Dan’s Blog

The Hypocrisy of QE3

Dan Calandro - Sunday, August 26, 2012

The Dow Jones Industrial Average shed 1% of its value this week as news surrounding the "fiscal cliff" continued to mount. To the contrary, the 15-51 strength Indicator gained 1.5% and gold rose more than 3%.  Here’s the year-to-date picture. 

8-24-12

The Dow and gold have been in a street fight for most of the year. One indicates the market economy and the other contradicts money -- and neither is showing any sign of dominance. Stock market strength is performing fabulously – but then again, these trends are only temporary.  

The Dow Jones is up 8% this year and gold has advanced 7%. Strength, via the 15-51 Indicator, has gained more than 40% in the eight months – that’s inflation in the highest order. These gains should be compared to the actual market economy (GDP) which is growing at a pitiful 1.5% per year – and that pace is slowing. That’s the reason the Dow can’t advance beyond its average historical high (point noted above.) Every time it tries to attain it, poor economic data turns it away. 

Even though the Wall Street establishment knows these valuations are high, everyday I hear calls to investors recommending that they "add" to their positions. Wall Street recommends, therefore, that their clients buy into inflation – to buy high. I caution you against spitting in the face of wise cliché.  

The fact that the Dow is up at the levels is an overstatement to the greatest proportion. Economic health is poor, unemployment is high, money is weak, and global recession is staring investors in the face. Any ambiguity in this condition is caused only by mass media speculation and operationally slick Wall Street sales rhetoric. They’re famous for artificially pumping-up prices in order to sell average investors – their customers – short. It happens all the time. (And it motivates me.)  

Realize that irrational exuberance is not a new idiom. The tech-boom, the housing-boom, all went awry for the same reason – Wall Street was drunk on irrational exuberance and too greedy to acknowledge it. I demonstrate this in my book surrounding the 2008 crash. And today we sit on that doorstep once again. 

Should the Dow Jones Industrial Average move beyond the action zone high point, consider it nothing short of irrational exuberance and brace yourself for impact. Remember, exactly one year before the market crashed, October 2007, the DJIA hit its all-time high of more than 14,100. One year later – the entire financial industry fell into ruin.  

Fool me once, shame on you. Fool me twice…

That said, and knowing that this stock market must correct from its inflated state, expect the 15-51 Indicator and gold to crisscross in dramatic fashion when chaos ensues. The reason for this is simple: the next correction will be due to a monetary crisis driven by global economic recession, a condition that is vehemently brewing at the very moment. That’s bad for stock prices and good for gold. 

And since the Wall Street establishment and cable news programs are speculating about the possibility of such a crisis or "fiscal cliff" proves one thing: Stock market valuations don’t yet reflect the crisis conditions that currently exist.

The reason for such speculation is only possible because GDP growth has not yet turned negative. In other words, because the numbers don’t prove that recession exists – it’s not there; and for so long as the "number suggest" avoiding recession is still mathematically possible. 

Nothing can be further from the sane truth. (See: Recessionary Proof

Investors should correctly expect a stock market adjustment.  

In the face of this reality, Wall Street is clamoring for another round of quantitative easing (QE), and just recently in a pointed comment, Senator Charles Schumer almost insisted more Fed action. Of course, Ben Bernanke’s over-active Fed already had been planning another round of quantitative easing for quite some time – this would be QE3.  

In some sordid way, the establishment believes that the only way America can avoid a "fiscal cliff" or deep recession is through more monetary shell games. So not true. 

Think of QE this way: the Federal Reserve prints new money and walks into a bank, let’s say JP Morgan Chase for example, and says to its CEO, Jamie Dimon, Here’s $250 billion – what kind of high-risk, troubled assets can you give me for the new cash?  

Dimon looks over his crappy investment list and says – Here’s some subpar paper (debts and mortgages) and deeds (titles to ownership) for underlying collateral (assets). None of them are paying market interest rates and most of them are spoiling. Good luck with them. Where’s the loot? 

A reasonable mind might wonder: Why would the Fed would do such a thing?

Since the QE programs began, the Fed has purchased more than $2 trillion of "troubled assets" from banks (and this doesn’t included Congressional programs such as TARP.) Much of the notes are subprime mortgages collateralized by American land (see: Land Grab.)  The Fed does this to reduce risk in bank portfolios in hopes that it will encourage banks to lend new money that will produce economic growth. (It also gives the Fed more land to mortgage to China.) But after two rounds of this kind of monetary easing, banks still aren’t lending and the economy is no better off than before the QE programs began.  

Look at my shocked face.  

Interest rates are already too low; lowering them more will only produce less bank activity. There’s no money in lending – that’s the reason banks aren’t lending it! Banks see inflation coming, and to lend money at these historically low rates will cause them to lose money in Real terms once inflation commences. 

Instead, banks, which are now all investment banks, would rather invest the new Fed money into – ready for this shocking revelation, ‘well-diversified investment portfolios’ – you know, stocks, bonds, commodities, emerging markets, and "synthetic" hedging vehicles (a.k.a. bets) – to maximize profits and "hedge" risks.  

That’s where the hypocrisy of QE begins – it really only helps the investment banks and certain politicians. It’s not a solution to economic woes; it delays them, inflates them, and makes them worse. Two prior QE rounds have proven this. A third time will only make fiscal matters worse.   

In a sane world, you would expect Wall Street to cheer good economic policy and banks to jeer poor monetary policy. But that’s not the case in today’s world. 

Wall Street loves the thought of a third round of QE not because it’s good for the economy but because it’s fresh meat. During QE, banks get to off a bunch of deadbeat investments for some newly printed cash. Perhaps that’s why bank stocks have been on a sustained run for some time. Financials, located in IS: 4-1 and IS: 4-2 in the 15-51 Indicator, are up 29% so far this year. Remember, when the government adds currency into the economy it does so through banks. And because they are the first to touch the new money, they are the first to inflate from it. 

The Federal Reserve, for its part, has done the same thing Wall Street banks have done. It has transformed itself from a national bank into a national hedge fund dealing in junk bonds and bad investments. This is against its traditional and intended role; and by so doing, has effectively transferred garbage assets from investment banks into the pockets of American taxpayers.  As if our problems with Congress aren’t bad enough already!

The Fed needs to get out of The Market, because like Fannie Mae and Freddie Mac, they are corrupting it. Please, no more QE – and then maybe, just maybe, we can stop Twisting in the Wind.  

Until then, Wall Street will accept every new round of QE with smiling cheer even though the practice stabs their customers, and all American taxpayers, directly in the back. 

Talk about hypocrisy.

I'm here,

d-

See also: De-Institutionalize

Stocks and the Inevitable "Fiscal Cliff"

Dan Calandro - Sunday, August 12, 2012

"The market" continues to tiptoe towards the action zone’s high point. The Dow Average is up 8% for this year despite lackluster economic growth and poor Market fundamentals. Stock market strength is up 34% year-to date and gold is keeping pace with nominal GDP, up 3%. Here’s the picture.

8-10-12a

For the most recent twelve months, the DJIA is up 22%; the 15-51 Indicator is up 36%. What justifies such a pace in the face of a shrinking economy? See chart below.

8-10-12b

Gold is down 3% in the most recent year. But viewing only these short-term charts can cast a false shadow over gold, which has been on a torrent run since the last monetary disaster. See the chart below. 

8-10-12c

In this five year stretch, gold is up 155%, stock market strength is up 144% and the average is up just 5% – barely keeping pace with Real GDP.   

While gold looks to be flattening long-term, there can be little doubt that it will regain its steam once America slips off the "fiscal cliff" and plummets into recession. Yes, plummets. I’ve been blogging about the "fiscal cliff" since before it got its stupid name (see: Unleashing American Ingenuity, October 2011.) 

Without Congressional action, the Bush tax cuts will expire at the end of 2012 along with $2 trillion of automatic spending cuts. That will turn a $15 trillion economy into $13 trillion – a 13% drop in market activity. That’s the so called "fiscal cliff" – and there’s no avoiding it. 

The government simply cannot keep spending $4 trillion per year when it only brings in $2 trillion. Like modern examples from Europe (i.e. Greece, Italy, Spain, and France) taxes cannot be raised high enough to cover faulty government and monetary shell games.   

It’s only a matter of time until over-leveraged governments implement austerity programs to save their fiscal standing. Cuts in health and education programs are always at the top of the list – and these cuts have no choice but to shrink markets and economies.  

It is these shrinking markets that always cause inflated stock markets to correct.

Stay tuned…

PS: To see remedies to the above condition see the rest of my Fixing the Market series located in the right rail.    

ShieldThe road to financial independence.™

Facebook, and a Muse called Morgan

Dan Calandro - Sunday, August 05, 2012

I’ve been following the facebook scandal since before the stock hit the street. In Facebook Flop, Too Big to Succeed, I said "IPO's commonly find their way into mutual funds. So if you own a mutual fund you might have lost a few bucks on facebook and don’t know it [yet]. That’s another hidden cost of pooled investment products..." – a.k.a. mutual funds.  

On July 8th my hunch was proven true in a Wall Street Journal article highlighting more than one hundred U.S. based mutual funds that took a beating on facebook stock. According to my calculations, owners of mutual funds listed in that article lost more than $500 million on facebook. While some companies have liquidated portions of their positions, others haven’t, and still others can’t sell out due to regulatory constraints. In other words, many mutual fund owners continue to lose money on the losing proposition that facebook turned out to be. 

I call it a scandal because that’s indeed what it was. The IPO, which was botched from the start, came with a despicable parade orchestrated by the Wall Street establishment that was covered in gross amounts throughout the media. The disgusting display of greed and corruption came at a time of great economic stress for many Americans, many of whom are mutual funds owners. The charade, promulgated by those with mass media credentials, is the latest example of Wall Street propaganda, dishonesty and deception.  

Of the many mutual funds listed in the aforementioned WSJ article, lead underwriter Morgan Stanley positioned facebook most aggressively in their mutual funds, allocating an average of 6% per fund to the social media company. That’s a crazy allocation!!!  

In 15-51 methodology, a 6% allocation is one of the top three stock selections in the entire portfolio. Placing such a weight on any IPO is nuts – let alone one with declining growth and exploding costs. That’s facebook – and Morgan Stanley knew it long before street date.  

In its first public announcement of operations, facebook recently reported $1 billion in revenue and $2 billion in expenses – and they expect that trend to continue! Forgive me, but doesn’t that sound like government work? One wonders where the $100 billion IPO valuation came from.

Yet despite this or their prior knowledge, Morgan Stanley fund managers placed facebook at the top of their allocation models in mutual funds partially entitled: Growth Trust, Focus Growth, and a series of Institutional Opportunity and Advantage funds. I don’t know about you, but it doesn’t sound like the facebook IPO belongs in any one of those funds.  

The extravaganza surrounding the facebook IPO was like no other. Millions of people all across the globe use the social network and were curious to see how it would fare in the public arena. Others looked forward to the opportunity of finding out more about facebook’s operations, how it made money, and how much it made. 

But even with all the fanfare surroundng it, I couldn’t find a single person interested in buying facebook stock. In fact, just a few days before street date I asked my friend Craig, a savvy and experienced trader, what he thought about facebook. He said, "Dead on arrival. I wouldn’t touch it with a ten foot pole" — which was a consistent theme throughout my network. And in the end, it wasn’t people that bought into the facebook hype but mutual funds.  

Fidelity, one of the nation’s largest mutual companies, placed facebook shares in no less than 39 of its mutual funds spread amongst many different types, from growth to income funds, conservative to aggressive funds, to income and value funds. Fidelity had facebook in almost every possible mutual fund class, their customers losing some $300 million on the deal so far.  

That’s why I say you can do better than your broker and mutual fund manager! Most people who would never buy facebook stock lost money on it through their mutual funds. 

Let us also not forget that Morgan Stanley and Goldman Sachs downgraded facebook’s operating position before it went public. Yes, Morgan Stanley downgraded the stock and then loaded up on it their mutual funds. Doesn’t that sound dirty? 

This, of course, is not to mention that in the face of its own downgrade, Morgan Stanley had the audacity to raise the IPO price and number of shares to be sold just days before facebook’s public debut. This prompted Goldman Sachs to brashly state that it would sell half of its facebook position if the IPO was priced at $38. These moves, no doubt, contributed to some of the technical errors experienced when the NASDAQ market opened trading for facebook stock.

That’s why large Swiss bank UBS, who lost $350 million on the facebook scam, is pursuing legal action against the NASDAQ. They’re trying to recoup some of their loss and who could blame them? Heck, if UBS had any guts they’d be suing Morgan Stanley, the true villain, but that would be bad for business and the industry in which UBS operates. For that reason, the NASDAQ will serve as the sacrificial lamb in this case.

The facebook IPO was a heist of epic proportions. Facebook and the Wall Street establishment bought low and manipulated the system to sell high to a mutual fund community who never saw it coming through a parade-like diversion. Sadly, many mutual fund owners continue to lose money on facebook and still don’t know it.  

And that’s what motivates me. You can call it a Muse called Morgan.  

It’s time to Lose Your Broker Not Your Money. You can do better than them!


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