As readers know, I was in Europe a few weeks ago, making a LOT of presentations. My London-based partners seem to feel that an hour or two of down time is wasted and only for sissies. I learn as much as I impart, and come away with lots of interesting information. Every now and then I learn something that gets into the category of what in the wide, wide world of (multiple expletives deleted) economics is going on? Subprime was like that when I first read about it. Could you really design CDOs that were so patently absurd and then sell them to the Europeans and Asians? Turns out you could.
Last week, Niels Jensen (head of Absolute Return Partners) and I were talking with a variety of pension funds. They started telling us about this thing called Solvency II. Outside the arcane world of European pension funds and insurance companies, it is not on the radar screen of most people. But it may be one of the more explosive problems in our future. Cutting to the chase, the new rules require insurance companies and pension funds to buy more bonds to match their liabilities. But as yields go down they are required to buy yet MORE bonds and then yields go down some more. And so on. The possibility of serious defaults by these same pension funds in the wake of these new rules (setting aside whether it makes sense to actually require pension funds to set aside enough assets to pay their obligations) is all too real. And more pervasive than we now think.
Niels, in his latest Absolute Return Letter, wrote up what we learned, and it is Today’s Outside the Box. Wonder why yields in Europe are falling? Read on.
“I am not sure if policy makers understand how potentially dangerous this situation is. We are on the road to insolvency. And, even if pension providers manage to stay solvent, future generations of retirees are likely to run into serious financial difficulties as their retirement savings earn next to nothing, because our political leaders forced new rules on the industry, the implications of which they did not grasp.”
I know, I am just a bundle of fun. But this really is stuff we should be aware of. And tomorrow I am off to discuss this and more (with some serious play time thrown in) at the Barefoot Ranch Symposium. Enjoy your week!
Your ready for some R&R analyst,
One of my favorite analysts is Albert Edwards of Societe Generale in London. Acerbic, witty and brilliant. Emphasis on brilliant. The fact that he is a Doppelganger for James Montier (who long time readers are well acquainted with) is a coincidence (or he would say vice versa). I only kind of have permission to forward this note to you, but better to ask forgiveness… So, this week he is our Outside the Box. And a short but good one he is.
I am in Amsterdam and it is late, but deadlines have no time line. Tomorrow more work on the book. It is getting close to the end. Most books are finished when the authors quit in disgust. How many edits can you do? I am close.
I wonder late at night, with maybe a few too many glasses of wine, why I feel like a book is so much more than an e-letter. Really? The last ten years of what I have written are on the archives. Good (ok, sometimes really good) is there. But some are an embarrassment. What was I thinking?
But somehow in my Old World brain, a book is more than a weekly letter. It is somehow more permanent than an "online" letter. Which may be archived forever. The book is "paper" and may be around for a few years. But the online version is here for a long time.
I know that is stupid. Really I do. But what is a 61 year old mind to do? A strange world we live in.
It is really time to hit the send button. More than you know! The conversation tonight has been too deep!
Your working on Labor Day analyst,
There were a lot of questions last week when I wrote about public pensions. So for this week’s Outside the Box, I offer you some more information about how bad the state deficit situation is, and for your specific state. States are having to cut more than 1% of national GDP in fiscal 2011, as federal stimulus money is slowly drying up. And that is just states. Local municipalities and schools have a similar problem. And then add on the possibility of the Bush tax cuts going away and that is a very serious situation. It is why I am so concerned and vocal about the need for the Bush tax cuts to be extended for at least one year until the economy is growing above stall speed. The headwinds from cities and states are severe, as you can see.
Basically, the states were profligate going into the downturn, and they have enormous costs going forward, so even for 2011 and 2012 they are going to have massive budget deficits. Some, like Illinois and Nevada have shortfalls of 40-50%. That is simply not sustainable.
The research is from the Center on Budget and Policy Priorities at http://www.cbpp.org/cms/index.cfm?fa=view&id=711 . For those in the US, I think you will find it interesting to see how your state is doing. For those outside, look and see how much the problem is in terms of GDP and realize what impact that is going to have on the overall US economy.
I am at the airport in Omaha with Trey on a trip looking at schools, and on to Illinois tonight. It is a lot cooler here than in Dallas, at least.
Your data watching analyst,
There is some debate about whether the recession is over. The National Bureau of Economic Research (NBER), a non-governmental organization made up of economists, has a committee that meets and decides after the fact when recessions begin and when they end. Martin Feldstein, the former president of the NBER, focusing on the job market, said last November that "the current downturn is likely to last much longer than previous downturns ... We will be lucky to see the recession end in 2009."
I have called this recovery a Statistical Recovery, in that some of the normal metrics are only getting better in comparison to very bad numbers a year ago. It is likely that we will still have not recovered to the level of economic activity we enjoyed at the peak of the last cycle over two years ago on a nominal basis. This is highly unusual and lengthy for a recession.
William Hester of the Hussman Funds (www.hussmanfunds.com) has written a very thorough analysis of what the NBER committee will be looking at to tell us whether the recession is over or not. Not surprisingly, the data is to as conclusive as one might like. Some of the tings which they look at seem to clearly suggest the recession is over, and was over last summer. Others are not so clear, which is why Feldstein is not ready to say the recession is over.
I think you will find this Hester's analysis interesting as this week's edition of Outside the Box. I especially liked the charts, as it gave me some insights into past recoveries. All the best, and have a great week!
Let me welcome you to a new year of Outside the Box. I doubt we will have trouble finding interesting commentary this year, as there are many things that could happen that demand our attention. We start with a short column by Ambrose Evans-Pritchard of the London Telegraph giving us a quick run down of the problems faced around the globe. He thinks the #1 problem is Japan, and I more or less agree. I have written about Japan many times in the past few years. In my speeches I refer to Japan as a bug in search of a windshield. I am not so sure about the timing, however, as the economic and fiscal insanity that is Japan may be able to go on for longer than many think possible. But to me it is not a question of whether there will be a crisis, but when there will be one. This year? 2011? 2012? I doubt Japan makes it to the middle of the decade with a very serious and sad day of reckoning.
The downside to the continuation of running massive deficits is that when the break does come, it will be all the more painful and difficult to deal with as the debt mounts. If there is an upside, it is for the rest of the world to see what can happen to a developed country like Japan when massive deficits are allowed to pile up one after another. It will be a morality play writ large upon the walls, which cannot be dismissed.
But as Ambrose points out, it is not just Japan. There are problems all over the developed world. He does end on the encouraging note that at some point we hit bottom and will find the buying opportunity of our lives.
This is a little darker than most of the cheery forecasts of late, but we need to think of the world at large and how we are all connected.
This Friday I write my annual forecast letter. It will be more upbeat than last year's. Until then, have a great week.
"Why" many ask, "is the stock market going up when the bond market is telling us the recovery will be tepid? Isn't there a disconnect?" And the answer is that there is, and this week good friend and fishing buddy Paul McCulley of PIMCO fame discusses that very topic with his usual insight and wit. He poses the conundrum that those expecting a "V" shaped recovery have pushed risk assets up quite high, and that the real risk to their position is that they in fact get a "V" shaped recovery. And yet, they could go higher and into bubble territory.
For the policy wonks among you, I offer a link to a recent paper by the Cleveland Fed, which suggests that the Fed could hold rates lower for far longer than we would think normal. Which makes What Paul writes even more important to understand. http://www.clevelandfed.org/research/commentary/2009/0809.cfm
I think you will find this a very interesting read. Meanwhile, I am off to Philadelphia where a team from Dallas was treated very well last night. I hope I get the same warm reception. And then to Orlando and back to Dallas. Have a great week.
Your just trying to puzzle it all out analyst,
This week I offer something unusual for outside the Box, in that I agree on almost all points with my friend David Rosenberg, except he tells it so much better than your humble analyst. David was the former Chief Economist at the former Merrill Lynch (ah, Mother Merrill, we barely knew ye.) and is now Chief Economist at Gluskin Sheff + Associates Inc., which is one of Canada's pre-eminent wealth management firms. Founded in 1984, they manage $4.4 billion. (For those who wonder, David left NYS to return home to Toronto. Much shorter commute time.) David looks at the recent stock market run-up, why he likes corporate bonds better than stocks, what is lagging with the consumer and a lot more. It is a very pithy read.
Have a good week, I am off to a beach in a few days, but there will be an e-letter this Friday. You are in good hands.
Your looking forward to reading with drinks with little umbrellas analyst,