Interesting Videoclips of the Week (September 17 – September 23)

On another Wednesday, on November 3, 2010, Chairman Bernanke launched QE2. This aggressive decision trashed the U.S. Dollar, launched precious metals, commodities into a higher orbit and transmitted inflation to emerging markets. This is not just our opinion or the considered opinion of many pandits and savants. It is what the charts prove.

This past Wednesday, on September 21, 2011, Chairman Bernanke launched Operation Twist. With this massive $400 billion dollar program, the Fed will buy Treasuries of longer maturities and finance this program by selling Treasuries of short maturities of three years or less. A full 29% of this amount will be used to buy Treasuries of maturities between 20 years & 30 years.

This is not just a Twist but a Torque. The QE2 program was a force. It pushed liquidity into the more leveraged economies and markets. It pushed the Dollar lower and pulled precious metals, commodities higher. The new Twist program is not a force. There is no new money injected into the markets. What is bought is paid for by what is sold. The objective is to turn short maturity rates higher and turn long maturity rates lower. In other words, a $400 billion Financial Torque Wrench .

The result of the Bernanke Torque is likely to turn the money flows going into the emerging markets back into the USA. It is likely to turn the spread between growth of emerging economies & US economy back towards its long term average.

If we are right, then the US Dollar is likely to rise in the coming weeks and emerging currencies are likely to fall relative to the Dollar. After fighting QE2-injected inflation for the past few months, central banks in EM countries are likely to face the torque of shifting their policies to fight deflationary outflows of capital.

Is this why EM Debt and EM currencies fell apart on Thursday and Friday? These asset classes had maintained a relative resiliency in the face of the European mess. But immediately after the Bernanke Torque announcement, these asset classes fell apart.  Is this just a steep but short correction or is it a major trend reversal? The latter, we think.

This is why the Bernanke Torque may end up taking away what Bernanke QE2 gave to EM.

* The Greek letter “tau” is the traditional symbol for torque. So those so inclined could call this program the Bernanke Tau.

2. Bernanke Torque & the Banks

The Federal Reserve is the nation’s Central Bank.  Chairman Bernanke is entrusted with the oversight of banks. He understands banks. Yet, he has launched a program that compresses the net interest margins in the entire banking sector.

Is the banking sector no longer important to Chairman Bernanke? Has he given up hope that Banks will increase their lending? Or does he believe that a stronger economy is more likely to increase lending than lower net interest margins? After all, the banks are sitting on $1.6 trillion of reserves already.

While we ask questions, Dick Bove, a visible banking analyst, proclaims. Read his proclamations in Fed Has Broken Banks & Doesn’t Know It on CNBC.com. There he makes the wild accusation that the government “is committed to breaking the hold of the banking system on the U.S. economy.” If Mr. Bove means the Obama Administration, he might have a case. But why would the Chairman of the Federal Reserve be committed to cutting down the banking system? We don’t get it.

But we also don’t get how the Bernanke Torque is supposed to help the American economy? An economy that has “significant downside risks” according to Bernanke himself?

3. The Bernanke Torque & US Treasuries

Wednesday was Christmas, Deewali and every joyous festival known to the long duration Treasury market. In less than two hours after the Fed announcement on Wednesday, the 30-Year Bond rallied by 3 points and its yield dropped by 18.8 basis points to 3.01%. On Thursday, the next day, the 30-Year Bond rallied by over 4.5 points and its yield dropped by 21 bps to 2.80%. On Friday, it suffered a minor setback, relatively speaking. The price dropped by 2 points and its yield rose by about 10 basis points to 2.90%. 

We cannot but help recall the action in the 5-Year Treasury after the QE2 announcement on Wednesday, November 3, 2010.  The 5-year Treasury rallied on that Wednesday and Thursday. The 5-year Treasury closed that Thursday at a yield of 1.03%.  Its price fell a bit on Friday and the yield rose by 2 bps to 1.05%.

Then, despite the weekly purchases by the Fed, the yield on the 5-Year Treasury kept rising upwards and within a short period reached 1.51%.  By April 8, 2011, the 5-Year yield had risen to 2.34% (on that day, the 10-year yield was 3.60%, the 30-year yield was 4.66%, the S&P closed at 1328).  The point being that the Treasury market had fully priced in the entire bullish impact of QE2 within two days of the Fed’s announcement.

The question is does this behavior repeat? Has the two day, 7 point rally in the 30-Year Treasury Bond already priced in the entire bullish impact of the Bernanke Torque? We shall see.

4. The Greatest Insurance You Can Buy

We have steadfastly maintained that the best insurance you can buy for tail risk is an adequate position in 30-Year Treasury Bond. Nothing we know works as well. It was QED this week. The beloved safe havens of Gold & Silver got demolished. Only a large position in long duration Treasuries protected portfolios.

The two people that have remained committed to their bullish posture are David Rosenberg and Gary Shilling. This week, the yield on the 30-Year touched Shilling’s target of 3%. We received a call this week from a friend and a reader about our coverage of Treasuries. The congratulations go entirely to Rosenberg, Shilling and the few others who had the courage to tell simple folks like us to stay long 30-Year Treasuries.

But is the call a signal of sorts? Does it add to what we see as a precedent of QE2 as discussed in section 3 above? It sort of does to us.

But that does not mean the cycle low of the 30-Year yield is here. The spread between the 30-Year & the 10-Year yields has been around 50 bps at previous cycle lows. This spread closed at 107 bps this past Thursday. So it may have a lot further to go. And the low in bond yield is not reached until the economy is well within the recession.

5. The US Stock Market

The US stock market loved QE2. In contrast, the US stock market hated the Bernanke Torque.  In fact, this week ended up being the worst week for the Dow since October 2008. Chairman Bernanke has stated unequivocally that the S&P 500 & US small caps are, to him, the strongest signals of the health of the US economy, an economy with “significant downside risks” as the Fed statement stated. So again, we wonder why he launched the Bernanke Torque.

The action in the US Stock market has been governed by the fundamentals of the European mess and the technical levels of the S&P.  Let us look at the technicals first.

None of the serious technical levels identified on September 10, 2011 (US Stock Market section of Videoclips of September 3 – September 9) h
ave been breached yet. But we did get pretty close to those danger levels intra-day on Thursday.

According to Mary Ann Bartels of BAC-Merrill, the severe decline on Thursday confirmed a “bear flag”, which creates risk to 1020-910 on the S&P.  She does not expect the first support of 1100 to hold and the risk to her is to 1020, 25% decline from the high. The flag break also raises the risk, she says, of a full blown bear market test of 910, 30% off the high.

Jim Rogers is far more intelligent and colorful than us. Read his comments in clip 4 below about the impact of Bernanke’s policies on pension plans, companies, state & local governments and the American savers. In short:

• He (Bernanke) is killing the people who save and invest and that is really hurting a very, very, very large part of the population

Featured Videoclips:

1. Terrence Keeley on Bloomberg’s Inside Track on Friday, September 23
2. George Soros on CNBC Closing Bell on Wednesday, September 21
3. Jim Chanos on Bloomberg’s Street Smart on Tuesday, September 20
4. Jim Rogers on CNBC Strategy Session – Thursday, September 22

This clip amply deserves the pole position of the week.  We thank BlackRock’s corporate communications group and Bloomberg’s segment producers for helping us get this clip and the transcript. Below are key excerpts from the transcript.

• Keeley – This the first time I’ve attended an IMF annual meeting with the same sense of urgency, the same sense of purpose, the same sense of immediacy.… In bilateral meetings, I can’t tell you how clear it is, with finance ministers, central bank governors, that there is something that must be done, something must come out of this weekend.
• 
  Keeley – Erik, there’s a role for the IMF to play. There’s a role for the Europeans to play. There’s a role for governments to play. And there’s a role for private capital to play…. And I have to admit, it’s absolutely true. We are in the middle – Larry Fink, in particular, in the middle of every important conversation where a private-public partnership can be part of the resolution….  Understand this, too. I think there’s, again, a misunderstanding. The pledges that will come out of this weekend for support for the euro zone still do not resolve the issues that must be solved by Europeans themselves.
• 
  Keeley – There is $20 trillion in the hands of central banks and sovereign wealth funds. Those assets, too, Erik, are very, very misallocated to low-risk assets at the expense of investments which could spark growth, infrastructure, bank recapitalization, any number of things…..  Let’s not discount in these dark hours, I mean, we’re rushing to negative yields on treasury bills as we did in the fall of 2008. Let’s not discount what that $29 trillion in ready capital that does not have to go to parliaments for approvals could do when properly focused.
• Keeley – Central banks and sovereigns, themselves, have a ban in the periphery. Say, they start coming back in to Italian debt, say they start coming back into Spanish debt, what happens to yields?…  The core stabilizes. And then we’re back to the races. So this risk on trade, this risk off-trade mentality which dominates right now could easily slip on a dime.    I will make you the following bet. Come Monday, risk will be back on. We will see more consoling statements….The IMF could mobilize another trillion dollars if needed. The EFSF could be expanded and probably will be expanded. The ECB is providing the last line of defense right now in the periphery for the core.  This will continue. We will see Greek funds come through. It’s a very dark moment. I would argue that the fear will be given over to greed before too long.
• Keeley – I had a meeting yesterday, Erik, with a central bank governor who will go unnamed, who said that she didn’t think the euro would exist in one year, that the euro would be dissolved. I promise you, by the end of this weekend, she will not hold that same position....(she? Janet Yellen? how many central bank governors are women?) … And I think this unanimity of purpose, the sense of urgency, the sense of immediacy, will pervade every – and certainly, been in every meeting that I’ve been in, and will continue to pervade the weekend….    I think there will be unanimity of purpose by the end of the weekend. And I think you’ll see far more consoling statements. Christine, new in the job, obviously, finding her way, but certainly saying the right things.   And the attitude here in Washington, at the IMF meetings is let’s fix this. Let’s do something. I do wager that they will.

This is a terrific interview. Kudos to Erik Schatzker for asking the right questions and letting his guest speak.  But, come on Erik, you wondered aloud what odds Terry Keeley would give you? Didn’t you see that you win either way with this wager.

This is an excellent interview by Carol Massar of Bloomberg. It is a long clip but a must watch in our opinion. It covers Europe, China and then touches on shorting the Health Care sector in the US.

• Chanos – Following the Short selling ban in the US (in September 2008), the funding crisis got worse in the banks in October-November of 08. Sure enough, when they did the short selling ban in Europe, the funding crisis got worse….They keep forgetting that the largest short sellers and purchasers of credit default swaps in financial institutions in times like these are other financial institutions, basically hedging their bets on their counterparties. If they cannot do that, they begin to pull and that’s what we are seeing. Again, the regulators don’t understand how the markets are interrelated in these things.  They figure if they stop the short selling, it will stop the problem. Short selling in these shares were the symptom, not the disease…We were short the European banks prior to the ban, we can’t do anything now….
• Chanos – There seems to be a continuing reliance on kicking the can down the road..we are going to solve the debt crisis in Europe by adding more debt..and as I said a few months ago, the can is kicking back. Markets are sick of these solutions, they know the accounting is no good..look at the European stress tests a year ago on the Irish banks, they said they needed a few billion euros, they ended up needing 30 billion euros…so these stress tests are a joke, the accounting is a joke and the markets are beginning to say no more..
• Massar – is the situation likely to be fixed some time soon or is it going to linger on for next 3 months, 6 months….?
• Chanos – roughly 25% of our GDP is Government spending right now, which a lot of people think is too high, in Europe, the number is 45-50%..so this is really so built into the structure of European economic system, that starting down this austerity path that the Germans and others feel is really necessary, is going to as Greece has found out and Ireland has found out, is not going to increase growth, it is going to decrease growth and we are in this weird trap of the fact that no one seems to have ever taken macro economics 101 in terms of trying to cut their way to prosperity..
• Massar – Do you foresee another recession at this point and does it give the opportunity to go out and take out more short positions?
• Chanos – I am not a macro guy..and you also know that while every one is focused on Europe, I am focused a little further East, That’s the interesting wild card in 2012 and we think the Chinese growth engine is beginning to sputter.
• Massar – when does it come undone and what are the implications? Is it akin to the crisis we went through with our property bubble?
• Chanos – It is happening. It is going down. Right now, the property stocks are leading on the way down, followed by the financial institutions in China. We have a proprietary sales model and we take a survey every week and that data came in last night. And in September, one of the seasonally strong months in China, condo sales in the Tier 1 & Tier 2 cities, were down 50-60% vs. a year ago. So this is happening..It is not something that is going to happen, it is happening as we sit here.

Below is a summary of the points made by Mr. Chanos on China (the emphasis are ours). We thank Bloomberg PR for sending it to us.

Then the conversation shifts to the drag of China on the world.

• Massar – So the deleveraging story that is going around the world, it comes to China then?
• Chanos – I think again, the story that people are missing is that China is the world’s growth engine and remember it accounts for nearly 1% of world’s GDP growth, it is 10% of the world’s economy growing at 10% a year, that is going to be a bigger drag going forward than people think.
• Chanos – ..the world believes that China is an engine of growth and will continue no matter happens in the West and it is not immune. Remember net exports as a % of Chinese GDP is de minimis, it is only 5%, everything there is focused in fixed investment, building and construction. People have to keep their eye on that. That’s the elephant in the room. 

At this point, Ms. Massar asks about the Buffet rule, the need for the rich to pay more in taxes and the carried interest tax break. We leave this to the readers to watch. 

The final part of the discussion was about short opportunities in healthcare the US.

• Chanos – We covered our shorts (last year) when we saw the (Obama health care) bill….I am beginning to rethink that position and we are reexamining health care again. On a bipartisan basis, people are beginning to realize that we cannot address our budget deficit problem without addressing health care. We pay twice what the rest of the world does…We are looking to add shorts going into next year. There is no way you can do meaningful deficit reduction, no way unless you begin to address runaway health care costs. And health care companies, basically in the US, get over half of their revenues from the US Government & State Governments. And yet, they have profit margins twice that of the S&P 500. They grow faster. And sooner or later, we are going to have to address that fact. 

The most candid and funniest exchange was when Chanos (he laughed aloud as he said it) acknowledged that he was short Netflix but its is still not a profitable position yet. Ms. Massar asked him about Coinstar.

• Chanos – we are short both (Netflix & Coinstar). The observation I would make is that Coinstar, which operates the red box kiosks, has held up fine. But all this started with Netflix when Reed Hastings realized correctly that the DVD business is dying. Yet, that is 80% of Coinstar’s revenues are from rent DVD and 2/3 of their cash flow.

4. Jim Rogers on Brazil’s Trade war – Jim Rogers on CNBC Strategy Session  (08:12 minute clip) –  Thursday, September 22

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