Archive for the ‘View From Up Top’ Category

Thoughts from the Frontline Weekly Newsletter

May 22, 2010 Leave a comment

The Case for a Fed Rate Hike

by John Mauldin
May 22, 2010

Everywhere there are arguments that
we are in a "V"-shaped recovery. And there are signs that in fact that is the
case. Today we will look at some of those, and then take up the topic of when
the Fed will raise rates. We open the case and look at the evidence. Is there
enough to come to a real conviction? I think there is. (And at the end of the
letter I mention two conferences I am speaking at in the next few months, in
Vancouver and San Francisco.)

But first, a little housekeeping.
The delivery rate for this letter has not been good for some time now and we
are aware of it. We get tons of letters and calls from long-time readers who
want to know why we have dropped them from the list. They keep resubscribing
but not getting the letter. It is a problem. I was not getting delivery on my
own personal accounts from well-known email providers. We apologize for any
inconvenience. Please know that we do not drop anyone from the list unless they
request it or we get hard bounces or undeliverable messages.

Hopefully that has all changed with
this letter. The problem has been that the list is so large that it is blocked
long before the letter ever hits your inbox. The computers at service providers
just assume anything this large can't be for real. We are now using a service
that is a third-party verification of our letter, which hopefully will fix the
problem (not a cheap solution, by the way!). So, there may be a lot of you for
whom this letter is (hopefully) a pleasant surprise after not getting it for
some time.

If that is the case, we would like
to know. If you have the time, drop me a response that says "got it" in the
subject line. And of course, if you don't want to get the letter you can hit
the unsubscribe button at the bottom. But even better, why not forward this to
a friend and tell them to subscribe?

For the record, we are working on a
MAJOR revision of the website and the letter. There will be a lot more ways for
you to interact with me and each other. A lot more information and
capabilities. We are excited. It should be here by the fall. Tiffani and I
think you are really going to like it. And now to the letter.

Employment Is Turning the Corner

There is a little-known employment report that
the BLS (Bureau of Labor Statistics) releases late in the month that is a
summary of the employment reports from the 50 states. Of late, this number has
been higher than the federal government survey. Adding the states together, we
find that 412,200 jobs (non-seasonally adjusted) were created in April, higher
than the establishment survey (which for whatever reason gets the headlines)
and more in line with the household survey, which showed an employment gain of
550,000 (seasonally adjusted).

I think it is well established by now that I am
not a fan of the birth/death employment estimates in the establishment survey.
That is where the BLS estimates the number of new jobs created by the birth or
death of new businesses. It is often a significant portion of the jobs survey
and it is a seasonally adjusted guess. There really is no alternative but to
make this estimate, but at the beginnings of recessions it always overestimates
the number of jobs, and at the beginnings of recoveries it will underestimate

Remember the "jobless recovery" of
2002-2004? Eventually (several years later) the BLS gets hard data from tax and
other sources and goes back and revises the employment numbers. No one cares,
because it is "old news." But we can now look back and see the jobless recovery
we thought we were in was not all that bad. The birth/death estimates decidedly
understated the growth that was going on at the time.

That may be the case now, too. The much stronger
state and household surveys suggest that we *may* be at the beginning of a
labor recovery that will be understated by the establishment survey, as the
birth/death model just won't catch that growth. If this pattern continues for
the next few months, I think we should begin to pay more attention to the state
and households surveys. Let's hope it does.

That being said, the level of
reported increases is not showing up in the income tax reports. There may be
several reasons for that, one of which is that people are going back to work
for less money and thus paying less taxes. And that would make sense, as there
are now five out of work people seeking jobs for every job opening. The
employers have the negotiating power.

Businesses are cautiously building
inventories and bringing people back to work. Sales-to-inventory levels are not
out of line and suggest we may see more inventory building this quarter, which
will directly help boost GDP. Retail sales growth is modest by previous
recovery standards, but there is at least growth.

The Headwinds of Money Supply

 But (and you knew there would be a but
coming), there are some headwinds we need to deal with before we can sound the
all-clear horn. First, growth in the money supply is slowing. Let's look at the
measure of money supply called MZM, or Money of Zero Maturity. Notice it was flat
for well over a year and actually down the last two months.


A broader measure of money is M2. 
Notice that it too has flat-lined for well over a year. If we look at the last
30 years, there is nothing you can see in the chart that even comes close to


I don't have access to a graph of
M3, though it is still produced by several groups (the Fed stopped several
years ago), but that chart would show that even M3 has gone negative. Remember
the conspiracy guys who thought the Fed stopped reporting M3 because they
thought the Fed wanted to hide the fat that it was going to increase the money
supply by large amounts and destroy the dollar? Hardly. The economists at the
Fed simply felt for a number of very public reasons that M3 doesn't have any
real meaning any more. They have a strong case, although I never understood why
they just didn't go ahead and keep publishing it anyway. It was just a few
computers programs. But what do I know?

Now, notice that with both graphs
you see a large increase beginning in the middle of 2008 as the Fed pumped the
money supply in order to inject liquidity into the system. This was basically
the $1.25 trillion purchase of mortgages, but toward the end even that was not
boosting the money supply as much as it did in the beginning. Why? Partially,
because of the following graph.

This shows total commercial lending
at US banks. It is down almost 25% in less than a year and a half. Notice that in
the last recession commercial lending dropped by "only" 18% in 3.5 years.


Lending to consumers is also down in a similar
fashion. Notice that money supply begins to go flat in 2009, just a little after
bank lending dried up.

Remember our old friend the equation that GDP is
equal to the money supply times the velocity of money (GDP=MV)? If GDP is
growing and the money supply is slowing, that means the velocity of money is
starting to turn back up. That would be a good thing, but we must be somewhat
cautious, in that the velocity of money is mean reverting over time, and it is
still well above its mean. If it started to once again slow down, as it has for
several years now with the current slow or no growth in the money supply, that would
not be good for GDP growth.

As a practical matter, that means the Fed will
not be reducing its mortgage holdings any time soon. They will wait until it is
obvious that a recovery is firmly entrenched. I don't see how they can risk
reducing the money supply any more than they already have, especially given the
next few charts.

Who Stole the Inflation?

Inflation just isn't what it used to be. Core
inflation is basically flat over the last year. We haven't seen that since the '50s.
Since the beginning of 2009 it is only up around 0.1%.


About five years ago, the Dallas
Fed developed a new methodology for measuring inflation, called the Trimmed
Mean PCE. It was developed by Dallas Fed economist Jim Dolmas.

Dolmas notes (quite correctly, I think)
that to exclude food and energy, just because they are volatile, ignores that other
quite volatile measures of inflation are still left in. Further, energy and
food inflation do have meaning in the real world.

What Dolmas does is use a statistical
device called "trimming." From the field of statistics, trim analysis
borrows the idea of ignoring a few "outliers." A trimmed mean,
for example, is calculated by discarding a certain number of lowest and highest
values and then computing the mean of those that remain.

How accurate is his measure? Dolmas
suggests it is a lot more accurate: "That is to say, compared to the usual
… measure, on average the monthly Trimmed mean measure would be expected to
come closer to true monthly core inflation by roughly .75 of a percentage
point, when the inflation rates are expressed in annual terms." That is
huge, at least in my book, especially when we look at how great the difference
is with the Fed's favorite methodology.

In 2006, the trimmed-inflation
methodology suggested the core inflation was understating inflation. Today, the
same methodology suggests that core inflation is overstating inflation. Look at
the tables below, which were last updated in March. The trends in inflation are
clearly down, and when the April data comes out it will be down again.


My good friend David Rosenberg pointed out this
morning a new study by the Cleveland Fed on inflation, which concludes that:
(i) the decline in recent months has transcended the housing effect; and, (ii)
the principal risk is for a further slowing. Treasury yields are likely headed
even lower. The title of the report is Are Some Prices in the CPI More
Forward Looking Than Others? We Think So,
by Michael F. Bryan and Brent
Meyer. It's well worth a read. (

"Abstract: Some of the items that make up the Consumer
Price Index change prices frequently, while others are slow to change. We
explored whether these two sets of prices – sticky and flexible – provide
insight on different aspects of the inflation process. We found that sticky
prices appear to incorporate expectations about future inflation to a greater
degree than prices that change on a frequent basis, while flexible prices
respond more powerfully to economic conditions-economic slack. Importantly, our
sticky-price measure seems to contain a component of inflation expectations,
and that component may be useful when trying to gauge where inflation is

Where is inflation heading? Well, the last FOMC statement held the view
that ‘inflation is likely to be subdued for some time.' We certainly don't have
reason to question that outlook. Indeed, while the recent trend in the core
flexible CPI has risen some recently (it's up 3.3 percent over the past 12
months ending in March) the trend in the core sticky-price CPI continues to
decline. Even excluding shelter, the 12-month growth rate in the core sticky
CPI has fallen 1.1 percentage points since December 2008, down to 1.8 percent
in March. So on the basis of these cuts of the CPI, we think ‘subdued for some
time' sums up the price trends nicely."

And speaking of the latest minutes from the last
Fed meeting, which came out this week, let's review a paragraph.

"In light of stable longer-term
inflation expectations and the likely continuation of substantial resource
slack, policymakers anticipated that both overall and core inflation would remain subdued through 2012, with measured
inflation somewhat below rates that policymakers considered to be consistent
over the longer run with the Federal Reserve's dual mandate."

The Fed Is On Hold

Let's review. Economists tell us it will take GDP
growth rates of 3.5% or more to have any real impact on employment. As I have
noted elsewhere, that is 300,000 jobs a month for five years to get us back to
where we were in 2007. Losing 8 million jobs is a big hole. What are the
prospects for 3.5% GDP growth, with high unemployment and large tax increases
coming in 2011from not only the Fed but state and local governments? My thought
is, not so great.

The trend in inflation is down.
Unemployment is way too high. The money supply is somnolent.

The Fed is on hold for the rest of
the year and well into 2011.

Case closed.

An Inverted Yield Curve?

A quick thought on inverted yield curves. As
long-time readers know, I have written extensively about research done on the
inverted yield curve, that condition where short-term rates are higher than
long-term rates. It is the best single indicator of recessions, and following
it allowed me to "predict" the last two recessions a year in advance. We won't
go now into why it seems to work, but it is useful, or has been in the past.

Clearly, if the Fed is on hold for at least
another year, it will be impossible for quite some time to get an inverted
yield curve. Obviously, long-term rates will not go below zero. Yet long-term
rates are headed down of late, and are lower than they were when we last had an
inverted yield curve in 2006. What would the yield curve look like without the
Fed massively intervening? Is there a way to "normalize" the short-term rates
that would give us a proxy for short-term rates without active Fed
intervention? Would it matter? If you have any thoughts on that topic, feel
free to share.

LA, Vancouver, San Francisco,
and a First
Often Wrong, Seldom in Doubt

I am off to LA tomorrow with son-in-law Ryan to
meet with the team at Fahrenheit Studios that is helping us design the new websites.
Then home for ten days, and then it's some much-needed vacation time with the
family (kids and spouses and grandbabies – a total of 12 of us), to Italy.

I will be speaking at the Agora Financial
Investment Symposium in Vancouver July 20-23rd. There are some
really great speakers and this is a fun crowd. I got them to knock off $200 for
my readers if you use the link and order form below. You can find a link
to the list of speakers a little ways into the link. Hope to see you there!

I will also be speaking at the San Francisco
Money Show August 19-21. I will have more on that show in the coming weeks, and
links for registration.

And a big thanks to Greg Buoncontri and his team
at Pitney Bowes. I spoke there last Wednesday and was made to feel quite
special. It was a very upbeat conference with great speakers on how the world
is changing. I learned a lot.

Finally, after ten years of writing this letter,
I had a first tonight. At 9:30 I realized what I was writing was just not ready
for prime time. You can't take the cake out of the oven until it is fully
baked. I have had some half-baked ideas before, but never knowingly. As I say,
I am often wrong but seldom in doubt. I really thought I knew where I was going,
but the longer I thought and the more I wrote the more I kept disagreeing with
myself. I still think there is some meat in the topic, but I need to think some
more on it. You, gentle reader, deserve nothing less. I take this letter

I had to stop, pour myself some
scotch, take a deep breath, and start over with a brand new topic. And since I
haven't written about Fed policy for some time, a letter on it was due. It is
now 1 AM and past time to hit the send button. Let's hope this doesn't happen
for another ten years.

Your ready to begin to slow down (at least for tonight)

John Mauldin

Categories: View From Up Top

Australian Dollar Tanks Below Initial Target

May 19, 2010 Leave a comment

AUDUSD is currently trading at an 8-month low of 0.8467, 100 pips below my initial target. The prospect of a slowing Chinese economy and the European crisis are taking a toll on the pair- and in a BIG way. Even the Euro is screaming higheragainst the Aussie (EURAUD) by over 2.5%. Taking some profits here won't hurt the ledger balance, however I remain long-term bearish and look for much lower prices in the months ahead.


Europe Throws a Hail Mary Pass

May 15, 2010 Leave a comment

By: John Mauldin

In a 1975
playoff game, the Dallas Cowboys were nearly out of time and facing
elimination from the playoffs, down 14-10 against a very good Minnesota
Vikings team. The Cowboys future Hall of Fame quarterback Roger
Staubach had no very good options. He later said he dropped back to
pass, closed his eyes and, as a good Catholic, said a Hail Mary and
threw the ball as far as he could. Wide receiver Drew Pearson had to
come back for the ball and, in a very controversial play, managed to
catch the ball on his hip and stumble into the end zone. Angry Vikings
fans threw trash onto the field, and one threw a whiskey bottle that
knocked a referee out. After that play, all last-minute desperation
passes became known as Hail Mary passes. (That was a very thrilling
game to watch!)

And that is what Europe did last weekend. They threw a Hail Mary
pass in an attempt to avoid the loss of the eurozone. Jean-Claude
Trichet blinked. Merkel capitulated. Today we consider what the
consequences of this new European-styled TARP will be for Europe and
the world. We do live in interesting times.

(At the end of the letter I note that I will be speaking at the
Agora Financial conference in Vancouver July 19-23. This is a wonderful
conference and a lot of my good friends are speaking. They have
extended their early-bird registration for one week for my readers.
Join me!)

Also, I am finalizing the details on the next two Conversations with
John Mauldin. The first will be on China, where I have two experts who
disagree with each other. It will be fun and most enlightening. The
next one will be on energy and oil. They will both be out in June.

We get a lot of positive responses to this service. Herb wrote about
the last Conversation, "Wow. What a great discussion. What smart
guests, how little BS. Congratulations. It's the best of your
Conversations that I've listened to."

And ACK wrote: "Wow!! Just the most important discussion I have been
treated to as an investor and fund manager this year or last. Your
product is dreadfully underpriced, as it delivers more value and
education than almost any other subscription that I have… Thanks so
much… This particular conversation was just mind-blowing!"

Actually, we get that last comment almost every issue, as we somehow
seem to connect the dots for different listeners. When we started, I
promised to do 6-8 a year, and we have already posted 6 timely
Conversations in the first 4 months of this year, including my special
Biotech Series as well as the Geopolitical Series with George Friedman.

For new readers, Conversations with John Mauldin is my one
subscription service. While this letter will always be free, we have
created a way for you to "listen in" on my conversations (or read the
transcripts) with some of my friends, many of whom you will recognize
and some whom you will want to know after you hear our conversations.
Basically, I call one or two friends each month and, just as we do over
dinner or at meetings, we talk about the issues of the day, back and
forth, with give and take and friendly debate. I think you will find it
enlightening and thought-provoking and a real contribution to your
education as an investor.

I can get some rather interesting people to come to the table.
Current subscribers can renew for a deeply discounted $129, and we will
extend that price to new subscribers as well. To learn more, go to
Click on the Subscribe button, and join me and my friends for some very
interesting Conversations. (I know the price says $199 on the site, but
for now you will only be charged for $129 – I promise.)

And we are starting a renewal cycle with the subscriptions and have
found a small bug in the software we purchased to handle them. Renewals
are therefore not instantaneous. It may take a day, and for that we
apologize. We are fixing it. And now on to Europe.

Europe Throws a Hail Mary Pass

On Thursday of last week Jean-Claude Trichet, president of the
European Central Bank, said three times "Non! Non! Non!" when asked in
a press conference if the ECB would consider buying Greek bonds. His
exclamation was accompanied by a forceful lecture on the need for
eurozone countries to get their fiscal houses in order, some of which I
quoted in last week's letter. Trichet was remonstrating about the need
for the ECB to remain independent, and was rather definite about it.

Then on Sunday he said, in effect, "Mais oui! Bring me your Greek bonds and we will buy them." What happened in just three days?

Basically, the leaders of Europe marched to the edge of the abyss,
looked over, decided it was a long way down, and did an about-face. It
was no small move, as they shoved almost $1 trillion onto the table in
an "all-in" bet.

Bailing out Greece is very unpopular in Germany. So why did
Chancellor Merkel agree to do so? This is the story that has come out
in the last few days.

"French President Nicolas Sarkozy threatened to pull out of the euro
unless German Chancellor Angela Merkel agreed to back the European
Union bailout plan at a summit last week in Brussels, El Pais newspaper

"According to El Pais, which didn't say how it obtained the
information, Spanish Prime Minister Jose Luis Rodriguez Zapatero said
(in a private meeting of his Socialist politicians) that Sarkozy
demanded 'the commitment of everyone, that everyone should help Greece,
everyone according to their means, or France would reconsider the
situation of the euro.'

"Sarkozy banged his fist on the table and threatened to quit the
euro, which forced Merkel to cave in, Zapatero told the Spanish
politicians, according to the El Pais account.

" 'If at this point, given how it's falling, Europe isn't capable of
making a united response, then there is no point to the euro,' the
newspaper quoted the French President as saying.

"It wouldn't be the first time Sarkozy linked the fate of the euro
to a willingness to support Greece. On March 7, before meeting Greek
Prime Minister George Papandreou in Paris, Sarkozy said: 'If we created
the euro, we cannot let a country in the eurozone fall. Otherwise there
was no point in creating the euro. We must support Greece because they
are making an effort." (Bloomberg)

I find this interesting when I compare it to the analysis from my friends at Stratfor:

"Germany now senses the opportunity to reform the eurozone so that
similar crises do not happen again. For starters, this will likely mean
entrenching the European Central Bank's ability to intervene in
government debt as a long-term solution to Europe's mounting fiscal
problems. It will also mean establishing German-designed European
institutions capable of monitoring national budgets and punishing
profligate spenders in the future. Whether these institutions will work
in the long term – or fail as attempts to enforce Europe's rules on
deficit levels and government debt have in the past – remains to be
seen. But from Germany's perspective, they must."

Well, at least France and Germany are not looking at each other over
the Maginot Line. But it is the age old-struggle: who will lead?

There are so many implications of this latest action, it is hard to know where to begin.

"What is the plan? First, European governments have committed €500bn
(€440bn in loan guarantees to eurozone members in difficulties, and a
€60bn increase in a balance of payments facility). Second, the
International Monetary Fund will, it appears, put up an additional
€250bn ($320bn, £215bn). Third, the European Central Bank has, to the
chagrin of Axel Weber, president of the Bundesbank, decided to purchase
the bonds of members under attack. Finally, the US Federal Reserve has
reopened swap lines, to provide foreign banks with access to dollar
funding. This is a panic-driven response to market panic. It reminds us
of the autumn of 2008." (Martin Wolf, Financial Times)

Above all, this is a move to buy time. There is enough in this fund
to purchase all the expected debt of Greece, Portugal, and Spain for
three years. The money could actually last a lot longer, as Spain might
not need to tap the fund for some time.

There were clearly some other quid pro quos that came out of this
weekend. Both Spain and Portugal announced new austerity moves, which
will help them get back below the 3% deficit limit mandated by the
Maastricht Treaty within (they hope) a few years. It was the usual
combination of tax increases, some budget cuts, and across-the-board
pay cuts for government workers. These are very left-wing socialist
governments, and their announcements were not popular with their
followers or the unions. But they are enacting these cuts before a
durable recovery has come about. They are committing themselves to a
very rough road.

But it is not just the PIIGS countries that are out of compliance in Europe. Look at the following chart from Der Spiegel. Note that France has a budget deficit of over 8%. There are going to have to be austerity measures enacted all over Europe.


Notice that Ireland has the largest deficit, at 14.7%. This is in
spite of (or more aptly because of) the enactment of severe austerity
measures, far beyond what Greece, Portugal, and Spain have
contemplated. And what has that gotten them? An economy that has shrunk
by almost 17% in the last two years, 14% unemployment, and a country in
the grip of outright deflation. Property prices have fallen by 34% and
are still falling. Their banks are in shambles.

And their debt-to-GDP is rising, because even as they borrow their
GDP is falling. It is hard to cut that ratio when GDP is falling. If
GDP falls 20%, then the debt-to-GDP ratio rises by 25%. And that means
your interest-rate costs are an ever bigger chunk of your tax revenues.

Let's be clear. These austerity measures are not growth plans. They
are not designed to help countries grow their way out of the problem.
There is no reason to think that if Greece enacts the measures that
have been proposed, that what happened to Ireland will not happen to
them. It almost certainly will. Credible estimates I have seen suggest
that the Club Med countries will see their GDP drop at least 4% this

It is not just the PIIGS. All of Europe will be making cuts. And in
the short term that is going to be a drag on growth and a headwind for
the euro.

It's More Than Just Government Debt

A recent study by Portuguese economist
Ricardo Cabral
shows that the PIIGS have even deeper problems. With the exception of
Italy, they have a large percentage of their debt owned by foreigners.

"Greece, for example, has approximately 79% of government gross debt
held by non-residents and has a net international investment position
of -82.2% of GDP. Interest payments on public debt represented nearly
40% of Greece's already large 2009 budget deficit – and this is set to

These interest payments leave the country, making their already bad
trade imbalances even worse. And the taxes that might be paid on the
interest go to other countries, too.

Cabral looks at the average external debt during 16 debt crises over
the past 30 years. On average, Greece, Spain, and Portugal are now 30%
worse off than these other countries when they went into crisis and
restructured debt.

Cabral notes (as I have done in past letters) that there are no good
choices. Continuing to increase debt owed to foreign creditors just
digs a deeper hole that they must dig out of. His conclusion is that
some sort of debt restructuring will ultimately be required.

Martin Wolf writes this week of the problems facing the eurozone:

"… the story of the eurozone economy has, in consequence, been one
of divergence, not convergence. The rough external balance masked the
emergence of countries with huge current account surpluses and
corresponding exports of capital, notably Germany, and of others with
the opposite condition, notably Spain. In countries with weak domestic
demand and low inflation, real interest rates were high; in countries
with strong demand and higher inflation, the reverse was true. The
result is not just huge fiscal deficits, now that private-sector
spending has collapsed, but a need to regain lost competitiveness. But,
inside the eurozone, this is possible only with falling wages, higher
productivity growth than in Germany (and so soaring unemployment), or

Take a look at the charts below from his Financial Times
column. The PIIGS have much higher labor costs per unit of production
than Germany, as much as 50% higher! Germany runs large trade surpluses
while the Club Med countries have large trade deficits.

A country may want to reduce its government debt, its businesses and
individuals may want to reduce their debt, and they might like to run a
trade deficit. However, the rules of accounting are such that you can
only do two of the three.

The reality is that the coming austerity measures are going to
reduce the ability of the PIIGS to buy products from outside their
countries. Germany's surplus will thereby suffer.


Let's look at yet another set of graphs from Der Spiegel to
get a handle on the problem facing these countries. Their unemployment
is already high and is going to get worse. They are not enacting
pro-growth policies. Spain, for instance, has a rule that a company
must pay a one-month severance fee for each year an employee has
worked. Thus, if you have worked for ten years, you get a ten-month
severance allowance if you are laid off. What that does is discourage
new employment, and it means that newer workers are laid off first.
That is one of the reason Spain has such a high unemployment rate among
young people.


The Grand Misallocation

What this Euro-TARP does is take money from mostly good credit and
give it to weak credit. It will crowd out private savings that go into
private enterprise (which is where jobs come from) and put it to
unproductive uses in the government debt of weak countries.

There are only two ways to grow an economy: you can grow your
population or you can increase productivity. That's it. The Club Med
countries are not growing their populations appreciably, as their birth
rates are low. And you increase productivity by investing private
capital into businesses, the way the Germans have done, which is why
their labor unit costs are so low compared to their competition.

Euro-TARP almost mandates that capital be misallocated into non-productivity-enhancing government programs and debt.

Europe is run by Keynesians (as is the US). They see everything as a
liquidity problem. And sometimes it is. But the PIIGS have a debt
problem. And you don't cure a debt problem with more debt unless you
have a clear path to grow your way out of the debt. But as I have
demonstrated, there is no clear path to growth with the current
policies. They will produce deflationary recessions, lower government
tax receipts from reduced GDP, and higher unemployment.

At the end of the day, Greece will just have more debt. Perhaps
Spain and Portugal can work through their problems, but that will be
very difficult and will involve considerable economic pain. Italy can
succeed if it decides to.

This new program simply buys time to try and figure things out. It
is Germany saying, "Ok, I give you 3-4 years. But don't come back
asking for more."

All this does is bridge to the middle of the decade, when the truly
massive health and pension promises made all over Europe must be dealt
with. The US has the option of raising taxes, reducing benefits, and
means testing, should we so choose to do so to meet the demands of
entitlement problems. Europe already has tax rates that are high and
growth-inhibiting. The entitlement problems in many countries are more
onerous, and their working populations are not growing.

This is just the beginning of their woes. They have a long way to go
and a short time to get there. Can it be done? Yes, of course. But it
is going to require a great deal of change. I hope they pull it off, I
really do. I have been to most of Europe and love every bit I have
seen. The world is better off with a united Europe.

That being said, I have my doubts that the European Union in its current form will exist in 5-7 years. I hope I am wrong.

One implication. The euro is on its way to parity with the dollar.
So is the pound. That is going to help their exports vis-à-vis the US.
Watch the yen fall rather sharply over the next few years. Senators
Schumer and Graham gripe about China. What are they going to say about
Europe, Britain, and Japan, all of which are on course to premeditated
devaluation? This is going to be just one more challenge for businesses
in countries with the world's stronger currencies.

Another side bet? The ECB says it will sterilize those government
bonds it buys (meaning, it will make sure it does not add to the money
supply). My bet is that when deflation starts to run throughout Europe,
the ECB will decide that maybe not so much sterilization is required
after all.

New York, LA, and Italy

As I noted above, I have cleared my schedule to be at the Agora
Financial Conference in Vancouver, July 19-23. They have a truly great
line-up of speakers. I suggest you go to and look at the program and then go ahead and register.

This week, I had to lay over in Montreal due to bad weather in
Chicago, which meant I had to get up at 2:45 am to make a flight to get
me back to Dallas in time for a speech. Ugh. I am fairly used to
travel, but I make a point not to push it. My body just needs my 8
hours' sleep, and sadly I can't sleep on planes, unlike Dennis Gartman,
who can sleep anywhere. It really kicked my butt.

On Monday I fly to New York for a day, then two nights in Stamford,
Connecticut, speaking to Pitney Bowes execs. I am looking forward to
Monday night, when I get to have dinner with Art Cashin, Greg Weldon,
and Cliff Draughn (coming up from Savannah) – we'll hash over the
problems of the world.

Then it's a quick trip to LA the following week, to meet with a team
of people who are helping us redesign our websites and services to you,
gentle reader. We are in for a major upgrade and I think you are really
going to like it.

And then home, where I will stay until June 3, when the whole family
(seven kids and spouses, grand-babies) takes a two-week vacation to
Italy. I am going to stay over and speak at the Global Interdependence
Center Conference in Paris, June 17th and 18th, with my good friend
(and euro-bull) David Kotok and other luminaries. There will be a lot
of central banker types, and if you want to get a feel for what's
happening in Europe you should come. Information is at

We have been planning (or Tiffani has) for the Italy trip. I really
can't wait, as it's going to be a ton of fun. Thanks for all the
suggestions as to where to go and what to see and where to eat! It has
been over 25 years since I was in Italy, and that was just a few days
in Rome and Venice. This time it's two full weeks, with a week in Rome
and Venice and then a week in Tuscany, then to Paris, and then back to
Tuscany and Milan. And since we decided to go, the euro has fallen 25%.
That helps a lot! I used miles to take everyone, but hotels are a real
expense. Every little bit helps.

It is once again late and time to hit the send button. Enjoy your week.

Your still recovering from an early morning analyst,

John Mauldin

Evolution of Valuations During Secular Bear Markets

May 13, 2010 Leave a comment

Below, I posted a reblog from pragcap about market valuation metrics and how they have yet to dip to levels seen at prior secular troughs. Despite this being the 10th year of a Secular bear market, valuations have yet to dip to levels that could be considered "cheap". This is a major lynch pin in many bearish forecaster's models. I too, find it to be one more compelling piece of evidence for the long-term bear's case suggesting several more years of downside risk in the economy and financial markets.

Case/Shiller 10 year P/E chart – we are currently in the upper quartile. Not Cheap!


The graph below is pretty sweet too….good work Data Diary.

By: Pragcap

Good stuff here from our friends at Data Diary who have pointed out a chart of valuations during a bear market.  Many investors have been quick to note that many valuation metrics remain quite high (such as Shiller’s 10 year PE) and that the current bear market never hit historical trough levels seen at the bottom of other major bear market lows.  This chart shows the average valuation contraction of previous bear markets.  According to this data we could have quite a ways lower to go before a true bottom is formed:

Another chart for the annals – this one from Sitka Pacific Capital Management (see the original article here).

Bear market valuation contractions THE TOPOGRAPHY OF BEAR MARKET VALUATIONS

Categories: View From Up Top

Are The Wheels About To Come Off The Chinese Band-Wagon?

May 4, 2010 Leave a comment

The prospect of a Chinese slowdown and major drop in equity and real estate prices is beginning to gain traction. For the longest time it has seemed this giant would never falter, until now. We are beginning to see the cracks in the foundation. Don't get me wrong, China, could be and likely is the future of global economic growth. However, with that said, they will not be unlike any other developing economy throughout human history…..there will be set-backs and some of them could be very significant.

If a comparison was to be made with their current situation to that of the  U.S. ,many decades ago, you would find that the States experienced rapid cycling between expansions and contractions coupled with extremely volatile stock market activity. I might add, China apparently hasn't had a recession in 30+ years? The topic of that anomaly, which is NOT organic, can be saved for another day. At any rate, it would be perfectly normal for set-backs to occur.

Chinese authorities just raised the reserve ratio requirements 50bps for the third time this year. Make no mistake about it……Chinese policymakers are acting as every other global monetary decision maker has throughout history by taking action AFTER the evidence has presented itself. There is very little preventative medicine when it comes to monetary policy, only (over)reactions.

Last night, manufacturing in China dipped according to the purchasing managers index to 55.4 from 57 in March. If a slowdown is in its infancy, this will not be an isolated event and economic numbers will begin trending lower. Stay tuned….

Aside from shorting some of the U.S. listed adr's I had recently suggested shorting the Australian Dollar(AUDUSD) as a good way to play a Chinese retraction.The Aussie at the time of this writing is  shedding nearly 2% on the heels of China's weakness and the RBA decision to bump rates to 4.5%.

Short AUDUSD – A Way To Play A Chinese Market Drop

April 28, 2010 Leave a comment

I like this idea from three standpoints – Technical, Fundamental, and as a solid Risk/Reward trade. A way to play a short coming in the Chinese stock market is to short the Australian Dollar vs U.S. Dollar (AUDUSD). Australia's economic condition, without the help of China's insatiable appetite for commodities, wouldn't be in nearly as good a shape as it is. It has been the carry-trade de jour since the March 2009 bottom. With its huge interest rate differential vs. other major pairs and strong chinese fundamentals it has made a great deal of sense to own this currency.

But what if China is on the cusp of faltering? The Shanghai Index doesn't look so hot these days and in fact stopped participating in the global re-inflation trade back in August. An ominous topping triangle pattern has been in formation since and now looks to be breaking downward. Markets tend to lead economies and if this is the case then the Chinese economy could be on the brink of a cool-down. If that is the case then they will no longer be gobbling down commodities and therefore putting the brakes on the Australian exporting machine.

The interest rate differential will be something to contend with and in fact eat into profits a bit, but I think its still a good way to play a China breakdown.

Notice how closely the Shanghai and Aussie trade with one another. The actual correlation isn't what statiticians would call high, but it's pretty obvious using the eyeball test that these do in fact trade in proximity to one another. Eyeball test……fundamental connection……I'm satisfied its a good play. A new high, above 0.9387, would be the protective stop and a reasonable target of 0.8600 provides, if a trade is placed right now, an approximate 4 to 1 Risk/Reward opportunity exist……odds I'll take any day!

  Spx vs shanghai         Aud shanghai