The Broken Price Signal at the Heart of Financial Markets


There’s a bit to discuss today…Aussie unemployment, deficit blowouts, US GDP numbers, euro interest rates and Twitter craziness. So let’s get stuck in…

Firstly, we must confess we’re not sure whether bad news is good news or good news is bad news anymore. Because with every data release, it seems like the market spins around to see what the respective central bank will make of it. Is it good/bad enough for less or more monetary easing…is it good/bad enough for taper on/taper off? They’re the only questions that matter these days.

And then sometimes the meaning of the data is whatever you want it to be. Take the Aussie employment statistics for October, released yesterday. The Financial Review reported:

 ‘Employers boosted hours worked last month at the fastest pace in 18 months, a tentative sign that the nations’ lacklustre labour market is on the cusp of recovery.

The report went on to say the increase in hours worked represented a silver lining in an otherwise soft report. And that’s how the market viewed it too…as soft. The stock market retreated yesterday (despite a strong move in the US to all-time highs) and the Aussie dollar weakened.

David Rogers at Dow Jones saw the release a little more accurately:

 ‘THE Australian dollar fell today after disappointing employment data left the door ajar for further interest rate cuts to stimulate the economy as it struggles to adjust to the end of the mining investment boom.

While total employment rose by 1,100 (seasonally adjusted) full time jobs fell by 27,800, with a 28,900 increase in part time jobs making up the difference. The overall unemployment rate now stands at 5.7%.

We think the employment market will get worse before it gets better. There is a great hope that some form of investment will take over from the considerable drop off in mining investment now occurring, but it’s not going to happen. The high paying jobs in the mining construction industry will be lost for good.

An easy money-fuelled house price boom is not going to lead to a housing investment boom while idiotic governments continue to restrict supply. They do so because restricted supply maintains high prices, and high prices line state government coffers via huge stamp duty revenues.

It’s not just the states scrounging around for income. The Federal government could do with a bit more too. As the government prepares to release its mid-year economic and fiscal outlook, the warnings are out that the budget numbers don’t look pretty. We could be in for a deficit this year of $50 billion. That’s up from Treasury’s August estimate of $30 billion.

Of course, Joe Hockey is doing what any self-respecting politician would do…blame the other side for the blowout. But the $8.8 billion one-off grant to the Reserve Bank and the repealing of tax changes announced under Labor is the main reason behind the rising deficit. Plus, revenue forecasts continue to deteriorate, so underlying economic weakness remains.

Not so in the US though. Economic growth in the September quarter came in at a robust 2.8%, well above expectations of 2% growth. But the headline number masked underlying weakness. Inventory accumulation (production sitting on shelves and not consumed) accounted for 0.8 percentage points of the growth number.

According to the Wall Street Journal:

 ‘Americans during the third quarter increased their spending at a 1.5% pace, matching only one other quarter for the lowest spending growth since 2009. Companies cut spending on equipment—a key indicator of business investment—for only the second time since the recovery began in mid-2009.

The rise in inventory means growth next quarter will probably be much weaker, perhaps as low as 1.5%. That’s near ‘stall-speed’ for the US economy.

The market wasn’t sure whether to interpret the data as good news or bad news. Was it ‘good’ because it was bad, meaning the Fed will continue spraying liquidity all over the place? Or was it bad because it was above expectations and suggestive of a Fed turning the pressure down on its liquidity hose?

Or maybe it was just bad. The stock market fell heavily. Current high prices don’t contain much room for earnings disappointments and a lacklustre economy means earnings growth is going to be hard to achieve in the coming quarters.

But you can’t disappoint on earnings if you don’t have any! Which is why Twitter surged 73% on its first day as a listed company, closing at US$44.90 following an IPO at $26. It doesn’t yet have any earnings, but the market still gives it a value of $31 billion.

Twitter’s performance is a sign of the times. Sure, it may make money, and its growth may be rapid, but you’re already paying for that profit growth. Its first day performance reflects the current craziness and speculative nature of Wall Street, not its genuine prospects.

Meanwhile, over in Europe ECB boss Mario Draghi reduced the main refinancing rate in the Eurozone by 25 basis points to 0.25%. The cut was in response to low inflation (currently 0.7%) and as it was unexpected, the euro initially fell sharply.

However in the scheme of things the decision is not a big deal. Europe is undergoing deep structural reforms and will have low inflation and low interest rates for years. The biggest risk is that the debt-to-GDP ratios of the heavily indebted southern European nations continue to blow out.

Italy’s debt-to-GDP ratio, for example, is heading towards 135%, up from 120% in 2012. There’s trouble brewing again in Europe. Debt restructurings will have to take place.

Maybe Italy could sell some of its massive gold hoard, officially the third largest in the world, to relieve its debt burden? Except doing so would hardly put a dent in its debt obligations. At current prices, Italy’s gold holdings are worth just US$102.4 billion. According to the Economist, Italy’s outstanding government debt is US$2.6 trillion.

Even at $20,000 an ounce, a gold sale would only wipe off a bit over US$1.5 trillion of debt. So it’s safe to say that at these prices, Italy won’t be selling an ounce of its gold.

Bizarrely, despite the cut in ECB interest rates and the underlying weakness in the US economic data, gold ‘prices’ fell overnight. And don’t forget with US payrolls data out tonight, those trading pieces of paper representing gold will have another wild trading session to contend with.

When you think about it, a falling gold price amidst a completely dysfunctional global economic backdrop signals a victory for the world’s economic planners. It represents the true corruption of price signals at the heart of the global financial system. When the one asset that’s meant to provide a warning that something is wrong no longer throws off the correct price signals, you know the system is broken beyond repair.

But we’re exaggerating and showing our bias. How dare we question the market? And besides, it’s only interest rates, foreign exchange markets and oil prices that are subject to manipulation. Gold is just a barbarous relic.


Greg Canavan+
for The Daily Reckoning Australia

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

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3 Comments on "The Broken Price Signal at the Heart of Financial Markets"

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2 years 11 months ago

We can’t blow another private credit bubble of large enough proportions so all things considered Joe has two options in his position
1) defict spend like a drunk
2) quit

Option three is not in Joe’s job description.

slewie the pi-rat
slewie the pi-rat
2 years 11 months ago

moar ‘debt restructurings’ in the EU?

go long Belgian Caterers 3X ETF [symbol: MkTrtl<3]
and short Consolidated Crapola.

what a spread!

justin king
justin king
2 years 11 months ago

Canavan has one of the best minds, and the least BIAS, of all the writers on the Reckoning.

And best of all, he’s CONSISTENT.

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