On this eve of the greatest IPO in history (Facebook), I have this to say….

I recently read an article by a US securities compliance lawyer about the perils exposed to investment advisors via social media websites. The upshot from the article (my understanding at least) was that investment advisors should try to ensure no one ‘likes’ them on Facebook because it may be construed as a testimonial. Good grief! I cannot believe it has come to this. Securities regulators are apparently concerned that people may be materially influenced in selecting an advisor to manage their life savings on the basis of what are usually inane and innocuous comments on Facebook, Twitter, and other social media websites. I have to believe people are not that stupid.

Regardless, this is a troubling development. Not least, because I find myself at the confluence of five events:

• the Facebook IPO (I am hard pressed to find something more worthy of shorting, with possible exception of the euro. );
• US investment industry regulators are figuring out how to manage the risk introduced by social media networking;
• the imminent release of my book that asserts the secular peak to the US stock market was a few weeks ago (Greedometer. Dow 5000. Why no one sees it coming.);
• a stock market that is early in the melt-down process;
• figuring out how an investment advisor may / should market a book (and not their practice) via social media networking, while not running afoul of regulators.

I understand that regulations for investment advisors are rightfully very firm in their view of advertising and testimonials. My understanding of their concern is that some investment advisors may cherry-pick from client comments to find something positive, and that this may represent an unrealistic and overly rosy portrayal of the practice. But it is a stretch to suggest investment advisors devote a portion of their time combing the internet in fear that someone might write something positive about them, or that they might be ‘liked’ on Facebook.

I plan on using social media to market my book because I hope and suspect it could be an effective method to get the word out. That being said, I have been counseled by a compliance consultant to take considerable measures to put up something of wall around the book and its marketing efforts, therein separating them from my practice. So be it.

Please don’t ‘like’ me. But please don’t not like me either.

What a day.

• Greece is front and center as fears of imminent melt-down spread.
• Of far more import than Greece is Spain. The price of Spanish Treasuries is plummeting with the rising yield. What about all those Spanish banks that used cheap LTRO money to buy Spanish sovereign bonds?  There’s a good chance those banks would be insolvent if they had to mark the assets down in price to current market levels. Do you think the run on Bankia (today) was helped by the LTRO feed trough?  Do you think Moody’s gave extra credit to the 16 Spanish banks that were down-graded today — because LTRO was helping?
• 
• Going in the opposite direction is the yield on the US 10yr Tnote. It dropped to an all-time low –under 1.7%.  As you know, I’ve been expecting this. I’m expecting a 1.5% yield on the 10yr note and a 2.2 – 2.3% interest rate on 15yr fixed mortgages. (How many famed Wall St prognosticators foresaw that in their January 2012 view?  A number approaching 0.)
• 
• The S&P500 fell through (if only a little) the 200-day exponential moving average (e.m.a.). Usually when things initially become weak, it’s reasonable to expect a bounce off the 200-day ema on the first meeting, then a drop through it on the second or third time.  Perhaps tomorrow’s Facebook IPO will provide some hype to squash this leg of the sell-off in risk assets.
• On a near term basis, stocks pretty much everywhere are oversold and primed for a bounce.  Yes, I expect that bounce to be short lived.
• An 8% drop in the S&P500 from its near term April peak aligns with what I’ve been writing for months now – thanks to the greedometers. This is the opening salvo for what will likely be a monumental drop for the S&P500 to the 500s early in 2013. (and Dow in the 5000s in 2013 — like the book says)

Speaking of which, the book (Greedometer. Dow 5000. Why nobody sees it coming) is still going through final edits. We’re a few more weeks away from it being available.  Bookmark www.greedometer.com or www.greedometerbook.com to check for availability.

One final quick note….  Let me say hello to all the blog readers in Australia and South Korea. The past few months have seen readers there grow to the #2 and #3 positions in terms of visitors per country according to the website statistics. Tell your friends.

Here’s something else that’s positive. If you were invested in very high quality bonds so far this year, you’ve probably been sleeping fairly well.

(Important) Housekeeping comments:

1. We’re approaching the date when we will combine 2 weekly email letters into 1. The new letter will contain a very brief summary and website link to facilitate login and access to the entire letter (economic news and data, analysis, the greedometers, and details on the specific investments we plan to buy / sell.)

2. An interactive greedometer gauge will be added to the website. For example, raising the profit margin on the S&P500 will show a rise to the greedometer reading, and raising the VIX will lower the greedometer reading. (pretty cool)

3. A new section of the website will be added to support an up-coming service: an annual subscription to a weekly newsletter. The service will be intended for investors that want to manage their own portfolios or perhaps cannot afford asset management service (or both). This subscription newsletter service will include information contained in the newsletter, but not information regarding what and when we’re buying or selling.

4. New web pages will be added next week regarding the book. I’m very pleased that some industry titans have agreed to provide feedback on portions of the book before I hit the send button to the publisher: Dr Lacy Hunt, Dr. Marc Faber, David Rosenberg, and John Mauldin.

Two weeks ago I wrote - ’We now resume our regularly scheduled crash — this is what secular tops looks like.’      I reiterate that point.

As the data slowly but surely arrive in early 2012, the greedometers are continuing to paint a picture consistent with the largest US stock market collapse since 1929 — slightly larger than the 57% drop in the S&P500 in 2007 – 2009. The greedometers have accurately anticipated and identified a secular (multi-year) top in US risk assets (common stock, REITS, high yield bonds, commodities). From here, more cracks will emerge in the foundation of the latest central banker induced bear market rally.

It was not surprising to see the S&P500 run out of steam and begin to fall back to earth :

• once it rose to the 23 level on the adjusted PE (2 weeks ago). As you know, this is one of the 8 parameters in the greedometer.
• since the gap between the 200-day exponential moving average and the daily price grew monumentally wide a month ago (and I commented on this in the March 21 Private Client letter).
• since the rats were jumping off the ship in the first 3 months of the year (corporate execs were selling shares in a quiet near-panic as they frequently do several months before a secular stock market peak).
• and of course, the greedometers……..

The greedometers are suggesting :

• the US economic growth rate peaked late last year
• early 2012 economic growth will be anemic
• the economy will enter recession in Q2 — probably in late May or early June. (We may get confirmation of this from the BEA at some point next year.)
• there will be a bounce back in risk assets between now & early July. But whether risk assets dip lower along the way is a tough call. Regardless, it won’t matter because the pre-Q2 earnings season faith-based rally is going to be obliterated in July and August as the S&P500 bounces off the 1140 range (a 20% drop from the April peaks, and the official entry point to a bear market for the S&P500). Queue Ben…

Will Ben Bernanke see his shadow when he emerges from his Jackson Hole meeting in August? Will we get 6 more months of Operation Twist? Or will he bite the bullet, resume his Vegas Fed ways, and announce efforts for a coordinated $6 – 10T round of new QE across the US, Europe, Japan, Britain, Canada, Australia, and others? When the S&P500 officially enters bear market territory in August, the pressure to print will be immense. Too tempting for a Keynesian.

Here in the US:

• A facebook IPO is coming! I can think of few things more worthy of shorting. In another sign the US stock market is peaked-out, we can add up the IPOs over the past year and find some real dogs. And speaking of technology companies that act as sirens for the broad economy, did you catch Cisco Systems CEO John Chambers last week? A nearly 14% drop in the stock price in 1 week. Over 21% since early April.
• 1Q 2012 earnings season is wrapping up. As of Thursday morning,
  • 458 S&P500 companies had reported so far.
  • 66% of companies are beating consensus earnings estimates. This has dropped a great deal from the initial 83% beat figure 4 weeks ago. 2 weeks ago I wrote that we’d likely end this earnings season in the 60 – 65% beat rate. I see no reason to change that. This is likely to be the lowest beat rate since the recovery in 2009. The long term average earnings ‘beat rate’ is roughly 67%.
  • Profit margin is 9.3% — very similar to last quarter’s near record profit margin. So, margins are holding up remarkably well. But! Recall the sudden collapse in April retail sales in Europe. This is going to dent profit margins and work its way back into the rest of the economic machine. Look for US retail sales to slow down this summer and for that to have follow-on effects elsewhere in the economy.
• My latest view of where S&P500 profit margins are going. Note the use of a 3-month rolling average for the profit margin, and 1-month average for stock market prices.

• What about next quarter’s pivotal earnings season forecast? More of the same sandbagging is being demonstrated by Wall St as depicted by the familiar slide in earnings estimates shortly before reality ‘makes fools of us all’…. This graph comes courtesy of Howard Silverblatt at S&P.

• This is old news, but since there was no economic comment last weekend, we’ll provide one on the jobs front.
  • Right on schedule, the April jobs report from the BLS disappointed. As weak as the headlines were, without hundreds of thousands of people continuing to fall out of the back end of the UI benefits system, the headline (U3) rate would have risen to 8.4%, not dropped to 8.1%.
  • The labor participation rate continued to drop — to the lowest level in decades.
  • The quality of jobs is dropping. Many that previously had high paying careers have had to settle for new careers / jobs with far lower salaries and benefits.
• The yield on the US 10-yr Tnote continued lower this week – for the 8th week in a row. It closed the week at 1.84%. And the 30-yr Tbond yield fell to 3.01% to close out the week. How many Wall St prognosticators foresaw that in January? Since bond prices are inversely correlated with yields, prices marched higher. I’m still looking for the 10yr T-note yield to drop to the 1.5% range this summer, and for 15-yr mortgage rates to drop to the 2.2% range.
• JP Morgan had a tough week. Shares fell over 11% — over 9% yesterday alone. Late thursday saw an announcement that the bank (the largest in the US) incurred a $2B loss from trading credit derivatives. Here’s the part that puzzles me. This loss is being spun as a hedge position gone bad. How’s that? Apparently JPM has a $2B trading loss because it bet the economy would improve and turned out to be wrong. Here’s the thing. If you employ derivatives (apparently in a big way) as a hedge and suffer a big loss because the economy doesn’t improve, that’s not hedging. In order for this to be hedging, JPM would have to have a considerably larger position that would rise in price if the economy worsened. Either that or its so-called derivatives hedge position was really not a hedge position at all, but was a speculative unhedged long bet that the economy would improve (more likely). If JPM had a big bet the economy would improve (and it did / and still does), keep that conflict of interest in mind when anyone from the firm is quoted indicating they see the economy improving. If they’ve got a big 1-way bet the economy is going to improve, what else would they say?

In Europe:

Big Picture: The European financial crisis is hitting additional headwinds as political risk increases. Let’s take stock. So far, seven countries have seen a changing of their political leaders / parties. The lowest paid, lowest skilled, and lowest educated people continue to suffer disproportionately, and are increasingly becoming a polarizing force. They are voting for extremist parties with an anti-EU or anti-globalization view. Financial system risk is increasing.

France:

• As expected, a new President was elected, and he’s decidedly left of centre i.e., from the socialist party. The French economy is already majority-lead by the government (56% of GDP comes from the French government). Mr. Hollande plans to achieve a pre-ordained 3% fiscal deficit target for 2013 and to balance the budget by 2017 (it would be the first time in 43 years). But he plans to make headway by tax increases alone. Sadly, Mr. Hollande will likely fail. If the IMF estimates his policies would leave a 3.9% deficit next year, you know it will be closer to 4.5%. And what do you know, yesterday the EU forecast the 2013 French budget deficit to be 4.2%. That too will be optimistic. All governments are prone to use rose-colored glasses when estimating GDP growth.
• The dynamics of the existing Franco-German economic core are going to be impacted. But we’ll have to wait for the results of the French National Assembly elections in June to begin to handicap the mandate of the new French President. What odds do you give bond ratings agencies in granting France a continued AAA rating amid low chances of improving their deficit?

Greece:

• The two main political parties were thrashed in last Sunday’s election. That said, the leader of the conservative New Democracy party (one of those 2 parties) won the most votes, but nowhere near enough to reach a majority.
• On Monday, the ND party leader handed back the keys after failing to form a coalition parliament with another party. This leaves the party with the second most number of votes (with a strong left of center bent) to form a coalition parliament. As of yesterday, they gave up as well.
• So Greece is going to see another election in June. The party with the best chances of winning is a hard left-of-center party whose platform is to nationalize Greek banks and essentially stiff the IMF, EU and everyone else.
• There’s zero chance a new Greek parliament will implement the harsh economic medicine required by the rest of the EU. In fact, the new parliament must find another 11B euro in spending cuts in the next month or risk being cut off by the EU – IMF sugar daddy. Do you hear the sound of printing presses warming-up? Drachma 2.0 is increasingly inevitable by the end of this year.

Spain: I’m sorry to keep beating up Spain, but there continues to be a gulf between reality and the views portrayed by politicians and bankers.

• Last week saw the 4th time in the past 3 years that Spain is saying they’ll clean up the bad real estate assets. Spain’s banks are sitting on 650B euro in real estate loans still marked at full value!!! That’s half the country’s GDP. And there’s another 300B euro owed by real estate developers.
• The 4th largest Bank – Bankia- was partially nationalized wherein 45% of the company will be owned by the state. And this is after a June IPO last year!
• Investors reacted with skepticism to last week’s proposals. The interest rate on the 10-yr note rose to over 6% as bonds sold off. Stocks followed suit.
• Here’s the Spanish stock market view. Stocks are back to their March 2009 lows. Ugly.

• More bank nationalizations and public capital injections merely shift the debt burden to the tax payer and deepen the recession. The EU released a report estimating Spain was in a 2-year recession and that it would miss 2012 & 2013 fiscal deficit targets. This is the same thing I’ve been writing for months — in stark contrast to what they’ve been saying so far. The EU forecasts a 6.3% deficit in 2013, not even close to the original target of 3%, and considerably higher than the recent slip to 5.3%.
• I’m sorry, but Spain is toast. The current bailout plans are nowhere near large enough to cope with this mess. I don’t know where the bailout money will come from, but come it will. And it will be freshly printed.

Britain: The QE taps are going to be shut off for a while because the damage inflicted by rising inflation is proving to be as large as the benefit it pumping up risk asset prices. The point of diminishing returns. You can bet the Fed is watching this experiment closely.

Germany:

• Perhaps tired of being the party crasher, Wolfgang Schauble (Minister of Finance) indicated on Thursday that slightly higher inflation -in the 2-3% range- could be tolerated. Is this a crack in the German opposition to more currency printing? Maybe. Then again, maybe not. Friday saw the Bundesbank President – Jens Weidmann take an opposing view of allowing inflation to slip higher.
• The german 10-yr Tnote hit an all-time low yield of 1.49% this week (still think we won’t hit 1.5% on the US 10yr note?) as investors ran for cover.
• Italy: An office of the federal tax collection agency was fire-bombed today.

In Asia:

China:

• The latest data shows the Chinese economy slowing its pace of growth more than expected in April. Industrial activity, retail sales, and investment all looked soft. All the more pressure to ‘do something’ to make things better. That this news comes while China is currently going through its toughest political turmoil since 1989 (Tiananmen) is worrisome (especially if you’re still subscribing to the view that China’s economy will do fine this year).
• The central bank will lower bank reserve requirements next week in an effort to support the economy.
• The BBC reports China is warning the Philippines with military conflict over the dispute regarding the Scarborough Shoal in the South China Sea. Is this a warm up act to China’s dispute with Japan over the Senkaku islands in the East China Sea?

India:

• The latest trade data are not good. India continues to import 50% more than it exports – as seen in the April data. The government is responding with subsidies to exporters.
• The Indian rupee has been clobbered over the past year. It continues to trade at all-time lows versus the US dollar.

The view presented by the greedometers still indicate April is the top for risk assets and that the economic slowdown of 2012 – 2013 began earlier this year. The US economy will probably slow to the point where it stalls completely and falls back into recession in the current quarter. The book (Greedometer. Dow 5000. Why nobody sees it coming.) will go into a great deal of detail supporting this assertion. The bond market has been pricing-in this view for a while already. The stock market has not yet begun to do this. But it will. Shortly.

Here in the US:

• Fed Chairman Bernanke did a scheduled press conference after a planned 2-day Fed meeting. Not a lot of news came from it, but with prodding during the press conference Ben continued to threaten the Fed knows how to operate a printing press and will use it if necessary. Risk on! (but for how long?)
• 1Q 2012 Earnings season had its biggest week in terms of the number of companies reporting.
  • 320 S&P500 companies have reported so far.
  • 70% of companies are beating consensus earnings estimates. This has dropped a great deal from the initial 83% beat figure 2 weeks ago. Given the trend over the past 2 weeks, we’re likely to end up in the 60-65% beat rate this quarter -once all the numbers are in. This is likely to be the lowest beat rate since the recovery in 2009. The long term average earnings ‘beat rate’ is roughly 67%.
  • Profit margin (with 64% of companies reported) is 9.9%. This is almost identical to that of the same week from the previous earnings season. So margins are holding up remarkably well. Long-time clients know the importance of tracking profit margin.

• This week saw the release of a monthly report from the NYSE that is always eagerly awaited (by me, at least). The use of margin during the month of March was rebounding from the lows 6 months ago. But it was not yet matching the supreme frothiness seen in April last year. This aligns with the fact that equity trade volumes have been anemic this year. The same extreme level of conviction, complacency, and greed is not happening this time. Not in the US equity market, at least. That’s likely because the latest bear market rally does not have a ‘made in the USA’ label on it. The ECB drove this round.

• 1Q 2012 GDP: I wrote that the BEA’s first estimate would probably be 2%, and that later in the year it would lower that estimate to the 1% range (a la 2011). I also wrote that GDP would be flat outside of what the consumer did.
• What the BEA announced:
  • +2.2% GDP growth.
  • Almost all of that 2.2% (2.04%) — came from the consumer. Pretty much what I estimated.
  • Wall St expectations were for 2.5 – 3%. A conspiracy of optimism.
  • GDP = Personal Consumption + Private Investment + Government + (net of exports -imports). Here’s how it breaks down :+2.04%(PC) +0.77%(PI) -0.6%(G) -0.01(E-I) = +2.2%
  • This may be more than you want to know, but 0.59 of the 0.77% GDP added from Private Investment continued to be an inventory build. That’s going to swing to a negative number — probably this quarter.
  • There’s a pattern of the BEA lowering previous estimates. One has to wonder when they’ll lower this week’s estimate, and how far.
• What happens when the consumer begins to pull the reigns in? Nearly immediately, we fall into recession. On that note, here’s the latest retail sales data from the Richmond Fed. It speaks for itself (with thanks to the Fed for this chart)… Unless retail sales pick up in May & June, it is going to be virtually impossible for the US economy to avoid contracting this quarter.
• The Case Shiller housing report. I previously estimated ‘another small drop in house prices on a national basis’ — and that ‘ the report will likely show prices down 35-36% from the peak and back to late 2002 levels’. That’s what we got. From here, look for house prices to level out for a few months, then roll-over and drop another 7 – 8% next winter. Rinse and repeat 1 more year but with a larger drop to (hopefully) the bottom of house prices — approaching half their peak price — the same as 1999.

• The yield on the US 10-yr Tnote continued lower this week – for the 6th week in a row. It closed the week at 1.95%. Since bond prices are inversely correlated with yields, the price went higher. I’m still looking for the 10yr T-note yield to drop to the 1.5% range this summer, and for 15-yr mortgage rates to drop to the 2.2% range. On a related note, the yield on 5-yr & 10-yr US inflation-indexed notes was driven below 0. A guaranteed loss (unless you manage to buy it, then sell it when/if the yield is driven further below 0). Clearly, someone’s expecting the currency printing presses to be turbo-charged (other than me).
• And finally, since the March 2009 lows, each time the Shiller-PE rises to the 23s (where it is now), the US stock market spasms.

In Europe:

• The European financial crisis is hitting additional headwinds as political risk increases.
• The Netherlands: Parliament fell apart as agreement on budget austerity could not be reached. The bond market is weighing-in on this transgression: the interest rate premium on Dutch 10-yr Tnotes has blown-out to levels only seen during the extreme points of the global financial crisis in late 2008/ early 2009. The Netherlands has been in recession since late last year. Moody’s is taking notice and warning they’ll cut the prized AAA debt rating.
• The eurozone retail purchasing managers index dropped to the lowest level since late last year (when the proverbial sky was falling), to a level consistent with recession. France, Germany, and Italy each saw retail sales and profit margins collapse in April. (with thanks for Markit Economics for the graph). A reading under 50 represents contraction.

• Spain:
  • Recession was announced this week. To be clear, that means the Spanish economy has contracted for the past 6 months. A 1.7% GDP contraction is forecast. There’s not much chance it will be that shallow. The odds continue to build that Spain is entering a decade of hard times (like the rest of Europe and the US).
  • S&P downgraded Spain’s credit rating by 2 notches this week.
  • The unemployment rate rose to 24.4%.
  • The Spanish stock market is re-testing the March 2009 lows.

• Britain: Recession was announced here too. That makes the list of European countries in recession: the UK, Ireland, Italy, Spain, Portugal, Greece, the Netherlands, Slovenia.
• Germany: The latest data shows manufacturing continues to contract.

In Asia:

• Japan:
  • The economy continues to stagnate, and deflation remains a threat.
  • Markets were expecting more ‘powerful monetary easing’ (printing currency to buy assets –mostly Japanese Govt Bonds). That’s what was announced yesterday. Yet the Japanese stock market sold-off with the supposedly good news of more monetary steroids, because a larger dose was expected.
  • But the bond market responded differently. The yield on the 10-yr T-note dropped under 0.9%!!!! When this reverses, its going to be monumentally brutal.
• India: S&P warned India it would lower the sovereign credit rating unless it begins reducing its budget deficit (5.9% last year). Since India’s current debt rating is the lowest investment grade rating. Only junk lies below.

Another very interesting week from the greedometers. It is increasingly looking like we’re within 2 weeks of a secular (long term) top in risk asset prices. Much more details in the private client letter on Wednesday. Speaking of which, next month will see further progress in terms of converging the 2 weekly letters into 1, and in separating the content displayed in client letters vs publicly available information.

The book (Greedometer. Dow 5000. Why nobody sees it coming.) is in the final stages of editing. I’m trying to get it out before the economy rolls over and stock markets fall again. Admittedly this is impossible because US GDP probably peaked in 4Q 2011 and is flat now (2Q). Thankfully, the US stock market continues to stretch upwards because it hasn’t figured this out yet. … tick tick tick…

Here in the US:

• 1Q 2012 Earnings season is under way.
  • 121 S&P500 companies have reported so far. The bar was set very low ahead of time (a la sandbagger), so a very high proportion -80%- of companies are beating consensus earnings estimates. This compares with 72% over the past year, and 67% over the past 5 years.
  • But so far earnings have grown at the lowest pace since the end of the last recession : 2%. Worse still, remove Apple’s earnings and we see an overall decline in S&P500 earnings of 1.5%! In fact, 7 of 10 S&P500 sectors are reporting a decline in earnings so far.
  • Revenue is up 3.9%. That’s always good. However, if revenue is up but earnings are up less -or down- you know gross margins are being hacked away. And that’s exactly what’s happening. The S&P500 profit margin so far is 8.5% with the financials removed. The previous quarter saw the overall S&P500 profit margin drop to 8.8% by the end of reporting season yet it started at 12.7% (thank you financials). We’re a month away from having a nearly full view of earnings, but I suspect we’ll see profit margins were compressing last quarter, and that we limp out of Q1 earnings season with an 8.0% profit margin — the lowest since 2010 (but still above the mean and with a long drop to go in order to complete the mean reversion). See the diagram in last week’s note for my profit margin mean reversion view for 2012.
  • Other than Apple skewing the data, it is all about the financial sector. The front end of earnings season is heavily weighted with the financial sector, so it skews the data. What little earnings growth there was came from a nearly 13% rate of growth from the financial sector. Yet revenue (much harder to manipulate) from financials shrank by 1.6%. You will recall I’ve commented previously that earnings from financials are the fattest and easiest to manipulate (and for that matter probably the most likely to be manipulated). The story remains the financial sector continues to add to earnings from reductions in loan loss reserves. This has been going on for a couple years now and is very long in the tooth. The US economy stalling in Q2 will probably cause bankers to stop reducing loan loss reserves.
  • Next week will see:
    • Over 170 of the S&P500 companies report. By the end of the week we’ll be nearly 40% through Q1 earnings season — enough to get an early sense of how Q1 will shape up.
    • A 2-day Fed meeting. The press conference afterwards will likely move markets.
    • The BEA’s advance (1st) estimate of 1Q GDP on Friday morning. Consensus is for a +2.5% gain. Anything under 2% will probably spook markets. Recall what happened last year. The BEA’s first estimate of 1Q GDP was +1.8% in April. It lowered that estimate to 0.3% eventually. A similar pattern might see an initial estimate in the 2% range then lowered to 1% or lower later in the year.
  • The Case Shiller housing report. Look for another small drop in house prices on a national basis. The report will likely show prices down 35-36% from the peak, and back to late 2002 levels. Good thing we had a record setting warm winter to help stop the slide.

In Europe:

• A G20 summit in Washington produced optimism the IMF would be able to find $400B in more bailout loan commitments for Europe. The US and Canada are not planning to contribute.
• Spain: The 10-year Tnote auction went well enough this week. No word on whether there was any additional back-door support from the ECB. But given the amount of LTRO money vacuumed up by Spanish commercial banks, it’s a safe bet they turned out in numbers to buy the 10year Tnote. But after the bond sale, the yield remained over 4% above the 10yr German bund. Not good.
• France: This weekend sees round 1 of a 2-round voting process to elect a new President. Sarkozy is likely to advance to the second round and bit pit against Hollande. Mr Hollande’s left of center platform may upset the current political paradigm in Europe if elected.
• Germany: Business confidence is back to year 2007 levels (very good). Fears over the Eurozone have driven down interest rates in Germany and kept the euro currency weak –all good things for German business. But Germany remains too reliant upon exports for GDP growth. A moderate slowdown in global demand will amplify economic weakness in Germany.

In South America:

• Brazil: The overnight lending rate was cut to 9% –the lowest since the 2008 financial crisis. Barriers to cutting the rate further are a 5% inflation rate, and a 6% tax free return via a government sponsored savings program. But the economy is stalling. GDP growth was 7.5% in 2010, fell to 2.7% last year, and dropped below 0 in February.

• From a 40,000ft view, the US economy seems to be slowing from an anemic pace to flat. I’m sticking with an estimate of 1.5 – 2% GDP growth rate for Q1, but 2Q is going to be hard pressed to see any growth at all. Indeed, I’m anticipating an increase in the speed of slowing as we go through the quarter and the year.
• 1Q 2012 Earnings season kicked off this week. From previous letters you know I’m going to be paying attention to the top line (revenue) more than the bottom line (earnings) because revenue is harder to manipulate, and it more tightly aligns with demand. Yet more important is going to be profit margins on the S&P500. It is arguably my favorite economic metric because it does such a good job of providing insight into where we are in the grand scheme of things, and because it is such an excellent mean-reverting engine. Since profit margins saw an all-time high a few months ago then began dropping, the odds favor more profit margin compression.

• The fact that Alcoa’s earnings beat by a wide margin speaks well of the continued demand for commodities used in manufacturing everywhere (but certainly China is being watched closer than other places).
• But earnings from JP Morgan & Wells Fargo disappointed despite beating recently lowered expectations. It is never a good omen for earnings season if JP Morgan’s results don’t lead the way higher.
• The last couple weeks saw a mild pull-back in the stock market that was likely attributable in some part to the usual pre-earnings season sandbagging that goes on (analysts lower their earnings expectations immediately before earnings season so the announced figure can “beat” expectations therein driving the stock higher). Arguably, this time the pre-earnings dip came a few weeks later than usual. Here’s a chart of Q1 earnings expectations over the past year. Notice the steady drop that troughs a few weeks immediately prior to earnings season beginning? (with thanks to Howard Silverblatt at S&P for this chart)

• In a deliberate display of strong leadership and self sacrifice, Goldman Sachs CEO Lloyd Blackfein took a reduction in 2011 pay. He was paid roughly $12M, far less than the $19M the previous year.
• JP Morgan CEO Jamie Dimon took home $23M last year.

In Europe:

• The 40,000ft view of Europe is the similar to that of the US but slightly worse: confidence is flagging, and the tentacles of recession are spreading.
• Spain: The new Prime Minister is seeing confidence from the international community eroded after only 4 months in office. He’s already on his back foot denying Spain needs a bailout. Look at the yield on the 10-yr note over the past month. It touched 6% again last week. That’s bailout territory.

• Growing concern about the Spanish banking system pushed the Spanish stock market to the lowest point since the March 2009 lows.
• Yesterday, the ECB poured cold water on hopes it would begin buying up bonds of PIIGS countries in the secondary bond market (to help keep yields from rising further).
• Italian borrowing costs are quietly rising as well.

In Asia:

• China:
  • The Chinese government is quietly adding more stimulative economic policy to help keep their economy from slowing precipitously. The economy grew at a 8.1% annualized real growth rate in 1Q. Admirable for any large economy, but decidedly below the 8.4% consensus estimate. Compounding the problem, a slightly elevated inflation rate will make it harder to add stimulative monetary policy without making inflation worse. (rock and hard place)
  • The latest trade data (March 2012) showed a swing back to trade surplus, but most of the credit went to a drop in imports. This does not support a view the Chinese economy will be able to quickly and painlessly (soft landing?) morph into one where domestic demand drives the economy.

Granted the Fed and ECB will be forced to come to the rescue in August, but what if their firetrucks are out of liquidity? And at which point will they go all-in with several $T more in QE:

• when the S&P500 drops from the 1400s to the 1100s in August?
• how about 800 in November?
• surely at 600 in March?

My view continues to be that Operation Twist 2.0 will be launched in August, but it will not be sufficient to re-ignite the crack-addict-like risk-on rally in stocks. Depending on the speed with which Europe deteriorates, the Fed and ECB will be forced to go all-in with their last monetary nuke somewhere between November and March. That final monetary intrusion will be epic: a doubling of the printing done to date. The inflation genie will be let out of the bottle. Bring on more financial repression.

As of this week, it is increasingly looking like April will be the economic and stock market peak. The greedometer and mini greedometer are within days of confirming this view. (much more in the private client letter on Wednesday)

Here in the US:

• The release of the minutes from the Fed’s March meeting proved interesting. Only 2 of the 10 voting FOMC board members voted that more QE could become necessary. As I wrote last summer, the point of diminishing returns for QE has been reached. You would expect this news to cause the dollar to rally, and risk assets and gold to take a breather.
• But! Next week begins 1Q 2012 earnings season, so a big drop in risk asset prices isn’t likely in the cards for another week (or 2 or 3). Given the bounce off the early October lows, and the fact S&P500 as-reported earnings actually contracted a bit last quarter, there’s a lot of pressure on stocks at these prices to deliver the goods. The odds favor a continued decrease in profit margins, shrinking revenue, and shrinking earnings. All conducive to a non-ratifying pullback later in the month and into May & June.
• March continued the pattern of record setting warm temperatures. The first quarter will go down in history as one of the warmest ever. This probably translated into a nice 1% GDP bump from consumer spending on things other than heating. That said, 1Q GDP still looks like a 2% number (though again, we may have to wait a year or two for the BEA to adjust its estimate to that).
• The March 2012 Employment report from the BLS:
  • The initial claims rate (aka U3 rate) dropped from 8.3% to 8.2%, and 120K new jobs were created. This is half the consensus estimate. (This is really feeling like 2010 and 2011.) The report is more of what we’ve seen over the past year: the headline U3 rate drops because people are using up their UI benefits and falling out the back end of the program with no job, but still lowering the U3 rate by virtue of no longer be counted in BLS claims data the same as if they found a job.The report showed 12.7M making initial claims. A reliance on the initial claims figure continues to be a complete misrepresentation.
  • Add another nearly 10M more that account for the incremental number of unemployed in the all- encompassing U6 rate vs the U3 rate.
  • Plus we’re still down 12M jobs from where we were in December 2007 -allowing for population growth. So these 22M people should be added to the 12.7M headline figure if you want to compare the current economy to that of 2007 (apples to apples.)
• The March US manufacturing index from ISM ticked up to 53.4 from February’s 52.4, beating consensus estimates. I’ll spare you the details of the report, but a key measure from the ISM report is the ratio of orders to inventory. An economy coming out of recession sees a growing orders / inventory ratio whereas a slowing economy sees the opposite. This ratio has been in decline for the past three months in a row. Nothing alarming yet, but not a healthy trend.
• The March ISM non-manufacturing index dropped from 57.3 to 56 in March — a bigger drop than was forecast. 56 still means the services portion of the economy is growing, but at a slower pace. The non-manufacturing portion of the US economy is larger than the manufacturing portion, so it’s followed closely.

In Europe:

• The ECB and Bank of England both suggested there was no more QE in the near future.
• Spain: Wednesday’s bond auction got the job done, but it wasn’t pretty. The yield on the 10-year note has been creeping back up.

• Here’s a troubling graph from the Financial Times. The upshot is Spain’s banks are loaded with Spanish sovereign debt. A 20% haircut on the value of the debt would likely wipe-out the Spanish banking system. And this graph is before LTRO 2 –which saw Spain’s banks vacuum-up more euros and buy yet more Spanish sovereign debt.

• Germany: As you’d anticipate, if there’s increasing fear in the PIIGS countries, the yield on German bunds is dropping as safety is sought.

• What’s important to track is the rising spread in interest rates between Spain and Germany. The gap on the 10year note rose to 4% this week. It hasn’t been there since December. And this is post $1.35T LTRO!

In Asia:

• China: The March Purchasing Managers Index (PMI) reading came in at a surprising 53.1, up from 51 in February. Mind you this reading comes courtesy of the Chinese government. A similar estimate of PMI by HSBC showed a continues decline -to the 5th month in a row. A PMI reading over 50 suggests an economy with a growing manufacturing sector.

• Mr. Bernanke got the week going with a speech before markets opened on Monday. His comments were interpreted as a sign that more dollar printing would be on the way (hello QE3!). Mind you, there was no explicit commitment. In so doing, Mr. Bernanke is continuing to paint the Fed into a corner and further cementing the reliance of equity markets to dollar printing — not a healthy relationship given that the point of diminishing returns has already been reached. With the S&P500 at approximately 1400, more Fed talk of QE is surprising. They must see something troubling. Ben suggested the drop in the unemployment rate might be a temporary phenomenon. No kidding. The reduction in the headline unemployment rate is virtually entirely due to claimants using-up their benefits and falling out of the UI system with no job.
• The BEA provided their third estimate on 4Q 211 GDP. No change.
• The latest Case-Shiller housing report:
  • Data for January was released. To no surprise, prices dropped a tiny bit further — to 34.4% below the bubble peak. The lowest since early 2003.

• • One of the shortfalls in using the Case-Shiller national housing data report is the lack of accounting for uneven shifts in geographic sales, and in the impacts of severe weather. A 3-month rolling average helps reduce those spurious effects, but when two months in a row see record setting warm weather (January & February), the results may be a little bumpy. We’ll see.
• Early this week saw an update to new home sales. Granted, January and February are the lowest months for the year. But given how the January-February period this year was the warmest in decades, you’d expect some nice numbers. You be the judge. Get out a magnifying glass and find the housing boom over the past 3 months. (the last datapoint is February 2012 with 25K new homes sold)

• 15% of the US population now uses food stamps: 46.5M people. We could partially explain this by way of the implosion of house prices leaving people with no equity, but unemployment remains the main problem. This picture speaks volumes. A comparison of the detonation in jobs for every recession since WW2…

• Maybe this graph is easier to understand. The US economy has never been in a hole this deep, this long after a recession (not since the Great Depression).

In Europe:

• The permanent bailout fund (ESM) is being enlarged to 700B euro. This remains a fraction of what will be required to keep everyone in the euro.
• My favorite article this week was from the Financial Times. They did an intriguing article about LTRO: http://www.ft.com/intl/cms/s/0/82205f6e-7735-11e1-baf3-00144feab49a.html#axzz1qQtYppys .  (go to www.ft.com and search on Leaning Tower of Perils) . The essence is LTRO is laying the foundation for another financial crisis, and we know when it will arrive: when LTRO ends.
• Germany:  Any bailout fund increase requires approval by the Bundestag (lower house of parliament/ analogous to the House of Representatives). This won’t be easy or popular.
• The ever-industrious Dutch have joined the bulk of Europe in recession. In order to retain their coveted AAA sovereign debt rating, they’ll need to do some extra trimming or they’ll see deficit spending breach 3% of GDP. But extra cutting increases the near term recession drop.

• Weekly initial unemployment claims dropped under 350,000 for the first time in four years. Good. Now if we could find jobs for the 6-7 million others that have lost jobs and fallen out of the UI system, that would be nice.
• The latest housing data has been a mixed bag. House prices are stabilizing, but sales volumes remain low. And this is despite the most favorable (warmest) January-February period in several decades, and the lowest mortgage rates ever. Expect house prices to continue to stabilize for a few months, then roll over again in late summer when the economy is visibly and undeniably weaker, sapping confidence and demand for leveraged depreciating assets (aka real estate). On the upside, we’ll likely see lower mortgage rates later this year as investors pile into the relative safety of US Treasury bonds and mortgage bonds.
• Per the Wednesday private client letter, we’re seeing a small pull-back in risk assets that should continue into next week. But the risk-on rally should resume mid/late week because this is the final few days of the quarter and with many hedge funds being been badly beaten they’ll be heavily window dressing on Thursday & Friday. And let’s not forget 1Q 2012 earnings season begins in 2 weeks, so it’s time to get pumped up.

In Europe:

• Manufacturing data was weaker than expected and suggest Europe will see GDP shrink in 1Q 2012 at a slow pace than 4Q 2011. But this still means Europe will have seen 2 successive quarters of contraction i.e., recession.

• Don’t look now but the yields of Italian and Spanish bonds are rising again. But now there’s (supposedly) no ECB to do back-door buying of PIIGS bonds to keep a lid on panic selling. Let’s see, LTRO 1 & 2 have been deployed. That was supposed to give Europe three years of breathing room. It’s been three months. Don’t forget, the ECB President has been told by the Bundesbank there better not be any more LTROs. And how is all that LTRO money working its way through the economy?:
• A look at the Bank for International Settlements (the BIS) data shows most of LTRO 1 & 2 cash remains parked at the ECB instead of being loaned. The exception being Italian and Spanish commercial banks put their new LTRO money to work in buying the sovereign bonds of their country — since no one else will. Yeah, there’s nothing to worry about in Europe. It’s all good.

In Asia:

• China: Manufacturing data spooked investors this week. Here’s a plot of the manufacturing index over the past nearly 3 years. Also included is a linear regression to see the (obvious) trend.

• You might examine this and reach the conclusion China’s manufacturing index is about to snap back since the current dip is as far away from the linear regression line as any other point (think reversion to the mean). Could be. But check out this plot as we expand the view……

• Still think manufacturing is about to snap back? Maybe it will. Come on, soft landing……