“One of the big themes of 2013 is the end of the US economic crisis.

That’s not to say that the economy is incredibly strong (GDP growth remains mediocre and unemployment is too high) but several of the key conditions that characterized the financial crisis, and the ensuing years, are starting to fade.

The household deleveraging process, for example, is almost done. That’s coinciding with a beginning of real interest rate normalization. In financial markets, we’re seeing an end to the risk-on-risk-off situation, and more dispersion among stocks.

One of the first firms to jump on board this idea was Goldman, which made its big call that things would start to normalize in 2013, particularly the back half (and now Goldman thinks it’s possible that it’s happening already).

Others have jumped on board too.

In a new note, Morgan Stanley‘s Vincent Reinhart talks about the coming inflection point for the US economy, and he also talks about the change coming in the second half of the year.

In the Morgan Stanley forecast for the US, the trajectory of economic activity marks an inflection point midway through 2013. The severe financial crisis of 2008-09 necessitated significant downward adjustments by the private sector to the levels of aggregate demand and efficient supply. As the event recedes further into history, however, the drag on growth from these ongoing level adjustments plays out.

In our forecast, the expansion of real GDP steps up to around 2-3/4 percent in the second half of this year and beyond….”

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“The International Monetary Fund’s No. 2 official urged policy makers to clean up banks and strengthen oversight of their financial systems or risk stalling a recent rally in global markets.

With the world economy still subdued, further repair of banks’ balance sheets is necessary, which may require more capital for some lenders and closure for others, David Lipton, the fund’s first deputy managing director, said in a speech in Washington yesterday. He also called for unwinding of excessive public and private debt.

“If these medium-term challenges are not adequately addressed, the recent rally in global markets may prove unsustainable,” Lipton said, according to his prepared remarks. “And the still fragile confidence in banks and the wider financial system could turn into fear, which could trigger a renewed sense of crisis.”

The MSCI World Index (MXWO) of stocks has risen about 7 percent this year as equity markets in the U.S., Japan and Europe rallied.

Still, the Washington-based IMF earlier this year cut its global growth forecast for 2013. Recently it said it would lower its prediction for the U.S., where $85 billion in federal government spending cuts have started to take effect.

Speaking to members of the Chartered Financial Analyst Society of Washington, Lipton said the global financial system is not yet safe, even if it is in a better shape than five years ago.

‘Enough Holes’….”

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“Credit markets are in uncharted territory as the global recovery is threatened by a mismatch between companies hoarding cash and record government debt, said Australia’s top-ranked bond manager.

“It’s pretty clear that the credit cycle is still broken,” Jeff Brunton, head of credit at AMP Capital Investors, said in an interview in Sydney this week. “I’ve been doing this for 20-odd years and it just feels very, very different to a normal cycle.”

Global growth may be a below-average 2.4 percent this year, forecasts compiled by Bloomberg show, even as central banks pour unprecedented sums of cash into the financial system. While AMP expects the rally that’s taken corporate borrowing costs to a five-year low to hold, it’s also buying derivatives to protect against risk aversion as policy makers grapple with a European backlash against austerity, Brunton said.

The AMP Capital Corporate Bond (AMPACBD) fund has delivered the best return among Australian fixed-income peers over the decade to Jan. 31, offering an average annual gain of 7.2 percent, according to Morningstar Inc. rankings. Over the same period, investors in Aussie corporate notes earned an annualized 7 percent, a better performance than any other developed market tracked by Bank of America Merrill Lynch indexes.

While more corporate borrowers are increasing profits, governments in the developed world remain mired in debt. Officials from Madrid to Washington and London are faced with the dilemma of trying to improve stagnant economies while combating deteriorating finances with austerity measures.

‘Rocky Path’ …”

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“Kyle Bass, addressing Chicago Booth’s Initiative on Global Markets last week, clarified his thesis on Japan in great detail, but it was the Q&A that has roused great concern. “The AIG of the world is back – I have 27 year old kids selling me one-year jump risk on Japan for less than 1bp – $5bn at a time… and it is happening in size.” As he explains, the regulatory capital hit for the bank is zero (hence as great a return on capital as one can imagine) and “if the bell tolls at the end of the year, the 27-year-old kid gets a bonus… and if he blows the bank to smithereens, ugh, he got a paycheck all year.” Critically, the bank that he bought the ‘cheap options’ from recently called to ask if he would close the position –“that happened to me before,” he warns, “in 2007 right before mortgages cracked.” His single best investment idea for the next ten years is, “Sell JPY, Buy Gold, and go to sleep,” as he warns of the current situation in markets, “we are right back there! The brevity of financial memory is about two years.”

Click the image below for the full presentation (unembeddable)….”

Full article and presentation

“Interest rates already have risen from their record lows, and at some point the Federal Reserve will begin to reverse its easing program, pushing them up even higher.

So investors are taking steps now to deal with higher rates later, including big-time players such as BlackRock, TCW Group and Pimco, The Wall Street Journal reports.

Their tactics include purchasing floating-rate debt, whose yields rise along with the overall rate structure; interest-rate swaps; Treasury inflation-protected securities (TIPS); and derivatives betting on losses by Treasurys.

With rates now so low, the concern is that just a slight rise in rates will be devastating to portfolios of Treasurys.

“We don’t subscribe to the view that once the fire starts, we’ll be able to outrun everybody through the door,” Stephen Kane, managing director for U.S. fixed income at TCW, tells The Journal.

“Rates could be up 50 basis points before your traders can get all the sell orders through.”

Rick Rieder, co-head of fixed income for the Americas at BlackRock, agrees.

“For 30 years, interest rates had declined and fixed income was the safe part of the portfolio,” Rieder tells The Journal. “Now fixed income is becoming something you have to be more active in.”

The 10-year Treasury yield stood at 2.06 percent late Monday, up from a record low of 1.38 percent last July….”

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“These days, Marks sees disquieting signs of another credit bubble, though it is just in “the fifth inning.” Central banks are pumping money into economies with abandon. And rates have descended to levels that hardly compensate investors for the risks incurred.

The leveraged buyout market, too, is heating up again, with private-equity firms willing to pay price-to-cash-flow ratios at the elevated levels of 2006, if not the absurd ratios of 2007.

Debt issuance, particularly of high-yield bonds and leveraged loans, is soaring. Individuals and pension funds, though hardly complacent about risk….”

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“The Standard & Poor’s 500 Index approached a record high and a gauge of market volatility slipped to the lowest level in almost six years as Apple Inc. (AAPL) rallied and banks advanced.

Apple jumped 1.2 percent, erasing earlier losses. BlackBerry surged 14 percent following a report that Lenovo Group Ltd. may consider buying the smartphone maker. Ford Motor Co. added 2.9 percent as deliveries in China jumped. Dick’s Sporting Goods Inc. tumbled 11 percent after forecasting profit that was less than analysts estimated. Kroger Co. lost 1 percent after being downgraded by a Hilliard Lyons analyst.

The Standard & Poor’s 500 Index added 0.2 percent to 1,554.41 at 3:29 p.m. in New York, trading within about 11 points of its record. The Dow climbed 29.68 points, or 0.2 percent, to 14,426.75, heading toward its fifth straight record close. The Chicago Board Options Exchange Volatility Index dropped to its lowest level since 2007. Trading in S&P 500stocks was 18 percent lower than the 30-day average.

“The path of least resistance continues to be higher,” Jordan Irving, who helps oversee $175 million at Irving Magee Investment Management in Philadelphia said in a phone interview. “The latest batch of economic data out of the U.S. was okay. If you’re lagging you might want to try to get a little juice in there to catch up.”

More than $10 trillion has been restored to U.S. equity values during the four-year bull market as the S&P 500 more than doubled from the bottom in 2009, fueled by corporate earnings that topped estimates and monetary stimulus from the Fed. The Dow recouped all its losses from the financial crisis in less than 65 months, more than a year faster than the recovery from the Internet bubble.

Volatility Index

The CBOE Volatility Index, which measures the cost of using options as insurance against declines in the S&P 500, dropped 6.6 percent to 11.76 today, the lowest level since April 2007. The gauge, known as the VIX, fell 18 percent last week and is down 35 percent for the year….”

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“Experts are split on what’s behind this huge 4-year long bull market.

Some believe it has been driven by improving fundamentals.  Others believe it has been driven by the Federal Reserve’s easy monetary policy.

In a recent note, BTIG’s Dan Greenhaus noted that the S&P 500 climbed 128 percent during a period when earnings jumped 129 percent.

In other words, he believes there’s a strong case to be made that the market reflects an earnings-driven rally.

But economist David Rosenberg believes that this assessment is faulty.

He takes a page out of Lakshman Achuthan’s book and notes that year-over-year earnings growth has gone negative. From Rosenberg’s Friday research note:

If contraction and recession are synonymous, then an earnings recession is already underway. These talking heads on CNBC are talking about an ‘earnings-driven rally’. I have no clue what they are talking about. My database is from Haver Analytics, who get their numbers from Standard & Poor’s, and the latest update was on March 6th. And at last count, S&P 500 Q4 operating EPS is running at -1.7% on a YoY basis, and at a $23.32 estimate right now for last quarter, it is actually running only moderately above the level prevailing in Q4 2006 ($21.99). So on this basis, earnings have only eked out a mere 0.8% annualized gain over the past seven years.

Rosenberg offers this chart…”

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“In one of Dylan Grice‘s final notes as an investment strategist at Société Générale, he wrote that he was “more worried than ever” by the “social debasement” that central banks were causing in society.

Grice announced in November that he was leaving SocGen for the buy side.

Today, he is out with his first note since joining Edelweiss Holdings, his new firm, and it touches on much of the same that was discussed in the SocGen note referenced above.

In the note – titled “Would the real Peter and Paul please stand up?” – Grice explains his theory of how monetary policy experimentation is leading to a breakdown of societal trust. The idea is that everyone sees their paper currency buying less and less physical goods, but the cause of this inflation is not widely understood, which means everyone just looks to cast the blame on each other.

Referring to the general populace, Grice writes:

The problem is that while they will be acutely aware of the reduction in their own spending power, they will be less aware of why their spending power has declined. So if they find groceries becoming more expensive they blame the retailers for raising prices; if they find petrol unaffordable, they blame the oil companies; if they find rents too expensive they blame landlords, and so on.

So now we see the mechanism by which debasing money debases trust. The unaware victims of this accidental redistribution don’t know who the enemy is, so they create an enemy.

“Deliberately impoverishing one group in society is a bad thing to do,” says Grice, referring to central banks, “But impoverishing a group in such an opaque, clandestine and underhanded way is worse.”

From there, Grice links several examples of phenomena currently unfolding around the world to this idea that central banks are debasing social trust with their “crackpot monetary ideas.”

Below is the key passage:

Full article

“Economic data is improving in the U.S., deteriorating in Europe, and a bit mixed in China.

Meanwhile, the stock markets are staging a huge rally.

Last week, Goldman Sachs economist Jim O’Neill gave a presentation at the prestigious Ambrosetti Financial Markets Workshop.  He updated its attendees on how he sees the world, and he outlined some of the issues that concerned him.

One issue was the evolving make-up of the German exports (slide 37).

“I repeated a remark I often make that on current trends, by 2020 Germany would rather be in a monetary union with China than with France,” said O’Neill

Indeed, China was another hot topic in his presentation.

“Probably the most important slide of the presentation is page 8 which shows global and regional GDP since 1980, and what we are assuming for this decade,” he said. “As I pointed out in Cernobbio, China growing at 7.5% is essentially equivalent to the US growing at 3.75%, given China is now $8.2 trillion in size.”

O’Neill believes China is an “underhyped” story.

His entire presentation gives an excellent and comprehensive view of the world.  And it’s worth reviewing closely.

NOTE: Thanks to Goldman Sachs Asset Management for giving us permission to feature this presentation.

Full presentation

“Did you think last summer was dry? It’s going to get worse.

On the heels of the worst U.S. drought since the 1950s, long-range weather forecasts are showing that not only will the drought continue, it will intensify.

Consequences could be disastrous for farming and ranching communities across the Midwest — and lead to another spike in commodities prices should yields again suffer.Read “How droughts will reshape the United States” on The Washington Post.

The U.S. economy is still only starting to process last year’s drought. On the consumer side, recent government reports confirm that food prices have just begun to rise due to last year’s drought that — at its peak last September — covered nearly two-thirds of the country. Though hot weather and lack of rain caused futures prices for corn and soy to peak at new record highs last August, a lag in the country’s agroprocessing system means consumers — and therefore the broader economy — won’t feel the full brunt of higher supermarket prices for meat, dairy, and grains until later this year. Read USDA report on the 2012 drought.….”

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“Federal Reserve stimulus and government borrowing to meet its obligations are driving stocks to record highs on a daily basis, according to RC Peck, chief investment strategist and CEO of Fearless Wealth.

“It really feels like this is what $8 trillion gets you, between deficit spending and money printing,” Peck told Newsmax TV in an exclusive interview. “It’s been about $8 trillion over the last four years and I really don’t think we’d be at these prices [if it weren’t for that].”

Peck added that the total doesn’t take into account the liabilities that the U.S. has assumed during the period…..”

Full article and video interview

“Someone is obviously not complying with the central-planner script and rotating fast enough into equities.

In February, total NYSE matched volume (defined as the number of shares of equity securities and exchange-traded products executed on the NYSE Group’s exchanges), dropped 13.6% from a year ago, 9.4% from January, and at 20.5 billion shares in the 19 trading days of February, represents a fresh decade low for the exchange (source).

Perhaps it is time for central planning to take it up a level and restore some more confidence in equities as an asset class….”

Full article

“When Ben S. Bernanke asserted last month that the Federal Reserve doesn’t ever have to sell assets, he raised questions about how the central bank can withdraw its record monetary stimulus without stoking inflation.

The Fed may decide to hold the bonds on its balance sheet to maturity as part of a review of the exit strategy Bernanke expects will be done “sometime soon,” he told lawmakers in Washington on Feb. 27. This would help address concerns that dumping assets on the market will lead to a rapid rise in borrowing costs. It also allows the Fed to avoid realizing losses on its bond holdings as interest rates climb.

Removing asset sales from the exit plan Fed officials agreed to in June 2011 means the central bank would stop prices from accelerating by relying primarily on its ability to pay interest on the cash it holds for banks. Given that the Fed’s total assets have reached an unprecedented level of more than $3 trillion, leaving them untouched when the economy picks up may stoke inflation, according to Dean Maki, chief U.S. economist at Barclays Plc in New York.

“If the Fed doesn’t withdraw quickly enough, there’s a risk of overshooting,” Maki said. “If the Fed gets rates back to a typical level and the economy is back to what’s regarded as normal, does having an expanded balance sheet have a notable effect on the economy, on asset markets, even once rates are normalized? We haven’t really had that situation in the U.S. before.”

‘Precisely Analogous’

No country has ever had a comparable increase in the size of its portfolio and unwound it “in the precisely analogous way,” Bernanke said in response to questions from members of the House Financial Services Committee. Japan was the only nation to use asset purchases, or quantitative easing, before the U.S. and is “still in that situation,” he said…..”

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“Beppe Grillo, the comedian-turned politician whose Five-Star Movement won 25 percent of the vote in last month’s Italian elections, said he would quit politics if his party members support a government led by Pier Luigi Bersani’s Democratic Party.

“If there were a confidence vote by the parliamentary group of the Five-Star Movement in favor of the ones that have destroyed Italy, I would retire from politics,” Grillo said late yesterday in a post on Twitter….”

Full article

“(Reuters) – Greece remains the biggest risk for the euro zone despite a calming of its economic and political crisis and may still have to leave the common currency, a senior conservative ally of German Chancellor Angela Merkel said.

Alexander Dobrindt, general secretary of the Christian Social Union (CSU), the Bavaria-based sister party of Merkel’s Christian Democrats (CDU), has long argued that Greece would be better off outside the euro zone.

But German conservatives’ criticism of Greece has eased since the conservative-led government of Prime Minister Antonis Samaras accelerated harsh austerity measures demanded by Germany and the EU as part of its bailout program.

“The greatest risk for the euro is still Greece… I still believe that Greece’s exit would be a possible long-term alternative, for Europe and for Greece itself,” Dobrindt told Die Welt am Sonntag newspaper, according to advance excerpts of the interview released on Saturday.

“We have created a situation that gives Greece a chance to return to stability and restore competitiveness. But I still hold that, if Greece is not able or willing to restore stability, then there must be a way outside the euro zone.”

Dobrindt urged the European Commission, the EU’s executive arm, to prepare the legal ground to allow for the legal bankruptcy of a euro zone member state and its exit from the currency union.

Dobrindt’s comments contrasted with those of the CSU chairman and Bavarian state premier, Horst Seehofer, who expressed solidarity with Greece and said it was on the “right path” when Samaras visited Munich last December.

Seehofer’s conciliatory tone echoed that of Merkel who, for all her frustration with the slow pace of Greek reforms, has decided that a “Grexit” would be far more costly for Germany and Europe than pressing on with the bailout program.

Merkel is also keen to avoid renewed market turbulence in the euro zone ahead of Germany’s federal election in September. Bavaria also holds a state election in the autumn which the CSU is tipped to win….”

Full article

“Investors often remember bull markets as days of wine and roses.

However, those fond memories are largely based on the latter stages of a bull market during which investors are convinced that there is indeed a bull market underway and that it will never end.

They seem to forget that the majority of a bull market is typically characterized by fear and indecision.

Sentiment during the early and middle stages of a bull market is usually clouded by the bad experiences of the prior bear market. Investors are often hesitant to invest in equities for fear of another bear market. Yet, they see higher returns on stocks than the returns they are getting on their more defensive securities. The emotional tug-of-war between fear of another bear market and greed of missing out on higher returns tends to keep most investors sidelined for most of a bull market.

This cycle has certainly been no different. The S&P 500® has produced a total return of more than 140% since the market trough in March 2009, but many investors still do not even believe that a bull market is underway. Investors continue to search for 5% yields and seemingly ignore the much higher total returns that stocks have been producing.

Another 1980s bull market?

We have thought for some time that the current bull market might be one of the strongest of our careers, and could potentially rival the 1980s bull market. Although this current cycle’s construction is quite different from the 1980s bull market, there are many aspects of this market that are curiously similar.

Investors did not fully embrace the 1980s bull market until several years after it began. Institutional investors did not fully appreciate the opportunities in equities until late-1985/early-1986 when oil prices collapsed, and it became clear that inflation was not going to constrain equity returns. Individual investors largely stayed in money market funds and bonds until early-1987 when they were lured into the equity market by January 1987’s 13% one-month return. Individual investors then entered the stock market in droves just in time for the 1987 Crash.

Similar to what is keeping investors on the sidelines during the current bull market, investors stayed out of the 1980s bull market for so long because there were many issues that investors thought were insurmountable. Table 1 highlights some of the issues that caused investors to forego for many years investing in the 1980s bull market. The irony is that they are largely the same as today’s concerns.

Of course, there are subtle differences between the 1980s concerns and today’s. In the 1980s, investors were worried that the Fed might tighten too much. Today, investors are concerned the Fed might ease too much. In the 1980s, it was Democrats who were concerned about budget deficits. Today, it is Republicans. The sovereign debt problems during the 1980s were largely associated with Latin America. Today, such concerns generally focus on Europe. In the 1980s, investors were concerned with Social Security bankrupting the nation. Today, it is Medicare and Medicaid.

Focusing on these differences, though, may miss the point. Investors were scared about a broad range of issues during the 1980s bull market, and the list of concerns is nearly identical to today’s list of concerns. Despite what many might suggest, the uncertainties associated with the current cycle are not unique….”
Full article and comparisons