PULL OUT YOUR OUIJA BOARDS

What's the difference between an econometric model and a mechanical link?

Not much if you're in the government forecasting business, according to an editorial in today's Wall Street Journal, "Government Forecasters Might as Well Use a Ouija Board."

Government economic forecasts receive a great deal of attention and are used to make a case for or against legislation or public policies. How good are the forecasts? The answer: not very. Forecasting is an inexact science at best, and the trust that Congress and the public invest in these estimates is not warranted.

The author, Edward P. Lazear ,a Stanford business professor and a former 2006-2009 chairman of the Council of Economic Advisers, writes about government predicted 1999-2013 GDP growth:

My analysis of 1999-2013 reveals that the CBO’s real GDP growth forecasts for the next year were off, on average, by 1.7 percentage points, either too high or low. Administration forecasts were similarly off by a slightly larger 1.8 percentage points on average, also to high or too low. Given that the average growth rate during this period was only 2.1%, errors of this magnitude are substantial.

Perhaps most damning: History is a better predictor of annual growth than government forecasts. Simply assuming that GDP growth will be 3.1% in each year—the average annual rate for the 30 years that precede the study period—results in an average forecast error of 1.5 percentage points. 

We've been writing about these suspect predictions for some time. Lazear goes on to point out that no actual data is used but rather a similar approach method employed to forecast jobs created or saved numbers.

The same approach is used to forecast jobs “created or saved” by the stimulus. Government economists generally assume a mechanical link between forecasted GDP growth and forecasted job growth. This means that estimating job effects is subject to the same qualification as estimated GDP effects. Both are based on models, not actual experience. The CBO described the methodology in its report, but those who reported or trumpeted the CBO’s stimulus numbers were generally unaware of how GDP or jobs numbers were generated.

Our one beef with Lazear's article is comparing Ouija boards to these model-driven, mechanical forecasters is an extremely unkind cut to all those dusty Ouija boards packed away in cluttered closets everywhere. 

http://online.wsj.com/articles/edward-lazear-government-forecasters-might-as-well-use-a-ouija-board-1413503121

OVER NIGHT

Things at least in Europe have calmed a bit as Reuters reports.

LONDON (Reuters) - World stocks hit a nine-month low on Friday but oil and southern European bonds were off their week's worst levels, as investors began to dust themselves off after one of the most volatile spells in world markets in years.

Nerves remained fragile, but some reassuring words from U.S. and European policymakers, U.S. data, and a sense there could be bargains to be had after the major falls in global equity and commodity markets, drew buyers in off the sidelines.

Bourses in London (.FTSE), Frankfurt (.GDAXI) and Paris (.FCHI) started the day up 1 to 1.5 percent and Athens (.ATG) rose 4.5 percent as Greek governments bonds steadied after their worst run since the height of the euro crisis in mid-2012.

Admittedly, this may be a lull in the storm that's hit world markets of late, but many investors will at least privately welcome it in the wake turmoil for the fourth straight week in the U.S. and Europe but the sixth for emerging markets.

Meanwhile, Bloomberg posted an interesting story about cash build ups in high yield or junk bond funds.

In a junk-bond market that has been anything but high-yield for almost two years, the world’s biggest debt-fund managers have been stockpiling cash for a selloff. After the worst one in three years, they’re getting ready to pounce.

Firms from Pacific Investment Management Co. to Blackstone Group LP say they are poised to scoop up speculative-grade corporate bonds after yields rose to the highest levels in more than a year. They’re looking for bargains after building up the highest levels of cash in almost three years.http://www.bloomberg.com/news/2014-10-17/pimco-to-blackstone-preparing-to-feast-after-yield-surge.html

So maybe in one form or another the calvary is set to ride to the rescue notwithstanding the Ebola outbreak, China, the looming threat of more deflation and collapsing oil prices.

As the saying goes the one-eyed man is king in the land of the blind. We shall see.

BIG ROCK CANDY MOUNTAIN

 

Most people have heard of back to the future. Well, with the S&P 500 it's now back to the first of the year because as of yesterday's close that's about where we are.

According to Market Watch, The S&P 500 Index has fallen 8% from its September highs, when it topped 2,000 points. We’re now back to where we started at the beginning of the year.

The drop has been fast and furious, with the benchmark index recently posting its worst three-day run since the dark days of 2011 amid the European debt crisis. It recorded its worst session of the year Wednesday
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Those previous declines proved to be buying opportunities. Since August 2011, the S&P 500 is up almost 80%.

Does that mean that history will repeat itself here and investors will once again start buying this dip or is it a form of equity Armageddon that will cause investors to close their wallets and go home for a long while? 

If the answer to that were easy markets would essentially stop being markets and everyone would find his or her way to the Big Rock Candy Mountain of success. 

About the only sure thing here is that ain't going to occur anytime soon because in the real world there ain't no Big Rock Candy Mountain. Only winners and losers.

In the meantime, if you have an idea of what's valuable and what you want to own, don't be too shy. And if it will screw up your courage a bit, here's a quote from Warren Buffett he gave a couple  of days ago.

“I like buying it as it goes down, and the more it goes down, the more I like to buy,” Buffett told CNBC.
t. man hatter

A WAYS TO GO

Most investors worthy of the name know who Big Ben Bernanke is, the $250,000 a speech speech maker.

Just kidding.

Like those who have gone before him, Bernanke is now moving about trying to solidify his place in Federal Reserve history.  And for him it's most likely going to be a hard sell. There's a certain irony here since Bernanke described himself on the job as a salesman, trying to sell the pubic that all is well that ends swell.

For it to end well for him he has to sell the public on the idea of economic recovery from the 2008 crisis that continues to remain elusive to say the least in the minds of many Americans. After a recent speech in New York the former Princeton economics professor was asked:

"....who was to blame for the 2008 financial crisis, he pleaded for some understanding from historians, saying:

Nobody is going to come out looking all that good, I tell you, when historians write it, but again I ask only for those future stories to think in real time and don’t impose the retrospective knowledge on what we were seeing as we went through the crisis.”

Even as Bernanke works hard to ensure his legacy is portrayed in a more positive light, there is a feeling that most Americans could not care less.

“You know, according to a recent poll, 17% of the population still thinks that Alan Greenspan is the chairman of the Federal Reserve. So I must have made a big impression,” Bernanke joked Wednesday, referring to a Pew Research Center poll that came out earlier this month. 

Bernanke painted himself as a salesman – one who has to sell the message of recovery to the public. It’s something he feels he hasn’t done well.

One of the parts of being a Fed chairman that Bernanke found to be a bit difficult is communicating with three different audiences simultaneously: the markets, the US Congress and the public.

He suggested that he felt burdened by the weight of what he could say and its effect on markets.

http://www.theguardian.com/money/us-money-blog/2014/oct/10/ben-bernanke-set-record-straight-book

Judging from stock market reactions the last few days, well looks as if its got a ways to go, Mr. Bernanke.

KEEPING IT SIMPLE

As the site linked below shows simple averages like the 200 day moving average from can reveal some interesting information.
 http://www.crossingwallstreet.com/archives/2014/10/yes-the-200-dma-works.html   

We too don't pretend to be technicians but over the years have looked at a variety of indicators and the 200 DMA is one of them. There's always a lot of talk around markets about trends. One of the interesting ones to us here is the good news tends to engender more of the same and so does bad news.

Like it or otherwise, that has a metaphysical ring to it that many write off as being too simplistic in our view. But the idea of keeping things simple is paid much lip service but seldom followed. Solutions to complicated problems in order to be valid don't always have to be as complex as the problem.

Humans can get greedy and humans can panic. Several years ago we had the good fortune to hang out with an old time commodities trader for a while before he moved on to the next dimension. He was a successful trader, meaning at the end of his career he had won more than he lost.

Too many people in our view want to put a figure or what's known today as an outcome on that. But his trading skills and rules were about as straight forward and as simple as a declarative sentence.
t. man hatter

GREECE IN TROUBLE AGAIN

Here's quick summary about the National Bank of Greece from 247wallst.com that should give you some idea how things in Greece are going.

Recall not too long ago pundits were applauding what they perceived as the turn around there when bond yields began their big decline for the peripheral members of the EU.

National Bank of Greece SA (NYSE: NBG) posted a drop of about about 19% today to add to yesterday’s 5.3% drop and post a second consecutive a new all-time low. Today’s low was $2.08 against a 52-week high of $6.48. Volume is about 4-times the daily average of around 3.7 million shares. Fitch Ratings warned today that Greek banks remain fragile and the political turmoil in the country is not engendering confidence in the government.

Wed, Oct 15 2014

* Greek stocks post biggest daily drop since July 2012

* Bond market closing its doors to Greece, analysts say

* Political uncertainty, bailout exit plans unnerve market (Adds PM comments)

By Marius Zaharia and Angeliki Koutantou

LONDON/ATHENS, Oct 15 (Reuters) - Greek stocks on Wednesday posted their biggest one-day loss since the height of the euro zone crisis, while bond yields soared to levels that threatened to derail government plans to quit an international bailout a year early.

Ten-year government bond yields jumped to 7.85 percent - levels at which Greece cannot afford to fund its huge debt and the Athens stock market plunged 6.8 percent in its biggest one-day loss since July 2012.

Shares have lost 11.5 percent in the past two days, their biggest fall since October 2008.

THE 7 PERCENT

Market concern over Greek borrowing costs has grown as they have approached 7 percent, though analysts say it does not necessarily mark the tipping point beyond which the costs of servicing debt would become unsustainable for the country.

Indeed, some analysts argue that Greece's debt of over 1.7 times economic output would be impossible to roll over even at lower cost. The European Union charges only 1.5 percent interest on its loans and Greece is still expected to initiate talks over some form of debt relief in the near term.

But charts show any rise in yields has historically picked up pace above 7 percent and forced countries such as Ireland, Portugal and Greece itself to seek bailouts. Only the European Central Bank's promise in 2012 to do "whatever it takes" to save the euro prevented Spain and Italy from having to ask for financial help when their yields topped 7 percent.

"With yields above 7 percent we are back in that very dangerous area again," Eleni Dendrinou-Louri, professor at Athens University of Economics and Business and a former deputy governor at the Bank of Greece, said in a speech in London.

"I believe that if you can borrow from the market is decided by the spreads that you see every day on the screen."

As Greek yields soared, German 10-year borrowing costs plunged to record lows as investors fretting about faltering global growth shed risky assets and sought shelter in top-rated government bonds.

As a result the Greek yield premium over the euro zone benchmark reached 710 bps, its widest since January.

Greece sold bonds to private investors earlier this year, making one of the fastest market comebacks by a sovereign that had defaulted, with a sale of five-year bonds that drew strong bids and was considered a great success.

IF ONLY THE SLOWDOWN WERE A GHOST

If there's anyone left on the planet who doesn't know about the Chinese slowdown, he's probably a member of some obscure troglodyte sect.

If there's anyone who doesn't realize by now the China situation affects other economies specifically like Australia and Emerging Markets and the overall global picture generally, he's probably the leader of that obscure sect.

If there's a story more discounted in the market than China's economic woes, it might be the energy glut. But that's debatable.

Boo birds usually draw the most rancor. But few Hip-hip hurray birds come under fire at all. The latest  market hand wringing session is little more than a few weeks old and one Federal Reserve member, John Williams, head of the San Francisco Fed, is ready to roll out QE4.

One wonders if he's a regular reader of the Financial Times' Martin Wolf and Wolf's constant calling for "well crafted" reforms. A skeptic might rightfully ask, if the plans were well-crafted to begin with by these prescient economic planners who populate bureaucratic attics like the IMF, why do they need to be reformed?

The short answer that Wolf and his anti-Berlin ilk never want to hear is: They were never followed or enforced.

Even the well-heeled, if one can believe the headlines, "Global luxury brands feel the effect of slowdown in demand from Asia," are apparently noting the bite.

What many hand wringers miss here is the China story is not a new one. It's an old one. During all the boom years few suspected, as is human nature, that someday it would end. Excuses get made. Troubling spots over looked. It's different this time becomes what it always is, a trite popular mantra pushed by MSM.

Back in the dot-com bubble days near the end high tech firms were lending money to their vendors who then lent it to their buyers so they could purchase the high tech firm's products. Sounds like building ghost cities just to be doing something.

The real concern here is not that this slowdown will become protracted. Not at all. Anything is possible. The real concern is the fear of such will give central bankers more jockeying room to screw things up even more.

STRAW HATS AND ENERGY PRICES

Oil prices are to straw hats as supply is to demand.

If one takes the shorter view on energy, the outlook remains somewhat bleak. But that's not what we're suggesting.

Much of the media coverage personifies that view. Everyone knows most money runners are quarter to quarter investors in the main. Quarterly window dressing is just one example.

There's an old Wall Street saying about the time to buy one's straw hats is in December not July. Straw hats were once upon a time men's fashion plates for humid summers. That was about demand. Energy prices as they continue to drift lower are simply a metaphor for the straw hats of a long ago yesteryear.

In those days it was most likely difficult to overpay for a straw hat in December when demand was practically nil. A quite similar situation in our view is now developing in the energy space. Sure energy prices can decline from here. And they probably will. But unlike some other investments they're never going to zero.

Straw hats served a dual purpose. They were cooler and they offered protection from the sun. Owning  energy at cheaper prices serve a similar purpose. It's a necessity and it ain't going away anytime soon irrespective of what you might hear.

Cheaper oil prices add more miles to the gallon of one's driving. It's a psychological reality.

Supposedly, smart investors can look into the future and see things others can't or don't. Sort of like old Willy Loman in Aurthur Miller's classic tragedy, "Death of a Salesman," going around talking out loud to himself, asking his wealthy deceased brother who went into the jungle poor and came out rich: "He'd you do it, Ben?"

In Willy's case we never really find out how Ben did it. But the implication is there, seeing opportunity in risk.

WHAT TOMORROW OFFERS

Most by now know that even though the market finished up for the day, it also gave up later in the day much of its early morning gains.

The DJIA managed to eke out a gain, but the pattern to all intents and reasons held.

Sinking energy prices weighed heavily again on the market as the slow growth worries capture investor attentions.

Here's a decent wrap for tomorrow from http://www.minyanville.com/special-features/daily-recap/articles/market-participants-crude-oil-Brent-crude/10/14/2014

Tomorrow's agenda is filled with important economic data releases, even though markets have appeared to ignore it over the past few weeks. Advance retail sales have typically been the third most volatile data release for markets. Tomorrow morning the September report will be released with total sales expected to decline by 0.1% for the month, mostly due to a decline in gasoline prices. The average unleaded gallon of gasoline fell by 10 cents during the month of September, which lowers total sales. Additionally, auto sales also declined from the prior month. After excluding those two categories, sales are expected to rise by 0.4% for the month. The producer price index for September and the Fed's Beige Book will also be released.

Overnight China will release consumer and producer price data for September. Consumer prices are expected to decline to a 1.7% annual rate from 2.0% in the month prior due to falling gas prices. The UK will release employment data. ECB President Mario Draghi is scheduled to speak twice tomorrow in two cultural events and comments on monetary policy are not highly expected.

Earnings reports will start to pick up tomorrow. Charles Schwab (SCHW), Keycorp (KEY), Blackrock (BLK), Bank of America (BAC), St Jude Medical (STJ), Netflix (NFLX), American Express (AXP), United Rentals (URI), eBay (EBAY), and Las Vegas Sands (LVS).

HOW FAR IS OBILIVION?

How far is oblivion nobody knows.

But from the fear in the market about a global economic crapout it must appear to many just beyond the horizon.

At any rate as we've said before the cure for low prices is low prices. The same holds for too much supply or too much demand. Unlike investors, markets are dynamic. The lower oil prices get the more supply has to come off the market eventually creating more demand.

And no different from other occasions that supply can come off the market in a variety of ways. That we're not there yet at $82 and change a barrel misses the point. The market will know it when the market sees it. 

Pick your entry points well. Unless we're way off base--and we could be--it won't be before long you'll espy tidbits about big-time investors easing into energy.

U.S. Oil Producers May Drill Themselves Into Oblivion

By Matthew Philips   October 13, 2014

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Photograph by Andrew Burton/Getty Images

An oil drilling rig on July 30, 2013, near Watford City, N.D.

Remember the fall of 2008? As the world spun out of control and the price of everything crashed, a barrel of oil lost 70 percent of its value over about five months. Of course, prices never should’ve been as high as $146 that summer, but they shouldn’t have crashed to $40 by the end of that year either.

As the oil market has recovered, there have since been three major corrections, when prices have fallen at least 15 percent over a few months. We’re now in the midst of a fourth, with oil prices down more than 20 percent since peaking in late June at around $115 a barrel. They’re now hovering in the mid-$80 range and could certainly go lower. That’s good news for U.S. consumers, who are finally starting to reap the rewards of the shale boom through low gasoline prices. But it could spell serious trouble for a lot of oil producers, many of whom are laden with debt andexaggerating their oil reserves.

In a way, oil companies in the U.S. are perpetuating the crash by continuing to drill and push up U.S. oil production to its fastest pace ever. Rather than pulling back in hopes of slowing the amount of supply on the market to try and boost prices, drillers are instead operating at full tilt and pumping oil as fast as they can. Just look at the number of horizontal rigs in the field:

STORY: Will Cheap Oil Choke the Russian Economy?

BloombergThere is a record number of horizontal oil rigs in the field

Over the past five years, the amount of horizontal rigs deployed in the U.S. has almost quadrupled, from 379 in early 2009 to more than 1,300 today. This is of course purely a fracking story. Almost all the recent gains in U.S. oil production are the result of horizontal drilling techniques being used across much of the Midwest, from Texas to North Dakota. Unlike conventional vertical wells, where more wells do not always equal more oil, the strategy in a shale field appears to be to drill as many as possible to unlock oil trapped in rock formations.

As the number of horizontal drill rigs has exploded, the number of vertical rigs in the U.S. has gone in the opposite direction, falling almost 70 percent over the past seven years.

BloombergVertical drilling is so 2006

So will U.S. oil producers frack their way into bankruptcy? That’s a real possibility now. They’ve certainly gotten more efficient at drilling, and don’t need the same price they did to remain profitable. But we’re getting pretty close. Back in July, Goldman Sachs estimated that U.S. shale producers needed $85 a barrel to break even. That’s about where we are right now. The futures market points to even lower prices next year, with contracts for oil next April trading at about $82 a barrel. Certainly, some producers need higher prices than others. Those at the bottom of the cost curve could benefit from a potential wave of bankruptcy that spreads across the oil patch; they could then scoop up some assets on the cheap.

STORY: Cheap Oil and Expensive Oil Tankers: This Is Contango

One final note of caution: The U.S. natural gas industry ran through this same cycle a few years ago with companies getting themselves into trouble by flooding the market with gas, crashing the price and themselves in the process. By mid-2012, the price of natural gas got too cheap to drill. The number of natural gas rigs in the field still isn’t anywhere close to returning to where it was a few years ago. 

STORY: Oil Prices Fall, and the Global Economy Wins

BloombergNatural gas rigs are still relatively scarce.

Philips is an associate editor for Bloomberg Businessweek in Washington. Follow him on Twitter@matthewaphilips.

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