Mid-Sell Bounce not happing yet

I was expecting a minor up move till 1320-1330 in S&P, which would have given another good entry opportunity for taking a short position. But so far it is not happening yet. Next week is Option Expiration and thereafter I expect the whole month of June to be in a down trend.
I think the major down move has taken place and the downside is limited. May be up to 2220 in Nasdaq Sept. futures. Question is should we dip the toe in the water now.
I plan to go long around beginning of July for a possible summer rally. 

Is a Tech. bubble out there or simple Ponzi schemes ?

Here and there we find mention of some possible tech bubble. LinkedIn IPO is mentioned. Facebook valuation is sighted. Groupon impending IPO is talked about. So we checked the tech index and we searched a lot for the bubble. But we could not see any bubbling valuation in the tech sector. Otherwise, Google would have been over $1000 by now. With its Android it is creating new values in the mobile sector; Apple would have been over $ 500 with its cloud entry and other plans.

Instead what we see is localized Ponzi scheme and greed of making a killing in little known tech names which are yet to prove their profitability. This method has been tried and tested and perfected on some well know MOMO stocks like PCLN or NFLX, where market movers  have relentlessly push the prices and have created a hype in the market about tech companies with little value. In the next downturn which is possibly few months away, retail investors would be holding these fancy tech shares which will not be worth the price of the paper on which they are printed. I may be wrong and I hope I am wrong but fears linger.

Let’s start with LinkedIn. This is basically an employment portal. There are other employment portals which are more profitable than LinkedIn. Only reason they have generated such hype over their share price is because it was a low float IPO. Less than 10% of the shares were offered in the market and if you want to short sell the share of LinkedIn, you will not be able to borrow it anywhere. We would love to purchase puts on LinkedIn but for the reason that the spreads are ridicules. For the share price to maintain at this level, the company will have to perform like a superman. Already from euphoric high of $100, it has reached $ 72 and we would not be surprised to see it trading below its offer price.

Groupon is another example of greed and manipulation. What Groupon does is to get local merchants to try selling at a loss just to get new customers. The revenue Groupon shows in its books are not its revenue anyway because it remits half of the proceeds to the traders after the deal is closed. We had an encounter with Groupon last year. We had a website selling gifts etc and were contacted by Groupon to provide coupons. The margins were thin, in the range of 25% on an average. We calculated that any sell generated through Groupon is actually a loss making proposition. And we decided not to go ahead with Groupon.

The same is true for every trader. Unless they have 200% margin on cost, it is well neigh impossible to make money by selling through Groupon. The traders, who try them, lose money and find that there is no customer loyalty for the new customers that have come in the 1^st place. Most traders cannot remain profitable and yet offer discount over 10%. So Groupon has to find new suckers (new traders willing to commit financial suicide) every day.  However, you cannot fool everybody for all the time and very soon traders will realize the folly of Groupon.

Apart from the faulty business model, Groupon management is withdrawing huge amounts of cash (refer http://www.businessinsider.com/groupon-ipo-insider-selling-2011-6) and creating a class B shares whereby they keep control of the company.

The biggest Ponzi around is that of Facebook. Facebook raised $ 500 from Goldman Sacs so we can imagine who will do the front running of creating all the hype and unloading their initial investment at a huge profit. Facebook has an estimated revenue valuation of $2 Billion but so has Groupon. Pray then why Facebook should have a valuation of $200 billion. The 500 million users are not generating any profit yet and knowing how the social networking ecosystem changes so quickly, who can guarantee that Facebook will be relevant 10 years down the line. Sure they would be able to sell their shares at an astronomical price, if they bring their IPO in the next two months time when investors, big and small is hungry for yield and are willing to take risk.

But once the economic cycle turns down, GDP numbers start printing zero or negative, all risk will be off.

My Stock Market Call and Bill Gross of PIMCO

My proprietary market analysis call can be divided into long term (one to three years), Medium Term (2 months to 12 months) and Short Term.( Week to two months).  

The Long Term forecast is rather easy to make. When combined with the demographics, debt and business cycle and mixed with volatile geopolitical situation developing, we are looking at a rather grim picture. The debt deleverage process has started and balance sheets will contract. Social unrest and xenophobia is increasing and will soon take an epic proportion right here in USA as well as in Europe.  I think the stock markets around the world will see their values reduced in half by the year 2015. However market can remain irrational longer than we can remain solvent. So don’t go and short the market today. There will be many rallies between now and the bottom and each one of them is a trading opportunity.

The Medium Term call is the tough one. Let us not delude ourselves with the thought that the markets are free and fair. May be I am wrong but I think the markets are manipulated to the hilt and it is our job to see that we don’t end up as suckers. As they say “Caveat Emptor”. In the medium term, the market is moved more by liquidity than by fundamentals. And that liquidity is now being provided by the central banks of the world. Banks are able to borrow at 0% and invest risk free in the treasury. So all the money that Fed provides to its primary dealers by POMO end up lowering the treasury yield, pushing the stock prices and as an unintended consequence, push up the commodity prices.  We see lots of churning in the medium term. High volatility will be norm. I expect by Sept 2011, the endgame will start and that trend will continue for a long while.

In the Short Term, things get really interesting. Please remember that I am not a day trader or scalper, so I am less interested in the inter-day movement. It seems that the stock markets in USA are reaching a top.  We are seeing a mini sell off in the beginning of June 2011. We hear talks of front running the end of POMO and people getting off the risk trade, which is equity and commodity. But I do not think that the end of the world in here yet. I am not a TA but let me make some simple suggestions about where S&P going to be in the short term and then we shall evaluate these projects as they come to pass.

From the top of 1370 in April 2011, we saw a close of 1279 yesterday (8^th June 2011). That is a 91 point or 6.7% drop. We see the channels as 5% or 10% not something in between. So I think the drop is not over yet. By end of June S&P should be near about 1230-1235 range. In the mean time option expiration is next week, 17^th June. They have to inflict the maximum pain on the maximum number of people. So they will now want to kill the put buyers and the short sellers. I expect the market to go up from here and show little pop till option expiration. Then the drop begins again till end of June.

Just when everybody and their grandmother is convinced of a crash and the air is heavy with the talks of end of POMO, thereby end of easy liquidity, and have piled on with all sorts of puts and short trade, the market starts to climb again from July onward. The retail trade will be the worst looser, as they will not believe that the market has turned till the S&P has reach or crossed 1400 by August. Then everyone joins the bull bandwagon and the last remaining dollar is put in the stock market.

Beyond August 2011, it becomes the subject of Medium Term projection. In support of my short term project, I have an unlikely witness. Bill Gross of PIMCO. Mr. Gross is one of the smartest fund managers in the world. He thinks that at the end of June, when POMO is closed and QE3 is not immediately announced, the yield in treasury market will go up. The reason treasury yield has come down below 3 is because Fed is monetizing debt and is engaged in a giant Ponzi scheme to keep the interest rate low. Gross thinks the treasury investors are destined "to get cooked like frogs in an increasingly hot pot of water,"

Now here I would like to draw your attention to the correlation between SPX and TNX.( COBE Treasury Yield Index). When TNX goes up, S&P Follows. Sometimes this correlation brakes but that is due to direct intervention of the FED. If as Gross says, the Yield will immediately go up from July, TNX will go up and S&P will follow through to the high. Till such time, the high rate of interest starts biting the growth and it becomes apparent that the 3^rd and 4^th quarter GDP will be zero or negative. By then it will be September. As far as conspiracy theories go, this one is brilliant as it gives the manipulators the chance to make a fool of everyone else.

Coming of the Lost Decades

In search of never ending growth, the present day politicians have adopted Keynesian economics as their life blood and have distorted it completely.  In order for the illusion of growth to continue, countries have added humongous amount of debt and they continue to do so. The following table illustrates the point.

The left hand column represents debt as a percentage of GDP. Japan stands at over 200% while Canada is the best of the G7 Countries at 34%.

 However the information that each country presents in not uniform. For e.g, USA does not include trillions of dollars of unfunded liabilities of its Social Security, pension, Medicaid etc. If all the unfunded liability is included, the Debt to GDP ratio of USA will push north of 90%. Talk of cleaver accounting!

Debt per se is not bad. Some would argue that debt is even necessary to efficient utilization of capital in the society whereby excess capital is used for productive purpose.  However, through centuries of data and observation, it has been found that when debt is above 90% of the GDP of a country, it becomes a drag on growth. In other word, high debt is in effect a negative factor for growth.

Then we have to consider the rate of interest that is being paid on debt. Japan is able to finance most of its debt internally. Japanese population is willing to finance its Government’s gambling habit at one percent rate of interest. But with the aging demographics, that is changing and the ability of the Japanese population to save and finance is diminishing to a point that in the next five to 10 years time, Japan will be forced to borrow money from the world and would have to pay a much higher rate of interest.

Spain, on the other hand has another problem. While its debt is only 63% of its GDP, most of its debt is tied to its banking sector which is virtually broke. The situation in Spain is similar to Ireland, where banks financed the housing bubble and when the bubble finally broke, they were left holding collateral which are worthless. These zombie banks are surviving because politicians have taken over the bad loans and garbage from the private sector and have put them in the hands of the public. So in effect the general population is now holding the smelly can and is being asked to sacrifice in the name of Austerity.

In USA, while the debt monetization by FED has kept the rate of interest at a very low level, there is only one way the rate of interest can go and that is up. It may not happen tomorrow or next month, but when the Bond Vigilantes wake up and find that US debt level is unsustainable, they will demand their pound of flesh.

All these debts are now deleveraging. Even with the best of efforts of the central banks of the world and bending all rules like “Mark to Fantasy”, even with adding billions of new debt to keep the Ponzi  scheme going, countries are unable to pull the cart any further. Growth is non existence and unemployment is high. In USA, officially the unemployment is 9.1% but unofficially over 15%. In Spain it is over 22% and most of the unemployment is among the young. These are causing social friction not seen or heard even a decade ago. Already constant unrest in Greece is pushing its national production to the negative territory. How long before we see the GDP is negative in USA. Already the last quarter GDP has been revised downward and next quarter GDP is being estimated at 1%. Too much leverage has been put into the system which cannot take leverage anymore and create growth to pay for the debt. Headwinds are strong.

According to Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics and a leading expert on financial crises. "If historic norms hold, deleveraging isn't pretty, and it is not a smooth process. We're already four years into this. I don't think the next six years look great."

The bubble economy of USA was fueled by consumers, who used home as ATM. They in turn were deceived by Greenspan and Bernanke into believing the rainbow and unicorn story. The consumers and businesses took too much debt. Total private sector debt was over 280% in 2008. Since then consumers and business have been paying off and reducing their debt but all such reduction is being negated by the Government and public sector.

Today states and municipalities in USA are finding themselves looking at the debt default monster in the face. With reduced revenue, they are scrambling to stay alive. They are looting their rainy day fund, just like Federal Govt. who is drawing from the unfunded pension obligation of their employees to keep the debt issuance going.  With every level of government resorting to sleight of hand to keep the illusion going, this amounts to generational robbery where the next generation will have to pay a heavy price for today’s politicians folly.

The deleveraging process has started and coupled with the demographics shift, we are looking for a long period of depression, may be as soon as the 2^nd half of the year 2011.

The Earth is full

Sometimes New York Times columnist Thomas Friedman really does hit the nail on the head, as he does in his column today, The Earth is Full.

Economists have been glorifying unending economic growth for half a century, while systematically discounting (quite literally) the social and ecological costs, especially in the long term. So much economic analysis seems to take place in a weird vacuum in which the laws of physics and biology don't apply, but an increasing number of scientists and economists have begin questioning this, as Peter Victor did last year in Nature. As Victor pointed out, questioning economic growth is typically viewed as heresy, even though it has obvious malign consequences for the physical and biological environment on which we depend. In pursuing growth, we've increased our total throughput of raw materials and fuel by a factor of nearly 10 in the 20th century alone, increasing our spillage of degraded waste (including waste heat energy, see below) into the environment by a similar factor. So it is perhaps not at all surprising that a different article in Nature, as Victor notes, concludes that...

"Humanity has gone beyond the 'safe operating space' of the planet with respect to climate change, nitrogen loadings and biodiversity loss, and threatens to do so with six other major global environmental issues."

Friedman puts the same point -- that we face real consequences from physical and biological limits, no matter how clever our economics -- in more vibrant terms:

"You really do have to wonder whether a few years from now we’ll look back at the first decade of the 21st century — when food prices spiked, energy prices soared, world population surged, tornadoes plowed through cities, floods and droughts set records, populations were displaced and governments were threatened by the confluence of it all — and ask ourselves: What were we thinking? How did we not panic when the evidence was so obvious that we’d crossed some growth/climate/natural resource/population red lines all at once?"

Of course, the natural response in confronting such red lines is to suggest that with sufficient cleverness we might find a way around them, perhaps even grow our way around them -- invest in business and technology now and by some miracle discovery perpetual motion machines. This explains, I think, we many people have treated with scorn Germany's decision to phase out its plans for nuclear energy in the next decade. Why would they restrict their options, especially given the real limits we face in CO2 emissions? Quite possibly or even probably the German decision was a feckless and emotional response in the wake of the Japanese Fukushima disaster, but it may also, even if unintentionally, respect some unalterable facts associated with Friedman's title -- The Earth is Full.

A couple of years ago, Nick Cowern and Chihak Ahn estimated the amount of energy we humans dissipate to the environment through our energy use as heat. Currently such energy plays a very small and largely insignificant role in the overall energy budget. But our energy use is growing at 2% per year globally, and in 100 or 150 years, they showed, will be enough to begin climate warming again, even in a dream world in which we control warming associated with CO2 emissions. The conclusion is that we will soon simply be using too much energy, which, by the laws of thermodynamics, will heat the Earth environment. We're becoming too big. The Earth is too full -- of us. So, we might well switch to nuclear energy, and doing so might help us counter warming from CO2 for a time, but it doesn't get us away from the rock bottom problem that we are (or will soon be) using and dissipating too much energy.  The abstract of the Cowern-Ahn paper describes the lesson of this analysis:

Global warming arises from 'temperature forcing', a net imbalance between energy fluxes entering and leaving the climate system and arising within it. Humanity introduces temperature forcing through greenhouse gas emissions, agriculture, and thermal emissions from fuel burning. Up to now climate projections, neglecting thermal emissions, typically foresee maximum forcing around the year 2050, followed by a decline. In this paper we show that, if humanity's energy use grows at 1%/year, slower than in recent history, and if thermal emissions are not controlled through novel energy technology, temperature forcing will increase indefinitely unless combated by geo-engineering. Alternatively, and more elegantly, humanity may use renewable sources such as wind, wave, tidal, ocean thermal, and solar energy that exploit energy flows already present in the climate system, or act as effective sinks for thermal energy.

The part I've marked in bold and italic is key. Nuclear energy brings another source of energy into play on Earth, by rapidly releasing energy which would otherwise be sequestered in nuclear forces for long periods of time. If we continue to increase our energy use, as growth enthusiasts assume we must, the only way to avoid climate warming will be to somehow counter our increased dissipation by reducing energy dissipation from other sources in the environment. Nuclear energy won't do that.

Just another way to see that there are indeed physical limits to growth, for us just as much as for a colony of bacteria expanding into a jar of sugar water. Why do so many people find this hard to accept?

The joke that is Euro

The EU bailout package for Greece, Ireland and Portugal is basically a self-serving mechanism, so that the banks in the creditor nations ( In France & Germany) can get paid back. It has less to do with the wellbeing of the average Greek or Irish citizen and everything to do with the politicians and bankers. This is a classic example when profits are privatized and losses and risks are passed on to the public.

Now there is a grab for the public service utilities in those broke countries. The public utility services like transportation or other basic infrastructures  will be put up for sale and eventually  privatized.  While it is not a bad thing per se, ( there is no free lunch) the cost will now be so high that it will inflict more pain to the general population.  With less or no income and higher cost, the lower 90% of the population is being squeezed dry to the point of social unrest. We see it already happening in Greece and in Spain. This trend will only grow in the months to come till a tipping point is reached.

But will this money grab save the Banks in Germany / France / USA ? I very much doubt it. The crisis is/was  1^st created by the politicians who promise and give all sorts of freebies to the public in order to get elected and grab the power. Now the Banks in Europe and their institutions (ECB, IMF, and the EU) are making a bad situation worse. In order to save the Banks which are actually broke and are leveraged 50 times, ECB and EU are taking the bad loans from the hands of the banks and putting it in the hands of the public.

I quote the following from Zerohedge : We estimate that the ECB has exposure to struggling eurozone economies (the so-called PIIGS) of around €444bn – an amount roughly equivalent to the GDP of Finland and Austria combined. Of this, around €190bn is exposure to the Greek state and Greek banks. Should the ECB see the value of its assets fall by just 4.25%, which is no longer a remote risk, its entire capital base would be wiped out."

From Open Europe:
"The ECB’s attempts to paper over the cracks in the eurozone may have temporarily softened the impact of the crisis, but have exacerbated the situation in the long-term. The ECB has dug itself into a hole and now we are seeing that there is no easy way out.”

“Huge risks have been transferred from struggling governments and banks onto the ECB’s books, with taxpayers as the ultimate guarantor. There’s a real risk that these assets will face radical write-downs in future with eurozone governments and banks teetering on the edge of bankruptcy. This amounts to a hidden – and potentially huge – bill to taxpayers to save the euro.”

And here we are wondering how come Euro is at its high vs. USDollar. This is a joke on us and this joke is going to end badly. However, all crises are an opportunity and I see an opportunity to short the Euro and other risk assets by end of August 2011. Technically, Euro can still exceed $1.50 in a short while but I think in a year’s time Euro will be at par or below US Dollar. Not that US Dollar is a paragon of virtue but because Euro at its present state does not have much future.

When the Lords and Barons of Europe (Both new and old types) come back from their summer vacation this August end, they might see their peasants revolting and their castles (banks) are burning down.  We better be ready to roast the marshmallows in that fire. 

A Random Walk

I am trying to be cheerful. Honestly, and then write a nice feel good article. An article about our goldilocks economy, make believe rainbow of never ending growth where unicorns eat the corn out of your hand. But I am finding it difficult to be cheerful.

But it should not be so. I see the futures jumping six handles pre-market and it seems the selling of the last few days might come to a close. Then we might start the never ending upward movement. After all, is that not the objective of our Govt.

But instead of the rainbow or unicorns, I see a great depression coming. It is like watching a train wreck in slow motion. Should we call it depression or great balance sheet contraction? When the bubble goes bust and bust it will, when all the sushi hit the fan, what we shall be left with? What will happen to the millions upon millions of middle class investors and retirees may be many pension funds who have taken on the risk to increase the yield for their members and other hard working lots.

There are so many Black Sawn events on the horizon that we might be tempted to think that swans are black after all. The financial downturn of 2008-2009 was just a snap shot of what is supposed to come. And when the next default hits us, which may be as early as August end 2011, the Governments of the world will have much less ammunition left to do anything. None of the problems which caused the crisis of 2008/2009 has been solved. They have simply been pushed down the road for another day. The too-big-to fail Banks have gone bigger, the assets in their books have further gone down the value, even with the “mark to fantasy” rules because home prices keep falling and the end of the fall is nowhere in site. After couple of Trillions of dollars, all we have to show for are 50,000 jobs in McDonald flipping burgers. Those who are fortunate to have jobs, have seen their wages being stagnant or being asked to do more work for the same while food inflation and gas price increase is taking out their discretionary spending ability.

The situation in Europe is so bad that there are no words to define the situation.  The EU leaders are engaged in the game of brinkmanship and are waiting for a miracle of happen. One day we hear that Greece is being bailed out, next day it is not. The fact is, there is no way out. EU is just buying time for their Banks, same as in USA. No country in the world can pay loan which is 160% of their GDP and when they are in recession, as is the situation with Greece.  More debt cannot be a solution for the debt problem.   The situation is same with Ireland, Portugal and the 800 pound gorilla named Spain. The risk of contagion is real and imminent.  We might see a Banking collapse in Europe by end of summer and things go downhill thereafter.

But hey, if they have been able to kick the can down so far, they might be able to do it for a while longer. The markets are rigged and they ( Big Banks & Central Banks) will continue their best effort to do so, until one day it snaps and the common investors are left holding the empty can.

So while the going is good, do not get fooled by the fairy tale but prepare for the coming depression and bubble collapse. It may not be tomorrow. In fact we might see a good poop up in July/August when they convince everyone that the music will never stop and draw in all the cash that are sitting on the sideline. But come September, at least I shall be on the other side of the fence. You have been warned.