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The Greater Depression or:How l Learned to Stop Worrying and Love the BearOctober 14, 2011
Private & Confidential
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DRAFT
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DRAFT
Throughout all my years
of investing I've found
that the big money was
never made in the buying
or the selling. The big
money was made in thewaiting.
- Jesse Livermore
Preface
3
A few months back, I turned on the news while getting ready for
work to see what the weather was going to be like that day. It had
been particularly hot and dry for the past couple of months with
basically no rain except for a random thunderstorm a few weeks
prior. I wanted to wear this new pair of expensive shoes I had just
purchased, but hadnt had a chance to waterproof yet, and while wehadnt had a lot of rain lately, I wanted to be sure that they would
be safe. There is nothing worse than buying a new pair of shoes and
ruining them the first time you wear them.
The first meteorologist I landed on said it was slight chance of
clouds, but overall a beautiful day with no rain in the forecast. This
meteorologist had been notoriously wrong to my recollection, and
being the skeptic I am, I turned to another station to get a second
opinion. Just to be sure.
The next one was a new weathergirl in town, who gave a similarstory, except she didnt even mention a chance for clouds. She went
on to say that as we were clearly in a drought, and it hadnt rained
for weeks, there was an extremely low chance for rain today. While
she was pretty and bubbly and seemed trustworthy, she didnt even
show a shot of the radar, which I thought was kind of odd until I
later found out that her shtick was giving sunny day forecast
regardless of what the instruments said. As a matter of fact, it was
later discovered that she couldnt even read meteorological
equipment.
Unsatisfied, I decided to go out on to my balcony and take a look atthe sky for myself. While it was a little dark outside, I thought it was
just because it was still early - until I looked toward the west. There I
saw massive storm heads moving in, black with rain. Call me crazy,
but I not only decided to wear another pair of shoes, but I also
brought an umbrella. Just to be sure.
My point is that I dont need a weather man to tell me if its raining,
and even if the weatherman says, No rain, I might plan for rain
anyway if I see storm clouds on the horizon with my own eyes.
There is a lot of this going on right now.
The MSM tends to spin the news to serve its own purpose/agenda
because doing so is in their best interest; appealing to a certain
demographic, or telling its target market what it wants to hear helps
retain viewership. Few will argue that media bias exists. If well-
informed conservative turns on CNN, he will likely be repulsed by
the blatant liberal slant to its reporting. Same for a liberal watchingFox News.
What some people do not realize, however, is that this same bias
that can be seen so clearly on politically-based news stations also
exists within business-oriented news outlets. I have learned, for
example, that getting all my economic news from CNBC is akin to
getting all my political news from CNN and the New York Times.
Currently, the MSM is trying to sell us on an economic recovery
that, frankly, has failed to materialize.
As you might know, I tend to get most of my economic news fromnon-mainstream media outlets because I believe it can be
dangerous to get all my news from one place, through one filter.
And I have found some that provide true, unbiased analysis of what
is going on without the spin.
I have been following some people such as Mish Shedlock and
Reggie Middleton for years, and have continued to read their
analyses because they have been so spot-on and very far ahead of
the curve. The sites I read called the top in residential real estate,
the collapse of Bear Sterns weeks before it imploded, the Lehman
collapse months before it imploded, and so on.
I have tried to aggregate information from several of these and
other sources outside of the mainstream, with the intent of
objectively basing my research on the data that is out there, not
what I want or hope to see or what some talking head wants me to
think. To be sure, I would like nothing more than to see another 20-
year bull market, especially at this stage in my life and career.
However, I believe it is more prudent to base my plans on the
outcome that is likely to occur rather than the one I simply hope will
occur, because only then will I be able to avoid being caught offguard and hopefully be able to position myself to profit from it.
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DRAFTPreface
4
My father taught me to analyze the world around me, the claims
that people made. He taught me how to apply logic and how to
debate. He taught me to do my homework, to investigate to find the
truth, to develop a healthy skepticism and look to corroborate
evidence. He used to say: You can lie about numbers, but numbers
dont lie. Perhaps (and this might sound kind of nerdy) this is why
finance and economics is my passion. I like trying to uncover the
truth, trying to solve the puzzle, trying to beat the market, especially
because in this realm one can also be rewarded so handsomely for
being good taking calculated risks. This is what drives me to search
for the truth and to pick apart the claims being made every day
about the economy.
Please keep in mind: This was not written to detract from our
investment direction, but rather to add to it, as I believe diversity of
opinion and healthy debate increases the likelihood of our making
the right decisions at the right time. I hope you will approach thisreport with an open mind that is truly objective and unbiased.
I put this together because I believe we are on the precipice of a
global economic collapse and I dont believe we are currently
positioned to profit from it. Most likely we would be hurt by a
significant downturn in the economy given our current portfolios
exposure.
My hope is that this will help generate thoughtful and meaningful
debate to arrive at a course of action for our firm, as the purpose of
this report is to investigate the forecast and determine if it might beprudent to pack an umbrella. Just to be sure.
ng
p.s. I know there is a lot here, but I tried to be both brief and
thorough. Pay particular attention to Key Slides with Red Star in
bottom corner.
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October 14, 2011
Table of Contents
Section Page
Executive Summary 6
Appendix I: Stock Market 40
Appendix II: Employment 55
Appendix III: Confidence 68
Appendix IV: Personal Consumption 78
Appendix V: Gross Domestic Product 86
Appendix VI: Housing 95
Appendix VII: Europe 115
Appendix VIII: Miscellaneous 124
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October 14, 2011
Executive Summary
Overview
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DRAFT
The Global Financial
Crisis (GFC) is not over
and Things have not
looked this bad for the
global economy since
2008
Analysis of current
economic data
indicates that the
occurrence of another
global downturn is not
only possible, but
probable
The U.S. is currentlyclose to falling into
another recession, if
its not already there.
Expect negative GDP
growth through 2012
The new Normal is an
era of increased
volatility and
uncertainty
From both an isolated,
and, more
importantly, a Total-
Portfolio perspective,
the establishment of a
directionally short
market position offers
a compelling risk-
reward
Executive Summary
Overview
7
Outline
In the Executive Summary, we will begin with Overviewof our
current situation and how we got here, followed by a
discussion surrounding the Economic Outlook.
Next, we will consider a simple framework for analyzing where
we are in our current economic cycle while discussing what we
are seeing the data related to the factors ofJobs, Confidence,
Consumption, and Growth.
We will then take an inventory of where we are currently,
and discuss the Recovery to this point.
Next, we will discuss how the Federal Reserves policies over
the last 30 years lead to the financial collapse in 2008, what
the Fed has done since then to fix the economy, and what
they are signaling for the near term along with the effect on
the broader market will likely be.
Next, we will investigate the concept of Secular Markets and
see how the returns one ultimately gets from an investment is
largely determined by when he invest, not by simply being
invested.
Finally, we will consider an investment idea that could present
a compelling risk-adjusted return on its own, and concurrently
lower the volatility of our overall portfolios returns.
The second part of this report is an Appendix, which exploreseach of the related topics in further detail:
The Market
Employment
Confidence
Consumption
Gross Domestic Product
Housing
Europe
Miscellaneous
Overview
The global economy is currently experiencing a slight
depression, which is basically a prolonged recession that lasts
several years. At its core, these problems are the result of
loose credit and expansive monetary policies by the worlds
Central Banks. The global financial system is a house of cardsbuilt on a foundation of debt, leverage, and risk. 2008 will pale
in comparison to the global credit crunch we are headed for
because none of the fundamental problems that caused the
GFC have been fixed. Anywhere.
In the recent Fed minutes release, the august phrase
"downside risks to the economic outlook have increased" was
changed to "there are significant downside risks to the
economic outlook, including strains in global financial
markets. We are currently seeing the acceleration in thedeterioration of global financial conditions. Many statistics
support the fact that the U.S. is worse off today than it was
prior to the previous recession, which officially ended 21 short
months ago.
9.5 million fewer workers than the 2007 peak
Real GDP lower than Q4 2007
Real retail sales $13 billion below 2007 peak
Real personal income $515 billion below 2008 peak
S&P 20% lower than peak (officially a bear market)
40% drop in bond yields since peak in 2007
It takes a long time to unwind the previous borrowing
excesses. Over-borrowing leads to bankruptcy and financial
ruin. And we are approaching a day of reckoning. We have
been living in the largest debt bubble in the history of the
world, and that bubble is ending. This is natural. We will soon
see that the debt-fueled prosperity we have enjoyed over the
last few decades was nothing but an illusion.
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DRAFT
The Global Financial
Crisis (GFC) is not over
and Things have not
looked this bad for the
global economy since
2008
Analysis of current
economic data
indicates that the
occurrence of another
global downturn is not
only possible, but
probable
The U.S. is currentlyclose to falling into
another recession, if
its not already there.
Expect negative GDP
growth through 2012
The new Normal is an
era of increased
volatility and
uncertainty
From both an isolated,
and, more
importantly, a Total-
Portfolio perspective,
the establishment of a
directionally short
market position offers
a compelling risk-
reward
Executive Summary
Overview (cont.)
8
The financial avalanche we are about to witness will destroy
the wealth of millions of people, making it glaringly apparent
why excessive debt is unsustainable and a bad thing.
The problem is not debt, per se, but rather the excessive level
of debt and the associated increase in systematic risk, whichitself is exacerbated by both the increased integration of and
the increased correlations between the worlds financial
markets and economies.
The modern financial system is dependent on perpetual
growth. As all (fiat) money is loaned into existence, it carries
with it an obligation to repay both principal and interest. As
the economy is able to grow at a 2% rate, debt servicing is not
a problem. But when growth slows, or worse, goes negative,
the problems begin to arise. One need only consider thefollowing graph, which shows the total debt (public and
private) as a percent of each countrys GDP, to see that the
excess debt problem is a huge problem in every major
economy around the globe:
Debt can only be rolled or repaid through growth and growth is
over, because the growth we have witnessed has been driven
by the expansion of debt, which is not expanding any longer.
Put simply, countries or economies built on debt cannot be
strong, unless growth in true value creation and productivity
per capita outpaces the cost of the debt.
The last bull market, which lasted from 1982 to 2000, was
driven by the secular decline in interest rates and the
expansion of credit, which allowed for the expansion of
investment, which led to increased risk-taking, which led to
more easy money, which not only helped change the structure
of our economy to one that is now consumption-based, but
also allowed for the investment in new technologies, which led
to the Internet Boom, which led to the Internet Bubble, which
topped in 2000, then popped.
The Feds response to fixing the economy and restoring
growth was to ease credit further by lowering the Fed Funds
rate more, which lead to more risk-seeking behavior, which led
to more growth, more consumption, and more credit
expansion, which ultimately led to the Housing Bubble, which
topped in 2007, then popped.
True to form, the Fed responded by lowered the Fed Funds
rate further in an attempt to generate growth, however, it alsoexpanded its manipulation of the financial markets beyond
simply buying short-term Treasury bills by making large scale
asset purchases. In essence, the Fed, which historically was the
Lender of Last Resort, also became the Buyer of Last
Resort, and effectively bailed out the entire banking system
by increasing the size of its balance sheet by about $2 Trillion.
However, wide-scale asset purchases and fiscal stimulus have
failed to generate the growth expected.
350%
450% 450%470%
410%
0%
50%
100%
150%
200%
250%
300%
350%
400%
450%
500%
U.S EuroZone UK Japan Canada
Aggregate(private&g
ov't)debt
toGDP
Total (Private & Government) Debt as Percent of GDP
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DRAFT
The Global Financial
Crisis (GFC) is not over
and Things have not
looked this bad for the
global economy since
2008
Analysis of current
economic data
indicates that the
occurrence of another
global downturn is not
only possible, but
probable
The U.S. is currentlyclose to falling into
another recession, if
its not already there.
Expect negative GDP
growth through 2012
The new Normal is an
era of increased
volatility and
uncertainty
From both an isolated,
and, more
importantly, a Total-
Portfolio perspective,
the establishment of a
directionally short
market position offers
a compelling risk-
reward
Executive Summary
Overview (cont.)
9
This should come as no surprise. There is too much waste and
too much debt still clogging the system, which is leading to the
law of diminishing returns for the Feds policies.
There is no way to unwind this debt spiral easily, at least not
without creating severe financial instability in the short-run.However, putting off the pain that needs to be felt in order
for the waste still in the system to be flushed out, will only
make the problem worse in the future.
Our political leaders and policy makers have made it apparent
that they are not willing to take the tough steps necessary to
truly fix our problems. This is evident by the kick the can
down the roadsolutions that have been applied so far. To
be sure, you cannot solve a debt problem with more debt.
We cannot afford to ignore the macroeconomic landscape and
invest based on hope. When we look at a company to buy, we
focus on the fundamentals of the organization, consider the
growth opportunities, and develop a road map for the future. I
believe it is prudent and possible to apply a similar framework
for the analysis of the overall economy, which is particularly
important because each and every investment in our portfolio
has a positive correlation to the overall health of the market.
The financial crisis in 2008 threw the world into the worstrecession since the Great Depression. The next financial crisis
will hit the world even harder and throw us into the Greater
Depression. And we are tipping into another recession right
now.
The same problems that brought down the banks in 2008 are
the same issues that are present right now with almost no
difference, save for some government backing. Nothing has
changed, at least not for the better.
The macro fundamentals are actually worse. Housing is still in a
decline, unemployment is still extremely high, and we have
more concentration of risk. For example, ca. 95% of notional
derivative exposure, which is at all-time highs, is currently
concentrated in 5 banks.
It is important to realize that all the losses are actually incurred
during the heady euphoria of the Boom, that the Bust is
nothing more than the overdue recognition of those mistakes,
and that to procrastinate thereafter in their acknowledgement
is not to avoid the pain, but to exacerbate it in much the same
way as a sufferer from a cancer can do himself nothing but
harm by trying to delay the awfulness of the therapy which
sadly must await.
We are about to experience the most terrifying opportunity ofour lifetimes. Will we be a part of the minority who are
positioned to profit from this Collapse, or part of the majority
that is taken by surprised?
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DRAFT
The U.S. economy will
likely register negative
growth during Q4 2011
and through 2012.
While monetary and fiscalpolicies helped create the
backdrop for the
slowdown in growth, it
has been aggravated by:
Falling productivity
Inventory reversal
Falling real-wages
The case of animpending recession rests
not only on cyclical
precursors evident in
productivity, real wages,
and inventory investment,
but also in dysfunctional
fiscal and monetary
policies.
Source:
http://goo.gl/LTrxK
Executive Summary
Economic Outlook
10
Productivity
Real GDP grew at approximately 2.5% in the last half of 2010. The
consensus forecast was for growth to continue to accelerate at a
rate of 3-4%, due to assumed economic impact of quantitative
easing and other fiscal stimulus. However, growth slowed to less
than 1% for the first half of this year.
Such an abrupt slowdown in growth, especially when it comes as a
surprise, leaves businesses with more workers than are necessary.
As most are slow to resort to layoffs, they instead see their unit
labor cost increase as output per man hour (productivity) falls. In
the first half of 2011, we saw productivity decrease at a 0.7%
annual rate with a corresponding increase in unit labor cost of
4.8%.
A drop in productivity coupled accompanied by an increase in unit
labor cost has historically been the preamble to a surge in layoffs
as companies try to fight margin compression.
Inventory Reversal (cont.)
In July and August production of consumer goods increased at
3.2% over Q2 2011, while retail sales contracted at a 1.4% rate,
pushing inventory investment to an even higher level of GDP.
This has set the stage for a slow-down in production, which will
only exacerbate the need to increase layoffs.Real Wages
Real hourly earnings has fallen by 2.2% over the 12 months ended
August 2011, and real disposable income is lower now than in
December 2010.
First, consumers simply cut savings (back to recession low of 4.5%)
to compensate for the lack of income growth, but now a
slowdown in spending is occurring.
Inventory Reversal
Inventory investment accounted for 35% of the rise in real GDP
between Q2 2009 and 2Q 2011, and now accounts for 1.18% of
real GDP (the 20 year average of 1%).
First, consumers simply cut savings (back to recession low of 4.5%)
to compensate for the lack of income growth, but now a
slowdown in spending is occurring. Real spending expanded only
0.7% in Q2 and remains sluggish.
The case of an impending recession rests not only on cyclical
precursors evident in productivity, real wages, and inventory
investment, but also in dysfunctional fiscal and monetary policies.
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DRAFTExecutive Summary
The Jobs > Confidence > Consumption > Growth Economic Model
11
Jobs
9.1% unemployment rate, 11% if adjusted for decrease in workforce
U-6 Unemployment back above 16%
Record unemployment duration 40.5 weeks
Labor force participation rate at 30-year low
S&P indicating unemployment about to spike
Disproportionate increase in long-term unemployment with 4% > 27 weeks
Confidence
University of Michigan Consumer confidence lowest it has been in 30 years
Fed Business Survey suggests further weakness
Pule of Commerce Index turning down, @ Sept-04 levels
73% of Americans think the country is headed in the wrong direction
Consumption
Real private wages have grown only 4.2% over the last 10 years
Labor share of national income has fallen to its lowest level in modern history (57.5%)
Over 42 million Americans now receive food stamps
48.5% of Americans live in a household that receives some kind of government aid; 5m onwelfare; 50m on Medicaid, 8m receiving unemployment compensation, 10.5m on SS disability
Growth during the later half of 2010 was driven by consumers lowering their savings rate
Growth
Growth is rolling over across the globe
ECRI Weekly Leading Index pointing toward another recession
Goldman and adjusted yield curve indicating between 40-65% chance of another recession
Estimates of growth, at both the country and individual company level, have been continuallyrevised throughout the current year
We have seen this trend in allmajor economies during 2011 (U.S. Europe, China, Japan)
The Jobs > Confidence >
Consumption > Growth
Model can serve as a
simple framework to see
where we are in an
economic cycle by focusing
on the key drivers of
economic growth in an
economy.
When jobs are plentiful,
people become more
confident about the future
and their personal financial
security, which prompts
increased consumption,
which leads to increasedgrowth, and vice versa.
In order for this potentially
self-sustaining cycle to
perpetuate, one of these
factors needs to generate
inertia to lead to the next
step. In order for the
Recovery to take hold
and gain momentum, one
of these key factors mustreverse course.
Consider our current
situation:
High structural
unemployment
Record low confidence
Extremely low
consumption
Slowing growth
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DRAFT
ZIRP QE
FiscalStimulus
QE2
Food &EnergyPrice
Pressures
Insurance &FinanceDistress
RisingInterest
RatesConsumerFrugality
Retail StoreClosings
InternationalSwap Crisis
Credit & DebitCard
Restrictions
U.S. ReserveCurrency
Crisis
New New
Deal
Executive Summary
The Tectonic Shift 2009-2013
12
EconomicCrisis
JobEliminations
& Layoffs
Sate & Local-Budget Crisis-
Federal
ResidentialReal EstateDouble Dip
EntitlementFunding Crisis
CurrencyCrisis
Bretton
Woods II 2009
2010
2011
2011-20122012
2012
2013
Gordon T. Long presents a
compelling roadmap for
the Global Financial Crisis,
which has been spot-on to
date.
Housing is set to leg down
once again, which will lead
to Commercial Real Estate
double dip, which will
usher in a new era a
consumer frugality. This
will spur on retail closing
and an entitlement funding
crisis that could lead to a
fiat currency crisis,
ultimately ending with aUS Reserve currency crisis.
The GFC began with a
Financial Crisis; currently,
we are seeing the
beginning of the Sovereign
Debt Crisis; this will lead to
Currency Crisis/Fiat Failure
Again, it is natural and
inevitable that a system
built on fiat currency and
the expansion of credit to
drive growth would go
through a purging process
as described here.
Source: Gordon T. Long
Research & Analytics
October 2011 Global Macro
Tipping Points 9/30/2011
www.gordontlong.com
We are here
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DRAFT
While the MSM goes
great lengths to sell us all
on this so-called
Recovery, anyone actually
believing it needs to get
their head checked.
Executive Summary
You Call This a Recovery?!
13
Growth in Real GDP Components: Current & 3 Previous Recoveries
Job Growth: Current & 3 Previous Recoveries
As you can see from the charts, Residential
Investment has been a major driving force in
previous economic recoveries. While it is a
small component of GDP, it had been an
important monetary policy transmissionmechanism in the past because it can expand
quickly as interest rates fall.
With low U.S. mortgage rates currently,
residential investment has failed to gain
traction and help drive us out of this recession.
This is due partially to the huge overhang of
vacant housing units.
Also personal consumption has not accelerated
as quickly as it has in the past, and with PCE at
approx. 70% of GDP, the lack of participation iscreating a drag.
Far fewer jobs have been created in this
recovery than in the last three, and again,
this is influenced by housing. Take a look at the
decline in construction jobs: down 9% vs.
increase of 4% in the last three recoveries.
This is because there is existing capacity inmost industries and excess housing units still in
the marketplace, coupled with household and
corporate deleveraging.
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E ti S
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DRAFTExecutive Summary
US Inventory Cycle Set to Force Headline ISM Much Lower
From Albert Edwards of
Societe Generale:
One of the US indicators
that has held up quite
well and maintained
some sense of hope thatrecession can still be
avoided is the ISM which
has stayed above the
critical 50 level. But
further pronounced
weakness seems baked
in the cake and will
disabuse the optimists.
The excess of inventories
over new orders
suggests a very sharp
slowdown (see left-hand
chart below), and the
inventory de-stocking
cycle is set to remove
one source of component
strength from the overall
ISM indicator
E ti S
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DRAFT
Graph shows the
percentage of the
previous peak for Real
GDP, Real GDP per Capita,
and Employment.
We can see that not only
was the drop from the
previous peak more
severe than that which
we have experienced over
the last 50 years, but also
that we have a long way
to go before we are back
at pre-recession levels,
particularly for
employment and per
capita GDP.
Executive Summary
Percent of Previous Peaks
16
E ec ti e S mmar
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DRAFT
Income here is indexed to
2000, which means that
household income is 10%
lower than it was a
decade ago.
An economy built on
Consumer Spending
cannot rebound until
either consumer spending
rebounds or is replaced
by something else (e.g.,
exports).
Executive Summary
Household Income Index and Unemployment Rate
17
Executive Summary
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DRAFT
Notice how the Debt-to-
GDP ratio has increased
since the BreakingPoint
around 1980. Since this
broke we have had a
tremendous bull marketof over 20 years, but
corresponding general
decline in average GDP
growth rates (A)
The excess debt that has
been accumulated over
the last 30 years as
interest rates were in a
steady decline, lending
standards were reduced
and massive pools of
available credit were
supplied has now begun
the inevitable unwinding
process.
Executive Summary
The Breaking Point
18
A
Executive Summary
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DRAFT
The drop in the 10-year
yield was accompanied by
a parabolic increase in the
total credit market debt
owed. The result has been
a secular decline in theGDP year-over-year
percent change.
Our problem isn't low
interest rates; it is excess
debt, which literally
drains the demand for
more credit.
The NFIB Small Business
Survey stated Poor
sales" are the number
one concern (not lack of
credit) and the lack of
demand on their
businesses do not
warrant adding on more
leverage. The number of
businesses currently
thinking this is a "good
time to expand" is at
some of the lowest levels
on record. Likewise,consumers are trying to
pay down debt, as
worries about job
security, rising food and
energy costs and stagnant
wages reduce their desire
to consume and make
debt reduction a priority.
Executive Summary
Rise of Debt Drained The Economy
19
Executive Summary
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DRAFT
During the previous
"Operation Twist" the
economy was
experiencing an
increasing trend of
growth. Interest rateswere also steadily rising
as stronger economic
growth allowed for higher
rates of interest to be
charged. Debt, as a
function of GDP,
remained well
constrained at low,
structurally manageable
levels. However,
beginning in 1980, theeconomy shifted and
interest rates began a
very steady decent. This
decline of interest rates
led to a massive
expansion of debt, which
ultimately sowed the
seeds for a slowing rate of
growth in the economy.
Executive Summary
GDP vs 10 Year Treasury
20
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What we are seeing play
out before our eyes is
exactly what is predicted
by the Austrian School of
Economics (more here
and here), which holdsthe view that economic
cycles are the
consequence of excessive
bank credit, exacerbated
by inherently damaging
central bank policies,
which tend to keep
interest rates too low for
too long, result in
excessive credit creation,
speculative economicbubbles and lowered
savings.
Or simply, a period of
sustained low interest
rates and excessive credit
creation results in a
volatile and unstable
imbalance between
savings and investment.
Executive Summary
Rising Money Supply & Credit = Declining Wages & GDP
21
From StreeTalkLive.com: We are not entirely sure what created this breaking point specifically whether it was deficit spending by the Reagan
Administration to break the back of inflation, deregulation, exportation of manufacturing and a shift to a serviced based economy, or a myriad of other
possibilities or even a combination of all of them. Whatever the specific reason; the policies that have been followed since thebreakingpoint have
continued to work at odds with the AmericanDreamto the benefit of Wall Street.Beginning in 1980 our world changed as we discovered the world of financial engineering, easy money and the wealth creation ability of successful use of
leverage. However, what we didn't realize then, and are slowly coming to grips with today, is that financial engineering had a very negative side effect - it
deteriorated our economic prosperity.
As the use of leverage crept through the system it slowly chipped away at the savings and productive investment. Without savings - consumers can't
consume, producers can't produce and the economy grinds to a halt as the cycle of economic growth is thrown into a "balance sheet recession" strangle
hold that is slowly pushing the economy towards unconsciousness.
Regardless of the specific cause, each interest rate reduction that was used from that point forward to stimulate economic growth did, in fact, lead to a
recovery in the economy; just not at levels as strong as they were in the previous cycle. Therefore, each cycle led to lower interest rates and economic
growth slowed and as a result of consumers and producers turning to credit and savings to finance the shortfall which in turn led to lower productive
investment. It was like an undetectable cancer slowing building in system. TheBreakingPointwas the beginning of the end of the Keynesian economic
model.
Executive Summary
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DRAFT
This graph is astounding.
It really puts the last 30
years of growth we
have experienced in its
proper perspective.
At the height of the
housing bubble, it took
over $3 of debt to finance
$1 of GDP.
Notice the change in
slope of this line at (A)
leading up to Tech Bubble
and then (B) to the
housing bubble.
It is taking increasingly
more debt to generate
our GDP. How sustainable
is this?
Executive Summary
Amount of Debt Required to Finance $1.00 of GDP
22
A
B
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This chart really sums up
the fact that all of our
recent growth has been
totally driven by
debt/credit expansion,
which is problem becauseof the diminishing returns
of more debt.
This would not be an
issue if the economy was
able to grow faster than
the corresponding debt
needed to fuel that
growth. Unfortunately,
this is not the case.
And what have we ended
up with? Well, banks
across the globe full of
toxic debt and pseudo-
assets and countries and
consumers leveraged to
the hilt.
Executive Summary
What Has (Really)Driven Our Growth?
23
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Debt Fueled Growth Leads to Deleveraging
This shows that Total
Credit Market Debt as a %
of GDP more than
doubled over the last 30
years.
While some deleveraging
has occurred recently,
dropping the ratio from
its high of 375% to about
350% in March 2011, we
are still almost 3x the low
in the early 1950s and
more than 2x the level in
the early 1980s.
This suggest more
deleveraging is ahead,
which would follow if, in
fact, credit has fueled the
growth. Deleveraging =
asset price deflation.
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DRAFT
This graph makes it clear
that the last cyclical bull
market, starting from the
low in March 2009 was
driven totally by Fed
intervention and
quantitative easing.
Over this time, the Fed
has driven the Fed Funds
rate from a pre-market
level of approximately 5%
to current near-zero
levels, which they have
indicated will continue for
the near term.
Notice how at (A) and (B)
the market fell off a cliff
following the conclusion
of respective Fed
intervention. In short, the
only thing holding up the
market has been the Fed.
See slide 148 in theAppendix of this report
for a more detailed look
at Federal Reserve
Intervention.
Executive Summary
The S&P 500 & Federal Reserve Intervention
25
B
A
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DRAFT
The major driver of Fed
Treasury purchases of
over $1.2 trillion since
the Great Collapse
began in 2008 was not
to satisfy its dualmandate, per se, but
rather to keep the
interest rate based
derivative market in
check.
Of the $244 trillion in
derivative exposure
sitting on the balance
sheets of U.S.commercial banks, $200
trillion of it is interest
rate based.
Levels of financial
leverage are higher
today than during the
Tech Bubble.
ecut e Su a y
The $200 Trillion Gorilla
26
While the stated purpose of the Feds interventionist policies
over the last couple of years has been to satisfy its dual
mandate of employment and economic stability, it seems like
Bernanke is interested in interest rates for other reasons.
After looking at a chart of 30-year Treasury yields, it is clear
that QE has not lowered interest rates. Further, the only time
interest rates did fall was when the Fed was not engaging in
quantitative easing.
The Fed is engaging in QE to:
Absorb the debt fueled by the U.S.s enormous deficit
Manage the interest rate based derivative market
Since the Great Crisis began, we have seen The Powers That
Be (TPTB) spend massive amounts of money in an attempt to
stop gap the downturn in private sector spending.
82% of the $244 trillion of U.S. commercial banks derivative
exposure is interest rate based. The graph at right shows the
banks with the largest exposure. These are also the banks that
the Fed has been funneling money into. This $200 trillion
gorilla in the room. Compare this to the CDS market, a major
contributor to the initial downturn in 2008, which was only
$50-60 trillion at that time.
Again, the real risk here is with counter party risk and if
anyone one has unhedged/naked exposure (like AIG did),
which can lead to cross-defaults.
Keep in mind that the large majority of interest rate swaps are
nominal payments on the 30-year fixed rate mortgages, and
the majority of bank profits come from the spread on these
derivative transactions. If the 10 year jumps 5%, putting
anyone with a fixed rate in the money, none of these banks
would be solvent.
30-Year Treasury Yield
Credit-based Derivative Exposure of Largest U.S. Banks
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DRAFT
The Fed has pushed the
Fed Funds rate from a
pre-recession level of 5%
to near zero, with no
plans on allowing them to
increase at least through
2013.
Notice how rates fell
again after QE2 ended
during the summer.
The adjusted yield curve
(which removes the
distortions caused by
extreme volatility and Fedmanipulation) is currently
20 bps away from
inversion between the 2-
year and the 5-year rates.
An inverted yield curve
preceded every recession
since 1970. Current
estimates based on this
methodology (out of
BofA) puts the occurrence
of another recession inthe U.S. at approximately
60%.
y
Daily Treasury Yields
27
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DRAFT
The issue now is that we
have entered into
the "Japan Syndrome".
Almost 30 years ago
Japan experienced its
own real estate/credit
bubble bust. Japan has
attempted virtually
everything the Fed has
tried from lowering
interest rates, liquidity
injections and currency
deflation in order to
restart their ailing
economy. It has all failed.
As a result of these
monetary experiments,Japan has remained in a
protracted economic
slump.
Notice how Japan, a net
export country with one
of the highest domestic
savings rates globally,
faced deflation following
the implementation of itsZIRP (zero interest rate
policy).
y
Were Turning Japanese (I really think so)
28
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DRAFT
While the Fed stopped
publishing M3 data in
March of 2006,
ShadowStats.com
continues to publish an
estimate.
Note that only when
Money Supply Growth
falls below zero (A), does
this indicate a contraction
over the previous 12
months.
While the impact of the
Feds QE efforts (in theirvarious forms) began to
finally work as M3
finally began to have
positive growth after
point (A), QE2 has ended
and M3 appears to be
rolling over again (B).
Source:
http://goo.gl/y9XA0
y
Inflation?
29
A
B
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DRAFT
So we have money supply
flattening out (previous
slide), and here we have
the velocity of money
turning down again. This
is deflationary.
The risk of hyperinflation,
at least in the
short/medium term, is
low in my opinion
because we have money
supply flattening out and
velocity of money turning
down.
Source:
http://goo.gl/y9XA0
Inflation? (2)
30
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DRAFT
Since the Fed Funds Rate
peaked in January of 1981
at 20.06% (!!!), it has
fallen to a current level of
approximately zero.
Over this same period,
the 10-year Treasury has
fallen from 15.7% to
approximately 2%
currently.
This indicates a secular
loosening of credit over
the last few decades.
10-Year Treasury Yield & Inflation
31
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DRAFT
The precipitous drop in
both the Fed Funds Rate
and, more importantly,
the 10-year, has virtually
driven all of the growth in
the U.S. economy since
the early 80s.
This is simply showing
that the economic growth
we have experienced has
been credit-driven.
With the FFR near zero
and the Fed is out of
bullets, in the traditionalsense. This is not to say
further easing will not
occur, however, it is likely
to take a new form.
S&P 500, 10-Year Treasury Yield, & FFR
32
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DRAFT
Graph shows inflation-
adjusted (i.e., real) S&P
historical returns
(excluding inflation and
dividends), along with a
regression line and call-
outs at extreme points
above and below that
line.
Blue and Red portions of
the line denote secular
bull and secular bear
markets, respectively.
Purple is unknown.
While we cannot tell the
future, and whether or
not 2009 (A) was the start
of another secular bull
market or simply a
bounce within a secular
bear started in 2000.
Excluding 1877, you will
note that the start of anytrue secular bull market
came only after a print at
least 50% below the
regression line. This
implies that we have
much further to fall
before the next secular
bull, as our recent print
below the regression line
was a mere 9%.
Inflation-Adjusted Regression to Trend
33
A
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DRAFT
The stock market returns
over the last century can
be divided between
periods of above- and
below-average returns,
denoted in the graph by
green or red bars,
respectively.
Valuation level at the
time of investment (i.e.,
price-to-earnings ratio)
relative to changes in that
valuation level over the
holding period generally
drive the return
ultimately realized by aninvestor.
For example, investing at
a time of above-average
P/E ratios will generally
only yield positive results
if the P/E ratio at exit is
even further above-
average.
Negative Annualized Returns Over The Next Decade Very Likely
34
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DRAFT
The first table shows a mix
of 20 year annualized
returns from different points
in time using the Nominal
Returns (not inflation
adjusted), including
dividends (reinvested),transaction costs, and taxes
paid.
Notice how much the
starting P/E ratio matters in
influencing the returns over
the following 20 years.(http://goo.gl/gwYUv)
The bulk of investment gains
tend to generally come fromexpansion in the P/E ratio
over time, and not from
improvements in earnings,
per se.
Thus, it is important to
understand where we are in
a PE cycle, as when you
invest has more of a bearing
on the returns you can
expect than simply being
invested.
Next, we see the
compression and expansion
of PE ratios since 1965.
Again, the values in the
squares represent the
annualized rates of return
since 1965.
Negative Annualized Returns Over The Next Decade Very Likely
35
An investment made in
1996 would have yielded
an annualized return of
only 3% over the last 14years
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DRAFT
Reasons current earnings
growth is unsustainable:
Much of recent earnings
growth has been driven
by unsustainable federal
stimulusMuch of recent financial
earnings are a mirage,
driven by assets not being
marked-to-market,
insufficient loan loss
reserves, and their prior
ability to borrow short
(essentially for free) and
lend long, which is
currently changing
through Operation Twist
Both Financial and non-
financial sectors have
margins outside of
historical norms, driven
by low headcounts and
increased outsourcing
Source:
http://goo.gl/OEW6E
Negative Annualized Returns Over The Next Decade Very Likely (2)
36
Essential Ideas
In spite of what efficient market theorists say, for a period of at least 20 years, it very much matters whether the starting valuation (PE) is
high or low when one starts to invest.
However, in any given year (or even for several years), stock market returns may do random things. In other words, just because a market is
richly valued does not mean it cannot get more so. Likewise, just because a market is cheaply valued, does not mean it cannot get cheaper.
As a result of the preceding point, many think that returns are random. While that may be true in a given year, over a suffic ient period of
time, expected future returns are anything but random.
The bulk of stock market gains frequently come from PE expansion, not from improved earnings.
It is important to know where in the cycle one is (whether PEs are in a state of expansion or contraction).
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If we were at (A) right
now, would you rather be
a buyer or a seller?
Do we have enough
empirical data toreasonably believe we are
more likely at a point
such as (X) or (Y) right
now?
Secular Markets: S&P Historical Inflation Adjusted Composite
37
A
X
Y
DRAFTExecutive Summary
d h ?
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The business cycle
oscillates between fear
and greed. Where one
decides to go long has all
the influence over the
returns ultimately
realized.
Given the growing anxiety
about the global
economy, the constant
bottom calling (i.e,
denial) since the
Collapse began, and fear
about the future, coupled
with the fact that we
have yet to seecapitulation, panic,
despondency, et. al.,
where do you think we
are in the cycle?
Fear, Hope, & Greed: Where Are We Now?
38
I am pretty smart.This is fun!
How could I have
been so wrong?
Temporary set-back.
Im a long-term
investor anyway.
Are we here
or are we here?
DRAFTExecutive Summary
R d i
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Given the current
economic environment,
the establishment of a
short market position
would be a relatively low-
risk mechanism that could
be employed efficiently
while both providing out-
sided returns relative to
the capital deployed, as
well lowering the
standard deviation of the
total returns of the MOI
portfolio as a whole.
The graph at the right
depicts the payout on thepurchase of $1 million of
SPY $108 March 2012
puts (in-the-money if SPY
falls below $108 by March
2012). The red line is the
payout at expiration.
If we were to revisit the
lows set in March of
2009, this position wouldreturn over $7 million in
profit.
Stops would be placed at
resistance points above
current market levels and
the position would be
monitored for
confirmation of the
trades antithesis.
Recommendation
39
Overview
Recommendation
October 14, 2011
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Appendix IThe Market
DRAFTThe Market
C t M k t S h t S&P 500
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Current Market Snapshot: S&P 500
41
DRAFTThe Market
S&P R i t T d
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Things tend to revert to
their mean over time.
This chart shows the
inflation-adjusted S&P
from 1870 to present,along with its regression
line. Below, the variance
between the market price
at a particular point in
time and the regression
line is plotted.
You can see that the
market is still about 30%
above trend.
Note also that each true
bottom did not occur
until a variance of 50% or
more below the trend
line.
Note also the duration of
the last few cycles:
approximately 18-19years.
S&P Regression to Trend
42
DRAFTThe Market
Q R ti Si 1900
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The Q Ratio is the ratio of
market value to
replacement value for a
particular asset. It gives
an indication as to how
over- or under-valued a
particular asset is.
So, for an individual
company, a Q ratio
greater than one implies
that its market value is
greater than its corporate
net worth.
We can see here that thecurrent Q ratio is still well
above its arithmetic mean
(0.71), implying that in
spite of the declines since
the bursting of the tech
bubble (in real terms), we
are still significantly
overvalued.
Q Ratio Since 1900
43
DRAFTThe Market
Q Ratio Percent Change from Geometric Mean
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Here, the Q ratio is
plotted as a percent
deviation from its
geometric mean.
Again, it is showing thatthe market is still
significantly overvalued.
Q Ratio Percent Change from Geometric Mean
44
DRAFTThe Market
Inflation Adjusted S&P and Q Ratio
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Here we can see the
correlation between the
S&P and the Q Ratio.
Inflation-Adjusted S&P and Q Ratio
45
DRAFTThe Market
S&P Composite and the Crestmont P/E Ratio
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The Crestmont P/E Ratio
is currently in the top
quintile. This indicates
relatively high level.
Definitely not a bottom.
S&P Composite and the Crestmont P/E Ratio
46
DRAFTThe Market
Q Ratio Crestmont P/E Cyclical P/E10 and S&P Variance from Regression
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All 4 of these indicators
are showing the market
as significantly
overvalued and due for a
secular correction.
Notice, each other
bottom has printed
approximately -50%
below the zero line.
Another way to look at
this is the extent to which
we are still in a bubble.
In short, We have a longway to go.
Q Ratio, Crestmont P/E, Cyclical P/E10, and S&P Variance from Regression
47
DRAFTThe Market
Market Cap as a % of GDP
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The market is still at over
120% of nominal GDP,
implying that we are still
in a bubble.
Market Cap as a % of GDP
M
48
M
DRAFTThe Market
Changes in Profit Margins Lead Changes in Stock Price
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We have discussed
already the margin
contraction corporations
are experiencing during
2011.
As further slowdowns in
demand will only
exacerbate this problem
further, causing margins
to fall even more, expect
future stock prices to fall.
Changes in Profit Margins Lead Changes in Stock Price
49
DRAFTThe Market
Technical Evidence for a Bear Market Decline
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There currently exists
substantial evidence that
a further bear market
decline is ahead.
A.Over the last two
months, the market has
experienced severe
volatility, which is not
typical of a bear
market. Also, its
inability to overcome
its 50 day moving
average is bearish.
B.Breaks below the 200
week moving average
are extremely bearish.
Notice how it hasprovided support and
resistance.
C.Notice what occurred
after the last real break
of the 200 week moving
average.
D.This chart suggests a
low of 600 will be
retested after a test of
the March 2009 lows.This represents a
decline of almost 50%
from current levels.
Source: http://goo.gl/SIi2b
Technical Evidence for a Bear Market Decline
50
A B
C D
DRAFTThe Market
High-Yield Credit Signaling Another Market Downturn
http://goo.gl/SIi2bhttp://goo.gl/SIi2bhttp://goo.gl/SIi2bhttp://goo.gl/SIi2bhttp://goo.gl/SIi2bhttp://goo.gl/SIi2bhttp://goo.gl/SIi2bhttp://goo.gl/SIi2b8/3/2019 The Greater Depression or - How I Learned to Stop Worrying and Love the Bear 2011.10.15
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Remember: Credit
anticipates, equity
confirms
Notice how the 50 day
moving average crossedunder the 200 day moving
average [1] prior to the
last major market
correction. You can see at
[2], the 50 has recently
crossed under the 200
once again. This indicates
that the market is
heading for a period of
contraction.
High Yield Credit Signaling Another Market Downturn
51
DRAFTThe Market
High-Yield Credit Signaling Another Market Downturn (2)
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Notice how High Yield
broke support and 30-
year bonds broke
resistance prior to the last
crash [1].
This signals Risk Off as
funds flow from the
riskier high yield to the
safer 30-year fund.
We can see at [2] that this
is occurring again as the
Market is shifting into
Risk Off mode once
again.
High Yield Credit Signaling Another Market Downturn (2)
52
DRAFTThe Market
Street Talk Advisors Intermediate Buy/Sell Indicator
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STA developed a
proprietary model that
provides intermediate
term signals for
increasing/reducing
equity exposure.
Street Talk Advisors Intermediate Buy/Sell Indicator
53
DRAFTThe Market
2-10 Spread and the S&P 500
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The expansion of the 2-10
yield spread has helped
prop up the market since
the Collapse began in
2008. As the yield curve
flattens, this support will
begin to fade.
2 10 Spread and the S&P 500
54
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Appendix IIEmployment (or lack thereof)
DRAFTEmployment
Weakest Employment Index Since March 2010; Respondents Uniformly Bearish
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While the overall NMI
came at 53, a drop from
53.3, but better than
expected 52.8, it is the
Employment index that is
attracting everyone's
attention, printing at48.7, down from 51.6: the
lowest from March 2010,
which has offset an
improvement in both
New Orders and Business
Activity. And the kicker,
all the responses in the
survey were negative
across the board
Source:
http://goo.gl/O4AeR
p y ; p y
56
Respondents were uniformly bearish:
"It appears everyone is waiting to see what
happens next. No trust in the economy or
the federal government to do what is
needed.
"Weak consumer confidence and high gas
prices are placing downward pressure on
retail sales volume." (Information)
"Business volume outlook and confidence
across many market areas in North America
appear to be softening." (Mining)
"The 2012 outlook is not optimistic; though
we keep hoping for a rebound, we see littlesign of an improved economy nothing at
least that will spur growth, investment or
expansion. Improved investment
performance in early 2011 caused us to
begin several large capital projects, and
although we have broken ground, we cannot
help but question if our timing was right."
(Educational Services)
"Third and fourth quarters appear to beslowing down in order volumes. Uncertainty
over U.S. and European economy is causing
clients to hold off on new orders."
(Professional, Scientific & Technical Services)
"Negative forecast for housing market's
future leads us to think we will be at
current levels of business at best for the
foreseeable future." (Wholesale Trade)
M
DRAFTEmployment
Percent Job Losses in Post WWII Recessions
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The current contraction
has generated the most
severe job losses in any
recession since WW2. The
fact that the
unemployment situation
is structural, rather thancyclical or transitional, is
evident by the fact that
over 40 months since the
employment peak, we are
still 5% below.
57
DRAFTEmployment
Initial Jobless Claims Over 400,000 (Still)
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For the week ended
October 1, 2011, initial
jobless claims came in at
401,000, the 26th
consecutive week over
395,000.
Red lines indicate
averages over highlighted
periods.
, ( )
58
DRAFTEmployment
Average Duration of Unemployment at All-Time High
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Average unemployment
duration is at the highest
level ever seen, and
shows no signs of rolling
over currently.
Unprecedented
This has clearly been
influenced by the
continual extensions of
unemployment benefits,
which are currently up to
99 weeks (!!!).
g p y g
59
DRAFTEmployment
Declining Labor Force Participation
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The falling labor force
participation rate is the
primary reason that
unemployment is 9.1%
currently instead of 11%.
"It takes GDP growth of
about 2.5 percent to keep
the jobless rate constant.
But the Fed expects
growth of only about 1
percent in the last six
months of the year. So
that's not enough to bring
down the unemployment
rate. Bernanke
While this may not look
bad from a historical
standpoint, it is
important to remember
that the 1970s ushered in
a new era of dual-income
households as more
women entered the work
force.
g p
60
DRAFTEmployment
Unemployment by Duration
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This Collapse has seen a
disproportionate rise in
longer term
unemployment with 4%
of the labor force
currently unemployed for
more than 6 months. Alsonote that this is only
marginally off of its highs.
61
DRAFTEmployment
Unemployment Weekly Claims
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We seem to have stalled
at about 400k weekly
claims.
Keep in mind that claims
over 300k are not good
for economic growth.
62
DRAFTEmployment
Needs To Generate 261,200 Jobs/mo. To Return To Pre-Depression Employment by 11/2016
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To provide some
perspective about how
bad the job situation
really is. The economy
would need to create
261,200 jobs per month
through the end ofObamas potential second
term in office in order to
return to pre-depression
unemployment. This
calculation takes into
account the historical
natural growth in the
labor force of
90,000/month
extrapolated out.
How likely is it that we
will be able to create 16.2
million jobs over the next
62 months?
63
DRAFTEmployment
Hypothetical Employment Paths
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Here we examine the
time it will take to arrive
back at Peak
Employment, varying the
rate at which jobs are
added on a monthly basis.
You can see that we will
not return to peak
employment for some
time, even if we were
able to add 158k jobs per
month, which is
extremely high.
64
DRAFTEmployment
Manufacturing Jobs
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This shows the decline in
manufacturing jobs and
speaks to the impact that
outsourcing our
production over the last
15 years has had on our
domestic employmentbase. Average levels of
each period are in red.
The manufacturing jobs
are gone because we
dont make anything in
the country any longer
its all been outsourced.
65
DRAFTEmployment
S&P Composite
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This shows that
unemployment is a
lagging indicator that
moves inversely with
stock prices.
This makes sense, as we
have already discussed
that a) changes in
profitability lead to
changes in stock price,
and that b) in an attempt
to regain lost profitability,
companies, must fire
workers in order to
reduce unit labor costs,
which increase with dropsin productivity.
Recent stock market
drops imply that another
surge in unemployment is
right around the corner.
66
DRAFTEmployment
Jobless Claims vs. S&P 500 (Inverted)
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As employment lags the
inverted S&P, this
indicates that
unemployment is set to
spike.
67
From StreetTalkLive.com:
Let's take a quick look at some numbers: 8, 160, 400, 350, 12 and 5. There have only been 8 weeks out of last 160 weeks that
unemployment claims have been below 400 thousand claims. In normal circumstances we are worried about recessions when
claims are rising above 350 thousand. Furthermore, jobless claims tend to plunge below 350 thousand a week within 12 months
after the end of a recession. Currently we are still holding above 400 thousand claims after more than two full years since the
recession officially ended.
October 14, 2011
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Appendix IIIConfidence
DRAFTConfidence
Sentiment Leads Consumption
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Remember: Sentiment
leads consumption
69
DRAFTConfidence
Fed Business Outlook Survey Report
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The recent Fed Business
Outlook survey suggest
further weakness.
Source:
http://www.philadelphiaf
ed.org/research-and-
data/regional-
economy/business-
outlook-
survey/2011/bos0911.pdf
70
"Responses to the Business Outlook Survey this month suggest
that regional manufacturing activity is continuing to contract,
but declines are less widespread than in August. The surveys
broad indicators for activity, shipments, and new orders all
remained negative for the second consecutive month.
Responding firms, however, indicated that employment was
slightly higher this month. The broadest indicator of future
activity remained positive and rebounded this month, suggesting
that recent declines are not expected to continue over the next
six months."
Increasing costs were somewhat more widespread this month
compared to last month. Nearly 29 percent of firms reported
paying higher prices for inputs this month. Only 6 percent
reported lower prices. The prices paid diffusion index increased
10 points, its first one-month increase in seven months.
And inflation is back
DRAFTConfidence
U of M Consumer Sentiment Index with GDP (August 2011)
http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdfhttp://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos0911.pdf8/3/2019 The Greater Depression or - How I Learned to Stop Worrying and Love the Bear 2011.10.15
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Shows the Michigan
Consumer Sentiment
Index along with GDP and
recessions.
Note that every other
precipitous fall in the
magnitude we have just
seen has been followed
by diminish, if not
negative, GDP prints.
71
DRAFTConfidence
Conference Board Consumer Confidence Index & NFIB Small Business Optimism Index
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Both indices are falling
precipitously again.
72
DRAFTConfidence
Ceridian-UCLA Pulse of Commerce Index
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The PCI is rolling over
again.
73
DRAFTConfidence
Confidence Board Consumer Confidence Index
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Consumer Confidence
Index dropping hard.
Drops this steep are
typically followed by
declines in GDP. Our
current GDP levels are
already close to fallinginto the red.
74
DRAFTConfidencePulse of CommerceTM Index: 3-Month Moving Average
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Pulse of Commerce rolling
over again, back at
September 2004 levels.
Also showing a similar
fractal to that which was
seen prior to the lastrecession.
75
DRAFTConfidenceNFIB Small Business Optimism Index
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Small business confidence
falling back to recession
levels.
76
DRAFTConfidenceU.S Misery Index
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This is a graph of CPI
Inflation plus
Unemployment Rate
Percentage.
You can see it has just hit
a new 28 year high.
77
October 14, 2011
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Appendix IV
Consumption
DRAFTConsumptionComponents of Real GDP since 2007
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Clearly the Personal
Consumption
Expenditures (PCE)
component has the
highest correlation to
Real GDP.
We are clearly in a
downtrend.
79
DRAFTConsumptionReal Mean Household Income Cumulative Growth
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Data from the recently
released Census Bureau
report showing the
cumulative growth in real
household income since
1967, by quintile , along
with the top 5%.
You will see that growth
was much higher for the
top quintile in general,
and for the top 5% in
particular.
Also, purchasing power of
2010 incomes has shrunk
to approximately mid-1990s levels.
This lack of purchasing
power has a huge drag on
consumer confidence.
80
DRAFTConsumptionDeclining Household Income
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Household income has
continued to fall since the
recession ended in
2009.
In a separate study by
Henry S. Farber, aneconomics professor from
Princeton found that
those who lost jobs
during the recession and
later found work made an
average of 17.5% less
than they had in their old
job.
Between June 2009,when the recession
officially ended, and June
2011, inflation-adjusted
median household
Income fell 6.7 percent,
to $49,909, according to a
study by two former
Census Bureau officials.
During the recession
from December 2007 to
June 2009 household
income fell 3.2 percent.
Source:
http://goo.gl/aX6bZ
81
DRAFTConsumptionConsumer Credit
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Consumer credit fell in
August by the most in
over a year. This is the
largest month-over-
month contraction since
1998.
This is equivalent to a six
standard deviation
deceleration in credit
availability (based on the
last 60 years).
82
DRAFTConsumptionConsumer Credit (2)
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Here is the breakdown
between revolving and
non-revolving credit. You
can see the bulk of the
drop was attributable to
the non-revolving
component, which spikedin July.
83
DRAFTConsumptionConsumer Credit
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The Government has
increased it share of total
consumer credit from
below 5% before the
Collapse, to over 15%
currently.
84
DRAFTConsumptionFood Stamp Participation and U-6 (Total) Unemployment
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With U-6
unemployment still
over 16%, we
currently have a
record of over 45
million Americans
receiving food stampbenefits.
October 14, 2011
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Appendix V
Gross Domestic Product
DRAFTGross Domestic ProductReal Annualized GDP Growth
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The 2nd Estimate for Q2
2011, which was revised
down from the initial
estimate, came in at a
mere 1% annualized rate.
We can see here not onlythe initial recovery here,
but also the slowing of
said recovery, with
growth rolling over.
While we have not seen
any negative prints since
the official end of the
recession, we are getting
dangerously close. Iexpect to see a negative
print in Q4 2011.
87
DRAFTGross Domestic ProductECRI Weekly Leading Index with Gross Domestic Product
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The Weekly Leading Index
(WLI) growth indicator of
the Economic Cycle
Research Institute (ECRI)
has now dropped further
into negative territory
after oscillating in anarrow range (1.5 to 2.1)
from late June through
the first week of August.
The sequence that follows
the pattern seen to the
right is:
P/E Ratio compression
GDP reductions in outlook
Reduced earningsestimates
Markets regress to their
mean
Without fiscal and
monetary support the
economy is prone to
further weakness given
the underlying weakness
in fundamentals:
Weak housing market
Sustained high
unemployment levels
Rising commodity prices
Stagnating wages
Low overall levels of GDP
growth
88
DRAFTGross Domestic ProductInvestment Contributions to Percent Change in Real GDP
http://www.businesscycle.com/resources/http://www.businessinsider.com/ecri-leading-indicator-negative-2011-9http://www.businessinsider.com/blackboard/ecrihttp://www.businessinsider.com/blackboard/ecrihttp://www.businessinsider.com/ecri-leading-indicator-negative-2011-9http://www.businesscycle.com/resources/8/3/2019 The Greater Depression or - How I Learned to Stop Worrying and Love the Bear 2011.10.15
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Notice how Residential
has not only remained in
negative territory since
the start of the housing
bubble bursting, but also
that it has currently
turned downward onceagain.
Equipment and software
purchases is also turning
down, with Non-
Residential structures
barely in positive
territory.
89
DRAFTGross Domestic ProductNon-Residential Investments as Percent of GDP
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While we have seen a
general rise in Equipment
and Software
purchases/investment
since the end of the
recession, investments in
Structures have failed tocome off of their
recession lows.
90
DRAFTGross Domestic ProductReal GDP (Billions of Chained 2005 Dollars), Seasonally-Adjusted Annual Rate
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Real GDP is still below its
pre-recession peak.
Also note the consistent
direction of
revisionsInteresting.
This is GDP in real terms
rolling over.
91
DRAFTGross Domestic ProductState Coincident Index, Number of States Showing Increased Activity
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