Financial Review

Wednesday, August 27, 2014 – The Greater Depression

08272014 Financial Review

DOW + 15 = 17,122
SPX + 0.10 = 2000.12 (record)
NAS – 1 = 4569
10 YR YLD – .03 = 2.36%
OIL – .16 = 93.70
GOLD + 2.10 = 1283.70
SILV + .08 = 19.54

Any positive day for the S&P 500 means a new record high close; today was the 31st of the year. Volume was really, really light.

This week the S&P 500 crossed above 2000, which would indicate the economy is strong; there are several economic indicators you could consider such as an abundance of corporate cash, a little more top line growth in the second quarter, and improved consumer confidence even if consumers haven’t found the cash to pay for things; but you also have the yield on the 10 year Treasury note dropping lower and lower, which would indicate the economy is weak. We are told the yield on Treasuries is low because of foreign buyers, and maybe Treasuries can be considered a global instrument; another possibility is that the deficit has been shrinking, meaning fewer new issuances…, still. Most divergences result in a reversion to the mean. So the big question is whether stocks come down or yields go up.

The US budget picture will likely worsen in coming months as companies wait until next year to see what actions Congress will take on taxes. A report from the Congressional Budget Office says the budget deficit for fiscal year 2014 will be an estimated $506 billion, a slight increase from the $492 billion projected in April. Revenues to the government from company tax payments are expected to total $315 billion, down from an estimated $351 billion in April.

The CBO says companies are deferring tax payments while they wait for Congress to decide whether to revive expired tax breaks. Lawmakers are expected to take up legislation after the November elections to renew through 2015 a mix of 50 temporary tax breaks, known in Congress as “tax extenders,” that expired at the end of 2013. The budget deficit is expected to fall to $469 billion in 2015, but then begin to rise as spending outpaces revenues.

CBO said its projections are based on the assumption that the economy will grow at a 1.5% annual pace this year but then speed up to an annual rate of 3.2% in 2015 and 3.5% in 2016. CBO officials said they believe that despite declines in unemployment levels, a substantial amount of slack remains in the US labor market due to the lower participation rate and an increased number of people working part time. And an important signal that significant slack remains in the labor market is the slow growth in hourly wages.

September is when you might expect stocks to fall; there is history to back that up. According to the Stock Trader’s Almanac since 1950, September is the worst performing month of the year for DJIA, S&P 500. Not every September results in losses, but in the past 64 years, there have been 38 losing Septembers compared to just 26 winners for the Dow Industrials. That does not mean this September will be negative in the markets, just that there is a strong statistical probability.

Then again, stocks are enjoying a bull market right now. In case it slipped your attention, the S&P 500 made 45 new record highs last year, and another 30 record highs so far this year. Record highs are bullish, not bearish. The past couple of Septembers have been just fine, thanks.

Not for everyone but for a few. We really have a Tale of Two Markets. “…the SEC which oversees stock exchanges has allowed both the New York Stock Exchange and Nasdaq to create a bifurcated market. The unsophisticated investor is given trading data on which to base trading decisions on a slow data feed called the Securities Information Processor or SIP. The SIP is not only slow in getting the data to the technology-challenged investor, but it has limited data.

“For the rich and powerful on Wall Street who can afford massive fees, there is another data feed offered by the exchanges called the Direct Feed. The Direct Feed data, which has far more useful information, arrives in the hands of High Frequency Traders and Wall Street’s proprietary traders ahead of the arrival of the SIP data. This allows the Direct Feed users to buy a stock on the cheap and sell the stock back to the SIP user at a higher price…

The New York Stock Exchange and Nasdaq, which also have a mandated regulatory role to ensure that their markets are fair and non-discriminatory, have allowed the two-tiered market to exist because they are collecting hundreds of millions of dollars a year selling the SIP to the dumb money and the Direct Feed to the smart money…”

“For someone that is not drinking the daily dose of electronic kool aid from the mainstream media, this is a systemic, institutionalized control fraud that inevitably leads to a financial crisis. And a close survey of the markets today might lead one to observe, ‘My God. These lunatics are going to do it again.’”

Of course we all remember the last really, really bad September. 2008. Ben Bernanke remembers; Tim Geithner remembers. The former Fed head and former Treasury Secretary were in court recently talking about September 2008. Bernanke and Geithner were making statements regarding a lawsuit related to the US government’s bailout of AIG, which, leading up to 2008, had written many of the insurance-like unregulated derivatives contracts that were at the center of the market crash. When market participants realized the derivatives products, marketed as top rated securities, actually contained toxic subprime loans, word quickly spread that the “insurance” obligations far exceeded the available capital of those writing the contracts had and a market crash ensued. Bernanke and Geithner were essentially the US government team that stepped in to shore up the US financial system.

The lawsuit was brought by Starr International, a firm run by Hank Greenberg, the former CEO of AIG. Greenberg claimed AIG was treated in a much harsher manner than the other financial firms that were bailed out in 2008, such as Hank Paulson’s old employer, Goldman Sachs. AIG claims that selling the assets, derivative products and loan obligations, during the crisis netted a much lower sale price than had the government waited. The Fed sold the assets primarily from 2009 to 2012. And so, Greenberg claims the government’s $182 billion bailout of AIG and the subsequent sale of AIG assets was unconstitutional.

So Bernanke and Geithner went to court to testify. Geithner said that back in September of 2008, the economy was in “free fall” with 12 of the 13 major financial institutions facing simultaneous failure, all with excessive exposure to unregulated derivatives. By the way, those same financial institutions have dramatically increased their exposure to these derivatives products, which now total somewhere between $700 trillion to a quadrillion in risk exposure, several times the available capital of each bank and large enough to wipe out the $72 trillion plus world economy several times over.

The WSJ reports that Bernanke said in his testimony: “September and October of 2008 was the worst financial crisis in global history, including the Great Depression.” Maybe we could call it the Greater Depression. Asked why he thought it was essential for the government to rescue AIG, Bernanke said, “AIG’s demise would be a catastrophe” and “could have resulted in a 1930s-style global financial and economic meltdown, with catastrophic implications for production, income, and jobs.”

To claim that 2008 was worse than the Great Depression certainly allows the opportunity for Bernanke to justify his actions, and claim credit for averting collapse; of course, the failure to do more also places blame for the ongoing weakness in the economy.

Meanwhile, Ukraine says there is now a war with Russia. Well, we could see that coming for some time. Tanks, artillery and infantry have crossed from Russia into an unbreached part of eastern Ukraine in recent days, and the Russians are attacking Ukrainian forces, which are retreating in the face of overwhelming firepower. Russia has denied that it has intervened militarily in Ukraine and the separatists have asserted that they are using captured Ukrainian equipment. The US is rejecting that denial and says it has photographs showing Russian artillery moving into Ukraine.

Just yesterday, Russian President Putin met with Ukrainian Prime Minister Poroshenko, in what was described as peace talks, but now looks more and more like a stalling tactic. Shortly after the talks Ukrainian officials said that Russia is making plans to shut off all gas transits and energy resources for Ukraine. As we’ve suspected all along, the Russia-Ukraine crisis will be a battle over energy and it will likely get ugly in the winter.

Fitch ratings Agency says Europe will remain heavily reliant on Russian gas for at least another decade, citing a lack of alternative sources. Europe already buys a quarter of its gas from Russia, and analysts expect consumption to increase by a third by 2030. The Fitch report says: “Any attempt to improve energy security by reducing European reliance on Russia would require either a significant reduction in overall gas demand or a big increase in alternative sources of supply, but neither of these appears likely,” and that leaves European countries at risk of being “held hostage by dominant suppliers”, including Russia.

The US is outside the sphere of Russian influence. We do not rely on Russian gas, but that does not mean we are outside of their reach. Russian hackers attacked the US financial system in the past couple of weeks, infiltrating and stealing data from JPMorgan Chase and at least one other bank. The FBI is investigating and thinks the hacks are in retaliation for sanctions. Authorities are investigating whether recent infiltrations of major European banks using a similar vulnerability are also linked to the attack. Investigators have not made a direct link to the Russian government, but claim the attacks were too sophisticated for typical cyber criminals.

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