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Solyndra for Dummies


I consider it almost a patriotic duty to ensure that the Solyndra scandal gets lots of coverage. It is a classic case of what can happen when politicians (of any stripe) and politically-correct enthusiasts (e.g., the green lobby) figure out ways to tap the public purse to fund their favorite initiatives. Industrial policy (of all kinds) is about the only sure way to ensure that taxpayer's money is wasted, often at the expense of more promising but less PC ventures. Be sure to see the four related cartoons here. HT: Glenn Reynolds

I believe strongly that any good idea worth its salt will have no trouble locating funding. As the late Jude Wanniski often argued, the supply of capital in the world is virtually unlimited if you have a good and profitable idea. Governments should never play the role of venture capitalist.

UPDATE (Sep. 14): This is taking on the proportions of a major scandal. See today's ABC News report here. Crony capitalism at its finest.

Money supply and panic update



If the supply of dollars (e.g., M2) is growing at an unprecedented pace (25.7% annualized over the past three months) and the reserves required to support a huge increase in bank deposits are literally exploding (up at a 96% annualized pace in the past three months—see top chart above), but the value of the dollar is rising (see bottom chart above), what can we infer about the demand for dollars?

That's easy: the demand for dollars is outstripping even the exploding supply of dollars.


If the interest rate on 3-mo. T-bills (the worlds preeminent risk-free asset) is effectively zero (see above chart), and the yield on 10-yr Treasuries is at historically low levels, what does this tell us?

That's easy: the demand for safety is extreme, and the price of safety is extremely high.


If the price of gold is at all-time nominal highs, and very close to all-time inflation-adjusted highs, measured against any currency on the planet, what does this tell us?

That's easy: markets are willing to pay an extremely high price for an asset that can't be debauched by politicians or central banks. No one gets the benefit of the doubt these days.

And what does all this tell us?

One: If the supply of dollars is not rising faster than the demand for dollars, then this is not an inflation story that is unfolding. The Fed is not making a mistake. In fact, the Fed has been preemptively supplying plenty of liquidity to the banking system, and that's exactly what the banking system has needed.

Two: If the demand for dollars and the safety of T-bills and gold is huge, there must be something out there that is scaring the bejeesus out of the world's capital markets. As I've been detailing in recent posts, everything points to the Eurozone sovereign debt crisis as the proximate cause for the panic that has overtaken markets in recent weeks. Governments all over the world have grown too big, too fast, and they have squandered the proceeds of all the debt they have taken on; the Eurozone is just the first to be forced to come to terms with this reality.

Three: If there's one big thing lacking right now in the world, it is leadership. The Greeks need to shut up, grow up, and tighten their belts, or just admit that they are scoundrels and default. The ECB needs to stop trying to bail out the slackers in the eurozone, and maybe that means letting some banks fail; after all, bank failures are not the end of the world. Obama needs to channel Clinton and triangulate, and stop trying to blame the Republicans and the Tea Party for the results of his abysmal economic policies. California's Gov. Brown needs to just say NO to the unions and their demands for outrageous retirement benefits—let's have some public sector austerity, please.

Europe is the main source of fear



The top chart compares the yield on 10-yr Treasuries (white line) with the level of the Euro Stoxx 50 Index, while the bottom chart compares the same yield on the 10-yr with the level of the S&P 500. 10-yr Treasuries are the beneficiaries of the risks plaguing economies (or the destination of capital flight as the case may be). The correlation between 10-yrs and European stocks is 0.97, while the correlation between 10-yrs and US stocks is 0.89. Both highly correlated, but the fit with European stocks seems pretty rock solid and constant, much more so than with US stocks. Once again, it appears that "it's Europe, stupid" that is the driving force these days.

Europeans rush for the exits

The panic in Europe is palpable, and can be seen in these charts:


2-yr eurozone swap spreads have soared to almost 100 bps, nearly as high as they were at the peak of the 2008 global financial panic. U.S. swap spreads are rising in sympathy, or simply out of fear that the Eurozone mess could end up infecting U.S. markets. Spreads here are still pretty close to what would be considered normal, however.


The focal point of the panic is Greece. 2-yr Greek government yields are going vertical, as Greek government debt now sells for about 45 cents on the dollar. This implies the near-certainty of a substantial default or restructuring of Greek debt, which totals some $450 billion. This will be the biggest default/restructuring in history. Greece is being effectively shut out of the capital markets, and the Greek populace apparently could care less, preferring instead to protest even the mention of austerity measures. Something very big will have to happen to prevent this default, and it's nowhere to be seen right now.


The euro has finally slumped against the dollar, falling over 5% since August 29th, and the dollar is up almost 5% against a basket of major currencies. The dollar is now the only cheap safe haven left, since the yen and swiss franc both reached highs that were seen as untenable. The news out of the ECB today is that tightenings are off the table and an easing of policy is on the way. This is facilitating the decline of the euro and will ameliorate the pain of defaults, although it's likely to come at the cost of higher inflation down the road. Regardless, what we are seeing here is just the eventual fallout of bloated governments in Europe that have borrowed too much money and squandered it. The money was squandered—and effectively lost—long ago (see my thoughts on what really happens in a default here), and now it's a game of musical chairs to see who will be left holding the bag when the music stops as it will have to sooner or later.


The Euro Stoxx 50 index  is down by about one-third from its recent highs, and is only 17% above its March 2009 lows. Very bad news is being priced in, as the market braces for a nasty recession.


The Euro Stoxx Banks index has essentially given up all its gains since the March 2009 lows. Prices now reflect a decline of over 80% from pre-recession highs. This is a catastrophe, much worse than the 68% decline in U.S. bank stocks over the same period. The banks have paid a huge price for their mistaken belief that sovereign debt was a bullet-proof investment. The only question now is whether their capital will be wiped out and they will cease to exist. But as far as the market is concerned, we are very close to seeing that happen. Will this be the end of the world as we know it? I doubt it. Things were even worse about three years ago, yet the world has managed a decent recovery to date.

One very important thing to keep in mind: many trillions of market cap have been wiped out in the past few months, much more than the value of PIIGS debt that could be defaulted on in a worst-case scenario. As far as the market is concerned, the worst-case PIIGS scenario has already happened. Yet life goes on. There are no mass closings of factories in Europe, no mass firings, the wheels of commerce continue to turn, the traffic continues to jam around rush hour.

Inventory and other recoveries


It may seem like a minor milestone, but this chart of wholesaler inventories shows that there has been a complete recovery (some might even call it a V-shaped recovery) following the great recession of 2008-9. This is an important barometer of business confidence and of economic conditions in general. Things are getting back to normal.

Just for fun I'll include a variety of other charts that show some complete or near-complete recoveries in other areas:


Nominal GDP has fully recovered and then some. Of course, much of this recovery is due to inflation. Real GDP as of June '11 was still 0.5% below its Dec. '07 high, but it will very likely exceed that high before the end of this year.


U.S. exports of goods and services have fully recovered and then some. Exports are now at record levels both nominally and as a percent of GDP, continuing the many-decades trend toward increased globalization. The U.S. economy has never been so integrated into the rest of the world. The export sector has never been such an important part of the economy. We are recovering and adapting in ways we never imagined before.


Retail sales have fully recovered and then some. Real retail sales are only about 3% below their prior high. Both recoveries are impressive given that the total number of people working today is still almost 5% less than at the peak in early 2008. Those still working are therefore more productive than their former counterparts.


2-yr swap spreads have recovered to levels that are consistent with a normally growing economy and healthy financial markets. This is extremely important, since swap spreads (see primer here for more info) are excellent, forward-looking indicators of financial market health, systemic risk, and general liquidity conditions.


New orders for capital goods (a good proxy for business investment spending) are only 3% shy of reaching a new high. Businesses have almost completely recovered from the shock to confidence that occurred in 2008. Capital spending is the seed corn of future productivity gains, so this augurs well for future growth.


After-tax corporate profits have recovered in spectacular fashion, and are 30% higher today than their pre-recession high. Businesses have undergone tremendous restructuring efforts, and productivity is high. This gives businesses an important cushion against adversity, and it provides the fuel for new job-creating opportunities in the future.



The first of the two charts above shows the total oil and gas rotary rig count in the U.S., which is within inches of recovering to its former highs. The second chart shows the global oil and gas rotary rig count which has already achieved that objective. The recovery in oil and gas exploration efforts is significant, considering that oil prices are still some 40% below their peak of 2008. This offers the promise that oil supplies will at least meet the world's growing demand for oil, thus keeping prices from returning to punishingly high levels. Meanwhile, huge new reserves of natural gas are now being exploited in the U.S., thanks to new drilling techniques, and this has brought natural gas prices down by over 80% from their 2008 peak. The energy outlook is bright.

What all of these charts show is that there has been important if not impressive progress on a number of economic and financial fronts. The financial and economic fundamentals of the U.S. economy have definitely improved and continue to improve in many areas. This contrasts acutely with a) the lowest Treasury yields in history, and b) $1850 gold, both of which are symptomatic of a market that is priced to nearly catastrophic conditions in the near future. Yes, conditions look bad in Europe, and yes, the Obama administration has done a piss-poor job of managing the economy, but are we really facing the end of the world as we know it?



20 bullish charts revisited

Late August last year was a time of rampant pessimism, incessant talk of an imminent double-dip recession, and lots of hand-wringing about the risk of European sovereign debt defaults. The major themes back then were very similar, in fact, to the themes of today. To counter the pessimism, I ran a post just over a year ago with 20 bullish charts, which through sheer good luck coincided almost to the day with the onset of an equity market rally that extended through April of this year. Bullishness was definitely not in vogue back then, and neither is it today. So I thought it might be interesting to revisit those charts to see how the economic fundamentals might have changed. The charts that follow are updated versions of the charts I showed last year, and in the same order, so you can open the original post in a separate window and compare the original to the updated chart and commentary.


Last year I noted that strength in new orders for capital goods reflected rising confidence on the part of business, and it also augured well for future growth. Since then, capital spending has continued to rise at an impressive rate, forming a clear V-shaped recovery. This indicator continues to be very bullish for the economy's future prospects.


Rising industrial production was a bullish indicator last year, and it continues to move in a positive direction. Granted, the pace of increase has slowed somewhat from what it was a year ago, and this coincides with what we know has been a slowdown in the economy's growth rate in the first half of this year.


This index of spot commodity prices has risen almost 20% since late August of last year. Back then, I noted that rising commodity prices reflect "strong growth in global demand and/or accommodative monetary policies worldwide [and] all but preclude the deflation that so many are worried about, and rule out the existence of a double-dip recession." That remains the case today.


Trade was bullish for growth last year and it continues to be today. Exports are growing at strong double-digit rates, and have surpassed their pre-recession highs. The global economy is likely still expanding, and this provides a strong backdrop for continued U.S. growth.



Corporate credit spreads today are 30-50 bps higher than they were in late August '10, and they are trading at levels which have preceded recessions in the past. This would be an obvious red flag if it weren't for the fact that spreads have widened primarily because Treasury yields have plunged to historic lows. The average yield on a high-yield bond hasn't risen at all over the past year, and has in fact dropped from 8.5% to 7.75%. Investment grade bond yields over the same period have risen marginally however, from 4.3% to 4.5%. I don't think this adds up to an obvious negative, but it is certainly less positive, and it undoubtedly reflects the threat of collateral damage from possible Eurozone sovereign bond defaults. Regardless, the fact that 2-yr swap spreads are still within a range that would be considered "normal" (15-35 bps) helps offset the marginal deterioration in corporate credit spreads. The low level of swap spreads is a good indication that the U.S. banking system is healthy and the level of systemic risk in the U.S. economy is low. The risks are mainly in Europe.



Everything I said last year about the yield curve applies again this year: "The slope of the yield curve has been an excellent leading indicator of recessions and recoveries for many decades. The curve typically flattens or inverts in advance of recessions, but today it is still very far from being flat or inverted. The curve is strongly upward-sloping, which reflects easy money and expectations that monetary policy will eventually need to tighten as the economy improves. We've never seen a recession develop when the curve was this steep and monetary policy was this easy." Although the yield curve today is somewhat less steep than it was a year ago, the real Fed funds rate is more negative, and Fed policy has become even more overtly accommodative than ever, with the Fed having pledged to keep the funds rate very low for at least the next two years. In sum, monetary policy remains a strong reason to expect continued economic growth.


Last year I noted that "the fact that the demand for temporary and part-time workers is steadily increasing may not guarantee a continued recovery, but I think it argues strongly against a double-dip recession being underway." Today we see that demand for temp and part-time workers has been relatively flat in recent months, whereas it was increasing at this time last year. I don't think this is bearish, nor does it rule out a double-dip recession. It most likely reflects the fact that the economy has been in slow-growth mode for most of this year.


Auto sales in the second quarter of this year suffered a setback in the wake of the Japanese tsunami supply-chain disruptions, but they look to be recovering. Despite the rather severe setback, sales are still up 5.6% from their August '10 levels. This remains a positive, but less so, due to the slower pace of growth this year.


Announced corporate layoffs this year are marginally higher than they were a year ago, but they remain at very low levels from an historical perspective. There is no indication here of any meaningful deterioration in the jobs market, especially when combined with the relatively flat behavior of weekly unemployment claims this year.


Last year's comment for the most part still applies today: "China and almost all emerging market economies are growing like gangbusters, and global trade is recovering nicely. What's good for emerging market economies is good for everyone, since the more they produce the more they can buy from us." I note however that the pace of growth in many emerging market economies has declined measurably in the past year. Brazil, for example, has slowed from 9.3% year over year growth last year to 3.1% as of June '11. This remains a positive for the U.S., but less so than before.


Corporate profits have been nothing short of spectacular in recent years, now exceeding all prior records. It's very hard to see a recession developing when profits are robust. Strong profits are the result of significant restructuring and cost-cutting efforts, and that means that a lot can go wrong with the economy before corporations have to undergo significant retrenchment. Looking forward, corporations have significant resources they can mobilize to fund expansion and new job formation, should the political environment and the outlook for the Eurozone improve.


According to this Bloomberg index of financial conditions, there has been some meaningful deterioration in the financial fundamentals in recent months. Moreover, the index today is low enough to signal the possibility of a double-dip recession. Of all the charts reviewed so far, this is the first to clearly signal concern. I would note, however, that the deterioration in financial conditions can be traced directly to the rising risk of Eurozone sovereign defaults, which have introduced great uncertainty into all markets—not to any deterioration in U.S. fundamentals. As I've said before, it's Europe, stupid.



Both of these measures of shipping costs have declined in the past year. From what I gather, this decline has much more to do with a significant increase in shipping capacity in recent years, than with any significant decline in shipping demand. Still, it probably adds up to a modest negative.



Last year at this time, it looked like prices for residential and commercial real estate had bottomed, and I thought that this effectively eliminated real estate and construction as sources of further economic weakness. Since then, prices have drifted a bit lower, and the recovery I hoped to see by now has so far failed to materialize (a fact that is also reflected in the recent decline in the stocks of major home builders). While I continue to expect things to improve, these charts suggest otherwise, but I don't think they are a significant negative. I note that construction spending has been flat so far this year.


Although the year over year growth in the Leading Indicators has dropped a bit since August '10, there is nothing here to suggest the approach of a double-dip recession. On the contrary, this indicator continues to strongly point to continued economic expansion.


The ISM manufacturing index last year was quite a bit stronger than it is today, so there has been some meaningful deterioration in this measure of the economy's growth fundamentals. Nevertheless, the index is still substantially above the levels that in the past have signaled the onset of recession, and is consistent with a modest pickup in growth to the 2-3% range. Additionally, I note that the ISM service index this year is roughly unchanged from its levels of last year.

In conclusion, most of these charts still support a bullish outlook (albeit a less bullish outlook compared to a year ago), especially in the context of a market that once again has become extremely bearish. Although there has been some deterioration in the economy's growth fundamentals over the past year and in recent months, there is still no indication that the economy is at risk of another recession.

Exports are posting impressive growth



The ongoing expansion of U.S. exports continues to be very impressive. As the top chart shows, exports have been growing at strong double-digit rates for over two years, recovering their former pre-recession growth rates and far surpassing their pre-recession high levels. Exports are now at an all-time record 13.3% of GDP, which is almost triple the size of just 25 years ago. This is the mark of an economy that is truly "globalizing."

For the bean counters (hint: whether we have a trade surplus or deficit is largely irrelevant to the overall health of the economy), imports have not grown relative to GDP for quite a few years (a reflection of generally weak domestic demand), while exports continue to grow (a reflection of strong global demand); thus net exports have made a significant contribution to GDP. Reminder to all: given that our imports still exceed our exports (i.e., we still have a trade deficit), if foreigners were to stop purchasing our debt, then they would have no alternative but to purchase more of our goods and services and/or more of our stocks and/or more of our real estate. All the money foreigners earn by selling us goods and services must, at the end of the day, be spent on something here in the U.S. So the concerns that, for example, China might stop purchasing massive quantities of our federal debt are misplaced, since if that were to happen then it is very likely that our exports would increase.

The 30% difference: U.S. vs. Eurozone




These charts help us appreciate just how painful the sovereign debt crisis has been for Europe: Eurozone stocks have underperformed U.S. stocks by almost 30% since the beginning of last year.

It was shortly after the beginning of 2010 that the world began to realize that Greece was in a world of hurt. Greek 2-yr bond yields stood at 3.4% when 2010 got underway, about 200 bps above German 2-yr yields of 1.3%, reflecting a modest degree of caution on the part of investors. By early May 2010, however, that spread had blown out to almost 1800 bps as investors began speculating that a Greek default was becoming likely. Things settled down briefly as other Eurozone countries came to the rescue, but then began to heat up again, culminating in today's spread of a nearly catastrophic 5400 bps.

The top chart above compares the total return on the S&P 500 index (green line) with the total return on the Euro Stoxx 50 index (white line), beginning at the end of 2006 through early this month, on a weekly basis. It should be clear that the two markets were moving almost in lockstep through the end of 2009. The second chart compares the same two indices beginning at the end of 2009 through today, on a daily basis. Here we can see how the performance gap opened up briefly in the first half of last year as the Greek crisis took center stage, and then started widening progressively from the end of August 2010 through today.

To date, the Eurozone's strategy to cope with the sovereign debt crisis has mainly consisted of efforts to spread the cost of a bailout among all the countries, and it shows, because the sovereign debt crisis is acting like a ball and chain on all of Europe. The current market capitalization of  Eurozone stocks is roughly $4.5 trillion; if the Eurozone market had continued to track the performance of the U.S. market, that market cap would be $6.3 trillion today. In other words, the cost of the sovereign debt crisis for Europe has been a staggering $1.8 trillion dollars (and probably much more, since without the eurozone crisis U.S. stocks would likely be trading at substantially higher levels today).

July capex revised upwards


This is an addendum to my previous post on the subject of July capital goods orders. With the Aug. 31st release of factory orders came an upward revision (one more of the many upward revisions to this series in recent years) to the July capital goods data. New orders for capital goods were revised up 0.8%, and are now only 3% below their all-time high, after rising 11.7% in the past year. Once again I'll make the point that this is not the stuff of which recessions are made. It's plain old good news that is being buried beneath the avalanche of angst coming out of Europe.

The Swiss capitulate


This morning the Swiss central bank announced that it will no longer tolerate a continued strengthening of the franc vis a vis the euro, placing a floor of 1.20 on the euro-franc exchange rate. The chart above shows the history of this rate, with the euro now having lost almost 30% of its value against the franc since late 2007.


This next chart shows the value of the dollar vis a vis the yen, with the dollar having lost about 40% of its value against the yen since 2007. Like the Swiss franc, the yen has appreciated so much in recent years that it is probably running out of room on the upside. Commodity currencies like the Canadian dollar and the Aussie dollar have also enjoyed tremendous appreciation, but further upside seems limited. That means that disaffected owners of the euro are essentially limited to the dollar if they want to opt out of the euro. Not surprisingly, the dollar has jumped 3% in the past few days, and is up over 1.5% today on the franc news. In this manner, the bad news coming out of Europe is good news for the dollar.

ISM service sector indices confirm weakness, but not recession




Today's August ISM survey of the service sector added little to what we already knew about the economy. Conditions were on the weak side in August, but since all components (with the exception of back orders) were comfortably above 50 (suggesting expansion), there is no reason to think we are sliding into a recession.