Thursday, December 29, 2011

Will Extreme Weather Events Batter the Insurance Industry in 2012?

As I enjoy a snow free December in Chicago, it makes me ponder if payback will come in the form of extreme weather later in the season. My perception is that the weather is getting weirder and extreme weather events have become more frequent. However, a post by Anthony Watts suggests observational bias is responsible for my perception of an increase in extreme weather events. "With instant messaging, and Internet enabled phones with cameras now, is it any wonder that nothing related to severe weather or disaster escapes our notice any more?" On the other hand, Chris Field, director of the Carnegie Institution's Department of Global Ecology at Stanford University judges "We're seeing an increase in extremes of high temperatures, an increase in extremes of heavy precipitation, an increase in the length and severity of droughts.,"

Hurricanes in particular are a type of extreme weather event where my perception does not match reality. As destructive as Irene was, it is the only hurricane to have made landfall in the U.S. since 2008. The doomsday predictions about increases in hurricanes making landfall in the U.S. due to global warming have not come to pass. However, as a caveat, it is important to note that 2010 and 2011 were extremely active years for tropical storms. Favorable steering currents and wind shear kept all but Irene from hitting the U.S. 

There was a big spike in tornado activity in 2011, with over 1,600 tornadoes and 552 fatalities.  There are, on average, 1,300 tornadoes each year in the United States, which have caused an average of 65 deaths in recent years. The 552 confirmed fatalities from tornadoes in 2011 is the second-most tornado deaths in a single year in US history. Yet, one year of abnormal activity does not make a trend.

Flooding and Drought
The spring of 2011, particularly April, brought extreme weather and climate events to many parts of the United States. Tornadoes, flooding, drought, and wildfires ravaged the U.S. during the spring, and set numerous records. While similar extremes have occurred throughout U.S. history, never before have they occurred in a single month. Once again, at this point it is impossible to know whether this was a one year aberration or the start of an ongoing change in extreme weather patterns.

Predicting the likelihood of extreme weather events in 2012 is practically a litmus test for whether you believe in global climate change. For those that judge that global climate change is occurring, it probably makes sense to underweight property insurance companies in your portfolio. For those that are skeptical about the claims about global climate change, property insurance companies may offer a suitable investment opportunity.  

The KBWP ETF offers a vehicle for global climate change skeptics and believers to profit (or lose) from their views. Investors can buy or short this ETF. Other Property and Casualty Insurance ETF's include IAK, KIE, and PIC.

The case for going long property and casualty insurance companies is:
1) increased rates implemented due to heavy claims in 2011 will boost revenue. Policy sales rose to $115.7 billion in the third quarter from $111.1 billion a year earlier, according to Property Casualty Insurers Association of America.
2) the extreme property damage from tornadoes in 2011 was an aberration as it is unusual for tornadoes to hit highly populated areas. Tornado activity in 2012 is unlikely to strike so many highly populated areas.

The case for going short property and casualty insurance companies is:
1) global warming is causing an increase in tropical storms. The U.S. has been fortunate the last two years that   steering winds and wind shear have kept hurricanes from hitting the east and gulf coasts. However, our good fortune is unlikely to hold on for a third year. The devastation of Irene may be a precursor to an increase in violent property destroying storms.
2) Low interest rates and a challenging stock market will continue to put pressure on insurers’ investment income.

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Is the U.S Stock Market Over Reacting to News From Europe?

Wednesday, December 28, 2011

Will Scheduled Release of Greece Banking Sector Report on 12/30/11 Be A Market Moving Event?

For doom and gloomers, a critical aspect of identifying opportunities for making money from the coming collapse of the economy is to predict events and dates that are likely to be catalysts for major market moves. In this vein, an interesting report is scheduled to be issued on Friday (12/30/11). The Greece Analytical Accounts of the Banking Sector for November is scheduled to be announced that day.

A collapse of the Greek banking system could be the first domino that sets off a chain reaction leading to an economic collapse. A run on the Greek banks could result if it becomes obvious that they are close to default based on the erosion of their deposit base as money continues to flow to safer havens.

There are three keys as to whether this data becomes a market moving event:
  1. The report must actually be released on the scheduled date (12/30/11)
  2. The report has to show a significant decline in bank deposits
  3. The markets have to decide that the change in deposit levels is a meaningful event.
As a caveat, the November 8 report that Greek bank deposits had dropped by $6 billion in September, the largest monthly amount ever, had no discernible impact on the markets. Thus, this report may also be a non-event. However, it is worth monitoring.

12/30/11 Update

The 1% decline in Greek bank deposits in November turned out to be a non-event. However, the fact that  deposits are down 26 percent from the peak in December 2009 and at their lowest level since February 2007 is not a sign of a healthy banking system.

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Tuesday, December 27, 2011

How Will Daily Dose of Bad New From Europe Impact U.S. Stock Market in 2012

The European debt crisis had a huge impact on the U.S. stock market in 2011. Numerous 100 point moves on the DJIA that were triggered by headlines from Europe. However, the moves were in both directions as the consensus seemed to be that a solution to the problem would be found by the EU. In particular, the run up to the EU fiscal treaty was a catalyst for the 800 point rally at the end of November.

However, nothing was done to actually solve the problems of Europe's excessive deficits, over leveraged banking system, and slowing economies. The austerity measures being taken across Europe are not sufficient to balance budgets and will depress economic activity. The crisis will worsen in 2012.

The economic statistics coming out of Europe are starting to feature a more negative tone. As an example, the number of people in France actively looking for work at the end of November rose by 29,900, or 1.1 percent, to 2,844,800, according to a 12/26 Labor Ministry statement. That’s the highest total since November 1999. The number of jobless climbed 5.2 percent from a year earlier.

The statistics being released now are backward looking. They do not provide an indication of the impact of the recent increases in the price of oil and the potentially investment killing impact of the deluge of news about the debt crisis and coming austerity measures. My perception is that results for December and January will show serious declines in economic activity.

The continued drumbeat of bad news will be provided by the following:
  1. Credit rating agency downgrades
  2. Banking system problems
  3. Higher interest rates required to fund sovereign debt
  4. Economic statistics
  5. Social unrest and strikes
  6. The collapsing economy in Greece
The problems in Europe are likely to impact the U.S. stock market. The interconnectivity of the financial markets, potential exposure of U.S. financial institutions to huge losses on European debt, and the potential lost sales to struggling European customers, makes what happens in Europe important on Wall Street. The daily dose of bad news coming out of Europe will set a negative tone for the opening of the U.S. stock market every day. My expectation is that Europe will be a major factor in pulling the DJIA to 9,000 or less by May, 2012.

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Will European Voters and Strikers Derail The New Treaty's Austerity Plans?

Monday, December 26, 2011

U.S to Fund $541 Billion of Debt in 1st Qtr, Japan to Fund $1.9 Trillion of Debt in 2012. Trouble Brewing?

It seems as if the U.S. and Japan have learned nothing from the European debt crisis. The world's two largest issuers of sovereign debt will continue to run up huge deficits in 2012. The U.S. will fund its deficit and roll over maturing debt by raising $541 billion via Treasury auctions during the first quarter of 2012. Japan’s government plans to raise $1.9 trillion via bond sales in the fiscal year starting April 1.

Both countries face the risk of a financial melt down if the interest rates required to fund their debts climb substantially. However, Japan seems headed for trouble much sooner than the U.S. Wolf Richter has calculated that 52% of Japanese tax revenues will be eaten up by interest payment on the debt despite the near zero interest rate policy of the Bank of Japan. In the U.S., interest payments on the debt will eat up about 10% of tax revenues in 2012, so the U.S. is not in nearly as dire shape. After reading Richter's post The Endgame: Japan Makes Another Move the only logical conclusion appears to be that the Japan is headed for a financial crisis within the next few years. Here is an except from the post.      

But two of the strengths of the Japanese economy that have supported the absurd
deficit levels—a high savings rate and a large trade surplus—have collapsed.
The savings rate is in the low single digits, and the trade surplus has turned into
a ¥2.2 trillion ($29 billion trade deficit in 2011 through November.

It seems a bit absurd that there are buyers for the the 10 year notes of the U.S. and Japan with interest rates at 2% and 1%, respectively, despite neither country showing any willingness to take austerity measures or hike taxes. Unless a change in course occurs, terrible trouble in may be brewing in both countries.

Greece has already proven that at some point the maximum maturity on debt instruments that investors will buy is limited to just 6 months. Time will tell if the governments in the U.S. and Japan have learned anything from the European debt crisis. Sadly, there is no discernible evidence that they have learned a thing.

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Thursday, December 22, 2011

Complacency About the Coming Depression Seems Impossible to Shake

The last time I attempted to warn friends that the U.S. stock market was in for a big decline, due to the declining housing market back in 2007, I was mostly ignored. The fact that I got that call correct has not gained me much credibility though. The reaction of my friends to warnings that an economic depression will start in 2012 is basically for them to ask "when did you start wearing a tin foil hat". I find it frustrating that my warnings to prepare for an economic collapse lead to my being considered a bit of a wacko. Time will tell if I am correct again, but no one reading this post can state that I did not warn them to be prepared for dark times ahead.

It seems remarkable to me that most of my friends have such short memories in regard to how badly their investment portfolios and retirement accounts got crushed by the stock market declines in 2000 and 2007. In both cases the S&P 500 declined by over 45% from peak to trough. I agree with Mark Faber's prediction that those that do not take steps to protect themselves from the coming decline "will be lucky to still have 50% of their wealth in 5 years’ time".

As the year end approaches, and I try to make my case for preparing for an upcoming collapse,  it seems like a good opportunity to provide a summary of the best posts from this blog:

  1. Predictions for 2012 From Economic Doom or Boom
  2. How Long Until A Populist Government in Europe Renounces Sovereign Debt?
  3. U.S. Economy At Risk From Self Fulfilling Prophecies of European Recession
  4. Is Holding Treasury Auctions on 39 Separate Days During The 1st Quarter Risky Business?
  5. Republican Politicians Are Confusing Antipathy For Obama with Support For No New Taxes
  6. Do 2012 Economic Forecasts for U.S. Foolishly Discount High Cost of Oil?
  7. Did Ross Perot Prove That American Voters Can Actually Do Budget Deficit Math?
  8. Beware of Little Old Ladies With Signs - Why The Tea Party Should Compromise on NO New Taxes
  9. The Impact of Layoffs on Stock Prices - It Is All About the Spin
  10. Are So Called "Catastrophe Portfolios" Sufficiently Leveraged For A Deep Crisis?

Wednesday, December 21, 2011

Predictions for 2012 From Economic Doom or Boom

The witches brew created in 2011 will poison the U.S. economy before the end of the 2nd quarter in 2012. The trillion dollar U.S. deficit will not provide enough stimulus to outweigh the impact of:
  • worsening of the debt crisis is Europe
  • contagion effect from Europe infecting the U.S. economy
  • the end of cheap oil
  • the gridlock in Congress and the complacency about the trillion dollar deficit
  • budget cutting in the U.S. at the state and municipal level
  • underfunded pension plans with income projections from fantasy island 
  • baby boomers retiring and selling off acquired assets
The efforts of the EU to solve the debt crisis will fall apart in the face of the huge amount of debt that must be refunded in February. The European debt crisis cannot be solved without restoring growth to the EU  economies. The austerity measures being proposed will shrink EU economies and lead to social unrest and labor strife. The downward spiral of the Greek economy may be the spark that sets off a firestorm of bank runs or sovereign debt auction failures.

In reading the rosy predictions for 2012 from most economists, it seems as if they are oblivious to the fact that events in Europe often move the DJIA by over 100 points in a day. It is mind boggling that they are so blind to the negative impact that Europe will have on all the world's developed economies, including the U.S., with so much evidence being offered by the daily volatility of the U.S. stock market.

The weak earnings reports from Oracle, Intel, and Texas Instruments are just the tip of the iceberg. When fourth quarter results begin coming out in January, they will be far worse than expected.

The decline in the U.S. stock market will start in January and pick up momentum in February and again in April. The first quarter will be a disaster. The weak first quarter earnings reports will drive the S & P 500 down to 900 or below by May, 2012. The tech heavy Nasdaq will decline even more.

The Euro will decline versus the dollar and broach the $1.20 level.

The Yen will decline against the dollar and be within 10% of parity (90 yen to a dollar) by the end of 2012.

Unknowns or Too Challenging to Predict

Interest Rates - The demand for U.S. Treasury bonds at historically low interest rates will slacken at some point in the future. However, it is impossible to determine when and what events will shake investors confidence in U.S. Treasury issued debt. When it does happen (2013 or 2014?), the upward spiral in interest rates may occur at frightening speed.

Price of Oil - The declining production from the established easy to pump oil wells that are wearing out may lead to supply shortages. However, the declining demand resulting from a world wide recession could lead to falling prices. The end of cheap oil is going to be a huge problem before the end of the decade. New sources of oil including fracking and tar sands are expensive and energy intensive and may not grow fast enough to compensate for the declines in established sources of production.

U.S. Dollar - The strength of the dollar in the face of huge deficits and trade imbalances demonstrates how risky the world's other currencies are considered. With the economies in Europe, Japan, and China all declining, the dollar may remain strong in 2012.

Gold - My perception is that gold will breach $2,000 in 2012, but gold is a risky investment as a severe recession or depression may lead to so much forced liquidation of the shiny metal that it holds down the price.

Related Posts

Will European Voters and Strikers Derail The New Treaty's Austerity Plans?

Tuesday, December 20, 2011

Be Wary of the Bi-Polar U.S. Stock Market

Today's daily dose of bad news about the European sovereign debt and banking crises was ignored by stock market traders that are terrified of missing out on a Santa Claus rally. A successful auction of Spanish sovereign debt and the Census Bureau report that the U.S. housing starts and permits for future construction surged to a 1-1/2 year high in November has propelled the DJIA to a 270 point gain as of mid-day (12/20/11). This moderate dose of positive news is being given far more weight than a report out of Greece from Ekathimerini that "The government has decided to stop tax returns and other obligation payments to enterprises, salary workers and pensioners as it sees the budget deficit soaring to over 10 percent of gross domestic product for 2011."

The low volume of stock market trading exacerbates the impact of news on the market due to all the traders away from their desks taking Christmas holidays. The daily doses of bad news may lead to more down days than up days for the balance of the year, but the up days may be explosive enough to produce  a Santa Claus rally.  However, once 2012 arrives and optimism about a Santa Claus rally is no longer in place to prop up the market, look out below. The deterioration of European economies due to the debt crisis will be daily news, and the contagion will eventually spread to the U.S.  The bi-polar volatility based on the day's new is likely to continue, only with more of a downside bias.

It is only a matter of time until a real bombshell hits. It may be from a run on a bank, a failed sovereign debt auction, or from a threat to oil supplies coming from the Mideast. However, a 500 point down day on the DJIA will likely occur sometime during the next 10 weeks. While I am not so rash as to short the stock market during the remainder of 2011 in the face of a potential Santa Claus rally, I am fearful enough that I am lightening up on my holdings. Today's rally has served as a good exit point. I will not start selling stocks short until the first week of 2012.

Monday, December 19, 2011

Will High Cost of Oil Damage Obama's Reelection Bid in 2012?

The approach of the end of the year is leading to the release of a deluge of economic forecasts for 2012. However, most of the forecasts based on historic modeling are garbage in garbage out. The high cost of oil and the European debt crisis are severely negative events that are not being given nearly enough weight by these backward looking models.

The U.S. economy is so fragile due to high unemployment, declining housing prices, high levels of household debt, and the growing number of senior citizens disposing of assets, that GDP will only grow a couple of percent in 2011 even with a trillion dollars of fiscal stimulus and an accommodating Federal Reserve. The high cost of oil and collateral damage from Europe's problems may tip the U.S. back into recession in 2012. President Obama's popularity ratings are already at record lows, even with an economy that is making moderate progress in reducing unemployment rates. His chance of reelection will dim if the economy takes a hit due to high oil prices.

High oil prices hit consumers directly in the pocketbook due to higher transportation and higher food costs. Since commuting and food expenses are necessities, workers cut back on discretionary spending when oil prices are high. Businesses are affected by cuts in consumer discretionary spending and hire fewer employees resulting in the economy and the unemployment rate remain stagnant.

The anti fossil fuel zealots in the Obama administration's EPA are contributing to the high cost of oil in the U.S. The moratorium on drilling in the Gulf  has probably led to oil production being down about 100,000 barrels a day versus where it otherwise would be. Also, other EPA restrictions on new drilling are holding down production. The oil boomlet from fracking is in large part due to the EPA not being able to regulate it.  This vibrant area of the U.S. economy is probably only experiencing growth because the Energy Policy Act of 2005 explicitly exempting fracking from the requirements of the Safe Drinking Water Act, the Clean Air Act, and the Clean Water Act. Leaving the regulation of fracking up to the states is working out fairly well. It is perturbing to realize that the job killing EPA is already drawing up regulations for fracking. While it is imperative that drinking water be protected from fracking activity, the states seem to be finding their way to appropriate regulations. 

The anti fossil fuel zealots in the EPA are totally disconnected from economic reality. Their infatuation with solar and wind energy ignores the fact that it only produces electricity and is barely of any use as a transportation fuel. The U.S. will be dependent on oil as our primary transportation fuel for decades. Restricting oil drilling activity in the Gulf and the rest of the U.S. has little impact on total world wide consumption of oil, but does increase the U.S.  imports of oil and hurts our economy. Thus, the anti fossil fuel zealots in the EPA are contributing to the high cost of oil, a weakened U.S economy and the unpopularity of President Obama. 

The high cost of oil and the administration's antipathy to U.S. oil drilling will be a huge obstacle to the Obama reelection bid in 2012. The high price of gasoline, most likely over $4.00 per gallon during the summer, will cost President Obama votes. The weakness in the  U.S. economy caused by the high cost of oil will be an issue that garners votes for the Republican candidate for President.

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Do 2012 Economic Forecasts for U.S. Foolishly Discount High Cost of Oil?

Friday, December 16, 2011

If U.S. Economy So Fragile that Social Security Tax Cut Required Then How Will We Muddle Thru An European Collapse?

In reading commentaries on the debate over whether to extend the 2% Social Security payroll tax reduction for 2012, the view of many of its supporters is that the U.S. economy is so fragile that growth will stall if this measure is not passed. However, it seems hard to reconcile concern about the impact of not extending the SS payroll tax cut with the general complacency about the European debt crisis. It seems ludicrous that a consensus seems to be building around the competing ideas that: 1) the U.S. economy is so fragile that an extension on the SS payroll tax reduction is required; and 2) the U.S. economy can muddle through a steep downturn in Europe.

My viewpoint is that the U.S economy is at terrible risk from a collapse of European economies. Southern  Europe is already in a depression, and the rest of the continent is soon to follow. The biggest question in my mind is when the collapse of the European economies will start. My expectation is that either a bank or a sovereign debt auction will fail by February, 2012 and this will set off a cascade of additional failures.

The impact on the fragile U.S. economy of a European collapse could  be as bad or worse than the Lehman failure in 2008. A European collapse would impact the U.S. economy due to the interconnectedness of the banking system, reduced exports of products and services, and the impact on earning of U.S multinational corporations. During the last U.S. Presidential year, the DJIA average dropped by 3,500 points with most of the drop occurring during a 30 day period from mid August to mid September . A comparable decline in the DJIA could be in the cards for 2012 if Europe collapses.

It seems unlikely that the results of the vote on an extension to the SS payroll tax cut will have even a fraction as large an impact on the U.S. economy as what happens in Europe.

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How Long Until A Populist Government in Europe Renounces Sovereign Debt?

The fiscal crisis in Europe is almost certain to explode at some point within the next few years. The most frequently discussed risks are bank runs or a country defaulting on its debts. However, a third source of risk comes from the potential for a populist party to gain control of an European government and renounce the country's sovereign debt. The austerity measures being forced upon the profligate nations of Europe are being attacked by politicians on both the right and the left. A Portuguese politician has come out with an ominous threat in stating "We have an atomic bomb that we can use in the face of the Germans and the French: this atomic bomb is simply that we won't pay," stated Pedro Nuno Santos, vice-president of the Socialist Party."

Opposition to the European Union's efforts to keep the eurozone debt crisis from exploding is growing in France, Portugal, Finland, the Netherlands, Hungary and Italy. While the opposition in most of these countries  is focused upon the "reform" measures, leaders of populist parties throughout Europe have no intention of implementing the austerity measures required to eliminate budget deficits. Thus, if a populist or leftist party takes control of an European government, a default becomes practically inevitable. While the risk of a debt renouncing party taking control of a European government seems slight during 2012 due to this year's light election schedule, it is something that could happen down the road. The elections in Greece and France in the upcoming months seem likely to be won by parties that are supportive of the Euro, but the election calendar becomes much more crowded in 2013 and 2015.  (A detailed international schedule can be viewed at the IFES election guide)

In addition to all the other risks to the U.S. stock market, investors should keep an eye on the progress of European populist and leftist political parties. Even the perception of an electoral victory could hasten the explosion of the eurozone as this would likely lead to a sovereign bond auction failure. Given the exposure of many of Europe's weakest banks to sovereign debt, a bond auction failure would set off a domino effect of  bank failures.

The general consensus seems to be that the impact on the U.S. economy of Europe's troubles will only be a reduction of 1-2% in gross domestic product (GDP). As discussed extensively in previous articles on this blog, my judgement is that the contagion will be far worse. My base case is that the S & P drops to 900 in 2012.

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Will the European Debt Crisis Stay Off The Front Page Long Enough For A U.S Stock Market Santa Claus Rally?

U.S. Economy At Risk From Self Fulfilling Prophecies of European Recession

Wednesday, December 14, 2011

10 Year U.S. Treasuries Down to 1.9% Despite Dysfunctional Government and Trillion Dollar Deficits

It would be hard for me to imaging an investment that is more likely to be a loser before reaching maturity than buying 10 Year U.S. Treasury notes that only pay an interest rate of 1.9%. The low rates on the 10 Year Note shows how few other attractive investments are available.

It seems bizarre that the gridlock in Congress over votes to continue a payroll tax cut, extend long-term jobless benefits, and fund the government to avoid yet another shutdown and being ignored by buyers of U.S. Treasuries.

Higher interest rates will almost certainly be required to fund the U.S. debt at some point during the next ten years, and the value of Treasury notes move inversely to interest rates. A healthy growing economy will lead to higher interest rates, as will a stagnant economy the runs up huge deficits due to social welfare spending.

Buying U.S. Treasuries at these low rates probably only makes sense for foreign buyers that expect their currencies to decline against the U.S. dollar. They might be a good short term vehicle for European's to park cash, but they are likely to be a horrible investment for U.S. investors that are paying dollars for the notes.

Greek Economy Worse Than Expected. Next Up - Europe Economy Is Worse Than Expected

The IMF announced yesterday that the Greek economy was worse than expected.  The budget deficit is now projected to be 9% of gross domestic product as the recession is constricting tax revenues and increasing spending on social welfare.

Readers of this blog will wonder why the decline in the Greek economy was "unexpected". As pointed out in the post "Greeks In Despair Over State of Economy", the suicide rate in Greece is up over 40% due to hopelessness about the future. It's patently obvious that imposing further austerity measures upon the Greek economy will lead to further declines. The Greek economy will not recover until actions are taken that stimulate increases in productivity and growth in the economy. The focus on preventing a default and austerity measures is self defeating.  The current strategy of "extend and pretend" is simply delaying the inevitable default by Greece.

It is surprising to me that so many economists are delusional about the likelihood of an easy solution being found to moderate the European debt crisis. It is only a matter of time before a country or a major bank defaults. Add in the reduced lending by banks and the high cost of oil and a Europe wide recession in virtually a certain outcome.

The "unexpected" headlines during the first quarter are going to state that the economies in Europe are declining more than projected.

The next set of "unexpected" headlines will be about the collateral damage caused to the U.S. economy by the problems in Europe.

It is only a matter of time before something blows up in Europe. The situation in Greece is becoming increasingly desperate, but additional problems exist all over the continent. The likelihood of runs on banks is also growing.

Here are a couple of predictions:

  1. The best case for the Euro during the next 6 months is that it only drops to 1.25 versus the dollar. A drop to 1.20 or below is not out of the question 
  2. The U,S. stock market is being propped up by the expectation of a Santa Claus rally, which may or may not occur. However, 2012 seems bleak. The S & P is very likely to dip down to 900 or below by the end of the second quarter due to contagion to the U.S. economy from Europe..  
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Tuesday, December 13, 2011

Will European Voters and Strikers Derail The New Treaty's Austerity Plans?

European leaders agreed last Friday to a new EU treaty aimed at solving the euro zone debt crisis.  A key aspect of the fiscal treaty was an agreement to pursue stricter budget rules.  However, it did not take Italian labor unions long to show their displeasure with the pact.  The three largest Italian public and private sector unions walked off their jobs yesterday.  The unions are planning strikes throughout this week in an attempt to force the Italian government to modify the austerity plan. These strikes raise the question of whether European voters and labor unions will support austerity measures required by stricter budget rules.

Nationalistic resentment about the austerity measures being imposed upon economies that are already in recession could lead to the fiscal treaty ultimately being rejected.  The EU's aim to have the fiscal treaty finalized by March and ratified by June may not be achievable.  In addition to British opposition to the fiscal treaty, several other non-euro zone countries, including Sweden, Hungary and the Czech Republic, require parliamentary approval before giving their full backing to the pact.

It seems appropriate to be skeptical about whether much progress was really made in solving the debt crisis at the meeting in Brussels.  Greece still teeters on the brink of default and the cost of funding debt in Italy, Portugal, and Spain is at unsustainable levels.  Further, the European banks lending will be constrained by need to a fill a capital shortfall of $150 billion to hit new minimum levels demanded by the European Banking Authority.  The next round of elections in Europe may also bring to office politicians that are opposed to the new EU treaty. In particular, France's President Sarkozy's will face a tough re-election battle against a Socialist Party candidate, Francois Hollande, that has announced he would renegotiate the treaty. 

There remains a great deal of optimism in the U.S. that: 1)  the problems in Europe will be solved or contained; or 2) that the U.S. economy will be able to muddle through even if Europe goes into a recession of a depression. Frankly, this complacency about the impact on the U.S. economy in 2012 of the European debt crisis may be misplaced. 

According to Goldman Sachs, "A small minority of investors expects a euro breakup and a deep recession in Europe. In this case our uncertainty-based P/E model suggests the S&P 500 could fall by roughly 25% to 900. Even if collapse is avoided, the continuation of “passive containment” and delay of resolution continues to raise the costs in both financial and economic terms, creating a poor condition for equity markets." 

Time will tell whether the small minority of Goldman's bearish investors are correct. However, all investors should prepare for the possibility that the bear case will come to pass. 

Monday, December 12, 2011

Will Gold Shine If The Economy Collapses?

The doom and gloom crowd have been big advocates of buying gold. However, as shown by the big decline in the price of gold today despite an increase in jitters about European debt, there are no guarantees that the price of gold will rise if the economy collapses.

One of the primary rationales for buying gold is the assumption governments will turn on the printing presses and expand the supply of fiat money in order to pay for decades of spending more money than they are collecting, As the public loses faith in debased paper currencies, many expect the demand for gold will increase exponentially.

However, the price of gold is determined by the laws of supply and demand. Gold is worth what the next buyer is willing to pay for it. If the economic situation becomes so bad that holders of gold are forced to liquidate their holdings in order to raise cash, then the price of gold will go down as the supply on the market goes up. Over at Zero Hedge, Tyler Durden is suggesting that banks may be selling and lending gold to raise much needed cash. This may be creating short term weakness in gold.

My opinion is that gold is likely to increase in value as the budget deficit driven debt crisis hits Europe in 2012  and the U.S. within the next few years. However, anyone that is considering buying gold should be very aware of the risks of owning the shiny metal. Gold is definitely not a risk free method of preparing for an economic collapse. Do not discount the risk to the market of an economic collapse requiring massive liquidations of gold and holding down its price.

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Are So Called "Catastrophe Portfolios" Sufficiently Leveraged For A Deep Crisis?
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Saturday, December 10, 2011

Just What the Struggling California Economy Needs, A Proposal to Shut Down Its Nukes

A California ballot initiative proposed for next fall would force California's two nuclear power plants to shut down immediately.  The initiative was approved for signature-gathering in mid November.  If supporters can collect 504,760 signatures by April 16, it will qualify for the November 2012 ballot. 

It will be interesting to monitor how much support this initiative obtains.  
The Nuclear Waste Act of 2012 would prohibit nuclear power generation in California.  The fact that California's two nuclear plants generate 16% of the state's electricity would probably doom this sort of initiative in most other states, but with California, one never knows.

The irony of shutting down nuclear plants and efforts to reduce carbon emissions is that their primary impact is to shift energy intensive manufacturing to Asia.  Thus, European cap and trade laws end up being a job killing tax on the economy without producing much a benefit in terms of reducing global carbon emissions.  In the case of shutting down nuclear plants in Germany and Japan, the lost electricity is being replaced by burning fossil fuels.  Thus, potentially dangerous nuclear power generation is being replaced by sources that positively contribute to air pollution and cost more to produce.

While it is easy to poke fun at California's tendency to veer to the looney left, America's backward policy on nuclear energy is leaving us behind in the race to develop breakthrough technologies.  Current nuclear power plants are are  based on 1950's designs that were considered advantageous because they generate weaponizable plutonium.  Development of new nuclear technologies that are safer and generate less waste are stymied in the U.S. due to licensing issues.

Bill Gates potential investment of up to a billion dollars in modern nuclear technology will go to China, India, Russia, or South Africa due to the U.S. having its head buried in the ground in regard to advanced technologies for generating electricity via nuclear.  Fourth generation nuclear technology could be the most important new technology of this decade, and the U.S. is missing out on an opportunity to get in on the ground floor. 

Friday, December 9, 2011

Will the European Debt Crisis Stay Off The Front Page Long Enough For A U.S Stock Market Santa Claus Rally?

The U.S. stock market reacted well today (Friday) with yet another +100 point move based on news from  Europe after European Union leaders agreed on a plan to toughen the region's budget rules. The sense of most investors remains intact that somehow a path  to muddle through the European debt crisis will be discovered. Thus, as long as the rating agencies don't play Grinch, there are no banks collapses, and none of the 13 worry events on the Wall Street Journal's road map to the EU crisis start a crescendo of falling domino's, then the U.S. stock market could have a nice rally during the balance of the year.

However, while U.S. economic data has been positive during the past month, there are already some concerning undertones. Companies with exposure to Europe are already starting to reduce their guidance for next year, including Apple, Texas Instruments, Altera, and DuPont. As pointed out by Michael Comeau, "all  this bad news, which is coming just three weeks before the end of the fourth quarter, flies in the face of some of the more positive recent US economic data, which of course, is backward-looking". 

Further "oil is too expensive to support growth and at lower prices supplies will not be sufficient to support meaningful growth." according to Rune Likvern

For those stock market investors and traders that are worried about a European economic collapse and its potential negative impact on the U.S market, determining how to play the balance of this year is challenging. There does seem to be a good likelihood of gains being made by staying long. On the other hand, there is also lots of risk of a big drop in prices from unexpected bad news. My strategy is going to be to start lightening up on positions now, and get completely out of the stock market during the first week of January. Also, for those with an appetite for risk, consider stocks that are good candidates for short selling (including most hardware manufacturers in the technology sector)

Thursday, December 8, 2011

Is The U.S. Stock Market Over Reacting to News From Europe?

The U.S. stock market has become headline driven based on events in Europe. News about the latest  initiative to "save" Europe often propels the market up to +100 point up days. Disappointment a few days later when the market realizes that the debt problem has not been solved leads to 100 point down days. Unfortunately, Europe is running out of time to save the Euro. 

The stock market rallies reflect naive optimism that a solution will be found to the European debt problem. The stock market declines reflect the realization that the risk to the U.S. economy from the European debt problem is very real.

The European countries need to borrow a huge amount of money in 2012. Adding together maturing debt, new borrowing and interest payments, Italy will need to find 400bn euros, France a tiny a bit less, Spain around 220bn euros and the UK approximately 260bn euros (based on data from Bloomberg and the European Commission).

Banks across the world are stuffed with sovereign debt. If more countries follow the Greek example of writing down loans, some banks will suffer horrible losses that will wipe out their entire capital base. The entire financial system seems likely to implode, and American banks will be infected as well. Simply a big jump in interest rates, causing bonds to lose value, could lead be an equally damaging result.

However, the debt crisis in not just limited to Europe. During the January - March 2012 quarter, the U.S. Treasury expects to issue $541 billion in net marketable debt. Thus, the Treasury will be competing for funds with European banks. 

The likelihood of a financial crisis in Europe occurring in 2012 are becoming increasingly likely, be it a country defaulting on its debt, or major bank failures. The collateral damage is likely to spread across the pond. Most of the Fortune 500 companies have European subsidiaries, financial institutions have exposure to European debt, and lots of U.S products get shipped to Europe.

It is appropriate to be worried about the impact of European debt problems on the U.S. stock market. In my opinion, a 2012 year end close for the Dow Jones Industrial Average below 10,000 is probable. If I am correct, retirement funds will take a big hit, and the problems of underfunded pension fund will become worse. 

Thus, be skeptical about the positive headlines from Europe, and beware of the negative ones. The only news that would truly indicate that Europe can solve its debt problems would be that their economy is growing. Anything else is just putting lipstick on Piigs.  

Sunday, December 4, 2011

U.S. Economy At Risk From Self Fulfilling Prophecies of European Recession

Predictions of an European recession are becoming increasingly common. As an example, the Organisation for Economic Cooperation and Development (OECD) recently predicted that the eurozone would shrink in the fourth quarter by 1%, and by 0.4% in the first quarter of 2012. The unrelenting drumbeat of news about the debt crisis has depressed consumer attitudes. European confidence in the economic outlook dropped to 93.7 in November from a 94.8 in October. That is the lowest since November 2009.

Beware of the impact of all the bad economic news coming out of Europe. Business investment and hiring in Europe is almost certain to be negatively effected by the downbeat projections. Each new prediction of an impending recession reduces the likelihood of its readers adding to their work forces. Manufacturing is already softening. The euro zone manufacturing PMI in November was confirmed at 46.4, its weakest level in two years, with factory activity in both of its biggest economies, Germany and France weakening. The UK factory PMI fell to 47.6 in November, its lowest since June 2009, further evidence that Britain's economy is in dangerous territory. "The manufacturing engine has run out of steam," said Rob Dobson, senior economist at Markit, which compiles the surveys.

As reported by Jonathan Fahey of the Associated Press,

The crisis "seems to be coming to a head right at the time the U.S. economy is at its most vulnerable," said Mark Vitner, an economist at Wells Fargo. It's affecting companies like Marlin Steel Wire Products, a 34-employee business based in Baltimore that's been seeking a $4 million contract from a German manufacturer for an industrial steel wire project. Marlin's CEO, Drew Greenblatt, says the German firm is in "pause mode" because of Europe's turmoil. The German company had promised the order by early November. Marlin's overall sales are growing briskly. But sales to Europe have been sinking. "If they were ordering like they customarily do, we would have hired more guys," Greenblatt said.

"It won't take much to tip us into another recession," said Sung Won Sohn, an economics professor at California State University, Channel Islands. "If Europe gets into any deeper trouble, it will take us and the rest of the world down, too."

In addition to a softening of demand for U.S. products and services, if European nations default on their debts, it could have a domino effect leading to huge losses at the "too big to fail banks". Reduced lending activity by the money center banks would put additional stress on the U.S. economy.

It is hard to see how Europe can possibly avoid a recession, as all the negative news is almost certain to feed upon itself. And if a eurozone nation defaults or the currency union breaks apart, Europe could fall into a depression.

An economic downturn in Europe could be the straw that breaks the back of the struggling U.S economy. The U.S. is already suffering from high unemployment, a dysfunctional Congress that is piling on debt, high energy costs, austerity measures by state and municipal government, and high priced oil. the problems in Europe may end up infecting the U.S.

Saturday, December 3, 2011

Will Austerity Measures Unleash A Wave Of General Strikes Across Europe in 2012?

The efforts among the Euro Zone countries to solve the debt crisis are all destined to fail as long as the member nations continue to run up huge deficits. Lots of proposals have been put forth to implement deficit cutting austerity measures. However, the reaction to implementation of austerity measure is likely to be a wave of general strikes.

Last week there were general strikes in Greece and Britain. These two general strikes may be just the tip of the iceberg previewing what may be coming in 2012. Given the widespread anger among middle and lower classes that deficit reductions unfairly target them by to pay for the economic woes created by an upper class that is escaping the pain of tax increases and service cuts, more general strikes seemingly would be an unsurprising reaction to austerity measures. 

The situation in Greece is particularly dicey. Next year's budget, which aims to push the deficit down to 6.7% of GDP from over 9% this year, will both aggravate the debt crisis and anger labor. If the planned austerity measures lead to a series of crippling general strikes, the economy will suffer and the deficit hole will grow even larger.

There are only three solutions to Europe’s debt problem: 1) turn on the printing presses; 2) default on sovereign debt, or 3) austerity measures. However given the likely reaction in the streets to austerity measures, it will be interesting to see if Europe’s political leadership can hold the line on implementing deficit  cuts. Do not be surprised if after a token effort at austerity measures leads to massive general strikes, the EU either turns on the printing presses or the Euro zone breaks apart. 

Will Oil Remain at $100 Per Barrel After the Dec 14 OPEC Meeting?

What will OPEC decide to do at their meeting on December 14? According to Al Arabiya News "OPEC officials are predicting a low-key gathering unlikely to make major changes to output policy". However, the deficit ridden economies in Europe, Japan, and the U.S. all desperately need lower oil prices. Thus, even a low key decision to keep oil at $100 per barrel is disastrous for oil importing nations. The global economy is in dire shape due to the debt and deficit crises and high priced oil exacerbates the problems.

The correlation between spikes in oil prices and U.S recessions suggests that oil prices of $100 per barrel by itself might be enough to throw the U.S. economy into a recession. Combining the almost certain softening of demand from Europe with high oil prices would be devastating to the U.S economy. As shown in the chart below the recessions of 1973, 1980, 1981, 2007 all occurred concurrently with spikes in the cost of oil.

The profligate government spending in Europe, Japan, and the U.S. have led debt levels that have become so large that austerity measures are now required. However, the austerity measures will hurt economic activity. In Greece the unemployment rate has doubled to 18% in little over a year, in large part to due imposing austerity measures. In the U.S., state and local governments shed 20,000 jobs during November due to budget restraints.

Given the drag that austerity measures are going to apply on economies in the developed world, the additional burden of $100 a barrel is likely to be too much for most nations' economies to overcome. Thus, while global economies may be headed into recession even if oil comes down in price, a global recession is almost a certainty if oil prices remain at $100 a barrel. And if oil spikes back up to $120 a barrel or more , the result could be disastrous for the world's most debt ridden economies, including the U.S.

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Do 2012 Economic Forecasts for U.S. Foolishly Discount High Cost of Oil?

Message to Congress - Cut Your Own Pay

The most commonly used term to describe the U.S, Congress is "dysfunctional". Over at the The Fix, they posted a telling chart created by Senator Michael Bennet comparing Congress' 9 % approval rating to unpopular people, things and ideas. "U.S. going communist" received an 11 percent approval rating and a recent Gallup poll reported 11 percent of people found polygamy "morally acceptable."

The failure of the Super Committee made it crystal clear that Congress has no intention of doing anything about the budget deficit until after the 2012 elections. The deadlock over whether to extend the payroll tax cut makes it impossible for businesses to make plans to use this savings in ways that could expand the economy. Rather than dealing with the budget and jobs deficits, Congress simply kicks the can down the road and exacerbates the problems hurting the economy. Given the uncertainty about the future caused by the gridlock in Washington, is it really surprising that business owners are holding on to their cash and the economy is failing to grow despite trillion dollar annual budget deficit stimulus?

The weak economy has forced 1,000's of municipal workers and company employees to accept pay cuts, regardless of their level of job performance. Last month, over 20,000 government jobs were eliminated at the federal, state, and local level due to insufficient tax receipts being produced by the weak economy and 315,000 Americans gave up looking for work.

It seems only fair that Congress recognize that given how poorly they are performing that they also take a pay cut. It would represent at least one accomplishment in cutting the budget deficit. It would also be about the most popular action this intensely unpopular Congress could take.

Congresswoman Gabrielle Giffords proposed legislation to cut the salaries of senators and representative by 5% before she was shot during a constituent event in January, 2011. "Members of Congress can't ask any American to cut back before we are willing to make some sacrifices of our own" stated Giffords. Not surprisingly, this proposal has not made much progress. You can express your support for this proposal by sending an email to Congresswoman Giffords via her House contact page

Friday, December 2, 2011

Why The Reported November Drop in Unemployment Rate is Too Good To Be True

The drop in the topline unemployment number by 0.4% to 8.6% seems like great news at first glance. However, the U.S. only added 120,000 new jobs during the month. It requires 95,000 new jobs per month just keep up with population growth. There is a huge fudge factor, the participation rate. Thus, by lowering the participation rate, the Bureau of Labor Statistics can make a mildly positive number appear to be spectacularly good.

  • In November, those "Not in Labor Force" rose by a staggering 487,000. Those not in the labor force were not counted as unemployed.

  • It the participation rate were held constant, the unemployment rate would be well over 11%.

  • As shown in this chart from The Market Ticker, the unemployment rate as a percent of the population remains at depressed levels

    Thus, the unemployment rate is disconnected from the number of employed workers paying taxes. Given that average hourly earnings decreased by 2 cents, or 0.1% to $23.18, this increase in employment will only have a mildly positive impact on tax revenues. And even generating this modest gain in employment was only achieved via an immense amount of fiscal stimulus via deficit spending by the Treasury (about $100,000,000 in an average month). No question, this is a positive report, but don't put to much credence in the supposed 0.4% drop in the unemployment rate.

    Thursday, December 1, 2011

    Do High Unemployment Rates in U.S and Europe Refute the Arguments For Outsourcing Blue Collar Jobs to Asia?

    There have been lots of commentators defending outsourcing of jobs arguing that "the creation of new jobs overseas will eventually lead to more jobs and higher incomes in the United States". However, the U.S. and Europe may have finally reached the tipping point where so many jobs have been outsourced to Asia that there simply are not enough jobs left to bring down unemployment rates.

    Countries in the developed world have been flooding their economies with fiscal stimulus and holding interest rates artificially low. Despite these efforts to prime the pump, unemployment rates remain high. The pump priming can not go on much longer because deficits have reached levels that already endanger the world's financial system. The failure of the pump priming to stimulate employment is in part due to not enough of the of the funds making their way to the hollowed out core of domestic manufacturers.

    Unemployment Rates By Country

    22%   Spain
    18%   Greece
    12%   Portugal
    10%   France
    9%     United States
    8%     Italy
    8%     United Kingdom

    Source: Trading Economics

    Unfortunately, the genie is out of the bottle. The "developed" economies have all become debtor nations, and policies that would restrict imports and recapture jobs would also lead to a disastrous trade war with the Asian countries that are their creditors.

    The United States and Europe are between a rock and a hard place. The massive debts require job killing austerity measures. The high unemployment rates require job stimulating deficit spending. However, debt levels are already so high that deficit spending at current levels is only viable for a few more years at best..

    The debt load in Greece finally became so high that their creditors have forced the country to impose austerity measures. The impact of the austerity measures has been a primary factor in the unemployment rate doubling from 9% to 18% in little more than a year.

    Americans seem to be oblivious to the danger of the increasing debt load. However, within a few years the U.S. will have to turn off the fiscal stimulus pump. At that point, double digit unemployment may become the new norm.

    The irony of the situation is that the softening economies in Europe may lead to unemployment problems for Asian exporting nations.