Why Some Key Charts Reveal the Reflation Rally May Be Tiring (Finally)

Trading From Ground Zero - We Don't Do It Enough

After going from Hero to Zero on the two S&P short positions, my March contracts expired, and I have not replaced them, instead opting to hang out in "wait and see" mode.

Contract expiration always tends to be a good exercise I find, as it forces me to ask myself "If I started over today, would I re-enter this position at current prices?" It's a question that we should ask ourselves more often - yet, we often don't, instead sitting and waiting for the market to turn our way.

Unfortunately, the market doesn't care what our positions are, it's going to go where it's going to go, whether we are long, short, or neither.

Checking in on Some Key Charts

Major indices hit new recovery highs today, with the DOW hitting it's highest mark in the last 18 months.

Trading volume remains tepid, however - as you can see from this chart of the S&P 500, this recent rally appears to lack some conviction:

Rallies have been occurring on lower volume than pullbacks.

(Chart courtesy of StockCharts.com)

Chinese shareholders have been less exuberant of late than their American counterparts, as the Shanghai Composite Index continues to flirt with a breakdown beneath its 200 day moving average:

While US markets climb everyday, China huffs and puffs.

(Chart courtesy of Yahoo Finance).

Regular readers know that China is one of our favorite leading indicators. Is China's recovery running out of steam already?

The experts at Stratfor Global Intelligence believe that China's economy will be run on lending for at least the next year (free video clip here) - the result of which remains to be seen.

Commodities, also, continue to lag the rally in equities:

Like Chinese stocks, commodities are also well off of recovery highs.

(Chart courtesy of StockCharts.com)

Bottom Line: These non-confirmations could be ominous bearish divergences, indicating the reflation rally is on it's last legs. The rally appears tired, but is not over yet.

On the other hand, if all 3 of these charts confirm new recovery highs together, we'd have to conclude that this rally still has some room to run.

Bill Gross' Take on Portugal's Downgrade and Escaping the Sovereign Debt Trap

Ever wonder what the hell takes the rating agencies so long?

Last week, leading credit agency Fitch downgraded Portugal's debtamid "growing concerns about the government's ability to service it's borrowings."

Well - duh - increased borrowings coupled with decreasing tax revenues should raise concerns. What amazes me is that the Euro traded down today on the news - this shouldn't have been news at all, everybody saw this coming from Portugal as soon as Greece got the hiccups.

If the tax revenues were coming back, there might be hope - but revenues are not coming back anytime soon, so hope is bleak, if not non-existent. Europe is an economic basketcase with declining demographics - it's completely toast.

Bond king Bill Gross of Pimco weighed in today - in his eyes, there are three factors which could, at least theoretically, allow a country to escape the sovereign debt trap:

• It must be able to print its own widely accepted currency
• Have manageable budget deficits, and
• Find investors willing to buy their bonds (Source: Forbes)

The US, for now at least, passes all 3 tests...Greece, Portugal, and the rest of the PIGS obviously do not. Much of the rest of the world does not either.

Is sovereign debt the next domino to tumble in the global financial crisis? It sure looks like things are teetering.

Why the Federal Deficit is in Even Worse Shape Than You Think

If there was any question before that the federal deficit was completely out of control and unsustainable, the successful passing of the "free healthcare for all" plan should completely seal the deal!

As you probably recall, the out-of-control debt spiral faced by our government sparked some interesting conversation at our local Casey phyle meeting about the safety, or lack thereof, of our retirement savings.

That conversation was originally inspired by a fine piece of analysis that Bud Conrad, Casey's Chief Economist, put together for The Casey Report. They've graciously given us permission to republish Bud's piece here, so read on to learn just how bad the federal deficit is:

http://commoditybullmarket.blogspot.com/2010/03/why-federal-deficit-is-in-even-worse.html

Current Positions - None

I don't really like anything long or short right now. I guess if you had to make a short term call, you'd go short, with the markets being as overbought as they are right now (20 of 24 days up).

But, that's a tough one to time. And with the markets now again hitting new highs, the bear market rally that began last March may not be over yet.

Bill Gross' Take on Portugal's Downgrade and Escaping the Sovereign Debt Trap

Ever wonder what the hell takes the rating agencies so long?

Today, leading credit agency Fitch downgraded Portugal's debt amid "growing concerns about the government's ability to service it's borrowings."

Well - duh - increased borrowings coupled with decreasing tax revenues should raise concerns. What amazes me is that the Euro traded down today on the news - this shouldn't have been news at all, everybody saw this coming from Portugal as soon as Greece got the hiccups.

If the tax revenues were coming back, there might be hope - but revenues are not coming back anytime soon, so hope is bleak, if not non-existent. Europe is an economic basketcase with declining demographics - it's completely toast.

Bond king Bill Gross of Pimco weighed in today - in his eyes, there are three factors which could, at least theoretically, allow a country to escape the sovereign debt trap:

• It must be able to print its own widely accepted currency
• Have manageable budget deficits, and
• Find investors willing to buy their bonds (Source: Forbes)

The US, for now at least, passes all 3 tests...Greece, Portugal, and the rest of the PIGS obviously do not. Much of the rest of the world does not either.

Is sovereign debt the next domino to tumble in the global financial crisis? It sure looks like things are teetering.

To put it in perspective how bad things are when the US looks good in comparison, check out Bud Conrad's excellent analysis about America's federal deficit (Hint: it's even worse than you think!)

Why The Federal Deficit Is In Even Worse Shape Than You Think

If there was any question before that the federal deficit was completely out of control and unsustainable, the successful passing of the "free healthcare for all" plan should completely seal the deal!

As you probably recall, the out-of-control debt spiral faced by our government sparked some interesting conversation at our local Casey phyle meeting about the safety, or lack thereof, of our retirement savings.

That conversation was originally inspired by a fine piece of analysis that Bud Conrad, Casey's Chief Economist, put together for The Casey Report. They've graciously given us permission to republish Bud's piece here, so read on to learn just how bad the federal deficit is. Believe it or not, it's probably worse than you think!

***

Battle for the Budget

By Bud Conrad, Editor, The Casey Report

Recently the Congressional Budget Office (CBO) published its scoring of President Obama's budget for the next 10 years. It shows a budget deficit of $9.8 trillion. That is just shy of $4 trillion worse than the CBO’s baseline budget, a budget that includes only the laws as currently enacted, with no estimates of any new programs lawmakers may add that worsen future projections.

That our budget is out of control is no surprise, but the charts I present here should provide some perspective of just how dangerous this set of budget estimates could turn out to be. The first chart below shows the amount of red ink in each year for the two CBO estimates.

To get a visual interpretation of just how big these budget deficits have become, I plotted the long-term history, then tacked on the CBO evaluation of the president's proposal. Knowing the propensity of governments to spend more than they promise makes one question if the large improvement shown in the dotted line will actually occur. Even if nothing changes, however, the results look like they could be very damaging for other aspects of our economy.

One aspect of the CBO projections that is difficult to defend is the expectation that inflation will stay incredibly low. In the next chart, I present the same sort of long-term history, coupled with the projection, for the Consumer Price Index (CPI).

In the next chart, I put together two of the most important measures: the three-month T-bill interest rate and the deficit expressed as a percentage of the gross domestic product (GDP). Both history and projection are shown.

The most important observation is just how disastrous the current deficit is in the historical context, even after rationalizing it by dividing it by the GDP. I overlaid the two series to show that higher deficits in the past tended to occur along with higher interest rates.

As you can see, we now have a significant anomaly, with the budget deficit at its worst in half a century, while interest rates remain near their lows for the period. A closer look at history shows many divergences, to the point that in the short term these two series tend to bounce in opposite directions. That is probably because when the economy shows weakness, the government expands its spending and collects lower taxes, so the deficit becomes worse. Thus, in the short-term cycle of a few years, these two measures often move in opposite directions.

But the situation we face now is much bigger than anything we've seen since the 1950s. The government bailouts and stimulus are at record levels, and the special actions of the Federal Reserve have driven interest rates close to 0%. It is my expectation that both inflation and interest rates will rise dramatically because of these large deficits.

I also think the projected interest rates are much lower than what I expect the deficit would require. As foreigners and others recognize how seriously indebted the U.S. government is becoming, they will expect higher interest rates to compensate for the debasement of the currency.

The budget analysis goes further in calculating the expected growth of the economy, which ranges from 2 to 4% over the years. Those are not large numbers for real GDP, but there is no expectation of another recession during the decade. If the economy didn't grow, tax revenue would be less, and the budget deficit would be worse.

While interest rates are expected to rise as shown in the chart above, the projections expect that they roll over and stop rising at around 5%. That is contrary to my expectations that they will be much higher, and even perhaps closer to 10%, by the end of the decade. If they are, the cost of funding the outstanding government borrowing escalates rapidly because the increased interest has to be added to the debt so that the debt grows even more.

The problem from the onset of this crisis has been the debt, and that continues to be the case.

Leaving aside the above two adjustments that could make the budget deficit worse, it’s helpful to look at the outcome with the given assumptions and see where it leads. Perhaps the most problematic result is that the debt of the federal government held by the public grows from $7.5 trillion in 2009 to $20 trillion by 2020. Such big numbers are hard to understand, though you can get some sense of things by considering that the government is intending on almost tripling the debt in just 11 years. The ratio of this outstanding debt to the GDP gives a flavor of how dangerous the situation has become. As Ken Rogoff and Carmen Reinhart have indicated in their new book, when we approach 90% government debt of GDP, we have serious potential for a currency crisis. As you can see, we are well on our way to those levels, even without assuming the two adjustments above.

How will the deficit be funded?

The question arises who will service the rising levels of debt. Clearly the taxpayers are on the hook for all these projections, with more to come. So the question becomes whether the tax base can grow fast enough to provide support for servicing the debt. The CBO gave us two series for the tax base. One is Domestic Economic Profits, and the other is Wages and Salaries. The basic assumption is that these are the main revenue streams that can be taxed by the government to fund its expenses. I added these two series together and divided by the GDP to determine if the tax base is growing more rapidly than the economy. Unfortunately, but as expected, the orange line in the above graph shows that the tax base only grows about as fast as the economy itself. That's not surprising, but the contrast to the rapid growth in debt will be a serious source of problems, as the only way the debt can be sustained will be through increasing the tax rates, and probably quite dramatically.

The latest set of budget predictions will probably be wrong, and not just because the assumptions are too optimistic, but because there is a relatively high probability that something will go off track to cause a major shift before the 10 years are completed. Unfortunately we are not preparing ourselves for such problems, and so I would interpret the CBO projections as being far too rosy.

Bud Conrad is the chief economist at Casey Research, and crunching numbers like these is his daily bread. It also enables him, together with the rest of the Casey Report team, to accurately forecast what’s in store for the U.S. economy… a skill that subscribers to The Casey Report have come to highly appreciate. Learn more about what the future holds and how to profit by clicking here.

Ed. Note: As you probably know, I am a longtime Casey Research subscriber and affiliate.

Why Experts Say the Chinese Economy Will Be "Run on Lending" for at Least the Next Year

Stratfor reports that Chinese exports have not picked up as expected, or at least hope, so the Chinese bad lending/debt binge is expected to continue for at least the next year.

But never fear, Chuck Schumer is on the scene, declaring the Chinese to be "mercantalists!"

What could possibly go wrong?

Investors Haven't Been This Bullish Since January - Uh Oh

Another up day for equities, and investors appear to be feeling pretty good about things. According to the S&P 500 Bullish Percent Index, investors haven't felt this upbeat about things since January:

Investors have been feeling on the up and up of late.

Chart courtesy of StockCharts.com

Unfortunately investor bullishness is a classic contrarian indicator - as evidenced by the recent S&P's performance - a near spitting image of the bullish index!

And what a coincidence - their rising mood has mirrored stocks!

Chart courtesy of StockCharts.com

This would indicate that a near-term pullback in the markets is likely. The breadth and depth of which could determine whether or not this bear market bounce is finally licked.

What Folks Like You Are Thinking Right Now, and the Decreasing Benefit of Additional Debt

I must have had a few too many beers this afternoon, because I swear my alma mater, Cornell, just advanced to the Sweet 16 - in convincing fashion no less.

Must have had a beer or sixteen today!

Some Ink in Casey's Daily Dispatch - Inflation/Deflation, Wiring Money to Central America, and More!

On Monday, I penned a piece for Casey's Daily Dispatch that highlighted the investment and geopolitical conclusions that our local "phyle" reached during our most recent meeting.

Last night our Sacramento Phyle got together at a local restaurant to banter about the usual talk you'd expect to overhear at such a place – like government confiscation of retirement plans, expatriation, wiring money to Central America, and our favorite shorting techniques; you know, the usual.

Our attendees are all medium to longtime Casey subscribers, ranging from Davis to the Sierra foothills, and we all enjoy getting together to break bread, have a drink, and talk about things that we quite frankly can't talk to anyone else in our lives about.

We kicked off the night chatting about the potential confiscation or lockup of retirement funds – namely 401(k)s and IRAs – by the U.S. government. Our fear is that with U.S. federal debt truly spiraling out of control (as detailed by Bud Conrad in the last Casey Report), there will come a point where the government will likely appoint itself "custodian" of all retirement accounts. Stocks are too risky, let us invest your money "safely" in government-sponsored annuities (i.e., government paper that no one else will buy!).

We've chatted before about using IRAs to purchase assets that can't easily be confiscated – such as overseas real estate – but the tenor at this meeting was more cautious than ever. Several members are seriously considering emptying their retirement accounts over the next few tax years and taking whatever penalties and taxes will be assessed.

But then where do you put the money? "Not in your local Citibank account!" someone joked. The consensus was that you'd probably be wise to get the money overseas, and possibly into physical bullion in the process.

In terms of the timing, the scary thing is that it could potentially happen real fast -- striking with lightning speed as the last downturn did. We put the odds on it happening after 2012, as we didn't believe it'd be politically feasible at the moment, especially with an election slaughter upcoming this year. But if the next leg of the financial crisis strikes, all bets could certainly be off.

The group as a whole is still favorably inclined towards gold, but our outlook has decidedly changed since the peak of gold stocks a couple years ago. At that time, we'd talk about junior miners, looking for the next really big play. Nobody has the stomach for that now – I know I don't – not after losing our shirts when gold tanked last time! Now gold is looked at as more of a safety play – something that could decline but is likely to decline less than other assets.

One contrarian-minded member joked that this probably meant that gold stocks are still a good buy, since the Wall of Worry is still making our stomachs churn!

Our feeling on the markets, for the last 4-6 months, has been: "What's taking so long?" We're universally bearish on the stock markets. Some of us have stayed in equity positions, raising trailing stops along the way. Others bailed early in the last rally. But on the whole, our picks for an S&P finish were around 800 or lower – decidedly more bearish than your average CNBC analyst!

Finally we still believe the big – and maybe only – question to ask right now is the inflation/deflation question. None of us are yet convinced that we've seen the last of deflation... we're still holding a wary eye to the situation, allowing the possibility that a wave of asset deflation potentially even more powerful than the last one could be on the way. And if that happens, you'd want to follow the playbook of the last bout – get long the dollar, and get out of everything else.

We generally agreed that serious inflation, and likely hyperinflation, is the most probable endgame. With the big question being, will that be prefaced by a serious, extended period of deflation first? If that happened, the dollar could rally quite a bit. And all assets would in turn get hit, probably severely, though we expect that gold would hold up better than most others. And eventually the dollar will have to be sacrificed, thanks to our fabulous deficits. So that's not a long-term play by any means.

So overall we're still in a wait-and-see mode as a group – battening down the hatches, preparing for the next wave of the storm to hit! We'll be meeting up again in early May, potentially with some new fireworks to chat about!

You can read the entire issue of Casey's Daily Dispatch here.

The Marginal Productivity of Debt

More and more economic studies seem to be indicating that the more debt we take on, the less good it's doing us - in fact, the marginal benefit may now be less than zero!

First, a piece passed along by good friend and astute reader Carson regarding the debt saturation dilemma.

This reminded me of a guest piece we published in 2009 by San Francisco School of Economics Professor Antal Fekete entitled The Marginal Productivity of Debt. Which began:

The paper mill on the Potomac is furiously spewing up new money. According to the manager of the mill, as indeed according to the Quantity Theory of Money, this should stop prices from falling and the economy from contracting.

In this article I present an argument why this conclusion is not valid. On the contrary, I shall show that new money created on the strength of a flood of new debt, is tantamount to pouring gasoline on the fire, making prices fall and the economy contract even more. The Obama administration has missed its historic opportunity to stop the deflation and depression inherited from the Bush administration because it entrusted the same people with the task of damage-control who had caused the disaster in the first place: the Keynesian and Friedmanite money doctors in the Fed and the Treasury.

You can read the rest of the piece here.

Moral of the story is that Ben Bernanke "can create all the money he wants and more, but he cannot make it flow uphill."

Since this piece was published about a year ago, whether or not Bernanke has even created quite a bit of money is up for debate. Depends who you ask/read. Either way, it's tough to make the case that the money is flowing, at least just yet.

It's starting to trickle, but that was to be expected with this bear market bounce. Where we head from here should be the real key - either the next shoe drops, or the trickle steadily increases - we shall see.

My Trading Activity - Still Short the S&P (Twice)

Nothing changed - this position is still a train wreck - markets are still rising on low volume - due to fall any day - blah blah blah.

As good friend and astute reader Carson recently pointed out, the markets can stay irrational longer than you can stay solvent. Oh, so true. Love hurts!

Still double short the S&P...though these positions used to look much sexier!

A classic bear market bounce...probably.

(Source: Yahoo finance)

Have a great rest of the week in the markets! Comments are always welcome and very much appreciated.

Portions of this article (or the whole thing if you can't get enough) may be republished for free on your website, blog, or email newsletter - all we ask for is proper attribution, and a backlink to our website!

Why Your 401K and IRA Savings Could Soon Be a Prime Government Target

Last week our local "Casey Research Phyle" got together at a local restaurant to banter about the usual talk you'd expect to overhear at such a place - like government confiscation of retirement plans, expatriation, wiring money to Central America, and our favorite shorting techniques - you know, the usual.

In these turbulent economic and social times, having a group of like-minded people to banter with is invaluable. In fact, trends forecaster Gerald Celente recommended exactly this on an interview he did Friday with Jim Puplava (link here - Celente comes on towards the end of the first hour - the guy is hysterical, and sharp too, one of my favorite guys to listen to).

Our group kicked off the night chatting about the potential confiscation or lockup of retirement funds - namely 401K's and IRA's - by the US government. Our fear is that with US federal debt truly spiraling out of control, there will come a point where the government will likely appoint itself "custodian" of all retirement accounts. Stocks are too risky, let us invest your money "safely" in government sponsored annuities (ie. government paper that no one else will buy!)

For those of you scoring at home, the federal government clocked a record $220 billion deficit in the month of February - a new Griswold land speed record! If we're past the tipping point of runaway deficits, then it appears the question of government "guided" 401K and IRA plans is not a matter of "if", but "when."

Our phyle has chatted before about using IRA's to purchase assets that can't easily be confiscated - such as overseas real estate - but the tenor at this meeting was more cautious than ever. Several members are seriously considering emptying their retirement accounts over the next few tax years, and taking whatever penalties and taxes will be assessed.

But then where do you put the money? "Not in your local CitiBank account!" someone joked. The consensus was that you'd probably be wise to get the money overseas, and possibly into physical bullion in the process.

In terms of the timing, the scary thing is that it could potentially happen real fast - striking with lightning speed as the last downturn did. We put the odds on it happening after 2012, as we didn't believe it'd be politically feasible at the moment, especially with an election slaughter upcoming this year. But if the next leg of the financial crisis strikes, all bets could certainly be off.

Robert Prechter has been sounding the warning bells on this possibility for some time now. I recall reading in one of his recent newsletters where he again warned readers to be wary of these government "deals", because the temptation to engage in shenanigans would be too much for the feds to resist if a crash scenario played out.

The potential threat to retirement plans appears to be creeping into the mainstream as well. Here's an editorial penned last month - by none other than Newt Gingrich - for Investors Business Daily entitled Class Warfare's Next Target: 401(k) Savings. So the fear has already spread beyond fringe publications like this blog!

What's the historical precedent here? Argentina raided its citizens' retirement savings just 9 years ago:

Argentina to Raid Retirement Savings as Reserves Plunge

December 07, 2001|From Bloomberg News

BUENOS AIRES — Argentina, which is defaulting on its debts, said it will seize $2.3 billion of retirement savings by forcing private pension funds to transfer the money to a state bank in exchange for Treasury bills.

The government targeted savings every worker is required to set aside from their paychecks since the creation of a private pension system in 1994, after the International Monetary Fund withheld a loan.

Economy Minister Domingo Cavallo said the government, which has more than $2 billion of debt due this month, will use the money to pay state pensions and wages.

"For all intents and purposes they are confiscating funds," said Scott Grannis, who helps manage $1.5 billion of emerging-market debt at Western Asset Management in Pasadena and has sold his Argentine bonds. "They are destroying confidence."

Think this can't happen here in the US? I wouldn't want to bet on it!

While this probably won't happen tomorrow, next week, or even next month, it certainly could come into play faster than everyone expect if another "crisis" occurs - because if we've learned anything, it's that for the federal government, a "crisis is a terrible thing to waste!"

Some Ink in Casey's Daily Dispatch - Tomorrow!

If you subscribe to Casey's Daily Dispatch, keep an eye out for tomorrow's issue - our full synopsis of the phyle meeting will be in there! Of course I'll toss a link up when available.

This Week in CBM

I'm liberally borrowing "this week in" with a tip of the hat to Leo Laporte, who runs an excellent podcast media network, including "This Week in Tech", a fantastic weekly listen if you're into tech.

Anyway here are some good reads for the week ahead in the markets, if you didn't already catch them:

• Doug Casey on how you can survive the upcoming financial apocalypse

• Well I'll be damned...the S&P hits a 17-month high! Where to next?

My Trading Activity - Still Short the S&P (Twice)

Still double short, and it's still a train wreck. A good trade gone awry!

However markets don't get much more overbought than this, so if I were a betting man, I'd have to wager that this will be a down week in stocks...potentially a disastrous decline. We shall see!

Still double short the S&P...though these positions used to look much sexier!

A new breakout in the S&P, or is a double top being formed?

(Source: Yahoo finance)

Have a great rest of the week in the markets! Comments are always welcome and very much appreciated.

Portions of this article (or the whole thing if you can't get enough) may be republished for free on your website, blog, or email newsletter - all we ask for is proper attribution, and a backlink to our website!