Is Real Unemployment closer to 18%? Watch those Long Positions!

In 1994, for the cited reason of statistical integrity, the Clinton Administration decided to exclude individuals who had given up looking for a job, after one year of trying, from government unemployment measurements. Today, if those individuals are added to (a) officially unemployed persons, (b) those who had unsuccessfully attempted to get a job in the last 12 months and (c) those that only have part-time employment status, the real measure of unemployment is closer to 18%, not 7.20% as reported on Friday.

                                

In the past, given the intrinsic correlation between Lines U-3  and U-6  in Table A-12 of the Labour Department’s monthly jobs report on one hand and alternative measurements including 12-month-plus “discouraged” workers on the other, analysts have not found it necessary to read beyond the publicly-announced unemployment numbers. But, as the alternative measurements of the domestic labour market (e.g. the SGS Alternative) now suggest jobless rates approaching Depression-era thresholds, investors who continue to hunt for value at today’s price levels need to urgently examine their founding premises. For information purposes, Line U-3 states the official unemployment rate, i.e. 7.20%, while Line U-6 includes officially unemployed persons, plus “marginally attached” workers, plus part-time workers (for a rate of 13.5%).

 

If the alternative measurements include certain momentum-related data from Friday’s jobs report, the picture of the present and the future is bleaker. Nearly 25% of the “officially” unemployed (total of 11.11 million) have been looking for work for over six months. The unemployment rate amongst teenagers remains above 20%. Though the establishment and household surveys currently in use are not designed to identify the role undocumented workers play in the jobs matrix, the Labour Department concedes that only “some” undocumented immigrants are counted—which leaves a huge pool of approximately five million people willing to work, or employed illegally at low wages, on the statistical fringes of the job market.

 

Despite the widely assumed fact that an unemployment rate of 25% confirms the recession-to-depression transition, comparisons with the 1929-1933 phase of history are largely misplaced. Before anybody gets into panic-mode, this writer must point out that today’s social security net, which President-elect Obama says he will improve, dictates that unemployment levels in the 20s will not create the same broad conditions of desperation (and potential social unrest) witnessed during the Great Depression. But it is a matter of grave concern that the biggest challenge to the unemployment scenario is not being openly acknowledged and debated: viewed from the prism of relative (domestic vs. foreign) production costs, any rise in American jobs and wages must be conditioned by the continuing ability of developing-world economies to deliver cheap goods to American ports, and cheap services to American boardrooms.

 

Unless, of course, another Smoot-Hawley Tarrif Act (1930), or something similar, is enacted along with the $850 billion (or thereabouts) stimulus package. Already, spokespersons for the incoming administration are indicating that the final rescue plan will contain a “Buy America” provision for contractors engaged in the building of roads, railways, bridges, schools and green projects. Such a provision could signal the start of an entirely new phase of protectionism. By itself, such protectionism would be good for jobs, at least in the near-term. But will it be good for American business?

 

Arguably, Friday’s jobs report reinforces the short call on the major indices (DIA, QQQQ, SPY), in anticipation of a 20%-plus decline in equities in the first half of this year. However, this writer’s short positions are predicated more on what lies in store in the future, and less on the shape of the present.

 

Very briefly, the ability of American assets to sustain earnings and valuations, and to service outstanding debt obligations on a timely basis, has diminished substantially over 2008, mainly due to the commencement of the long-overdue de-leveraging process, deliberate and otherwise, in the global economy. We need to wait for this de-leveraging to achieve rationality via proven benchmarks before embarking on any bottom-fishing exercises.

 

www.quoteplatform.com 

 

 

 

 

 

Political Case to Short India

On Thursday morning, 18 bomb explosions created havoc in towns across India’s north-eastern state of Assam; at least 70 people died, and more than 200 were injured. This latest act of terrorism, coming in the wake of similar serial-bomb explosions in a number of key Indian cities in recent months, raises two rather troubling questions for mutual funds managers investing in India, questions which perhaps need to be answered prior to granting credibility to any financial analysis of the India opportunity.

 

Is the Indian social fabric crumbling, one attack at a time? And will the terrorism, along with at least half-a-dozen robust domestic protest movements, force political changes which deserve to be recognized before dedicating investor money to Indian equities?

 

The unwinding of neighbouring Pakistan as a modern-day nation has already caused complete and undiluted chaos in the Karachi Stock Exchange. Credit default swaps for Pakistan have widened to unprecedented levels, with Asia reporting the absence of firm quotes even at 3,500 basis points for 5-year sovereign risk. Though the Indian economy can be distinguished from Pakistan in key fundamental respects, there are ample grounds to conclude that impending political changes in New Delhi spell trouble for India’s risk profile. Moreover, Indian intelligence officials routinely blame Pakistan for the terrorism inside India, and the common (and logical) assumption is that the worsening economic climate in Pakistan will lead to even more terrorism on both sides of the border.

 

Facts from the ground in India are increasingly suggesting that extremist right-wing Hindu parties and their equally partisan regional allies will capture a majority in next year’s general elections. And one does not have to dig deep to find out the reason why such radical entities are destined to make a strong comeback in traditionally secular India: growing middle- and lower-income discontent due to deteriorating living conditions in hundreds of big cities and small townships. Even committed leftist commentators have begun to draw parallels between the consequences of the Great Depression (1929) on the fate of Germany and the impact of today’s global recession on the future shape of India.

 

India’s rural landscape is another matter altogether, with extremist communist groups effectively controlling the majority of villages in at least 50 districts across 8 states. Despite 50 years of land reforms and poverty eradication programmes, more than 95% of the agrarian population lives in poverty, or extreme poverty, depending upon definitions. The success of their counterparts in Nepal has only emboldened those seeking social change through armed struggle.

 

It is important to understand how the political undercurrents will influence India’s credit ratings, India’s stock markets and, most importantly, future legislative changes which will alter perceptions governing the pricing of political risk insurance for those doing business in India. As of now, credit default swaps are being priced around 525 basis points, and political risk insurance beyond 2009 is unavailable. Thinly-traded far forwards contracts to buy dollars against the rupee continue to trend higher, from a low of 18% for 3 years earlier in the year to 25%-plus last week; this pricing shift is also being reflected in currency swap rates.

 

How then can India-friendly fund managers justify a medium-term position in India? Firstly, it is true that, regardless of the political transition, to a 21^st century version of Fascism, in this instance, select corporations can and will continue to record profits; so stock picking, as opposed to index-linked investments, should be critical. Secondly, taking post-1979 Iran as a classic example, religious extremism translates into massive government spending programmes, in economic terms; so infrastructure technologies should attract foreign joint ventures.

 

But specific situations apart, the case for an overall bullish tone on India defies logic.

 

 www.quoteplatform.com

crossborderreports@shaw.ca

 

 

Short India is Perfect Emerging Market Trade

American fund managers investing in the emerging markets today are fundamentally assuming that, over a given time horizon, profits from equity investments will far exceed losses from currency devaluations. That assumption needs to be contextualized in the reality that, if investments in emerging markets like India were made on a fully hedged (forex risk) basis today, mutual funds would be forced to realize significant losses in their financial statements at the very outset.

 

The Indian rupee far forward rate, to offset currency risk on 3-year equity investments, will result in a net loss of about 24% today for dollar investors. Thinly traded 5-year contracts to purchase dollars are being offered at a premium of 35%. Few fund managers are known to actually offset foreign exchange risk unless, of course, they are confronted with panic conditions, like those witnessed this month.

 

Forward premiums apart, the rupee has lost 20% of its value against the dollar during the course of this year. There are several reasons to anticipate another 15% move downwards by early 2009 and to predict a further widening of forward differentials. Interestingly, the single most powerful indicator of the fate of the rupee is the behaviour of “hot” money being generated every day by India’s huge and powerful underground economy.

 

Dubai’s “hawala” traders claim that over $300 million has left India’s shore this month alone; hawala currency exchanges are executed outside mainstream banking channels with an exceptionally high degree of anonymity. India’s central bank, which periodically intervenes in the inter-bank foreign exchange markets for limited durations, has no ability whatsoever to control the flow of cash in the hawala system. Further bad news from the global economy, like yesterday’s downgrade in Pakistan’s credit rating, will only increase hot money outflows.

 

Besides, the only inference one can draw form statistical data is that the Indian economy is now in reversal, as opposed to being in the midst of a cyclical downturn as many asset managers would like to believe, with several sectors contracting at an alarming rate. The default rate amongst 30 million credit card holders is likely to breach 22% before the end of this year, by conservative estimates. The crisis in housing will force most of India’s leading real estate companies to renege on their debt service obligations in forthcoming weeks. Speaking of consumer confidence, a recent survey showed that more than 50% of working Indians fear losing their jobs in 2009. Darkening the scenario are rising food prices, which have been steadily chipping away at the value of middle- and lower-income family incomes since the commodity boom began in mid-2007.

 

Before fund managers invest in India or, for that matter, in other emerging markets, they should ask themselves the same three questions which the holders of underground capital, the ones with most at stake on a daily basis, ask themselves each morning: How much of the phenomenal growth in consumer spending power in this decade can be attributed to easy credit? Is the debt-induced fairy tale coming to an end? And, perhaps most importantly, are poverty levels in the urban and rural centres creating the potential for deep-rooted social unrest?

 

The short India trade is justified by both, currency risk arbitrage considerations and the status of the Indian economy. Such a short trade may not be possible to execute in the equity exchanges. But the short India canvas is wide enough: buy synthetic shorts on exchange-trade India funds and shares on each rally, buy stock index puts in similar fashion, and buy 3-year sovereign default risk and far forward dollars now.

                                                                                        

www.quoteplatform.com

crossborderreports@shaw.ca

 

The Dawn of State Capitalism: The bailouts

In 1916, a few months prior to the Russian Revolution, Vladimir Lenin declared that imperialism, dominated by international monopolies, was the highest, and final, stage of capitalism, and that extreme distress amongst the marginalized would inevitably create revolutionary conditions. However, as Nazi Germany was to prove within a little over two decades, that though revolutionary conditions do indeed lead to a social revolution, the nature of that revolution does not necessarily follow the vision outlined by Lenin or, for that matter, by Karl Marx.

 

The current state of the global economy today makes the best case for restraining the power of private capital to exploit, waste, enrich, indulge and, finally, self-destruct. But as the rapidly unfolding events are proving today, far from being in crisis, big capital is undergoing a compelling resurgence. Ostensibly, authorities in Europe and America are busy trying to find answers to the unprecedented chaos within their financial systems; the facts however show that what really is happening is the cementing, by legislation, of the alliance between institutions representing political power on one hand and corporations in control of the engines of the domestic and global environment on the other.

 

State capitalism, as this phenomenon can be termed, is not akin to nationalization, as many western economic experts would lead you to believe. State capitalism, as understood from a detailed study of the structural framework of countries like Russia, China and Iran, is not one step forward towards socialism, by any measure. In fact, state capitalism enables private capital, particularly big capital, to continue its relentless pursuit for profit with renewed vigour, primarily due to replacement of insurance pools by political authority as the willing re-insurer of last resort, and all resorts with the passage of time.

 

Closely scrutinized, the Wall Street bailout package and other rescue programmes constitute, for all practical purposes, transfer of business risks to the state when the very business models (including banking, housing and industry) which characterized the free world are on the verge of imploding. While approving the bailout, the US Congress also passed legislation granting a 25-billion-dollar loan for General Motors, Chrysler and Ford, apparently to produce fuel-efficient cars. Another 600 billion dollars have been approved for veteran affairs and, yes, for defense and homeland security. And latest reports suggest that at least two additional economic stimulus bills, each worth at least 200 billion dollars, are now circulating in the corridors of power in Washington.

 

In the interim, nobody has credible answers to declining family incomes, to rising unemployment, to the quality of health care and education for the middle- and lower-income segments of the population, and to the grave situation concerning immigration. The better judgement is that, outside the steady flow of political spin, state capitalism is not a system designed to help the needy. Truth be told, today’s global economy does not provide the kind of surpluses which sustained the concept of a welfare state for nearly five decades anyway.

 

The question of the day is this: what does this phenomenon of state capitalism tell us about the fate of the credit and the equity markets?

 

Firstly, as the examples cited prove, spreads on debt and valuations of equity will be dictated by those in political and financial power, not by free market supply and demand considerations. Secondly, since state capitalism, as an ideology, addresses economic misalignments on a crisis-by-crisis basis, the capital markets are due for exponentially higher levels of volatility and implied volatility; option prices will shortly hit record, never-seen-before levels.  

 

Finally, and most importantly, credit for the working poor will become increasingly onerous and, in many instances, non-existent. As much as one hates to bring pre-1933 Germany into the equation, it is a fact that the consolidation of state capitalism under Adolf Hitler gradually eliminated the economic functions of medium and small businesses. The case for the expropriation of Jewish capital was firmly predicated on this proposition. Any discussion of the evils of Nazi Germany invariably point to the holocaust; but, before one gets to the holocaust, it is critical to understand the economic dynamics which created Kristallnacht, the Night of Broken Glass (November, 1938), when thousands of Jewish homes and businesses were destroyed by marauding gangs under the very eyes of law enforcement. One is not suggesting that Kristallnach will be repeated in American or Europe; today, tight credit will do the job, and more.

 

Political and social considerations apart, investors with cash on hand certainly stand to make money in the dawn of the new era. In terms of equities, the trick is to ride the forthcoming wave of recapitalizations, by investing after a corporate restructuring plan has been announced in a definitive manner. In terms of securitized debt, the safest approach is to demand substantially higher spreads (with 10-12% as a minimum regardless of a credit rating) only once it is evident that the underlying asset has passed thorough valuation scrutiny and is not subject to collateral attack.

 

In brief, this is no cyclical crisis and, in the eyes of big capital, what we are going through is a major socio-economic transaction, not a crisis of mammoth proportions. Why Lenin and Marx failed to foresee the development of state capitalism, as yet another higher stage of capitalism, will be the subject of a separate commentary.

 

Quote Platform Initiates ME Risk Offset Contracts

July 08, Vancouver, BC, Canada: Quote Platform Syndicate Inc., a specialist financial services outfit pricing political, trade and currency risks for the emerging markets, is now offering a range of tailor-made hedge contracts for corporations engaged in business in the broader Middle East. Risk-offset mechanisms will be structured for short and medium term maturities, depending upon the level of credit risk which can be secured between the contracting parties.

 

In recent months, Quote Platform has tested its pricing matrix in relation to (1) trade deals between India and Iraq, (2) discounting of Iran corporate risk and (3) real estate securitizations in Lebanon. A synthetic programme to test currency and interest rate swaps for the Gulf region has also yielded quotable price parameters.

 

Since Quote Platform’s pricing matrix fundamentally entails the creation or identification of risk buying syndicates, as counterparties, the availability of political risk insurance coverage has to be ascertained on a deal-specific basis. At this juncture, indicative 1-year political risk premiums for Iraq and Iran are 12% and 18% respectively; the premium for Iraqi Kurdistan is in the 7-9% range. A 2-year transaction political risk deal for Pakistan was recently concluded at 8% per annum.

 

Of course, given the chaotic pricing conditions in the debt markets, the largest number of inquiries relate to the offset of risks inherent in debt securitizations originating in the developing world, in particular the risk of a degradation of the securitized assets.

 

Quote Platform’s principals and partners have been involved in engineering financial products and arbitrage opportunities emerging markets for almost three decades.

 

 

For further information, contact:

 

Rakesh Saxena, Director

Quote Platform Syndicate Inc.

Canadian office: 3080 River Road

Richmond BC V7C 5N2 Canada

http://quoteplatform.com

http://uniqueanalysis.org

email: crossborderreports@shaw.ca and derivatives@shaw.ca