Wednesday, January 25, 2012

You won't believe who owes U.S. billions

How would it be if the next few hundred billion dollars or so in U.S. bills could be paid off in cash? No borrowing. No additional debt.

Just as Barack Obama is planning to borrow another pile of currency, probably from China, to pay for his programs and promotions, calls are starting to develop for the U.S. to call in the debts that are due – and have been due for roughly two generations.

Those would be the sovereign debt bonds sold by China before the communist revolution – bonds that were issued with the promise by the Chinese that they would be an internationally recognized debt of China and its successor governments until paid.

But so far? Nothing.

The issue got the attention of Peter Huessy, the president of GeoStrategic Analysis, a defense forecasting firm, in a commentary at Fox News not long back.

“Many people assume China has the U.S. over a barrel. The country buys so much of our debt – around $800 billion – that we cannot ‘rock the boat’ when it comes to U.S. and China relations. That has meant not pressing the PRC ‘too hard’ when it comes to North Korea, or Iran,” he wrote. “Just recently, a top Obama administration delegation visited the People’s Republic of China. While there, the Chinese were told not to worry about the U.S. paying its debts to the country – their investments in the U.S. were safe. True enough.”

But he added, “I was struck with the fact that the PRC, however, does not pay its debts to the U.S.”

WND reported when Obama’s first “stimulus” package of some $700 billion-plus was being pushed through Congress that some of the beneficiaries would be Chinese companies – even while the billions of unpaid debt remained outstanding.

At that time, Kevin O”Brien, writing for the Global Association of Risk Professionals, warned that the situation could develop into a significant problem.

“One of the greatest problems facing China is the government’s failure to acknowledge and effectively address the true extent of state institutions’ bad debt,” he wrote.

“The repayment obligation was inherited by the People’s Republic of China, when the communists took control in 1949. The successor government doctrine of settled international law affirms continuity of obligations among international recognized successive governments,” O’Brien wrote.

Huessy explained what happened.

“Many decades ago, China sold sovereign bonds worldwide to investors in many nations. They sold tens of thousands of these bonds on U.S. soil to American citizens on the recommendation of our government, indicating it was a solid investment,” he said. “Over the last sixty years, China has refused to pay to these bondholders either the principal or interest on these full faith and credit sovereign bonds.”

He noted that in 1987 the British financial markets threatened to keep China out because of the unpaid bonds due to owners in that nation, so the Chinese reached agreement to pay up. But only to those bondholders.

That’s what is know as a “selective default,” meaning some debts were paid but others were not, Huessy said.

He noted that U.S. credit rating agencies such as Standard and Poor’s claim they simply can overlook that.

“Under the rules, they are granted a license by the Security and Exchange Commission (SEC) of the United States to be a nationally recognized statistical rating organization (NRSRO), a charter to assess the risk of investing in sovereign and corporate debt, stocks, or bonds. The ‘selective default’ of the PRC must be acknowledged, in that the metrics used by the NRSRO organizations that they themselves have promised to follow as part of their license agreement includes just such a requirement,” he warned.

“Now if China was found in selective default, this would cause the PRC to have to pay considerably more to finance its debt than it does now. Billions more,” he said.

He noted that China insisted, when Saddam Hussein’s government in Iraq collapsed several years ago, that any successor government in Iraq must be held to the existing debts, and the U.N. agreed to its demands.

“Currently, the People’s Republic of China owes a debt of over $750 billion to American citizens who are holding these full faith and credit sovereign bonds (many of them denominated in gold) sold to them by the Republic of China. Worldwide, the debt China owes to all bondholders is estimated to be several trillion dollars. The debt owed to the American people should be paid. The U.S. government could dollar for dollar offset bond interest we owe China with interest, principal and penalties China owes us,” Huessy said.

It wasn’t too far off the date when China demanded Iraq be held to account that the Chinese Ministry of Finance in 2006 issued an official communiqué addressed to “the Embassy of the United States of America in China,” in which the Chinese government formally repudiated China’s defaulted full faith and credit sovereign debt and announced that it would not repay any debt held by America, O’Brien explained.

China, meanwhile, continues to boast of its economic growth and influence, moves that periodically prompt outraged members of Congress to try to bring the issue to a head. A few years back it was Sen. James Inhofe, R-Okla., tried to advance a resolution noting China’s attempt “to conceal its defaulted government debt from investors.”

Huessy indicated that the White House should be jumping on the issue.

“That could even be part of the upcoming budget and debt agreement, paid down over a period of years,” he noted.

Meanwhile, under last year’s debt increase law, Obama can raise the nation’s debt cap, now $15.2 trillion, after he notifies Congress of the need unless his plan is opposed by a two-third supermajority, an unlikely event.

Fox News reports that almost $1 trillion of the new debt for the U.S. “can be attributed to Obama’s 2009 deficit-financed economic stimulus package,” of which some of the benefits went to Chinese-owned companies.

Jay Taylor: Turning Hard Times Into Good Times

1/24/2012: Gold & Country Confiscation. What Can You Do About It?

James Paulsen: Investment Outlook (January 23, 2012)

Main Street Misery Sets Wall Street’s Valuation

Investment and Economic Outlook, January 23, 2012

by James Paulsen, Chief Investment Strategist, Wells Capital Management (Wells Fargo)
During 2011, the stock market suffered a significant erosion in its price-earnings (PE) multiple. On a trailing four-quarter basis, the PE multiple on the S&P 500 finished 2011 at about 13 times compared to about 15 times at the end of 2010. Rising earnings were offset by a declining valuation resulting in a flat stock market last year. Will the stock market’s valuation revive in 2012? And, what is the outlook for PE multiples during the next several years?

The valuation of Wall Street often reflects the character of Main Street. Indeed, for the last several decades the PE multiple of the stock market has been closely related to the Misery Index (sum of the U.S. unemployment rate and the core consumer price inflation rate) on Main Street. A higher (declining) unemployment rate and/or inflation rate tends to lower (raise) the valuation investors are willing to pay for stocks. In the aftermath of the 2008 crisis, “Main Street Misery” remains high suggesting that Wall Street valuations could rise substantially in future years should Main Street fortunes slowly improve.


The accompanying chart overlays the S&P 500 PE multiple with the Misery Index. The PE multiple is based on the trailing five-year moving average of reported earnings and the Misery Index is shown on an inverted scale (misery rises when the dotted line declines). Since 1970, the sum of the unemployment rate and the core consumer inflation rate has done a good job duplicating the movements of the stock market PE multiple. That is, the valuation of the stock market is consistently impacted by the rate of inflation and labor unemployment on Main Street.

The collapse of the PE multiple in the 1970s resulted from both runaway inflation and stubbornly high rates of labor unemployment. Conversely, the Great Bull Run of the 1980s and 1990s occurred against the backdrop of a steady decline in both the inflation rate and unemployment rate. From 1980 until 2000, the core consumer price inflation rate declined from about 13 percent to 2 percent. The unemployment rate fell from a post-war high of 10.8 percent in 1982 to a low near 4 percent in the 1990s. Lower inflation and declining unemployment combined to improve the Misery Index from about 20 percent to only about 5.5 percent which produced about a four-fold increase in the S&P 500 PE multiple! Since 2000, however, although the core inflation rate has trended sideways, the unemployment rate has surged causing a near doubling in the Misery Index, and a halving in the S&P 500 PE multiple. It appears “Misery on Main Street” establishes “Valuation on Wall Street.” Therefore, what is the outlook for “Main Street Misery” and what does it imply about future stock market PE multiples?

A Little “Misery Math” for Stock Investors?

Currently, the Misery Index is 10.7 comprised by an 8.5 percent unemployment rate and a 2.2 percent core inflation rate. The stock market’s trailing 5-year PE multiple is about 16.5 times. What does a little “Misery Math” imply for the stock market in 2012?

The pace of job creation finally appears to be strong enough to produce a slow but steady decline in the unemployment rate. A modest assumption for 2012 would be the unemployment rate declines to between 7.5 percent and 8 percent. The core consumer price inflation rate is also likely to moderate this year. A significant decline in commodity prices last year, a recent moderation in core producer price trends (sixmonth annualized core PPI inflation slowed to 2.3 percent in the second half of 2011 versus a 3.7 rise in last year’s first half) and a continued deceleration in wage inflation suggest a mild decline this year (perhaps to between 1.5 and 2 percent?) in core consumer price inflation. Assuming the unemployment rate declines to 7.7 percent and the core consumer price inflation rate drops to 1.8 percent, the Misery Index would fall to 9.5 percent in 2012. The accompanying chart implies about a 19 to 20 PE multiple with a 9.5 percent Misery Index. Finally, assuming 2012 S&P 500 earnings per share reach current consensus expectations of $105, the trailing five-year average earnings would be about $80. A 19 PE multiple applied to $80 yields a S&P 500 target price for 2012 of 1520.

What does the Misery Index suggest for the stock market longer term? Looking out a few years is, of course, much more uncertain. However, if the recovery continues for the next four years, the unemployment rate would likely slowly decline to between 4 and 6 percent. The real wild card for the Misery Index and therefore the stock market longer term is what happens to core consumer price inflation. Assume the unemployment rate declines to 5 percent, but consider three different inflation scenarios—a high inflation outcome of 10 percent core inflation, a medium inflation outcome of 5 percent, and a low inflation outcome of 2 percent. It seems reasonable that as the recovery matures, core consumer inflation will not likely be much lower than it is today and could be substantially higher.

Finally, we conservatively estimate that four years from now, five-year trailing S&P 500 share earnings would reach $120, $115, and $110 respectively in the high, medium, and low inflation scenarios. What are the implied four-year forward S&P 500 price targets for each of these scenarios? The high inflation scenario implies a 15 percent Misery Index and from the accompanying chart this yields a PE multiple of about 11.5 and a future price target of 1380. The medium inflation scenario yields a PE multiple of 18.2 and a price target of 2093. Finally, the low inflation scenario implies a 27 PE and a price target of almost 3000!


As the accompanying chart illustrates, Main Street and Wall Street are closely connected. Misery on Main destroys the Valuation on Wall!

For 2012, the stock market could be driven higher by improved optimism and renewed confidence resulting from a slow but steady decline in the unemployment rate. Indeed, the relationship between the Misery Index and the PE multiple suggests a 1500 price target for the S&P 500 is reasonable assuming only modest declines this year in the unemployment rate and core inflation.

Long term, however, what will prove most important for Wall Street is the inflation outcome. If the character of the contemporary recovery is ravished by surging inflation, the stock market may reflect ongoing Main Street Misery by extending its decade long sideways trading channel. Alternatively, should inflation remain reasonably contained during the next few years of this recovery, stock market valuations may surge higher as the Misery Index on Main Street steadily improves.

BP Energy Outlook To 2030: BP, DVN, PBR, XOM

BP (NYSE:BP) expects global demand for energy to continue to grow over the next two decades, driven by population and income growth from the emerging economies. These forecasts and others related to supply and demand for energy are contained in Energy Outlook 2030, a long-term macro outlook on energy trends recently published by BP.

Global Energy Growth
BP estimates that demand for all forms of energy will increase by 39% through 2030, equal to a 1.6% annual rate. The company expects virtually all of this growth to come from non-OECD countries.

This rate of growth is slightly less than growth forecast by Exxon Mobil (NYSE:XOM) in The Outlook for Energy, a similar publication released by that company in December 2011. The company is looking for annual growth in energy demand to average 0.9% from 2010 to 2040.

Assumptions Used
BP's energy demand growth estimates are based on population growth of 0.9% per year through 2030, implying an additional 1.4 billion people. The company also assumes growth in GDP of 3.7% per year over the next two decades, an increase over the actual growth of 3.2% from 1990 to 2010.

Sources of Growth
As one might expect, BP is looking for almost all demand growth for energy to come from non-OECD countries. The company expects energy consumption for these nations to be 69% higher in 2030, with growth averaging 2.7% per year.

Market Share
BP also expects fossil fuels to maintain its status as the chief source of energy through 2030, with 81% of demand comprised of oil, natural gas and coal by the end of the forecast period. In 1990, these three fossil fuels supplied 89% of the world's energy needs.

The relative share of energy demand within the fossil fuel category will also shift markedly, according to BP, with crude oil losing the most market share through 2030. The company expects demand for liquids to grow 18%, and reach 103 million barrels per day by 2030. This growth, while impressive, will reduce its share of energy demand to 27% by 2030, down from 39% in 1990.

Natural gas demand will gain market share through 2030, with this commodity's market share reaching 26% by 2030, up from 22% in 1990.

Energy Independence?
One interesting prediction by BP is that the Western Hemisphere will become almost totally energy self-sufficient by 2030. This independence will be powered by increased production from the oil sands of Canada, deepwater areas offshore Brazil and production from shale oil and natural gas in the onshore United States, coupled with the anticipated overall decline in oil demand.

Devon Energy (NYSE:DVN) has operations in two of these three areas and might benefit if BP's forecast is realized. The company is involved with the Jackfish Project, a multistage oil sands project in Canada, and also has extensive acreage in a number of onshore shale oil and natural gas plays in the United States.

Petroleo Brasileiro (NYSE:PBR) is the state oil company of Brazil, and has an intensive exploration and development program planned over the next five years. The company is expected to spend $224 billion from 2010 to 2014.

The Bottom Line
BP expects brisk growth in demand for energy to continue for the next two decades, with this growth coming from what used to be called the Second and Third World areas. While some investors might find this forecast reassuring, is anyone really surprised that yet another major oil company has provided a macro forecast that supports an investment in the sector.

The American Debt Imperium and the Mother of all Bubbles

Baltic Dry Index – Sell-Off Overdone?

The Baltic Dry Index crashed by 50.4% to 893 on Friday from a high of 1,799 in the last week of 2011 and is 58.2% lower than October’s high of 2,136.


The Baltic Dry Index is generally viewed as a leading indicator of global economic activity as dry bulk primarily consists of commodities such as building materials, coal, metallic ores and grain. The massive growth in demand for commodities from 2005 to 2008 led to a surge in shipping rates as measured by the Baltic Dry Index. The demand and surging shipping rates subsequently resulted in a significant increase in capacity as the number of ships built increased sharply. Even during the great 2008/2009 crisis capacity continued to be increased as it takes two years to build a ship. Historically the capacity was generally tight and the supply seen as inelastic, resulting in marginal changes in demand causing rapid changes in shipping rates. The current significant surplus capacity in the industry means that supply exceeds potential demand to such an extent that supply elasticity has increased, resulting in rapid changes occurring in what is essentially a downtrend – yes, fundamentally the Baltic Dry Index is in a bear market as shown by the long-term chart below.


But what causes the rapid changes in demand and therefore the Baltic Dry Index? My research indicates that global manufacturing demand has very little to do with it. The answer is Chinese manufacturing demand but not the actual level of manufacturing measured by the CFLP Manufacturing PMI. In previous articles I referred to the CFLP Manufacturing PMI that is supposed to be seasonally adjusted. Despite the seasonal adjustment, a seasonal trend is clearly evident and I therefore seasonally adjusted the series further. I was amazed to find that the monthly seasonal factors and the Baltic Dry Index track each other. The reason why is not hard to find, as China is by far the world’s biggest consumer and importer of commodities and therefore the biggest player in dry bulk. Seasonally weak periods in the economy will lead to low physical demand for commodities and therefore low freight demand. On the other hand, strong periods in the economy will lead to high freight demand.

In the graph below I depicted my calculated PMI seasonal factor against the Baltic Dry Index. I have also indicated China’s New Year’s Golden Week holiday on the chart as it coincides with and explains the reasons for the weak seasonal pattern in January/February. The impact on China’s manufacturing sector is massive as the New Year’s Golden Week lasts for 15 days and includes three public holidays, while factory workers are allowed to take Sundays off. This year New Year will be celebrated on January 23, and the festival will last until February 6. The onset of the festive season/weak seasonal patch is therefore the reason behind the tumble in the Baltic Dry Index.

Sources: CFLP; Li & Fung; I-Net Bridge; Plexus Asset Management,

January/February could also mean a seasonal low for the Baltic Dry Index as from a seasonal perspective March and April are the strongest months in China’s manufacturing sector. In March and April last year the Baltic Dry Index failed to rise rapidly due to Japan’s twin disasters in March that severely restricted trade between China and Japan.

Notorious Market Timer Joe Granville Predicts A 50% Plunge

Notorious market timer Joe Granville predicted a 50% market plunge yesterday on Bloomberg Television:

Joseph Granville, whose “sell everything” call in 1981 sparked a decline in U.S. stocks, said the Dow Jones Industrial Average (INDU) will drop toward 8,000 this year because of waning momentum and volume.

“Volume precedes prices,” Granville, 88, a technical analyst who has been publishing the Granville Market Letter from Kansas City, Missouri for about 50 years, said in an interview on “Street Smart” on Bloomberg Television. “You are seeing much lower volume. That tells you that prices are going to go much lower, much lower than most people think possible and very few people have projected.”

Art Cashin noted the significance of Granville's call (via Zero Hedge):

Calamity Joe Is Back - Last week, we wrote that various cycles and technicians were pointing to a possible market top, on or about January 23rd. The “causes” ranged from sophisticated oscillators to the new moon to astrological confluences. Yesterday, one more “cause” was added and it came from a somewhat controversial Wall Street legend - Joe Granville.

Here's the video:

Production Cut Spells Profits for Apache : APA

Apache Corp. (NYSE:APA) — This independent energy company, which explores for, develops and produces natural gas, crude oil and natural gas liquids, has been in a bear market since August, when it broke down from its 200-day moving average at $120.

On Oct. 5, with the stock at $79, the Trade of the Day recommended buying APA following a positive signal from our proprietary indicator, the Collins-Bollinger Reversal (CBR), for a trade to $90.

The trade was successful and the stock is now recommended for a longer-term move higher following the break from a base at its 50-day moving average (blue line).

Chesapeake Energy (NYSE:CHK) announced yesterday that it will cut natural gas production by 8%, which should result in higher gas prices that would benefit APA.

Initially the stock should trade up to its 200-day moving average at over $105, but S&P has a “five-star strong buy” on APA with a 12-month target of $145.

Trade of the Day – Apache Corp. (NYSE:APA)

Where to Find Good Value in Europe (Koesterich)

by Russ Koesterich, Chief Investment Strategist, iShares

Call #1: An Update on Europe & Overweight Norway

While there have been developments toward solving the European debt crisis in recent months, more needs to be done.

Funding costs for Italy and Spain remain high, particularly for Italy. It also looks more likely that at some point in the next year or two Greece will need to default and potentially leave the euro zone. Europe also has yet to definitively address the fiscal and growth problems in the peripheral countries.

With the European crisis dragging on and Europe likely to experience at least a mild recession this year, stocks in the region have become very cheap — the Euro Stoxx Index is trading at 8.3 next year’s earnings. I still, however, continue to be cautious on the region overall and advocate avoiding large parts of Europe – particularly Spain and Italy. These markets are cheap for a reason.

Still, I do like some countries in the economically stable northern region of the continent. Much of Northern Europe arguably represents a good value for long-term investors when you consider these countries’ current valuations, growth prospects and perceived risk. I’m reiterating my overweight views of Germany and the Netherlands, and I’m also now advocating an overweight position in Norwegian equities.

From a valuation perspective, you can buy global large caps in Northern Europe for virtually the same price as the more fundamentally challenged companies in southern Europe. Stocks in Germany’s DAX index, for instance, currently trade at less than 9x next year’s earnings, while equities in Norway and in the Netherlands are trading at just 8.5x next year’s earnings.

Meanwhile, countries in Northern Europe, particularly the Nordic countries, are generally expected to grow faster than other developed markets. Based on International Monetary Fund forecasts, Sweden, Finland and Norway should post economic growth this year well above the developed market average.

Finally, based on current credit default swap spreads, these countries are perceived as less risky than the problem children further to the south. This is largely due to Northern Europe’s very modest debt burdens (potential iShares solutions: EWG, EWN).

Source: Bloomberg

Chart of the Day - J.M. Smucker Company (SJM)

The "Chart of the Day" is J.M. Smucker Company (SJM), which showed up on Monday's Barchart "All Time High" list. Smucker on Monday posted a new all-time high of $81.25 and closed up 0.85%. TrendSpotter has been Long since Dec 20 at $78.39. In recent news on the stock, JP Morgan on Nov 18 added Smucker to its Focus List and reiterated its Overweight rating. Barron's on Nov 18 ran a favorable article on Smucker, saying the company should benefit from recent price increases and that its brands should give it leverage with retailers and resonate with consumers as the economy improves. J.M. Smucker Company, with a market cap of $9 billion, is the leading marketer of jams, jellies, preserves, and other fruit spreads in the U.S.