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Posted in Newsclips, Samples

A Short History Of QE And The Stock Market

Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.

Ben Bernanke, Washington Post Op-Ed, November 4, 2010

Bernanke’s statement above lays out the purpose of QE as he sees it.  It is all about the stock market and creating a wealth effect.  So how effective has QE been in moving stocks?  Below we detail all the different phases of QE along with any subsequent pauses along the way.  We also detail how the stock market has performed in each phase.


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QE1 – November 25, 2008 to March 18, 2009 (-9.25%)

We mark this period as starting on November 25, 2008 with this unscheduled FOMC statement:

The Federal Reserve announced on Tuesday that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)–Fannie Mae, Freddie Mac, and the Federal Home Loan Banks–and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae.  Spreads of rates on GSE debt and on GSE-guaranteed mortgages have widened appreciably of late.  This action is being taken to reduce the cost and increase the availability of credit for the purchase of houses, which in turn should support housing markets and foster improved conditions in financial markets more generally.

Purchases of up to $100 billion in GSE direct obligations under the program will be conducted with the Federal Reserve’s primary dealers through a series of competitive auctions and will begin next week.  Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end. Purchases of both direct obligations and MBS are expected to take place over several quarters.  Further information regarding the operational details of this program will be provided after consultation with market participants.

Since markets anticipate, we started QE1 with the date of its announcement (November 25, 2008) and not on the date it started (the following week).

We mark the end of this period with the expansion of QE1 on March 18, 2009 (more below).

Why Did Stocks Decline?

The perception is the market rallies when quantitative easing is underway.  So why didn’t the stock market rally?  Despite the implementation of QE1, the Federal Reserve’s balance sheet actually contracted, as shown below in blue.  QE1′s asset purchases (red line) were inadequate in offsetting the closing of lending facilities (loans) such as TAF (Term Auction Facilities) and the CPFF (Commercial Paper Funding Facilities), shown in green.


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Simply put, QE1 was too small.  So on March 18, 2009 the FOMC expanded the program.  This increase in purchases had a profound effect on the markets.

QE 1 Expanded – March 18, 2009 to March 31, 2010 (50.29%)

On March 18, 2009, at the FOMC meeting, the following was released:

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability.  The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.  To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion.  Moreover, to help improve conditions in private credit markets, the Committee decided to purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve has launched the Term Asset-Backed Securities Loan Facility to facilitate the extension of credit to households and small businesses and anticipates that the range of eligible collateral for this facility is likely to be expanded to include other financial assets.  The Committee will continue to carefully monitor the size and composition of the Federal Reserve’s balance sheet in light of evolving financial and economic developments.

We mark this date as the start of QE1 Expanded.

As the statement above notes, the FOMC expected QE1 Expanded to end on September 30, 2009 (highlighted).  However, on August 12, 2009 the FOMC said :

They would gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October.

In other words, the FOMC said they would extend the end date of their program, choosing to taper their purchases rather than end them immediately.  Then, on September 23, 2009, the FOMC said:

The Committee will gradually slow the pace of these purchases in order to promote a smooth transition in markets and anticipates that they will be executed by the end of the first quarter of 2010.

The FOMC made no further changes to QE1 Expanded and it tapered to an end on March 31, 2010.

First Non QE Period – March 31, 2010 to August 27, 2010 (-8.97%)

The Federal Reserve ended QE – Expanded on March 31, 2010 as detailed above.  We date this as the beginning of the First Non QE Period.  This period ended with Bernanke’s now infamous Jackson Hole speech of August 27, 2010 (more below).

A heated debate took place at the end of QE 1 – Expanded about the future of Federal Reserve policy.  The majority of economists believed the Federal Reserve was permanently done with QE programs on March 31, 2010.  We detailed this on March 17, 2010.  Since no more monetary stimulus was forthcoming, the equity market struggled until Bernanke reversed course in his Jackson Hole speech by suggesting more monetary stimulus would be coming.

QE 2 – August 27, 2010 to June 30, 2011 (22.81%)

We date the beginning of QE2 as Bernanke’s Bernanke’s now infamous Jackson Hole speech on August 27, 2010.  Most believed the key passage below signaled QE2 was coming:

The Federal Reserve is already supporting the economic recovery by maintaining an extraordinarily accommodative monetary policy, using multiple tools. Should further action prove necessary, policy options are available to provide additional stimulus. Any deployment of these options requires a careful comparison of benefit and cost. However, the Committee will certainly use its tools as needed to maintain price stability–avoiding excessive inflation or further disinflation–and to promote the continuation of the economic recovery.

This program was formalized at the November 3, 2010 FOMC meeting:

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to expand its holdings of securities. The Committee will maintain its existing policy of reinvesting principal payments from its securities holdings. In addition, the Committee intends to purchase a further $600 billion of longer-term Treasury securities by the end of the second quarter of 2011, a pace of about $75 billion per month. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Federal Reserve ended this program all at once (no taper) on June 30, 2011, just as they promised when they first announced it.

Second Non QE Period – June 30, 2011 to August 26, 2011 (-9.99%)

We date the Second Non QE Period from June 30, 2011 (the end of QE2). Just like QE1, the perception among a majority of economists was that QE2 marked the end of all Federal Reserve stimulus.  The market slumped on this idea until Bernanke’s Jackson Hole speech on August 26, 2011 suggested otherwise.

At this speech Bernanke dropped big hints that Operation Twist was coming.  This was confirmed by a September 6, 2011 Wall Street Journal article stating the market expected Operation Twist to be approved at the September 22, 2011 FOMC meeting.  None of this was a surprise because Bill Gross had predicted Operation Twist was coming as early as June 15, 2011.

Operation Twist – August 26, 2011 to April 4, 2012 (18.88%)

We date the beginning of Operation Twist from Bernanke’s Jackson Hole speech on August 26, 2011.  The program was approved at the September 22, 2011 FOMC meeting.

We date the end of Operation Twist as the April 4, 2012 article by Jon Hilsenrath of The Wall Street Journal.  Hilsensrath, who is widely considered to be the Federal Reserve’s mouthpiece, said:

The Fed is in no hurry to launch new measures to boost economic growth, minutes from the central bank’s most recent meeting showed, disappointing investors eager for more stimulus. Among the hints dropped in minutes of the Fed’s March 13 policy gathering, Federal Reserve staff concluded that the U.S. economy is a little more susceptible to inflation than previously thought. That and other signals suggested that another round of bond buying by the Fed to push down long-term interest rates isn’t imminent.

Hilsenrath Says QE To End With Twist’s End – April 4, 2012 to June 6, 2012 (-5.99%)

Since market’s are forward-looking, we believe the period between the Jon Hilsenrath article saying the Federal Reserve would end stimulus with the end of Operation Twist and the Hilsenrath article saying the Federal Reserve is reconsidering should be treated as a separate period, similar to the Non QE periods noted above.  This period begins with Jon Hilensrath’s April 4, 2012 article noted above and ends with this June 6, 2012 article:

Disappointing U.S. economic data, new strains in financial markets and deepening worries about Europe’s fiscal crisis have prompted a shift at the Federal Reserve, putting back on the table the possibility of action to spur the recovery. Such action seemed highly unlikely at the central bank’s April meeting, when forecasts for growth and employment were brightening. At their policy meeting this month, Fed officials will weigh whether the U.S. economic outlook is deteriorating enough to justify new measures to boost growth, according to interviews and Fed speeches.

Hilsenrath Backtracks on QE’s End – June 6, 2012 to August 17, 2012 (7.83%)

We date this period from Hilsenrath’s June 6, 2012 article noted above to this August 17, 2012 article:

The Federal Reserve’s “hawks” are speaking out against additional action by the central bank to spur the economy. The Fed has moved despite this group’s opposition before. Thus, the comments now don’t represent a signal from the central bank that it is backing away from its statement earlier this month that it might act.

Underscoring the idea that Operation Twist was not the end of Federal Reserve stimulus was the June 20, 2012 FOMC meeting two weeks later where the FOMC extended Operation Twist’s end from September 30, 2012 to December 31, 2012:

The Committee also decided to continue through the end of the year its program to extend the average maturity of its holdings of securities. Specifically, the Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less.

QE 3 – August 17, 2012 to November 29, 2012 (-0.16%)

We date QE3 from the August 17, 2012 article noted above.  On August 23, 2012 Hilsenrath underscored QE3 was coming with this:

The Federal Reserve sent its strongest signal yet that it is preparing new steps to bolster the economic recovery, saying measures would be needed fairly soon unless growth substantially and convincingly picks up.

QE3 was approved by the FOMC on September 13, 2012:

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month. The Committee also will continue through the end of the year its program to extend the average maturity of its holdings of securities as announced in June, and it is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities. These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

We date the end of QE3 with the November 29, 2012 Jon Hilsenrath article stating more QE was coming after Operation Twist ended on December 31, 2012:

Federal Reserve officials are likely to continue buying long-term mortgage-backed and Treasury bonds in 2013 as they confront a slow-growing economy and threats of new turbulence and uncertainty related to fiscal policy. Fed officials face several important decisions at their next policy meeting Dec. 11-12, the most pressing of which is what to do about those bond-buying programs, which are meant to drive down borrowing costs, boost the prices of assets like stocks and homes, and stimulate spending and investment. Fed Chairman Ben Bernanke said at his news conference in September that the central bank would review all its asset purchases at the end of the year, when one of the bond-buying programs expires.

QE 3 Expanded -  November 29, 2012 to May 1, 2013 (12.82%)

We date QE3 Expanded from the November 29, 2012 Jon Hilsenrath article noted above to the May 1, 2013 FOMC meeting where the committee said:

The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

Unlike most of the turn dates discussed here, the FOMC’s increase or reduce statement was not widely anticipated by the market.

FOMC Says ‘Increase or Reduce” – May 1, 2013 to Present (4.53% as of May 30, 2013)

We date the Increase or Reduce period from the May 1, 2013 FOMC meeting.  This period is still ongoing.


On November 25, 2008 the FOMC first announced QE1.  Since that date:

  • Total stock market gains, through May 30, 2013 = 92.96% (1,133 trading days)
  • Total stock market gains when QE was ongoing through May 30, 2013 = 120.42% (986 trading days or 87% of the trading days since November 25, 2008)
  • Total stock market gains when No QE or Hilsenrath said the FOMC would end = -27.46% (147 trading days or 13% of the trading days since November 25, 2008)

This study shows QE has been extraordinarily effective in boosting stock prices and the FOMC is correct to worry what happens when they stop. Restated, the bull market of the last 4+ years has a lot to do with FOMC stimulus.  If history is any guide, its removal would figure to be a profound negative for equity prices.

Posted in Newsclips, Samples

The Strategic Petroleum Reserve and Oil Prices


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  • The Financial Times – Obama pressed to open emergency oil stocks
    The Obama administration is coming under growing pressure to cool petrol prices by releasing emergency stocks of oil. However, critics say this would be the wrong response to the wrong problem at the wrong time. The oil price surge has increased speculation that the US and its allies could repeat the co-ordinated release of crude stockpiles they undertook last summer to compensate for lost supply from Libya. The move led to an 8 per cent price fall. On Friday, Timothy Geithner, US Treasury secretary, said there was “a case” for releasing crude from the US strategic petroleum reserve, or SPR, “in some circumstances” – a significant shift for an administration that had previously ruled out another release. What has triggered the change is the steady drumbeat of soaring petrol prices, with the US national average now $3.68 a gallon – a record February high. “Nothing terrifies a sitting president more than rising gasoline prices, which in President Obama’s case could imperil the economic recovery and torpedo his re-election prospects,” said Robert McNally, head of the Rapidan Group energy consultancy and a former White House official.


The chart above shows the SPR’s inventory level, highlighting the last four SPR sales.

Regarding the highlighted part above about last year’s release, see the chart below.  The last announcement of an SPR release occurred on June 24, 2011 encompassing a release of 60 million barrels globally, 30 million of which came from the U.S. SPR.

Overlaid on the SPR inventory levels is the price of nearby WTI futures.  WTI closed at $91.16 the day of the announcement.  It rose to $97.60 the week the release began (July 15, 2011) and dropped to $88.18 the week the release ended (September 16).  This is a drop of 3% from the announcement to the end of the release.  It is a drop of 8% to 10% during the release.

The U.S. consumes 19 million barrels of crude oil a day, so a 30 million barrel release is roughly 50 hours of consumption spread out over 30 days.  The world consumes 80 million barrels of crude oil a day, so a 60 million worldwide release is 18 hours of consumption spread out over 30 days.  We will leave it the reader to decide if the SPR release made a difference.

When gas prices rise, politicians are helpless to do anything over the short-term.  This is especially troublesome for politicians when an election is less than a year away.  SPR releases are ineffective at altering the price.  They do, however, give politicians cover to take credit for any down-tick or argue any up-tick would have been worse without the release.

Therefore, we expect an announcement of SPR release in the next several weeks.  We expect it to be met with plenty of fanfare and arguments that it will matter.  We expect it will again amount to hours of consumption and not make a difference.  Administration officials will disagree.


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  • The Telegraph (UK) – Soaring oil prices will dwarf the Greek drama
    Since last week’s eurozone “grand summit”, the headlines have been positive and, in the official photos anyway, the main players appear to be smiling. As such, the global equity rally goes on

    Behind the rictus grins, though, the gloves remain off, the rhetorical daggers still drawn. Having launched the biggest sovereign debt restructuring in history, Athens now faces the Herculean task of persuading holders of Greek bonds to accept a “voluntary” hair-cut. Creditors are being asked to swap their bonds for a combination of new short-term instruments, issued by the European Financial Stability Facility, and longer-term Greek government debt. If half of them agree to take the hit then, under “collective action clauses” approved by the Greek parliament, the deal could be forced on all bond-holders. This is a default in all but name, then, with “the powers that be” desperate to hold the single currency together while not triggering credit default swap (CDS) insurance policies that could themselves spark a whole new wave of financial panic. The reported bond-holder loss will be 53.5pc – a headline number largely for the consumption of furious taxpayers in those eurozone nations that remain notionally solvent. In reality, payment durations and coupons will be tweaked, once the media has moved on, to ensure bondholders suffer less. To be sure, though, there is still significant loss embedded in this deal, which is why the CDS switch could ultimately be flicked. That remains the case even if tame ratings agencies confirm their ludicrous “judgement” that an imposed €200bn (£170bn) debt-swap doesn’t amount to a “credit event”.

Posted in Samples

Discussing Our Outlook


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Jim Was also on Bloomberg Radio Friday talking about the same issue. Here is a partial transcript.

TOM KEENE, BLOOMBERG SURVEILLANCE: Let’s get right to it, Jim Bianco, Bianco Research. Jim, good morning.


KEENE: You have a really sharp note about correlations. This is the linkage of things. We are highly correlated, particularly in the equity markets. Is that a good or bad thing?

BIANCO: It is on balance a bad thing. But you are right, the stock market is more correlated now than at any point since we have data on the S&P back to 1926. Meaning all stocks move up and down together, all stocks – if you put out a stock chart of them – looks like every other stock, which looks like the S&P 500.

Now, a lot of people have argued that the reason that is happening is the markets are being irrational, and I have said, no, they are being perfectly rational.

KEENE: Yes, I totally agree. Continue.

BIANCO: Yes, because every time there is unpleasantry, either in Europe or in the United States, in the economy or the financial markets, we demand the government and the central bank come with a trillion dollar plus solution to it. That is what the complaint is in Europe. Where is the trillion euro solution? Get it for us so we can put this problem away.

KEENE: And, folks, there is a lot of detail here and a lot of financial theory. You nail it, Jim, in one sentence where you say we are all correlated, and at some point we are not going to be and either equities will go to credit, or credit will go to equities. Discuss that.

BIANCO: Yes, because what has happened is is that the word correlation does not exist in the credit markets. The bond market has been doing far worse than the stock market. And when you have these correlations, it tends to be the market that isn’t correlated that is the leading indicator, and that is the bond market. So as corporate bonds continue to do worse and worse, my concern is they are showing us the way that we are going to go. And that the stock market might eventually give it up and go the way of the corporate bond market, which is much lower in price.

KEENE: What you just heard there, folks, is how pros talk. They talk about correlations and co-movements. Like in bonds, they don’t talk about a single yield. They talk about the dynamics between two yields or even three, or the spread market. That was brilliant by Jim Bianco. Ken?

Below are some stories that reiterate our view.

  • - El-Erian: Why Good Companies May Get Even Cheaper for Awhile
    Cheap stocks and corporate bonds can get a lot cheaper before regaining their footing. This is especially true when the combination of too much debt and too little income growth forces a system to delever, as is increasingly the case these days. In such a world, markets are driven by top-down economic and policy factors (“macro”) rather than company earnings and balance sheets. It is also a world in which “bad technical” can result in price behavior that deviates significantly from “fundamentals,” and for a long time. The dilemma confronting investors is essentially the same as that facing a home buyer looking at a good house in a rapidly-deteriorating neighborhood. It makes sense to buy if, and only if, the neighborhood is likely to stabilize, the buyer has the ability to hold on to the property, and he/she secures a sufficient price discount on account of the inherent uncertainty. Investors with “permanent capital,” like Mr. Buffet, are particularly well placed to strike this volatile balance. Yet they should only do so if they also believe that the combination of a bad macro and bad technicals will not, in itself, cause company fundamentals to deteriorate substantially and, thus, lower intrinsic values.
  • The Financial Times – Gillian Tett: Why $14,000bn no longer scares us
    ‘The more zeros I heard, the more desensitised I felt. Big numbers, like sex, have lost the ability to shock’
    Last weekend, for example, I took part in the Annual Meetings of the International Monetary Fund and World Bank Group in Washington, where I listened to leaders toss vast numbers about (€440bn! $14,000bn! Y23,000bn!); but, the more zeros I heard the more desensitised I felt. Big numbers, like sex, have lost the ability to shock. Is there any answer to this (other than returning to a world of cash)? Not an obvious one. These days, some civic groups are trying new tactics to communicate the debt, such as posting pictures on the internet of a stack of 14 trillion single dollar bills, laid out on a football pitch. Some schools are trying to teach personal finance lessons by forcing students to keep cash in a jar and pay for items out of that – rather than getting addicted to plastic cards. And in the exchange traded fund sector, there is a particularly fascinating cultural twist: some funds that deal with ETFs handling gold have now installed webcams in their vaults, to “prove” that these funds are backed by tangible bullion. Investors, it seems, want to watch those gold bars; they don’t trust the idea of zeros flying about in cyber space. But – sadly – there are no webcams in the rest of the ETF world, let alone the rest of the financial industry or government accounts. Even if there were, there would be precious little to “see”; except, of course, for something like that ever-moving electronic clock near Times Square. And its $14,613,324,053,350 score.
  • The Wall Street Journal – Spooked Investors Make a Run for Safety
    To a large degree, the fate of global financial markets is seen as in the hands of government officials, particularly in Europe and the U.S, which investors say makes the outcome even harder than usual to predict.

Posted in Newsclips, Samples

A Terrible Employment Report In Charts




Below is a chart showing the cumulative losses in real estate jobs since housing peaked.  This industry has yet to recover from a jobs standpoint.


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  • Calculated Risk (blog) – May Employment Report: 54,000 Jobs, 9.1% Unemployment Rate
    Nonfarm payroll employment changed little (+54,000) in May, and the unemployment rate was essentially unchanged at 9.1 percent, the U.S. Bureau of Labor Statistics reported today. Job gains continued in professional and business services, health care, and mining. Employment levels in other major private-sector industries were little changed, and local government employment continued to decline. … The change in total nonfarm payroll employment for March was revised from +221,000 to +194,000, and the change for April was revised from +244,000 to +232,000.


  • Zero Hedge (blog) – Birth/Death Adjustment+ 206,000!
    Take away the Birth/Death adjustment of 206,000 and the Real NFP is: -150,000. This is the biggest monthly B/D adjustment in over a year. And if as all the pundit claimed last month, demanding the McDonalds addition of 62,000 janitorial, part-time jobs be added to the May number, the economy really lost over 200,000 in May. Time to price in QE 666.
Posted in Newsclips, Samples

Will QE3 Happen?


We will hold a conference call on this subject at 9AM CT (handout, register).

  • Yahoo Finance – Time to Let Markets Adjust on Their Own, Stop Intervention: Jim Bianco
    “Quantitative easing is all about trying to prevent pain in the marketplace,” he says. ” But in doing so, it prevents adjustments, and that’s why markets like housing can’t move forward.” Given the latest housing statistics, few would argue that point. “The problem with housing is that we’re at the wrong price, so prices have to come down” Bianco says. “But we don’t want prices to come down, so we invent like 58 programs and QE to prevent them from coming down, and then we complain that prices aren’t going up. Going up?! They still need to come down.” But as much as Bianco would like to see the Fed’s money-printing experiment ended with QE2, he admits that the chance of QE3 goes up with each weak data point that comes out. And lately there have been many of them, including the private payroll flop from ADP and a big slump in ISM Manufacturing on Wednesday alone. “I cant imagine the Fed would do two trillion of quantitative easing…and saying ‘Look guys, we tried, you’re on your own,’” Bianco says. ” No, there will be QE3 and 4 and 5.” “At some point, if you believe in free markets and the capitalist system, you have to let markets adjust” or risk an outcome like Japan, which Bianco says has been “muddling along” for 22 years. “Never really a catastrophe, but never really gets better either.” In place of “slow and ugly,” Bianco would prefer a “very modified version” of what was done in 1974 and 1932 that “would be bad over the very short term but then it’s over and things start getting better…we hit bottom and can see things moving forward as opposed to this perpetual waiting and waiting and waiting like Japan.”


In the story and video above we offer our opinion on Federal Reserve policy.  We think both QEs were unnecessary and might have done more harm than good.

This is not how the Federal Reserve sees it.  They approved over $2 trillion in QE (aka money printing) and vigorously defended the programs, believing they were one of the only institutions with the tools to help a struggling economy.  This is why we believe the Federal Reserve will not sit back and watch the economy sink.  Should the economy suffer, they will feel compelled to help.  Think of QE3 as a put option.  It only gets exercised if the economy sinks.

Regarding deteriorating economic conditions, see the next chart which shows the economy has seriously underperformed expectations in the last few months.  In fact, we have not seen the economy fall this short of expectations since the fall of 2008.  Should these type of disappointments continue, the Federal Reserve will feel compelled to act.


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The next story is from Jon Hilsenrath, the Federal Reserve’s “mouthpiece” at The Wall Street Journal.  Read this to be a signal from the Federal Reserve that QE3 is not in the offing.  We understand Bernanke does not want to institute another round of QE, but we ultimately believe the economy could force his hand.
  • The Wall Street Journal – Jon Hilsenrath:  Fed Holds Steady as Economy Slows
    Federal Reserve officials are in no hurry to respond to recent indications U.S. economic growth has hit another soft patch, despite chatter in financial markets that the Fed might start a new program of U.S. Treasury-bond purchases to boost growth. The central bank has already purchased more than $2 trillion of mortgage and Treasury bonds. The purchases are meant to hold interest rates down by reducing the supply of securities in private hands and to drive investors into areas such as stocks to encourage businesses and consumers…In an April news conference, Mr. Bernanke said the tradeoffs that would come with additional purchases were becoming unappealing. “It’s not clear we can get substantial improvements in [employment] without some additional inflation risk,” he said. Fed officials have largely held to that line.
  • The Financial Times – Back towards a US double-dip
    The US economy was supposed to be in bloom by late spring, but it is hardly growing at all. Expectations for second-quarter growth are not much better than the measly 1.8 per cent annualised rate of the first quarter…The recovery has stalled. It is unlikely that America will find itself back in recession but the possibility of a double dip cannot be dismissed. The problem is not on the supply side of the ledger. Corporate profits are still healthy. Big companies continue to sit on a cash hoard. Large and middle-sized companies can easily borrow more, at low rates. The problem is on the demand side. American consumers, who constitute 70 per cent of the total economy, cannot and will not buy enough to get it moving. They justifiably worry that they will not be able to pay their bills, or afford to send their children to college, or to retire. Banks, with equal justification, are reluctant to lend to them. But as long as consumers hold back, companies remain reluctant to hire new workers or raise the wages of current ones, feeding the vicious cycle.
  • CNBC – Third Time’s a Charm? Whispers of QE3 Emerge
    Most Fed watchers still see a third round of quantitative easing, or QE3, as a very remote possibility. The obstacles this time around are greater, since inflation has been creeping higher and the jobless rate, while still at an elevated 9 percent, has come down quite a bit in recent months. “It’s highly unlikely, but never say never,” said Jim O’Sullivan, chief economist at MF Global. The Fed would also prefer to avoid reliving the domestic and international furor its second round of bond buys unleashed. Though Fed officials would rather not admit it, the criticism has weighed on their decision-making. When the central bank embarked on the $600 billion round of Treasury bond buys, Republican politicians, some economists, and even a couple of top Fed officials cautioned that the measure, aimed at keeping borrowing costs down and stimulating the economy, would not work and risked sparking inflation. Policymakers in emerging economies, for their part, argued the measures were a thinly veiled effort to weaken the dollar and boost U.S. exports at their expense. They bemoaned the rise in currency values and capital inflows that ensued.
  • CNBC – El-Erian: Why Fed Is Unlikely to Have Third Round of Easing
    I suspect that it is very unlikely that there will be a QE3. This view is based on an assessment of economic, political and international factors. As Chairman Bernanke noted in his August Jackson Hole speech, and reiterated in his first press conference a few weeks ago, policy measures should be judged in terms of the expected balance of benefits, costs and risks. I suspect that there is now broad agreement that, in the case of QE3, this balance has shifted: lowering the potential gains and increasing the probability of collateral damage and adverse unintended consequences. It is also clear that, in its attempt to deliver “good” asset price inflation (e.g., higher equity prices), the Fed also got “bad” inflation. The latter, which essentially took the form of higher commodity prices, is stagflationary in that it imposes an inflationary tax on both production and consumption—thus countering the objective of QE2. Politics also plays a complicating role. With the Fed’s balance sheet having already ballooned, there is growing unease in Washington about an unelected group of officials being so able to implement de facto fiscal measures with few checks and balances. I suspect that Fed officials realize this, and will likely resist further steps that would significantly erode their operational autonomy.


El-Erian’s arguments are sound.  But, again, if the economy is struggling, is the Federal Reserve seriously going leave the markets to fend for themselves?  Despite decreased benefits from further QE in the face of inflationary pressures, history suggests otherwise.
  • MarketWatch – All eyes on Bernanke, but QE3 has sailed
    With investor panic growing faster than the U.S. economy is weakening, all eyes turn to Fed chief Ben Bernanke this month to see if he will launch a third round of bond buying to prop up the global markets. Don’t hold your breadth, folks. The QE3 has sailed…The June swoon, or sell-in-May-and-go-away, or the end of the eight-best-months seasonal trading pattern, or whatever the jargon is for it on Wall Street, is a traditional Wall Street occurrence and this year investors are playing it up like it’s Lehman Brothers all over again…Investors would be wrong to hope Bernanke will ride to the rescue again with a third round of quantitative easing, or QE3, by buying Treasury bonds in bulk. Of course, the Fed will keep buying in some format, but the massive program itself will end this month and we’ll be on our own. In fact, the summer scare in the markets plays well into Bernanke’s strategy of preventing a crisis of no buyers of Treasury bonds when QE2 ends by delivering a steady supply of new buyers spooked about the outlook for stocks and commodities.
  • – Fed May Signal Balance Sheet Will Stay at Record
    A wave of surprisingly weak data on the U.S. economy may spur Federal Reserve policy makers to support growth by making it clear they’re in no hurry to shrink the central bank’s record balance sheet. There’s a “strong possibility” that the Federal Open Market Committee will say following the June 21-22 meeting that it will keep reinvesting proceeds from maturing debt for a while, said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. (JPM) in New York. Previously, the FOMC has said it will keep the benchmark interest rate near zero for an “extended period” without a similar pledge about its balance sheet…The slowdown may push policy makers to consider what options are left after their second $600 billion round of asset purchases sparked a Republican backlash. Saying the balance sheet won’t shrink immediately could dispel any notion that the Fed is about to push up borrowing costs.
Posted in Newsclips, Samples

How Bad Is Housing?


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  • The Wall Street Journal – Housing Imperils Recovery
    Home prices have sunk to 2002 levels, effectively wiping out almost a decade’s worth of home equity across the U.S. and imperiling the fragile economic recovery as Americans confront the falling value of their biggest investment. A closely watched home-price index released Tuesday, the S&P/Case-Shiller National Index, showed that prices nationwide fell 4.2% in the first quarter after declining 3.6% in the fourth quarter of 2010. The index had seen increases in 2009 and early 2010.”Home prices continue on their downward spiral with no relief in sight,” said David M. Blitzer, chairman of S&P’s index committee. The report signals “a double dip in home prices across much of the nation,” he said. That doesn’t bode well for the economy, which historically has depended on home buying and other consumer spending to rebound. Falling prices hurt economic growth in a number of ways. Not only do homebuyers curb spending when their homes are losing value, but continued price erosion keeps families stuck in homes they can’t sell because they are worth less than what they owe.
  • The Associated Press – Cities that weathered housing bust now suffering
    Home prices in big metro areas have sunk to their lowest since 2002, the Standard & Poor’s/Case-Shiller 20-city monthly index showed Tuesday. Since the bubble burst in 2006, prices have fallen more than they did during the Great Depression. The index, which covers metro areas that include about 70 percent of U.S. households, is updated every quarter and provides a three-month average. The March data is the latest available. Foreclosures have forced prices down so much that some middle-class neighborhoods have turned into lower-income areas within months. Prices are expected to keep falling until the glut of foreclosures for sale is reduced, companies start hiring in greater force, banks ease lending rules and more people think it makes sense again to buy a house. In some markets, that could take years. The latest report points to a “double dip in home prices across much of the nation,” said David Blitzer, chairman of the Index Committee at Standard & Poor’s.


The chart above shows the Case/Shiller Index is at its lowest level since 2003, not its lowest level since 2002 as noted above.  Either way, house prices are extremely depressed.
  • The Wall Journal – Five Questions on Tuesday’s S&P/Case-Shiller
    Why is housing still so weak?
    Many households can’t move because they owe more than their homes are worth. Even households that aren’t underwater have seen such a big loss of wealth that they may be unwilling to sell at current prices. Credit also remains tight. While mortgage rates are low, borrowers that don’t have perfect credit and that can’t make a 20% down payment often aren’t going to qualify for the lowest rates. Insurance premiums on loans backed by the Federal Housing Administration, which allows down payments as low as 3.5%, have risen twice in the last year. And banks are scrutinizing borrowers’ incomes and tax returns, looking for any possible red flag. Many buyers aren’t willing to buy unless sellers give a decent discount—call it insurance against future price declines. Sellers already think they’re giving away the store, and may balk at further price cuts. Against this backdrop of anemic demand, the supply of homes is high as banks push more foreclosed properties onto the market. Banks are less reluctant to cut prices to unload homes quickly than traditional sellers, and because those homes sometimes require more work, they tend to sell for less. Many of those homes are being sold at discounts to investors that are willing to make all-cash bids, which can reduce the appraised value of all homes in that neighborhood.
  • The New York Times – Bottom May Be Near for Slide in Housing
    For real estate, some economists say, an end to the seemingly endless decline in housing values might be in sight.Not immediately. At the moment, prices are still dropping. In 20 large cities, prices fell 0.8 percent in March from the previous month, according to the Standard & Poor’s Case-Shiller Home Price Index released Tuesday. That pushed the closely watched index below its level of two years ago to a new post-bubble low, and put it 33.1 percent under its July 2006 peak. Few analysts expect housing prices to rebound anytime soon. But quite a few are predicting that the market is close to the moment when things will stop getting worse, which will be a major improvement all by itself. “By far the bulk of the downturn of housing prices is beyond us,” said Paul Dales of Capital Economics. He expects the market to slip 5 percent further, slightly more than he was expecting a few months ago. “There are some amazingly favorable signs. Housing is the most undervalued it’s been in 35 years,” Mr. Dales said. “At some point, it’s going to do very well.”


Many stories are noting that the current housing decline is greater than the decline of the Great Depression.  This comes from the Case/Shiller Annual Index which goes back to 1890.  Case/Shiller used the Grebler-Blank-Winnick data from 1890 to 1947 (explanation, data).   This data shows home prices fell 30% during the Great Depression (1925 to 1933) and the median price of a Washington DC home fell 27% over the same period.  So, while Barry Ritholtz’s Big Picture post below is conceptually correct to point out that every other price index fell 75% to 90% during the Great Depression, Grebler-Blank-Winnick’s housing data from that period does not show house prices fell to quite that extent.
Knowing this, let us take a stab at explaining why housing fared so much better than other prices during the Great Depression:
  • Home-ownership levels were much lower during the Great Depression.  In 2006 ownership levels peaked around 70%. In the 1930s they were never above 50% (data).
  • More homes were owned outright (no mortgage) in the 1930s versus today.   The typical mortgage in the 1930s required a 50% down payment and carried a 5-year term.  The percentage of homes owned outright in the 1930s was much higher than it is today (source).
  • Given the two points above, there were fewer forced liquidations in the 1930s compared to today.  Underwater mortgages were a rare event, not the common event that they are today.

In other words, housing was a source of strength during the Great Depression while it is the weak link dragging down the economy during the Great Recession and its aftermath.


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  • The Big Picture (Blog) – Barry Ritholtz: Is Residential Real Estate Worse than During Depression?
    Both the Housing markets and available financing were widely different, then versus now. In addition to the lower Home ownership levels (66.2% vs 47.8%), it was more concentrated among the wealthy as opposed to broad-based ownership now. Many more people lived on family farms early in the 20th century (than today). And, more homes were owned outright (no mortgage) in the 1930s versus today. I have to track down the data, but I recall it was over 70% in the 1920s with no mortgage versus about 40% today. But the biggest and most important difference was financing: Mortgages were 3 to 5 year, interest only, with a balloon payment of the amount borrowed at the end. After that 3 year period, you either resigned with the bank, or sold the land and paid off the note. There was no such thing as a 30 year fixed rate mortgage in the 1920s or ’30s. THAT would have had a huge impact on prices. Banks were failing by the 1000s; even someone with the means to roll their mortgage over might have foudn the bank did not have the ability to do so. With few buyers and almost no credit, the odds favor that RE prices would fall quite substantially. How much? One study of Manhattan (Estate Prices During the Roaring Twenties and the Great Depression) that looked at market-based transactions home prices between 1920 and 1939 found that Home prices plummeted 67% during the great depression. Yes, home prices are bad. They are nearing the 35% drop we forecast back in 2005. But worse than the Great Depression? I don’t think so . . .

Posted in Newsclips, Samples

What Is The Yield Curve Saying?

  • – Caroline Baum: Recession Forecasts? Yield Curve Says No Way
    Green shoots are proliferating in gardens across America, but for some forecasters it already looks like the end of summer. A few are even hinting at recession by year-end. That’s highly unlikely. While black swans have gained a new cachet following the prices-can’t-fall-nationwide housing bust and the financial meltdown it triggered, the most important leading indicator, the yield curve, is saying there will be no recession anytime soon. With the Federal Reserve’s benchmark rate at zero to 0.25 percent and the 10-year Treasury note yielding 3.06 percent, the spread between the two interest rates is among the widest in history. It’s the reverse configuration, an inverted yield curve with short rates above long rates, that augurs recession. The spread — or the “term structure of interest rates,” as it’s known in academic circles — isn’t some mystical talisman with omniscient powers. It derives its prognosticating ability from the simple fact that one rate is artificially pegged by the central bank while the other is determined by the market. Their relationship encapsulates the stance of monetary policy.


As the chart below shows, the yield curve is a bit over 3%.  As the second chart shows, the odds of a recession given this steep of a yield curve are essentially zero.  Those interested in the calculations behind this recession model can read the New York Federal Reserve’s Current Issue Volume 12, Number 5.

Although the odds of a recession may be low, as we pointed out in the post above, the economy is still vulnerable to a soft patch of economic data.  The longer the soft patch persists, the more seriously the Federal Reserve may be to considering QE3.  In other words, Bernanke might not need to see a recession to seriously consider more stimulus.  We are not at that point as of now, but it bears watching.


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Posted in Newsclips, Samples

How Much Money Does It Take To Manipulate The Oil Market?

  • MarketBeat (WSJ Blog) – How to Manipulate the Oil Market for Just $1 Billion
    One of the striking things about the CFTC case alleging oil-market manipulation is how little money the CFTC suggests was involved, which would seem to make such a scheme remarkably cheap to run…At the time Arcadia et al were allegedly building this position, Cushing crude oil cost about $93 a barrel. So ostensibly it cost about $428 million to buy up enough physical crude to manipulate the market. When the defendants allegedly took their second bite of the apple, in early March, according to the complaint, they amassed 6.3 million barrels of crude. At the time, Cushing crude cost an average of about $107 a barrel, so 6.3 million barrels would have cost about $674 million. So, if I’m interpreting this correctly, the complaint alleges Arcadia et al spent about $1.1 billion to corner the market in physical crude at Cushing, and that was enough to rack up a $50 million illicit profit. That seems like kind of a long walk for a 5% return, is my first thought, although if it’s possible to use leverage to amass such a stockpile, then it could become markedly easier and more profitable. My second thought is that, if we assume for the sake of argument that even the concept alleged here is realistic, that relatively small operators could accomplish corner the WTI crude-oil market with just $1 billion, then how easy must it be for far larger players to manipulate the market for even greater gains? Am I missing something here?
  • The Financial Times – Lex: Oil: you can’t prosecute foolishness
    At last, at long last, those nefarious speculators are being made to pay for sky-high energy prices. In other news, crude oil rose again today…Try as they might, agencies such as the CFTC cannot track down Messrs Supply and Demand in order to serve charges. Ditto for Messrs Fear and Greed and, lest regulators anger the Congress that sent them on such quests, they did not even try to go after Mr Flawed Energy Policy. The trumpeted “nationwide crude oil investigation” will do no more to control high pump prices than charges against analyst Henry Blodget did to resurrect losers such as or those against Angelo Mozilo did to help holders of no-money-down “liar loans”. Human foibles and political cowardice encouraged people to drive hulking cars, buy dotcom stocks and take out excessive mortgages. Crimes were committed on the way, but foolishness cannot be prosecuted. It is human to ask for someone’s scalp when things turn out badly. Count on elected officials to work overtime on the case. Just don’t expect them to solve the problem.


The second article above perfectly sums up the battle against “evil speculators.”  Speculators are an easy scapegoat when markets go haywire, but excessive speculation is a very difficult accusation to prove.

For example, the first article above estimates that Arcadia spent roughly $1.1 billion in an attempt to corner the crude oil market.  Assuming there are roughly 60 million barrels of crude oil tradeded every day at an average of $100/barrel at the time Arcadia bought, this would mean the crude oil market totaled approximately $6 billion a day.  In other words, Arcadia cornered roughly one-sixth of one days total market value.  This was enough to manipulate prices over a period of several weeks?

Is this enough to consider Arcadia an evil speculator?  We have no idea, and it seems as though the CFTC will have a difficult time pinpointing the laws that were broken as well.  When all else fails, evil speculators can simply be charged with disruptive trading, a catchall accusation that is equivalent to disorderly conduct for regular citizens.

Posted in Newsclips, Samples

Cartoons – Federal Reserve Edition

  • Liberty Street Blog (New York Fed) – Historical Echoes: Communication before the Blog…
    Over the years, the Federal Reserve System has used many methods to communicate about the role it plays in support of stable prices, full employment, and financial stability. Current communication tools include the new press conferences by the Chairman, speeches by Bank presidents, public websites, economic education programs, local outreach efforts, publications, and blogs like this one. Ninety years ago, however, the options were more limited. The Fed was still new and the nation’s economy was plagued by a growing number of bank failures. The five posters below (from the mid-1920s), with their images of strength and stability, were part of a larger series designed for display at member banks. They were likely intended to inform the public about the Federal Reserve System and foster confidence in its member banks. Thanks to the San Francisco Fed archive for making the posters available.

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Posted in Newsclips, Samples

What Foreigners Buy U.S. Treasuries?


As we detailed in this week’s TIC Update, China is dangerously close to becoming a net seller of U.S. assets on a 12-month rolling basis.  Even their net purchases of U.S. Treasuries seem to be plummeting towards nothing.  If the Chinese are not buying Treasuries, then who is?

The charts below detail:

  • Foreign buying of U.S. Treasuries (first)
  • Foreign ownership of U.S. Treasuries (second)
  • Official versus private investor buying of U.S. Treasuries (third chart)
  • Official versus private investor ownership of U.S. Treasuries (fourth chart)

The charts illustrate the following:

  • Ownership patterns and buying patterns are very different.  The Japanese and Chinese own a lot of Treasuries but the UK is by far the largest buyer over the last 12 months.
  • Years ago official institutions (central banks) were a huge buyer of U.S. Treasuries.  Today private investors dominate buying patterns.  Ownership patterns are the opposite. Official institutions own the larger share of Treasuries.


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Posted in Newsclips, Samples

The FOMC Minutes


Jim Bianco was on CNBC yesterday afternoon discussing the FOMC minutes.  To view the interview, click on the picture above.  To view any of our recent interviews click here.
  • The Wall Street Journal – Fed Officials See Gradual Exit Plan
    Minutes of the Fed’s April 26-27 meeting, released Wednesday with the normal three-week lag, showed Fed officials had an extensive discussion about what is known as their exit strategy from an era of easy credit…In normal times this wouldn’t require much debate. The Fed would simply raise its benchmark short-term interest rate, known as the federal funds rate, to tighten credit, slow growth and pull back inflation. Because of the unusual steps it took during and after the financial crisis, its exit from easy-money policies this time around will be more complicated. It must substantially reduce a $2.4 trillion portfolio of mortgage and Treasury securities. The first step, as Fed chairman Ben Bernanke indicated in a first-ever news conference following the April meeting, will be a decision to allow the mortgage portfolio to start shrinking on its own—by allowing the securities to mature without reinvesting the proceeds in Treasurys, as it has been doing. At the same time or shortly thereafter it will do the same thing with some of its long-term Treasury bonds. At some point, the Fed will slowly and steadily sell its mortgage holdings. Officials were inclined to hold off on active securities sales until after they had taken other steps, including raising the short-term fed funds rate, the minutes showed.


We found the following passage from yesterday’s FOMC minutes interesting:

A number of participants noted that it would be advisable to begin using the temporary reserves-draining tools in advance of an increase in the Committee’s federal funds rate target, in part because doing so would put the Federal Reserve in a better position to assess the effectiveness of the draining tools and judge the size of draining operations that might be required to support changes in the interest on excess reserves (IOER) rate in implementing a desired increase in short-term rates. A number of participants also noted that they would be prepared to sell securities sooner if the temporary reserves-draining operations and the end of the reinvestment of principal payments were not sufficient to support a fairly tight link between increases in the IOER rate and increases in short-term market interest rates.

Earlier this month we commented on the Federal Reserve’s exit strategy, detailing this exact point.  Namely, the Federal Reserve is not sure raising rates will produce the intended result.  This is a point that few Federal Reserve watchers seem to understand.  Here is what we wrote two weeks ago and yesterday’s minutes only confirm it:

Our interpretation of these internal debates is that the Federal Reserve is worried interest that reserves will not be an effective tool in raising market interest rates. As we noted last month, this tool was ineffective in creating a floor on the funds rate in 2008. Additionally, the FDIC fee must be worrying Federal Reserve officials. In order for interest on reserves to be effective, the Federal Reserve might have to hike a lot (say 75 basis points) to get a small hike in market rates (say 25 basis points). Such an over-sized hike carries the risk of being misinterpreted as a panicked move by the FOMC.

Because of this, some in the FOMC seem to be arguing that assets should be sold before rates are raised. This is a sequence that we have long favored. Unfortunately, reducing the balance sheet to a more normal level will likely require a prolonged period of asset sales (which is why we did not favor QE2). If inflation expectations reach unacceptable levels, the market will not have this kind of patience. This could force the FOMC’s hand to raise interest on reserves by a large margin, bringing with it the same problems mentioned above.

We believe the Federal Reserve knows all this, which is why they had “intense” debates about the exit strategy last week. They understand that unacceptably high levels of inflation expectations are not good and could lead to a lot of market misunderstandings and volatility. The bottom line is they are still not sure how or what sequence they should use because they are not sure what will happen when the exit strategy begins. They are guessing, like the rest of us.

Bottom Line: The FOMC, and many Federal Reserve watchers, want us to believe everything is under control.    We disagree, seeing the exit strategy as a giant leap of faith.  It is a leap that is manageable if inflation expectations stay within acceptable levels (“well anchored” as the Bernanke puts it) and gets “messy” should inflation expectations move higher.

These minutes also frequently mention inflation expectations, as did Bernanke at his press conference last month.  Again, when discussing Federal Reserve policy, one must start with inflation expectations, TIPS inflation breakeven rates and the University of Michigan inflation expectation survey.


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Posted in Newsclips, Samples

Understandings Earnings Estimates

Earnings Estimates

In the video above, Hewitt Packard’s CEO Leo Apotheker said the following:

Carl:  Before we let you go, Leo, I don’t know if there’s been a quarter since you joined where the company beat, if you will, I wonder you’ve got to be looking forward to that day.

Leo Apotheker: We’ve beat this quarter.

Carl:  But with accompanied by guidance that was very disappointing.  Every quarter has had some level of disappointment. Are you looking forward to one where there is none?

Leo: Of course. But I just want to make sure we get the facts right. We beat expectations in Q2 both on a revenue and margin side and EPS side. Let’s get the facts straight.

Becky: But the stock market is showing your stock down 5% this morning because of disappointment about the outlook for the third and fourth quarters. That’s a concern.

Apotheker:  I can easily understand that. We will walk our investors through our guidance for the rest of the year and explain the reasons. But I would like to make sure that we get the verbiage right and the facts right. You did beat for this quarter you beat both on the bottom and top line. That’s good news.

The transcript cannot convey the frustration in Apotheker’s voice when he was accused of missing expectations for the current quarter.  He can understand the stock falling, he can understand the outlook being poor, but do not accuse him of missing on the quarter.  Apotheker stressed this point multiple times.

Gamed Earnings

As the next two charts show, beating earnings and revenues expectations is nothing new.  Aggregate S&P 500 earnings have beaten expectations for 50 straight quarters, including the current quarter.  As we explained last July:

The chart below highlights the inception of SEC regulation “FD” (aka, Fair Disclosure). Before FD roughly 50% of companies beat expectations, as would be the case if analysts were trying to get it right. Now that companies have to disclose to all at the same time, we believe their investor relations departments are masters at “guiding” analysts just below actual earnings. This way the companies “beat” expectations and get the positive press and accolades that come with it. Further, it seems that everyone is happy with this apparent gaming of the system.

This is why we believe the percentage of companies that beat expectations is a meaningless statistic. The game is designed for this to happen, even when earnings are collapsing (during 2008?s epic collapse in earnings more than 50% of companies still beat expectations).

Note that the percentage of companies beating estimates has been falling in recent quarters, from 75%  in the first quarter of 2010 to 67% in the first quarter of 2011.  By this metric, earnings are not doing that well.


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In recent quarters investors have caught on that earnings are gamed and have greatly discounted these results. So they are now turning their attention to revenues. The next chart shows the percentage of S&P 500 companies that beat revenues estimates. This data series only started in 2006.


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At first blush revenues appear to offer a more honest view of companies’ financial outlooks than earnings. If analysts were actually trying to get it right, the number of companies beating the benchmark should vacillate around 50%. Revenues estimates did exactly this.

In recent quarters, however, revenues are showing an upside bias. Is this because companies are genuinely reporting good numbers or are the investor relations departments now gaming these numbers as well? It’s hard to tell. But we can say in our unscientific review of earnings releases that companies are highlighting revenue beats more now than ever. This is a red flag that these numbers are also being gamed.

Earnings Estimates

In the next video Robert Keiser, vice-president of S&P’s valuation and risk management strategies team, applauds the earnings numbers and suggests they are the most important driver of higher stock prices.

Melissa:  Does it simply tell us that Wall Street got it wrong when it came to the first quarter, that the expectations were too low?

Robert Keiser:  There were double digit earnings growth where the S&P outperformed expectations and the economy is growing 2 to 3% and consistently. In terms of the second floor, based on the company’s guidance, they give guidance and beyond, obviously we have a much better sense in terms of the reaction themselves. The analysts said estimates for S&P earnings are now up to $99.90 and the bar has been raised.

Later Keiser said:

Keiser:  The S&P estimate is right now going to earn $112 a share. Every quarter that the market either meets or beats expectations, there’s a little bit more confidence and it’s going to take about 1400 and sometime in 2012.

Keiser’s assumption is that earnings estimates are stable and even somewhat accurate.  However, as the next two charts show, the 12-month forward earnings estimates as calculated by Bloomberg are $122.44 for the S&P 500, essentially the same as S&P’s estimates.  However, the second chart shows, the error rate between forward earnings estimates and actual earnings is growing.  The worst miss occurred in 2008, which exceeded the record set in 2001.  In other words, earnings estimates are becoming less accurate, not more accurate.

So before Keiser tells us that the forward P/E ratio on an estimate of $112 is cheap, why should we believe this will happen?  Forward estimates were also that high in 2009.  How did that work out?oneyear0517111.gif

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Current quarter earnings estimates are gamed and 12-month forward earnings estimates are getting worse over time.  Use them in valuation estimates of the market at your peril.

Posted in Newsclips, Samples

What Does Company Guidance Tell Us About The Economy?


In the block above, we highlighted how earnings estimates are being gamed and have become more inaccurate in recent years.

If earnings estimates are no longer a good tool in predicting economic activity or market movements, can company guidance offer any insight?

The chart below shows the daily number of companies offering positive guidance in red, negative guidance in blue, and neutral guidance in black. The sharp-eyed reader will note that positive guidance (red) is almost always below both negative guidance (blue) and neutral guidance (black). This means the majority of guidance is either neutral or down. Analysts are always too optimistic on future earnings, making it nearly impossible for a company to offer higher guidance than analysts’ estimates.


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This index below plots the number of companies offering positive guidance minus those offering negative guidance plus 1/2 the number of companies offering neutral guidance divided by the total number of companies offering guidance. Neutral guidance gets a 1/2 weighting because affirming the consensus is not as important as offering guidance that differs from expectations (positive or negative).

A rising ratio means companies are offering relatively better guidance while a falling ratio means the opposite. By this measure guidance is more positive than usual.


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Does Guidance Lead The Economy?

The next chart overlays the Company Guidance Index with the ECRI Growth Rate index. The ECRI is a weekly measure of seven economic releases that are supposed to lead the economy (detailed here).

Without running a statistical analysis, it is clear that the ECRI turns ahead of the Company Guidance Index. Currently the ECRI growth rate is heading down while the Company Guidance Index is heading higher. In the last year, any relationship between company guidance and the economy appears random.  Divergences between these measures are often reconciled with the Company Guidance Index moving toward the ECRI and not the other way around. In other words, the ECRI leads the economy and the Company Guidance Index.


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Does Guidance Lead The Stock Market?

If guidance is on the rise, should investors expect further gains in the stock market in the near future? In one word, no.

Let’s examine stock returns in the quarter immediately following previous peaks in the Company Guidance Index. The chart below plots the 3-month rate of change of the S&P 500 in red and the 3-month average of the Company Guidance Index in blue.

  • The second-highest peak in the Company Guidance Index occurred on June 5, 2002. In the 3 months following that peak, the S&P 500 returned -14.44%.
  • In the 3 months following the Company Guidance Index’ June 7, 2004 peak, the S&P 500 returned -0.89%.
  • In the 3 months following the Company Guidance Index’ July 22, 2008 peak, the S&P 500 returned -28.70%.

This is not meant to imply that stocks fall soon after the Company Guidance Index peaks. However, the argument that rising guidance is positive for stocks is not supported by the data. A quick look at the chart shows a general lack of any relationship between these two measures. We are not surprised by this lack of correlation because many more things than company guidance (or forecasts) drive stock prices, especially in recent years.


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Posted in Newsclips, Samples

Silver ETFs

  • MarketBeat (WSJ Blog) – Silver ETF Unshockingly Sets Volume Record
    ETF Securities USA announced today that its silver ETF, ETFS Silver Trust, ticker SIVR, experienced record one-day trading volume of 5.25 million shares on May 5 and a record week of volume during the week of May 2. The average daily volume increased 18.5 times. Not too shocking: That was during the time the froth was being blown off the silver market. Nymex silver lost 23% that week alone. You could argue that having ETFs easing trading in silver helped speed the decline along, though to be fair the silver market has always been volatile, and you could also argue that ETFs made it easier for people to jump out of the way. “The transparent and liquid nature of the product provided investors who were sellers or buyers that week with the ability to access liquidity in an orderly and efficient manner, against a highly volatile market backdrop for silver prices,” marketed William Rhind, head of sales and marketing for ETFS Marketing, in a marketing press release.


Not only are silver ETFs experiencing their highest trading volume ever, but the SLV fund even surpassed the S&P 500 ETF (SPY) on a handful of days in terms of number of shares traded.  As we detailed at the end of April:

Volume of the silver ETF (SLV) topped the volume of the S&P 500 ETF (SPY), making it the first commodity ETF to claim the distinction. Although the NASDAQ 100 ETF (QQQ) often traded more shares than SPY prior to the financial crisis, SPY is often considered the benchmark for broad domestic index ETFs since it is the oldest (started in January 1993) and currently trades more on a dollar volume basis than any other ETF.

Excluding other domestic broad market indices, a quick review of some of the most popular foreign, sector, commodity, and fixed income ETFs (GLD, SLV, EEM, XLF, EFA, SKF and TLT) shows that the SPY fund has been the most traded ETF on all but a handful of days since its inception. Below is a table highlighting these days.


Posted in Newsclips, Samples

Can We Have A Bond Debacle When Everyone Is Forecasting It? – 99% Bearish Edition


This is an update from last month:

The table below shows the results of Bloomberg’s survey of economists. It details economists’ expectations for 10-year Treasury yields over the next six months. For those familiar with this survey, we use the quarter-end results closest to six months into the future.

See the bottom of the table. Since December 2002 Bloomberg has conducted 99 monthly surveys. Of these, an incredible 95 surveys (96%) have forecasted higher rates. To repeat, only four times since 2002 (4%) have economists been forecasting lower rates. Those instances are highlighted in red. Even these bullish forecasts can be explained in a bearish light.

In all these cases (June 2007, June 2008, June 2009 and December 2010), interest rates spiked dramatically higher during the survey period, which can be a week long to 10 days long and cover the same period of time as the payroll report, causing some economists’ forecasts that were bearish when given to look bullish when they were finally published (We use the yield on the survey’s release date to grade these results). We do not have the data to adjust for this reporting quirk, but it could very well mean that 100% of these forecasts actually expected higher rates.

Further, as also shown at the bottom of the table, an average of 78% of the respondents in these surveys expect higher rates. In 36 of the 99 monthly surveys, more than 90% of the respondents were looking for higher interest rates, including the latest survey (May 2011) which shows 99% (69 of 70) respondents see higher rates in the next six months. These instances are in bold below.

Economists are always bearish on interest rates. Expansion, great recession, bubble, surplus, deficit, inflation, deflation, equity bull market, equity bear market, easing, tightening, Republican, Democrat, winter, summer, Yankees, Red Sox – it doesn’t matter. The results are always the same. So, can we have a bond debacle when everyone is forecasting it?

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Posted in Newsclips, Samples

Citi’s Reverse Split And Volume


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  • – Citi’s reverse split has tiny impact on volume
    Moving from worst to just bad, the NYSE composite volume is the trading volume of all the issues who are members of the NYSE. This is what most people think of when looking at volume. It includes all the shares of NYSE listed stocks no matter where the trades were facilitated. So the effect of Citigroup’s split will be somewhat muted but still significant, attributing typically close to 10% of the total NYSE.  When referring to the market volume, other media outlets may reference the total composite volume of all shares traded on all the major exchanges. Using this view, Citigroup’s split should decrease the total by about 4%.  These are the three common methodologies. Keep in mind that these are generalities. Each data provider may modify the data by being either over-inclusive (adding exchanges) or restrictive (subtracting issues ADRs, ETFs, non-operating companies, etc.). Many acknowledge the predictive benefits of using volume data, yet few actually apply the data correctly. However, serious volume watchers use either dollar totals or capital weighted figures in analyzing volumes.


The chart above shows composite volume for the S&P 500 stocks only, our preferred measure of volume.  The two brown bars show Monday and Tuesday’s volume, after the Citi split.  Monday’s volume was the lowest non-holiday volume since we started this measure in 2008.

The chart below shows the percentage of volume coming from financial stocks that accepted TARP money (BTCPP <Index> on Bloomberg).  Citi was one of the largest financial institutions to accept TARP funds.  Collectively these institutions (which totals 199) average between 10% and 15% of NYSE composite volume.  In the two days since Citi’s reverse split, these companies have accounted for less than 5% of NYSE composite volume (red bars and arrows).

Citi’s reverse split is having a significant effect in depressing volume and will continue to do so moving forward.


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Posted in Newsclips, Samples

Citi’s Reverse Split

  • The Wall Street Journal – Citigroup Instantly Becomes a $40 Stock
    Citigroup, the heaviest-traded U.S. stock that accounted for 6.8% of total U.S. stock trading volume last year, drastically shrunk its share count. The move instantly erased its single-digit stock price, which has been a persistent reminder of the trauma the bank suffered during the financial crisis. Through a reverse split, Citigroup was able to ax a huge number of shares outstanding by turning every 10 shares into a single share. Instead of trading for less than $5 a share, where Citigroup has languished despite improvements in profits and capital, the New York financial behemoth instantly became a $40 stock. Shares of the bank fell $1.04, or 2.3%, to $44.16…Broader studies also show a mixed record for reverse splits. James Rosenfeld, an associate professor of finance at Emory University’s business school in Atlanta, said he and April Klein of New York University’s business school had tracked the performance of 1,600 companies that did reverse stock splits over a three- year period. They underperformed the returns of comparable companies by 50 percentage points.
  • MarketBeat (WSJ Blog) – Don’t Blame Citigroup (Entirely) For Your Weak Volume Insecurities
    With trading done for the day, it’s time to take a look at Citigroup’s much-vaunted one-for-10 reverse stock split. Did trading volumes shrivel up and die with the much-diluted presence of one of America’s highest-profile corporations — one that combines brand-name recognition with oceans of liquidity and one of the most bargain-basement-cheap price tags on the Street? The answer: Not really. Just to sum up, total NYSE composite volume today rolled in at just 3.03 billion shares — making it the second-slowest day so far in 2011, and well below this year’s daily average of 4.33 billion shares. The obvious blame for this goes to Citigroup, which after its decupling exercise is now only contributing tens of millions to NYSE composite volume, rather than the hundreds of millions it used to contribute in those halcyon pre-reverse-split days.


The first story above points out that Citi accounted for 6.5% of NYSE composite volume last year.  As we pointed out on April 6, the stock’s reverse split would depress composite volume.  Our chart below shows yesterday’s volume (last red bar) was the lowest non-holiday volume since October 29, 2007.  If the technicians were worried about the bearish implications of a rally with declining volume, this will only grow larger considering Citi’s reverse split.

FYI – Our data, calculated by Bloomberg (MVOLNU <index>), shows NYSE composite volume was 2.93 billion yesterday.  The story above says NYSE composite volume was 3.03 billion shares.  We are not sure what data source they used which might lead to this slight discrepancy.


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Posted in Newsclips, Samples

Did The CME Silver Margin Hikes Create The Crash Last Week?


  • The New York Times – Response to Volatility in Silver Takes Hold
    On April 25, half a dozen officials from the CME Group, which runs many of the nation’s commodities exchanges, met via videophone to discuss the eye-popping rise in the price of silver, which had doubled in just six months to about $47 a troy ounce. They didn’t realize it, but they were about to take the first step toward popping a bubble in global commodities prices. Worried about the speculative run-up and the increased volatility of the silver market, the officials concluded that it was time to raise the amount of money that buyers and sellers had to put down as collateral to guarantee their trades. The first increase in so-called margin requirements took hold the next day, effectively making it more expensive for speculators and other kinds of traders to play in the market. But the price kept going up, reaching nearly $50 a troy ounce on April 28. Over the next week or so, the exchange decided to raise collateral requirements even higher, in four more steps that would kick in every couple of days. … CME says it makes margin changes regularly. Silver margins were raised five times and lowered once in 2010, for example. Corn margins were raised 36 percent in one day last October.


Typically futures margins are moved in deliberate ways and with great care.  The concern is moving margins can have a huge impact on prices.

However, as the chart above shows, this was not the case with silver in the last two weeks.  Even though prices and volatility did not materially change, the CME (which now owns the Comex where silver is traded) announced five margin hikes over a nine day period.  The New York Times story above says four hikes, but the last hike announced last Wednesday May 4, was actually two margin hikes at once, one for Wednesday, May 4 and another for today, Monday, May 9.  In checking with old-timers in the market, and looking at some margin records, we cannot find an instance where two margin hikes were announced at the same time, or five margin hikes over a nine day period when prices and volatility were little changed.

Before this episode, veteran futures traders would tell you that hiking margins five times in nine days would cause havoc in that market.  Isn’t that exactly what happened last week with silver?  Why did the CME act in this manner?  The New York Times story above only makes passing mention of it.

We are not arguing against margin hikes once speculation rises in a market.  However, hiking five times in nine days gives the impression of irrational decision making.  This type of uncertainty makes any market ripe for a correction.

Posted in Newsclips, Samples

Could Ending QE2 Be Good For Bonds?


  • The Wall Street Journal – Mark Gongloff:  A ‘Buy’ Sign for Treasurys?
    Some Bet End of QE2 Will Be Boon to Bonds
    The recent rally is evidence for some investors that the end of the Fed’s second big bond-buying program, known as quantitative easing, or QE2, might actually benefit or, at worst, be a non-event for bonds. It could be a boon for Treasurys if economic growth slows, knocking down commodity prices and reducing the risk of inflation. “If QE2 contributed to stocks and to risk assets and to the commodity bubble, well, what happens after QE2?” said David Ader, head of government-bond strategy at CRT Capital. “When QE2 ends, maybe those assets go the other way, and people buy more Treasurys.” The swift decline in stocks and commodities last week further bolstered the argument that the end of QE2 would actually benefit bonds.


We have long argued that QE2 was about supporting risk assets and not about supporting the bond market.  Therefore, if risk assets suffer when QE2 ends, it would be bullish for Treasuries.

We addressed this in our late March conference call:

So how does this help to raise stock prices? Remember that we have talked about this before. POMO – permanent open market operations – occur everyday at 11:00. Everyday at 11:00, the Federal Reserve purchases Treasuries. Everyday at 11:00, a group of Treasuries – say, $6 billion-worth of Treasuries – is converted to cash.

What happens with that cash? The Federal Reserve’s portfolio balance theory says that cash will go where it is treated the best. Right now, that is “risk on markets.” Right now, as the Federal Reserve converts Treasuries to cash by purchasing them, that money tends to leak out into other places and in other ways in the market. One of the big places that the Federal Reserve believes that it goes – and I agree with them – is equities.

There was a story in The Wall Street Journal yesterday and there was a story last week, as well, about what is going to happen to Treasuries when QE2 stops. The assumption in the story is that the Federal Reserve is buying Treasuries to push down interest rates. I think that it is the opposite – that the Federal Reserve is engaged in QE2 to get money out of Treasuries and get it into other markets. One of the reasons why yields may have been biased upward is because of QE2. And when it ends, it might have somewhat of a stabilizing force in interest rates.

Let me be clear on my word usage. I said “stabilizing force.” I did not say that, when QE2 ends, rates are going to go down. There is not going to be money being pulled out of Treasuries anymore.

  • Reuters - PIMCO would only buy Treasuries on recession risk
    PIMCO’s Bill Gross, who runs the world’s largest bond fund, said on Friday the only way he would reverse his “short” position on U.S. government-related bonds and purchase Treasuries again is if the United States heads into another recession. Since the news on April 11 that Gross turned more bearish on government debt including Treasuries, reflecting his growing worries over the country’s fiscal deficit and debt burden, Treasury prices have been soaring. On Friday Treasury prices fell after an unexpectedly strong U.S. monthly employment report. Treasuries then reversed course on a media report, later denied, that Greece is mulling quitting the euro zone, which revived safe-haven demand for bonds. Asked Friday what would change his bet against government debt, Gross told Reuters: “Treasury yields are currently yielding substantially less than historical averages when compared with inflation. Perhaps the only justification for a further rally would be weak economic growth or a future recession that substantially lowered inflation and inflationary expectations.” The benchmark 10-year U.S. Treasury note was flat, with the yield at 3.15 percent, in early afternoon trading on Friday. On April 11, the yield stood at 3.58 percent. Gross said for now, the impact of negative real interest rates on commodity prices and other inflation generators argues for Treasury yields to move in an upward direction. “Debt ceilings and deficit reduction frustrations, as well as the end of QE2 in June are other bearish influences,” Gross added.
Posted in Newsclips, Samples

Could The Real Contrarian Bet In Silver Be A Long Position?

  • The Wall Street Journal – Silver Slips Below $40, Spooks Other Markets
    Silver plunged for a third consecutive day, ending below $40 for the first time in almost a month as investors continued to bail out of the market due to higher trading costs. Silver prices have lost 19% since Friday, when CME Group Inc. said it would raise the amount of money traders had to have on hand, known as margins, for the second time that week. The exchange raised margins again on Monday, and on Wednesday announced two more increases which come in to force at the close of business on Thursday and on Monday. “It’s a continuation of the higher margins squeezing traders out,” said Rob Kurzatkowski, senior commodities analyst at optionsXpress. As expected, the increase in margin requirements has driven weaker traders out of the market. However, the exodus has also pulled silver prices down.
  • The Financial Times – Lex: High-low silver!
    The leading vehicle for US retail speculation, the iShares Silver Trust, has traded the equivalent of nearly 2bn ounces since the beginning of April – close to three times the annual new global supply from mines. The sudden enthusiasm for silver may be explained by the fact that it was somewhat late to the precious metals party. For investors who felt they had missed the boat with gold, or wanted to get in on the ground floor for the next big thing, silver beckoned last year. The ratio of the price of gold to silver dropped to around 32 by last week, well below the 20th century average of 50. The ratio is useful only as a gauge of relative froth though. Just based on relative rarity in the earth’s crust it should be around 16 times, but silver, as both a precious metal and an industrial commodity, is more useful than gold.


Last week the volume of the iShares Silver ETF (SLV) topped that of the S&P 500 ETF (SPY) on multiple occasions. Despite this sign that is often taken as rampant speculation, we argued that speculation in the SLV fund was not to blame for the massive runup in bullion prices (pages 5 and 6). Our argument was based on the fact that SLV’s holdings of bullion (red line below) were essentially unchanged from the year-end 2010 levels. In other words, SLV was not a buyer of bullion despite the rally from under $30 to nearly $50 this calender year.

If SLV was experiencing a rapid influx of new money, the price of the ETF would trade well above the price of bullion. In this scenario, the ETF managers would sell these buyers new “over-priced” shares and use the proceeds to buy new physical silver for the fund. This is done to keep the ETF’s price as close to a 1:1 ratio with the price of silver as possible. Because the amount of physical bullion (red line below), as well as the number of shares outstanding, have essentially remained relatively stable, we can assume the demand to own SLV is being offset by an equal number of willing SLV sellers at current prices.

So long as this supply/demand balance in SLV shares exists, the ETF manager of SLV is not forced to buy bullion in the physical market. If the price in the physical market soars, as it has this year, we cannot blame the ETF for pushing the physical market higher in price.

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Motivated Sellers Of Silver

As the chart above shows, when the price of silver broke down this week, sellers of the SLV came out in droves. These motivated sellers of SLV pushed its price to a substantial discount to silver bullion prices, violating the 1:1 ratio. This is shown below.

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When motivated sellers cause a significant discount to bullion prices, the ETF manager buys SLV shares in the open market. He pays for these shares by selling bullion and then retires these shares, causing the number of SLV shares outstanding to fall. So, when this happens, the ETF is a seller of bullion and a contributor to lower bullion prices. This has been happening this week as the first chart above illustrates.


There is an assumption in the market that the public has been a huge, irrational buyer of silver via SLV. If this were the case, we would have seen the price of SLV trade at a significant premium to bullion, causing this ETF manager to sell new SLV shares into the market, increasing shares outstanding and using the proceeds to buy bullion. This has not been the case.

Instead we have seen the opposite. Few signs of irrational buying of SLV were visible during silver’s advance, but now that prices broke sharply to the downside we have seen motivated SLV sellers. They have pushed the price of SLV to a significant discount, prompting the ETF manager to buy SLV, thus reducing the shares outstanding, and sell bullion to pay for them.

The public was never really an irrational buyer of SLV, but the signs now point to them being an irrational seller of SLV during this week’s downturn. Throughout the rally this year, those that incorrectly assumed that the public’s irrational buying of SLV pushed bullion prices higher wanted to make a contrarian bet to sell silver. Month after month the price of silver bullion rose, more than doubling in a few months, proving this idea wrong. We believe the reason was that the public was not a motivated buyer of SLV. The speculative/irrational buying of silver during this period was coming from sources away from SLV (professional traders, hedge funds, the Chinese, all of the above). We also recently concluded that these speculative flows are not coming from managed futures funds and “other reportable” traders.

In reality, the irrational bet by SLV investors (read: the public) is shaping up to be selling. If so, the contraraian bet now might be to buy SLV looking for these motivated SLV sellers to wind up on the wrong side of this trade.