Vigilant Investor

As we’ve discussed during prior live streaming shows, we are now doing a short, 15-minute daily live update every day at market close, 4:15 p.m. ET. Tune in or subscribe to the podcast recording by clicking the Talkshoe ID below.

While consensus experts are getting surprised left and right by this week’s very weak numbers, we at Vigilant Investor were not, in the least.

Yesterday it was announced that in October the economy grew faster than forecast, at a 2.2%, but still at the slowest pace for the year. This was revised adjustment from the Commerce Department, who was expecting 1.6%, but upped the number based on increasing inventories. The slew of information for the week has been hardly glowing. U.S. New home sales fell 3.2%, their largest ever contraction. Meanwhile, durable goods orders declined by an abysmal 8.3%, the most since July 2000. This is leading many analysts to suggest that Fed rate cuts are all the more likely, especially if those numbers don’t improve soon. Adding insult to injury, the Chicago Purchasing Managers’ Index (PMI), a leading gauge of businesses activity, surprised consensus analysts dropping to 49.9 from 53.5 in October. Below 50 signals a recession. Some predict layoffs are in the future if the PMI slumps further.

Meanwhile, retailer sales in November were growing slower than expected as analysts dropped their forecast with Wal-Mart as the retailer for Middle-America again lowered its expectations and announced its worst monthly performance in 10 years.

The dollar showed continued weakness, slumping further — a long term trend we should all expect to continue, especially when measured against hard assets vs. other currencies that are often printed out of thin air to maintain trade parity against the U.S. dollar.

Proof is in hard asset prices, with Oil rising above $63 in today’s trading, while gold marched to a 12 week high trading above $650, up over $40 for November alone, and over 30% for the year.

Mainstream finance folks will continue to view us as Cassandra’s. We think the proof is in what is unfolding. Will this be the final unwinding of the Credit bubble, or will policy makers engineer another round of liquidity stimulation to ward off the inevitable for one more cycle? We don’t know, but act as if all is just fine at your own risk.

Remain Vigilant!

Tonight on Vigilant Investor Live (every Wed, 9:00 p.m. ET) we’ll bracket our pre-recorded conversation with Robert Blumen with fresh observations and discussion, listeners included.

Our discussion with Mr. Blumen, an Austrian School of Economics essayist, covers a recent piece of his digesting a June 2006 proposal from former Treasury Secretary, Lawrence Summers, encouraging the world’s central banks to diversify their massive reserves into more lucrative investments in the stock market. Mr. Blumen not only explains why such “investment” by central planners is extremely disruptive to a healthy economy, but also that those objections have been warned by proponents of the Austrian School of Economics for over 80 years. (Simply, they are too inconvenient in that they do not justify government meddling in markets, period!)

For those interested, the pieces referenced in the discussion are as follows:

• Blumen: Will Central Bankers Become Central Planners?
• Mises: Economic Calculation in the Socialist Commonwealth

Yet this time is different. Sure, that’s the classic “ah ha!” — code words for ever-cynical investors to ignore anything that follows. But it’s important to understand the corollary of this reaction — namely that nothing ever changes. That’s where I have a serious problem. Consider globalization — the most important mega-force of our lifetime. This is the first time that the powerful disinflationary forces of globalization have had a major impact on the endgame of a modern-day business cycle. Consider IT-enabled technological change; this is the first time that revolutionary breakthroughs in connectivity, miniaturization, and software programming have shaped the cyclical endgame. Consider ever-mounting global imbalances — a disparity between current account surpluses and deficits that has reached a record 6% of world GDP. This is the first time that imbalances of this magnitude have threatened the global economy and world financial markets. Consider also the gap between record returns on capital and the sharply depressed rewards of labor in the developed world; it’s been a long time since the potential social and political consequences of such tensions were in play. I could go on and on — underscoring the unprecedented growth in synthetic securities (i.e., derivatives), the doubling of the global labor supply traceable to the emergence of China, India, and the former Soviet Union, rapidly aging populations in the developed world, unfunded retirement and medical-care liabilities, and surging M&A and LBO activity. The point is that it makes no sense whatsoever to ignore the truly unique features of the current climate. Those who dismiss such possibilities because of the legendary lore of four words — “this time is different” — do so at great peril, in my view.

That’s Stephen Roach, Managing Director and Chief Economist of Morgan Stanley, in his most recent dispatch — yesterday’s “The End is Never the Same“. Roach knows a skunk when he smells it. He’s just having a hard time getting his arms all the way around it given he’s missing a fundamental understanding of the Austrian Business Cycle, at the core of the Austrian School of Economics’ thinking on bubble environments. Hence Roach has been waffling on the outcome of the current mess — one that he’s partially identifying very well, hence please give this entire piece a read.

For those who want the complete picture that Roach is missing, we recommend our post yesterday and the reference to Sean Corrigan for a concise and thorough update.

Orders for Durable Goods in U.S. Unexpectedly Decline 8.3%

Orders for U.S.-made durable goods declined last month by the most since July 2000, suggesting a slowing economy is prompting companies to curb spending.

OECD Offers Warning on Dollar Slide

Jose Angel Gurria, secretary-general for the Organization for Economic Cooperation and Development, said the United States’ growing current account deficit and the current account surplus of Asian and oil exporting countries was making investors back away from the U.S. dollar.

Consumer Confidence in U.S. Unexpectedly Declines

Confidence among U.S. consumers unexpectedly fell this month, posing a risk for spending as the holiday shopping season gets under way.

Existing Home Sales Flat, Prices Fall

The National Association of Realtors said Tuesday that existing home sales edged up 0.5 percent to a seasonally adjusted annual rate of 6.24 million last month. It was the first increase after seven consecutive monthly declines.

However, the median price for a home sold dropped to $221,000 in October, a decline of 3.5 percent from a year ago. That was the biggest year-over-year price decline on record.

It marked the third straight month that median prices have fallen compared with the same period a year ago, the longest stretch of such declines on record. The median is the point where half the homes sold for more and half for less.

France in ‘vigilance’ plea on falling dollar

Thierry Breton, France’s finance minister, urged “collective vigilance” in the face of the falling US dollar. He promised to raise the euro’s recent rally with fellow eurozone finance ministers at their monthly meeting in Brussels on Monday night.

Dollar slumps to 20-month low against euro

The dollar fell to a fresh 20-month low against the euro and a two-year trough against sterling on Monday as the beleaguered US currency continued its recent slide.

European Money-Supply Growth Stays Near 3-Year High

Money-supply growth, which the European Central Bank uses to gauge future inflation, remained close to a three-year high in October.

Paulson Backs a `Strong’ Dollar, Says U.S. Economy Is `Healthy’

U.S. Treasury Secretary Henry Paulson said the U.S. is best served by a “strong” dollar and that he feels “very good” about the American economy. Paulson’s latest comments on the dollar come as the U.S. currency heads for its fourth annual decline in the past five years, falling 10 percent against the euro and 1.4 percent versus the yen so far in 2006.

While most in the U.S. were relaxing with their feet up for the Thanksgiving holiday, the rest of the world hammered the dollar downward this past Friday. Today, the Dow Jones Industrials had its worst day in four months, shedding 158 points as the dollar continued its fifth-straight down day, hitting a 20 month low against the Euro.

When the Dow plummets 150 points in the face of a sudden dollar capitulation, we wonder if the gig is finally up. Odds are that the crack is not yet here, but when you follow the macro fundamentals that we do as students of the Austrian School of Economics, you know a plummet is a distinct possibility since the U.S. economy itself is a house of cards with a gargantuan credit-bubble as its foundation. The likelihood of a serious correction in equities, at least, is only increased by the abject indifference from a majority on Wall Street and Main Street, as affirmed by numerous sentiment indexes showing record-high bullishness, and further noted by the near record lows on the VIX.

Vigilant Investor regulars know most of the backdrop to this unfolding story already, but you too will enjoy some timely pieces that have hit the wires in the last couple of days. Neither should go unread, and both should be forwarded to friends and loved ones with hopes that readers will start to rethink their core assumptions.

The first piece is from an Austrian School pro, Sean Corrigan,” Commodities, Crises, and Cycles“:

Albert Hahn once referred to this phenomenon of ‘inflation without inflation’ as being the most dangerous type of all, since it was almost guaranteed to lull policy makers and financiers into the most enormous of errors.

But, of course, despite the fundamental lack of equity involved, the masses have been taught to clamour ceaselessly for a regime of easy money, for this gives rise to the illusion of ‘making bread from stones’ - as Keynes, the most persuasive modern advocate of this fateful ruse, once put it.

Easy money is popular because it fosters a period of feverish economic activity through lowering the rate of interest well below the level which would serve to match the supply of genuine savings to the demands arising from the most compelling entrepreneurial investment schemes in strict sequence of their merit.

When money is easy, many more undertakings can be launched than are strictly warranted by the resources available.

This gives rise to the intoxication of a boom for so long as we can defer the crucial question of how all this will be funded - that is, supplied with the necessary real resources - as opposed to merely being financed; that is, furnished with the extra, fraudulent credit needed to contend for an unaugmented pool of such scarce resources.

Live now, pay later

A great part of the appeal is that, with no-one having to undergo the rigours of conscious abstinence today in order to provide for a greater plenty tomorrow, inflation is a means of burning the candle at both ends - of living a gloriously indulgent Rake’s Progress.

Inevitably, what is consumed in the flames which illuminate the revelry is nothing less than hard-won capital. It is only later, when the taper gutters and goes out, that the true extent of the impoverishment which has paid for such a Bacchanal is fully revealed.

Frustratingly, the date of that day of reckoning cannot ever be predetermined - a fact which makes Cassandras of those of us who tend to fret about its inevitability.

The last point resonates with many of us sounding the alarm, to no avail.

Our other snippet is from a better known hedge fund contrarian, Bill Fleckenstein, in his most recent Contrarian Chronicles, “The upside-down logic of Wall Street“.

“Part of me thinks that the current mini-mania in equities is a response to Fed-induced liquidity. And yet, when I discuss with my good friend Jim Grant what the big central banks of the world are doing — Japan’s, the United States’ and Europe’s — he suggests that they really aren’t spewing out liquidity as aggressively as people think. Of course, if they were, one might expect commodities to be on more of a run than they have been. To me, they seem to be suggesting that the world economy is slowing down at the margin.”

Therefore, I’ve concluded that what we may have is the illusion of a liquidity fest. The stock market is acting as though there’s an enormous fire hose of liquidity gushing forth — when, what might actually be the case, is that a wanton derivatives/credit/lending mania is in full force.

Markets in motion may stay in motion. If, however, the source of the propulsion is mispriced and badly structured credit, things can come to a sudden stop. But if that were to occur, the Fed at some point would ride to the rescue with plenty of liquidity. That is Marc’s point and is, of course, the point of my pet saying that in a social democracy with a fiat currency, all roads lead to inflation.

Again, please read both pieces noted above. Together they will get you up to speed on why playing the consensus curve at the moment might cost you. While the herd may be totally oblivious or disdainfully indifferent, vigilance will pay off in the long run.

Stephen Roach weighs in again, and he’s come back to our view after dabbling with the consensus again for the last ten months. Welcome back Steve!

“What I find truly fascinating is that most still cling to the now-discredited notion that US consumers will just keep on spending; this argument further claims that since they haven’t flinched yet, they are unlikely to do so in the months ahead. As I spun around the world last week, I found this view to be the most deeply entrenched pillar of consensus thinking. Yet this premise is not only completely at odds with the weak retail sales of the past two months, but it also ducks a similar impression conveyed by the broader data on personal consumption expenditures. According to our latest estimates, growth in real consumer spending slowed to a 2.5% average annual rate in the final three quarters of 2006 — a significant shortfall from the 3.7% ten-year growth trend. If that’s not a flinch, I don’t know what one is.”

Read all of “Two-Engine Slowdown” from Managing Director and Chief Economist of Morgan Stanley, Stephen Roach.

News last week was not rosy regarding the economy. GDP under expectations. Housing slumping big time.

New U.S. house prices suffered their steepest year-over-year drop since 1970. Pundits tried to pick through the crumbs from last weeks reports to find tidbits of good news. Of course, the markets reacted less than positively, nonetheless.

The good news? Homebuilders had relieved themselves of some of their backlog in new-home inventory, leading National Association of Realtors - but did so by slashing prices by 9.7% from September 2005. Keep in mind, that near 10% cut would be a great deal larger if other buyers incentives were being included in the re-pricing - free upgrades and other giveaways.

Economic data for the month — including employment, industrial production and retail sales — should have shown sharp increases in annual growth over last year’s dismal Hurricane Katrina numbers. But no such luck. Instead numbers came in well below consensus forecasts, showing slowing annual growth, slowing retail sales, as well as tepid employment growth. Given that these numbers are already generally rigged to look better than reality, observers should take note.

Moreover, Bloomberg reports that Joe Carson, director of economic research at Alliance Bernstein LP in New York noticed that GDP benefited dramatically from a statistical fluke in auto reporting. Thanks to an unexpected 26% annualized increase reported production GDP was pushed ahead by .7%. In other words, the officially rigged GDP was .9% vs. the reported 1.6%. You can read the details in Bloomberg’s “U.S. Data Fluke Exaggerated Growth, Will Be Reversed.”

As announced last week, due to the Thanksgiving Holiday, Vigilant Investor Live was tonight, 9:00 p.m. ET instead of its usual Wednesday evening slot. You can dowload a recording or subscribe to us as a podcast. Tune in!

The death of economist Milton Friedman last week at the age of 94 marks a great loss for advocates of freedom everywhere. He was perhaps the most successful free-market economist of the 20th century, in terms of his real-world impact on politics and policy. Many modern politicians, including Ronald Reagan, considered him a major influence in their careers.

Milton Friedman was a strong advocate of economic liberty who opposed government intervention in both the purely economic and broader social spheres of our society. He believed not only in laissez-faire capitalism, but also the larger cause of individual liberty in the political sense.

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“For the naïve mind there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government’s Treasury Department!”

–Ludwig von Mises, The Theory of Money and Credit

A surfeit of liquidity in the financial markets is tempting bankers to underwrite and finance deals that may come back to haunt them, a top banker at Goldman Sachs said on Thursday. Eugene Leouzon, the chief underwriting officer for Europe and Asia at Goldman Sachs who sits on the investment bank’s global credit committee, said the current conditions were unparalleled in his experience of investment banking.

“The markets are really, really red hot,” said Leouzon, who approves new loans and debt deals to fund mergers and acquisitions.

“The things we are seeing being done, both on the investment grade side and the non-investment grade side, are I would say borderline stupid,” he told the Reuters Investment Banking Summit in London.”There is just too much capital going after too little by way of deals.”

“We, as an industry, are doing things that we shouldn’t be doing,” he said.

That’s from a Reuters article published today [Bankers push limits in hot debt market]. The global debt market is some $60 trillion — a massive figure - filled with all sorts of leverage and exotic derivatives exposure. Earlier today we posted a quote from George Eliot that we think covers the recklessness in the markets these days. At least a few lone voices out there, like Leouzon, are paying attention.

“The sense of security most frequently springs from habit than from conviction, and for this reason it often subsists after a change in the conditions as might have been expected to suggest alarm. The lapse of time during which a given event has not happened, is, in this logic of habit, constantly alleged as a reason why an event should never happen, even when the lapse of time is precisely the added condition which makes the event imminent. A man will tell you that he has worked in a mine for forty years unhurt by an accident as a reason why he should apprehend no danger, though the roof is beginning to sink; and it is often observable, that the older a man gets, the more difficult it is to him to retain a believing conception of his own death.”

–George Eliot, Silas Marner