Dan’s Blog

Down, Up, and Around the World

Dan Calandro - Monday, October 27, 2014

Volatility has once again found the stock market – and again, contradictory new reports are at the core.

On Wednesday, October 22, 2014, the Wall Street Journal online posted an article entitled, Clouds Darken for America’s Blue-Chip Stocks, citing weak results for traditional powerhouse stocks like AT&T, Coca-Cola, IBM, Wal-Mart, and General Electric. The article went on to note that a collective one-third (or 66%) of the entire Dow Jones Industrial Average "posted shrinking or flat revenue over the past 12 months."

Stocks fell 1% on that day. 

But just one day later, on October 23, a contradictory article appeared in the same publication entitled, U.S. Stocks Rally on Strong Earnings. This article reported strong earnings performances by two key Dow components: Caterpillar and 3M. Those two stocks, just 7% of the Dow, lifted "the market" by more than 1% on Thursday; and then added another point on Friday, October 24.  

Around the world poor economics continued to pour in – starting right here in America. On Thursday the U.S. Department of Labor reported worse than expected new jobless claims (283,000), and U.S. manufacturing fell short of expectations. 

In China, the world’s second largest economy, growth was projected to "slow sharply during the coming decade," while its "productivity [takes a] nose dive." China’s new government continues to struggle making economic reforms and is currently facing a "deepening housing slump" and serious environmental and budgetary concerns.

A lackluster China hurts global output. 

In the troubled Euro-Zone the first wave of earnings reports showed significant weakness – a grim outlook for their economy – especially now that the European Central Bank announced 25 of the Euro’s banks recently failed stress tests. 

Not good.

With all the war and strife in the Middle East it’s easy to forget about their economies. Managing director of the International Monetary Fund, Christine Lagarde, hasn’t. She recently urged Persian Gulf countries to balance their budgets amid falling oil prices. Those countries, like Saudi Arabia, have been on a spending spree building critical infrastructure elements like roads, bridges, and hospitals to fend off radical sentiment and unrest stewing from the Arab Spring. A significant drop in oil prices will cause unsustainable deficits that will threaten their spending efforts.

And then who knows what will happen there. 

Russia is in somewhat the same predicament. Already hampered by western government sanctions imposed for its actions in the Ukraine, a drop in oil prices greatly affects central government planning in that communist regime. For instance, Russia’s budget is predicated on an oil price of $100 per barrel. Oil is currently trading at $81/barrell. This kind of strain causes the specter of war to increase, as wartime conditions in oil rich nations threaten supply and raises prices – to thus increase revenues to oil dependent nations. 

The world is on a collision course with calamity. 

Yet the stock market appears not to see it. And while volatility has re-entered the equation, stocks and gold have produced little blood so far this year. See below. 


Both stocks and gold have moved a lot so far but have really gone nowhere: the Dow Average is up just 1.4%, 15-51 strength has gained only 1.7%; and gold - down 11% from its year-to-date high - is higher by just 1.9% in the ten months. 

Stocks and gold seem to be basing at these levels. 

Perhaps that is more easily seen through a longer view. The chart below spans more than three years and begins when stocks essentially reached "fair value." During this time 15-51 strength gained 70%, the Dow Average added 44% and gold lost 8%. See below.


During the period shown above the economy grew at just 7% in Real terms – just a few measly points per year. That puts the growth multiple for the 15-51 strength indicator at 10 times economic output, and the Dow Average’s at 6 times, or 600% of economic output. 

That’s an unsustainable level of stock price inflation – which is the reason for increased market volatility - around the world.

Stay tuned…

ShieldThe road to financial independence.™

The Same Different Things

Dan Calandro - Sunday, October 05, 2014

Reoccurring themes in the markets continued to play out again this week: the unemployment rate dropped to 5.9% – and labor participation didn’t change a bit; it’s still at 40 year lows. The International Monetary Fund (IMF) predicted lower global output warning "high debt, high unemployment…and mounting risks in the financial sector could spell years of weak growth" – yet European bonds went negative, a condition where lenders pay borrowers to borrow. Negative yields are a bad sign; they indicate an ass-backwards market – yet the stock market remains near all-time highs. 

Let me try to make sense of things…

As mentioned in Danger Will Robinson, the European Central Bank (ECB) is enacting a charge to deposits held by large European banks. This move is intended to encourage lending by charging an expense to idle bank capital. In other words, put idle capital to work or pay a tax.  

But the European economy stinks, as noted above by IMF managing director Christine Lagarde. Her comments substantiate the reason the ECB announced their plan to initiate a quantitative easing (QE) several weeks ago. QE is a move intended to strengthen banks. 

So let me ask this: If European banks are weak (hence the need for them to be strengthened via QE) then why is the ECB forcing them to lower their capital reserves by charging them an expense on those same reserves?

When asked why Europe would adopt QE, Andrew Roberts, co-head of European economics at RBS, said "Italy is the reason…[their] economic weakness is deepening." Yet Italy’s bond yields have dropped a stunning 63% since the last time they were bailed-out (2012), and they currently pay fractions less than the U.S.

How Italian bonds can be yielding 2.4% while the U.S. is paying essentially the same rate (2.45%) is nothing short of market dysfunction – a dysfunction that can only occur with over-reaching government intrusion.

Here’s how it happens…

Europe is in a no growth position and is again teetering on recession; job growth is dismal and free market activity is in such steady decline that deflation is a legitimate concern. For these reasons companies do not want to borrow - prospects are too bleak. And individuals aren't borrowing as well - either they don’t’ want to borrow or cannot afford to do it.

Europe is in economic gridlock and money isn’t moving. That’s why the ECB is acting. 

Unfortunately their actions will only make matters worse. Consider this…

Banks, now forced to put excess capital to work or face a charge, and with only limited free market options available, look to profit and cover their costs (the charge from the ECB) by lending it to sovereign States, like Italy. Italy’s current yield (2.4%) easily covers the charge imposed by the ECB (estimated to be a small fraction less than .25%.)

That's what markets do; they inherently search to maximize profits. Profit, of course, is their goal and purpose. Besides, States like Italy are more likely to get bailed-out when the next mess hits the fan – especially with a QE program already in tact. In other words, sovereign debt produces more return with less risk.

Sound familiar?- Wait, there's more... 

The increased demand for sovereign State bonds forced by ECB policy is the driving force behind falling yields in the Euro Zone. Put another way, poor monetary policy is facilitating higher debt levels to entities that can’t rightfully honor their obligations – like Argentina, Portugal, and Italy, to name a few.

Ironic, isn't it?- This is the same exact dynamic that occurred during the "subprime mortgage crisis" that produced the 2008 market crash. The only difference this time is that the lending isn’t happening to individuals unable to repay but Countries!

That’s a much bigger problem. 

So many things point to history repeating itself. For instance, during the last debt-boom the yield curve was often inverted, where consumers realized a monetary benefit from taking more debt (even though they couldn’t pay it back) because interest rates were less than inflation. The same is true now in Germany, where yields have recently gone negative.

With demand being so great for international sovereign debt, Italy, like so many subprime mortgagers did during the housing-boom, has no problem taking on more debt than it could reasonably afford - at rock bottom interest rates.

So please tell me: Why should we believe that this monetary ponzi scheme won’t end with a worse kind of disaster as the last one? - especially knowing that the same exact things are being done now as then, albeit in a slightly different manner.

The next crash is going to be an ugly one because not just banks but countries will be failing. Central bankers will be unable to print the massive amounts of new currency required to avert disaster without wreaking inflationary havoc on the economy. That’s why gold remains a huge buy here – and I don’t care one bit it has taken it on the chin lately. That’s a total misnomer (see: Programmed Trading for more info.) 

There’s an old saying, trade on speculation and invest on facts. The first is a short term perspective and the latter is a long term strategy. 

Think long term, strategically, and…  

Stay tuned…


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