The Correction in the US Equities Markets Nobody Wants to Talk About

Posted on March 17, 2013. Filed under: Companies, Debt Ceiling, Economy, Financial Crisis, Fiscal Cliff, Securities | Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , |

Edgar Perez, Author, The Speed Traders, and Knightmare on Wall Street

Edgar Perez, Author, The Speed Traders, and Knightmare on Wall Street

Stocks in the US markets slipped on Friday, ending the Dow Jones Industrial Average’s (DJIA) longest winning streak since 1996, just after snapping a 10-day run. Data from Thomson Reuters’ Lipper service showed that investors in U.S.-based funds had poured $11.26 billion of new cash into stock funds this last week, the most since late January. The DJIA slipped 25.03 points, or 0.17 percent, to 14,514.11 at the close. Meanwhile, it was announced that the fewest workers on record were fired in January and job openings rebounded, showing employers were gaining confidence the U.S. expansion would be sustained.

According to some pundits, recent market activity is essentially driven by positive corporate earnings. The S&P500 Price/Earnings (PE) ratio is currently slightly high at 16.5, if we compare with past indicators. The median S&P500 Trailing Twelve Months (TTM) PE ratio has been about 14.5 over the last 100 years; average is around 16. It was during much of 2009 when the disconnect between price and TTM earnings was so extreme that the P/E ratio was in triple digits, as high as the 120s. Going back to the 1870’s, the average P/E ratio has been about 15; therefore, the US equity markets are not excessively valued, leaving some room for further growth.

Other pundits point to the Federal Reserve’s determination to continue stimulating the economy with increased liquidity. Mohammed Apabhai, head of Asia trading at Citigroup Global Markets, favors this train of thought. He has noted that there is a 70 percent correlation between stock market performance and liquidity, “whether it’s through the promise of lower rates, QE (Quantitative Easing) or promise of more QE.” The Federal Reserve has launched three rounds of Quantitative Easing since the financial crisis hit in 2008.

More likely, both factors are in play, very good corporate earnings and monetary policy that pushes investors to take risks in equities. So is the earnings momentum sustainable? Unfortunately, savings from the smaller share of the pie from labor, government spending and earnings coming from emerging markets (EM) outside the US are all factors that will be curtailed at some moment. Is the Fed eager to continue being the huge player in this equation? Some of its members are increasingly worried about the effectiveness of the continued QE; if the labor market recovers, as the January numbers showed, the Fed most probably might be ending its bond purchases soon.

As pointed out by James Saft, wages in the US have taken a smaller and smaller piece of the pie; now below 44pc of GDP and dropping, down several percentage points since 1999. That is in part the consequence of globalization and the offshoring of jobs. However, the labor which can be offshored largely has already been and the likely trend is for new manufacturing technologies to start pushing jobs back into the US. As has been of national knowledge as well, there is a real danger of declining government spending. A dollar spent by the government is a dollar that supports household income, and consumption, and of course corporate profits; there will be less dollars starting this month thank to the sequester, a series of spending cuts and tax increases aimed at reducing the budget deficit.

Emerging markets are looking overstretched heading into the second quarter, Barclays Capital said in a report dated March 15, pointing out that the cyclical recoveries in EM have slowed down. Consensus growth forecasts (according to Bloomberg) have been revised down by 0.75 percentage points on average since mid-2012.  EM equities have been slow to react to these developments due partly to the continued inflows into the asset class from retail clients. The correction has started recently and the performance by country year to date has been mixed, but the most pronounced selloffs have been associated with the largest revisions to GDP growth forecasts. Adding to this dire situation, the economies of emerging markets grew at a slower pace in February than the month before, according to HSBC’s monthly purchasing managers’ index. The PMI recorded a level of 52.3, down from 53.8 in January, its lowest since August. The index covers 16 leading emerging markets, including India, Brazil and China, which all saw their rate of growth fall. Investors had been questioning whether emerging markets, whose growth depends in part on exports to mature markets, could continue to expand at fast rates of almost 10% in some cases.

What the equity markets want indeed is stable and/or predictably increasing US profits and the Fed to stay in the bond markets. Saft ironically suggested that markets’ best hope might be a cut in government spending deep enough to kill job growth and indefinitely extend QE, something that nobody else would agree with. Instead, markets would be happy with a bit of positive news today followed by another bit of negative news tomorrow. Unfortunately for the markets, profits will start showing stagnation starting with first quarter results. Federal Reserve said in September 2012, when QE3 was announced, that it would start pumping $40 billion a month to purchase agency mortgage-backed securities (MBS) until the labor market improves substantially. When will the Fed determine that the job market has made enough progress to reduce stimulus? The numbers for February will prove paramount in this regard. As these two important factors converge in a nightmarish scenario, equities markets should beware of the ensuing correction, coming as early as in the second quarter.

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The Fiscal Cliff Debacle: American Exceptionalism Under Attack

Posted on January 2, 2013. Filed under: Debt Ceiling, Economy, Financial Crisis, Fiscal Cliff | Tags: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , |

Madeleine Albright, Edgar Perez and Condoleezza Rice at CME Group's Global Financial Leadership Conference 2012

Edgar Perez with Madeleine Albright and Condoleezza Rice, former U.S. Secretaries of State for Presidents Clinton and Bush, respectively

Last night, the U.S. House of Representatives approved a bill undoing tax increases for more than 99% of households, providing a temporary victory to President Obama and Democrats as Republicans vowed to fight them in the upcoming months for spending cuts in exchange for raising the debt ceiling. The 257-167 vote just before midnight topped a drama-filled day as Republicans initially balked at a bipartisan Senate measure. Ultimately 151 of 236 Republicans voted no. Obama said he’d sign the bill into law.

The final days of the tension surrounding the fiscal cliff of scheduled tax increases and spending cuts illustrated once again the partisan struggle that has made U.S. budget policy unpredictable and prone to crises as deadlines loom. Obama wielded the leverage he gained in his November 6 re-election, securing most of the tax increases he sought without sacrificing the spending cuts he had offered to Republicans in hopes of a larger deficit-reduction grand bargain.

Republicans immediately turned to their next battle, a bid to use the need to raise the nation’s $16.4 trillion debt ceiling to force Obama to accept cuts in entitlement programs such as Medicare. Congress must act as early as mid-February to prevent a default and the dispute may reprise a similar August 2011 episode that led to a downgrade of the U.S. credit rating.

Is the U.S. able to continue giving lessons in American exceptionalism to a world that still respects and admire its past and present? How to explain to the world that current representatives of the American people are able to drive the country so close to a fiscal cliff, potentially dragging the rest of the world? No doubt the majority of Americans have stared at this show with disbelief and puzzlement. Until not so long ago, Americans believed politicians wouldn’t make things so difficult and would reach instead a measured and timely deal. Things didn’t have to go this far to technically miss the deadline.

The answer can be found inside our legal system through the constitution and its twenty seven amendments. In this particular case, section 4 of the fourteenth amendment to the United States Constitution gives the President unilateral authority to raise or ignore the national debt ceiling, and that if challenged the Supreme Court would likely rule in favor of expanded executive power or dismiss the case altogether for lack of standing, as argued by Jeffrey Rosen, legal affairs editor of The New Republic. Furthermore, the president’s role as the ultimate guardian of the constitutional order, charged with taking care that the laws be faithfully executed, provides him with the authority to raise the debt ceiling, as argued by Eric Posner, professor of law at the University of Chicago, and Adrian Vermeule, professor of law at Harvard University.

After the Great Recession of the 1920s, as President Franklin Roosevelt was moving ahead with his plans to confront the economic crisis, he hinted darkly that “it is to be hoped that the normal balance of executive and legislative authority may be wholly equal, wholly adequate to meet the unprecedented task before us. But it may be that an unprecedented demand and need for undelayed action may call for temporary departure from that normal balance of public procedure.” After this admonition, Congress gave Roosevelt the authorities he sought and he did have to follow through on his threat.

Last night Obama said he won’t “have another debate with this Congress over whether or not they should pay the bills they’ve already racked up.” Let’s just hope that President Obama, a former constitutional law professor himself, has the insight and courage to execute the agenda he was elected for leveraging all the tools provided within our constitutional framework. If he is successful, God bless him. If he fails, the American people will kick his party out of the White House in 2016. There is no excuse for inaction; there is no need for more drama; there is no time for more posturing; ultimately, there is no reason to hold America from displaying the exceptionalism Alexis de Tocqueville recognized centuries ago and the world expects for centuries to come.

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