Today finds US equity markets up, in fact, they are eclipsing new nominal records. The US economy must see a screaming recovery on the horizon, right?
While the economic recovery, which began in the dark days of 2009 continues to plod along at a predictable pace, there are two factors that are contributing significantly to the determined rise of the equity markets.
First and foremost, strange as it may seem, the US Government is actually paying down debt. A combination of sequester savings, the fiscal cliff with its notable 2% payroll tax increase, and a slew of paybacks on public “investments” made during the financial crisis has the US Treasury somewhat awash in cash, which in turn has caused the supply of US Treasuries on the market to shrink.
In the meantime, the Federal Reserve still has the monetary spigots on full blast and the Primary dealers, who have had their spigots trained on Treasuries, are now directing the overflow into equities, which has caused stocks to rise despite a rise in the US Dollar index (which just passed 83) and the fact that roughly 50% of individual investors are completely out of the stock market. Once Ben Bernanke has his way with the USD and the individual investors get off the fence, this rally will run quite a ways.
The second, and more important factor that is propelling the US Stock indices to record highs, is that it is Tuesday, the day when most people’s 401K contributions and auto investment plans find their way into equities. Zerohedge has provided some interesting analysis as to the effect of Tuesdays on stock indices returns which can be ready here:
Oh my. Two words, four meager characters, made famous by Jesse “The Body” Ventura during his ringside blow by blow commentary in the glory days of the WWF (circa 1986). These words, which so eloquently summed up the effects of a pile driver, seem strangely appropriate to describe what is occurring in equity markets around the globe during their first chance to “react” to the S&P downgrade of the US Government’s sovereign debt rating.
As we write, the Dow is down 5%, ditto for Oil. Gold is up over 4% and the downgraded bonds of the US Government of the 10 year variety are up (in other words, yields have fallen) approximately 4%.
What is going on? We will give you a clue, Bank of America (BAC) is down almost 20% on massive volume.
Still guessing? We won’t keep you in suspense. This downgrade, whether deserved or not, early or late, is wreaking havoc with mutual fund investment policies which call for excess funds to be held in AAA rated debt. There are not enough German bunds or UK gilts in circulation to pick up the excess funds gushing out of Treasuries.
The obvious implication is that USD bank deposits should rise.
More deposits that it can’t lend at a profit would tank behemoths like B of A, and Uncle Sam may have trouble saving it. That, and B of A is being sued for fraud, again.
Enough of B of A, back to the money flying out of US Government obligations by investment policy edict. Where will this money go? That is what is currently being sorted out in the markets. And at the moment it is UGLY for equities on a global scale. Don’t worry, by late next week, so much money will be pumped into the system that equities will have no choice but to rise.
We can’t help but think back to this chart (BELOW) showing the proliferation of AAA debt in the world. It seemed as if it was everywhere, like pine trees in a forest. Now, with one simple action, those who trust S&P’s judgment (which history has show is at one’s own peril) find themselves with at least $14 Trillion less AAA issues to choose from. More, if you count the implied downgrades of government agency and other government guaranteed debt.
Stepping away from the technicalities of investment policies and looking at the downgrade in a philosophical sense, it is like a minor earthquake that triggers a tsunami that the financial world is now helplessly watching roll ashore, or like a giant snowball has been pushed downhill and threatens to start an avalanche.
The financial world is looking at these twin disasters and now realizes that the only thing standing between them and the demise of the current financial and currency systems is, are you ready for this?
The Central Banks of the World!!! Not exactly knights in shining armor, if you ask us. We might be more comfortable if Pee-wee Herman were on the case. At least he could provide entertainment as the demise unfolds!
The downgrade is another chink in the armor of the world’s largest knight in shining armor, the United States of America. Every day, more people are coming to grips with the fact that the US of A cannot provide security and social benefits at such low rates. Bill Bonner of the Daily Reckoning regularly explores this decline of the American Empire.
As we touched on the other day, what man calls nations today are, for purposes of analysis, simply competing security agencies which have a man-made geographical monopoly. The problem, as any businessman will tell you, is that nowadays the agency’s customers can’t take the price hikes. Neither can they easily choose to move their business to a competitor. Expatriating is not cheap and involves a host of logistical problems.
The book of Isaiah, chapter 40, God refers to the nations as a “drop in the bucket” and “dust on the scales.” The obvious implication is that nations do not last, and in extreme cases, dealing with a government may feel like one is dealing with the Mafia. The need to preserve a geographical monopoly can make an analysis of the actions of a government or a mafia eerily similar.
Seen through this lens, S&P is like the snitch who broke Omerta and tells everyone that the Mafia boss can’t pay on his contracts. Now the boss will likely face an increase in the vig on what he owes the loanshark.
How long before the rat gets whacked?
Don’t forget to keep your eye on events in the Middle East, especially Palestine. Something bigger than we image is brewing there and our guess is that the eyes of the world will soon be focused there.