No Doubt: The Worst is Yet to Come
Can Protectionism be avoided?
By Frank Barbera CMT. February 17, 2009
Over the weekend, ‘60 Minutes’ did a lengthy piece on the “Buy American” clause which the Obama Administration at one point seemed likely to be including in the forthcoming stimulus package. Originally, the language in the bill stipulated that government funded projects use only US-made materials (steel etc.). Across the US, Labor Unions have understandably wanted the strong ‘Buy America’ provision, while companies with large-scale exports have opposed the initiative. During his campaign, Obama ads which ran in widely ‘labor-heavy’ states used the slogan, “Buy American, Vote Obama”. In viewing the 60 Minutes report, it was easy to see both points of view, with a senior executive at Nucor arguing that Chinese dumping of cheap steel is costing American jobs, counter-pointed by the CEO of Caterpillar who suggested that this kind of language could open the door to new found Trade Wars with other countries viewing the language as a move toward protectionism by the United States.
To that end, President Obama seems to be coming to the conclusion that risking this kind of bearish signal is simply too high a gamble and has now opted to settle on a middle of the road, watered down version in which the Buy American language only requires that the government spend funds in ways that which do not violate U.S. trade agreements. When interviewed, President Obama said that his change was prompted by concerns that tough ‘Buy American’ requirements could spark international trade wars. Speaking with ABC News, Obama stated that he was against provisions that ‘signal protectionism’ stating, “I think that would be a mistake right now. That is a potential source of trade wars that we can’t afford at a time when trade is sinking all across the globe, -- a downward protectionist spiral could be very dangerous.”
Well, for Mr. Obama this was a really important ‘big decision’ which in this case, he has made the correct move. This is not to say that the US has ever enjoyed anything approaching genuine ‘free-trade.’ In my opinion, all of the academic studies conducted over the last few decades on the benefits of free trade were close to horse manure, as in the real world I entirely agree with the executive from Nucor that free trade has been primarily an academic fiction. In the case of the United States, the executive decision making for the last few decades has not been “for and of” the benefit of the people, but ‘for and of’ the benefit of US multi-national corporations seeking short sighted gains in quarter-to-quarter earnings per share. Make no mistake, it has been in the name of corporate greed, and not the welfare of the American people, that large scale outsourcing had been allowed to flourish unchecked, with the US Manufacturing base dismantled, bought and paid for by corporate lobbyists.
Thus to those Americans now losing jobs to low cost, unfair foreign competition, the outrage is palable, justified and understandable as too many Americans have been ‘thrown under the bus’ by the very corporations they work for. So the issue here becomes not whether there is a ‘right’ or ‘wrong’ at work. American workers have been wronged for far too long by short-sighted ‘profit maximizing’ policies thinly cloaked behind a veil of non-real world academic studies. Instead, the question of the day becomes, is “now’ the time to begin unwinding these policies with strong language; and on the matter of the timing issue, it is undoubtedly true that including potentially provocative language at a time when world trade is under massive pressure and the US is massively beholden to its foreign creditors, on this score, the timing is poor and Obama has likely made the right call.
If foreign creditors were to backlash against a change in the existing (unfair) terms of trade, simply boycotting government bond auctions in the coming months could send long term interest rates thru the roof and the US Dollar into a free fall. The resulting economic carnage from a currency crisis would make the entire recession seen to date as but the opening act of an even larger economic melt down. So, on that score, with the US moving to a Keynesian based ‘Deficit Spending” – “Solution” to the current problem - it is no time to begin what could only become yet another powerful and escalating tragedy. In the end, as we have noted for years, the specter of a currency crisis still looms large as the current stimulus spending and resulting deficits will more likely than not trigger currency problems two to three years down the line. For the US, and indeed the rest of the developed world, the looming forces of global rebalancing have set us on a path toward continued economic upheaval for some time from which there is likely no ‘pain free’ way out.
On Monday, it was reported that Japan’s GDP contracted at the fastest pace, (a 12.7% year over year rate of change) not seen since late 1974. Things are getting undeniably worse, and whether the US and indeed the rest of the world will be able to resist the cries for protectionism under today’s extreme economic circumstances is very questionable. For now, a first brush with protectionism seems to have been averted.
California to begin layoff proceedings today
By JUDY LIN, The Associated Press
“We are dealing with a catastrophe of unbelievable proportions," said state Sen. Alan Lowenthal, a Democrat from Long Beach and chairman of the Senate transportation committee.”
At home, the bad news just continues to pour in, with states like California grappling with massive budget deficits and today announcing more then 20,000 jobs cuts. What’s more, in the weeks ahead, much higher taxes will be enacted driving up the burden on incomes at precisely the time when most working people can least afford it. This is a form of state-government ‘protectionism’ that can only trigger a ‘fight or flight’ response. For many residents of states raising taxes, the net outcome will be to drive people elsewhere, into other states which are not as predatory. In the end, there is a real question whether revenues will increase or decrease as a result of higher taxes. This obvious logic seems lost on many states lawmakers who have recklessly allowed these deficits to develop during the good times by not setting any money for a rainy day. I guess to many lawmakers were ‘die hard’ housing bulls, never expecting another down turn in the residential housing market. Was this really that hard to envision? At any rate, the path ahead for many states is bleak, and will likely include broad scale downsizing of state budgets as severe belt tightening is now the only real way out. For those holding Municipal Bonds, we point out the chart below of the Nuveen Muni Bond Index. At the moment, the index is still above the 20, 50 and 200 day moving averages, having enjoyed an eight week advance.
Above: Nuveen Muni Bond Index with 20 day, 50 day, and 200 day MA.
Yet while Muni Bonds have enjoyed a solid recovery so far, as can be seen in the chart below, the medium term 25 day RSI is now very heavily overbought. For Muni’s, this is high risk territory and will likely yield an important longer range sell signal. In our view, with a number of states getting ready to increase fee’s and taxes, revenues will likely falter even more in the months ahead. This is the old concept of “raising taxes in a recession” and it is ultra regressive.
As a result, we believe that the Nuveen Muni Bond Index will in the weeks ahead begin a new, multi month decline back down to the prior lows and ultimately, probably to levels not seen in many years. The potential ‘sell signal’ forming on Muni’s is one indication that the current economic down turn still has a long way to go and will be with us the bulk of 2009 if not into 2010. Speaking of overbought conditions, we also monitor a number of the fashionable trades from last year, perhaps none of which was more fashionable than BRIC. Of course, BRIC is the acronym for Brazil, Russia, India, China some of the formerly fast growing corners of the world. Yet, in my view, BRIC is now also quite substantially overbought. As can be seen in the chart below, over the balance of the last 10 weeks, the unweighted GST Index that tracks BRIC has traced out a textbook Elliott “A-B-C” counter trend rally. This is perfect Wave 4 price structure and it implies that another major breakdown is dead ahead. In my view, the prices for both Steel and Copper, along with a host of other base metals are squarely in the cross-hairs of the major gun sights. For Copper at $1.55, the price structure suggests that another major break down is possible, (likely) with downside objectives over the medium term to between $.90 per pound and $1.10 per pound. Ultimately, a decline below $.80 is possible as the global recession deepens. For BRIC, this will imply substantial downside price pressure on key markets like Brazil and China.
Above: longer range unweighted view of BRIC Markets (Brazil, Russia, India, China)
As can be seen by the 14 day RSI on BRIC, the indicator is already above +70 which in a classic bear market is usually a heavily overbought value. Note the scale shift to the downside which is very obvious for the BRIC markets. During the bull market phase, RSI traded in a range primarily bounded by +80 and +40, while during the bear market, the range has shifted down (see dashed lines right side of chart) to +20 and +60. At the moment, the gauge is not far below the peak seen in May of last year and we all know what followed that high, and it wasn’t pretty.
On the recession front, the last few days have seen a number of once high flying companies moving into, or nearing imminent bankruptcy. This is always the reality in bear markets where the excesses of the prior cycle, starting with the over-leveraged, over-indebted fall upon hard times first. Perhaps few people in the last few decades have symbolized success and the ability to gain ground (using leverage) as well as Donald Trump. Unfortunately, leverage is one of the instruments that can cut both ways, and last week, “the Donald” and his daughter Ivanka both resigned from Trumps Casino Group. Today, the Trump Entertainment Resorts (TRMP) filed bankruptcy for the third time.
On the luckier side of today’s news, was Sirius Satellite where beleaguered CEO Mel Karmazin found a lifeline in John Malone, CEO of Liberty Media which agreed to lend Sirius $530 million dollars with a 15% interest rate payable in December 2012. The loan comes just in time as Sirius was rumored to be considering filing bankruptcy as early as today. Once an ultra high flier at more than $70 per share, Sirius Satellite resides today below $.20.
Above: SIX FlAGS (SIX) Above: SIRIUS SATELLITE RADIO (SIRI)
Other former high fliers that are also on the brink of disaster include Landry’s Restaurants (LNY) which has approximately 17,000 employees and owns familiar names such as The Charthouse and Rainforest Café, Krispy Kreme (KKD) which has 4,000 employee’s and now hovers just over $1.00 from an August 22nd, 2003 peak of $49.00. Six Flags (SIX- $.30) is also at great risk, with over 40,000 employees; the company has been losing money and selling off properties to try and pay down debt over the last two years. For Six Flags, this summer vacation season will probably be a key ‘make or break’ outcome for a company that has seen its stock price move lower for the balance of the last 10 years. With much doubt, the trend in consumer spending appears to be accelerating, as sales for even the strongest franchises are under pressure. Take French cosmetic maker L'Oreal – with cosmetics a fairly ‘recession’ proof staple. On Monday, L’Oreal stated that annual net profit fell 27% percent after disappointing American holiday sales, although the figures from a year earlier were boosted by a one-off gain. The maker of Maybelline mascara and Lancome fragrances posted a net profit of Euro $1.95 billion weighed down by Euro $115 million of special charges. This result compared to Euro$2.66 billion in profit in 2007.
Above: French cosmetics maker, L’Oreal (plotted in Euro’s) down over 50% from its early 2008 peak and testing multi-year lows.
In my view, while some might argue the point on whether ‘women’s cosmetics’ are a staple item, it is quite telling when normally big money machines like L’Oreal see sales falling off the cliff. Looking through the stock market, we see continued signs of a near absence of hope where it comes to discretionary spending. Over the last few years, we have tracked an index of 30 stocks whose products represent the kind of spending which could be described as ‘discretionary.’ We call it the GST Leisure and Discretionary Spending Index and it includes names like Carnival Cruises, Royal Carribean, Callaway Golf, World Wrestling, Sirius Satellite, Steinway, Starbucks, Electronic Arts, Gaylord Entertainment, Luxottica, Constellation Brands, and Disney among others. As can be seen in the chart below, this index rolled over about three months before the stock market high in October 2007 and really broke down very badly during the market crash of September-October 2009.
Above: Top clip, Leisure and Discretionary Spending Index versus S&P (lower clip)
Above: Leisure and Discretionary Spending, then S&P, the R/S Line making new lows.
As can be seen in the close up view shown above, the Leisure and Discretionary Spending Index is already virtually at new lows, with the relative strength versus S&P 500 making new multi-year lows over the last few days. Again, this is not the kind of action that one would expect to see if a turnaround were anywhere on the horizon. Sticking with the theme of ‘discretionary spending’ we see that even at the highest end, there is huge change taking place on the margin. Of course, what could be more ‘discretionary’ than the world of Fine Art. Often a repository of long term investment dollars, the bull market, or should I say, mania in Art prices that took place in the last decade was heavily funded by the growth of hedge fund bonuses and real estate moguls. Two items that these days are in full retreat. No surprise then, that prices are coming down across a wide range of the ART World where back in mid November, 2008, Christies had to call a halt to an auction of the works of Francis Bacon, where bids for some of the best pieces were nowhere close to expectations.
November 13, 2008
Art market in shock as Christie's calls halt to Francis Bacon sale
Over the last few months, a number of auctions have produced results where the number of unsold works has totaled between 30 to 40% of the total lots up for auction. With very few exceptions, prices have been in a pronounced tailspin, especially for those contemporary artists which has seen prices skyrocket in a fashion that would have made even the hottest internet stock blush. In an essay for Prospect Magazine by Ben Lewis, A second tulip mania, December 2008, Mr. Lewis notes that:
“Even these numbers understate the incredible tulip-like increases in the value of the hottest artists. The Chinese painter Zhang Xiaogang saw his work appreciate 6,000 times, from $1,000 to $6m (1999-2008); work by the American artist Richard Prince went up 60 to 80 times (2003-2008). The German painter Anselm Reyle was unknown in 2003; you could have picked up one of his stripe paintings for €14,000. Now he has a studio with 60 assistants turning them out for about €200,000 each. Any figures for the whole contemporary art market are guesswork, though Christie's chief executive, Ed Dolman, recently estimated that it had grown in value from $4bn a year to somewhere between $20-30bn in the past eight years.
The latest round of contemporary art auctions in London has gone badly. In October, the Phillips de Pury sale made only £5m—a quarter of the minimum estimate; at Christie's almost half the lots didn't sell; and an air of denial hung over the Frieze art fair like a fog. More and more of such work has been churned out by cookie-cutter artists without regard to originality or aesthetic merit. Economist and historian of financial crashes, Edward Chancellor, observed recently: Most contemporary art is inherently worthless. It is not like Titian and other old masters of which there are few and whose value will not fall away. It's like subprime CDOs."
Above: Christies of London plumbing the depths of multi-year lows down over 80% already from the peak.
Above: Sotheby’s (BID) also down over 80% from the peak.
No surprise that the major players in the ART World have seen their stock prices collapse with stocks like Sotheby’s and Christies still below long term moving averages and still showing downside continuation patterns. In fact, that is the one clear theme we see in looking at the markets these days, that the unwinding of prior excesses still has a long way to go, with the US Stock market likely now in the early stages of a new breakdown move, a move which Asian and European markets are already telegraphing. In our work, we track the behavior of options prices quite closely as a gauge of market bottoms and right now, we see an absence of fear, high levels of complacency and overbought readings on our CBOE Options A/D Ratio, all-in-all, a strong signal that the worst is yet to come.
Above: CBOE Options A/D Ratio with 9 week RSI. RSI is now overbought suggesting a downside reversal lies ahead, this is a good indication that the stock market may well break down.
That’s all for now,
© 2009 Frank Barbera