NEW$ TO U(SE)

Doug Short has this post on Moving Averages. Good way to spot major secular directional changes. To avoid whipsaws, wait for the m.a. to change direction. See his full post for more details.

Based on the 10-month m.a., we are only back at the long term trend line. Beware, especially since valuations are not compelling like they were in March (see EQUITIES: TIME FOR A PAUSE).

Background on Moving Averages

Buying and selling based on a moving average of monthly closes can be an effective strategy for managing the risk of severe loss from major bear markets. In essence, when the monthly close of the index is above the moving average value, you hold the index. When the index closes below, you move to cash. The disadvantage is that it never gets you out at the precise top or back in at the very bottom. Also, it can produce the occasional whipsaw (short-term buy or sell signal).

How economists can misunderstand the crisis

Niall Ferguson nails Paul Krugman in the FT. No best friends here!

On Wednesday last week, yields on 10-year US Treasuries – generally seen as the benchmark for long-term interest rates – rose above 3.73 per cent. Once upon a time that would have been considered rather low. But the financial crisis has changed all that: at the end of last year, the yield on the 10-year fell to 2.06 per cent. In other words, long-term rates have risen by 167 basis points in the space of five months. In relative terms, that represents an 81 per cent jump.

Most commentators were unnerved by this development, coinciding as it did with warnings about the fiscal health of the US. For me, however, it was good news. For it settled a rather public argument between me and the Princeton economist Paul Krugman.

It is a brave or foolhardy man who picks a fight with Mr Krugman, the most recent recipient of the Nobel Prize for Economics. Yet a cat may look at a king, and sometimes a historian can challenge an economist.

A month ago Mr Krugman and I sat on a panel convened in New York to discuss the financial crisis. I made the point that “the running of massive fiscal deficits in excess of 12 per cent of gross domestic product this year, and the issuance therefore of vast quantities of freshly-minted bonds” was likely to push long-term interest rates up, at a time when the Federal Reserve aims at keeping them down. I predicted a “painful tug-of-war between our monetary policy and our fiscal policy, as the markets realise just what a vast quantity of bonds are going to have to be absorbed by the financial system this year”.

De haut en bas came the patronising response: I belonged to a “Dark Age” of economics. It was “really sad” that my knowledge of the dismal science had not even got up to 1937 (the year after Keynes’s General Theory was published), much less its zenith in 2005 (the year Mr Krugman’s macro-economics textbook appeared). Did I not grasp that the key to the crisis was “a vast excess of desired savings over willing investment”? “We have a global savings glut,” explained Mr Krugman, “which is why there is, in fact, no upward pressure on interest rates.”

Now, I do not need lessons about the General Theory . But I think perhaps Mr Krugman would benefit from a refresher course about that work’s historical context. Having reissued his book The Return of Depression Economics, he clearly has an interest in representing the current crisis as a repeat of the 1930s. But it is not. US real GDP is forecast by the International Monetary Fund to fall by 2.8 per cent this year and to stagnate next year. This is a far cry from the early 1930s, when real output collapsed by 30 per cent. So far this is a big recession, comparable in scale with 1973-1975. Nor has globalisation collapsed the way it did in the 1930s.

Credit for averting a second Great Depression should principally go to Fed chairman Ben Bernanke, whose knowledge of the early 1930s banking crisis is second to none, and whose double dose of near-zero short-term rates and quantitative easing – a doubling of the Fed’s balance sheet since September – has averted a pandemic of bank failures. No doubt, too, the $787bn stimulus package is also boosting US GDP this quarter.

But the stimulus package only accounts for a part of the massive deficit the US federal government is projected to run this year. Borrowing is forecast to be $1,840bn – equivalent to around half of all federal outlays and 13 per cent of GDP. A deficit this size has not been seen in the US since the second world war. A further $10,000bn will need to be borrowed in the decade ahead, according to the Congressional Budget Office. Even if the White House’s over-optimistic growth forecasts are correct, that will still take the gross federal debt above 100 per cent of GDP by 2017. And this ignores the vast off-balance-sheet liabilities of the Medicare and Social Security systems.

It is hardly surprising, then, that the bond market is quailing. For only on Planet Econ-101 (the standard macroeconomics course drummed into every US undergraduate) could such a tidal wave of debt issuance exert “no upward pressure on interest rates”.

Of course, Mr Krugman knew what I meant. “The only thing that might drive up interest rates,” he acknowledged during our debate, “is that people may grow dubious about the financial solvency of governments.” Might? May? The fact is that people – not least the Chinese government – are already distinctly dubious. They understand that US fiscal policy implies big purchases of government bonds by the Fed this year, since neither foreign nor private domestic purchases will suffice to fund the deficit. This policy is known as printing money and it is what many governments tried in the 1970s, with inflationary consequences you do not need to be a historian to recall.

No doubt there are powerful deflationary headwinds blowing in the other direction today. There is surplus capacity in world manufacturing. But the price of key commodities has surged since February. Monetary expansion in the US, where M2 is growing at an annual rate of 9 per cent, well above its post-1960 average, seems likely to lead to inflation if not this year, then next. In the words of the Chinese central bank’s latest quarterly report: “A policy mistake … may bring inflation risks to the whole world.”

The policy mistake has already been made – to adopt the fiscal policy of a world war to fight a recession. In the absence of credible commitments to end the chronic US structural deficit, there will be further upward pressure on interest rates, despite the glut of global savings. It was Keynes who noted that “even the most practical man of affairs is usually in the thrall of the ideas of some long-dead economist”. Today the long-dead economist is Keynes, and it is professors of economics, not practical men, who are in thrall to his ideas.

The writer is Laurence A. Tisch professor of history at Harvard University and author of The Ascent of Money (Penguin)

Related posts:

Niall Ferguson: A Pessimistic Assessment, Especially for Europe

Paul Krugman: The Big Inflation Scare

“THERE WILL BE BLOOD”, HARVARD ECONOMIC HISTORIAN NIALL FERGUSON

This piece by Forbes was probably written too late to catch a $5 million sale by Lee Scott, his first sale since March 2006 (see NOTABLE US INSIDER TRANSACTIONS and Barron’s Former Wal-Mart CEO’s $5 Million Sale.

Shares of the biggest retailer on the block are looking like a big fat buying opportunity, at least according to what some of its insiders have been doing. (…)

Insiders at Wal-Mart have been rather bullish of late, with two insiders buying $372,000 worth of stock at $49.59 per share on May 19 and May 20. Insider transaction research service Insider Score calls it "the largest one-month cluster purchase in more than a year," referring to the aggressive buying by more than one insider. Insider Score rates Wal-Mart a "10" for "very positive" and notes the bullish "buy inflection" and a "buy reversal."

"Director James Breyer took down $248,000, increasing his stake 4% to 127,000 shares," reports Insider Score. "Breyer, one of the most active buyers since 2003, last purchased $250,000 at similar levels in March. Executive VP Susan Chambers bought $79,000, fractionally raising her holdings to 127,000 shares. It was her first buy since at least 2006."

So how good have these insiders been at getting into the stock at the right prices? Says Insider Score, "Chambers, who joined the discount retailer in 1999, last exercised or sold $264,000 at $54.08 in March 2008, generating a small 36% gain on options due to expire in less than a year. The recent purchases extend an uptick in buying stretching back to November 2008 with insiders purchasing around the $50.00 mark."

The renewed buying takes on more significance since it follows a long stretch of heavy selling. "Prior to November, insiders had been sellers in 2008 disposing of $21M at an average price of $58.44 per share.

OVERALL loan quality at American banks is the worst in at least a quarter century, and the quality of loans is deteriorating at the fastest pace ever, according to statistics released this week by the Federal Deposit Insurance Corporation.(…)

Of the entire book of loans and leases at all banks — totaling $7.7 trillion at the end of March — 7.75 percent were showing some sign of distress, the F.D.I.C. reported. That was up from 6.9 percent at the end of 2008 and from 4.1 percent a year earlier. It also exceeded the previous high of 7.26 percent set in 1990 and 1991, during the last crisis in American banking.

(…) Virtually the only encouraging news in the report was that the banks’ loan portfolio might be worsening more slowly than it was. While the increase of 3.65 percentage points in a year is the highest ever, the quarterly rise was smaller than in the fourth quarter of last year.

The figures, as shown in the accompanying charts, include loans that are more than 30 days behind in payments, a category that will include some loans that catch up and become current. But the percentage that are at least 90 days overdue, or on which the bank has stopped accruing interest or written off, is also higher than at any time since 1984.(…)

The problems stretch across nearly every category of loan, and every size of bank, although the loan problems appear to be somewhat less severe at smaller banks.

Over all, 8.77 percent of real estate loans are troubled, but some types of such loans are in far worse shape than others. Construction and development loans are in the worst shape, with 17.68 percent of loans troubled, and loans secured by farmland are in the best shape, with only 2.98 percent of such loans reported as having problems.

One area that could get much worse is loans on commercial buildings, including stores and offices. Just 4.01 percent of such loans are troubled, less than half the peak of the early 1990s. A large number of those loans will need to be refinanced in the next few years, however, which could be impossible where real estate values have fallen sharply.

Loans to businesses — called commercial and industrial loans — also appear to be doing better than they did in the early 1990s. That could reflect the fact that many such loans are no longer on bank balance sheets, having been sold into the securitization market. Some analysts also fear a wave of defaults on these loans.

The rising stress for some consumers is shown by the fact that banks are taking charge-offs for bad debt at an annual rate of 7.79 percent, and that about one in seven of such loans is classified as troubled.(…)

Full NYT article

A BARRON’S INTERVIEW WITH NIALL FERGUSON: The Harvard professor and media star is cautious on the global economic outlook — and bleak about Europe.

On the economy

• It would be excessively optimistic, however, to conclude from a relatively small set of green shoots in the economic data that we are all going to live happily ever after. It is certainly way too early to say the Obama administration is right that the economy is going to grow at 3% next year and 4% in 2011. I find that scenario as implausible as a rerun of the Great Depression.
• The U.S. can run bigger deficits at lower cost, because of its reserve-currency status.
• The contraction in Germany and Japan probably will be roughly twice that of the U.S. Real gross-domestic-product growth in Japan is almost certainly going to be a negative 6% or 7% this year. In the U.S., it is going to be about minus 2.6% for this year.
• This is probably more like a slight depression. We won’t see a big V-shaped bounce. Much of the consumption growth in the decade up to 2007 was fueled by things like mortgage-equity withdrawal. That game is clearly over. Strip that out, and you are looking at an annual economic-growth rate in the U.S. closer to 1½% to 2% than 4%.

On regulations:

• My feeling is that all this zeal for regulation actually grows out of a very faulty analysis. Why do I think that? For one, if this crisis was all about regulation it took a hell of a long time to come about because deregulation began in 1980. And deregulation can’t be all bad because lots of good things happened in the world economy after 1980. The second problem is if deregulation was the issue, why was it that the most regulated entities, banks, caused the biggest trouble, and that unregulated hedge funds didn’t? Some hedge funds have failed, but there has been no systemic downside to it. And thirdly, the regulatory frameworks are not the same on both sides of the Atlantic, and yet European banks are in as big a mess as the American ones. German banks are the most leveraged on average in the world. Now the Germans have been wagging their fingers at the Anglo-Saxon model, but their model didn’t prevent extra leverage in the balance sheets.

On the UK, BRIC and European banks

• The U.K. needs another dose of Thatcherism very urgently
• The emerging-market story is actually much more straightforward because there is a real stimulus package out there that is working much better than the U.S. stimulus package: It is the one in China. It is giving a shot in the arm to those economies that supply commodities to China, and they are the markets that have rallied the most since the year began. The Russian stock market essentially is a play on the price of oil. Brazil is partly a food story, and India has done pretty impressively, too. So, if you had to take a view on equities, it would be the BRICs [Brazil, Russia, India, China] over the U.S. There is also a big commodities opportunity there.
• But Western European banks are in worse shape, and what really is going to hurt them is the mess that is Eastern Europe, from Ukraine to the Baltics, Romania, Hungary, and Slovakia. These economies are in a terrible mess.

Updated Microsoft Search Service Draws Pre-Launch Kudos

(…) Microsoft is a distant third in the U.S. Internet-search market, with market share in the mid-single digits, trailing well behind Yahoo!’s roughly 20% share and Google in the mid-60s or higher, depending on who is counting. The real question: Can Bing boost Microsoft’s market share in search? Judging from the demo at D, plus some noodling around on a pre-release version of the site, I think they very well might succeed.

The Bing search approach focuses on providing people not just with blue links, but also with practical information. Type in a flight number, and get back departure and arrival times and a gate number. Type in Warren Zevon, and you will get back images, links to video, albums, fan sites and related artists. Enter a consumer-products company name, and you get back a link to its Website, as well as — I love this part — a customer-service 800 number to call for help.

People certainly found it appealing. One fund manager I chatted with said that not only does he intend to start using the service when it launches June 3, but also that he is mulling whether to short Google. I was a little startled by that response, but you can see his point: Microsoft might be able to nibble some market share away from Google at the margin, and slow its steady march to complete domination.(…)

Full Barron’s column

Barron’s Michael Santoli reports on investor sentiment in Flatland:

(…) Jason Goepfert of www.SentimenTrader.com, noted Friday that we’ve just completed four straight weeks in which the weekly highs were within 0.75% of one another, and weekly lows were within 0.75% of one another. Goepfert says that since 1928, such a four-week stretch of stasis has lasted another week only 17% of the time, and only once has continued for a sixth week. So, a sharper move is likely, if the historical record has something to say.

A data-packed week to start a new month is upon us, one featuring a monthly jobs report, a couple of Treasury-bond auctions, the deadline for the Fed’s asset-backed purchase program and a likely bankruptcy filing by General Motors (GM).

Interestingly, Goepfert finds that a break from such calm stretches has more often than not tended to be a move lower and has frequently been a "head fake" that led to higher index levels a month later. This being the markets, neutral sentiment is defined as "evenly split divergent opinions" rather than "indifference," which feeds "mutually assured frustration," not "placid acceptance."

The American Association of Individual Investors’ weekly poll showed a slight excess of bears, but an unusually slim 11% professing neutrality. Dean Curnutt of www.macroriskadvisors.com polled clients, with the CBOE Volatility Index, or VIX, near 30, whether the VIX would hit 20 or 40 first. This amounts to whether folks believe a tougher, choppier market (VIX to 40) would emerge before a calmer, firmer one (VIX to 20).

About 75% went with 40 — but with plenty of qualifiers and without much conviction evident. Many felt the calm would persist for a bit, followed by a market storm deeper into summer. (This conforms with history, incidentally, which shows volatility tends to hit a low for the year in June or July.)

In all, investors are bemused more than bullish, wishful of lower entry points rather than eager to chase. Ned Davis Research seems to have it right, treating investor sentiment as a net positive for now — which should keep short-term downside risk modest — while remaining on alert for giddiness to emerge.

Earlier this week, David Rosenberg noted from the Conference Board Confidence Report:

(…)the share of households who are bullish on equities rose to 35.8% from 31.7% in April and the March low of 19.6% (this is the highest since July 2001). The ‘bear share’ fell to 30.8% from 35.7% (was 52.8% at the March market lows) — the lowest the bear share has been since October 2007. Could be the hidden ‘contrary’ negative data-point in a report that is being viewed as widespread bullish for equities.

THE LAST TIME THAT THERE WERE MORE EQUITY MARKET BULLS (35.8%) THAN BEARS (30.8%) WAS BACK IN OCTOBER OF 2007 WHEN THE MARKET WAS HITTING ITS PEAK. THIS METRIC WORKS LIKE A CHARM BECAUSE LAST MARCH, AT THE MARKET LOWS, THE GAP BETWEEN THE BEARS (52.8%) AND THE BULLS (19.6%) IN THE OTHER DIRECTION WAS THE LARGEST SPREAD SINCE JULY 2008 (AND THE SECOND LARGEST GAP ON RECORD).

(See CONTRARIANS, READ THIS!)

The fast money is proving slow to jump on the market’s bandwagon.

Hedge funds, decried by many as quick traders, have played catch-up during the market rally since March. The average fund was 45% "net long" as of May 19, or had investment holdings valued at 45% more than its bearish "short" positions, according to Hedge Fund Research.

That figure is up from 33% earlier this year, but still is far below its 55% level a year ago. Funds are less bullish now than they were just before the market crumbled last fall.

Hedge-fund managers, and their investors, said many remain in a neutral position. Hedge funds tend to underperform stock-market averages at inflection points, in part because they aim to create a "hedged" performance, rather than ape the market.

While a stock surge might force a mutual-fund manager to jump in because he is judged against the index, the pressure on hedge funds is less.

Many funds are skeptical the economy has entered a new period of growth that justifies high equity multiples. Others fear dislocations from governments shoveling money at problems. (…)

WSJ