Talking the Talk, They will Walk the Walk

You can talk the talk. Do you walk the walk?
- Full Metal Jacket

Well it didn't take to long for things to get dicey again in Europe.  Even though Greece was restructured 3 weeks ago, and the ECB lent ~$1 Trillion of LTRO funds, bond rates in Italy and Spain are climbing higher.  On March 1, the 10 year Spanish bond was 4.87%.  Today Spanish rates hit 6%.  This is important because as the 10 year bond moves towards 7%, it means investors have lost confidence the Spain can resolve its budget deficit and make good on its debts.  7% is the line in the sand as this is when Greece, Ireland and Portugal needed bailouts.

Source: Bloomberg

Almost on cue, the ECB restarts talk about it's bond buying program.  From the Telegraph: ECB may act to bring down Spanish borrowing costs

Benoit Coeure, an executive director of the ECB, said the bank could restart its sovereign bond buying programme in a move likely to antagonize Germany but relieve a spiralling political, economic and social crisis in Spain.

Mr Coeure said that market fears over Spain were "not justified" but he added: "Will the ECB intervene? We have an instrument, the securities markets programme [SMP] which hasn't been used recently but it still exists."

Bond traders were soothed by the comments. The yield on Spain's benchmark 10-year bonds was pulled back from 6pc on Tuesday to 5.88pc, while the yield on Italy's 10-year debt also dropped marginally, to 5.54pc. 

Mr Rajoy delivered a strongly-worded speech to parliament insisting that it was "as clear as day" that Spain would not need a Greek-style bail-out.

Occasionally I'm asked how did I know things were going to blow-up in 2007.  My first clue was when the word "contained" was used by Ben Bernanke and Hank Paulson with regard to subprime mortgages.  Mike Mish Shedlock shred those claims to pieces using examples of Washington Mutual mortgages.  Another clue came from Paulson's claim that the US would not need to take over Fannie Mae and Freddie Mac.  When things are officially denied like that, watch out because it's going to happen.

Rajoy is right in that Spain will not need a Greek-style bailout - it's going to need a Spanish-style bailout because Spain's economy is more than double the size of Greece, Portugal, and Ireland combined.

We've Seen This Movie Before

The movie I refer to is how the ECB, IMF, and EU treated Greece's fiscal problems.  Currently Spain is sticking to cutting its budget though I've read that the EU wants it to raise taxes as well.  I expect to hear more about selling national assets to pay down debt.  When the ECB starts buying more Spanish bonds, then start to watch Spanish banks as they are reported to have been buying Spanish bonds using the LTRO money.  As these bonds have dropped in price, the losses to banks are building.  Worse if there is a Spanish restructuring, remember that the ECB gets paid in full while investors and banks get shellacked.

The only way Spain does not get bailed out is if it leaves the EU first.  What are the odds the politicians go that route?

And in the U.S.

The one direct affect of Spain should be falling bond rates in the U.S. as investors seek a place of refuge.  Ironically when bonds rates rose a few weeks ago, I wondered if people had forgotten that the LTRO in Europe simply bought time - it didn't solve anything.  Maybe most people thought it bought 3 years of time.  Regardless, bond rates in the U.S. should stay lower as questions about Europe and questions of the U.S.'s recovery remain in focus.

And about that U.S. recovery, it seems the best we can get is conflicting data.  What I might find humorous, if it wasn't so maddening, is how the good data took hopes of a new quantitative easing program off the table - but then unexpected bad data (in the form of the March employment numbers) immediately raised the hopes for such a program again.  The reason I, as a stay-at-home dad, find this maddening is that it resembles my two year old's temper tantrums.  Give us QE3 or watch the stock market tank.

What's worse is I see the Fed giving in as they have every time the stock market threatened to fall.  From Advisor Perspectives: Fed Intervention and the Market

I'm not the only one who sees the Fed giving in.  From Bloomberg: Gross Cuts Treasuries, Raises Mortgages in Fed Buy Bet

Bill Gross, who runs the world’s biggest bond fund at Pacific Investment Management Co., cut holdings of Treasuries last month to 32 percent, the lowest since December, and raised mortgages to the most since 2009.

Gross reduced the proportion of U.S. government and Treasury debt in the $252.4 billion Total Return Fund in March from 37 percent of assets in February, according to a report on the company’s website today.

Bill Gross, co-chief investment officer of Pacific Investment Management Co. (PIMCO), speaks during an alumni event hosted by UCLA Anderson School of Management in Beverly Hills on Nov. 17, 2011. Photographer: Andrew Harrer/Bloomberg

He raised the fund’s holdings of mortgages to 53 percent last month, the highest since June 2009, from 52 percent in February, in a bet that the Federal Reserve will buy the securities in a new round of purchases. Newport Beach, California-based Pimco doesn’t comment directly on monthly changes in its portfolio holdings.

The Fed will probably shift focus to buying mortgage securities to keep borrowing rates low when its so-called Operation Twist program ends in June, Gross said in a March 28 interview on Bloomberg Television’s “InBusiness with Margaret Brennan.”

Bill Gross successfully front ran previous Fed easing, meaning he bought treasuries and mortgages at a lower price to sell them to the Fed at a higher price.  Can it work again?  As the Fed has consistently talked the talk and walked the walk, I wouldn't bet against it.

Parting Thoughts

I've read recently that you have to trade (invest) the market you have, not the market that you want.  It made me think if I ever have invested in a market that I want.  Thinking back to when I got started in 1998, that was the final legs of the Internet bubble.  Afterwards, the Federal Reserve slashed rates so low and kept them there so long, that the housing bubble formed and kicked off the debt crisis.  Now global central banks are printing trillions in an effort to get things back to normal.

However what is normal? Looking back, it seems that all I have experienced in financial markets is managed by interest rate setting central bankers. When do bond markets finally say "enough" and start selling (thus raising interest rates)?

Perhaps what I really need to answer is what would make me sell my bond mutual funds.  Quantitative easing 3?  More Congressional stimulus? More tax cuts without offsetting spending cuts?  Maybe even no spending cuts?  More government borrowing?

As it is late, I'm going to let these questions go unanswered though I have a bunch of thoughts swirling through my head.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.

To the Moon and Back

Fly me to the moon

Let me play among the stars
Let me see what spring is like
On a, Jupiter and Mars
In other words, hold my hand
In other words, baby, kiss me
- Frank Sinatra (Fly Me to the Moon)

When I first started thinking about this article, I focused on how the EU's Long Term Refinance Operation (LTRO) was approximately the same amount deposited overnight at the ECB (~€500 billion).  Since the banks were not using these funds, I questioned what was their reason for saving them.  Looking at the end of February, the LTRO may refinance up to €1.5 trillion in bank collateral. Now why would banks want to refinance that much if they haven't even made use of the December operation?

At first I thought maybe this was a new attempt to quietly create a firewall to contain a Greek default.  After all, €2.0 trillion was discussed over the summer as a reasonable amount to protect Spanish and Italian debt markets from any contagion. However upon further reading, I found a different reason.

$7.6 trillion

Now if I stopped the article hear, you might not think much more about it. So let me repeat, seven point six trillion dollars.  Again, no effect?  The debt crisis that the world is plodding through can make us immune to such large numbers when you consider the bailouts, lending programs, swaps, the size of the economy.  So let's put some perspective around this number, from OpEdNews: How can you visualize a trillion dollars? (emphasis mine)

Just how large is this, really?

Ok. I'm not the brightest bulb in the pack when it comes to math, but I wanted to imagine what a trillion dollars looks like. My former colleague at Cornell, Carl Sagan, used to speak of the number of Stars in the Universe as being "billions and billions". A trillion is a thousand billion, or a million million. In simple written numbers: A million is 1,000,000. A billion is 1,000,000,000. A trillion is 1,000,000,000,000. Easy enough.

So how tall is a stack of a trillion $1 bills? I'm sure someone will check my math done on a pocket calculator, but here goes.

A Ream (500 sheets) of ordinary copy paper like you use in your computer printer is about 2 inches tall. Paper that our Greenbacks are printed on may be a little thiner, but this is close enough for government work.

Therefore, a foot (12") of paper is about 3,000 sheets. 3,000 sheets x 5,280 feet per mile = 15,840,000 sheets per mile. Are we getting close? Not really. That's only about 16 million bucks, chunk change to our Congressional Critters.

OK. If we divide 1,000,000,000,000 sheets by 15,840,000 sheets per mile, we should get approximately how many MILES high a stack of a trillion Dollar Bills would be.

Canceling out zeros and rounding off so I can fit numbers into my limited calculator window, I come up with a little over 63,000 miles.

... our Earth is 24,907 miles around at it's Equator.

 So $1 trillion would wrap around the equator roughly 2.5 times.

Now while you may be calculating how many miles is $7.6 trillion, let's move on to what this money represents.  From Bloomberg, World’s Biggest Economies Face $7.6 Trillion Bond Tab as Rally Seen Fading.

Governments of the world’s leading economies have more than $7.6 trillion of debt maturing this year, with most facing a rise in borrowing costs.

...

The amount needing to be refinanced rises to more than $8 trillion when interest payments are included.

...

Italy auctioned 7 billion euros ($9.14 billion) of debt on Dec. 29, less than the 8.5 billion euros targeted. With an economy sinking into its fourth recession since 2001, Prime Minister Mario Monti’s government must refinance about $428 billion of securities coming due this year, the third-most, with another $70 billion in interest payments, data compiled by Bloomberg show.

Borrowing costs for G-7 nations will rise as much as 39 percent from 2011, based on forecasts of 10-year government bond yields by economists and strategists surveyed by Bloomberg in separate surveys. China’s 10-year yields may remain little changed, while India’s are projected to fall to 8.02 percent from 8.36 percent. The survey doesn’t include estimates for Russia and Brazil.

After Italy, France has the most amount of debt coming due, at $367 billion, followed by Germany at $285 billion. Canada has $221 billion, while Brazil has $169 billion, the U.K. has $165 billion, China (PRCH) has $121 billion and India $57 billion. Russia has the least maturing, or $13 billion. 

By the way, a one way trip to the moon is ~239,000 miles.  Bloomberg summarized this information nicely in a table at the end of the article:

 Table 1: Bond and Bill Redemptions and Interest Payments

Country	2012 Bond, Bill Redemptions ($)	Coupon Payments (e.g. interest)
Japan	3,000 billion	117 billion
U.S.	2,783 billion	212 billion
Italy	428 billion	72 billion
France	367 billion	54 billion
Germany	285 billion	45 billion
Canada	221 billion	14 billion
Brazil	169 billion	31 billion
U.K.	165 billion	67 billion
China	121 billion	41 billion
India	57 billion	39 billion
Russia	13 billion	9 billion

Have you figured it out yet?  Somewhere sovereign countries and their banks have to find the money that literally goes to the moon and back.  

Actually, they need more than this as Spain was not accounted for.  I found the following graph on Zero Hedge.  Note that Spain needs somewhere less than €200 billion in 2012.

Source: Zero Hedge

Scrutinizing this graph, I couldn't help to notice that while future funding needs drop off for 2013 and 2014, the amounts are not insubstantial.  Ultimately this leaves me pondering the following - where is all this cash going to come from?

IMF to the Rescue

So will the IMF come to the rescue?  Not likely as Peter Boockvar reports: IMF wants more cash, glass half full or half empty?

Glass half full reads the story that the IMF wants to increase its resources to $1T from the current $385b in an attempt to help ease the European debt crisis and glass half empty reads the IMF belief that there is a $2T funding gap over the next two years as extremely worrisome. On top of the $385b the IMF has, the EU has pledged an additional $185b (UK is holding out right now) and the IMF hopes that China, Brazil, Russia, India, Japan and those rich oil guys in the Mideast will stump up more cash to help.

So the IMF needs cash so that it can respond to crisis situations - namely rescuing Europe.  Again, where is all this cash going to come from?  Did you know that humans cannot touch their elbow with their tongue?

Have You Ever Heard of Sarko-nomics

Interestingly, I believe the answer is at hand, at least temporarily.  With the exception of Greece, Ireland, and Portugal, EU countries have been refinancing their debt in the market until late summer/fall 2011.  At this time, financial markets began to question whether Italy and Spain could repay their debts.  Interest rates in these two countries began to rise requiring the European Central Bank (ECB) to intervene by purchasing Italian and Spanish sovereign debt.  This aided keeping interest rates lower.  Keeping rates below 7% is critical as this was when Greece, Ireland, and Portugal needed bailouts.

However such intervention was undesirable as it was not within the ECB's mandate.  The ECB is prohibited from providing monetary assistance (e.g. quantitative easing). Furthermore, intervention was not a long term solution.

What about the European Financial Stability Facility (EFSF) and the European Stability Mechanism (ESM)?  The ESM is slated to be available in July 2012 with the ability to lend €500 billion.  As reported by Reuters, Euro zone faces lower EFSF lending power or higher guarantees.

The EFSF has an effective lending capacity of 440 billion euros thanks to guarantees from euro zone governments.

Because only six of the 17 countries sharing the euro had the highest AAA rating when the EFSF was set up, rating agencies demanded that the guarantees be much higher than the EFSF's actual lending power and equal 780 billion euros.

The loss of S&P's top rating by France and Austria means that without any changes, the EFSF's lending capacity will fall by 180 billion euros - the share of guarantees by Vienna and Paris for the fund, the senior official said.

Since the EFSF has now committed 43.7 billion euros to a financing programme for Ireland and Portugal, the loss of 180 billion would leave it 216.3 billion to finance a second programme for Greece and any other future euro zone needs.

Are you still trying to touch your elbow with your tongue? Even with the most recent talk about combining the EFSF and ESM, €700+ billion is not enough.

What about the Long Term Refinancing Operation (LTRO) by the ECB - didn't it loan out nearly €500 billion in December?  As revealed by Hussman Funds in Five Global Risks to Monitor in 2012, the €500 billion is more like €191 billion. (emphasis mine)

While there was much fanfare last month after the ECB loaned 523 banks 489 billion euros, the actual amount of new funds was a more modest number. This is because two earlier loan programs expired on the same day as the three-year LTRO was held, and banks probably rolled these funds into the three-year operation. The earlier operations included a 3-month loan of 141 billion euros offered in September, and a net 112 billion euros of overnight loans. The ECB also allowed banks to shift 45 billion euros from an October operation into the 3-year LTRO. Of the 489 billion Euros operation, that left about 191 billion euros of fresh loans.

Channeling Chief Brody from Jaws, we're going to need a bigger boat.  Enter Sarko-nomics as revealed by PrudentBear.com: Europe’s Chronic Disease.

Europe will be forced to resort to “Sarko-nomics” to finance itself - European banks purchase sovereign debt, which is then pledged as collateral to borrow unlimited funds from the ECB or national central banks.

This perpetuates the circular flow of funds with governments supporting banks that are in turn supposed to bail out the government. It does not address the unsustainable high cost of funds for countries like Italy. If its cost of debt stays around current market rates, then Italy’s interest costs will rise by about euro 30 billion over the next two years, from 4.2% of GDP currently to 5.1% next year and 5.6% in 2013.

Debt reduction through restructuring remains off the agenda. The adverse market reaction to the announcement of the 50% Greek writedown forced the EU to assure investors that it was a one-off and did not constitute a precedent. Despite this, investors remain sceptical, limiting purchases of European sovereign debt.

So in order to get the cash, banks are going to have to lend their loans to the ECB to get more cash through the LTRO.  The banks can then refinance the debt coming due with this new cash, which they also owe to the ECB in order to get their original loans back.  Is your head spinning?  That's the perpetually circular flow of funds that author Satyajit Das was talking about.

So We've Got the Bigger Boat

Answering where the cash is going to come from, it's going to be printed into existence - poof!  Through the LTRO, the ECB has found a means to temporarily bend the rules and print money.

However, we didn't get a bigger boat.  While there is relief in the credit markets, it is only temporary as the LTRO only is a 3 year lending program.  Although debt could be rolled over after 3 years, the debt still remains - in fact it rises.  Banks earn a profit on the spread of borrowing at 1% and lending at higher rates, but the ECB is taking lower credit quality assets that pose more risk onto its balance sheet.

In other words, nothing is saved - only more time was bought to try and find a solution.

So How Does This Affect Me in the US

Since about the end of January, I keep reading more and more analysts, fund managers, and financial professionals buying stocks.  Up until this time, I've had trouble figuring out why because of the risks I've highlight in articles such as Good News From Europe, Though I Have Trouble Seeing It, It's Just a Minor Flesh Wound, and Stay True to the Path or Take the Fork in the Road.

Yet today I read U.S. stocks and gold to drive higher in Marketwatch from Mary Anne & Pamela Aden. Over the years, I have sporadically read their work and been impressed as they never follow the crowd. Today however that changed, so I sat up when I read:

U.S. stocks and gold are leading the way. In fact, these are our top picks for the months ahead and they're looking good. Here's why ...

— Gold has been a consistent winner year after year. The technicals are bullish and so are the fundamentals. Gold's bull market rise will remain intact by staying above $1560.

Due to monetary uncertainties and massive debt, central banks are big gold buyers. And so is the public, especially in China, India and other emerging nations. This is keeping demand strong.

Ongoing government spending, monetization, low interest rates in the Western world and weak currencies are also putting upward pressure on gold and silver.

These are the basic reasons why gold will continue to head higher, and it's why we like SPDR Gold Shares and iShares Silver Trust.

— Stocks have been moving up on improving economic news, as well as the fact the Fed stands ready to jump in again, if needed, to help boost the economy.

Europe has also calmed down somewhat and taken together, these two factors have led to a sense of calm and some optimism. That is, investors have chosen to focus on the good news for now, even though the fundamental reality has not changed.

As you know, sentiment drives the markets, not necessarily reality. As investors, our reality has to be accepting the current sentiment.

The Adens have recommended gold for many years now, but I cannot recall ever reading a recommendation on buying stocks.  Granted, they hedge their enthusiasm by saying that these are their top picks for the months ahead. Still they have good company as noted in How Many Bulls in this Rodeo, Clowns Want to Know and James Bond Isn't the Only Dangerous Bond.  

Parting Thoughts  

I'm still not sold on buying stocks for my "retiree" nest egg, but I do find that I'm questioning it more every day.  I am still bullish on gold, gold ETFs, and gold miners as there doesn't seem to be an end in sight of central bank programs to aid the global economy.  Please note that I am invested in these types of assets.

Remember, repay, restructure, or default are the only solutions to ridding oneself of debt.  Can the ECB continue to delay the tough choices that the EU keeps deciding to forego?  I don't know.  I can only wait and watch.


Disclaimer: Please remember that I’m just a guy sharing information on a blog, and this is NOT official investment advice. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Please consult your investment adviser before making any investment decisions. During your conversation with said investment adviser, ask why they believe in their recommendation. If you are not convinced by their explanation, any action that you take or forego is also your responsibility. Just in case you missed that, you are responsible for your investments.

With that said, don’t let your investments keep you up at night. If they do keep you awake, you may be taking more risks than you are comfortable with. Talk to a professional about reallocating to less risky investments so that you can sleep. During your conversation with said professional, ask why they believe that their recommendation is less risky. If you are not convinced by their explanation, don’t invest. Remember:

1. It’s your nest egg.
2. Opportunities are easier to make up than losses.