Archives for June 2014

Voila: World War Three

Whoever really runs things these days for the semi-mummified royal administration down in Saudi Arabia must be leaving skid-marks in his small-clothes thinking about Abu Bakr al-Baghdadi and his ISIS army of psychopathic killers sweeping hither and thither through what is again being quaintly called “the Levant.” ISIS just concluded an orgy of crucifixions up in Syria over the weekend, the victims being other Islamic militants who were not radical enough, or who had dallied with US support.

Crucifixion sends an interesting and complex message to various parties around this systemically fracturing globe. It’s a step back from the disabling horror of video beheadings, but it still packs a punch. For the Christian West, it re-awakens a certain central cultural narrative that had gone somnolent there for a century or so. ISIS’s message: If you thought the Romans were bad…. Among the human race, you see, the memories linger.

ISIS has successfully shocked the world over the last two weeks by negating eight years, several trillion dollars, and 4,500 battle deaths in the USA’s endeavor to turn Iraq into an obedient oil dispensary. Now they have gone and announced that their conquests of the moment amount to a Caliphate, that is, an Islamic theocracy. In that sense, they are at least out-doing America’s Republican Party, which has been trying to do something similar here from sea to shining sea but finds itself thwarted by hostile blue states on both coasts.

More to the point, the press (another quaint term, I suppose) is not paying any attention whatsoever to what goes down with ISIS and the other states besides Iraq and Syria in the region. I aver to Saudi Arabia especially because Americans seem to regard it as an impregnable bastion against the bloodthirsty craziness spreading over the rest of the Muslim world. Saudi Arabia is, of course, the keystone of OPEC. Saudi Arabia has had the distinction of remaining stable through all the escalating tumult of recent decades, reliably pumping out its roughly 10 million barrels a day like Bossy the cow in America’s oil import barn.

Or seeming to remain stable, I should say, because the Saud family royal administration of mummified rulers and senile princes looks more and more like a Potemkin monarchy every month. 90-year-old King Abdullah has been rumored to be on life support lo these last two years, his successor brothers already dead and gone, and other powerful Arabian clans with leaders who can walk across a room and speak itching to kick this zombie Saud family off the throne. To make matters worse, the Sauds have also managed to sponsor much of the organized Sunni terrorism in the region (around the world, really) in their role as the chief enemy of the Shia ­— as represented by the politicized clergy of Iran.

Things are happening at lightning speed over in the region and beware of how the turmoil spreads from one flashpoint to another. This would be an opportunity for ISIS to put the Saud family on the spot regarding the just-announced Caliphate — as in the question: who really calls the shots for this new theocratic kingdom? (Answer: maybe not you, doddering, mummified, America suck-up Saudi Arabia). What’s more, what happens to the other kingdoms and rickety states in that corner of the world? For instance, Lebanon, which has been a sort of political demolition derby for three decades. The founder of the group al Qaeda in Iraq (AQI), pre-cursor to ISIS, was the Lebanese Abu Mus‘ab al-Zarqawi — blown up in a USA air strike some years ago. Lebanon has been under the sway of Hezbollah for a decade and Hezbollah is sponsored by Shi’ite Iran, making it an enemy of ISIS. Might ISIS roll westward over Hezbollah now to capture the pearl of the Mediterranean (or what’s left of it) Beirut? I wouldn’t be surprised.

Then there’s Jordan, and it’s youngish King Abdullah, another notorious USA ass-kisser. Those crucifixion photos coming out of Syria must be making him a little loose in the bowels. And, of course, Syria, where this whole thing started, is a smoldering rump-roast of a state. And finally, that bugbear in the bull’s-eye of the old Levant: Israel.

It is miraculous that Israel has managed so far to stay out of the way of this juggernaut. Of course, among its chief enemies are Hezbollah and Hezbollah’s foster father, Iran, which happen to be the enemy of ISIS and, of course, in that part of the world the enemy of my enemy is my ally — though, I’m sorry, it’s rather impossible to imagine Israel getting all chummy with the psychopaths of ISIS. One thing is a fact: all other things being equal, Israel has the capability of turning any other state or kingdom in the region into an ashtray, if push came to shove. Voila: World War Three.

Letter to Editorial Board of The New York Times: “Real Cause Is Regulatory Capture/Corruption”

Courtesy of Larry Doyle.

I sent a copy of this letter to the members of the Editorial Board of The New York Times this morning. 

To the Editorial Board of The New York Times

Re: Sunday Editorial, The Dark Pool Iceberg: Lawsuit Against Barclays Shows Need for More Scrutiny

Dear Mr. Rosenthal, et al,

I was pleased to read your editorial in this past Sunday’s New York Times regarding the recent lawsuit brought by New York Attorney General Eric Schneiderman against Barclays for engaging in a ‘pernicious fraud’ within its equity division and specifically in the operation of its dark pool.

The allegations made by AG Schneiderman are supported by information provided by whistleblowers who had previously worked at Barclays. The outrage by investors and the public should be justifiably long and loud. The erosion of trust and confidence in Wall Street broadly speaking will continue to undermine our economy. We all suffer in the process.

I fully concur with your assertion,

“There is no reason to believe that this kind of wrongdoing is limited to Barclays.”

As you certainly well know, you never find just one mouse. You conclude your editorial by writing:

“In a financial system that is presumably built on the integrity of its public markets, banks should not be entitled to operate increasingly in the shadows, where even large and savvy clients can get mugged. Financial regulators need to force more order and transparency on the system, and to prosecute the wrongdoing that comes to light in the process. Mr. Schneiderman has shown the way, but he can’t do it alone.”

You are correct in this summation. But let’s stop right here and ponder that this editorial is being written in June 2014, a full 6 years past the onset of the economic crisis and a full 4 years since the passage of Dodd-Frank, legislation promoted as reforming Wall Street. How is it that the practices alleged in this lawsuit might come to pass and would seem to have persisted for a number of years?

I will tell you.

Lying, fraud, self-dealing, blatant misrepresentations and more as laid out in this lawsuit against Barclays are symptoms of a Wall Street that remains out of control. What is the cause that needs to be addressed, exposed, and rectified? A financial regulatory system that covers the spectrum of being ill-equipped, incompetent, captured, and corrupted.

While those within the regulatory system itself all too often cry for more funding in order to provide meaningful investor protection, let’s not be so naive as to think that merely throwing money at regulators who have shown themselves to be ineffectual, captured, and corrupted will solve our problems.

While some might think that painting our financial regulators with a bright red “C” for being corrupted is overly aggressive, two of America’s most highly acclaimed financial whistleblowers used that very term to do just that.

On February 4, 2009, renowned Madoff whistleblower Harry Markopolos in the midst of Congressional testimony proclaimed that Wall Street’s self-regulator FINRA was deserving of an A+ in corruption. On January 7, 2014 upon the release of my book (In Bed with Wall Street; Palgrave MacMillan), SEC whistleblower Gary Aguirre is quoted on page 144 as saying:

“I saw how SEC management would create a fictional rationale for not pursuing the investigation against John Mack . . . Somewhere between the third and fourth fictionalized account, I understood just how deeply the corruption was embedded in the (SEC) Enforcement’s management.”

I concur with you again in your assessment that Mr. Schneiderman can not clean up Wall Street on his own. The simple fact is monitoring Wall Street is the purview not primarily of AG Schneiderman but rather the SEC, FINRA, and other financial regulators including the Federal Reserve and CFTC.

Interestingly enough, in January 2013 FINRA itself made a public vow that it would shine a light on the nefarious activities that have been shown to transpire within Wall Street’s dark pools. Yet, despite this public proclamation, FINRA has done little to provide meaningful protection against the ‘pernicious fraud’ alleged by AG Schneiderman.

For those who look closely, the evidence of regulatory capture and corruption is screaming. Having written the aforementioned book that details and documents significant examples of lying, fraud, misrepresentation, and self-dealing within these regulators, I call on you to shine the wide-angled lens of transparency that comes from your elevated position on the editorial board of The New York Times into these regulators and also upon our public officials atop Capitol Hill.

If you want a host of starting points, I am more than happy to have my publisher send each member of the editorial board a copy of my book. The index alone will provide plentiful material and referenced documents to begin the process of rooting out the cause that allows symptoms such as Barclays shark-filled dark pool to perpetuate.

Those within the power bases on Wall Street and Washington certainly would prefer to have firms such as Barclays pay token fines while maintaining the captured and corrupted status quo.  But as you well know, Wall Street and Washington are not representative of America.

I exhort you to uphold your mandate to pursue, promote, and protect the public interest with a full blown expose of our captured and corrupted financial regulators and public officials. In doing so, you will also need to expose their cronies on Wall Street who welcome them on the other side of the revolving door and fill their campaign coffers with funds that strike most Americans as little more than payoffs that ultimately allow ‘pernicious frauds’ to continue.

I look forward to your response and welcome the opportunity to engage you in this pursuit.

Sincere regards,

The New Normal of Healthcare Spending

Thoughts from the Frontline: The New Normal of Healthcare Spending

?By John Mauldin

A rather interesting shockwave came across the newsfeeds this week. I was actually doing a TV interview when the host announced that GDP was down 2.9% for the first quarter. There was not much else I could do but note that that was a really bad, ugly, terrible, not very good number. But I had no real basis, without any facts in front of me, by which to understand why the revision was so extreme. Sure, we were all expecting a pretty large revision, but what we got was the worst decline in five years and the largest downward revision since recordkeeping began. Later, a quick perusal of the data on the BLS website revealed the culprits: exports and healthcare spending.

Last year I was one of the very few who suggested that the implementation of Obamacare could cause a recession (see more below). Such a suggestion was universally dismissed by all right-thinking economists, and for very good reasons based in sound economic theory, I might add. But sometimes the real world neglects to adhere to our models and theories, and that was my concern.

While I doubt we’ll see a recession – classically understood as two quarters in a row of negative GDP – this rather large bump in the road offers a number of teaching opportunities. This week’s letter will look at the actual numbers; and then, rather than try to spin the numbers to fit some preconceived political agenda, we will examine what actually happened in the spending data and why. And while it may surprise some of you, I actually think a few good things did happen, things I find encouraging.

Anytime I write about healthcare it’s controversial, and I expect this letter will be received that way as well. However, as I (and many others) haveclearly established, the healthcare system in the United States is massively dysfunctional. We are simply spending too much money on healthcare and are on a path to spending an unsustainable amount of money by the end of the decade. Things are going to change no matter what. The Affordable Care Act (ACA or Obamacare) was one way to try to address the problem. The majority of the country now feels this might not have been the best way, but that really doesn’t make any difference. It is going to be the basic law for another three to four years. My job, at least in this letter, is not to discuss policy but rather the economic effects of the policies we have chosen to implement, and what those effects may mean for our investment portfolios.

GDP Shocker: a Drop of 2.9%!

First, let’s look just at the facts as given to us by the BLS. US Q1 GDP Q/Q was revised much lower, to -2.9% on an annualized basis, down from the -1.0% previously reported (which itself was revised lower from the +0.1% initially reported) and well below the expected decline of -1.8%. How did we go from barely positive to down 2.9%?

When the BLS gives us its first estimate of previous-quarter GDP, it is forced to use models based on previous trends until the actual data comes in. This is why we get two monthly revisions and in future years will get even further revisions. (Sidebar: don’t you wish the US Bureau of Labor Statistics could be as good as their Chinese counterparts? The Chinese never have to revise their numbers. Obviously they are very good at this type of thing.)

And we all know that assumptions will sometimes bite you in the derrière. Look at this chart of projected healthcare spending from the original release of first-quarter GDP data in April. Notice that the projected spending was almost double what it had been just the previous quarter and over four times the previous year’s average. I’m not quite certain how trend models got to that number, but then I’m not a mathematician. In any event, here’s the chart, courtesy of Zero Hedge:

Now fast-forward to last week’s revision and notice that the healthcare spending number has dropped from the previous quarter, not doubled. In fact, it dropped an enormous 6.4%. Rather than contributing 0.62% to GDP is it did in the fourth quarter of 2013, in Q1 2014 it subtracted 0.16% from GDP growth.

Just for the record, here are the actual numbers from the BLS data. Roughly 2/3 of the negative revision in Q1 GDP was from healthcare spending, and the rest was from falling exports and rising imports (from an accounting standpoint, imports are a negative in figuring GDP).

I want us to look quickly at two charts to get some historical perspective on growth in the US. The first is GDP quarter by quarter for the last seven years. Notice that only two quarters ago we had a 4.1% positive quarter. During the 19 quarters since the current expansion began in June 2009, the economy has grown at an annual rate of 2.1%, compared to the 4.1% average in every other expansion since 1960.

In fact, rather than the comfortable +3% from 1950 through 2000, growth fell to +1.9% for the entire decade of the aughts and has not risen appreciably above that in the last four years. Here is a chart showing the rolling four-quarter average for GDP growth since 1980. With last quarter’s negative revision included, we’ve only grown 1.6% for the last 12 months. Dude, who stole my productivity?

The New Normal of Healthcare Spending

On October 6, 2013, I penned a rather lengthy discussion of the economic impact of the Affordable Care Act. I still think it was one of the better pieces I have written. You can read it here. I offered an analysis of what healthcare will look like within a few years. Essentially, we are moving to a three-tiered system. Somewhere between 3 to 5% of people will have what is coming to be known as concierge care, another 20% or so will have what we think of as traditional insurance, and the remaining 75% will get by with some form of government-mandated and -controlled healthcare (with high deductibles and increasing costs).

I titled the letter I wrote back in October “The Road to a New Medical Order.” Business Insider, which posts my letter each week (a surprising number of people think I actually write for them, which is fine by me, I guess) generally tries to come up with impactful and somewhat controversial headlines to attract readers. Their headline over my piece was “Obama Care Will Change Everything – And I Think It Might Cause a Recession.” And yes, buried deep in the article I did write:

When I am asked what keeps me up at night about our economy, my ready answer for the past few months has been the unknown transition costs associated with the ACA. I hope Jack Rivkin is right and that the transition to Obamacare proves to be just another Y2K. I truly believe that healthcare will be significantly better in 10 years, largely due to advances in technology, but also as we streamline our healthcare delivery. So I’m a long-term optimist, though I have to confess that, in the short term, which would be through the last half of 2014, I am quite concerned that dislocating 1 to 2% of the economy could be enough to push us into recession. I have nothing factual to base that on – no inverted yield curve, no evident bubble getting ready to burst – so I will stop far short of a prediction. Let’s just say that these issues need to be right up front on our radar screens. And it wouldn't hurt to keep our fingers crossed.

Let’s run through a quick summary of my analysis then – which is the same as how I see things today. We are going to reduce the amount of money we spend on healthcare by around 1% of GDP a year for the next four years, or about 5% per year in actual reductions. While right-thinking economists will point out that that money will be spent elsewhere, and they are correct, my concern was – and it is evidently turning out to be pretty correct – that the transition will be messy. I simply do not believe that you can change the “plumbing” of how healthcare dollars are spent, totally change the incentive structure, and demand more service for 20% fewer dollars while reducing the number of workers at hospitals, without serious short-term dislocations. Like we saw last quarter.

Will all this wash out over the next few years? Absolutely. We are not on some permanent healthcare spending death march where quarter by quarter healthcare spending will keep dropping. It is just, to borrow a phrase from my friend Mohamed El-Erian, that we are entering into a New Normal of Healthcare Spending. And eventually that money that we are not spending on healthcare will get spent on something else, and those people that are not employed in the healthcare industry will find other jobs or end up taking less pay for doing the same job. But it is the turmoil created in the midst of that process that is going to create some ups and downs in the economy (more on that later).

I have regular conversations with numerous friends about what’s happening in the healthcare world, as I think that is where the real action is. For an economist, this is a wonderful experiment in incentive structures. And if you are an economist worth your salt, you know that economics is all about incentives. Individuals have an incentive to maximize their healthcare services and reduce their actual out-of-pocket expenses. Healthcare businesses have an incentive to make sure that expenses don’t exceed revenues. And the ACA is nothing if it is not an enormous incentive-changing machine.

Jack Rivkin sent me a note yesterday detailing a conversation he had recently with a healthcare provider. (I’ll remove names, just in case.)

Had a great 3 hour dinner discussion in Chicago three weeks ago with the head of the … Hospital. He realizes he’s at the bottom of the food chain but is very excited about what is happening. First dinner with him was three years ago when he was just beginning. He’s substantially changing the mix of his work force. That includes doctors who are now employees, not independent business folks. He has made the switch to outcomes-oriented medicine and is looking to become his own insurance company where he believes the big ripoff has been taking place. You should hear what he has to say about Blue Cross/Blue Shield and the people running it. He is tired of getting paid for procedures as opposed to outcomes, e.g., [he’s] down from using 7 different types of hip replacements to 3, based on those with the best long-term success. The doctors were told you either switch to what we have chosen or find another hospital. Actually “fired” some doctors when the data showed what a high rate of repetition [their] patients had.

That complaint about insurance companies is showing up a lot. Here’s a section from a great little article by Jake Novak at CNBC called “An Obamacare bailout? Insurers already got one!”

Whether the ACA has actually helped more citizens than it's hurt has turned into a partisan war of statistics. That war will be waged for years to come. While I believe the new law will ultimately hurt more people than it helps, I realize those on the other side of the political spectrum will never agree with that assessment.

So let's not have that fruitless argument.

Instead let's focus on something the two major political camps can agree on, even if it is something that will make both of them very angry. Based on the non-partisan, hard numbers, the big winners in Obamacare America are… drumroll please… the insurance companies!

Yes, those greedy, heartless, bureaucratic, and anti-competitive health-insurance companies that President Obama kinda sorta blamed for his mother's death and Republicans blasted for seeking a bailout, and doctors accused of interfering with their medical judgment are all still alive and kicking in the 2014 world of the ACA.

Of course, insurance companies would simply argue that they’re playing by the rules and that they’re having a really difficult time making profits. Most insurance plans under Obamacare are going to rise significantly in cost later this year or next year.

Again, we find out something about incentives. It should be no surprise that a significant number of people with serious health issues who had no insurance have now signed up for the new healthcare programs. Lanhee Chen on the BloombergView site sees it this way:

At its base, the data show that people insured through the law’s exchanges have higher rates of serious medical conditions. Of the enrollees who have seen a doctor or other health-care provider in the first quarter of this year, 27 percent have significant medical problems, including diabetes, cancer, heart trouble and psychiatric conditions. That rate is substantially higher than that for patients in nonexchange market plans over the same period. And it’s more than double the rate of those who were able to hold onto their existing individual market insurance plans after President Barack Obama was forced to allow them to keep them.

This outcome should not surprise anyone. The law’s one-size-fits-all regulatory regime, which requires insurers to offer coverage to all comers and prohibits pricing of coverage based on an applicant’s health status, was bound to increase the number of relatively sicker people purchasing insurance through the exchanges. Moreover, Obama’s executive action, which effectively allowed many people who had individual market plans to remain in them through at least 2016, bifurcated the insurance markets such that healthier people remained in the plans they already had, while relatively sicker patients were left to acquire coverage through the Affordable Care Act’s exchanges.

Some of the bad risk in the exchanges has been offset by the enrollment of relatively healthy people who acquired coverage because of the law’s generous subsidies. Yet the numbers make clear that the exchanges remain a haven for those who may consume more medical services than others. (Bloomberg)

The ACA is going to be enormously contentious, as the rules are conflicting as to how insurers can make up their losses. President Obama would like to do it one way that he thinks is allowed within the rules, but there are many in Congress who think that’s a bailout for insurance companies and is against the rules. However it plays out, the ACA is going to cost someone, whether it’s taxpayers or those buying insurance, a great deal more money than initially budgeted. And the insurers will continue to be everybody’s favorite whipping boy.

As an aside, I find it an enormously intriguing idea that a healthcare hospital group is seriously thinking about setting up its own insurance company. You gotta love America, 100 different experiments going on at once. Some of them are sure to be game changers.

Why Healthcare Spending Went Down

My contacts in hospitals and elsewhere in the healthcare industry confirm that healthcare spending was down dramatically (though perhaps not quite the 6.4% in the data) in the first quarter. These same sources suggest that healthcare spending has rebounded during the second quarter. The first week of June was actually the best week ever for one major healthcare provider, but the overall trend is still for somewhat lower healthcare spending than last year.

So what happened in the first quarter? Evidently, several things. Number one, if you haven’t noticed, the deductibles for most of the ACA programs were quite high, often running as much as $5000 (which, for what it’s worth, is the deductible on my own insurance program – buying a lower deductible is significantly more expensive than simply paying the higher deductible. Go figure.)

The high deductibles were a shock to many people who were used to more-traditional health insurance. They postponed some services and started looking for transparency of pricing for the more expensive services. It is no longer uncommon for a patient to ask for a prescription for an MRI that they can take to another provider across the street who will charge them half of what the hospital provider will. If you’re paying it out of pocket, you begin to pay attention to what you’re paying. I think we should applaud that increase in transparency.

To those points, Dr. Toby Cosgrove, CEO of Cleveland Clinic, recently noted:

The entire healthcare system will have less money coming into it – we are taking costs out, so will all hospitals…. Obamacare is accelerating the process…. but this is due to transparency of costs and consumer[s] with high-deductible plans. This is a huge social experiment involving almost 18% of GDP and 100% of people… this will take four to five years to shake out.”

Further, there were a lot of people who didn’t get Obamacare insurance in the first few months and had to wait until March or April for their insurance to kick in. Other people have lost their insurance inexplicably because insurers are losing control of their internal management systems amid all the turmoil. People are postponing what they can until their insurance kicks in or gets reinstated. Apparently, some of this has gotten sorted out in the second quarter, and healthcare spending is on a trajectory to the “new normal,” which may eventually be about 20% less than what we spend today.

Muddle Through Economy Redux

I still think the next shoe to drop may be in the third and fourth quarter when hospitals begin to realize that they have significant cash-flow problems. Estimates are that we have about 10% too many hospitals, and the creative destruction of the new healthcare system is going to relieve us of that excess. Only the strong and well-managed will survive. This is of course going to create turmoil in the whole healthcare employment world, etc., etc.

Further, Obamacare is the largest middle-class tax increase in history. Yes, enrollees are getting healthcare for their additional expenditures, but you get extra government services for an increase in regular taxes. Call it a premium or call it a tax, it still amounts to a reduction in disposable income for individuals and families. Tax increases have a negative effect on the economy equal to roughly three times their actual amount. We have gone over that research numerous times.

And that negative effect doesn’t come all at once but is actually spread out over about three years, so the Obamacare taxes will still be creating a headwind to growth this year and next.

Further, although the president has postponed some of the “features” of the ACA, such as the business mandates, they are going to kick in eventually. We’ve already seen a rather large rise in temporary employment as employers shed full-time employees so they don’t have to cover their insurance. We’re going to see more such unintentional consequences, because that’s just where the incentives are. This will of course create even more headwinds for growth and productivity.

We would have to achieve 3% GDP growth in each of the next three quarters simply to average 2% for 2014. If you go back and look at the chart on US real GDP growth, you will notice that we haven’t grown that consistently since the recovery began in 2009. GDP growth has been rather noisy.

We are at best in a slow-growth Muddle Through economy. And the problem is that consumers are getting hammered from all directions: incomes are roughly flat and core expenses are rising.

Returning to the BLS GDP report, we see that inflation was 1.3% in the first quarter as measured by personal consumption expenditures (PCE). One of the “checks and balances” I like to look at when thinking about PCE is what the Dallas Federal Reserve calls the “trimmed mean PCE inflation rate.” Basically they take all the components of inflation in the PCE (which is the Fed’s preferred measure of inflation) and remove the “outliers” (trimming them off, as it were) to smooth out the noise. And sure enough, when you go back and look at the one-month PCE inflation rates for the first quarter, 1.3% seems to be close enough for government work. But then when you look at the chart of what’s happened since then, you see a rather sharp rise in PCE. If that inflation shows up in the BLS statistics next quarter, in their first measure of Q2 GDP (which we will see in late July), it could reduce overall real GDP growth by about 1%. Just saying.

Sidebar: It is all well and good for Janet Yellen to talk about how noisy inflation is and therefore ignore it, but in the things that you and I buy there are what economists call “inelastic” items, which means that we have to buy them no matter what the price – things like food and gas and healthcare. We can talk about whether the overall inflation rate for the entire economy is low, but for the mass of consumers in the middle, inflation is running considerably higher than 1.3%.

All this is to say that while I don’t think the US will fall into an “official recession” next quarter, we are extremely vulnerable to “exogenous shocks.” If either China or Europe has a serious problem, or the price of oil increases dramatically for this or that geopolitical reason, then, with the economy flying barely above stall speed, it wouldn’t take much to push us into a recession. We need to have our antennae up in a world where the biggest bull market seems to be in complacency.

Let’s wrap this session up with a cautionary note from my friend Rich Yamarone (aka Darth Vader)

According to the latest data from the Bureau of Economic Analysis, there has never been a time in history that year-over-year gross domestic income has been at its current pace (2.6 percent) without the U.S. economy ultimately falling into recession. That’s more than 50 years of history, which is about as good as one could ever hope for in an economic indicator.

Stay tuned.

The Frontiers of Life Extension Science

Since we are on the subject of healthcare, let me throw in an additional “bonus note” that my friend Pat Cox, who writes Transformational Technology Alert for Mauldin Economics, sent out to the readers of his free technology updates. Pat and I have regular discussions about the latest discoveries on the very cutting edge of technology and especially biotechnology. This is one of the things that keeps me optimistic, because I think that in 10 to 15 years technology will have totally transformed our healthcare delivery systems and significantly reduced the cost in the system, because we will be healthier and there will be cures for some of the most expensive diseases – we’ll actually be fighting back against the ravages of old age. At least that’s my hope as I approach my 65th birthday in a few months.

So let’s look at this fascinating and rather optimistic piece of research that Pat has come across. (More and more, biotechnology is coming to resemble the science fiction that I read.) By the way, if you like what you read, you can subscribe to get his regular updates for free at this link.

By Patrick Cox

In the article below, I discuss work on the frontiers of life-extension science, including the importance of growth differentiation factor 11 (GDF11), and my friendship with the brilliant writer Robert Heinlein.

There’s an obscure reference to me in Robert Heinlein’s (RAH) book To Sail Beyond the Sunset. It came about due to something I said to him in the home he built in Bonny Doon, California. RAH had asked me to write an article about him and his soon-to-be-published book, The Cat Who Walks Through Walls, for the Wall Street Journal.

So I chose the wine, and his wife Ginny cooked several meals that day as the conversation extended into the morning hours. Pixel, the cat that inspired the book title, was there as well. If you’re interested, I'm pretty sure the article I wrote can be found online if you search for my and his names.

The Cat Who Walks Through Walls is interesting for several reasons. One is that it may be viewed as a sequel to Heinlein's The Moon Is a Harsh Mistress, though it also continues story lines found in The Number of the Beast. As such, one of the main characters in the book is Lazarus Long, who first appeared in Methuselah’s Children. As the name of that book implies, it involves extremely long-lived characters.

Heinlein gave two explanations for his characters’ longevity. One was selectively bred genetics. The other was periodic blood transfusions from very young donors.

Of course, we’re talking about science fiction, so nobody really believed that young blood could extend lives. If they had, it would have certainly been a simple hypothesis to test. In fact, 73 years after Methuselah’s Children was serialized in Astounding Science Fiction, the experiment was performed last month at the Stanford University School of Medicine – using mice.

Interestingly, the senior author of the Stanford blood study, Tony Wyss-Coray, PhD, noted that the experiment could have been done 20 years ago. Actually, it could have been done long before that. The procedure was relatively simple.

The team gave 18-month-old mice components of blood from 3-month-old mice eight times in 24 days. Then they gave the aged mice a kind of rodent IQ or memory test, which showed significant improvements.

The overview of the study, published in the journal Nature, states:

As human lifespan increases, a greater fraction of the population is suffering from age-related cognitive impairments, making it important to elucidate a means to combat the effects of aging. Here we report that exposure of an aged animal to young blood can counteract and reverse pre-existing effects of brain aging at the molecular, structural, functional and cognitive level. Genome-wide microarray analysis of heterochronic parabionts – in which circulatory systems of young and aged animals are connected – identified synaptic plasticity–related transcriptional changes in the hippocampus of aged mice.

In other words, the brains of the older mice given transfusions of plasma (the cell-free portion of blood from the young mice) did not simply perform better, they exhibited physical signs of a reversal of aging. Clearly, this is a pretty big deal. To reiterate the last sentence of the summary: “Our data indicate that exposure of aged mice to young blood late in life is capable of rejuvenating synaptic plasticity and improving cognitive function.”

Many of the stories about the Stanford study focused on the likelihood that specific factors in the young blood responsible for the rejuvenation can probably be isolated and used on their own. A prime suspect is the protein expressed by the growth differentiation factor 11 (GDF11) gene. GDF11 protein production decreases with age; prior research has shown that it has rejuvenating effects in parts of the body other than the brain.

I’ve written several times in my weekly alerts, for example, about the Amy Wagers and Richard Lee Harvard experiment. Reported in Cell, it showed that age-related damage to heart muscle in older mice will reverse when GDF11 proteins are transferred from younger mice. This is of enormous interest to researchers because, as you probably know, heart muscle does not normally regenerate in older animals.

It’s not surprising, therefore, that Wyss-Coray is the cofounder of Alkahest, a biotech startup exploring the possibility of commercializing some therapy based on his experiments. I don’t think that Alkahest is likely to be the leader in this field, however.

The reason is that therapies based on the Wyss-Coray experiments would be less than optimal. If you are given an exogenous dose of a naturally occurring protein, it tends to upset the regulatory axis that balances all the interactive and complex forces at work in our bodies.

I’m convinced, therefore, that there are better ways to restore rejuvenating GDF11 to youthful levels. One way is to introduce youthful stem cells, engineered from the patient’s own induced pluripotent stem cells (iPSCs), which express GDF11 at high levels.

Induced Pluripotent Stem Cells

One of the most exciting developments in modern medicine is the creation of induced pluripotent stem (iPS) cells. As it happens, I’ve had skin cells taken from inside my left arm transformed into iPS cells by one of the companies in our portfolio. Those iPS cells are identical to the embryonic stem cells that I came from. Because they have my DNA, there’s no chance of immune rejection, which is one of the advantages they have over cells derived from embryonic stem cell lines.

My iPS cells were then engineered to become youthful heart muscle cells. Based on animal experiments, we have every reason to believe that those cells would become part of my body and repair any damage that my heart may have suffered. Here’s a shot of my youthful cardiomyocytes beating in the lab.

Those same iPSCs, however, could also be engineered to become the type of cell, already developed and patented, that produces high levels of GDF11. Placed into my circulatory system, they would replicate and produce their rejuvenating proteins permanently. This would eliminate the need for periodic transfusion or pills. Another method, owned by a different company in the portfolio, is to put DNA plasmids engineered to express GDF11 into a group of cells so that they permanently produce the protein.

This type of therapy is inevitable. Friends of mine who keep track of high-end anti-aging clinics tell me that extremely wealthy clients are paying for youthful blood transfusions right now. The cost, they tell me, is astronomical. Superior results, however, could be attained using induced pluripotent stem cells or DNA vaccines for far less money.

It’s ironic that most ancient cultures and religions seemed to treat young blood as a sacred symbol of power and life. Historically, there are many stories about victors and vampires who drank blood to acquire youth and strength. Ancient instincts were correct, however, in that youthful, healthy blood does have power, as the ancient kings and warlords of mythology believed.

There’s a race going on right now to see who delivers that power and life first. As Dr. Wyss-Coray noted in the paper about his experiment, “As human lifespan increases, a greater fraction of the population is suffering from age-related cognitive impairments, making it important to elucidate a means to combat the effects of aging.” Personally, I suspect that Alzheimer’s and other sources of cognitive impairments will be cured in the next decade. The human desire for increased health and time, however, is limitless, so we’ll continue to follow these life-extending biotechnologies closely as they develop.

(To learn more about Pat’s Breakthrough Technology Alert and other Mauldin Economics publications, click on this link, where you will find an offer to subscribe to all of our publications at a significant discount. This is a permanently low price, and the offer will go away after Monday.)

The Strategic Investment Conference Presentations

The first group of presentations and select videos from the 2014 Strategic Investment Conference is now available! Videos of two of our most popular speakers, Kyle Bass and David Rosenberg, are available, as well as numerous other presentations and summaries. If you are a Mauldin Circle member, you can access the videos by going to to log in to your “members only” area of the Altegris website. Upon login, click on the “SIC 2014” link in the upper-left corner to view the videos and more. If you have forgotten your login information, simply click “Forgot Login?” and your information will be sent to you.

If you are not already a Mauldin Circle member, the good news is that this program is completely free. In order to join, you must, however, be an accredited investor. Please register here to be qualified by my partners at Altegris and added to the subscriber roster. Once you register, an Altegris representative will call you to provide access to the videos, presentations, and summaries from selected speakers at our 2014 conference.

Nantucket, New York City, Maine, and San Antonio

What would be considered a normal schedule for me would see me doing all of the above-named cities in less than a month, rather than according to my current travel schedule, which lets me spread them out over three months! I will be in Nantucket at a private conference in the middle of July, then in New York July 13-16. Then, as always, I (along with my son Trey) will be in Grand Lake Stream, Maine, the first Friday in August. I think this will be my eighth annual summer expedition to northern Maine and Leen’s Lodge for David Kotok’s big to-do. Then in the middle of September I will join a number of friends and a great roster of speakers at the Casey Research Conference in the Hill Country outside of San Antonio. I’m sure there will be other trips here and there, but I am anticipating being at home a little more for the next few months.

One of the benefits of being home is that I can get into a regular routine at the gym. I and a partner are working with a personal trainer at the gym in our building. His training style is a little different for us and has me doing things that I quite frankly haven’t thought about doing in 40 years. Wind sprints, steps, all sorts of novel ways to torture the body and get your heart rate up, and yes, old-fashioned weights now and then. This morning he introduced me to boxing gloves. The last time I had on boxing gloves, I was a sophomore in high school when our gym coach had us put on gloves and I went into a ring for about three minutes. I took them off with a vow to never touch them again. It was an exhausting three minutes trying to avoid getting pummeled. At least this morning the big brute wasn’t hitting back, but it was quite the workout. I really do need to get in better shape.

I’m cooking for a group of friends and family, so I need to hit the send button and get the prime rib started. Have a great week.

Your wishing I could avoid the healthcare system altogether analyst,

John Mauldin, Editor

Analysts Can’t Always Be Trusted

Here’s One Way Wall Street Cheats.

Los Angeles based Wedbush Securities got some national press last Friday morning when republished their Jun. 26, 2014, research blurb on Bed, Bath & Beyond (BBBY).  The analyst indicated he was now neutral on BBBY @ $61.11 per share. He cut his target price by $8 per share to $58.

The report was accompanied by a chart dated June 26, 2014 @ 4:00 PM.

What was not said was that BBBY had reported after the close on the previous day. The stock was already trading in the $56 range as the analyst was writing to clients.

Barron’s on-line editor was complicit in publishing the Wedbush piece without fact-checking to see that it could not have been accurate at the time of its release.

How can I be sure that the Wedbush analyst knew about both the Q1 news and BBBY’s share price reaction? He discussed the quarterly report in his research alert (see excerpt below).

Wedbush Research  BBBY Jun. 26, 2014 with author's annotations.JPG

Pretending to have downgraded the stock before its $5 per share drop is not ethical. Counting his firm’s change in rating from a closing price that was no longer available inflates their model portfolio results in a way that customers know does not reflect reality.

Here is what took place in the shares of Bed, Bath & Beyond after the close on Wednesday but prior to Thursday’s opening. Note the impossibility of trading at $61.11 after 4 PM on June 25, 2014.

Exposing Wall Street's Cheats

Past-posting is not a new concept. It was the main theme of The Sting, Hollywood’s Best Picture of 1973.


The Sting with quote


Now let’s look at the quality of advice Wedbush was offering, ignoring the fact that they failed to address events that had already taken place.

The analyst went to a Neutral, supposedly at $61.11 with a price target of $58. Is there anyone reading this that would like to hold a non-dividend paying stock that you believe will be about 5% lower in the foreseeable future? Just asking.

Was that $58 goal price really a good evaluation of where BBBY could be a year? The buzz on the Street was that BBBY had ‘missed’ its quarter. In fact, the 93-cents was right within management’s previous guidance range of $0.92 – $0.96. It exactly matched the year ago fiscal Q1 EPS in a period that spanned a (-2.9%) GDP and the much ballyhooed Polar Vortex.

I found that pretty impressive.

After digesting the ‘disappointing’ numbers here are the latest earnings estimates from up to 28 different analysts as reported on Yahoo Finance.

Click here to finish reading this article.




Macro-Economic Factors Make for Bad Market Timing

Would knowing next year’s GDP in advance help you invest?

By Dr. Paul Price

Data released by Zacks Investments shows advanced knowledge of some pretty important economic information… might actually have led you astray.

Lost & Confused - image

Since 1933, there have been nine full years which showed negative GDP. Six of those years experienced positive stock market action including three of the past four, and six of the most recent eight.

Negative GDP & Market Returns


The one miss, 2008, was a big one. That was the year the Standard & Poors 500 dropped a whopping 37%. The huge stock market loss experienced at the start of The Great Recession was sandwiched by impressive gains during GDP declines in 1980, 1982 and 2009.

Will 2014 become the next recession year? The recently revised (-2.9%) first quarter certainly points out that possibility. Does that mean you should be hiding in cash? The chart above says it’s dangerous to base allocation decisions on macro-economic factors.

Since GDP is not really correlated with equity performance your best bet is still gauging buy-sell decisions on a bottoms-up basis.

Bottoms Up - image

Cheers to that.

Japan’s households stung by consumption tax

Japan's households stung by consumption tax

Courtesy of
Japan's household spending fell sharply in May as the consumption tax hike took its toll. While some decline was expected, the 8% year-on-year drop puts the BOJ's optimistic economic forecast in doubt. As inflation cools with the diminishing impact of weaker yen (discussed here), the central bank is likely to accelerate asset purchases later this year.


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K is for Kruger-Dunning Effect

We all know people suffering from Dunning-Kruger syndrome, but as Tim Richards explains, there is absolutely no point in sending this article to them. They will not believe you, they will not thank you, they will not change. ~ Ilene

K is for Kruger-Dunning Effect

The Kruger-Dunning Effect (or, more traditionally, the Dunning-Kruger Effect) identifies the issue that some people are too stupid to know that they’re stupid. They’re also completely convinced that they’re correct, regardless of outcomes or feedback. This is a very dangerous combination, especially in a world of digital connectivity, where whoever is most confident is the guru most followed.


The Dunning-Kruger effect is named after its discoverers, Justin Kruger and David Dunning. The name of their seminal paper sums it up really: Unskilled and Unaware of It: How Difficulties in Recognising One’s Own Incompetence Leads to Inflated Self-Assessments. I can’t outdo the paper for humor, however unintentional, so here’s a quote from the abstract:

“Across 4 studies, the authors found that participants scoring in the bottom quartile on tests of humor, grammar, and logic grossly overestimated their test performance and ability. Although their test scores put them in the 12th percentile, they estimated themselves to be in the 62nd.”

Most of us suffer from overconfidence, but Dunning-Kruger victims do so to an extraordinary degree, and do so even on tasks on which they have received repeated feedback demonstrating that they’re bloody useless. One study showed that good students got better with feedback but that the poorest performers didn’t, and continued to demonstrate gross overconfidence in their abilities despite repeatedly being told they were idiots (I paraphrase).


Although the problem has been repeatedly demonstrated no one knows why this affects certain people and not others. Worryingly this means that you may have the problem because, if you do, you’ll never know. So I’m afraid there’s not much I can do about that. It’s just something you’re born with. Sorry.


While I can’t help people who have the problem I can, at least, help those who don’t. Because Dunning-Kruger sufferers don’t realize they’re hopeless they tend to be extremely overconfident – and extreme overconfidence is something that attracts followers. In a digitally connected world this is very dangerous, because we lose the social cues that tell us when people are, well, a bit odd. I mean, on-line everyone’s a bit odd.

So, don’t take anyone on-line at face value, don’t follow people who don’t exhibit any degree of self-awareness or a sense of humor or who can’t spell or conjugate a verb and don’t have anything to do with anyone who can’t tolerate sensible, contradictory, advice. They may just be afflicted by confirmation bias, but they may be much, much more dangerous. People with D-K, you see, can’t even recognize competence in others.
And also: Don’t Lose Money in the Stupid Corner
Read more: A Liberal Arts Investor’s Reading List

For all the biases (so far to K, but the list is growing) go to: The A to Z of Behavioral Bias

Is Obamacare Bad For US Economic Growth?

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

Following the rather stunning shenanigans of Q1 GDP with regard healthcare spending (as we detailed here), we thought, four years after its passage in 2010, it worth analyzing Obamacare's economic impact? Beforehand, economists generally believed that the broader coverage would raise the demand for healthcare goods and services, although there was some disagreement about related effects on healthcare inflation. In reality, as UBS notes, there was too much optimism about a positive immediate economic impact and a negative price inflation effect.

Via UBS' Maury Harris,

Statisticians at the Bureau of Economic Analysis (BEA) initially were far too optimistic about what expanded healthcare coverage would immediately mean for U.S. economic activity. When calculating their first estimate of Q1(14) real GDP growth at the end of April, the BEA assumed a 9.1% annualized rate of increase in healthcare services consumption—one-ninth of overall real GDP. However, with more complete information, the BEA now reports a 1.4% decline in such spending. That was enough to trim 1.2 percentage points from earlier estimated annual real GDP growth. According to the BEA,

"The revision to health care services reflected the incorporation of newly available Census Bureau quarterly services survey (QSS) data for the first quarter. The QSS data reflect the revenues for-profit and nonprofit hospitals, physician offices, nursing homes, and other health care providers and the expenses of nonprofit hospitals and other nonprofit health care providers. Prior to receiving the Census QSS data, BEA used information on Medicaid benefits and on ACA insurance exchange enrollments to prepare the previously published estimates of health services."

Does American public see any effects from ACA?

Considering government statisticians' struggles in trying to measure what the ACA is doing to the economy, it is useful to ask if the American public thinks it is making much difference in their lives. A Gallup poll conducted on May 21-25 asked the following question: "As you may know, a few of the provisions of the healthcare law have already gone into effect. So far, has the new law helped you and your family, not had an effect, or has it hurt you and your family?" 14% felt it was helpful, a larger 24% responded that it was not helpful, and 59% cited no effect.

A subsequent Bloomberg National Poll on June 6-9 asked a somewhat similar question: "Since the healthcare law went into effect on January 1st of this year, have you experienced a big change, a little change, or no real change in your health care?" A big change was reported by 24% of respondents, little change was reported by 15% of the respondents, and no real change was cited by 60% of the respondents.

While the ACA implementation has not yet made much difference for most Americans, has it influenced their sense of longer-term security—one key to longer-term saving trends? From a behavioral perspective, more secure households should save less and less secure households should save more. The May 21-25 Gallup poll asked this question: "In the long run, how do you think the healthcare law will affect your family's healthcare situation? Will it make things better, not make much difference, or will it make things worse?" 36% responded "worse" versus 22% responding "better".

So far at least, the ACA does not appear to be a longer-term net confidence booster.

Earlier sharp slowdown in healthcare inflation was unsustainable

In addition to consumption and confidence impacts, the ACA potentially influences healthcare costs. The slowdown until recently in the y/y change in the core personal consumption expenditures (PCE) chain price index inflation was partly attributable to slower healthcare inflation. Economists debated whether the ACA should receive any of the credit, with doubters citing earlier instances where healthcare inflation slowed only to subsequently pick up.

Over the three months through May, healthcare goods and services prices accounted for around 43% of the 40 basis point re-acceleration of core PCE price inflation.

With the y/y change in the hourly employment cost index (ECI) for hospital workers up 1.7% in Q1(14), it is hard to see labor-intensive healthcare services prices rising by much less for any sustained period.

*  *  *

In summary – Yes, Obamacare is bad for the US economy

But apart from massive over-optimism, and negative impacts on confidence and consumption, we are sure the voting public will get behind the man who instigated all of this…

6 Weeks of Manic-Depressive Insider Trading Action

Bottoms Up is the Way to Go

By Dr. Paul Price of Market Shadows

Even corporate insiders have been indecisive over the last six weeks as world events and market sentiment shifted rapidly. The Thomson Reuters Insider Sell-Buy ratio has been pretty accurate during that period and over the full year ended June 27, 2104.

Bullish signals have been more reliable than bearish ones, which have registered false negatives on occasion. Transactions by corporate officers and directors can be taken seriously as real money is on the line rather than simply answers to a sentiment poll, which may be suspect as to methodology and/or accuracy. (Also, there are many reasons insiders sell large amounts of stocks, but only one reason insiders buy large positions — they think the stock will go higher. Buying is a stronger indicator than selling.)

Note: The chart below is for the week ended June 27, 2014, but the red line shows as carrying into July. That error is from the source, Thomson Reuters. Hopefully it will be corrected before next week’s update.

Insider Sell-Buy  Jun. 27, 2014

Does the recent swing to bearish levels mean you shouldn’t be buying stocks right now? No, but it suggests more stringent standards for identifying bargains. This is not the time for indiscriminate deployment of cash. (Not that it’s ever a great time for indiscriminate deployment of cash. 🙂

Companies like Bed, Bath & Beyond (BBBY), Panera Bread (PNRA), Con Agra (CAG), Valmont Industries (VMI) and Kelly Services (KELYA) traded far enough below normal valuations to temp me into buying, or adding to my personal holdings last week.

Making buy and sell decisions on specific company fundamentals is usually a better way to go than simply moving into or out of cash due to general market conditions.

Market Shadows’ Virtual Value Portfolio managed to hit a new all-time peak on June 27, 2014, despite all the mixed messages which have been floating around.

VVP performance  Jun. 27, 2014


Three More GM Recalls Today: When Will It End?

Courtesy of Mish.

In a seemingly unending series of recalls, GM announce three more recalls today. This set involves pickup trucks, SUVs, Corvettes, and police cars.

With every announcement, I wonder “Is this the last?”

But here we go again.

The Wall Street Journal reports GM Discloses Yet Another Recall.

General Motors Co. disclosed three new recalls on Friday covering more than 473,600 vehicles, including some of its latest Corvette sports cars, amid stepped up safety reviews.

The nation’s largest auto maker recalled 466,940 full-size pickup trucks and sport-utility vehicles to recalibrate software in the transfer case which may electronically switch to neutral without input from the driver. GM said it is not aware of any crashes or injuries related to the problem. The recall covers certain model years of the Chevrolet Silverado, GMC Sierra and SUVs including the Chevrolet Tahoe.

n a second recall, GM said its dealers will inspect, and replace if needed, the windshield wiper module assembly in about 4,800 of the 2013 and 2014 model year Chevrolet Caprice police cars and 2014 Chevrolet SS sport sedans. If the motor gear teeth become stripped, the wipers may not operate. GM said it isn’t aware of any crashes or injuries related to this issue.

Lastly, dealers will replace the two rear shock absorbers in 1,939 of the 2014 model year Chevrolet Corvettes in the U.S. due to the potential cracking. GM said it is not aware of any crashes or injuries related to the problem.

20 Million Recalls and Counting

GM’s recall total has now reached 20 million. Clearly GM wants to get every conceivable bit of bad news regarding recalls out of the way. Thus, I suspect the end of recalls is near.

Auto Bad News Over?

Is all the auto-related bad news out of the way?

Not quite….

Continue Here

The Keynesian End Game Is Near: No Escape Velocity This Year, Either

The Keynesian End Game Is Near: No Escape Velocity This Year, Either

Courtesy of David Stockman of Contra Corner

The economic releases of the past few days are putting the lie to the Keynesian escape velocity myth. The latter is not just around the corner – and 2014 is now virtually certain to mark the fifth year running when the boom predicted by Wall Street economist at the beginning of the year fizzled as actual results unfolded.

In that context, yesterday’s punk number on personal consumption expenditures during May was the inflection point. Not only did American consumers not come bounding out of their winter ice caves as predicted by virtually every “sell side” economist, the number actually embodied a case of groundhog economics. That is, the May constant dollar PCE (personal consumption expenditure) print of $10.881 trillion suggested that consumers went back into hibernation! It was nearly the same as that during frigid February and actually below the March level of $10.916 trillion. Stated differently, the American consumer is dropping, not shopping, and the winter weather—-that surprising thing called snow and cold—had nothing to do with it.

So this is the time to call out the Wall Street amen chorus. Its impudent insistence that the Fed’s mad money printing campaign is the magic elixir that will revive the main street economy has gone altogether too far.

In that context, a bubblevision guest on Wednesday dismissed the shocking Q1 GDP shrinkage as stale news that reflected events……well,100 days ago! Only in a world were Wall Street stock peddlers masquerading as economists think the world turns on the weekly maneuvers and word clouds of the Fed could 100 days ago be considered irrelevant ancient history.  But the young man in question—-one Dan Greenhaus, chief investment strategist of BTIG—-had an even more preposterous point. Based on the sentiment surveys and other factoids, he had divined that the negative Q1 number reflected January and February results and that the US economy had strongly rebounded in March.

In other words, he had done what amounted to an intra-quarter seasonal adjustment and explained away the following true facts. There have been 265 quarterly GDP prints since 1947; only 18 of these posted a number below the -2.9% recorded for Q1; and in only one of these 18 deeply down quarters was the US economy not in recession. To spot a four-week run rate of sunshine economics hidden in that 13-week stretch of badly slumping activity is surely evidence of too much time at the Kool-Aid dispenser.

Here is the more sober take on the matter. After two months, Q2 real PCE is running at $10.889 trillion, and is therefore clocking in at a 1.2% annualized rate of gain on Q1. Moreover, even if June’s nominal PCE prints at a 0.8% monthly gain—-a rate that has not been realized in years—-Q2 real PCE would still come in well below 2%. And since the Keynesian case requires consumers to come screaming out of the blocks pulling the 70% of GDP accounted for by PCE behind them, the distinct possibility exists that Q2 results will come in below 3%. That means that by mid-2014 the US economy will have barely attained the level posted for Q4 2013.

After all, there are no signs that the other components of Q2 GDP are on any kind of tear. Housing starts are actually below Q1 after two months. Likewise, real fixed business investment has been decelerating over the last few quarters—and there is no indication of a reversal. Likewise, quarter-to-date global trade data offer no hope of a sudden boom in US exports; nor has there been any evident acceleration of government sector consumption and investment. Even if inventory accumulation picks up, there are only three quarters in the last 45 that have added more than 2.0% to the quarterly GDP print.

The truth is, the “consumer is back” narrative is getting pretty tiresome because it is belied by the facts. The May print, for example, reflected only a 1.8% real PCE gain over May 2013. And delving further back into the so-called recovery, it is obvious that real consumer spending growth has been decelerating, not fixing to explode. Thus, the Y/Y gain in May 2013 was 1.9%, and that compared to 2.4% the prior year, and 2.6% the year before that (i.e. the years ending in May 2010). Overall, real PCE has expanded at a only a 1.2% annual rate since its cyclical peak in the spring of 2008.



That trend rate is in the sub-basement of modern history. During the prior six-year cycle, for example, real PCE had expanded at a 2.5% rate from the October 2001 peak—or by more than double the rate of the current cycle.



Moreover, the latter had the benefit of the Fed’s last push of US households into the stratosphere of peak debt. And it cannot be emphasized enough that era is over. Real PCE growth, therefore, is a function of wage and salary income growth, and it is evident that that latter is not happening. Indeed, the Fed’s wealth effects policy is undoubtedly having a perverse effect.  Corporate boards and CEOs are being rewarded for stock buybacks and restructuring charges.  So they borrow more and hire less.


Household Leverage Ratio - Click to enlarge

Household Leverage Ratio – Click to enlarge


The truth of the matter is that we are now living on borrowed time. Shortly, we will enter month 61 of the current so-called recovery, meaning that the present cycle is already long-in-the-tooth compared to the 55 months average of 10 cycles since 1949. Yet there are two headwinds that the Kool-Aid drinkers constantly deny.

First, even CPI inflation is back in the two percent zone and possibly accelerating.  That means that real wage and salary incomes are stalling, as is now the case on a year-on-year basis.

Secondly, even the tepid recovery of PCE that we have had—-was achieved at the expense of drawing down the household savings rate to nearly rock-bottom levels, as shown below. Why in the world do Keynesian think that an aging population will defer saving for retirement indefinitely? More importantly, why would monetary policy be designed to punish savers with zero deposit rates for seven years running?



The answer is self-evident. The Wall Street hockey sticks are designed to elicit bullish impulses on main street. Zero interest rates are designed to prop-up risk asset markets—-so that the sheep can once again be led to the slaughter.

Escape velocity picture source. 


Glad We Didn’t “Sell in May and Go Away”

Major Averages: Mixed        

Market Shadows’ Value Mix: New Record

By Dr. Paul Price of Market Shadows

The DJIA and SPY posted fractional losses this week while the Nasdaq Composite rose by almost 0.7%. The three indices are all in the black year to date with profits running from 1.66% to 6.09%. The Dow is now the laggard after the tech-heavy Nasdaq rebounded strongly in recent weeks.

Major Indices  As of Jun. 27, 2014

Our own Virtual Value Portfolio had a better week than the broad market, gaining 0.82% since last Friday. Boardwalk Pipelines (BWP) was especially strong. We beat Murphy’s Law as both lots, of what is now our largest position, are up more than 50% since our March 2014, acquisition dates. BWP’s move helped our portfolio set a new closing record.

Our unlevered, plain vanilla value blend is now ahead by 8.56% YTD and + 52.74% since our Oct. 26, 2012, inception date.

VVP as of Jun. 27, 2014

We happily added the cast-off shares of Bed, Bath & Beyond (BBBY) to our list on Thursday after the shares got down to a three-year low. Unlike most of TV’s talking heads, we welcomed the chance to buy low. By Friday’s close BBBY had rebounded 3.3% from our purchase price only one day earlier.

See results on all our completed trades and currently held stocks by clicking on the following link…

Virtual Value Portfolio.

Check the status of all our put writing activities by using this link…

Market Shadows’ Put Writing Portfolio.


Another Ghost Town in China, This Time a Replica of Manhattan

(Click this link for the Bloomberg article and video.)

Another Ghost Town in China, This Time a Replica of Manhattan

Courtesy of Mish.

Malinvestment in China proceeds at a staggering pace. Technically, this growth adds to GDP, but eventually it will be written off.

Ghost cities, ghost malls, and empty train stations in China have been in the news for years. The world's largest mall is unoccupied and entire cities sit vacant. 

We can now add another ghost city to the list, a big one. Bloomberg reports China Builds Its Own Manhattan — Except It's a Ghost Town.

China’s project to build a replica Manhattan is taking shape against a backdrop of vacant office towers and unfinished hotels, underscoring the risks to a slowing economy from the nation’s unprecedented investment boom.

The skyscraper-filled skyline of the Conch Bay district in the northern port city of Tianjin has none of a metropolis’s bustle up close, with dirt-covered glass doors and construction on some edifices halted. The area’s failure to attract tenants since the first building was finished in 2010 bodes ill across the Hai River for the separate Yujiapu development, which is modeled on New York’s Manhattan and remains in progress.

The deserted area underscores the challenge facing China’s leaders in dealing with the fallout from a record credit-fueled investment spree while sustaining growth and jobs in the world’s second-biggest economy. A Tianjin local-government financing vehicle connected to the developments said revenue fell 68 percent in 2013 to an amount that’s less than one-third of debt due this year.

“There will have to be a reckoning,” said Stephen Green, head of Greater China research at Standard Chartered Plc in Hong Kong. Sales of bonds by local-government vehicles to repay bank loans are just “buying time,” he said. “The people will pay” for it through bank bailouts, recapitalization with public money or inflation. 

Conch Bay showed few signs of life during a June 19 visit by Bloomberg reporters. Work on Glorious Oriental, a two-tower residential and office complex, had stopped, and at the north end of Conch Bay, the main building of the Country Garden Phoenix Hotel, billed as Asia’s largest hotel, was a deserted shell with no signs of any work under way.

Calls to Glorious Oriental’s Beijing and Tianjin offices went unanswered.

Wang Wei, a 34-year-old Tianjin resident, was driving through the area to check out property prices, finding them six times higher than what he’d be willing to pay. “I’ve seen a lot of reports about the area, but apparently it’s not a place fit for home — at least for now,” said Wang. “No shops, no schools, no hospitals and no neighbors.”


Buildings stand in the Conch Bay district of Tianjin, China. Photographer: Steve Engle/Bloomberg

Continue Here


Divided Iraq Inevitable; Isis Targets Baghdad Green Zone; Obama’s Inane Weapon’s Proposal

Courtesy of Mish.

A breakup if Iraq is now inevitable, even as the US and Iran are ideologically aligned in preventing that outcome.

And while the US is still worried about potential problems a separate Kurdistan may cause, Turkey is Ready to Accept Kurdish State in Historic Shift.

“In the past an independent Kurdish state was a reason for war [for Turkey] but no one has the right to say this now,” Huseyin Celik, spokesman for the ruling AK party, told the Financial Times.

“In Turkey, even the word ‘Kurdistan’ makes people nervous, but their name is Kurdistan,” he added. “If Iraq is divided and it is inevitable, they are our brothers . . . Unfortunately, the situation in Iraq is not good and it looks like it is going to be divided.”

This week, Avigdor Lieberman, Israel’s foreign minister, also told John Kerry, the US secretary of state, that the creation of an independent Kurdish state was a foregone conclusion.

In strongly worded comments for a Nato member, Mr Celik blamed not just Nouri al-Maliki, the Iraqi prime minister, for Iraq’s growing fragmentation, but also the US: “They didn’t bring peace, stability, unity, they just left chaos, widows, orphans. They created a Shia bloc to the south of our country.”

Mr. Celik’s observation is correct but insufficient. At a cost of trillions of dollars to the US and even more to Iraq, the illegal and unwarranted US attack left Iraq in ruins and laid the grounds for an Isis uprising.

Isis Targets Baghdad Green Zone

Please consider City on Edge as Baghdad Residents Await Isis Attack

Isis, which along with allied Sunni armed groups seized Mosul and other cities this month, has made clear it is aiming to take Baghdad. An eerie calm has settled on the city. There have been few bombings or assassinations in the last two weeks convincing many that Isis is planning something big, perhaps to coincide with the start of the holy month of Ramadan next week.

“They will try to suffocate Baghdad economically,” says Hisham Hashemi, a researcher and author of the forthcoming book, The World of Daish. “Isis considers the centre of Baghdad as a site for mischievous acts, where they intend to carry out bombings and killings.”

How Big is Isis?

The US state department estimates Isis is about 3,000 strong. Other report put the number as high as 10,000. Regardless of size, Sophisticated Tactics Key to Isis Strength.

“They [Isis] are going against a supposedly professional military force with a speed and ferocity that has the Iraqis taking to their heels,” says Patrick Skinner, a former counter-terrorism officer at the Central Intelligence Agency and now analyst at the Soufan Group. “The Iraqi Security Forces [ISF] are mind-crushingly inept.”

Of immediate concern is the seizure by the jihadis of a range of high-grade military equipment. A force once lightly armed with an arsenal of shoulder-held missile launchers and anti-aircraft guns mounted on pick-up trucks, Isis is now far more comprehensively kitted out, thanks to its raids on the depots of the Iraqi army’s second motorised division….

Continue Here

From the Archives : Shedding Light on Dark Pools

Courtesy of Larry Doyle.

In light of the recent legal action brought by NY AG Eric Schneiderman against Barclays, I thought it might be beneficial to rerun a commentary that was initially posted here on October 20, 2009.

Ponder that date for a minute. The issues exposed in the suit brought against Barclays are not new developments. 

Think of the theft and corruption that has transpired within these dark pools and elsewhere in the last 5 years if not much longer than that given that our financial regulators are ‘in bed with Wall Street?’ Some of my assertions expressed in this post have been shown to be more wishful thinking than reality.  

Kudos to Joe Saluzzi once again. While a number of people in the markets have been pushing for increased oversight of high frequency trading, in my opinion, nobody deserves more credit than Joe Saluzzi of Themis Trading.

The pressure initiated by Joe and pushed by others is starting to bear real results. How so?

The highly predatory nature of ‘flash orders’ will likely be discontinued. Now we learn that trading activity in dark pools will also likely be seriously restricted. What are dark pools? Why should you care? If you have an interest in the markets, you should care. Let’s navigate.

I was honored to have Joe join me on August 2nd on No Quarter Radio’s Sense on Cents with Larry Doyle. From my review of that interview, we learned that dark pools have developed in the following manner:

– Originally launched by one or two exchanges for the purpose of allowing major money managers to cross large blocks of stock ‘off the floor’ and thus protect the buyers and sellers identities and the price of the transaction

– Now every dealer and exchange have developed dark pools resulting in more and more business occurring off exchanges and without any benefit of transparency. Who is disadvantged? Those without access to the dark pools.

– Dark pools initially had minimum size orders, but many dark pools have increasingly shifted away from a size requirement.

– Dark pools have developed in such a way that some market participants will abuse the intended purpose of the facility, that is to transact, and instead will look to discover information on pending orders through these dark pools.

In summary, dark pools have become a facility which certain market participants are able to utilize at the expense of other market participants. As such, they provide anything but a level playing field. Why were these dark pools ever allowed to develop in such a fashion? Great question and likely a testament to the power of the Wall Street lobby and the profit driven structure of the exchanges.

At long last and thanks to the efforts of Joe and others who desire a fair and level playing field for all investors, the SEC is addressing the problems lurking in these dark pools. Bloomberg highlights this development in writing, Dark Pool Trade Limit Said to Be Cut 95% in SEC Plan:

The U.S. Securities and Exchange Commission will propose toughening its limits on the amount of anonymous trading carried out on stock platforms called dark pools, according to two people familiar with the deliberations.

The commission will propose lowering the amount of daily volume in a company’s shares that can be executed on the networks before prices must be made public to 0.25 percent from 5 percent tomorrow, said the people, who declined to be identified because the discussions weren’t public. John Nester, an SEC spokesman, declined to comment.

The rule change may curtail the number of transactions on dark pools, off-exchange platforms run by firms such as Goldman Sachs Group Inc. and Getco LLC that have drawn scrutiny from Democratic Senators Ted Kaufman of Delaware and Charles Schumer of New York. The systems usually shut down trading in a security when they approach the current 5 percent limit.

Traders turn to dark pools instead of public markets such as the New York Stock Exchange to avoid revealing their identities and giving competitors clues about their strategies. Kaufman and Schumer say the platforms limit transparency in securities markets and put smaller investors at a disadvantage.

A market that does not serve the interests of all its participants in an equitable fashion is not a market. An exchange which favors certain participants over others is not an exchange. Dark pools are another form of crony capitalism.

Thank you Joe Saluzzi for exposing the inequity in this corner of our landscape.


[Read more…]

Rolling the Drunks

Rolling the Drunks

Courtesy of 


In nineteenth century New York City, one of the more popular ways for the lower-class criminal element to earn a living was emptying the pockets of the inebriated passersby.

The scam was so popular, it was given its own name: Rolling the drunks.

Essentially, the tavern or saloon owners would spot the most intoxicated patrons within their own establishment and point them out to a gang of street ruffians waiting just outside the premises. As the mark ambled off of his bar stool and out into the street, the gang – usually a mob of young men – would surround the man and “roll” him into an alley so they could remove any valuables he may have been carrying on his person. A crack over the head with a brickbat would be sure to keep to the victim quiet or incapacitated for a few hours whilst the thieves went inside to share the spoils with the barman. This scheme could be repeated daily and nightly, to the satisfaction of both the bar’s proprietor and the pickpockets themselves.

Easy money.

Last night, New York’s Attorney General leveled an incredibly harsh fraud charge at the global investment bank Barclays PLC. The gist of the AG’s accusation is that Barclays built their internal dark pool into the largest such electronic trading venue in the world by promising its institutional brokerage customers that it was keeping them safe from the types of predators who were picking off their orders on other exchanges, via front-running and other nefarious machinations. Schneiderman’s office says that, not only were these clients not protected within the Barclays trading environment, it actually turns out that Barclays itself was inviting the most notorious electronic pickpockets in the game through a backdoor to ply their wicked trade and rob the unsuspecting customers under cover of darkness.

In short, Barclays is being accused of rolling the drunks.

But it’s even worse than that – if the complaint is true, they were also going out of their way to assure the drunks that the alley next to their establishment was being kept ruffian-free, when it fact, it was being stocked with thieves deliberately.

If true, this would be yet another bald-faced outrage bobbing atop a sea of frigid outrageousness that, by now, has us utterly numb.

From the New York State AG’s website:

Barclays heavily promoted a service called Liquidity Profiling, which Barclays claimed was a “surveillance” system that tracked every trade in Barclays’ dark pool in order to identify predatory traders, rate them based on the objective characteristics of their trading behavior, and hold them accountable for engaging in predatory practices.

Contrary to those promises, the complaint alleges that:

  • Barclays has never prohibited any trader from participating in its dark pool, regardless of how predatory its activity was determined to be;
  • Barclays did not regularly update the ratings of high-frequency trading firms monitored by Liquidity Profiling;
  • Barclays “overrode” certain Liquidity Profiling ratings – including for some of its own internal trading desks that engaged in high-frequency trading – by assigning safe ratings to traders that were otherwise determined to be toxic.

The complaint further alleges that, contrary to Barclays’ representations that it protects clients from aggressive or predatory high-frequency trading in its dark pool, Barclays in fact operates its dark pool to favor high-frequency traders and has actively sought to attract them by giving them systematic advantages over others trading in the pool.


I’ll be on NPR’s On Point Radio program this morning (that was yesterday) at 10am ET to discuss the story as well as dark pool usage in general and what it means for America’s investors. Scott Patterson, author of the excellent books Dark Pools and The Quants will be joining me. More information on how to catch the show below:

Private Stocks And ‘Dark Pools’ In American Finance (On Point)

Read Also:

“The Stock Market is Rigged!”  (TRB)

The Wall Street Journal: ‘Dark Pools’ Face New SEC Probe 

The Reformed Broker: “The stock market is a giant distraction to the business of investing.” 

Bloomberg: Dark Pools Take Larger Share of Trades Amid SEC Scrutiny


What’s Behind The Rise In U.S. Industrial Production?

Courtesy of Charles Hugh-Smith, Of Two Minds

The domestic energy boom is behind the expansion of Industrial Production.

In contrast to other measures of economic activity that are stagnant or declining, U.S. industrial production has been rising: Industrial Production and Capacity Utilization (Federal Reserve data)

Is this evidence that manufacturing is on-shoring, i.e. returning from overseas? While there is anecdotal evidence for on-shoring, it appears that energy production (classified as part of mining in government statistics) is the big driver of rising industrial production.

Longtime correspondent B.C. submitted these two charts breaking down industrial production into mining, manufacturing and total production. While manufacturing has recently returned to pre-recession levels of late 2007, energy production (included in mining) has soared as the energy industry has put fracking and new wells into production. B.C. Commented: "The remarkable untold story: Ex mining and oil and gas extraction, US Industrial Production has been in contraction for most of the period since Peak Oil in 2005-08."

The red line is the ratio of total production to mining/energy. Its decline reflects the dominance of mining/energy in the rise of industrial production as a whole.

The second chart is percent change from a year ago. This shows the rate of manufacturing expansion has been declining since 2010 while mining/energy has been on a tear, spiking as high as 10% gains per year.

Here is a chart of the U.S. oil/gas rig count:

For context, here is a longer term look at the U.S. rig count. Note that the number of active rigs in the early 1980s was considerably higher than the present count.

For context, here is total U.S. energy consumption. The takeaway here is the reliance on oil, gas and coal, i.e. the fossil fuels:

One last bit of context: U.S. oil imports. While the increase of 3+ million barrels a day in domestic production is welcome on many fronts (more jobs, more money kept at home, reduced dependence on foreign suppliers, etc.), the U.S. still needs to import crude oil.

U.S. Imports by Country of Origin (U.S. Energy Information Administration)

*  *  *

Do these charts look sustainable?


The top ten ETFs of 2014 at the halfway point

The top ten ETFs of 2014 at the halfway point

Screen Shot 2014-06-27 at 11.43.16 AM

The most fascinating thing about the leading coffee ETNs (1 and 3), which rose 62% and 57% respectively, is that they faced a combined $100 million plus in outflows through the first six months – another reminder that flows aren’t terribly important to exchange traded product performance, while the underlying investments are (almost) everything.

Read the full article on why these ten worked so well so far at the link below.



Why “Margin Debt” Is Meaningless In The New Shadow Banking Normal


Why "Margin Debt" Is Meaningless In The New Shadow Banking Normal

Courtesy of ZeroHedge. View original post here.

Everyone who has followed this website since 2009 will know that we firmly believe that the "magic plumbing" of the modern financial system is not what is seen on the surface, in terms of declared "on the books" assets and liabilities, but what happens beneath it – in the shadow banking system, a place where trillions in liabilities are created and destroyed via the repo market, to provide short-term funding for all sorts of financial intermediaries, frequently with zero actual exposure in bank Ks and Qs due to regulatory loopholes that allow the "netting" of hundreds of billions of offsetting repo exposure and keeping them off the books, exposure which than can be rehypothecated countless numbers of times. In theory, this works fine. In practice, when a collateral chain is broken and net suddenly becomes gross, you end up with near systemic collapse (especially when the underlying collateral is found to have never existed in the first place – see China).

This is precisely what happened following the failure of Lehman when in addition to all other credit risks, maturity, credit and liquidity, one also had to add counterparty risk. Suddenly, the realization that any and every bank can fail caused a sudden and epic rush on repo, in the process truncating collateral chains and smashing the velocity of collateral. This is also why the Fed had to step in and take over virtually the entire financial system: after all the Fed can't fail, or so the conventional wisdom goes. And with this backstop in place, the US financial system has been moving slowly since 2009, as counterparty risk has never been mitigated. In fact, for all its confusion, the Fed doesn't realize that because it has onboarded countarparty risk exposure as one of its primary functions, there is no hope that a return to normalcy will ever be achieved.

In brief: counterparty risk – one where the overnight funding market may freeze up at any given moment in a world without the Fed – is now a staple of the financial system. It also explains why the Fed will never be able to exit the market. The second it does, there will be sweeping repo runs of the kind that crushed Lehman and the money market system in 2008.

Long-winded introduction aside, the reason why I bring up the repo market is because in recent years there has been much attention on one specific metric: securities margin debt as reported monthly by the NYSE, and which recently peaked at a record $465 billion. Some look at margin debt as an indication of how stretched investors are and further point to record margin debt peaks as inflection points in the market as the likelihood of margin calls surges and even the smallest drop in asset prices can result in an avalanche of liquidations and a self-fulfilling prophecy of selling.

In theory (again) this is correct. In practice (again) this is very much an anachronism of what the market used to look like. Unfortunately, in the New Normal, NYSE margin debt is completely useless in demonstrating just how stretched investors, especially sophisticated investors like hedge funds are. In an age when retail investors have thrown in the towel on the manipulated, rigged market, hedge funds are all the matters.

So where should one look for hints on the true leverage of market participants? Why the shadow banking system of course, and the repo market in particular.

Luckily, since the topic of shadow banking is quite complicated (virtually none of the regulators, auditors, enforcers or even central-bankers understand its nuances), one of the most erudite sources on the repo market, the IMF's Manmohan Singh, has just released his annual primer on shadow banking, this time titled "Financial Plumbing and Monetary Policy." Singh touches on all the salient points we have covered in the past several years: offsetting shadow banking liability contraction, the Fed's Reverse Repo initiative, collateral velocity, the ZLB impact on unsecured overnight funding markets, and high quality assets. It is a worthy read for anyone curious about how the financial system really works because we firmly believe that Singh along with Zoltan Pozsar, Peter Stella and Citi's Matt King are some of the very few people who actually "get it."

But aside from Singh's extensive discussion on the intricacies of how funding works in a New Normal which has been mangled beyond recognition by central banks, Singh has a Box aside on precisely the topic at hand: how hedge funds fund themselves, and why margin debt is completely irrelevant in a world in which funding needs are provided not by the exchange itself but by other interconnected financial intermediaries mostly Prime Brokers: a process which is preferred furthermore because the net exposure never has to be revealed to either bank shareholders or hedge fund LPs.

This is what Singh has to say about how hedge funds operate in repo space:

Hedge Funds (HF) largely finance their positions by either (i) pledging collateral to prime brokers (PB) to borrow money, or (ii) repurchase agreements (or repo) with either their PB or another dealer where the repo [are] their collateral for funding. This box estimates the repo financing by HF with the key banks active in collateral markets, as of end-2007 and end-2013.

To estimate repo related collateral from HF for 2007, we take the assets under management (AUM) of $2 trillion and the 27 percent share of strategies that would use repo (i.e., primarily non-equity related strategies). Aggregate leverage is higher in fixed income, global macro strategies that are funded via repo relative to equity type strategies. Using the aggregate leverage of 4 (source FSA hedge fund surveys, United Kingdom), this would imply that approx US$540 billion times four or, US$2.2 trillion pledged collateral could have gone to the banks. However, about 60–70 percent of the strategies are hedged simultaneously so only one-third of US$2.2 trillion could reach the banks that can be re-pledged onwards—i.e., US$750 billion pledged collateral that came to the banks could be re-used onwards as of end-2007.

On the 60–70 percent threshold assumption—at the bottom of the rate cycle, there is more hedging so this threshold is higher when compared to top of the rate cycle. In other words, the threshold prior to Lehman’s demise maybe closer to 60 percent and thus more pledged collateral available (i.e., less simultaneous hedging) to the dealers. Present times are close to the bottom of the rate cycle; so threshold may now be over 70 percent (i.e., more simultaneous hedging) and thus, less pledged collateral for reuse passes to the dealers. Doing similar arithmetic for end-2013, with aggregate leverage, including derivative use, lower at 3.5 (relative to end-2007) but AUM much higher at US$2.6 trillion, and share of HF strategies using repo also higher (around 40 percent) relative to 2007, would put the estimate at US$900 billion (adjusted downward due to the higher threshold for hedging due to the bottom rate cycle). With collateral reuse factor between 2 and 3 (largely due to inter-dealer collateral moves that link the supply/demand collateral chain), the size of the bilateral global repo market is at par or larger than the TPR (tri-party repo) in the U.S. [although HFs play a  dominant role in bilateral repo, dealers also use collateral from primary issuance to cover shorts in their repo inventory].

To be technical, if about two-third strategies are hedged, the collateral from the remaining one-third may not all be reused/turned to cash by the banks—it depends on their balance sheet space and this issue is getting more traction as proposed regulations will take affect going forward. Also, banks can be very different with UBS bank curtailing balance sheet activities in pledged collateral area while others trying to enter this market.

In short, when it comes to funding, the most sophisticated market participants, hedge funds, have zero use for conventional cash exposure such as exchange margin, which is well below half a trillion, and instead obtain at least half of their funding needs in the shadow market via repo, to the tune of about $1 trillion (and likely more depending on one's assumption about collateral reuse).

Which is why the next time someone says to pay attention to market leverage and points out the NYSE margin debt, feel free to correct them that this accounts for a tiny fraction of the overall leverage involved in the market – almost exclusively that attributed to retail investors who, as we know barely exist. For a real representation of market leverage one has to evaluate just how much repo funding the shadow banking system has afforded to hedge funds. Sadly, since there is no regulatory required reporting framework for disclosing this information on a consistent basis, one is largely stuck estimating what true leverage in the market is.

Actually, there is one loophole. As we showed in April, once a year hedge funds update their annual Form ARDs to show not only their net assets, which exclude shadow banking liquidity, but all regulatory assets, which capture all forms of funding.

For all those curious, here is where the hedge fund world truly stands when accounting for all sources of funding in the current market. We leave it up to readers to decide if leverage as high as 9.3x is "high."

And the change overtime:

It is mostly here where the largely undocumented credit unwind will take place once the relentless bubble finally pops, and to be sure, nobody will have possibly been able to see it coming.

Barclays Dark Pool Lawsuit and the ‘In Bed with Wall Street Conspiracy’

Courtesy of Larry Doyle.

The lawsuit filed by New York Attorney General Eric Schneiderman against Barclays for ‘pernicious fraud’ in the operation of its dark pool sent shock waves through Wall Street yesterday.

The equity valuations for a number of large Wall Street banks declined significantly under the premise that this lawsuit will impact their own business operations in a negative fashion.

Beyond that, though, many might think serious allegations of lying, blatant misrepresentations, fraud, self-dealing, predatory practices aka high frequency trading, investor abuse, and the like mean one thing: just another day on Wall Street.

Let’s play hardball today and navigate a little deeper.

While many will focus on the practices exposed by this lawsuit, I am much more interested in the players. Specifically, why is it that the New York Attorney General is bringing this action rather than the Wall Street’s cops at Finra and/or the SEC?

We learn from this lawsuit that over a year ago the NY AG’s office launched an initiative that ultimately led to this suit. But let’s go back even further than that. In January 2013 — yes, January 2013 a full 18 months ago – The Wall Street Journal wrote a commentary entitled, Vow of New Light for ‘Dark’ Trades and highlighted the following:

A top U.S. regulator plans to shine a light on dark pools, private trading venues that allow buyers and sellers to post orders that are hidden from the rest of the market.

Richard Ketchum, chief executive of the Financial Industry Regulatory Authority, said in an interview Tuesday that the regulator is expanding its oversight of the dark-trading venues, with an eye on whether orders placed in public exchanges are “trying to move prices or encourage sellers that may advance their trading in the dark market.”

The regulator also is boosting its surveillance of high-speed trading and is increasingly looking at rapid-fire trading across exchanges, he said. “You’re going to see more [focus] in those areas in 2013,” Mr. Ketchum said.

Experts said regulators have lagged behind rapid advances in computer-trading technology in recent years, leaving investors in the dark about how the market operates.

Regulators are scrambling to catch up, however. Finra on Tuesday said it implemented a system in 2012 that can track trading patterns that “address more than 50 threat scenarios” across about 80% of the stock market.

The question both begs and screams, if Finra was talking about shining a light on dark pools in January 2013, then what happened?


Regular readers of this blog and my book know the answer to that question. The cops at Finra and the SEC have shown themselves to be ill-equipped, incompetent, captured, or corrupt — but ultimately ‘in bed with Wall Street.’

The media and pols might feign disgust over the allegations of lying, blatant misrepresentations, fraud, self-dealing, predatory practices, investor abuse, and the like embedded within this lawsuit against Barclays. How pathetic.

If those within the fourth estate and atop Capitol Hill cared to look inside the pages of my book, In Bed with Wall Street: The Conspiracy Crippling Our Global Economy, they would see that iterations of the same destructive practices alleged in this suit have also transpired within the regulators themselves.

Navigate accordingly.

Why CEOs Love Buybacks (One Simple Chart)

Courtesy of ZeroHedge. View original post here.

Submitted by Tyler Durden.

The CEOs of U.S. companies are compensated exceedingly well with the heads of the S&P 500 paid 331 times as much, on average, as production and nonsupervisory employees.

As we wrote a month ago to explain the 'mystery and completely indiscriminate' buyer of US stocks, "Since a vast majority of executive compensation agreements are tied to company stock 'performance,' C-suites are perversely happy if their own corporate cash is used to buy the stock near or at all time highs. After all, the management year end bonus will benefit that much more, while keeping activist investors delighted (and away from the embarrassing public spotlight)."

Sure enough, as HBR explains, executive comp in recent decades comes down to four words: stock options and restricted stock (and more and more in the last few years).

Via Harvard Business Review,

The CEOs of U.S. companies are compensated exceedingly well. A recent analysis by the AFL-CIO found that the heads of S&P 500 companies are paid 331 times as much, on average, as production and nonsupervisory employees. Regardless of whether this is fair – some believe that CEOs aren’t paid nearly enough – it’s worth understanding how we got here.

As the black line shows, CEO pay took off in the 1990s. This resulted in part from activist shareholders’ and academics’ pushing for stronger links between compensation and returns. The SEC also changed holding-period rules so that the acquisition of an option rather than its exercise was the basis for reporting a purchase, making stock options much more attractive to executives.

Kevin J. Murphy, a professor at the USC Marshall School of Business and an expert on executive pay, has collected data and examined research on the earnings of the S&P 500 CEOs since 1992. He finds that – as the bands of color illustrate above – much of the story of executive comp in recent decades comes down to four words: stock options and restricted stock.

And we said a month ago…

So the next time someone asks who keeps on buying stock despite all the negative newsflow, despite the bond yield sliding ever lower despite relentless broken-record pleas that a "recovery is just around the corner", and with vol near all time lows confirming peak complacency… now you know.

Except when the cheap money runs out (or reach for yield demand slows) and investors' mindsets finally switch to realize that appeasement via buybacks is a loser's game in the end for a company's staying power (as opposed to capex and real investment)

Bitcoins to Become Legal Currency in California; Bill Awaits Signing by Gov. Brown; Commodities vs. Currencies



Courtesy of Mish.

California Bill AB-129 Lawful Money passed the California Senate on June 19, and the Assembly on June 23. The bill now awaits signing by Governor Jerry Brown.

Existing law prohibits a corporation, flexible purpose corporation, association, or individual from issuing or putting in circulation, as money, anything but the lawful money of the United States. AB-129 would repeal that provision.

Coindesk reports California’s Bill to Make Bitcoin ‘Lawful Money’ Heads to Governor.

AB-129, authored by Assembly Member Roger Dickinson, would recognize digital currencies – along with a host of other commonly-issued forms of value including points and coupons – as lawful alternatives to the US dollar. The state-backed currency would still have legal superiority, as Californian residents are not required to accept forms of lawful money.

Dickinson recently commented that the law is primarily designed to allow California consumers the ability to continue using a variety of common payment methods, and to remove penalties currently on the books for their usage.

Comments from Bill Author

Let's tune in to what Roger Dickinson has to say in his Bitcoin Press Release.

Assembly member Roger Dickinson’s (D-Sacramento) bill AB 129 addressing alternative currencies passed the Assembly.  Modern methods of payment have expanded beyond cash or credit card.  AB 129 repeals an outdated restriction on the use of "anything but the lawful money of the United States."  The literal meaning of the restriction indicates that anyone using alternative currency is in violation of the law.  However, people commonly use digital currency, community currency, and reward points without penalty.

“In an era of evolving payment methods, from Amazon Coins to Starbucks Stars, it is impractical to ignore the growing use of cash alternatives,” Dickinson said. “This bill is intended to fine-tune current law to address Californians’ payment habits in the mobile and digital fields.”

Bitcoin, a growing digital currency, has gained recent media attention as businesses have expanded to accept Bitcoins for payment. Long before the introduction of digital currencies, various businesses created point models that allow consumers to use points to pay for goods or services. Many communities have created "community currencies" that are created by members of a community and the merchants who agree to accept the alternative currency. These "community currencies" are created for a variety of reasons, some of which include encouraging consumers to shop at small businesses within the community or increasing neighborhood cohesiveness.

Commodity vs. Currency

Three cheers to Dickinson. At the federal level, we need a more commonsense ruling that bitcoin is a currency, not an ordinary commodity like copper.

By the way, money is a commodity as well as a currency.

In Man, Economy, and State, Murray Rothbard explains "Money is a commodity that serves as a general medium of exchange."

Continue Here


Dark Pools, Barclays and the ‘Tone at the Top’

Courtesy of Pam Martens.

New York State Attorney General, Eric Schneiderman, (Right) Announcing Fraud Lawsuit Against Barclays Over Its Dark Pool

Yesterday, New York State Attorney General Eric Schneiderman filed a civil fraud complaint against the global bank, Barclays, for what can best be summed up as fostering an internal culture that rewards serial lying to customers and enforces the culture of lies by firing or intimidating employees who refuse to go along.

The lawsuit was framed around well documented allegations that Barclays is running a dark pool that allows, encourages, and facilitates high frequency traders to front run the orders of slower market participants like pensions and mutual funds; but the critical takeaway from the complaint goes to the very heart of global banking. The complaint is the clearest proof yet that the insidiously corrupt culture of global banking has not been reformed but has instead metastasized throughout each operating unit of the unmanageable behemoths.

To fully grasp this reality, it is helpful to reflect on what was happening at Barclays in the summer of 2012. Barclays was fined $451 million for fostering a culture which resulted in its traders colluding with other employees of the bank and outside banks to rig the interest rate benchmark known as Libor. Embarrassing emails showing the casual attitude the employees demonstrated toward breaking the law resulted in hearings by Parliament’s Treasury Select Committee in 2012 to examine Barclays’ leadership.

Marcus Agius, Former Chairman of Barclays, Testifying About LIBOR Before the UK's Treasury Select Committee

On July 10, 2012, the Treasury Select Committee called Barclays Chairman, Marcus Agius to testify. It also released an April 10, 2012 letter to Agius from the U.K.’s Financial Services Authority, the main U.K. regulator of global banks at the time, which outlined a laundry list of serious concerns about Barclays and noted the following: “…I wished to bring to your attention our concerns about the cumulative impression created by a pattern of behavior over the last few years, in which Barclays often seems to be seeking to gain advantage through the use of complex structures, or through arguing for regulatory approaches which are at the aggressive end of interpretation of the relevant rules and regulations.”

Continue Here

Made a Valuation-Based Swap

Sold IBM to Pick Up BBBY

By Dr. Paul Price of Market Shadows

When you are fully invested and a too-good-to-miss chance to buy pops up, you need to triage your portfolio. Something must be sold  to raise cash for the new position. With Bed, Bath & Beyond (BBBY) down 9% this morning and on the bargain rack, we jettisoned our 30 shares of IBM @ $180.04 to pick up 97 shares of BBBY @ $55.63.

Sold IBM to buy BBBY

We had accumulated IBM in two stages. One batch of IBM showed a small gain while the other was let go for a slight loss. Include dividends and we’ll cash it a wash. Our bet is that over the long haul the ultra-depressed valuation for BBBY will have reversed more sharply than IBM’s.

That’s been the case previously as Bed, Bath & Beyond has stair-stepped higher after each previous decline. Management still expects that the current fiscal year (ends next February) will come in above $5  per share, an all-time record.

BBBY FY 2007 - FY 2013 stats

Today’s collapse to an intraday low of $54.96 was impossible to catch. We feel lucky to have gotten in well below the old 52-week range despite fiscal Q1 numbers that were within previous guidance and equal to the same period one year earlier, despite numerous headwinds including the Polar Vortex and a 2.9% overall GDP decline. Sales per share were actually higher than they were in 2013’s Q1.

BBBY new visual

We are happy to own a high-quality name at a 31% discount to where the same shares were trading as recently as January this year. BBBY shares have not been available at this low a P/E since the dark days of 2008.


Disclosure: Paul is long BBBY shares amd short BBBY puts in his personal accounts. He added 368 shares today at an average price of $55.62.