DailyFinance.comhttp://www.dailyfinance.comDailyFinance.comhttp://o.aolcdn.com/os/df/2013/img/2-dailyfinance_logo_m.pngDailyFinance.comhttp://www.dailyfinance.comen-usCopyright 2013 Weblogs, Inc. The contents of this feed are available for non-commercial use only.Blogsmith http://www.blogsmith.com/Can Investors Profit from President Obama's New Energy Policy?http://www.dailyfinance.com/2011/04/04/can-investors-profit-from-president-obamas-new-energy-policy/http://www.dailyfinance.com/2011/04/04/can-investors-profit-from-president-obamas-new-energy-policy/http://www.dailyfinance.com/2011/04/04/can-investors-profit-from-president-obamas-new-energy-policy/#commentsFiled under: , , , ,

Can Investors Profit from President Obama's New Energy Policy?Last week, President Obama outlined a new energy policy that aims to reduce America's dependence on imported oil by using more of the nation's abundant reserves of natural gas, encouraging more efficient vehicle fleets and expanding the use of alternative energy sources such as wind and solar.

There's no telling how much profit will actually be generated in each of these industries, but it's worth looking at a few exchange-trade funds that act as proxies for natural gas and alternative energy to see if there are ways individual investors can capitalize on these new policies.

Since the president touted a federal tax credit for the purchase of electric vehicles, as wells as a directive for federal agencies to purchase alternative fuel vehicles, companies that manufacture hybrid or electric cars such as General Motors, (GM) with its Chevy Volt and Nissan (NSANY) with its Leaf, might be expected to post more sales. But since these global companies produce millions of vehicles, it will take both time and a major change in buying trends to boost the relatively modest sales numbers of electric and hybrid models to the point that they make a big impact on manufacturers' bottom lines.

Compared to the relatively diffuse impact the announced policies could have on auto sales, natural gas, solar and wind are "pure plays" on the growing use of natural gas and a federal emphasis on encouraging alternative energy.

Charting the Alternatives

Rather than attempt to review the dozens of publicly traded natural gas, wind and solar companies for trends, let's refer to exchange-traded funds that act as proxies for each industry: the U.S. Natural Gas Fund, (UNG); the Global Clean Energy Index Fund (ICLN); the Global Solar Energy Index (TAN), and the Global Wind Energy Fund (FAN).

Here are the charts for ICLN, UNG, and the S&P 500, which we can use as a baseline for comparison.







Despite the obvious promise of natural gas and alternative energy, both ICLN and UNG have dramatically underperformed compared to the S&P 500.

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ICLN tanked along with the rest of the market during the global financial crisis, recovered strongly to the $25 level in spring of 2009, and has since drifted down to a trading range below $20. A recent uptick brought it to $18.77, a far cry from its 2008 levels around $50.

The irony about natural gas is that its new-found abundance due to technological advances has caused its price to plummet. This is reflected in the chart of UNG, which has cratered from $80 in 2008 to just above $11. In terms of relative performance, the broad-based S&P 500 has outperformed both natural gas and clean energy, as it has more than doubled off its lows and reached price levels last seen in 2008.

Much Promise, Little Profit -- So Far ...

Next, let's compare the narrower ETFs for solar (TAN) and wind energy (FAN) and the natural gas fund UNG against the S&P 500 on a nine-month chart, which captures the relative price movement of each since last summer's swoon and subsequent liftoff in September.

What really pops out of this comparative chart is the solar ETF's volatility. It has outperformed the SPX and then crashed back down, all in a few months. Wind energy has underperformed the SPX, but recently closed the gap, logging a 10% gain since last summer. But it still lags the S&P 500's nearly 20% gain over the period.

Natural gas, meanwhile, has sunk 35% since last summer, a dismal return for its investors. However, long-term investors might be willing to bet that these price levels are the bottom of the range, and buy now for the future, when natural gas might not be so cheap.

Investors in wind, solar and other clean energies will have to buckle up for the ride, for heightened volatility seems to be a salient characteristic of these sectors. Their underperformance since 2009 could be seen as either discouraging or as an opportunity to buy into future earnings at reasonable prices.

Investing in sectors which may benefit handsomely in the future from the policies of today requires patience and a strong stomach for uncertainty and volatility: There are no sure things or crystal balls when it comes to investing, only probabilities, forecasts and whatever we can glean from the charts.


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]]>alternative energyclean energyelectric vehicleenergy policyexchange traded fundsFANfraccingfrackingfrakkingfuel efficiencyfuel efficientgm voltICLNNatural GasnissanNissan Leafpresident obamarelative performancesolarsolar powerSP 500SPXTANUNGwind energywind powerCharles Hugh SmithMon, 04 Apr 2011 10:00:00 ESTCould Oil Prices Be Headed for a Dip?http://www.dailyfinance.com/2011/03/30/could-oil-prices-slump/http://www.dailyfinance.com/2011/03/30/could-oil-prices-slump/http://www.dailyfinance.com/2011/03/30/could-oil-prices-slump/#commentsFiled under: , ,

The reasons for oil's climb above $100 a barrel are well-known, including rising demand from fast-growing Asian economies, along with the risks of continuing geopolitical turmoil in North Africa and the Mideast. But as my colleague Charles Wallace recently reported, a significant premium in the price of oil stems from speculation, which has recently skyrocketed as traders and fund managers seek out commodity and global growth plays.

With oil swinging from around $50 per barrel in 2007 to $145 a barrel in 2008 and then plummeting to $32 a barrel in 2009, this huge increase in speculative trading has led to tremendous volatility.

And that leads to this question: could oil slump sharply, despite all the reasons typically given for higher prices, mostly as a function of the speculative trade?

Speculation Does Not Equal Endless Bull Markets

The recent explosion in oil speculation can be seen in the following two charts. The first depicts volume -- the total number of futures contracts traded -- and the second charts open interest, the number of contracts outstanding. This data is from the U.S. Commodity Futures Trading Commission (CFTC), which regulates the futures markets for commonly traded commodities.



The chart below, showing oil price history, illustrates how massive increases in speculation do not guarantee endless bull markets: highly leveraged speculative trades can quickly reverse course when sentiment changes. Rising volume and speculative interest increase volatility, as extremes of sentiment are reflected in large positions being taken on the long (bullish) or short (bearish) side.

Notice both volume and open interest rose sharply from 2006. Since then, oil rose in a bubble-like spike to $145 per barrel, and then subsequently crashed back to $32 per barrel a few scant months later as the global recession took hold. It has since tripled to over $100 barrel.

The next chart might give the oil bulls pause: the Commitment of Traders (COT) commercial traders' long and short positions in oil. Many investors and analysts look at COT for three basic categories of traders: small speculators, the large speculators -- such as hedge funds -- and commercial traders (typically global corporations that hedge against big swings in commodity prices), and large financial institutions' trading desks.

A short position by a large firm, in other words, might act as "portfolio insurance" or a hedge against volatility. Thus a firm that owned long contracts for oil might buy a short position to protect against losses should oil fall.

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Note how the short interest of the commercial traders rose above long positions in the buildup to oil, peaking in 2008. As the price of oil marched ever higher, commercial traders sought out more protection in the form of short positions.

But higher short positions might also reflect trading bets that the high price won't last, and that a reversal is imminent.

Recently, long positions have declined while short positions have jumped. The spread between the two has widened to the largest gap in the past decade. Clearly, major players are betting (or hedging) that oil could drop precipitously.

Fearful of a Decline, or Betting on It

A recent report from Goldman Sachs concluded there is about $10 per barrel of speculative premium priced into oil. That suggests if the speculation declined, oil might fall at best $10 a barrel. From this point of view, oil is still priced mostly by fundamental supply-and-demand issues, and speculation adds no more that about 10% to the cost at today's price of $104 per barrel.

Given an expected rise in demand for oil -- especially as Japan replaces the electricity generation capacity it recently lost, as a result of the earthquake and tsunami that damaged the Fukushima nuclear reactors --Goldman Sachs estimates there is no more than $10 a barrel downside in the price of oil.

Perhaps, but estimating the consequences of increased speculation is not a precise science. Given the above chart, it seems evident that some of the biggest players aren't taking any chances. The unprecedented spread between long and short positions suggests somebody is either fearful of a major decline in the price of oil -- or is actively betting on it.


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]]>CFTCGoldman Sachshedgingoiloil pricesoil speculationspeculative premiumCharles Hugh SmithWed, 30 Mar 2011 10:00:00 ESTWhy the European Debt Crisis Is Far From Overhttp://www.dailyfinance.com/2011/03/27/why-the-european-debt-crisis-is-far-from-over/http://www.dailyfinance.com/2011/03/27/why-the-european-debt-crisis-is-far-from-over/http://www.dailyfinance.com/2011/03/27/why-the-european-debt-crisis-is-far-from-over/#commentsFiled under: , , , , , , ,

The European debt crisis is back in the headlines, and the news is not good. Portugal's prime minister resigned after his austerity plan for the beleaguered nation were rejected by opposition parties in parliament, and Germany's leadership is waffling on funding the huge bailouts needed by debt-burdened countries such as Ireland and Greece, reflecting the deep ambiguity of German voters weary of bailing out their weaker neighbors. Despite the brave talk of a few months ago, it now seems all but inevitable that Portugal will also need a gigantic bailout of at least 70 billion euros, or $99 billion.

Ratings agencies have downgraded Portugal's debt, and investors have responded by pushing the yield on its bonds to more than 8%, roughly 4.5% higher than the yield on German bonds. Yields on Ireland's debt exceed 10%, reflecting the perceived risk of default or renegotiation.

With Europe at risk of stumbling as a result of its austerity measures and the costs of bailouts, investors need to rethink investments in eurozone economies and the euro itself.

Eurozone growth is already anemic: France managed a meager 0.3% gain in the fourth quarter of 2010, and 1.5% for all of 2010, while the U.S. economy expanded 3.1% in late 2010.

The bailouts are not small potatoes. The temporary rescue fund, known as the European Financial Stability Facility, is currently set at 250 billion euros ($353.6 billion) , and European Union officials want to expand it to 440 billion euros ($622.3 billion). The wealthier nations of Europe have already loaned 177 billion euros ($250.3 billion) to bail out Greece and Ireland, and the high yields on those nations bonds and credit default swaps -- insurance against default -- show that investors continue to see a high risk of default.

Spain Also at Risk

While Spain's economy expanded at a modest 0.9% pace last year, its debt situation remains precarious enough that ratings agency Moody's recently downgraded its bonds. The basic problems of Spain will be familiar to Americans: A property bubble drove residential real estate prices to unrealistic heights, and lenders made loans based on those sky-high valuations. Once home prices retreated, banks were left with large quantities of defaults on land and houses.

Analysts are now suggesting Spanish banks will need at least 50 billion euros in additional capital ($70.7 billion) to cover these mounting losses.

As if these losses weren't troubling enough, rising interest rates threaten to further undermine Spain's homeowners. The European Central Bank President Jean-Claude Trichet recently said that the ECB's key interest rate could rise from 1% as early as April. Fully 97% of Spain's home loans are variable-rate: Their payments will rise when interest rates click higher.

Despite an unemployment rate around 20% and its recent debt downgrades, mainstream analysts see Spain as an unlikely candidate for a costly bailout. But Spain is burdened with the costs of bailing out its own banks, and other analysts are not so sanguine, citing a lack of information on the quality of assets held by the banks. In other words, some fear Spanish banks are overstating the value of their real estate holdings to hide the full extent of their losses.

Structural Flaws in the European Union Papered Over

While there is plenty of chatter about bailouts, austerity measures and heavy debt loads, few analysts are speaking to the potentially fatal weakness built into the European Union and its single currency, the euro, a flaw that is now painfully obvious.

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While the European Union consolidated power over the shared currency and trade, it left control over trade deficits and budget deficits entirely in the hands of the member states. Lip service was paid to fiscal responsibility via caps on deficit spending, but in the real world, there were no meaningful controls limiting private or state credit expansion, or on sovereign borrowing and spending.

In effect, the importing nations within the union (Ireland, Greece, Portugal and to a degree, Spain and Italy) were given the solid credit ratings and expansive credit limits of their exporting cousins such as Germany, The Netherlands and France. To make a real-world analogy, it's as if a spendthrift younger brother was handed a no-limit credit card with a low interest rate, backed by a guarantee from a sober, cash-rich and credit-averse older sibling.

For awhile, it was highly profitable for the big European and international banks to expand lending to these eager new borrowers. This led to over-consumption by the importing nations and handsome profits for big Eurozone banks. And while the real estate and credit bubble lasted, the citizens of the bubble economies enjoyed the consumerist dream of borrow and spend today, and pay the debts tomorrow.

Tomorrow has arrived, but the foundation of the banks' assets -- the market value of housing -- has eroded to the point that both banks and homeowners face insolvency. The heightened risk of default, both by banks and the governments trying to bail them out, has caused interest rates in the debt-burdened countries to rise. Faced with rising costs of servicing their debts, and spending cuts to bring deficits under control, the citizens of the states such as Portugal are rebelling against austerity measures. On the other side, taxpayers and voters in fiscally sound member states such as Finland and Germany are rebelling about being saddled with the costs of bailing out their weaker neighbors.

This structural imbalance will not be easily addressed, but until it's fixed, the E.U. and the euro, are at risk of a great political and fiscal fracturing.


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]]>bailoutbondsdeficit spendingeuroEuropean Central BankEuropean debt crisisEuropean financial stability facilityEuropean unionEurozoneFranceGermanyGreeceinterest ratesirelandPIIGSportugalsovereign debtsovereign debt crisisSpainTrichetCharles Hugh SmithSun, 27 Mar 2011 08:00:00 ESTNew Mortgage Regulations Could Bruise Housing Markethttp://www.dailyfinance.com/2011/03/23/new-mortgage-regulations-could-hurt-housing/http://www.dailyfinance.com/2011/03/23/new-mortgage-regulations-could-hurt-housing/http://www.dailyfinance.com/2011/03/23/new-mortgage-regulations-could-hurt-housing/#commentsFiled under: ,

New regulations limiting mortgage brokers' compensation go into effect on April 1, and they might prove to be appropriate for an April Fools' Day. Though aimed at unscrupulous mortgage brokers, it seems the regulations will instead hit the nation's struggling housing market.

The Federal Reserve Board says that its regulatory goal is to "protect mortgage borrowers from unfair, abusive, or deceptive lending practices that can arise from loan originator compensation practices." The basic idea is to prevent loan officers from steering borrowers into riskier types of loans or a higher-than-average interest rate to make a higher commission.

Officially titled "Loan Originator Compensation amendment to Regulation Z," The new rules apply to mortgage brokers and the companies that employ them, as well as mortgage loan officers employed by banks and other lenders.

Closing the Barn Door....

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Since most of us only deal with mortgage loan origination fees when we buy a home or refinance a mortgage, the average citizen will have a tough time sorting out the often-arcane issues at stake. But the bottom line is straightforward: the already-limited mortgage market is about to become more limited, as small mortgage brokers are essentially being shoved out of business. Call it "unintended consequences" or a cloaked plan to channel more of the mortgage business to the "too big to fail" big banks -- but regardless of the motivations, the rules may end up limiting consumer choice and make it harder for home buyers to get a loan.

While the stated goal of the new rules is laudable, those in the mortgage industry say it's a case of closing the barn door after the horse has bolted: the risky, subprime-type mortgages that were the root cause of the problem have already vanished from the mortgage market.

Since the rules largely apply to small lenders and brokers who must sell the mortgages they originate to larger banks -- most banks and other direct lenders, including big mortgage companies that function like banks, are exempt from the new regulations -- then the limits will weigh entirely on smaller independent players.

Setting Ground Rules

Critics, including U.S. Senators David Vitter and John Tester, observe these rules will further concentrate a market already dominated by mega-large banks. According to the senators, two banks already originate 43% of the nation's mortgages. It's difficult to see how home buyers will benefit from the effective exclusion of small independent brokers and lenders.

What the regulations do is set some ground rules. For example, consumers must be offered the lowest possible interest rate and fees for which they qualify. They also limit loan officer and broker compensation in several key ways.

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According to the Federal Reserve Board, a loan originator "may not receive compensation that is based on the interest rate or other loan terms." In other words, a lender can no longer pay a loan broker a yield-spread premium, which is tied to the rate or terms of the mortgage.

Currently, the brokerage firm and the loan officer typically split this rebate, which is typically stated in "points," where each point equals 1% of the loan amount. Thus a loan origination might earn an $8,000 fee, $4,000 of which goes to the loan officer and $4,000 to the mortgage broker.

Under the new rules, the mortgage broker cannot pass on part of the commission to the loan officer, who must now be paid an hourly wage or salary.

The idea is to remove the incentive of the loan officer to push the consumer into a more lucrative loan -- but the result is to remove the incentive to remain in the independent mortgage business.

The Insider's View

Mark Helling, a licensed loan officer based in Ohio, summed up the view from inside the industry. "After April 1st," he says, "a loan officer will have to be paid the same rate whether it is an easy loan that takes two weeks to close or a foreclosed property in need of rehabbing for marginal borrowers that takes three months of work to close. Just when the country needs the most experienced and knowledgeable mortgage professionals to help liquidate the flood of foreclosed homes, the Fed is making it unprofitable for loan officers to accept these deals."

From the point of view of those in the mortgage industry trenches, what the rules do is increase the regulatory expenses of being in sales but eliminate the commissions that are the lifeblood of any sales enterprise.

The Fed Board also says the final rule "prohibits a loan originator that receives compensation directly from the consumer from also receiving compensation from the lender or another party." In other words, a loan originator cannot collect payments from both the consumer and the lender in a single transaction. If a broker is paid a commission by the lender based on the loan amount, then the broker is barred from charge the borrower "points" or fees for the loan processing.

This prohibits loan officers from paying borrowers' fees or issuing them a credit from their own commission. This has been a common practice within the industry -- and from the inside perspective, it has offered a flexible way to lower borrower's costs.

A Case of Overkill?

These major regulatory changes are being made in the service of fair lending practices. But to those seeing their livelihoods threatened, it looks like a sledgehammer is being used where a flyswatter would have sufficed.

"As far as trying to protect consumers from those seeking to charge a higher interest rate, with all of the competition out there for mortgage loans," Helling observes, "all a consumer has to do is check one or two other banks and they can quickly find out if they are getting a fair deal or not."

The rules will also interact in potentially harmful ways with the massive Dodd-Frank Wall Street Reform and Consumer Protection Act, the most sweeping financial regulation since the Great Depression.

At issue is section 1413 of the Dodd-Frank Act, which states that any violation of the loan originator compensation rules will offer the borrower a "defense to foreclosure" for the life of the loan.

In other words, if a delinquent borrower can go back and find some violation of the compensation rules in his/her mortgage origination, the lender is effectively barred from foreclosing on the borrower's loan.

Drying Up Competition

Given the risks this presents to banks, many observers -- including the two senators -- expect the large banks that typically buy mortgages from independent brokers and small lenders to shun these mortgages. Why buy a mortgage that could go sour via a future default -- that could preclude foreclosure as a remedy?

The net result of these rules could hurt the housing market in several ways. If mortgage brokers can no longer make enough in commissions to stay in business, then the mortgage options for home buyers will shrink. The most productive loan officers will find reduced incentives to their remaining independent, so there will be less competition offered to the big banks which already dominate the industry.

Perhaps most devastating, the financial institutions which have bought mortgages originated by brokers and smaller lenders will have a powerful incentive to avoid the risks that are being placed on these mortgages by the Dodd-Frank Act. The housing market may well sag further, as mortgage sources and competition dry up.

The need for thoughtful financial regulation has been made painfully apparent by the excesses of the credit and housing bubbles, but squashing legitimate independent loan originators and further concentrating the mortgage industry into the hands of the "too big to fail" banks seems counterproductive.


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]]>commissionsDodd-Frank ActFederal Reserve Boardhousingloan officersmortgage brokersmortgagesreal estateCharles Hugh SmithWed, 23 Mar 2011 11:00:00 ESTIs the Rally Over, or Is It Just Taking a Breather?http://www.dailyfinance.com/2011/03/23/is-the-rally-over-or-is-it-just-taking-a-breather/http://www.dailyfinance.com/2011/03/23/is-the-rally-over-or-is-it-just-taking-a-breather/http://www.dailyfinance.com/2011/03/23/is-the-rally-over-or-is-it-just-taking-a-breather/#commentsFiled under: , ,

tradersThere are two opposing sentiments feeding the U.S. stock market right now: On the negative side, the news from Japan and Libya is unsettling, but on the positive side, economic reports continue to reflect improvements in key aspects of the American economy's health.

It's a Wall Street truism that markets dislike uncertainty more than they dislike bad news, which is one reason why they have swooned recently: The long-term economic effects of Japan's devastating earthquake and tsunami, and of the civil conflict in Libya are complete unknowns, and each has the strong possibility of being negative for the U.S. economy.

Technical analysis offers a perspective on market action that is one step removed from the daily fluctuations triggered by world events. While some of the motions of the market are obviously news-driven, beneath the daily perturbations of good and bad news lay deeper patterns and trends which typically reassert themselves after the dust settles.

Going Up or Going Down?

Stripped of complexity, technical analysis boils down to this: identifying the current trend, and looking for evidence that the trend will continue or reverse.

This is why technicians look at moving averages (MA), which smooth out the daily ups and downs and plot the longer-term trendline. The longer the moving average timeline, the more weight is given to the trend it traces.

For example, let's look at a weekly (long-term) chart of the broad-based S&P 500. I've drawn two moving averages favored by many analysts, the 20-week and the 40-week moving averages.



When price remains above the 20-week MA, the market is in an unambiguous uptrend. When the 20-week MA is climbing above the 40-week MA, this reflects a solid uptrend: The shorter-term average is above the longer-term average.

Conversely, when the shorter-term average drops below the longer-term line, that reflects a weakening trend.

These moving averages tend to offer support for trends and resistance to reversals. The recent swoon, for example, tested the 20-week MA, dipping below that line, but closing above it by Friday. In essence, the 20-week MA acted as support.

Spotting the Turning Points

The commonly used indicators of relative strength (RSI), MACD (moving average convergence-divergence) and stochastics are all declining, indicating that there is weakness in the current upward trend. Yet the damage to price has been modest so far, barely denting the 2-year-old rally.

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Many technicians follow the 40-week cycle (that's about nine months). Observers have noticed that over time, the market often reaches highs or lows on this cycle. Nothing in technical analysis is written in stone, of course, and these types of overlays are notoriously easy to adjust to make them "fit" the real market's action. Nonetheless, it's instructive to apply a 40-week cycle just to see what might be revealed.

The first 40-week mark after the market hit bottom early in March 2009 didn't align with any distinctive top or bottom, but the next 40-week mark (early September 2010) corresponds remarkably well with the point at which the market exploded into a new uptrend. If this pattern has any meaning -- and it might not -- it suggests that the next near-term low in the S&P 500 might be about two and half months away, around early June.

That also corresponds with seasonal trends: The market tends to top out in spring -- hence the well-known advice, "sell in May and go away" -- and then decline, hitting bottom in the summer months.

One possible warning sign is that the upper Bollinger band has flattened and turned down. If we look at previous periods when the market has fallen, this same pattern emerges early in the decline.

In summary: On this long-term chart, the S&P 500 would need to drop decisively below the 20-week moving average before we would feel that the long-term trend was threatening to reverse.

Things Are Looking Down

On the daily chart, the recent market action in the S&P 500 looks a bit more bearish. The uptrend has been decisively broken, and the 20-day moving average is poised to cross through the 50-day MA -- a bearish cross which reflects that the short-term trend is now down.



Two of the three common momentum indicators -- RSI and stochastics -- have bottomed out near oversold territory and are bouncing modestly higher. MACD, however, has slipped below the neutral line and is still declining, suggesting the slump has yet to hit bottom. For the market to regain its constructive stance, price needs to climb back above the 50-day moving average (currently at 1,302) and the MACD trend indicator needs to reverse course and work its way back above the neutral line.

Filling the Gaps; Bulls that Bear Watching

Turning to the tech-dominated Nasdaq market, we find an even weaker technical snapshot, as the 20-day moving average has already made a bearish cross below the 50-day MA. The stochastics indicator has already reached oversold conditions that in the past have triggered a reversal, but what's different this time is the MACD, which is bearishly below the neutral line and still dropping.



Technicians have observed that the gaps formed when price opens strongly up or down tend to get filled in later, meaning that price returns to the area that was "jumped" and moves through the gap. An example of this can be seen in late January, when a gap that was opened by a leap upward in price was filled in about three weeks later when the market retreated.

Bulls have a reason to be hopeful for a gap-filling move from the market at the moment, because there are two open gaps right now above the current level -- one near the NADAQ's peak, and another just below the significant 50-day moving average. To fill these gaps, price will have to resume an uptrend.

However, on the bearish side, a longstanding gap just above the 2,500 level is waiting to be filled -- but to reach it would require a 140-point drop.

Technicians also look at sentiment readings, which reflect investor confidence and caution. Recent readings collected on March 15, four days after the earthquake and tsunami devastated Northeastern Japan, showed investor sentiment to be remarkably bullish, barely changed from the previous week, while bearish sentiment remained very low. Both readings suggest a complacency which technicians find worrisome: Complacency reflects a market vulnerable to trend reversal. At true market lows, bulls are scarce and bearish sentiment rises to extremes. When it comes to sentiment, bullish readings are not necessarily bullish indicators.

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]]>40-weekbear market forecastbollinger bandsbull market forecastColumnsinvestor sentimentjapan earthquakelibyalibya protestsMACDmoving averagesNASDAQopen gapsoutlookSP 500stochasticsstock marketTechnical AnalysistsunamiCharles Hugh SmithWed, 23 Mar 2011 06:30:00 ESTMarket Snapshot: What's Thriving in Battered Economyhttp://www.dailyfinance.com/2011/03/15/a-snapshot-of-the-market-whats-weak-whats-strong/http://www.dailyfinance.com/2011/03/15/a-snapshot-of-the-market-whats-weak-whats-strong/http://www.dailyfinance.com/2011/03/15/a-snapshot-of-the-market-whats-weak-whats-strong/#commentsFiled under: , , , , ,

The economy has had more than its share of trouble lately: Japan's earthquake comes on top of rising oil and food prices, political turmoil in the Middle East and a crop of government austerity measures. Here's what's thriving in the battered economy.The tragic earthquake that devastated northeast Japan also has struck the global economy. And the natural disaster comes after several other blows that have hit the economy lately. Rising prices for food and oil, turmoil in the Middle East and belt-tightening by deficit-hampered governments all have weakened the prospects for strong growth.

Amid all the unsteadiness, investors are looking for ways to protect their portfolios against rising risks and potential losses. Some sectors and investments might be well placed to hold their own -- or even gain -- in the current atmosphere of uncertainty and heightened risk.

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And as the global economy has grown, investment opportunities have expanded. New exchange-traded funds (ETFs) have popped up for popular investment categories, such as precious metals and emerging markets.

It's impossible to review all of the hundreds of investing options in the global marketplace, so I'm aiming to get a snapshot of the market by reviewing six charts that cover a spectrum of options: the tech-dominated NASDAQ; emerging markets, as covered by the EEM ETF; gold, via the GLD ETF; the energy sector, through the XLE ETF; bonds, via the TLT Treasury bond fund; and currency, with the U.S. dollar index (DXY).

Diversity Reduces Risk

My reasoning for this selection is based on a simple investing principle for lowering risk: choosing a variety of investments that are inversely correlated -- meaning they act as a seesaw: when one is up, the other is down, and vice versa -- or weakly correlated, meaning they move up and down independently of each other.

Markets that move in lockstep don't really offer any meaningful diversity or hedging. Owning a portfolio of sectors and markets that move together is equivalent to putting all your eggs in one basket. So the key to hedging your bets is picking investments that behave differently in different scenarios.

For example, the dollar and U.S. bonds have a strong inverse correlation with equities -- meaning that when stocks decline, bonds and the dollar tend to strengthen -- so I've included them as potential hedges against stock-market weakness. Oil prices have risen sharply, so I've included an ETF for the energy sector.

And as the U.S. economy has worked its way through the recession, many investors also have turned to emerging markets and precious metals in the hope of higher returns, which is why I've also included exchange-traded funds for those sectors.

To screen out the noise of daily trading, I've selected long-term weekly charts.

The NASDAQ



The tech-heavy NASDAQ has been on a tear, along with the S&P 500 and the Dow Jones Industrial Average, but there are signs that the uptrend is running out of steam: indicators have rolled over and the price is testing the 20-week moving average. A decisive break below this line could lead to a test of the 50-week moving average around 2,450. Broadly speaking, this area offers resistance and support going back to pre-recession 2008, and should be watched carefully.

Emerging Markets



Emerging markets have remained flat since the middle of January, trading in a narrowing band which has traced out a pennant or wedge, a pattern which technicians view as evidence of indecision. This lack of direction is also visible in the tightening Bollinger bands, a move that reflects decreasing volatility.

Wedges and narrowing Bollinger bands typically lead to major moves either up or down, and an accompanying increase in volatility.

There are troubling signs of weakness here: The price has fallen below the 20-week moving average, which now acts as resistance, and the trend indicators have turned down. An open gap at 42 beckons, signaling that the price could dip down to fill that gap.

There's not much bullish evidence here, and plenty to signal caution.

Gold



Precious metals -- including gold, silver and platinum -- have all registered strong gains. This run had led some observers to discern a speculative bubble in gold and silver. A glance at this chart finds little evidence for speculative extremes. Instead, it shows firm and steady growth, even though the price dips down to test the trendline from time to time.

The moving average convergence divergence (MACD), an indicator used to calculate buy and sell signals, remains bullish as well. Gold could suddenly reverse and crash -- that's always a risk in any open market -- but there is precious little technical evidence that such a crash is imminent.

Bonds



As might be expected when stocks swoon, Treasury bonds -- here represented by the TLT bond fund -- have gained. Both the MACD and the lower Bollinger band in this chart have turned up, signaling a trend reversal from a previous decline. Prices have reached the 20-week moving average, and a breach above this line would help confirm that an uptrend is taking hold.

In the past few years, when equities slide, bonds have outperformed. Conversely, when stock have roared ahead, bonds have slipped. Is that historical correlation holds true, bonds may be expected to strengthen if stocks fall into a pronounced downtrend.

The U.S. Dollar



Like bonds, the dollar acts as a so-called "flight to safety" or "safe haven" when stocks swoon. The dollar has risen sharply in stock downturns, topping out when the stock market bottoms. Prices have fallen to support -- meaning they seem to have bottomed out -- around 76, potentially tracing out a bullish double-bottom pattern.

The psychology of a double bottom is common sense: If the price holds at previous lows, investors believe that "the bottom is in" and the coast for gains is now clear.

A Stochastics reading, which compares the current price to historical prices, indicates that the dollar has been deeply oversold and suggests that investor sentiment has reached its lowest point. That bearish climax means that a reversal is likely, as the market rarely rewards the majority for holding the same position as everyone else.

Once again, stocks and the dollar are on a seesaw: If stocks slip, the dollar tends to rise in value.

Oil and Other Energy



The XLE energy ETF's chart clearly displays the extraordinary run that oil has experienced in the past seven months. The indicators have turned down, mirroring the recent weakness in price, which is testing the trendline. Despite this recent decline, prices remain well above the moving averages, which means that energy is still in an uptrend.

No market advances in a straight line forever, so some pullback would be natural. Is this the first step in a major trend reversal, or merely a pause that refreshes the oil bulls? That is impossible to say just yet. Some significant level of support, such as the 20-week moving average, would have to be broken to truly call the uptrend into question. It would not be surprising for price to dip down and test this support, as those who have profited handsomely from this bull run pocket some gains.

But any market that has climbed this far this fast bears close monitoring.

No market is immune to risk and uncertainty, of course. Markets that look strong can suddenly reverse, while those that look sickly can suddenly rebound. Still, a watchful analysis of trends and market correlations can offer investors some clues about risk and potential returns in these uncertain times.

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]]>bollinger bandsDXYEEMemerging marketsEnergyenergy stocksETFetf investingETFsGLDgoldInvestinginvesting in goldmoving averagesNASDAQoilpennant patternstock markettechtech stockstechnical analysistechnologytechnology stocksTLTtreasury bondstrendlinetrendsU.S. dollarXLECharles Hugh SmithTue, 15 Mar 2011 15:00:00 ESTA Breakout Is Likely -- but in Which Direction?http://www.dailyfinance.com/2011/03/10/stock-market-breakout-likely-but-in-which-direction/http://www.dailyfinance.com/2011/03/10/stock-market-breakout-likely-but-in-which-direction/http://www.dailyfinance.com/2011/03/10/stock-market-breakout-likely-but-in-which-direction/#commentsFiled under: , , , ,

A variety of technical signals are suggesting we're at a crucial decision point for the stock market: Either the bull recovers from its recent swoon and moves decisively up toward new highs, or the market reverses trend dramatically and moves down.

Although many market observers dismiss technical analysis as unscientific speculation more akin to astrology than math-based quantitative analysis, those skeptics are missing the point: Technical analysis isn't rooted in brute-force matching of curve sets, it's rooted in human psychology. Levels of resistance and support are not mathematical certainties -- they reflect the human psychological tendencies toward greed and fear.

When the market finally recovers a key level, for example, those investors who have grown weary of being underwater simply want their initial capital back, so they sell. This creates resistance. When the market declines, those who have reaped gains from buying during previous dips will jump in and buy more stock at what they perceive as "bargain" prices. This creates support.

And proponents of number-crunching quantitative analysis shouldn't be too cocky about their tool of choice: Quant analysis is based on past price action and patterns just like technical analysis. Just because a math-derived curve set matches recent price action does not preclude the unexpected from happening. This is why quant-based funds such as Long-Term Capital Management tend to self-destruct when markets trend strongly in unpredictable ways.

There are a lot of crosswinds in the market right now. Gains in retail sales and jobs are trends that support a bullish stance, while rising oil prices, food inflation and geopolitical uncertainty are giving credibility to a more cautious or even bearish perspective.

Warnings from Carl Icahn and Bill Gross

Small investors often look to highly successful "superstar" investors for hints on where the market is heading, and two recent news items about such big names have provided solid support for the bear camp: Legendary investor Carl Icahn has dissolved his hedge fund and is returning its capital to shareholders, citing the risk of another financial crisis. And famed bond manager Bill Gross has reduced the Treasury bond holdings of the world's largest bond fund, Pimco's Total Return Fund, to zero. The amount of cash the fund holds has swollen from $11 billion to more than $54 billion, its largest cash position ever.

There isn't any other way to interpret this except as a multibillion-dollar bet against the Federal Reserve's reassuring stance that inflation will remain tame for years to come. If you fear inflation might accelerate, the last investments you want to own are long-term, low-yield bonds that will instantly lose money if interest rates start rising.

Some analysts also interpret this move as an expression of doubt that the Fed will launch a massive third round of quantitative easing in June when the current QE2 campaign is scheduled to end. The Fed's ongoing $600 billion quantitative easing program is widely regarded as having strongly supported the rising equity markets.

As for the rising retail sales numbers, part of those "gains" can be attributed to rising costs: People and businesses are paying more than before for the same goods. If households are spending borrowed money again, that's not a sign of strength -- it's a sign of weakness in the household balance sheet. Consumers turned on the credit card spigot again in December, and they've loaded up on car loan debt this year.

What analysts should be looking at is whether household incomes are rising. Unfortunately, the answer is clear: Wage earners aren't benefiting much from the recent strong gains in productivity.

In an economy based on consumer spending, stagnant household incomes don't provide a strong foundation for future spending increases.

As for stock valuations, by at least one analyst's reckoning, many stocks are at all-time highs. Does the underlying economy support sky-high stock valuations? That's an open question, and one the market is obviously pondering.

To round out the backdrop for the market's current indecision, let's look at these two log-term charts of the S&P 500 and the Nasdaq.

The Nasdaq has retreated from the highs last reached in 2007, following a pattern that looks a lot like a classic "double top."




The S&P 500, meanwhile, traced out a massive double top pattern earlier in the decade. Its rapid ascent from the 2009 lows has been far more robust than the recovery in the overall economy, a disconnect that the current market queasiness reflects.



Now let's look at the daily chart of the broad-based S&P 500 (SPX).



The push and pull of hope and doubt is visible in the wedge (also called a flag or pennant) that has been traced out over the past three weeks. This is a classic wedge of lower highs and higher lows as prices are squeezed into a narrowing band of volatile swings.

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Wedges are typically broken by big moves either up or down. A collapse in oil prices or a strong jobs report might provide the catalyst for an upside breakout, while accelerating inflation, a further rise in oil prices or a weaker-than-anticipated jobs report might trigger a breakdown and a trend reversal.

The 1,300 level offers both a psychological and technical support -- a round number and the 50-day moving average. Any sustained break below 1,300 would signal a possible trend reversal.

The bull has stumbled recently. For it regain its footing, the market would need to climb above the 20-day moving average (MA) and then retest recent highs around 1,343.

The two-month chart of the Nasdaq offers an interesting technical snapshot of indecision: As fear that the rally is over takes hold, the market drops significantly. Then as "bargain-hunting" and hopefulness return, it moves back up to the 2,800 level. But then by day four or five, doubt returns with a vengeance, and the market plummets again only to retrace back up to the 2,800 zone of resistance a few days later.



Now that pattern is breaking down: Price has failed to climb back above the critical 20-day moving average even as it has turned down, and is now clinging precariously to the key 50-day moving average. A break through the 50-day MA would be technically significant.

Nobody knows what the market will do tomorrow, much less three months or three years from now. But to the degree that markets reflect the emotions and calculations of its human participants, the current indicators of doubt and indecision deserve careful watching.

Disclosure: The writer has a small position in ProShares UltraShort QQQ (QID), an inverse ETF on the NASDAQ 100.


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]]>bear market forecastbear market outlookBill Grossbondsbull market forecastbull market outlookCarl Icahnfear and greedFederal Reserveinvestor psychologymoving averagesNASDAQproductivityquantitative analysisquantitative easingSP 500stocksT-BillsTechnical Analysistreasury bondsUS TreasuriesCharles Hugh SmithThu, 10 Mar 2011 06:30:00 ESTWill China's 'Have-Nots' Be Next to Rebel?http://www.dailyfinance.com/2011/03/09/will-chinese-poor-be-next-to-rebel/http://www.dailyfinance.com/2011/03/09/will-chinese-poor-be-next-to-rebel/http://www.dailyfinance.com/2011/03/09/will-chinese-poor-be-next-to-rebel/#commentsFiled under: ,

Will China's 'Have-Nots' Be the Next to Rebel? China, the planet's most populous country and home to one of its most dynamic economies, is in most respects a world away from the smaller, less influential, oil-dominated nations in the Mideast currently boiling with anti-government unrest.

But beneath the obvious differences, China faces some similar issues: rapidly rising inflation in food and other essentials, and a troubling gap between the financial and political "haves" and the far more numerous "have-nots."

These developmental issues aren't lost on China's leadership, which recently announced major initiatives to tame inflation and narrow the gap between those who have grown wealthy during the nation's remarkable rise and those primarily rural citizens who've been left behind.

Considering where China started in 1978 -- without much industry or opportunity for its then nearly 1 billion citizens -- its rapid ascent has been remarkable, lifting hundreds of millions of people out of poverty in a mere generation. But the same forces that turned China's economy into a juggernaut have created an enormous gap between the wealthy and the typical worker -- a gap that could fuel dissatisfaction with the central government.

Extreme Wealth Concentrated at the Very Top

Chinese Premier Wen Jiabao opened the annual gathering of the National People's Congress last week by announcing a campaign to reduce China's wealth gap. That divide is uncomfortably on display in the People's Congress itself: The richest 70 of its 2,987 members have a combined wealth of 493.1 billion yuan ($75.1 billion), according to the research group Hurun Report.

By contrast, the wealthiest 70 people in the 535-member U.S. Congress have a combined wealth of $4.8 billion, according to the Washington-based Center for Responsive Politics. Factor in that America's per capita income is roughly 10 times greater than China's, and you get a feel for the depth of China's wealth divide.

China's Gini coefficient, an income-distribution gauge used by economists that ranges from 0 (perfect equality) to 1 (complete inequality), has climbed to near 0.5 from less than 0.3 a generation ago, according to Li Shi, professor of economics at the School of Economics and Business at Beijing Normal University. Levels of inequality above 0.4 are widely considered a predictor of social unrest. (The U.S. has a Gini coefficient of 0.46, compared to 0.31 for the European Union.)

One way to narrow the gap is to increase the minimum wage, a move analysts at Credit Suisse expect China's regional governments to take in 2011. A boost of the minimum wage in 2010 helped raise rural incomes by 10.9% that year. That increase hasn't necessarily translated into higher disposable income, however, as skyrocketing inflation and home prices have sapped households' purchasing power.

Savings System Is Stacked Against Workers

Changes in the labor market are helping factory workers earn more, but the improvements aren't necessarily helping new college graduates, whose wages have stagnated to the point that some are earning less than migrant workers in factories. A shortage of migrant workers in key industrial cities has also fueled higher wages for factory workers.

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Though profits and GDP have been surging over the past decade as China's productivity improved, these gains have not trickled down to the workers' paychecks. According to the National Development and Reform Commission, incomes kept pace with profits and GDP in only three of China's 27 provinces.

Victor Shih, an associate professor of political science at Northwestern University in Illinois, has suggested in an article in international current-affairs magazine The Diplomat that the basic makeup of China's economy and political structure is creating a nation of haves and have-nots. Shih sees the government's tight control over yields on savings accounts and lending rates as one cause of rising inequality: As inflation accelerates, China's savers are losing money because the return on savings is lower than the rate of inflation. Negative returns on savings are a stealth tax on China's households and a subsidy to the government-owned banks.

The banks then turn around and loan money to politically connected real estate developers and government-owned enterprises at interest rates that are near zero in inflation-adjusted terms. "In effect," Shih writes, " the Chinese financial system channels wealth from ordinary households to a small handful of connected insiders and state-owned firms."

Leadership Faces a Thorny Dilemma

Another source of wealth inequality stems from the substantial cash payments made to insiders and top managers that go unreported in regular channels -- so-called "grey income." These large cash payments are considered "commissions" or "bonuses" in China, but by Western standards, they would widely be considered as bribes and payoffs.

A Credit Suisse survey of urban households in China found that $1.5 trillion in grey income had gone unreported in the official household income numbers. About 60% of this grey income flowed to the top 10% of households. According to Shih, while income of typical households rose 8%, the top 10% saw their incomes leap by 25%

The net result of these structural imbalances, in Shih's view, is a China that is "increasingly splitting into a small upper class that spends freely on luxury goods, and a remaining population whose earnings and savings are eroded by inflation and state confiscation."

The Communist Party leadership is keenly aware of the discontent created by widespread corruption and rising prices. Premier Wen named illegal land seizures, food safety, housing price increases and corruption as evidence that institutional changes are needed to end excessive concentrations of power. And he said combating inflation is China's top economic priority in 2011.

Taking No Chances

That will be easier said than done, however. China's leadership is on the horns of a dilemma: If it continues pumping up rapid growth, it will inevitably feed inflation, while if it raises interest rates and curbs lending to limit inflation, that will restrain overall growth.

In the meantime, China's autocratic government isn't taking any chances with social unrest. Recent crackdowns on Internet activity and foreign journalists are highly visible signs of the central government's resolve to head off any anti-government unrest.

But suppression of the media and dissent will only go so far. China's leadership knows it has to effectively tackle the thorny issues of rising inflation, widening wealth inequality and corruption -- and soon, because the aspirations of its people cannot be returned to where they were in the low-opportunity days of 1978.

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]]>BeijingbribesChinaChina real estate bubbleChinese middle classChinese social unrestChinese wealth gapColumnscorruption in ChinaGini Coefficientgrey incomeincome inequalityinflation in Chinaminimum wagePremier Wen Jiabaorural poorstealth taxwealthyuanCharles Hugh SmithWed, 09 Mar 2011 06:30:00 ESTPublic Employee Benefits: The Numbers Behind the Debatehttp://www.dailyfinance.com/2011/03/02/public-employee-benefits-economic-trends/http://www.dailyfinance.com/2011/03/02/public-employee-benefits-economic-trends/http://www.dailyfinance.com/2011/03/02/public-employee-benefits-economic-trends/#commentsFiled under: , , , ,

Setting aside the politically sensitive aspects of the ongoing national debate over public workers' benefits, we can learn a lot from a fundamental economic analysis of one city's pension and health care costs.

Before we get to that specific analysis, more broadly, growth in the overall economy as measured by GDP is the basis for higher incomes and higher taxes. If GDP is flat, then household incomes are also flat. If the government increases taxes by more than the growth rate of the GDP, it's virtually certain to crimp household disposable income.

Below is a graph of U.S GDP growth since 2000. Adjusted for inflation, the U.S. economy grew smartly between 2001 and 2007 -- 35% -- and then went flat. In constant dollars, U.S. GDP in 2010 was almost precisely the same as it was in 2007: $13.363 trillion in 2007 and $13.382 trillion in 2010.


But household income hasn't even been treading water -- it has declined. According to the Census Bureau, real median household income in 2009 was $49,777, a 5% decline from its 1999 peak of $52,388 (adjusted for inflation).

To keep the U.S. economy afloat, the federal government has borrowed and spent extraordinary sums of money. As I recently reported on DailyFinance, federal spending has leaped by about $1 trillion since 2007. The national deficits of the past three years and the estimated shortfalls for fiscal years 2011 and 2012 exceed $6 trillion.

2008: $458 billion
2009: $1.4 trillion
2010: $1.3 trillion
2011: $1.5 trillion (CBO est.)
2012: $1.6 trillion (est.)

But without this infusion of federal spending, U.S. GDP would have declined, as indicated by the red line on the chart.

Clearly, the macroeconomic backdrop hasn't been conducive to higher wages or increased tax revenues.

States and Local Government Face Structural Shortfalls

Combine a flat economy and declining household incomes with state and local government costs that keep rising, and the result is a structural disconnect between revenues and expenses. The nonpartisan Little Hoover Commission closely examined the finances and governance of public pensions in California, and it recently issued a 100-page report on this long-term structural disconnect between expected pension revenues and state revenues, and pension expenses.

So, let's take a closer look at Berkeley, Calif., home of the University of California at Berkeley, as a typical representative of other "town-gown" college cities in the U.S. (For context: Berkeley's population is about 102,000, while Madison, Wis., has about 235,000 residents.)

While these numbers may be higher than your local city, county and state figures, they track national trends in public pension and health care costs.

In Berkeley, pensions for retired city workers will cost about $32.7 million in fiscal year 2013 and rise to $41 million by 2016. Those figures are up from about $2 million in 2000.

Clearly, pension costs are rising significantly faster than GDP. Even if we assume the $2 million pension costs in 2000 were significantly under what should have been contributed and push that starting point up to $10 million (the light-blue line), the trend doesn't really change: Pension costs are still rising steeply while GDP is either flat (including unprecedented federal borrowing and spending) or declining (if we factor out the massive federal spending).

Public employee health care costs have been rising an average of 11% per year in the decade since 2000.

Here's what happens to $1 in health care spending when costs increase 11% per year:

$1 (2001)
1.11
1.23
1.37
1.52
1.69
1.87
2.08 (2008)
2.3
2.56
2.84
$3.15 (2012)
3.5
3.88
4.31
$4.78 (2016)

At this rate of growth, costs triple by 2012 and almost quintuple by 2016, which illustrates the fundamental problem: Revenues are flat due to a slow economy, while costs are rising at a rate far exceeding that of the general economy.

Willie Brown, a staunch union supporter and former California legislative leader and San Francisco mayor, recently wrote in the San Francisco Chronicle:
People constantly ask how we wound up in this mess. The answer is, we are all to blame. There was no way we [political leaders] should have agreed to guaranteed fixed-amount pensions and health care packages without takebacks that would have triggered if the economy went bad. And the public also needs to shoulder some of the blame for voting repeatedly to expand retirement benefits, especially health benefits for government workers and their families, which are turning out to be an even more expensive problem than pensions.
The other backdrop to today's benefit crisis relates to the relative performances of the stock market during two key periods. In the later half of the 1990s, the markets outperformed, and many pension and benefit plans modified their contribution regimens based on projected annual stock market growth rates of 8% -- forever. But the market has underperformed since the 2000 peak, and after a decade of those weak returns, it's no surprise that pension funds are facing shortfalls.



Adjusted for inflation, stock returns since 2000 have been negative, even counting dividends. The S&P 500 index has declined from over 1,500 in 2000 to around 1,300 in 2011 -- a 13% decline that must be added to a reduction in purchasing power (inflation) of another 28%. Not counting dividends of around 2% a year, that's a decline of 41%. Just to stay even with inflation, the S&P 500 would have to be above 1,900 now.

A 2% annual dividend yield compounded since 2000 turns $100 into $124.34. So buy-and-hold pension funds have experienced a 24% gain based on dividends since 2000, but a 41% loss in equity value, resulting in a net 17% loss. A 2% (inflation-adjusted) growth rate in the real economy compounds to a 24% increase over 11 years -- but that 11% annual increase in employee health care costs discussed earlier compounds into a 315% increase.

And there, where those two macroeconomic forces collide, lies the heart of the debate over public workers' benefits: Not in "greedy" unions or "heartless" union-busters, but in the stock market's underperformance (plus some absurdly optimistic planning assumptions) and the rapid growth of health care costs.

If we as a nation can't trim the growth rate of health care costs to match the growth rate of the economy, we'll face a structural financial problem that won't go away.

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]]>balanced budgetberkeley californiaCBOColumnscontributionsemployee healthcare costsGDPGreat Recessionhealth carehealth care costshealthcare costsinflationLittle Hoover Commissionmacroeconomicsmadison wisconsinpublic employee benefitspublic employee healthcarepublic pension debatepublic pensionsreducingstock market returnstrendsWillie BrownCharles Hugh SmithWed, 02 Mar 2011 10:30:00 ESTWe're No. 1 (and No. 3)! Surprising Facts About the U.S. and Oilhttp://www.dailyfinance.com/2011/02/28/surprising-facts-about-us-and-oil/http://www.dailyfinance.com/2011/02/28/surprising-facts-about-us-and-oil/http://www.dailyfinance.com/2011/02/28/surprising-facts-about-us-and-oil/#commentsFiled under: ,

California oil wellWith the price of oil fluctuating around $100 per barrel, here's a timely question: Where does America get its oil? Some of the answers might surprise you.

All of the data here are derived from the U.S. Department of Energy's Energy Information Administration (EIA), which is treasure trove of data on global energy. For example, Libya has the largest proven reserves of oil in Africa.

Let's start with America's oil consumption, which is 18.8 million barrels per day (MBD), according to the EIA. That usage puts the U.S. atop the list of the world's largest oil consumers by a wide margin. Indeed, U.S. demand is more than that of the next four nations combined: Japan, Russia and rising economic powers China and India:

U.S : 18.8 MBD
China: 8.3
Japan: 4.4
India: 3.1
Russia: 2.7

Who's Pumping What

What countries are the top producers of oil? The answer provides an important context for any discussion of oil supply:

Russia: 9.9 MBD
Saudi Arabia: 9.7
U.S.: 9.1

Are you surprised that the U.S. is still the No. 3 producer of oil in the world? The U.S. produces roughly the same amount of oil as Canada, Mexico and the United Arab Emirates combined (No. 6, 7 and 8 on the top producers list). That means the U.S. supplies 48.6% of its consumption while it imports 51.4% of consumption, or 9.67 MBD, from oil-exporting nations.

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Given that total global production of oil is 85.5 MBD and total consumption is 85.6 MBD, the U.S. by itself consumes 22% of the world's oil supply.

You may have noticed in the above chart that the EIA lists both "crude oil production" and "total oil production" in the U.S. Crude oil production is 5.36 MBD, a number that has remained stable for the past few years. The EIA also has a chart that lists oil production by region and state. The data contain all sorts of interesting tidbits -- for example, crude oil production in North Dakota has risen from 85,000 barrels a day in 2004 to 218,000 barrels a day in 2009. California still produces 567,000 barrels a day, and Texas pumps 1.1 million barrels day, about the same amount the U.S. imports from Saudi Arabia.

The EIA states that total U.S. production is 9.14 MBD, considerably more than the 5.36 MBD listed for crude oil alone. What's the source of the discrepancy? The EIA lists other sources, such as "Natural gas plant liquids."

Geopolitical Diversity

So where does the U.S. get the 9.67 million barrels a day of oil we import? It turns out our biggest suppliers are North American neighbors.

From:
OPEC: 4.67 MBD
The Persian Gulf: 1.67
Non-OPEC: 5

From:
Canada: 2 MBD
Mexico: 1.2
Saudi Arabia: 1
Nigeria: 1
Venezuela: 0.82
Iraq: 0.33
Angola: 0.30
Brazil: 0.27

The U.S. imports oil from a geopolitically diverse array of nations: The Persian Gulf, Africa, South America and North America. Interestingly, the U.S. draws relatively little oil from the world's top producer, Russia.

The silver lining, if there is one, in the trend toward higher oil prices is that America obtains a modest percentage of its imported oil imports from countries, such as Libya, experiencing political turmoil and instability. However, the U.S. relies on other nations for more than half its oil supplies, a potentially unstable dependence in an increasingly unstable world.

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]]>CanadaColumnsEIAEnergy Information AdministrationLibyaMexicooiloil consumptionoil importsoil pricesoil productionoil usageSaudi Arabiatop oil consumerstop oil producersCharles Hugh SmithMon, 28 Feb 2011 16:15:00 ESTWhat Are We Getting for an Extra $1 Trillion in Federal Spending?http://www.dailyfinance.com/2011/02/28/what-are-we-getting-for-an-extra-1-trillion-in-federal-spending/http://www.dailyfinance.com/2011/02/28/what-are-we-getting-for-an-extra-1-trillion-in-federal-spending/http://www.dailyfinance.com/2011/02/28/what-are-we-getting-for-an-extra-1-trillion-in-federal-spending/#commentsFiled under: ,

U.S. Capitol building with American flags As every constituency fights to protect its herd of sacred cows, there's certainly no shortage of political jockeying in the battle over the 2012 federal budget. What's missing, however, is this simple question: What exactly are we getting for the extra $1 trillion a year the federal government is now spending?

Few commentators bother to look back three years and compare federal spending in 2007 with that of 2010. Remarkably, Washington spends $1 trillion more a year now than it did a mere three years ago. Here are the numbers from the Office of Management and Budget website (I include the 2004 figures for context):

2004 -- Revenues: $1.88 trillion. Spending: $2.29 trillion. Deficit: $412 billion
2007 -- Revenues: $2.56 trillion. Spending: $2.72 trillion. Deficit: $160 billion
2010 -- Revenues: $2.16 trillion. Spending: $3.72 trillion. Deficit: $1.3 trillion

In the three years from 2007 to 2010, federal spending jumped almost exactly $1 trillion, or 36.7%.

Here are the deficits of the past three years and the estimated shortfalls for fiscal years 2011 and 2012:

2008: $0.5 trillion
2009: $1.4 trillion
2010: $1.3 trillion
2011: $1.5 trillion (est.)
2012: $1.6 trillion (est.)

Total: $6.26 trillion in five years

Publicly Held Debt Jumped 80%

And this isn't even the real total being added to the national debt because "supplemental appropriations" for war costs and other large expenditures are "off-budget" and not included in the "official" federal deficit. The same is also true of funds appropriated to bail out mortgage giants Freddie Mac and Fannie Mae and other financial institutions.

Gross debt increased by $1 trillion in fiscal year 2008, $1.9 trillion in 2009 and $1.7 trillion in 2010 -- considerably higher than the "official" deficit numbers. Debt held by the public, which includes Treasury bonds owned by the central banks of China, Japan and other countries, jumped 80% from $5 trillion in 2007 to $9 trillion in 2010.

As I reported on DailyFinance in January, these additional trillions in debt will eventually trigger unwelcome consequences for the nation.

It's sobering to realize that federal spending has leaped $1.5 trillion -- a staggering 60% -- in just six years, from 2004 to 2010, and $1 trillion --36% -- just since 2007. Though the Great Recession officially ended in mid-2009, federal deficits just keep going up.

Meanwhile, the U.S. economy has been treading water. In inflation-adjusted dollars, U.S. GDP in 2010 was almost precisely the same as it was in 2007: $13.363 trillion in 2007 and $13.382 trillion in 2010.

An Opaque Tangle

So what is America getting for this extra $1 trillion in federal spending a year?

I'd like to report a straightforward answer, but the truth is the budget is an opaque tangle of questionable estimates, off-budget expenditures and numbers that have been sliced and diced in so many different ways that it's essentially impossible to sort out what we're actually getting for this extraordinary outlay of tax revenues and borrowed money.

For example, one of the best graphics depicting the entire federal budget (prepared by The New York Times) includes the Department of Energy in its calculation of the Defense budget because Energy handles the production and research and development of America's nuclear weapons. Other sources leave Energy as a stand-alone agency.

Still, if we cut through the thicket of often-conflicting statistics, we can assemble some basic answers.

No Help From the Great Recession

First, let's factor in inflation from 2007 to 2010: According to the Bureau of Labor Statistics, that accounts for 5% of any change. So, $50 billion of that $1 trillion a year can be attributed to inflation.

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Next, let's consider the consequences of the Great Recession: extended unemployment costs and food stamps (now called SNAP, for Supplemental Nutrition Assistance Program).

In 2007, SNAP cost around $30 billion. In 2010, that rose to $68 billion as the number of people receiving SNAP benefits rose by 15.6 million people, or 57%, to 43.2 million in October 2010. So, costs rose $38 billion in those three years.

The cost of continuing unemployment extensions is estimated at $65 billion. According to The New York Times graphic, total unemployment program costs in 2010 were $158 billion.

So together, these two recession-related programs cost about $100 billion more a year.

The $787 billion stimulus package passed by Congress in 2009, the American Recovery and Reinvestment Act of 2009, is being spent over several years: $154 billion in 2009, $353 billion in 2010, $232 billion in 2011 and the remainder over 2012 and beyond.

$650 Billion Still Unaccounted For

Roughly speaking, that averages to about $250 billion for each of the recession years, but it doesn't affect the 2012 federal spending plan much.

So where is the $1 trillion a year going? Around $350 billion a year can be attributed to recession-caused spending: extended unemployment, SNAP and the stimulus package.

That still leaves $650 billion unaccounted for, and it doesn't address the 2012 budget, which isn't much influenced by the little remaining stimulus spending.

According to the sources listed above, the following major federal programs saw significant increases between 2007 and 2010:

Medicaid -- 2007: $276 billion. 2010: $293 billion (+17 billion).
Medicare -- 2007: $395 billion. 2010: $462 billion (+67 billion).
Social Security -- 2007: $586 billion. 2010: $724 billion (+138 billion).
Defense -- 2007: $548 billion. 2010: $663 billion (+115 billion). Other sources list $699 billion in 2007 and $738 billion in 2010.

These increases in the federal government's biggest four programs come to $337 billion.

TARP and Total Interest Aren't the Culprit

The other recession-related cost is the Troubled Asset Relief Program (TARP), the $700 billion bailout of Wall Street and banks, which expired last year. As noted above, the ongoing costs to bail out Fannie Mae and Freddie Mac, as well as other financial institutions, is off-budget and thus the tens of billions of losses being funded by taxpayers isn't even included in these official budget figures.

The Congressional Budget Office estimated last summer that the final cost of TARP to taxpayers had fallen to around $66 billion because many banks had repaid their government loans. Divided over 2008, 2009 and 2010, that would account for roughly $22 billion per year.

How about interest on the national debt? The interest paid on external (non-intergovernmental) debt has declined from $189 billion in 2009 to $164 billion 2010 as interest rates have fallen to historic lows, so that's not the cause of higher spending.

The recession-related costs and the growth of the four major federal programs come to about $710 billion. Factor in the increase attributed to inflation, and the total rises to about $750 billion.

The other $250 billion of the $1 trillion increase from 2007 to 2010 is spread over the dozens of other federal agencies and programs.

What We Could Get for $1 Trillion

What's troubling about the 2012 federal budget is that it remains $1 trillion higher than budgets just a few years ago, but the recession-related spending on TARP and the stimulus will be history.

So, back to our original question: What are we getting for $1 trillion in additional spending?

One way to grasp how enormous is this sum is to imagine what else it could pay for. It could have paid off all of the $830 billion of outstanding student loans in the U.S., for instance, and left $170 billion to spend -- about the size of Ireland's entire GDP, or enough to fund the Veterans Administration ($122 billion) and the Department of Transportation ($43 billion), combined.

Instead, all we're getting for our $1 trillion in additional spending and $1.5 trillion in additional debt in 2012 is a continuation of the status quo.

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]]>CBOfederal budgetfederal budget deficitFederal spendingnational debtoff budgetOMBrecessionsnaptarpunemployment benefitsCharles Hugh SmithMon, 28 Feb 2011 10:35:00 ESTLibya Isn't the Only Force Working Against Stockshttp://www.dailyfinance.com/2011/02/24/stock-market-outlook-technical-analysis-bear-market-warning/http://www.dailyfinance.com/2011/02/24/stock-market-outlook-technical-analysis-bear-market-warning/http://www.dailyfinance.com/2011/02/24/stock-market-outlook-technical-analysis-bear-market-warning/#commentsFiled under: , , , ,

Searching the stars for signs of the futureThis week's violent upheavals in Libya and the resulting spike in crude oil prices not only contributed to a nearly 300-point, two-day swoon for stocks, they also raised fears of further turmoil and market declines. That makes it a good time to look at some basic charts and see what price levels may become important "lines in the sand" for investors in the near future.

As I noted in a DailyFinance column back in late December, various indicators such as interest rates and the Baltic Dry Index were flashing warning signs that the explosive rally the market had been experiencing since September was about to run into some headwinds. There's nothing fancy about the basic risk: Any rally that produces such dizzying gains in such a short span of time (see chart below) is vulnerable to a weakening of the euphoria that powered it.

One market truism -- not a law of nature, just an observation by technicians -- is that markets tend to exit a trend the way they entered it. If prices leaped up in a fast ascent, their fall tends to be just as steep. The same is true of sharp drops -- they are often followed by equally sharp recoveries.

We can see the near-vertical climb since September 2010 in the 10-year chart of the Nasdaq stock market.



Here's another observation that should give investors pause: The market has reversed at right around the same level as the 2007 peak. If the Nasdaq fails to rebound and climb decisively to a new high, this becomes a double-top -- a bearish technical signal that the current rally has topped out and reversed.

This theory on reversals is also valid at bottoms: When a market tests a recent low and holds as it did in late August 2010, forming a double-bottom, that's a good bullish signal.



Moving Average Predicts Serious Weakness

Technical analysis isn't a crystal ball: It provides us with models of what might happen, not predictions.

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There are obvious lines of support that should the market keep sliding too far: The band around 2,550, which was the peak reached in April 2010, also offered resistance back in 2008. Now that the Nasdaq has broken out above that level, it provides some strong support. Below that, the 200-week moving average (MA) established long-term support between 2,335 and the 50-week MA of 2,430.

Looking at the one-year chart of the Nasdaq market, we see it's currently clinging precariously to a 50-day moving average of 2,720. Though two previous dips tested the 20-day moving average, this is the first instance since the rally began in September that price has broken below the 50-day MA. That suggests this period of weakness is more severe than previous outbreaks of nervousness.

That zone around 2,550 -- the level at which the market broke out to new highs -- is a major line in the sand. If the Nasdaq breaks down below that, it could be a harbinger of further declines. On the other hand, a sharp rebound back above 2,800 and a retest of previous highs would show the bull was only taking a brief breather.

The Dollar as an Inverse Indicator

As my DailyFinance colleague Joseph Lazzaro recently reported, the U.S. dollar has had some significantly bullish tradewinds filling its sails this year. As this 10-year chart of the DXY (dollar index) shows, this hasn't been positive for the U.S. stock market, as the dollar has been moving inversely to the stock market for most of the past decade.



While stocks steadily rose with only a few hiccups from late 2002 to mid-2008, the dollar declined by some 36%. Then, as panic struck the global financial markets in late 2008, the dollar rebounded strongly and stocks tanked.

While the inverse correlation isn't perfect, it's still significant: When stocks fell hard in May 2010, the dollar popped up. As stocks recovered, the dollar declined.

On this 10-year chart of the dollar, we see a distinctive uptrend since 2008, marked by higher lows. If the inverse correlation of the dollar and stocks holds -- and there is no guarantee it will -- then that slow, grinding rise in the dollar may be signaling a long-term headwind against further stock gains.

In a market that has showered strong gains on bulls, common sense -- and the technical indicators -- suggest that investors would be wise to set stop-loss orders now to protect profits and secure portfolios against further declines.

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]]>bear marketbull marketColumnscrude oildollar stocks see-sawdouble bottomdouble topegypt protestsforecastlibyalibya protestsmoving averageNASDAQoutlookPredictionspricesresistancestock market rallysupporttechnical analysisU.S. dollarwarningCharles Hugh SmithThu, 24 Feb 2011 11:00:00 ESTTrapped: The Fed Has Painted Itself Into a Cornerhttp://www.dailyfinance.com/2011/02/23/trapped-the-fed-has-painted-itself-into-a-corner/http://www.dailyfinance.com/2011/02/23/trapped-the-fed-has-painted-itself-into-a-corner/http://www.dailyfinance.com/2011/02/23/trapped-the-fed-has-painted-itself-into-a-corner/#commentsFiled under: , , , , ,

Fed Chairman Ben BernankeAs prices for commodities such as cotton, sugar and grains skyrocket, many financial commentators have been pointing the finger at Federal Reserve Chairman Ben Bernanke's "easy money" policies of zero interest rates (ZIRP) and quantitative easing (QE2) as a major cause.

The Fed intended these two policies to lower long-term interest rates and to nudge investors into riskier assets, thus stimulating growth. At least one part of that strategy is working. By lowering the yields on traditional financial investments such as bonds to near-zero, the Fed has essentially forced trading desks and hedge funds to scour the globe for higher yields.

Many traders and investors have found that higher yield in commodities, which is where speculative money is now flowing in abundance, helping to push up prices. Because the price of wheat, for example, is roughly the same everywhere in a global market, these rapid price increases are destabilizing poorer countries where much of household income is devoted to food.

Charges and Countercharges

Global demand for many commodities is outstripping supply, and that imbalance is a key factor in higher prices around the world. But a global economy awash in low-interest, speculative "hot money" seeking higher yields is further fueling imbalances.

Fed officials have faced pointed criticism from nations such as China and Germany, which see the Fed's policies as firing up inflation and suppressing the U.S. dollar. Fed Chairman Bernanke has countered these charges by identifying the problem as one of currency valuations. He suggests that other nations should offset rising commodity prices by letting their currencies climb in value.

Bernanke's protests, however, have a hollow ring: Clearly, skyrocketing commodity prices aren't just a currency-trade issue. For example, consider this cotton-price chart, which has "gone parabolic." Can anyone seriously claim that the "solution" to this situation is for China to allow its currency, the yuan, to appreciate? Is the yuan the real cause of wheat and corn both shooting up 80% in 2010?



The reason why Bernanke's claim is so transparently nonsensical is that commodities are rising everywhere, not just those originating in China. Despite official assurances that inflation in the U.S. is now running at a modest 0.7% annually, by one measure, it's actually hitting an annual rate of 2.5%. By another, it's already a white-hot 10.6%.

This chart shows how rising prices are built into the supply chain, with the result being costs of intermediate and crude goods are rising smartly.



Inflation is running hot around the world, not just in China and the U.S. This also suggests that the issue isn't one that can be resolved with currency adjustments.

Even though inflation appears to be lower in the U.S. than in other major economies, it's hitting the average U.S. household hard because wages aren't rising along with prices. Indeed, according to the U.S. Census Bureau, real median household income in 2009 was $49,777, a 5% decline from the 1999 peak of $52,388 (adjusted for inflation).

This is in marked contrast to nations such as China, where workers are gaining substantial raises (21% in Beijing, for example), to counter rapidly rising costs.

An Unbreakable Cycle

The Fed is being disingenuous in claiming it's blameless for global inflation. And in a larger sense, the central bank is attempting to repeal the business cycle. In the normal course of capitalism, low rates and easy credit lead to increased borrowing, which leads to rising consumption and investment in production to feed that increased consumption.

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This leads to higher profits, which generates more investment and credit expansion.

At some point, the cycle hits a brick wall: Borrowers can no afford to pay more interest as rates rise, so debt stops increasing, and consumption and demand slump as borrowing levels off. In the rush to mint profits, production capacity now exceeds demand. And as a result, prices and profits both fall -- the natural consequence of excess capacity.

As the boom progressed, investors sought out riskier, more marginal investments. But as new debt and demand fall, these riskier investments lose money and are either shuttered or sold for a loss.

Then, as profits decline, workers are laid off, and commercial borrowers find their income streams aren't sufficient to meet their obligations. The credit cycle turns from expansion to contraction, as marginal borrowers go bankrupt and insolvent businesses and loans are liquidated or written down.

This purging of bad debt, speculative excess and misallocated resources lays the foundation for another cycle of renewed growth.

Credit Goes to the Wrong Hands

But the Fed is attempting to repeal this business/credit cycle. Rather than allow credit to fall sharply and interest rates to rise as bad debt is purged from the financial system, the Fed has pursued a policy of making credit even cheaper in the hopes that borrowers will be able to borrow more since rates are near-zero.

However, because consumers and enterprises are still burdened with mountains of existing debt and undeclared losses, few are willing or qualified to borrow more. As I recently wrote here, consumer debt in the U.S. has declined a paltry 2.7% in the wake of the Great Recession.

The Fed's quantitative easing thus ends up flowing not to households or productive enterprises but to the "too big to fail" banks and Wall Street firms, which then seek higher returns in assets such as stocks and commodities. The Fed's intention was to push money into productive growth, but instead it has fed pools of speculative money chasing high returns in global commodities. This is helping to fuel inflation in food and other commodities -- not just in the U.S. but globally.

In a Double Bind

Now the Fed has painted itself into a corner. If it keeps interest rates low and continues pouring hundreds of billions of dollars into "hot money" hands, it will be adding to the destabilizing forces of rising commodity inflation. If it stops its QE2 stimulus to help cool global inflation, then interest rates will rise, pushing marginal borrowers out of the market and increasing borrowing costs for everyone from new home buyers to Wall Street speculators. That could destabilize the fragile recovery and the bull market in stocks.

By attempting to repeal the business cycle and refusing to allow a necessary credit cleansing (writing off of bad debt) and repricing of risk, the Fed has created an inescapable double bind for itself: either continue pursuing easy-money policies and help destabilize the global economy with rising commodity inflation, or allow interest rates to rise and destabilize speculative markets and marginal borrowers.

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]]>Ben Bernankebusiness cyclecommoditiescommodity inflationcotton pricescredit cyclecurrency exchangeFederal Reserveinflationinterest ratesmonetary policyquantitative easingCharles Hugh SmithWed, 23 Feb 2011 12:30:00 ESTPutting Consumer Debt Into a Bigger Perpsectivehttp://www.dailyfinance.com/2011/02/21/consumer-debt-rise-again-recession-recovery-credit-card-use/http://www.dailyfinance.com/2011/02/21/consumer-debt-rise-again-recession-recovery-credit-card-use/http://www.dailyfinance.com/2011/02/21/consumer-debt-rise-again-recession-recovery-credit-card-use/#commentsFiled under: , , , , ,

One thing you could be sure of in pre-Great Recession America was that U.S. consumer debt would rise pretty consistently. The chart below from a Federal Reserve Bank of New York report titled Quarterly Report on Household Debt and Credit depicts the trend: In the 10-year period from 1999 to 2008, debt dipped significantly only once, in mid-2001.

Considering that 2001 was a recessionary year marked by 9/11, that's all the more remarkable.

Then came the recent downturn. The expansion of debt peaked in mid-2008 and then began a steady decline as the recession took hold. Though the slump officially ended in mid-2009, consumer debt continued falling through 2010.



As reported on DailyFinance earlier this month, consumer credit use staged a modest recovery in December 2010: Revolving debt (credit cards) increased from $807.2 billion in November to $826.6 billion in December, and nonrevolving debt (auto loans, etc.) rose from $1.608 trillion in November to $1.611 trillion in December.

This expansion aligns with the 0.6% improvement in retail sales logged in December and the 6.7% rise in consumer sales for 2010. But does this increase mark a new trend of rising consumer debt, or was it more akin to bouncing along the bottom?

To get some longer-term perspective on this question, let's look at some charts from the St. Louis Federal Reserve and review both the Federal Reserve's Flow of Funds report and the New York Fed's recent report on consumer credit.

An Economywide Expansion of Debt

As we can see in the chart below, consumer debt rose steadily during the inflationary 1970s, flattened briefly in the deep recession of 1982-83, and then began a steep 25-year rise. Consumer debt rose from $2 trillion in 1984 to $14 trillion in 2008 -- an extraordinary expansion, given that adjusted for inflation, that $2 trillion from 1984 would equal $4.23 trillion in today's dollars.



That is, even discounting for the effects of inflation, consumer debt more than tripled.

At $14 trillion, the debt is equivalent to the entire GDP of the U.S. That's a big number, but as the next chart demonstrates, it pales in comparison to the total debt, both public and private, racked up by the nation as a whole since the early 1980s.



If total debt owed had tracked inflation since 1984, then it would be around $20 trillion. Instead, it's more than $50 trillion.

What's striking about this long-term consumer credit chart is the modest scale of the recessionary dip in debt: The recent break from relentless expansion of debt doesn't look very significant on this chart.

Clearly, America has been on a debt binge since the mid-1980s. In constant dollars (adjusted for inflation), the nation's GDP rose from $6 trillion 1985 to $13.4 trillion in 2010 -- an increase of 223%.

If debt had risen in proportion to GDP, then the nation's total would be around $22 trillion, not $52 trillion.

Digging Into the Debt Data

You've probably noticed that there are three different numbers for total consumer debt presented in the various Federal Reserve reports and charts: The St. Louis Fed pegs total consumer debt at above $13 trillion, the New York Fed's chart claims it's $11.4 trillion and the definitive Federal Reserve Balance Sheet of Households sets the total at $12.5 trillion: $10.12 trillion in mortgages -- including home equity lines of credit (HELOCs) -- and $2.4 trillion in consumer debt -- credit cards, auto loans, etc.

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Despite the variances in debt totals -- discrepancies caused by the inclusion or exclusion of small pools of consumer debt such as "other loans and advances") -- what all sources confirm is that debt hasn't declined very much. Consider mortgages and HELOCs: With several million homes already foreclosed on, and several million more in the pipeline, you'd think mortgage debt might have declined more than a meager 4% just from bank writedowns.

But mortgage debt has dropped from a housing bubble high of $10.53 trillion in 2007 to $10.12 trillion in the fourth quarter of 2010 -- not much, considering the significant decline in home prices in those years.

Consumer debt has barely moved in that time -- from $13.8 trillion in 2007 to $13.43 trillion in 2010. Revolving and nonrevolving consumer debt (credit cards and auto loans) sank from $2.55 trillion in 2007 to $2.4 trillion in 2010, but "other bank loans and advances" leaped from $237 billion to $394 billion -- a hefty $157 billion rise.

Not Rising, Not Falling

According to the Fed's comprehensive accounting, total consumer debt fell by $370 billion from 2007 -- a decline of only 2.7%.

Upon closer examination of the Fed's Credit Market report issued on Feb. 7, several numbers really jump out. Conventional consumer debt (credit cards and auto loans) has been bouncing around since 2009 in a trendless fashion.

Debt fell from $2.55 trillion in 2007 to $2.406 trillion in early 2009, then popped up to $2.437 trillion in the fourth quarter of that year, only to decline again in mid-2010 to $2.411 trillion.

In effect, consumer debt has been moving up and down in a narrow band for the past two years, neither declining nor rising significantly.

Banks Get More Conservative About Credit Cards

Strikingly, the total consumer debt that was securitized and sold to investors has plummeted by over half-a-trillion dollars, from $683 billion in 2007 to $133 billion in late 2010. This suggests that lenders are no longer able to sell off their consumer debt accounts and are instead holding them.

Given that the banks are at risk for future losses, it should come as no surprise that, according the New York Fed report, credit card issuers slashed the number of card accounts from almost 500 million in 2008 to 380 million now -- a reduction of 23% in a few short years.

That's still a lot of cards, and we seem to be churning those accounts rather vigorously: A whopping 211 million credit card accounts were closed in 2010, and 164 million were opened.

Judging by the delinquency rates, lenders and borrowers aren't out of the woods yet: 10.8% of all debt is delinquent, down a bit from a year ago, at about $1.2 trillion. That's nearly seven times the GDP of Ireland and nearly four times the GDP of Greece.

Deep Indebtedness Continues

While the number of delinquent mortgages has declined -- when homes are foreclosed on, they're no longer delinquent -- both credit card and student loan delinquency rates are still rising: about 13% of credit card accounts and 11% of student loans are delinquent.

While there are bright spots in the report -- auto loan and mortgage originations have risen substantially from their lows -- there's no getting away from the historically deep indebtedness of the nation and its consumers, the stubbornly high delinquency rates and the modest declines in total consumer debt.

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]]>Auto LoansCar LoansConsumer DebtConsumer SpendingCredit Card DebtCredit CardsDelinquenciesDelinquency RatesFed Flow Of FundsFederal ReserveForeclosuresGreat RecessionHelocHome Equity Line Of CreditInflationMortgage Write DownsMortgagesNew York FedOriginationRetail SalesRevolving DebtSecuritized LoansSt. Louis FedCharles Hugh SmithMon, 21 Feb 2011 10:30:00 ESTUncle Sam Wants You. . .to Buy Treasury Bondshttp://www.dailyfinance.com/2011/02/20/uncle-sam-wants-you-to-buy-treasury-bonds/http://www.dailyfinance.com/2011/02/20/uncle-sam-wants-you-to-buy-treasury-bonds/http://www.dailyfinance.com/2011/02/20/uncle-sam-wants-you-to-buy-treasury-bonds/#commentsFiled under: , , , , ,

The U.S. Treasury has an unenviable job: It has to find buyers for trillions of dollars in new bonds that are sold to fund each year's federal deficit and replace maturing bonds. It hopes average citizens will pony up and invest hundreds of billions of dollars in newly issued bonds, but that might not be a winning investment for you.

With deficits climbing from $455 billion in 2008 to $1.42 trillion in 2009, $1.3 trillion in 2010 and an estimated $1.5 trillion in 2011, the Treasury's task has become even more challenging.

For context, the current debt owed to "the public" -- which includes foreign bond owners -- and to other federal agencies such as the Social Security Trust Funds, is by the Treasury's own reckoning $14.1 trillion. That's roughly equal to the nation's GDP of about $14.5 trillion.

Even if we discount the interest owed to Social Security, that still leaves more than $9.5 trillion on which interest must be paid every year. According to the Treasury, the interest paid in 2010 was $413 billion. In one of the few positives to this tale, the interest paid on America's external debt did decline to $164 billion in 2010 from $189 billion in 2009 as interest rates fell to historic lows.

This isn't chicken feed, however. The interest paid on the external debt is nearly equal to the budgets of the Department of Veterans Affairs ($52 billion), Housing and Urban Development ($47 billion) and Transportation ($71 billion).

The Treasury's Office of Debt Management recently issued a report outlining the Treasury's plans to find buyers for all those bonds. But it faces a number of fundamental problems.

1. The Treasury' projections of future deficits are grossly underestimated. The report's three estimates for the federal deficit in 2012 -- from primary dealers, the Congressional Budget Office and the Office of Management and Budget -- range from $911 billion to $1.1 trillion. Yet other reports from the Obama administration project that the 2012 deficit will reach $1.6 trillion.

This sort of low-balling of future deficits weakens the credibility of the Treasury's report, and suggests that the amount of bonds it must sell will be far greater than presented.

2. Today's historically low interest rates won't last forever. Right now, the yield on a one-year Treasury bond is a meager 0.27%, and the yield on a three-year bond is a modest 1.04%.

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Given that inflation is, by some authoritative estimates, running at about 2.5% in the U.S., and double that in other major economies such as China, investors in those three-year bonds are losing capital every year they hold them.

Rising inflation isn't a flash in pan, either: Wholesale prices are increasing, which guarantees future price jumps in retail goods.

How long can the Treasury find buyers who willing to lose money on U.S. bonds? Probably not long. That may be why the yields on long-term Treasurys have been climbing steadily in recent months. The yield on the 30-year bond, for example, has risen from 3.71% last October to 4.75% this month -- a jump of 27% in less than a year.

3. If the Treasury has to pay higher interest to entice buyers, it will. At that point, the interest paid by the federal government will rise sharply.

The Treasury already estimates interest payments will reach $800 billion by 2020 -- and that's assuming rates stay at rock-bottom levels.



Higher interest payments will inevitably crowd out other federal spending. If we set aside the overly rosy forecasts and assume a structural deficit of $1.5 trillion annually for the next four years, then by 2015, the national debt will be over $20 trillion, and the external debt will be over $15 trillion. Even at a modest average yield of 5%, the interest on that $15 trillion would be $750 billion a year, dwarfing both of the government's biggest programs, Social Security ($695 billion) and the Department of Defense ($663 billion).

4. The Treasury remains dependent on foreign buyers. While the Federal Reserve's $600 billion quantitative easing program of buying Treasurys, known as QE2, has boosted the Fed's bond holdings above those of China (the Fed holds over $1 trillion compared to China's $877 billion), as this chart depicts, the Treasury still depends heavily on foreign buyers.





Should foreign buyers balk at today's low yields, the Treasury would have to raise interest rates to lure them back. Counting on the Federal Reserve to snap up another trillion or two of Treasurys is also an iffy proposition because some Fed board members are already talking about trimming the purchases of U.S.bonds. The QE2 program is slated to end this June.

5. There's heavy competition from other governments issuing their own sovereign debt. Developed nations around the globe are issuing unprecedented quantities of new bonds to fund their deficits. The Bank of International Settlements issued a report last year, The future of public debt: prospects and implications, which outlined the extraordinary demands that government borrowing will place on the global bond markets. The report also noted that interest rates are rising globally in response to heavy sales of sovereign debt.

U.S. Treasurys, in other words, will have to compete with many other nations' debt for buyers. And as populations age around the world, the Bank of International Settlements expects government deficits to skyrocket. Given the trillions of dollars in new bonds governments will be issuing globally, it doesn't take much imagination to foresee a world in which rates could rise far more rapidly than the Treasury currently expects.

The Solution Is You

The Treasury's answer to its need for future buyers is to turn to potential domestic purchasers: banks, pension funds and you, the so-called retail buyer of U.S. bonds. The Treasury is hoping to sell American citizens some $337 billion in new bonds over the next few years, along with $525 billion to insurers and pension funds and a whopping $1.675 trillion to banks.

Would it be wise for investors to buy bonds yielding 1% when inflation is clipping along at 2.5%? Can pension funds and insurers meet their future obligations by earning 1% or 2%? Is it wise to gamble on future inflation being tame by buying long-term bonds? If inflation rises, the market value of those bonds would drop significantly.

All in all, the Treasury seems to be grossly underestimating future deficits, future inflation, future competition in the debt market from other governments, the possibility that foreigners will no longer be big buyers of U.S. debt and the willingness of potential domestic investors to ignore these critical issues.

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]]>Bank of International SettlementsbanksBISchinaChinas bond holdingsColumnsFederal deficitsFederal Reserveforeign ownership of U.S. bondsfuture inflationinflationinteresinterest ratesNational DebtOffice of Management and BudgetOMBpension fundsSafe Investmentssocial securitysovereign debtT-Billstreasury bondsU.S. bondsU.S. Treasurywholesale inflationyieldsCharles Hugh SmithSun, 20 Feb 2011 09:05:00 ESTHocus + Pocus = The 2012 Federal Budget Planhttp://www.dailyfinance.com/2011/02/17/2012-federal-budget-hocus-pocus/http://www.dailyfinance.com/2011/02/17/2012-federal-budget-hocus-pocus/http://www.dailyfinance.com/2011/02/17/2012-federal-budget-hocus-pocus/#commentsFiled under:

Like all budgets, the federal government's spending plan is all about revenues and expenditures. Unfortunately, Uncle Sam is very good at grossly overestimating tax receipts and grossly underestimating spending.

This shouldn't surprise us, because the best way to "sell" a program or a budget is to lowball the costs and exaggerate the revenues. And it's not hard to find these flim-flam projections -- they're all public record.

Let's start with 2008, the year the U.S. economy slipped into recession: All data is drawn from the Whitehouse.gov website's Office of Management and Budget (OMB) tables.
  • 2008 estimate: receipts: $2.66 trillion; outlays: $2.9 trillion; deficit: minus $239 billion
Problem is, the OMB whiffed the deficit by a few hundred billion because the actual number came in at $455 billion.

And here are estimates made in 2008 for future years:
  • 2009: receipts: $2.8 trillion; outlays: $2.98 trillion; deficit: minus $187 billion.
  • 2010: receipts: $2.95 trillion; outlays: $3 trillion; deficit: minus $94 billion.
  • 2011: receipts: $3.1 trillion; outlays: $3.15 trillion; deficit: minus $53 billion.
These estimates were laughably off the mark: The actual deficit projected for fiscal year 2011 is now $1.5 trillion, according to the nonpartisan Congressional Budget Office (CBO).

Pie-in-the-Sky Figures?

Maybe the recession caught the federal budget estimators off guard, you say? Fair enough. Let's look at the estimates they made in 2009, when the economy was in a recessionary free-fall. By 2009, the OMB had plenty of data on the recession, and the opportunity to revise its previous estimates to more realistic levels.

But instead, the OMB continued issuing pie-in-the-sky estimates that grossly underestimated future deficits:
  • 2009 estimate: receipts: $2.7 trillion; outlays: $3.1 trillion; deficit: minus $407 billion.
  • 2010 estimate: receipts: $2.93 trillion; outlays: $3.09 trillion; deficit: minus $159.9 billion.
  • 2011 estimate: receipts: $3.07 trillion; outlays: $3.17 trillion; deficit: minus $94 billion.
  • 2012 estimate: receipts: $3.26 trillion; outlays: $3.22 trillion; surplus: $48 billion.
So, in the depths of the Great Recession, the OMB reckoned the federal government would be generating a surplus of $48 billion by 2012.

Next Year's Numbers

Now comes the President's just-delivered 2012 budget, which estimates a $1.6 trillion deficit, a sum that equals 11% of the nation's GDP.

The entire proposed 2012 budget is laid out in mind-numbing detail in a 180-page document that's long on minutiae and short on clear summaries. For instance, on the Table S-1 (page 146) the projected deficit in the proposed budget is listed at only $828 billion. This is markedly at odds with the $1.6 trillion deficit number cited in news reports.

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The explanation is the $1.6 trillion deficit is based on current tax and spending policies, and the lower number in the proposed budget includes much higher tax revenues, thanks to the higher taxes proposed by the president.

But if we peek beneath the hood, these estimates of vastly higher tax revenues look suspiciously disconnected from history. Analyst and author Chris Martenson exhaustively dissected these estimates for future tax revenues -- and found the projections anticipate an astounding 65% increase in federal tax revenues in a mere four years.

Such a rise is unprecedented in U.S. history. Even the glory years of previous economic booms came nowhere close to increasing federal revenues at this pace.

Off by a Trillion Dollars

The proposed 2012 budget also counts on federal spending to decline both absolutely (from about $3.8 trillion to $3.7 trillion) and as a percentage of GDP -- from the current 25% of GDP to 22%. But this rosy outlook flies in the face of recent history.

As noted above, in the recession year of 2009, the OMB expected federal tax revenues to total some $3.2 trillion by 2012 -- a number that's about $1 trillion too high. The agency also expected federal outlays to reach $3.2 trillion -- too low by a cool $500 billion.

In other words, regardless of the economic climate, the OMB (and by extension, the White House) grossly overestimated tax revenues and grossly underestimated outlays.

The proposed 2012 budget expects tax revenues to climb to $3 trillion by 2013 -- a rather astonishing expectation, given that total tax revenues for 2011 are estimated to total about $2.1 trillion.

Is it even remotely plausible that the struggling U.S. economy will enable federal tax revenues to shoot up by almost 50% in a mere two years?

We might also reasonably ask if outlays can be restrained as projected. The OMB projected 2011's outlays to be $3.17 trillion a mere two years ago, but the reality is federal spending will be above $3.8 trillion this fiscal year.

The Big Three of the U.S. Budget

The New York Times recently published a graphic displaying each department's share of the federal budget showing the vast majority of federal spending is devoted to defense, Social Security and Medicare.

In the real world, these budgets are expanding rapidly, not declining. As I described here last month, Social Security outlays are already outstripping the program's income, years earlier than expected.

As for Medicare, baby boomers born in 1946 are now turning 65 and are entering Medicare at a rate of 7,000 per day, which will expand the ranks of this program by over 2.5 million this year alone.

Pentagon spending continues to climb for a number of reasons, including the rising cost of advanced weaponry. The new F-35 Lightning fighter jet, for example, will cost around $110 million a piece, with actual costs estimated to rise to $150 million per aircraft, according to some defense analysts.

According to the U.S. Navy, the plane being replaced, the Super Hornet F-18 E/F, cost $57 million each, though other estimates place its cost at $87 million. Either way, the replacement aircraft is significantly more expensive.

Clearly, it will be difficult to restrain costs in the three federal programs that dominate the budget.

After comparing the OMB projections with real-world data, it's a wonder the agency has any credibility at all. Perhaps it shouldn't.

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]]>2012 budgetbudget cutCBOColumnsCongressional Budget Officedefense spendingdeficit spendingFederal budgetFederal deficitFederal spendingmedicareobama budgetobama budget 2012Office of Management and BudgetOMBsocial securitytax revenuesCharles Hugh SmithThu, 17 Feb 2011 12:00:00 ESTWhat's the Real Unemployment Number?http://www.dailyfinance.com/2011/02/09/real-unemployment-number/http://www.dailyfinance.com/2011/02/09/real-unemployment-number/http://www.dailyfinance.com/2011/02/09/real-unemployment-number/#commentsFiled under: , , ,

Last week's surprisingly sharp decline in the unemployment rate from 9.4% to 9% and equally surprising anemic job growth -- 36,000 new jobs -- left a lot of investors scratching their heads. How could the unemployment rate plummet so significantly while a such a trivial number of new jobs were created?

If we simply extrapolate those numbers, we get some nonsensical results. If adding 36,000 jobs to the 139 million jobs in the U.S. economy lowers the unemployment rate by 0.4 percentage points, then adding just 720,000 jobs should lower the unemployment rate by 8 points -- from 9% to only 1%.

Yet the Bureau of Labor Statistics data shows that 812,000 jobs were added in the year from January 2010 to January 2011 (138,511,000 vs. 139,323,000). Based on the unemployment rate announced last week, we could expect that those 812,000 additional jobs would have lowered the unemployment rate to near-zero. But of course, we know they didn't.



What gives?

The basic reason why the numbers don't add up is that the BLS is constantly adjusting the variables of this basic equation:

Number of people in the workforce (civilian labor force) - number of people with jobs (employed) = number of unemployed people.

The BLS tracks the "civilian noninstitutional population" -- everyone not in the Armed Forces, school, prison, etc. -- and the "civilian labor force." The category "not in labor force" includes everyone else, including "discouraged workers" who want a job but who have stopped seeking one.

This ongoing adjustment of who gets counted as part of the labor force leads statisticians to lower the unemployment rate -- even though the number of employed people has barely ticked up.



To understand this, let's consider a labor force of 100 people, of which 20 are unemployed. The unemployment rate is 20%. But if 10 unemployed people drop out of the labor force, that reduces the total labor force to 90, and the number of unemployed to 10. As if by magic, the unemployment rate is now only 11%, even though the number of people with jobs remains unchanged.

This is the "magic" behind last week's astonishing decline in the unemployment rate.

Using the BLS data, we can reconstruct exactly what has happened over the past few years of recession and mild recovery.

The U.S. gains about 2 million new residents every year from births and legal immigration. For instance, the civilian noninstitutional population rose from 236.5 million in October 2009 to 238.5 million in October 2010.



Given this substantial increase in population every year, we might reasonably expect the civilian labor force to expand proportionally, as students graduate and new immigrants enter the workforce.

Yet according to the BLS, the civilian labor force was 153.8 million in January 2008 and 153.2 million in January 2011 -- a decline of 600,000 while the population increased by some 6 million. And the not-in-labor-force category expanded by 2 million from January 2010 to January 2011, from 83.4 million to 85.5 million.

How is this possible? When unemployed people stop looking for jobs at their local unemployment office, the government no longer counts them as unemployed. That's how the number of unemployed can drop from 15 million in November 2010 to 13.8 million in January 2011, a decline of 1.2 million, even though the economy created only about 400,000 jobs in those three months.

Over a longer time period, the not-in-labor-force group rose from 78.8 million in January 2008 to 85.5 million in January 2011 -- an increase of almost 7 million.

How do you drop the unemployment rate? Simple: remove 7 million people from the labor force.

The Real Unemployment Level Is. . .

If the labor force reflected the growth in population, then we might expect it to have increased by almost 2 million people a year. Rather than decline by 600,000 over three years, the labor force should have increased by 6 million to about 159 million.

If we take the number of unemployed as roughly 15 million (the BLS number from November 2010) and the true labor force as 160 million (out of an estimated total population of 310 million), then the true unemployment rate would be about 9.4% -- right where it was before the recent adjustment to 9%.

Other government statistical adjustments make equally little sense. Analyst Mike "Mish" Shedlock has revealed the inconsistencies of the BLS "birth-death model," which guesstimates the number of jobs created by small businesses being "born" and "dying." Depending on what the "black box" issues every month (the BLS does not reveal its methodology), the government may report that the economy has created hundreds of thousands of new jobs -- that are often revised away in estimates a few months later.

Job Growth Is Still Weak

For context, let's look at some other employment numbers. According to the ADP National Employment Report, which I reported on for DailyFinance in late December, the economy lost about 9 million private sector jobs during the recession -- about 7.75% of all private -sector jobs.

Rather than get bogged down in the legerdemain of the BLS unemployment, birth-death model and not-in-labor-force numbers, we can assess U.S. job growth just by looking exclusively at the number of jobs. Isn't that the meaningful gauge we all seek?

According to the BLS, the U.S. had 138.2 million jobs in October 2009, a few months after the official end of the recession. Sixteen months later, the country had 139.3 million jobs -- a gain of 1.1 million. That's a growth rate of about 880,000 new jobs a year. While that's certainly encouraging, this rate of job growth lags far behind those of previous post-recession recoveries as this chart depicts.



Bottom line: The numbers that matter in the U.S. economy are the total number of jobs and the number of jobs created, not the constantly massaged unemployment rate and not-in-labor-force numbers.

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]]>adp jobs databirth-death modelBLSbureau of labor statisticscivilian labor forcediscouraged workersemploymenthiringhiring outlookjob creationjobsLabor Departmentlabor department statisticsnot in labor forcerecessionunemploymentunemployment rateworkforceCharles Hugh SmithWed, 09 Feb 2011 11:00:00 ESTHow High (or Low) Could the Stock Market Go?http://www.dailyfinance.com/2011/02/08/how-high-or-low-could-the-stock-market-go/http://www.dailyfinance.com/2011/02/08/how-high-or-low-could-the-stock-market-go/http://www.dailyfinance.com/2011/02/08/how-high-or-low-could-the-stock-market-go/#commentsFiled under: , ,

Stock chart on trading floor of NYSEThe U.S. stock market has been on a tear since September, gaining more than 20% in a mere five months. For perspective, annual equity returns average about 5% over the long run.

That means the market has logged four years of average gains in only five months. And it raises the question: What's next for the U.S. markets, not just next month, but in the next year or two?

The bullish case is well established: The economic recovery is solidly advancing, corporate profits are still rising, inflation is low and some evidence shows companies are starting to hire again.

Let's look at a 10-year chart to identify the bullish targets for the Dow: 13,000 and then 14,000.



Chartists have long noted that long-term tops often form what is called a "head and shoulders" pattern in which lower "shoulders" precede and follow the peak or "head." This pattern is clearly visible in the Dow's 2007-2008 top and decline.

The sharp 84% rise from the March 2009 low has brought the Dow back above the 12,000 level and into a band of resistance and potential support around 11,900 to 12,200. The next stop for the bulls is 13,000, the left shoulder on the chart above, last touched in 2008. Beyond that, the next goal is the 14,000 level that marked the 2007 top.

From the view of a 10-year chart, we can see that this advance from 6,500 to 12,170 has been meteoric compared to the more leisurely recovery from 2003-2006, when it took about four years for the market to advance from 7,600 to over 12,000. This suggests that the past two years have been extraordinary rather than typical, and so we might expect more typical returns in the years ahead.

What's Typical?

You'd think figuring out what "typical returns" are would be a relatively straightforward calculation, but -- as with many things financial -- it turns out to be complicated. Some calculate long-term annual returns of around 7%, and others estimate 6.5% as a reasonable expectation for total returns, or dividends plus appreciation/growth. Yet other careful analyses reckon that a return of roughly 4.1% is more realistic.

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Why is it so difficult to assess mean returns over the long term? Economists Eugene Fama and Kenneth French have shown that the uncertainties of expected returns don't diminish over long time frames, so the uncertainties of 30-year and 50-year returns are higher than shorter-term yields. In effect, the uncertainty over two years is four times the uncertainty over one year.

Calculating long-term returns and mean returns turns out to be an inherently iffy proposition. "In particular, we don't know the true expected returns on portfolios," Fama wrote in an investment forum in 2009. "We typically use historical average returns to estimate expected returns, but the estimates are quite noisy, and they leave lots of uncertainty about true expected returns."

In other words, projections using average annual returns are guesstimates because historical returns aren't reliable guides.

To put this truism into perspective, let's turn to some longer-term charts showing the Dow, from 1977 to the present, and the broad-based S&P 500 index , from 1965 to the present.





We can see that stocks really took off in 1995, and made an unprecedented ascent in five short years to the dot-com top in 2000. In the Dow, this top marks what could be a left shoulder in a multiyear topping pattern, with the peak reached about seven years later in 2007 tracing out the head. If this pattern holds, then the current rally may be the right shoulder.

Alternatively, the Dow might reach for the 14,000 level, and either form a double top there or move on to new heights.

The S&P 500 has already traced out a multiyear double top, with the first peak in 2000 and the second in 2007.

A Return to the Long-Term Average

One tool statisticians use is the "regression (or reversion) to the mean," which refers to the probability that extremes of activity or response tend to revert to the long-term average.

This suggests that any period of extreme outperformance, such as the past 22 months, will be followed by lower and more average returns.

We can estimate the mean return in several ways. On the charts, I took 2% above inflation as a baseline return. At this rate, $1 invested in 1989, six years into the great 1982-2000 Bull Market, would have grown to $1.52 in 2010. A dollar in 1989 now equals $1.76 in 2010 dollars, so I've multiplied our return by 1.76 to adjust for inflation.

By these calculations, the Dow should be around 5,300 and the S&P 500 should be about 800.

If we forget inflation and just plug in an annual mean return of 6.5%, then the S&P 500 should be about 1,125. If we go with a 5% mean return, then the S&P 500 should be around 835.

A Safe Bet, If. . .

Author and analyst Jeremy Siegel found that since the early 1800s, equities had never offered a negative return, after inflation, if held for 17 years or more. That suggests stocks are a safe bet for long-term investors, if they can handle short-term volatility.

Technically speaking, these long-term charts suggest that stocks entered an unusual period of outperformance in 1995 that will eventually end as returns revert to longer-term averages. Nobody knows what those averages will be, but we can look to history from some guidance, and to charts for possible future outcomes.

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]]>bearbear marketbearishbull marketBullishDow Jones Industrial AverageHead and ShouldersinflationInvestingregression to the meanreversion to the meanSP 500standard and poorsstock marketstock market outlookstock marketsstock returnsstockstechnical analysisCharles Hugh SmithTue, 08 Feb 2011 11:00:00 ESTWhat Does Chinese Inflation Mean for Americans?http://www.dailyfinance.com/2011/01/27/what-chinas-rising-inflation-means-to-you/http://www.dailyfinance.com/2011/01/27/what-chinas-rising-inflation-means-to-you/http://www.dailyfinance.com/2011/01/27/what-chinas-rising-inflation-means-to-you/#commentsFiled under: , ,

Plenty of stories have recently discussed concerns over rising inflation in China. And since China-U.S. trade is a major factor in both nations' economies, you might wonder what impact Chinese inflation could have on the American economy and inflation: good, bad or indifferent?

For an answer, we need to place China's inflation rate and U.S. trade with China in a larger context.

There's little doubt that China's official inflation rate of 5% dramatically understates the actual experienced of Chinese consumers. By one informal study, prices for basic food items in urban areas are higher than in the U.S., even though the average urban wage in China is about $3,200 -- or roughly one-tenth of the median earnings for U.S. workers (about $31,000 for all workers, full-time and part-time, and about $41,000 for full-time employees).

Increasingly Worried

Anecdotally, our friends in China report some grocery items there have doubled in price within the past year. Other informal, "on the ground" accounts estimate price increases for both fresh and prepared food of between 25% and 60%.

Surveys have also found China's consumers are more worried about inflation now than at any other time in the past 10 years.

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The basic reason China's inflation rate is soaring is its money supply, fixed investments and credit expansion are all on fire. Broad money supply leaped 19.5% in November 2010, industrial output gained 13.3%, and urban fixed-assets investment rose 25%. Money supply has jumped by 55% in the past two years, and outstanding loans have risen by 60%. China's GDP is growing at a rate of about 10%, which is considerably less than the growth of its money supply and debt.

This explosion of easy money and credit has inflated a property bubble in China, driving up prices for urban apartments and rental units -- a topic I looked at last year.

Is inflation throughout the Chinese economy real? Yes. Does it pose a risk to the stability of China's economy? Many economists, including those working in China, think it does.

In that case, does Chinese inflation pose any risk to the U.S. economy? To assess that concern, let's put U.S. trade with China in perspective.

Not Everything Is Made in China

Though it often seems that much of what's on the shelves in the big-box retail stores is made in China, U.S. imports from China run about $366 billion, according to both the U.S. Census Bureau and the CIA Factbook. That's a mere 2.3% of the sprawling $14.6 trillion U.S. economy. U.S. exports to China were around $82 billion for 2010, a rise of about $12 billion, or 17%, from 2009.

And if we make an apples-to-apples comparison of trade -- imports and exports -- we can see that trade has a somewhat larger role in China's economy than it does in the U.S.:

United States
GDP: $14.62 trillion
Per capita income: $47,400
Imports: $1.903 trillion (19.3% from China)
Exports: $1.27 trillion
Current account balance: -$561 billion

China
GDP: $9.854 trillion
Per capita income: $7,400
Imports: $1.307 trillion
Exports: $1.506 trillion (20% to the U.S.)
Current account balance: $272 billion

China's positive trade balance of $272 billion a year is about 2.7% of its economy, while the U.S. negative trade balance of -$561 billion is about 3.8% of the U.S. economy.

Total trade (imports and exports) makes up about 21.7% of the total U.S. GDP, while total trade accounts for about 28.5% of China's GDP. Imports from China are only one-fifth of all U.S. imports, and exports to the U.S. are about the same share of China's exports: 20%.

In other words, the economies of both the U.S. and China are still largely domestic: Trade makes up around one-quarter of each nation's GDP, and trade with the other nation is about 20% of each nation's total trade activity.

Companies Quickly Shift Their Outsourcing

Let's imagine that, in response to rapidly rising costs in China and a strengthening of its currency (the renminbi or yuan), the price of imported goods from China rises 20%. Since imports from China represent a mere 2.3% of the U.S. economy, these higher prices end up being a tiny sliver of the U.S. economy.

If you've purchased footwear recently, you may have noticed your shoes were made in an East Asian country other than China -- Vietnam, for instance. Global manufacturers respond to price increases in one country by shifting production elsewhere, and those adjustments will likely lessen the impact of higher production costs in China.

Compare the limited impact of trade on the U.S. economy with the major impact it has on Germany's:

Germany
GDP: $3.3 trillion
Exports: $1.337 trillion (4.5% to China)
Imports: $1.12 trillion (8.2% from China)

Fully 74% of the German economy is trade-related. Now there's an economy that could be significantly hurt by inflation from its trading partners.

Though the direct impact of China's surging inflation will probably be modest on the U.S. economy, there are potential indirect consequences. If China has to slow its growth to cool home-grown inflation, that will likely cut demand for commodities such as iron ore, copper and energy. And as its economy slows, China may well import less from other countries.

Both of these factors could chill global growth rates, and a global chill would offer the U.S. a mixed bag. On one hand, any reduction in commodity costs would be welcome, but a slowing world economy could crimp U.S. exports.

All in all, the impact of China's inflation on the diverse U.S. economy will likely be in proportion to its relative share of the U.S. GDP: modest.

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]]>chinaChina inflationChinese inflationChinese investmentsCIA factbookcurrent account balanceexportsGermanyImportspeoples republic of chinatradetrade with ChinaU.S. GDPus exportsUS importsCharles Hugh SmithThu, 27 Jan 2011 06:30:00 ESTSocial Insecurity: Inside the 'Trust Fund' Illusionhttp://www.dailyfinance.com/2011/01/20/social-security-trust-fund-illusion-debt-deficit-bonds-borrow/http://www.dailyfinance.com/2011/01/20/social-security-trust-fund-illusion-debt-deficit-bonds-borrow/http://www.dailyfinance.com/2011/01/20/social-security-trust-fund-illusion-debt-deficit-bonds-borrow/#commentsFiled under: , , , ,

The recent tax deal approved by Congress and the president cut the payroll taxes that employees will contribute to Social Security for 2011 by about a third, and that $112 billion reduction in receipts has advocates of the program worried that the political meddling in Social Security's finances may threaten its viability.

Unfortunately, the Social Security Administration's (SSA) finances have been meddled with for decades, and a one-year tax holiday is the least of the program's problems. As I reported on DailyFinance this week, Social Security is already deep in the red, with outlays exceeding payroll tax revenues by $76 billion in 2010 -- a deficit that wasn't expected to occur until 2018.

Though the program's trustees continue to reassure the public that Social Security's funding is secure through 2037, rising outlays and slumping revenues -- not even counting the "tax holiday" cut -- call that rosy outlook into question. And the trustees' short-term projections have been so far off the mark that the validity of their longer-term estimates must also be in doubt. Their estimate of total revenues was too high by $50 billion in 2010, and their estimate for 2011 income is $855 billion -- fully $114 billion more than the system's 2010 income.

It would require a stupendous increase in employment to hit that mark, and precious little evidence suggests such a powerful hiring boom is in the works. Instead, there's plenty of evidence that the current recovery is a jobless one: 9 million jobs -- 8% of all private-sector jobs -- have vanished since 2008, and another 8% more have slipped from full-time to part-time or temporary. America's millions of self-employed, freelance and contract workers have seen their incomes decline by 5%.

But if payroll taxes don't rebound strongly in 2011 and beyond, the long-term viability of Social Security will be in doubt, because with the baby boomers beginning to retire en masse, the number of people receiving benefits is climbing rapidly.

About One-Fifth of the Federal Budget

To understand the basics of Social Security's cloudy future, we need a quick refresher on the system.

Social Security has over 53 million beneficiaries -- 17% of the U.S. population of 312 million, or about 1 in 6 Americans. As a comparison, that's substantially more than the entire population of Spain (46.5 million). Its outlays in fiscal year 2010 totaled $707 billion, about one-fifth of the $3.45 trillion federal budget. And its payouts will inexorably rise in coming decades, thanks to the 76 million-strong baby boom generation. The first boomers qualified for Social Security in 2008, and over 3 million more enter the system every year.

Social Security is a "pay as you go" retirement system, intended to run with a surplus designed to fund future shortfalls. Payroll taxes paid by current workers and employers fund today's retiree benefits, and the difference between tax receipts and outlays -- a surplus, until recently -- is transferred to the U.S. Treasury.

In exchange for this excess cash, the Treasury issued the Social Security Trust Fund special nonmarketable securities. The Trust Fund now holds about $2.6 trillion in these securities. (Technically, there are two trust funds, one for the main Social Security program and one for Disability Insurance, but the SSA usually combines the two.)

If You Can't Sell a Bond, Is It Worthless?

Though the SSA doesn't state it directly, what this means is that the Treasury took $2.6 trillion in Social Security cash surpluses and transferred it to the federal government to spend on other government programs. (For context, the total net wealth of U.S. households is $54.9 trillion, according to Federal Reserve data.)

The fact that the Treasury bonds the Trust Fund received in return for that $2.6 trillion are nonmarketable -- that is, they aren't bonds that can be sold on the global bond market -- has led some observers to characterize them as worthless.

The Social Security Administration defends the worthiness of its special bonds in its FAQ page:
"The [surplus] money flowing into the trust funds is invested in U.S. Government securities. Because the government spends this borrowed cash, some people see the current increase in the trust fund assets as an accumulation of securities that the government will be unable to make good on in the future. Without legislation to restore long-range solvency of the trust funds, redemption of long-term securities prior to maturity would be necessary.

Far from being 'worthless IOUs,' the investments held by the trust funds are backed by the full faith and credit of the U.S. Government. The government has always repaid Social Security, with interest. The special-issue securities are, therefore, just as safe as U.S. Savings Bonds or other financial instruments of the Federal government."

This debt to Social Security is called "intragovernmental holdings," and it is included in the total national debt, along with other special Treasury securities held by other agencies.

The "Trust Fund" Is Not a "Lockbox"

What the Social Security website fails to explain is where the Treasury gets the money to redeem those bonds. The answer: It borrows the money on the global bond market by selling freshly issued real Treasury bonds.

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In other words, Social Security's nonmarketable bonds are merely markers for actual Treasury bonds, which must be sold, and for which interest must be paid. Thus, Social Security is entirely dependent on the Treasury's sale of new bonds for its future solvency. If interest rates spike or global buyers become wary of buying trillions of dollars in U.S. T-bills, costs for that borrowing will skyrocket, crowding out all other federal spending.

As a result, U.S. taxpayers are now paying twice for their Social Security benefits: Once through payroll taxes, and again when the Treasury uses their taxes to pay interest on the bonds it sold to fund Social Security.

This is not some far-in-the-future issue: The Treasury reported in October that it had to sell new bonds to fund Social Security shortfalls in 15 of the previous 25 months.

A Budgetary Illusion

Another way of understanding the hollowness of Social Security's nonmarketable securities is to ask: What difference would it make if we erased the Trust Fund from the ledger?

The answer: none whatsoever. In the "Trust Fund" we now have, when Social Security's outlays exceed its payroll-tax income, then the Treasury sells freshly minted bonds and transfers the cash to Social Security. If we eliminated the so-called Trust Fund, the exact same thing would occur: When Social Security's outlays exceed its payroll-tax income, the Treasury would sell bonds and transfer the cash to Social Security.

This thought experiment reveals that the Trust Fund is illusory, but the reality is that the U.S. Treasury will have to borrow $2.6 trillion on the global bond market to redeem Social Security's nonmarketable securities. That means the Social Security system is totally dependent on the Treasury's ability to sell trillions of dollars of bonds at interest rates that won't cripple the federal government.

The Treasury borrowed $1.3 trillion in 2010 just to fund the federal deficit. As baby boomers retire and payroll taxes remain stagnant, the Treasury will have to borrow substantially more to fund shortfalls in Social Security. If the global bond market hesitates to buy more Treasury debt at low interest rates, then all federal programs will feel the impact -- including Social Security.

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]]>Baby Boombond marketbond ratingsColumnsfederal debtFederal deficitinterest ratesIOUjobless recoverynon-marketable securitiespayroll taxrecessionsocial securitySocial Security trust fundSocial Security TrusteessurplusT-Billstreasury bondsU.S. Treasuryunemploymentunemployment rateCharles Hugh SmithThu, 20 Jan 2011 12:00:00 EST