Fiscal Plan B Fails House Approval, Ball is now with President

Most recent report on U.S. efforts to address its budget or fiscal cliff shows continued hardship, despite irrational market optimism. For a couple of weeks, President and Speaker of the House John Boehner have been discussing differences in desired fiscal direction. In so doing, both have realized mostly differences, and not common ground.

Boehner announced a Plan B. He took it to a vote in the House tonight and it failed. Obviously Boehner was looking for strength in his own majority party  to push a lead on fiscal policy in the House of Representatives.

Revenue bills must originate and be passed in the House of Representatives. They can't come from the Senate. Revenue bills, or budget setting, are essentially between House of Representatives by passing a bill, and the President by signing it into law. Senate can make changes, but the idea must pass the House of Representatives first.

What's more, President of the U.S. can't dictate to the House of Representatives a revenue bill. Rather, game starts in the House of Representatives, with all knowing that President has veto power. Typically, as a result, negotiations start with the House and President, certainly when the current Democrat Senate is inclined to follow their Democrat President.

When U.S. has a Democrat President and Senate, but a Republican House of Representatives, the obvious negotiation is between the House and the President.

Leader of the House of Representatives is Speaker of the House, John Boehner. Mr. Boehner was elected by a majority of the House, being Republicans.

Though Mr. Boehner's vote failed in the House, ball is now completely and squarely in President Obama's court to propose something that can pass a first hurdle, being the House of Representatives. Even Boehner's plan B didn't pass the House.  Suggested is a substantial width of chasm between House and President expectations.

Looks like President Obama must now realize power over national purse strings held by House of Representatives. To move government requires such realization of balance of power. Election is over, now its governing.

What is degrading to processes of governing is media characterizing an act of compromise as an act of "caving". Recalls base talk shows with lots of violent behavior displayed on set, which only excites crowds to finally encourage self-perceived protagonists, or martyrs.

But how long will it take to close this balance of power chasm, especially given a Christmas recess in the House. Checks and balances were intended to slow action, but more so with social policy as opposed to budgets. Budgets historically haven't proven this difficult.

Continued negotiations remain invited and open among all parties.

Obviously, past market confidence will fail and show declines in equities and an increasing dollar, with suspected correlations. If not, market sees a ghost in fog.

U.S. Expands QE3, But Markets are Disappointed, by being Underwhelmed

Seeing today’s market activity, one becomes concerned with market responses to central bank activity. Federal Reserve today concluded their two day meeting with an announcement turning convinced speculation into what was already convincing.

That is, Fed said it would roll its “operation twist” into some $45B/month in treasury purchases. This becomes a new round of treasury purchases not seen since conclusion of QE2, in 2011. Interesting also is Fed’s tying monetary policy to a 6.5% unemployment rate, as opposed to particular dates. Seems far more logical.

What disappoints is equity responses today when Fed announced additional easing. Dow jumped up in a cheer, but closed down by three points. Currencies, namely U.S. dollar and euro, went into normal correlation with U.S. dollar down and euro up. But ended showing some sign of risk hesitation.

Overall, U.S. markets have demonstrated sound and positive responses to global central bank easing announcements. Generally leading major U.S. equity advance in recent past have been Fed’s September QE3 announcement and ECB’S Outright Monetary Transaction of September as well. Also creating equity increases was ECB's Long Term Refinancing Operation (LTRO) brought in December and expanded in February. Markets went up consistently with all these announcements.

Today, we have existing Fed purchases of mortgage backed securities (MBS), expanded into Operation Twist money going into treasury purchases starting in January. For ECB, they’ve expanded LTRO twice, and announced their Outright Market Transactions in September.

But today, in response to expanded U.S. asset purchases, equities either fell, or remained unchanged in U.S. A disappointment, at least for me.

While all central banking efforts have maintained asset prices, fundamentals for companies have not improved proportionate to central bank liquidity infusions. Or, for the matter, Europe’s LTRO and improvement for bank balance sheets.

Simply stated for companies, only about 40% beat revenue expectations, after expectations were cut several times.  Q3 earnings season saw some surprising disappointment, with Apple and Google, together with McDonalds and Caterpillar…to name a few. Look at S&P or Dow charts through Q3 earning’s season.

When European Union is in GDP contraction, and Japan joins in recession, little space exists for U.S. decoupling.

Essential is improvement in demand and willingness to invest. A U.S. budget starts confidence in growth. Especially where U.S. shows GDP growth currently.

CURRENCY/EQUITY ASSET PRICING CORRELATIONS PART II: AUGUST TO OCTOBER

Equity and Currency Pricing are Looking More Normal, but Currencies also Show Caution

Currency/equity prices showed a noted divergence late last week. S&P went up where euro went down and U.S. dollar went up. Going into this week, risk appetite seems more in play with currencies. But interesting to note is 1.3000 appears to be key resistance for euro and 80 key support for U.S. dollar. Today, Equities are showing strength, but currencies seem less convicted.

Euro’s daily chart shows moderate price increases for Monday and Tuesday. However, MACD histogram continues to weaken with the indicator threatening to turn down. For U.S. dollar, it’s in decline, but its MACD histogram also seems week. Equities, in contrast, simply look strong.

Looking at these asset correlations, one can see decided influences that drove pricing among the three assets. Any divergence in past correlations raises a warning and indicates potential of a change in dynamics, or one asset class front running the others.

Below is a continuation of last article “Currency/Equity Asset Pricing Correlations Part I: July to August.”

Last article looked at July through August market activity among U.S. dollar, euro and equities. Notable were ECB negotiations with Germany. While negotiations initially were framed by public comments and affirmed by markets, an agreed policy was announced in September.

Looking at September, August’s developments came to fruition.

ECB and Fed Comments Brought Cautious Optimism to Markets, But German Comments Confused Markets

After Mario Draghi’s remarks of doing what it takes on July 26, markets found optimism in August due to expressed ECB commitments. Markets held an optimistic caution with release of Fed minutes on August 22.

Until August 22, equity markets moved up on an escalator, with slow steps made every day. On August 2, S&P closed at 1,365, and on August 20, S&P closed up 1,418. Same time period, euro and U.S. dollar proved unconvinced and moved sideways.

Day before release of Fed minutes, August 21 saw S&P drop from a four year high closing at 1,413 and Chicago Board of Exchange equity volatility index (VIX) gained 7% ending at 15.02. Where equities fell and VIX indicated larger declines ahead, U.S. dollar looked decidedly risk on opening at 82.46 to close down bullishly at 81.91. Euro demonstrated a rise breaking its drift.

Early on August 21, equities started a rally on reports that ECB would start buying Spanish and Italian debt. Also encouraging was German Chancellor Angela Merkel remarked that Germany would do whatever it could to support the euro, mirroring ECB’ Mario Draghi’s statement of July 26.

Dashing rallying equities was a Deutsche Bundesbank statement critical of both Draghi’s and Merkel’s remarks. German Central Bank said it was hesitant to engage in euro system sovereign bond purchases with such purchasing posing a risk to stability.

Apparent Consequences of Confused German, European Direction

Close of trade on August 21 saw market participants walk off the field confused over conflicting remarks. Equities took the conflict to hart and went risk off. Currencies saw a brighter side and went risk on with dollar declines and euro advances.

August 22 didn’t revive equities, as otherwise expected. But currencies continued in bullish fashion. Federal Reserve minutes of their July meeting were released. Minutes revealed a consensus to engage in a new QE program soon should no economic improvement develop. This comment made QE almost assured, save a miracle in economic indicators. Given trends in economic indicators, no miracle could reasonably be foreseen.

Despite Fed assurances, equities declined on August 22 and VIX increased. From there, equities went into a mild downward slump until September 6. U.S. dollar on August 22 fell .42 points and euro took off upward.

Euro closed on August 20 at 1.2347 and opened August 21 gapping up to 1.2436, up some .89 pips. By August 22, euro closed at 1.2529.

U.S. dollar then began a slight rise reflecting a mild decline in equities. Euro however engaged in a sideways bullish push up. Overall indications suggest market confusion due to conflicting remarks, but confusion was optimistically skewed given currency movement.

Euro Strength Foretold Market Response to ECB and Fed Easing Announcements

September’s policy statements from central banks kicked off a rally that would gird markets until Q3’s earnings season.

Simply stated, ECB and other European stakeholders worked out an approach despite previously confusing statements. On September 6, ECB announced their Outright Monetary Transactions (OMT). In order to activate such bond purchasing, ECB explained that a country must first request assistance. Thereby the country would subject itself to fiscal review and necessary austerity. Still S&P leaped up opening at 1,403 and closing at 1,432, up 29 points.

Euro experienced a major gap up in overnight trade and opened September 7 in U.S at 1.2704 to close up some 111 pips at 1.2815. U.S. Dollar relaxed finding itself down at 80.25 from an opening of 81.04.

Further juicing a bullish market was a September 13 Fed announcement revealing its $40B/month in mortgage backed securities (MBS), without a time frame. All markets, currency and equity alike, responded in bullish fashion.

Market Euphoria Turned into Sobriety Due to Limitations of Easing Prospects

September 17 marked an S&P multiyear high, a euro high and a U.S. dollar low. Leading to September 17 was a four day bull party for markets resulting from a September 12 German high court decision approving Germany’s participation in Europe’s European Stabilization Mechanism.

September 17 witnessed an end to a party fueled by central bank announcements and a critical German high court decision. On September 17, Dow fell .3% down to 13,553, S&P fell .3% to 1,461 and VIX increased .6% closing at 14.59.

Breaking up a bull party appears to be reality setting in on ECB OMT transactions. Markets realized no major bond buying would occur in Europe. In fact, for bond buying to trigger, it became evident European countries would have to sacrifice sovereignty in exchange for assistance. Also, for Fed announcement, MBS purchases implied bank responsibility to create mortgages in order to create MBS’s, thereby feeding Fed purchases.

Come October, central bank propositions were known and expectations started to price in. From September 17 to October 18, U.S. dollar trended up, euro formed a cup and S&P failed at a triple top.

Q3 Earnings Season Turned Sobriety into Depression and Banks Disappointed with Good Earnings But Bad Interest Margins

Essential reality set in prior to an expected disappointing Q3 earnings season. Reality revealed that ECB efforts would only be triggered upon country request. Meaning markets would not see any immediate bond buying by ECB. Greek experience juxtaposed against Spain to tell hesitation of countries requesting ECB assistance. Still Spanish and Italian bonds cooled.

For U.S., Fed’s QE3 wasn’t an open purchase of assets as in last two QE experiences. Rather, with QE 3 being restricted to MBS, banks realized that they needed to create mortgages to feed the MBS purchasing machine over time. Troubling for this proposition was realized as banks released earnings in Q3. One phrase cooled U.S. equities against QE3: Net Interest Margin.

With Net interest margin having been in decline, and higher earning securities obviously coming to maturity, issuing new mortgages at very cheap interest looked challenging for bank income. Suggested was/is banks must make up difference in margin with fees, service charges or trading. But Dodd-Frank legislation restricts other revenue stream capacity.

Apparent to markets was a Fed effort to grow U.S. economic propositions by growing real-estate. But to do so, banks remain a cautious partner due to interest margins. ECB’s OMT exist only once called upon by a particular country.    

CURRENCY/EQUITY ASSET PRICING CORRELATIONS PART I: JULY to AUGUST

Essential Nature of Asset Pricing Now and Over Months

Price action among assets have over months revealed euro and S&P to be positively correlated, while U.S. dollar moves opposite and is negatively correlated with euro and S&P. Last two trading sessions, however, are showing an odd break from these correlations.

Namely, as mentioned in last article, euro is in decline while S&P is up, and the U.S. dollar is up. Normally, where S&P goes up, one could expect euro to increase and dollar to decline. Stated otherwise, S&P is breaking from correlations to show risk appetite or a bullish sentiment. Euro and U.S. dollar are showing an opposite risk aversion or bearish sentiment.

Looking at past information that moved market price reveals fundamental influences on current asset class divergence today. Without knowing where you’ve been, how can you tell where you will go tomorrow.

July Market Activity Showed Considerable Disappointment, Except Exploratory ECB Comments  

Starting with the July to September period provides a reason for S&P recovering from its low of 1310 level in July. Going into September, S&P levels managed to reach 1470, which amounted to a multi-year high.

July 24 starts this period’s tail by knowing U.S. earnings season was in full bloom. This day marked a third day of 100+ point declines on the Dow Jones Industrial Average, with July 24 down 104 points to close at 12,617. U.S. dollar index was on a rip reaching 84.0, a high. Euro sunk like lead and saw a level below 1.2000.

Reason for S&P and euro declines and a U.S. dollar rise was Q2 earnings reports and renewed Greece problems magnifying Spain’s problems. On July 24 United Parcel Service, a strong bellwether, reported earnings and revenues that missed already reduced estimates and its stock fell 4.6%. Richmond Fed Manufacturing Index showed contraction and Reuters reported Greece would need another debt restructuring.

By July 25, things were looking up. Although Apple’s earnings were a surprising upset, Caterpillar and Boeing reported strong results. Still, sale of new houses reported a June gain of 350,000 when 369,000 was expected by economists. Also known was Spain’s borrowing level stood at an unsustainable 7.75%, German business confidence looked weak and Britain’s economy slumped for a third quarter.

Given these factors, equities closed mixed on July 25 with Dow up at 12,676, and S&P remained down, but only by a fraction.

Reason for July 25 avoiding a fourth day of deep equity losses appears to have come from Europe. While Caterpillar and Boeing looked good in Q2, ECB’s Edward Nowatny made a comment that bazooka power of European Stabilization Mechanism should be justifiably bolstered.

Such comments appeared to light a candle in darkness. ECB hadn’t yet announced their easing measures and Federal Reserve was “watching the economy closely”.

July 26 Activity Affirmed ECB’s Exploratory Comments and Renewed Equities, Euro and Took Stress off U.S. Dollar

July 26 sent a pitch to equity markets in the strike zone. Instead of rebuffing Edward Nowatny’s aggressive comments, ECB President Mario Draghi added to comments. Draghi made his politically charged comment that he would do whatever necessary to protect the Euro Zone. Consequently, Spanish yields retreated from threatening levels. Also helping were U.S. jobless claims coming in less than expected, durable goods beat expectations and where Exxon Mobile disappointed; 3M, Akamai Technology and Whole Foods Markets looked good.

July 26 saw Dow up an unimaginable 212 points, especially given previous trends on closings. Euro gapped up to just under 1.2280 from an abysmal 1.2100 space, U.S dollar took a steep loss into an 82.00 area from a near 84.00 area.

Nature of German and ECB Negotiations to Accomplish a Lasting Market Confidence Through August

ECB statements and some good earnings reports, against reduced earnings expectations, lit a firecracker under the back-side of equities. But more gunpowder was needed to push equities to recent year highs witnessed in September. Despite this gunpowder that would come, currencies stayed within range and correlations.

After July 26, on July 27, S&P made another grand advance, up a sharp 1.9% and Dow up 1.5% or 187 points to cross the 13,000 level, an obviously protected level today.

ECB remarks kicked of discussions among all European contributors, especially with Germany, which funds much of European activity.

Terms of ECB and German negotiation became defined by setting policy expectations in public spaces through exploratory comments. Markets affirmed the comments. ECB thereby gained a lead in negotiations, through placing market expectation “follow-through” on difficult countries that are deservedly difficult, due to imbalances.

Result was a real discussion of where to go, and by how much. Breaking a juggernaut.

Germany parlayed its stressed movement into limiting ECB.  Where ECB expressed open buying of bonds, the two agreed on Outright Market Transactions (OMT)….of buying bonds of countries to support debt pricing…..but only if and when a country asks for help….and thereby sacrifices fiscal sovereignty. It wasn’t until September that German/ECB negotiations resulted in a real policy.

Before German/ECB negotiations resulted in a September announcement, markets went into August with optimism, enhanced by Fed minutes.

Fiscal players in U.S. currently aren’t displaying similar alacrity in discussions as demonstrated by tough German and ECB negotiations.

Currencies Are Risk Off, Equities Are Risk On: A Divergence In Past Asset Performance

Last couple of days show asset classes acting in divergence from past market movement. Since summer of 2012, euro and S&P have traded almost in lock step….providing indications of sentiment. Trading in opposite correlation are U.S. dollars. Such positive euro and S&P correlations and its inverse, U.S. dollar, have not been numerically precise, but have moved with convincing consistency. These three assets have been so consistent; they’ve been market prophets due to all three moving in expected correlation.

Recently, the currency component of these three assets move according to last several months of history. Being when dollar goes up, euros go down. However, and also recently, equities aren't moving according to several months of predictability. S&P and Dow are moving up. Given dollar and euro currency movements, one would expect equities, or S&P and Dow, to go down. But they haven’t, in fact equities are increasing in value.

Equities are breaking from past correlation and rising from side way movement. Still, currencies trade according to months of performance. Currencies are seriously risk off with dollar up and euro down in notable terms. But equities assert a serious risk on look, by going up. Therein resides divergence in currency and equity assets. Equities are now outperforming past correlations with currencies. Why.... is the question now.

Currencies are tied to fundamental country performance….essentially a country’s economic indicators and domestic ability to show wealth…as in consumption, inflation and debt. Equities are tied to  fundamental capacity of companies to increase revenue firstly. Depending on ability of management, revenues are theoretically converted into earnings, boosting shareholder value.

Looking at recent movement in equities against currencies, such divergence doesn't appear to be justified by fundamentals . That is, equity markets or company earnings and revenues don't look that much better versus issues countries are confronting. Conversely, equity markets might be seeing optimism in coming country or company performance. 

Reason for optimism seems remarkably clouded now. Clouds right now come especially from prospects of fiscal solutions in the U.S., and whether the Federal Reserve will expand QE3. 

Fundamentals for both currencies and equities remain challenged after economic indicators and company earnings reports are considered.  

Public Domain Software: Pain From Intellectual Property To Electronic Retailer

Technology is seeing Trending Price Deterioration

Essential problem confronting technology companies, especially original equipment manufacturers, is a price deterioration of product. Anecdotally, if one prices an electronic item at a wholesaler, then looks at same item on a major internet retailer such as E-Bay for instance, a level of price competition can be witnessed. What is disturbing, however, are increasing frequencies when same item will show up at impossibly deep discounts.

Ramification of this effect across supply and distribution chains disrupt business planning prospects from memory suppliers to electronic retailers. This effect has been witnessed for years in memory markets and lower value added electronics. Now, it occurs in tablets, smartphones and equipment in general. Operating system associated with these lower priced products often times is Android.

Lost Value in Intellectual Property, along with Supply and Distribution Chains

Protecting product pricing typically comes from retaining control over intellectual property rights, while also managing business chains. Firstly supply chains need to be managed to prevent outsourced manufacturers robbing technology. Secondly, distribution chains need an ability to show pricing discipline to prevent flooding markets and price declines.

However, first attack to this model is putting intellectual property into the public domain for innovation and new discovery. Android and WebOS are primary examples. Where Android did not involve a deep upfront investment by a single company, WebOS was held by Palm, bought by Hewlett Packard for $1B. Now it’s given to public collaborative development.

WebOS was the intellectual property backing future propositions for Palm. Hewlett Packard’s justification for buying Palm was moving Palm’s technology into currently competitive products. Now WebOS is in the public collaborative space, as opposed to Hewlett Packard’s portfolio of intellectual property.

Apple once had a very unique product. Now Android finds its way into various products sold by various companies. Some of these companies look for market share by defining their products with cheap pricing. Defining a company by distinguishing your products with cheapest price is a losing proposition.

Strength is in Maintaining an “Ecosystem” of Integrated Products that Improve User Experience Across all Products

Apple’s major strength today is their “ecosystem” of products. Which basically equates to intellectually protected products (outside of Samsung’s win, loss or draw) a protected supply chain (again outside of Samsung issues) and a distribution chain that is so far exemplar in sustaining price strength.

Apple’s other major strength is its integrated products which not only communicate with each other, but do so in a synergistic way. For example, seeing your phone on your living room TV set….at least should you be so inclined. And a new Apple TV system is expected.

Android teaches that once intellectual property is released to the public domain, intellectual property value deteriorates for any one company. Result appears that many companies compete against each other for fast deployment of existing technology. A race then occurs to cheapest pricing. Winner in this model becomes the company that adapts new technological creation into equipment production on the cheap. Rising labor costs in China can be a limiting factor, but other ASEAN countries?