The Catastrophe Portfolio

Many of the world’s wealthiest families have reportedly been hedging their portfolios from the risks of financial meltdown via a ‘catastrophe portfolio’.

From the Reuters

The world's wealthiest families have embarked on damage limitation rather than seeking to boost their fortunes as financial turmoil erodes their riches, with some so worried they are putting their money in 'catastrophe' portfolios.

"We have to explain to our clients, it's not about making money these days, it's about keeping wealth," said Ivan Adamovich, head of the Geneva operations of Swiss bank Wegelin.

With inflation eating away at people's nest eggs and rock-bottom interest rates making living off capital increasingly difficult, many rich people are taking new risks just to stand still, private bankers said.

"We have already inflation higher than interest rates in many markets ... Unless you take some risk you will not achieve a level of return just maintaining (wealth)," Pierre de Weck, head of Deutsche Bank's private wealth management business, said at the Reuters Wealth Management Summit in Geneva.

Adamovich said a model portfolio designed to protect people's wealth in the face of global catastrophe has attracted more interest as financial turmoil spread in recent months.

The "catastrophe portfolio" allocates one third of money to gold, one third to defensive and internationally diversified blue chip company shares and a third to the debt of ultra safe developed countries.

In my view, there is NO such thing as a catastrophe portfolio or a portfolio designed to weather the proverbial storm. That’s because whether it be cash, bonds, gold or blue chips, all are subject to market or systematic risks which entirely depends on the character of the coming crisis.

Hyperinflation would be good for gold and bad for cash, but a systemic deflation from a major banking system collapse contagion would likely do the opposite. On the other hand, wars may adversely impact blue chips or transnational companies, while ‘ultra safe government debt’ could be a delusion if their welfare system has soaked up on too much debt from having an economy that consumes more than she produces or earns. Of course there are possible gray areas, such as debt defaults.

Also, since the conventional markets have been greatly influenced by pervasive bubble policies and political interferences, then my conjecture is that the ramifications from the actions of political authorities will remain as major factors in determining the risk environment.

This makes taking action from reading and analyzing the political tea leaves a better and a more flexible approach than a one-size-fit-all portfolio.

Quote of the Day: Class Warfare

From Walter E Williams

For politicians, it's another story: Demonize people whose power you want to usurp. That's the typical way totalitarians gain power. They give the masses someone to hate. In 18th-century France, it was Maximilien Robespierre's promoting hatred of the aristocracy that was the key to his acquiring more dictatorial power than the aristocracy had ever had. In the 20th century, the communists gained power by promoting public hatred of the czars and capitalists. In Germany, Adolf Hitler gained power by promoting hatred of Jews and Bolsheviks. In each case, the power gained led to greater misery and bloodshed than anything the old regime could have done.

That’s why politics is a zero sum game.

Paul Krugman’s Positive Take on the Blogsphere

I have been saying that the information or digital age has been changing the way information flows or has been democratizing knowledge.

Writes Paul Krugman (Hat tip Bob Wenzel) [bold emphasis mine]

What the blogs have done, in a way, is open up that process. Twenty years ago it was possible and even normal to get research into circulation and have everyone talking about it without having gone through the refereeing process – but you had to be part of a certain circle, and basically had to have graduated from a prestigious department, to be part of that game. Now you can break in from anywhere; although there’s still at any given time a sort of magic circle that’s hard to get into, it’s less formal and less defined by where you sit or where you went to school.

Since there’s some kind of conservation principle here, the fact that it’s easier for people with less formal credentials to get heard means that people who have those credentials are less guaranteed of respectful treatment. So yes, we’ve seen some famous names run into firestorms of criticism — *justified* criticism – even as some “nobodies” become players. That’s a good thing! Famous economists have been saying foolish things forever; now they get called on it.

And this process has showed what things are really like. If some famous economists seem to be showing themselves intellectually naked, it’s not really a change in their wardrobe, it’s the fact that it’s easier than it used to be for little boys to get a word in.

As you can see, I think this is all positive. The econoblogosphere makes it a lot harder for economists to shout down other people by pulling rank — although some of them still try — but that’s a good thing.

Mr. Krugman doesn’t say it directly, but the econoblogsphere has been functioning as self-regulating free market of economic opinions or ideas and this is a development to cheer about.

War on Naked Shorts: EU Bans Short Selling

Politicization of the marketplace has been broadening. Trading curbs are not only applied to commodities but to short-selling as well.

From Bloomberg,

The European Union reached a deal as part of a short-selling law that will pave the way for an optional ban on naked credit-default swaps on sovereign debt.

Poland, which holds the rotating presidency of the EU, and lawmakers from the European Parliament reached the accord at a meeting in Brussels yesterday.

Under the deal, traders may be prevented from buying CDS on government bonds unless they either own the sovereign debt or other assets whose price moves in tandem with it. Nations will have the right to opt out of the measure if they detect signs that it may affect their borrowing costs.

“These balanced measures will ensure that sovereign CDS are used for the purpose for which they were designed, hedging against the risk of sovereign default, without putting at risk the proper functioning of sovereign-debt markets,” EU Financial Services Commissioner Michel Barnier said in a statement.

German Finance Minister Wolfgang Schaeuble and lawmakers in the European Parliament have called for a ban on naked CDS trades on government debt over concerns the practice fueled the euro zone’s debt crisis. Germany already has restrictions on using swaps to bet on sovereign defaults.

Some European governments have also criticized the use of short selling to bet against bank stocks, arguing that the practice has roiled markets. Volatility that sent European bank stocks to two-year lows led France, Spain, Belgium and Italy in August to impose temporary bans on short selling that remain in force.

Opt-Out Clause

Under yesterday’s deal, national regulators will be able to suspend the CDS ban in their territory at the first signs that it may harm their sovereign debt market.

The opt out-clause won over some critics of possible bans.

“I never signed up to the belief that a ban on uncovered sovereign CDS would have any positive impact,” Syed Kamall, who represents London in the EU Parliament, said in an e-mailed statement. “However, I’m reassured that member states will have the ability to opt out of the ban, if they see signals that sovereign debt markets are distressed.”

The European Securities and Markets Authority will give a non-binding opinion on whether a national regulators’ decision to drop the ban makes sense. ESMA coordinates the work of national markets regulators in the 27-nation EU.

Renew Indefinitely

While the suspensions will in theory be temporary, regulators will be able to renew them indefinitely. Under the terms of the agreement, existing CDS positions will be grandfathered until they expire.

CDS are instruments that act as insurance for the buyer against losses on bonds. The practice becomes naked when someone buys swaps on debt that they do not actually own.

The measure forms part of a broader agreement on an EU law that will also curb naked short selling of stocks and government bonds.

All these curbs seem like a 'comprehensive strategy' to preserve the status quo

Global governments want to see LOWER commodity prices because this allows them some space to apply more inflationism to uphold political goals when deemed as expedient by the incumbent authorities. Also this allows them to declare victory against ‘inflation’ or to swagger about the success of their policies.

Governments do not want see the public go SHORT on sovereign debt because the welfare state based governments badly desire to maintain their spendthrift -borrow and spend-ways, whose benefits accrue to the political class, their voting constituent groups and their cronies.

Instead governments want HIGHER stock markets, particularly the banking and financial sectors as these institutions hold much of sovereign debt in their balance sheets as Basel mandated ‘risk free’ assets. Remember, banks serve as the PRINCIPAL conduits in the financing of the welfare state.

That’s why a ban on naked shorts, a form of price control, has been designed NOT only to preserve the access to funding by the welfare state, they are meant to keep banking and financial stocks AFLOAT.

Besides for central bankers higher stock markets PROMOTE aggregate demand via more spending (regardless of what kind of spending).

Yet these policies are directed to benefit holders financial assets at the expense of the productive sectors of the economy. Wealth/Income inequality and political inequality anyone?

To add it up: The overall direction of global market interventions has been to promote Bernanke’s doctrine of the wealth effect worldwide and to preserve the welfare state.

The caveat is that all these cumulative actions presumes that market interventions will effectively skew the law of demand supply in their favor—a utopian scenario.

Occupy Wall Street guys, have you been listening?

War on Commodities: US Regulators Approve Derivative Trading Curbs

The relentless politicization of the marketplace continues, with intensifying fixation on commodity trading curbs

From Bloomberg,

The top U.S. derivatives regulators voted 3 to 2 today to curb trading in oil, wheat, gold and other commodities after a boom in raw-materials speculation, record- high prices and years of debate and delay.

The rule has been among the most controversial provisions of the Dodd-Frank financial overhaul, enacted last year, which gave the Commodity Futures Trading Commission the authority to limit trading in over-the-counter commodity swaps as well as exchange-traded futures. The rule will limit the number of contracts a single firm can hold.

“Our duty is to protect both market participants and the American public from fraud, manipulation and other abuses,” Chairman Gary Gensler said at the commission’s meeting in Washington in support of the rule. “Position limits have served since the Commodity Exchange Act passed in 1936 as a tool to curb or prevent excessive speculation that may burden interstate commerce.”

The rule limits traders to 25 percent of deliverable supply in the month nearest to delivery. The spot-month limits apply separately to physically settled and cash-settled contracts. Deliverable supply will be determined by the CFTC in conjunction with the exchanges.

Gas Contracts

Cash-settled natural gas contracts will be subject to a different regime. Traders will be permitted to hold contracts equal to five times deliverable supply in Henry Hub swaps, derivatives that settle in cash instead of the delivery of the underlying commodity. Henry Hub is a natural gas delivery point in Erath, Louisiana, and the benchmark for U.S. futures.

Outside the spot month, the caps limit traders to 10 percent of the first 25,000 contracts of open interest and 2.5 percent thereafter.

“You want speculation or you don’t have any markets,” said Commissioner Bart Chilton in an interview today on Bloomberg TV. “There’s nothing wrong with speculators. It’s when it begins to get excessive. We’ve seen where you can have 30, 35, 40 percent plus in some markets with just one trader holding onto that concentration. That can impact markets.”

The commission estimates that the limits will affect 85 energy traders, 12 metals traders and 84 traders of certain agricultural contracts. The caps will go into effect 60 days after the agency defines the term “swap.” The agency declined to estimate when that will be. Limits outside the spot month are likely to go into effect in late 2012.

Affected Contracts

The limits will apply to 28 physical commodity futures and their financially equivalent swaps including contracts for corn, wheat, soybeans, oats, cotton, oil, heating oil, gasoline, cocoa, milk, sugar, silver, palladium and platinum.

The rule calls for traders to aggregate their positions, a change that may affect large firms with multiple strategies. It also would tighten an exemption allowing so-called bona fide hedgers to exceed the caps.

The new ruling is certainly not about protecting the public from fraud, which has always been used as excuse for interference.

The flurry of various interventions in the commodity spectrum has been directed at controlling prices with the ultimate goal of containing consumer price inflation. This opens the doors to further interventions in the marketplace and the economy which most likely will be channeled through monetary policies.

This has been part of the signaling channel policies designed to manage inflation expectations or to camouflage the untoward effects of current policies.

Again this will likely impact the commodity markets on the short term.

The markets will always find a way to go around or skirt regulations. Price controls or edicts won’t stop the laws of economics, especially from venting on the negative consequences from arbitrary regulations. Price controls only skew the economic balance of these commodities which leads to even more volatility.

The sad thing is that it has been the nature of politics not to penalize authorities or hold them accountable for any failure of their actions. On the other hand, policy failures translates to even more interventions.

Occupy Washington, the US Federal Reserve and the Princeton University

Investing savant Dr. Marc Faber says that demonstrators against Wall Street should instead occupy Washington and the US Federal Reserve.

The Business Intelligence Middle East quotes Dr. Faber (bold emphasis mine)

On the US Federal Reserve’s preference to support the banking and financial class through bubble policies:

We cannot blame Wall Street and well-to-do people for the mishap, for this ratio to have exploded on the upside. We have to blame essentially expansionary monetary policies that favor assets. So you have low consumer price inflation, you have no wage inflation."

In fact, the problem in America is that real wages, real compensation has been down since the 1970s. But at the same time, asset prices, equities, real estate and so forth have gone up dramatically, and that favors people who have these assets. And so the ratio expanded and you have now a record wealth inequality, and income inequality…

On Washington’s bribery of Americans in order to expand welfare state for the benefit of the political class and their cronies.

The problem with government is that the original intention of, especially a democracy, is very good.

Everybody has a say in how societies should be structured, but over time, it becomes very polarized and it moves into the hands of powerful business interests, and also interest groups like the military complex, or say the welfare recipients and so forth…

So you end up with kind of on the one hand a tyranny of the masses where you distribute all kinds of goodies to people. Like in America roughly 50% of the population gets a handout one way or the other from the government. So by continuing to support these people, you get their votes.

The protestors should focus on the root of the problem

Wall Street is a minority, anyone else would have done the same, they use the system but they didn't create the system. The system was created by the lobbyists and by Washington. So they [the protesters] should actually go to Washington and also occupy the Federal Reserve on the way

Professor William L. Anderson further suggests for an Occupy Princeton University movement (highlights mine)

That's right, I am calling for an immediate occupation of...Princeton University, and specifically, its economics department. There is no other place on earth that has given us more players and more enablers of the financial madness that has gripped this economy for many years.

Reason: Because of the notoriety of some of the academic alumnus towards interventionist and inflationist policies: Ben Bernanke, Alan Blinder, Alan Krueger and Paul Krugman

Continue reading Professor Anderson’s explanations here

Quote of the Day: Cycles of Political Institutions

From Bill Bonner

As an institution matures, little by little it shifts from serving its original purpose to serving the ends of those who control it. It becomes rigid — digging in its heels and resisting any change that would diminish the power and wealth of the controlling groups. The longer the institution remains unchanged, the more parasitic and arthritic it becomes. It drains resources away from honest production and redirects them towards favored groups of leeches.

Then…history returns. Then cometh the revolution.

Global Equity Markets Update: Deepening Losses

Global equity markets appear to be in a deepening funk.

Of last month's 10, now only four of the 78 global equity market indices monitored by Bespoke Invest posted gains, the Bespoke writes,

Just four countries are currently in the black this year -- Venezuela, Botswana, Jamaica and Ecuador. Greece and the Ukraine are the worst performers year-to-date with respective declines of -45.15% and -46.93%. The UK ranks second out of the G7 countries with a decline of 7.35%, followed by Canada (-10.13%) and Germany (-13.70%). Italy is the worst performing G7 country so far in 2011 with a decline of 19.25%. All of the BRICs are down more than 10% year to date.

And nearly a third of global benchmarks may be tipping into the bear market territory. Currently 8 or 14% of the total have losses of more than 20%

So far ASEAN markets continue to outperform the world but they have also been in the red.

The broadening of stock market declines reveal how interrelated today’s financial markets are and how global markets react in tidal flows as consequence to central banking boom bust policies.

The Next Phase of Euro Bailout: Market Volatility from Broken Promises

I have been saying that financial markets have been riding partly based on the promises of European political leaders that have been meant to be broken. Now the breaking down of such pledges begins

From Bloomberg (bold emphasis mine)

Europe’s options for overcoming the debt crisis narrowed as Germany doused expectations of a breakthrough at this weekend’s summit and central bankers balked at extended bond purchases.

European stocks and the euro reversed initial gains yesterday, slumping after German Chancellor Angela Merkel’s office knocked down what it called “dreams” that the Oct. 23 summit will be the last word in taming the crisis. Christian Noyer, head of France’s central bank, ruled out a ramping up of the European Central Bank’s bond-buying program as part of a multi-pronged strategy to shield countries like Italy.

While Group of 20 finance ministers and central bankers pressed European Union leaders to set out a strategy by the end of the week, divisions flared over an emerging plan to avoid a Greek default, bolster banks and curb contagion.

“We’re really in a bind here,” Carl Weinberg, founder and chief economist at High Frequency Economics, said in an interview with Betty Liu on Bloomberg Television’s “In the Loop.” “We have a lot of egos, a lot of national interests, a lot of political considerations, and that’s just hampering us from getting to a solution.”

The ECB said yesterday it bought 2.2 billion euros ($3 billion) of bonds last week, the least since it restarted the market support program in August over the objections of Germans on its council. While looking to exit the bond-buying business, the ECB also opposes the use of its balance sheet to boost the government-financed 440 billion-euro rescue fund with enough firepower to do that job…

Merkel has made it clear that “dreams that are taking hold again now that with this package everything will be solved and everything will be over on Monday won’t be able to be fulfilled,” Seibert told reporters in Berlin. The search for an end to the crisis “surely extends well into next year.”

Group of 20 finance ministers and central bankers concluded weekend talks in Paris endorsing parts of Europe’s emerging crisis plan. Providing a week to act, they set the Oct. 23 meeting of European leaders as the deadline.

My guess is that the recent market rebound may have given Euro’s political leaders some confidence to back off from their earlier assurances, AND OR that the reality of the heterogeneity and complexity of the underlying problems has been rendering their ‘grandiose’ centralized plans for a ‘comprehensive’ rescue as untenable.

Importantly the October 23 deadline by the G-20 on Euro policy makers will likely amplify current volatility.

Telegraphing reluctance to inject more ‘money from thin air’ means that turbulent times are not over.

Video: How to silence a Nobel Prize winning economist: Ask him about the economy.

This video from Peter Schiff is a must watch. (hat tip Justin Ptak Mises Blog)

The current Nobel Prize winners, whom are economic modelers or supposed technical experts on the economy, can't seem to defend their work, or much less explain their perspective of the US or European economy, in public.

Incredibly or even embarrassingly, both opted to take a silent stance in a news conference.

Watch the Princeton news conference video through this link

Another vindication of the great Ludwig von Mises who once wrote,

There is no such thing as quantitative economics. All economic quantities we know about are data of economic history. No reasonable man can contend that the relations between price and supply is, in general or in respect of certain commodities, constant. We know, on the contrary, that external phenomena affect different people in different ways, that the reactions of the same people to the same external events vary, and that it is not possible to assign individuals to classes of men reacting in the same way. This insight is a product of our aprioristic theory.

The European Central Bank as Symbol of Capitalism?

Today’s headlines reads “Rallies vs. Corporate Greed Sweep World” (Inquirer, Agence France-Presse, Associated Press) [emphasis added]

Other than Rome’s, the demonstrations across Europe were largely peaceful, with thousands of people marching past ancient monuments and gathering in front of capitalist symbols like the European Central Bank in Frankfurt.

My auto impulse response: WTFAYTA??!!

To save you precious seconds from searching, the acronym is the internet slang of "What The F*** Are You Talking About?"

Don’t these media guys know that…

Centralization of credit in the banks of the state, by means of a national bank with state capital and an exclusive monopoly.

…is the 5^th of the 10 measures of Marx-Engels Communist manifesto????

So how the heck does a ‘communist’ institution metamorphose into a symbol of capitalism???

Mises Institute’s Jonathan M.F. Catalán has a nice apropos cartoon depicting a past protest against the Aldrich Plan in 1912 or the proposed formation of the US central bank

The parody presciently portrays what has been happening today: a political economy based on Too big to Fail Banks-central banking-welfare/warfare state or a central bank-led cartel.

The ECB as a symbol of capitalism serves as telling evidence of how media has either been totally ignorant or complicit to the political propaganda aimed at shifting the culpability away from the government to everyone else.

The snowballing populist protest has rightly been directed at central banks, but media and many people and even some protestors don't get it: Corporate greed exists because of the symbiotic political relations with Political greed.

The lyrics below from Depeche Mode’s 1983 song ‘Everything Counts in Large Amounts’ seems event relevant

The graph on the wall
Tells the story of it all
Picture it now see just how
The lies and deceit gained a little more power
Confidence - taken in
By a suntan and a grin

The grabbing hands grab all they can
All for themselves - after all
The grabbing hands grab all they can
All for themselves - after all
It's a competitive world

More Inflation Myths: Velocity of Money

John Mauldin defines inflation as

a combination of the money supply AND the velocity of money. In short, if the velocity of money is falling, the Fed can print a great deal of money (expanding its balance sheet) without bringing about inflation.

So how valid or real is his definition?

The Velocity of M2 has been in a decline since 2006. This decline culminated in 2008 with the Lehman bankruptcy. Since bottoming out in early 2009, the velocity of M2 has been rangebound

In contrast, % change of M2 has been ascendant from 2007 and peaked during the first quarter of 2009. From 2009-2010, M2 has been in a steady decline. Following a bottom in early 2010, the % change of the M2 has been roaring upwards.

By the conditional definition that inflation is a function of Money Supply AND velocity, the US should be witnessing disinflation from 2009-2010, since it was only then where both money stock AND velocity had a synchronized decline. And from 2010 to date, a stagnant or rangebound inflation rate.

Unfortunately, only part of the story seems correct. US inflation rate fell from July 2008 and bottomed in July 2009. Since, US CPI rate continues to climb upwards in defiance of Mr. Mauldin’s definition of inflation (chart from trading economics)

The same story applies when seen with the US Producer’s Price Index

Mr. Mauldin was actually discussing the chances of hyperinflation in the US using the Weimar Germany as example

The Weimar hyperinflation according to Wikipedia.org is the

period of hyperinflation in Germany (the Weimar Republic) between 1921 and 1923. (I am emphasizing the period)

Chart from Now and Futures

During the Weimar episode, the velocity of money AND money supply only spiked together during the grand finale, which means that by clinging on to the velocity of money to define inflation, the value of your cash would have been a toilet paper. Similar to the Zimbabwe dollar.

In short, in the Weimar experience velocity of money lagged money supply growth.

Professor Hans Sennholz described how hyperinflation occurred in Weimar Germany (bold emphasis mine)

The German inflation of 1914–1923 had an inconspicuous beginning, a creeping rate of one to two percent. On the first day of the war, the German Reichsbank, like the other central banks of the belligerent powers, suspended redeemability of its notes in order to prevent a run on its gold reserves.

Like all the other banks, it offered assistance to the central government in financing the war effort. Since taxes are always unpopular, the German government preferred to borrow the needed amounts of money rather than raise its taxes substantially. To this end it was readily assisted by the Reichsbank, which discounted most treasury obligations.

A growing percentage of government debt thus found its way into the vaults of the central bank and an equivalent amount of printing press money into people's cash holdings. In short, the central bank was monetizing the growing government debt.

By the end of the war the amount of money in circulation had risen fourfold and prices some 140 percent. Yet the German mark had suffered no more than the British pound, was somewhat weaker than the American dollar but stronger than the French franc. Five years later, in December 1923, the Reichsbank had issued 496.5 quintillion marks, each of which had fallen to one-trillionth of its 1914 gold value

I am delighted that the recent political schisms (Volker et. al.) and the division among US Federal Reserve officials seems to have prompted team Bernanke’s reluctance to deploy QE 3.0.

This is a manifestation of institutional ‘check and balance’ that indeed lessens the odds of a US based hyperinflation

However, using velocity of money as an excuse to justify the actions of the US Federal Reserve resonates exactly why hyperinflation transpired in Weimar

Again Hans Sennholz (bold emphasis added)

The most amazing economic sophism that was advanced by eminent financiers, politicians, and economists endeavored to show that there was neither monetary nor credit inflation in Germany. These experts readily admitted that the nominal amount of paper money issued was indeed enormous. But the real value of all currency in circulation, that is, the gold value in terms of gold or goods prices, they argued, was much lower than before the war or than that of other industrial countries….

Of course, this fantastic conclusion drawn by monetary authorities and experts bore ominous consequences for millions of people. Through devious sophisms it simply removed the cause of disaster from individual responsibility and thus also all limits to the issuance of more paper money.

The source of this momentous error probably lies in the ignorance of one of the most important determinants of money value, which is the very attitude of people toward money. For one reason or another people may vary their cash holdings. An increase in cash holdings by many people tends to raise the exchange value of money; reduction in cash holdings tends to lower it. Now in order to change radically their cash holdings, individuals must have cogent reasons. They naturally enlarge their holdings whenever they anticipate rising money value as, for instance, in a depression. And they reduce their holdings whenever they expect declining money value. In the German hyperinflation they reduced their holdings to an absolute minimum and finally avoided any possession at all. It is obvious that goods prices must then rise faster and the value of money depreciate faster than the rate of money creation. If the value of individual cash holdings declines faster than the rate of money printing, the value of the total stock of money must also depreciate faster than this rate. This is so well understood that even the mathematical economists emphasize the money "velocity" in their equations and calculations of money value. But the German monetary authorities were unaware of such basic principles of human action.

To give an aura of credibility, many adhere to statistical aggregates for economic definitions and explanations. They forget that economics and money is about people and their actions.

Sharp Market Gyrations Could Imply an Inflection Point

The path to a robust political economy must begin with treating political decision making (and the incentives and information embedded in that process) in the realm of policy making not as a footnote caution, but at the very beginning of the analysis.-Professor Peter Boettke

Violent gyrations in the equity markets usually occur during inflection or reversal periods of major trends.

While the current upside swing could reflect a bottoming phase, on the other hand, it could also reflect a transition towards a downside bias—a bear market.

For example, in 2007, after the first jolt from the market peak in July, both the major bellwethers of the US and the Philippines, the S&P 500 (blue-bar) and the Phisix (black candle), dramatically recoiled to the upside (red rectangles).

The initial rally saw both indices BROKE out of the resistance levels (green vertical lines) but eventually faltered. The second downswing had almost been a miniature replica of the first violent reversal.

Seen in the lens of a chart technician or chartist, such dynamic represents a chart pattern failure, where whipsaw motions can be identified as ‘bull traps’—or as investopedia defines[1],

A false signal indicating that a declining trend in a stock or index has reversed and is heading upwards when, in fact, the security will continue to decline

Consequently, following the two failed patterns which diminished the vim of the bulls, the bears assumed dominance.

Don’t Get Married to an Investing theme

I am NOT suggesting that today would be a repeat of 2007-2008.

I keep pounding on the fact that patterns only capture parts of the reality, where the motion of time will always be distinctive with reference to the changes brought about by people’s actions, as well as, the changes in the environment.

It would signify a monumental folly to bet the farm based on the expectation of pattern repetition alone.

And one of the major difference between today and 2007-2008 as I wrote last September[2]

Central bank activism essentially differentiates today’s environment from that of 2008.

As I explained before[3], my bias outcome is for a non-recession bear market.

I think current US markets will likely exhibit symptoms of the non recession bear markets of the 1962 (Kennedy Slide) and 1987 (Black Monday).

Charts from Economagic

And this should be reflected on global markets too

But exposing risk money based on personal biases can be very costly.

Individual expectation of the marketplace and reality usually depart. We DO NOT and CANNOT know everything, and should humbly accept such truism. The desire to see certain outcomes, when facts present themselves to the contrary, will inflict not only monetary losses, but most importantly, mental or psychic anguish from stubborn DENIAL.

This explains the popular trading maxim “Don’t get married to a stock.” Rephrasing this, we should NOT get married to an investment theme.

Prudent investing suggest that we should be taking action based on theory and backed by evidences which either confirms or falsifies it. Confirmation means that we can position to gain profits while a non-confirmation should impel us to consider exiting positions regardless of the profit or loss standings. Learning to manage the state of our emotions reflects on our degree of self-discipline.

And since our understanding of the marketplace shapes our expectations and our attendant actions, we need to seek constant improvement. Expanding our horizons should improve the batting average of our profitability or returns.

Going back to the financial markets, it has been my understanding that the principal drivers of the global financial markets has been the actions of political authorities. Their actions do NOT merely influence the markets, current policymaking via accelerating dosages of inflationism, myriad forms of trading controls and the imposition of byzantine financial and bank regulations represent as direct acts of market manipulation.

Political insider trading not only distorts price signals but importantly politicizes the distribution of gains towards the political class and their benefactors.

In short, in the understanding of the above we just should follow the money.

---

[1] Investopedia.com Bull Market Trap

[2] See Definitely Not a Reprise of 2008, Phisix-ASEAN Equities Still in Consolidation, September 18, 2011

[3] See Phisix-ASEAN Market Volatility: Politically Induced Boom Bust Cycles October 2, 2011

More Evidence of China’s Unraveling Bubble?

A day after I pointed out my suspicions of a possible implosion of China’s bubble economy, China’s government announced that she will be intervening to support their banking and financial system by acquiring shares of major banks through her sovereign wealth fund, Central Huijin[1].

China’s reported interventions sent the Shanghai index up 3% over the week.

Financial bailouts has not been confined to China’s stock markets, but to the real economy too, China declared another bailout package for small companies[2]. The measure includes tax breaks, easier access to loans and leniency on appraising bad loans following the reported collapse of some manufacturers in Wenzhou which has been indicative of the growing risks to China’s economy.

Resorting to emergency stabilization policies basically confirms my suspicions, China is presently suffering from either a sharp economic slowdown or in the process of a bubble implosion. The latter is where I am leaning on, but this requires more evidence.

As earlier mentioned, China’s recent strains have been representative of the unintended consequences of China’s boom bust or inflationist policies. Part of which constitutes the aftereffects of the 2008 stimulus, combined with the impact from China’s struggle to contain her inner demons—elevated consumer price inflation (CPI).

And also as previously noted, the bear market of the Shanghai index since 2007 represents a continuing dynamic of China’s massive boom bust cycle that only has shifted from the stock market to the property sector.

Slowing money supply growth from the series of interest rates increases, the hiking of bank reserves requirements and the appreciation of her currency, the yuan, has been putting financial strains on the massive misallocation of capital due to the previous policies directed at preventing a bust and the political imperatives to maintain a permanent state of quasi booms[3].

And to further give weight to my suspicions, we seem to be seeing substantial outflows of hot money which has materially reduced China’s foreign reserve accumulation. Part of this has also been been attributed to China’s declining current account surpluses[4].

For now, the continuity of the outflows is not clear and will likely depend on the scale of economic and financial deterioration.

Seen from the perspective of China’s currency, we are unlikely to see the yuan appreciate further. And contrary to public expectations, the unwinding of China’s bubble economy would lead to a depreciating yuan.

While many see the current downturn to meaningfully reduce China’s lofty Consumer Price Inflation (CPI), which gives China’s government more latitude to ‘ease’ credit or provide additional bailout measures, economic downturns do not mechanically imply a disinflation of consumer prices. This will greatly depend on the actions of the Chinese government

But more bailouts should be expected as the political objectives for the China’s ruling class ensures such course of action. China’s political stewards will work to postpone an inevitable bubble meltdown. That’s because a sharp economic downturn will likely trigger China’s version of the Arab Spring uprising or a populist upheaval that magnifies the risk of toppling the incumbent regime. There have already been snowballing accounts of protest movements[5] over the country.

Put differently, signs of accelerating stress levels in the financial sector, where loan losses from bad debts could spike to 60% of equity capital according to the estimates the Credit Suisse[6], and a slowdown in parts of the China’s economy suggests that the campaign to contain inflation will shift towards promoting inflation as evidenced by the two bailout measures unveiled last week. There will be more coming.

And like the current policymaking dilemma in the Eurozone, where Euro officials have been struggling to thresh out a “comprehensive strategy” which would ring fence the Euro’s fragile banking sector[7], and similar to the sequential actions of US authorities leading towards the Lehman bankruptcy in 2008, Chinese officials are likely to apply a whack-a-mole approach in dealing with the emergent economic strains.

Unlike in 2008, last week’s twin bailout packages have been inexplicit or indeterminate as there has been no amount specified.

In short, expect Chinese policies to be reactive until such problems will become significant enough for the government to announce a massive specific systemwide bailout program.

Dissonant Market Signals

For the meantime, the current financial and economic environment remains fundamentally a guesswork.

China and the Eurozone’s bailout has hardly boosted copper prices.

Dr. Copper, whose price action have conventionally been interpreted as exhibiting the health conditions of the global economy seems unconvinced, as the recent price performance has evidently lagged the recovery seen in global equity markets.

For chartists, the current rally appear to have forged a bearish rising wedge pattern which seem ominous for another bout of selling episode.

And considering the newly announced expansions of QE measures by the European Central Bank (ECB)[8] and the Bank of England (BoE)[9] as well as the soaring money supply aggregates in the US (which is a fundamental reason why the US is unlikely to fall into a recession unless an external shock occurs like that of China), the same essence of skepticism can be construed to the underperformance of gold prices.

While threats to[10] and actual imposition of various trading curbs on the commodity markets are currently being waged by global authorities, the effects of these are likely to be short term. The greater and more lasting impact would emanate from the large scale redistribution schemes of bailouts, taxations and inflationism.

Nonetheless, the unfolding events in China poses as a black swan event that could undermine the current rally.

Thus, we should closely observe the developments in China and how Chinese and global authorities will react to the unfolding developments.

Grandiose Plans and Promises Meant To Be Broken

To repeat, the current state of the markets appear to be driven by the spate of newly implemented political programs such as QEs, bailouts (Drexia[11]) etc..., as well as, promises for a political resolution on what has mainly been a politically induced problem for the China, the Eurozone and the US.

The current European based QEs may not seem as large as the previous which, in my view, could be a source of liquidity strains on the financial markets starving for sustained massive injections of money or inflationism.

It would be interesting to see if the flurry of news of actual and proposed bailouts will succeed in the restoration of confidence (which means reduced market volatilities highlighted by a fortified upside trend) or if such narratives will be reinforced by concrete actions such as the recent ratification[12] of the European Financial Stability Fund (EFSF) or recently announced QEs by the ECB and the BoE. Again, size matters.

So far some stories or plans may just end up in the shelf or in the trash bins signifying another failed attempt at propping up a highly fragile and tenuous system.

In the Eurozone, a proposal being floated to ring fence the region’s banking system will be through the conversion of the EFSF into an insurance like credit mechanism, where the EFSF will bear the first 20% of losses on sovereign debts, but allows the banks to lever up its firepower fivefold to € 2 trillion[13]

Yet the lack of real resources, insufficient capital by the ECB, highly concentrated and the high default correlation of underlying investments could be possible factors that could undermine such grandiose plans. Besides, such plans appear to have been tailor fitted to reduce credit rating risks of France and Germany aside from allowing the ECB to monetize on these debts[14].

Again given the complexities of the system, it would be difficult to conceive how these centralized plans would ever succeed.

At the end of the day, the final intuitive recourse, like in most of our history, would be for political authorities to engage in inflationism.

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[1] See Black Swan Event: Has China’s Bubble Been Pricked?, October 9, 2011

[2] Bloomberg.com China Offers Help to Small Companies Amid Wenzhou Risks, October 14, 2011 SFGATE.com

[3] See China’s Bubble Cycle Deepens with More Grand Inflation Based Projects, June 2, 2011

[4] Danske Bank China: FX intervention eased substantially in Q3, October 14, 2011

[5] See Does Growing Signs of People Power Upheavals in China Presage a ‘China Spring’? September 26, 2011

[6] Bloomberg.com Chinese Banks’ Bad Debt May Hit 60% of Equity Capital, Credit Suisse Says October 12, 2011

[7] Bloomberg.com Europe Crisis Plan Wins Global Backing as G-20 Urges Action, October 15, 2011 Businessweek.com

[8] See European Central Bank expands QE to include Covered Bonds, October 6, 2011

[9] See Bank of England Activates QE 2.0 October 6, 2011

[10] See War on Commodities: Eurozone Threatens to Impose Derivative Trading Curbs, October 15, 2011

[11] See Reported Bailout of Belgium’s Dexia Spurs a fantastic US Equity Market Comeback October 5, 2011

[12] See Slovakia ratifies Euro Bailout Fund (EFSF), October 14, 2011

[13] Reuters.com G20 tells euro zone to fix debt crisis within weeks October 15, 2011 Hindustantimes.com

[14] Das Satjayit A Psychiatric Assessment of the Eurozone's Leveraged Bailout Fund, October 5, Minyanville.com

Iranian Terror Plot: US Government’s Imaginary Hobgoblins

From Judge Andrew P. Napolitano (bold emphasis mine)

Since the tragedy of 9/11, numerous crazies and low-level copy-cats have engaged in criminal behavior which they hoped would result in the deaths of innocent Americans and somehow advance the cause of jihad. If you ask the leadership of the FBI, most of whose field agents are tireless, dedicated, Constitution-supporting professionals, it will tell you that it has foiled about seventeen plots to kill Americans during the past ten years. What it will not tell you is that there have been twenty foiled plots; and of them, three were interrupted by members of the public. The seventeen that were interrupted by the feds were created by them.

We all remember the three that were foiled by diligent Americans: The shoe bomber, the underwear bomber, and the Times Square bomber. In all of these cases, the crimes charged were those of attempting to kill and conspiring with others to do so. In all three of those cases, alert Americans on transcontinental flights on or the streets of New York told authorities of bizarre behavior, or actually subdued the threats themselves. There was no foiling by the FBI. The plotters were – thankfully – bumbling fools who had poorly planned their criminal behavior, and who ended up harming no one. All three are serving life terms.

But the more curious cases are the remaining seventeen for which the federal government has taken credit. They all have a common and reprehensible thread. They were planned, plotted, controlled, and carried out by the federal government itself. In all of these seventeen cases – from the Ft. Dix Six to the Lackawanna Seven to the Portland Parade Bomber – the feds found young men of Muslim backgrounds; loners who were bitter at America. They befriended them, cajoled them, and persuaded them that they could change the world by killing Americans. In all these cases, agents worked undercover and portrayed themselves to the targets as Arabs of like un-American mind. In some cases, the federal agents used third parties to act as middlemen. The third parties are typically persons who have been convicted of crimes and who, in return for leniency at their sentencings, were willing to work with the same feds who prosecuted them in order to help entrap whomever else those feds are pursuing.

Thus, in all seventeen of these cases, because of the command and control of federal agents, no one was ever in danger, no one was harmed, no bomb went off, and no property was damaged. But in all those cases, the losers whom the feds targeted each believed that they were interacting with real plotters who would really bring them cash and bombs. As we know, sometimes the cash arrived, but the bombs never did. The defendants were essentially charged and convicted for playing a game with federal agents.

The most recent of those government-generated plots was revealed yesterday. It has a new twist as it allegedly involves agents of the intelligence apparatus of the government of Iran. It, too, was destined to go nowhere, as the feds monitored and taped every move made by the target as he interacted with federal agents whom he stupidly believed to be drug dealers and co-conspirators. Today, the feds themselves revealed that high officials of Iran's government knew nothing of this. Of course, the neocons have demanded bombs on Tehran, no matter what the government there knew. And this plot came to light the day before the Attorney General himself was subpoenaed by Congress in the Fast and Furious case.

Read the rest here

Creating something from nothing isn’t just about the money printing; essentially this represents the fundamental precept guiding today’s modern political institutions. It’s the politics of free lunch.

So in order to justify the existence, the continued funding and the expansion of the warfare-anti terror state, credits on political ‘achievement’ targets has to be demonstrated. Hence if there have been no actual terror threats, then, as shown above, just engineer one.

With the help of mainstream media and the sundry apologists for the establishment, our civil liberties would then be diminished in the name of the security.

The great libertarian H. L. Mencken was darned right,

The whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by menacing it with an endless series of hobgoblins, all of them imaginary.