on Friday. That is what matters It seems it is extremely unlikely the market doesn't break 1150 as a result. The problem for bears is if we really break 1150 there aren't any great levels to look for a potential top. You have maybe 1170 and than your back to year highs. The market is convinced that there is no way equities can go down as the Fed and all of its power will keep them going higher. Even if the premise is completely a joke, the belief and growing belief by everyone makes it extremely difficult for the market to go down. It becomes reflexive as George Soros likes to call it.

Again it comes down to Europe. Irish and Portugal spreads were wider again today. Moody's downgraded the unsecured debt of Ireland's Anglo bank. Right now it is assumed the Euro will only go up which is a ludicrous assumption but market sentiment is higher than it was in November 2009 when the Euro peaked. As long as the Euro is moving higher I think it is impossible to be super bearish. Any U.S. economic weakness will be "good" news as it means a higher QE 2 number in November.

Durable Goods Number

Very good durable goods number ex transportation and the futures are flying. Ex transportation durable goods order was up 2% on expectations of being up 1%. All the numbers were revised higher from the previous month.

So we have the mirror image from last month. Very good number, markets at highs looking like they are going to break higher, and futures flying pre market. The way this market trades in response to this number throughout today will be fascinating. The durable goods number is so volatile on a month to month basis that fundamentally it is hard to glean anything from it. However, the bulls have the excuse to send this market screaming. If they can't and the rally fades it will tell you alot.

Market Musings

It has been awhile since I have mused about some of my market thoughts. Main reason is because I haven't really had that strong of an opinion. After realizing (to late) that we weren't breaking down at 1040 a month ago, it has been a matter of hiding in a bomb shelter for us bears. Starting last Friday I started thinking it was possible we could be reaching some sort of topping process. I told several friends I would hate to be short before the Fed meeting and I would hate to be long after. Monday was a big up day but we have lost basically all of that as of today. Are we consolidating or have we indeed been in the topping process I suspected over the last week and are now ready to break down?

One of the main market data points that a month ago made me scratch my head and wonder if something wasn't right (and like an idiot I didn't act upon it) was the durable goods number. Usually, I don't pay much attention to that number (which is why I talked myself out of doing anything last month) but last months number was horrific. Durable goods ex transportation was down 3.7%. If I remember correctly the previous expectation was close to flat. It was a horrible absolute number and a horrible relative number. The market crunched pre market and than rallied and basically ignored a horrific data point. It caught my attention but like I said, talked myself out of doing anything much to my detriment. So this number is going to be interesting. If it is bad and the market sells off hard I think it will be interesting. If it is good and the market pops and than sells off to only finish slightly up or even down I think that tells you alot also.

What I describe above is just a trading signal I will be watching. More fundamentally it is still Europe Europe Europe. The European stock market is now down 3 days in a row and the economic data this morning was flat out lousy showing a very disturbing slowing trend. Ireland is now considered the 5th most likely sovereign to default joining such illustrious names as Venezuela, Argentina, and Greece. Portugal spreads are also widening. Spanish banks seem to be rolling over. Not a good situation. The thing that is holding up right now is the Euro which was surging after the Fed announcement on Tuesday. It may have a little higher to go based on trading technicals but that rise also seems about done. Based on European debt spreads, Europe appears to be in worse shape than it was four months ago. It is just a matter of time before the market pays attention again.

In general the market feels like it has topped. I am watching European government debt spreads, the Euro, and copper to try to give some clues if this is indeed the case. We have the end of the quarter coming up so the likelihood is the market doesn't just fall apart but it will be very telling if it fails once again in this area.

The Ultimate CDO (or Ponzi) - EFSF Rated AAA

Remember one of the main causes of the housing crises and the mess we find ourselves in today? Well it was the structured products and how Wall St was able to take junky credit mortgages, wrap them together as one security, and sell them convincing the rating agencies and buyers that they were AAA. Basically, throw one hundred junk mortgages together and boom, you have the perfect mortgage. The argument was because of diversification it was really safe.

Well that thinking with tons of leverage almost caused the entire system to collapse. It would have collapsed except the government took all the risk.

Welcome to today and the governments have managed to do the same thing. According to the New York Times "The European Financial Stability Facility, as the fund is known, was rated AAA by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings. Standard & Poor’s said its understanding was that 'guarantees from member governments supporting the repayment of E.F.S.F. obligations will be unconditional, irrevocable and timely, and thereby consistent with our criteria for sovereign guarantees.'"

That is tragic or funny (depending on your perspective) on all sorts of levels. 1) The facility has not been pre funded. It is only going to be funded if there is an actual problem. I am sure everyone is setting money aside so it can be guaranteed to be there if need be. Truly AAA material. 2) What is even worse is that 3/4 of the countries that make up the EFSF aren't AAA. Basically we have just taken a bunch of junky mortgages, thrown them together and presto made it AAA. In this case we just took a bunch of junky countries and made them AAA.

Of course there is no problem now so the market prices it as if there will never be a problem.

More brokenness as our system slips towards the abyss.

Anglo Irish Bank = Creditanstalt?

I have been saying watch Europe watch Europe watch Europe. I still think that is where the next leg down in this whole mess will originate. Well news from Ireland just caused a major reversal in Europe and while U.S. futures are still positive, the luster has been taken off. Creditanstalt may be upon us.

From the Irish Independent

These are desperate economic times. So desperate that the subject of Ireland defaulting on its bank and sovereign debts is now routine conversation among academics, bankers and economists.

However, up until now, such an idea was rarely entertained by senior politicians, but in a surprising move yesterday the leader of the Labour Party, Eamon Gilmore, came very close to suggesting such a course of action when he talked about the Government "negotiating'' with bondholders in Anglo Irish Bank.

While Mr Gilmore trenchantly denied such an approach meant defaulting, he certainly came very close to that position.

If the market sees this as a gesture towards default, it's over. It is like the banks CEO being forced to come out and say everything is fine. When I got a call two days before suggesting I take money out of Bear Stearns money market funds as a precaution, I knew the game was up.

It continues...

Of course, Mr Gilmore (and his position got some support from Barclays last night) has some options. One is to simply press to reduce the total amount owed to the bondholders, allowing Anglo to book a gain from having to pay out less interest than originally agreed.

The second approach, one championed by the 'Financial Times', is to tell the bondholders you intend to swap their bonds for shares in Anglo.

This would effectively leave the bank, which is a heartbeat away from technical insolvency, in their hands. This is known as a debt-for-equity swap and is very common in downturns when companies run into problems. Technically it is also known as a distressed exchange offer. This approach could be taken, but again it comes with significant risks which need to be acknowledged by political commentators like Gilmore and others pressing for this course of action.

The problem with this idea is that there is no way Anglo Irish Bank is worth €16.5bn at the moment. So if the bondholders swapped all their bonds for Anglo shares they would be settling for less than par value. This is a selective default.

Of course, the big danger is not what would happen in Anglo if this course is taken, but what would happen at the other Irish banks. By how much would their fund-raising costs go up?

That is exactly right. Anglo Irish is big but not that big. The question is contagion. Is it Creditanstalt all over again? (the Austrian bank that declared bankruptcy in May 11, 1931 that really got the depression going).

finally...

The final danger is: would an Anglo technical default raise the funding costs for Ireland Inc itself? Again it is hard to say. There are two schools. One suggests that by cutting Anglo loose, Ireland becomes a better credit risk and funding costs could actually drop.

Others suggest once you welch on any debts, your funding costs elsewhere rise and you may even be locked out of the bond market entirely.

That is a danger and it may spill over to Portugal sovereign or Spain etc. but I think the bigger danger is other European banks. A) the funding costs could shoot up with an entire knew liquidity squeeze and B) all of a sudden you have precedence for sovereign nations not to take responsibilities of the banks. A for sure popular choice among the electorate. I mean if Ireland allows a default on one of its large banks why should Greek people suffer? Or Spaniards?

Something almost has to happen now in the next week. Irish - Bund Spreads are exploding.

Charlie Munger Interview

A couple of days ago Warren Buffett was being quoted as saying how amazing the United States is going to be and how bullish on America he was. Well there may be some schism with the famous partnership because Munger is not as optimistic.

Yesterday Munger participated in a interview of sorts with CNBC's Becky Quick at the Ross School of Business at the University of Michigan. He spoke and fielded questions for 2 hours!! The video is freaking long but worth every second. It can be seen in its entirety here. He talks about the economy (about 10% of the video) and says employment problems are around for a long time and that many industries haven't seen the worst of it.

He also said "Tom Friedman said its like the car that has to run across 300 miles of hot desert without a spare tire. We have used all the standard tricks that it is safe to use and now we still have the damn desert to cross without the spare tire."

I don't want to give the impression he is cataclysimic because he is not. He thinks it could get as bad as Japan but doesn't think the odds are that it will. Of course in my opinion Japan is a positive outcome.

Another thing that really struck me was that he talked about the bailouts, and how they were a must. He said you do not want to know what would have happened if they didn't occur. He than goes on to talk about how the Germans had such a great system but how Hitler came around with enough economic hardship. My question is this: what has changed from the bailouts? I completely agree. No bailouts and the world would have changed in ways you cannot imagine. However, that is why I am so bearish on where we are currently. The bailouts did not change anything and just ratcheted up the pressure. Instead of cleansing the sewage system we just got more sewage that is more toxic than ever. So if what would have happened was going to be so bad that even someone like Munger who is a hard core capitalist endorses them, you have to think of the probability of it still happening since the problem is still there. It is unwise not to be prepared for at least the possibility.

The the very end may have been the biggest nugget as far as overall wisdom though not related to the economy at all. He said you must study Singapore's Lee Kuan Yew, the first prime minister of Singapore. That he, almost single handily, created the best system in the history of man including Athens and the United States. For any life alive today it is a must study.

Like I said, it is freaking long, but well worth your time to watch the entire thing.

Japan to Lend to California?

Now to the really absurd item of the day. A Japanese state owned bank is planning on lending the state of California billions of dollars to build a high speed train to run from San Francisco to Los Angeles. You just can't make this stuff up. Part of the reason Japan is making the loan is to help Japanese companies in the bidding process. That makes alot of sense. Let a bankrupt country make a loan to a bankrupt state so they can hire a company from your country to paid with money from your country. If we are going to play ponzi why do it in such an inefficient manner? Just give the money directly to the Japanese company?? This money being spent can't possibly be expected to be paid off from earnings. Instead the gamble I am sure is that someone will refinance it down the road. The way our system is run.

From Bloomberg

Japan said it’s ready to lend California money to help pay for a planned high-speed railroad as trainmakers from Asia to Europe compete for work on a project that will cost at least $40 billion.

and

California won $2.3 billion of federal funds to help build the high-speed train, the biggest award in Obama’s high-speed rail funding program. The state also approved in 2008 a $10 billion bond sale to help fund the line, which is due to start services in 2020.

The California State Auditor has said that the state’s business plan for the high-speed rail network doesn’t include steps to replace all of the $17 billion to $19 billion in federal funds initially envisioned for the system.