Scrape Away the Noise and Hype, and What Remains? (May 11, 2010)
Market fluctuations are mostly noise. To understand the trends beneath the surface noise, we need to establish an integrated context.
The Mainstream Financial Media (MFM) is famously (or infamously) deficient in any context other than the day's swirl of data, rumor and response. Markets have been swinging wildly as players (and manipulators) attempt to predict the market's response to "news" and the emotions that the "news" may spark.
Rather than play the pointless game of parsing what amounts to signal noise, we would be better served to establish a longer-term context within which "news" can be properly placed and understood.
1. The Eurozone is doomed. Regardless of "investor relief" triggered by various bailouts, rescue plans and "fixes," as I explained yesterday in Why the Eurozone Is Doomed, there is no way that any rescue plan, loan or bailout can paper over the structural abyss separating merchantilist Germany and its export-dependent neighbors from the import-and-credit-dependent, consumerist, deficit-spending nations within the Eurozone (Greece, Portugal, Spain, et al.) and Britain.
The euro will drop to parity with the U.S. dollar (USD), with dire consequences for U.S. multinationals which have been feeding off the "cheap" dollar, reaping record profits when they transfer their sales in euros into dollars.
That foreign exchange arbitrage will reverse, and Euro-based global corporations will benefit on sales made in USD. But those corporate profits will not be enough to bail out the eurozone's profligate deficit spending or crushing debt burdens.
The "fear trade," that is, risk aversion, will devastate all global trades which were based on low-perceived-risk and high valuations.
2. U.S. corporate profits will stall. As their overseas sales lose the foreign exchange advantages of a cheap dollar, U.S. global companies will face the consequences of their slowing sales.
For the past six quarters, U.S. global corporations reaped vast profits by slashing headcount, inventories and expenses across the enterprise. Even better from the view of a financial media desperate to generate the shameless propaganda of "good news," the low level of profits in Q1 2009 have enabled apparently fantastic "growth" in profits via the "year over year" (YOY) comparisons favored by financial propagandists.
Meanwhile, behind the smoke screen of bogus "profit growth," global sales are still falling when compared to 2005-2007. Indeed, even YOY comparisons have shown that global giants such as Caterpiller saw 11% declines in sales even as their profits (in U.S. dollars) rose handsomely.
The obvious but rarely mentioned reality is that all these corporations have already plucked all the low-hanging fruit in terms of cost savings and reduced payroll. From here on, they will have to grow earnings via growing revenues.
As the eurozone stumbles and China's real estate/credit bubble finally implodes, that will become essentially impossible for global companies.
3. China's real estate/credit bubble implodes. You cannot inflate credit and real estate bubble forever. China's leadership knows this and as a result it is attempting to pop the bubble with a few modest pinpricks. Alas, balloons inflated to high pressure do not develop slow leaks; they pop with glorious violence.
While it is always possible the unprecedented diversion of resources and credit into empty malls, sports arenas, cities and highrises will somehow end without affecting the Chinese and global economies, the odds are not very good if you consider the history of bubbles and the success rate of central government management/manipulation of credit bubbles.
4. The jobless "recovery" will slip back into a job-shedding recession. If we subtract the bogus phantom jobs created by the "birth-death model" and the temporary Census Bureau jobs, the U.S. economy is staggering along the zero line, neither creating jobs nor losing them. If that is the best that stupendous stimulation via Federal spending and zero-interest rates can do to "stimulate" organic (non-government created) growth in employment, it certainly suggests that any reduction in Federal stimulus-spending and flagrant pumping of money via the Federal Reserve "monetary easing" will result in a renewed decline in employment.
It doesn't take much of a crystal ball to foresee massive layoffs as state and local governments are finally forced to face the music of reduced tax revenues and higher employee pension costs. As usual, the media is touting a 3% rise in tax revenues as "proof" the recession is over--yet few note that tax revenues have dropped by 20% or 30% in many locales. A 3% rise is not enough to repair the damage done by two years of recession, and all the accounting tricks and gimmicks which the California Legislature and other states' leaders have deployed to mask the true depth of their deficits are wearing thin.
An eerie silence has descended over Sacramento, as if the politicos and their media lackeys are hoping that keeping quiet will allow a $20 billion deficit to magically vanish without the public (and voters) becoming alarmed before the November elections. Good luck, politicos; sadly, you cannot print money nor force the Federal government to bail you out.
With costs of employment rising by the day--healthcare, employment taxes, etc.--very few private businesses have high enough gross margins to justify hiring anyone permanently. Contract/temp workers are the solution, and any increase in free-lance headcounts does not presage a surge in permanent hiring. If there is an army of unemployed willing to work for far less than a permanent employee costs, why bother increasing permanent headcount?
Global companies are still pursuing the savings of global wage arbitrage, and every increase in structural costs here in the U.S. (healthcare goes up 7-15% every year, taxes are going up, etc.) only increases the attractiveness of overseas employees and contract/free-lance workers in the U.S.
The recent past is no longer a model for the near future. The more the MSM and government leaders tout "a return to growth" (hey, if you borrow and spend $3 trillion in two years and nationalize the mortgage industry, you should get some kind of pulse in the comatose patient), the more tenuous and threadbare their shrill claims sound to an increasingly skeptical public.
Borrowing another $5 or $10 trillion to bail out weak Eurozone nations and "stimulate" a deflationary global economy may keep the patient alive a few months or years longer, but the past model of basing "growth" on serial credit bubbles and bailouts is no longer sustainable.
Giving Greece another $10 billion will not magically enable it to make it interest payments or roll over old debt. That game is over, though the players are hoping we'll buy into the charade one more time.
Nothing structural has been fixed, much less addressed. The charade of "recovery" may run a few more months, but if we scrape away the noise, the underlying trends are not sustainable.
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