Byron Wien: So Much to Worry About

The Wall Street pro's concerns include valuations, housing, and a group scarier than ISIS.

By Byron Wien

Updated Oct. 2, 2014 5:43 p.m.  

The Standard & Poor's 500 finally broke above 2000, but has now fallen (hopefully temporarily) somewhat below that level. Alibaba  has had a successful initial public offering, with the stock closing 38% above its offering price on its first day of trading.
Animal spirits still prevail, but there is concern that the biggest initial public offering ever may have sapped capital from the rest of the market. Federal Reserve Chair Janet Yellen has indicated that monetary policy will remain accommodative "for a considerable time" even though the bond-buying program of the last several years ends this month, and this suggests that the first increase in short-term rates will be later rather than sooner.
The United States economy grew more than 4% in the second quarter after a dismal first, and it now looks like second half real growth may trend toward 3%. Scotland voted to remain a part of the United Kingdom. Investors' outlook reflects these favorable conditions; most surveys reveal an optimistic view.

Against this background, however, there are a number of troubling conditions which could change the positive mood. I still believe the rest of the year will be good for the economy and the market, but, like most observers, I have my worries. The first is valuation. The S&P 500 is now trading at about 17 times 2014 earnings and probably 16 times next year's estimate. I look at trailing 12 month earnings and, on that basis, "bubbles" occur at 25 to 30 times, some distance from the current level. Those who believe that the market is approaching a bubble condition may be using the so-called cyclically adjusted price-earnings ratio (CAPE) developed by Robert Shiller of Yale. When market valuation is analyzed this way, the price-earnings ratio is now 26, definitely putting the market in overvalued territory, based on the history of this series. The CAPE method worked well in the 1980s, the early 1990s and leading up to the decline of 2008-2009, but the market has continued to rise in the past half-decade in spite of its warnings.
I take note of what the CAPE is saying but its message is not central to my strategy work. It reminds me of the dividend discount model I developed at Morgan Stanley in the 1980s which related the level of the S&P 500 to the yield on the 10-year U.S. Treasury. The model worked well in the late 1980s and early 1990s and I thought it would carry me through to retirement. It was a sad day in the mid-1990s when I realized it was no longer relevant.
The valuation context could change if earnings fell short of estimates. Right now analysts seem to be stepping up their forecasts. I started the year thinking the S&P 500 would earn $115, but there are now forecasts out there as high as $120 for this year and $127 for 2015. This has occurred in spite of the preponderance of negative guidance being given to analysts by the companies they follow. The favorable earnings outlook would change if the United States slipped back into a recession, but most of the indicators I am reviewing suggest that is unlikely to happen anytime soon. Based on a study by Omega Advisors, which draws on a number of sources, the market peaks about seven months before the economy starts to decline, but the market has not definitively topped out yet and the economy still appears to have some momentum.
The Omega study lists a number of conditions that would typically characterize a recession/pre-recession state: inflation is increasing, the yield curve is inverted, inventories are heavy, employment is declining, weekly jobless claims are around 500,000, and leading indicators, industrial production, consumer confidence and the stock market are declining. Almost none of these conditions are in place now.
The one economic area I am concerned about is housing. With the improvement in employment and continued low interest rates I would have expected the monthly figures on housing starts, new and existing home sales, and mortgage applications for purchase to be consistently strong, but the data have been mixed.
I wonder if there are some secular changes taking place in terms of more flexible lifestyles, as well as delayed marriages and family formations. Housing is a key component of growth, so this is an area that bears close attention.
It probably is reasonable to worry about the quality of earnings. Interest rates are low and most corporations have deductions or credits that enable them to have a favorable tax rate. As a result, profit margins are at an all-time high and I do not expect them to revert to the mean any time soon. Even if they did, the market peak tends to occur up to a year after margins peak. Earnings per share are increasing at a high-single-digit rate, but revenues are expanding more modestly (4%-5%). Profit margins can remain lofty, but an important factor contributing to earnings per share growth has been share buybacks. Corporate net income has increased more in line with revenue growth. Companies have considerable cash on their balance sheets and share buybacks are viewed as a more tax-efficient way to reward shareholders than increased dividends, but dividend payouts have been strong this year. Share buybacks are likely to continue, but it is important to recognize the significant role they are playing in earnings per share growth. The rise in the stock market is being driven by factors other than pure net income increases.
There are other ways to look at valuation besides price-earnings ratios. At the market peak in 2000 the S&P 500 was selling at 2.2 times sales, according to a study by Ned Davis Research using Compustat data. The ratio at the peak in 2007 was 1.5 times. Recently the ratio was 1.7 times. The dividend was 1.1% in 2000; 1.6% in 2007 and 1.9% recently. Price to book was 5.1 times in 2000; 3.0 in 2007 and 2.7 recently. Cash per share to protect against adversity was $140 in 2000; $353 in 2007 and $443 recently. Debt to assets was 36.7% in 2000; 32.1% in 2007 and 23.2% recently. These ratios support the conclusion that the U.S. equity market is generally not as richly priced as it was in 2000 or 2007.
At this point geopolitical turbulence appears to have receded as a market-influencing factor. The situation in Ukraine has quieted down with a cease-fire reported in the pro-Russian regions. President Vladimir Putin is negotiating for more political autonomy for the areas where separatism has strongest support with the hope that punitive sanctions will be lifted. The Russian economy has clearly suffered as a result of the conflict and Putin, having gotten much of what he wanted in Ukraine (as well as Crimea), seems to have opted for a more gradual approach to his objective of reuniting a part of the former Soviet Union. (He called the break-up "the biggest geopolitical catastrophe of the twentieth century.")
How long the cease-fire will last is an open question, but Europe needs Russia as a customer for its manufactured products and it also needs Russian gas as winter approaches. Europe was on a path to grow 1% before Ukraine erupted, and the conflict has reduced the likelihood of hitting that mark. If we are truly entering a period of negotiation rather than conflict, the 1% real growth target is back in place. In addition, the head of the European Central Bank, Mario Draghi, has announced several steps underway toward monetary accommodation, which should stimulate European growth. All of this is favorable for European equities and ultimately for the U.S. market and the dollar, but the situation is fluid and could reverse toward the negative at any time.
More troubling is the situation in Syria and Iraq. President Obama has ordered air strikes against the Islamic State of Iraq and Syria (ISIS) to prevent the further incursion of ISIS troops into Kurdistan and curb the power of that organization in the region. A number of Arab and European states are fighting alongside the United States. The U.S. has been able to gain more international support for this effort, possibly because the recent beheadings have dramatized ISIS's barbaric brutality. It is doubtful that air strikes alone will do more than slow ISIS down. The first targets were oil-producing sites in Syria which provided revenue for ISIS's military operations. ISIS already occupies a reasonable amount of territory which it is not likely to surrender. The Chairman of the Joint Chiefs of Staff Martin Dempsey has said that ground troops may need to be sent in, even though there is no popular support in the United States for that alternative. President Obama has said that the ground fighters will have to be Arabs and Muslims from other nearby states like Saudi Arabia, Iraq, Jordan, the United Arab Emirates and Qatar. While there seems to be broad approval for our air strike efforts against ISIS, there are risks. The organization's Syrian headquarters in Raqqa is located in the heavily populated area and any bombing there would likely result in civilian casualties, thereby causing international criticism of our efforts.
ISIS's objective is to establish a "caliphate" or Islamic state in the region. As violent as they are, their political interest seems to be confined to the Middle East. In contrast, we have come to learn about Khorasan, an al-Qaeda related organization which does have attacks against cities in Europe and the United States as an objective. While putting terrorism out of your mind is easy given that it has been more than a dozen years since 9/11, we have been both skilled and lucky in thwarting planned attacks against us. We all hope our protective efforts will continue, but the threat has not gone away.
The nuclear weapons negotiations with Iran seem to have reached an impasse. Part of this is because of the complicated political relationships in the Middle East. Saudi Arabia has been an ally of the United States against ISIS and has encouraged us to provide arms to selected Syrian rebels, which we have resisted. Saudi Arabia is also adamant in not wanting Iran to become a nuclear power and is fearful that any deal which the Americans negotiate will be violated in important ways. In addition, the Saudis are worried that the United States may water down the tough parts of the agreement on the nuclear program to get Iran's military support in fighting ISIS. The United States is hoping to mollify the Saudis regarding any problems they might have with the nuclear agreement we negotiate with Iran. We are counting on Saudi military support against ISIS, and if Iranian oil production were reduced sharply for any reason, Saudi Arabia will play a role in making up the difference. The interrelationships among Saudi Arabia, the United States and Iran are tenuous at best and a breakdown at any level could result in higher oil prices. I have expected an agreement which would result in Iran limiting its nuclear enrichment program, but the progress has been erratic and a turn for the worse could have a negative market impact.
On Israel/Gaza, a cease-fire is also in place, but this is a conflict that is likely to be with us indefinitely. Both sides have made demands that will be hard to reconcile, so a permanent peace agreement is unlikely to be negotiated soon. The large number of Palestinian casualties has resulted in considerable criticism against Israel, particularly in Europe, but Israel argues that it was just defending itself against Hamas' missile attacks. It is hard to see any basis for agreement because the two sides are so far apart. I am going to the Middle East this month and specifically to Israel in November. Hopefully, I will have a more informed opinion when I return from these trips.
Finally I worry about the South China Sea. As the second largest economy in the world, China can be expected to have a political voice that it wants everyone to hear. China believes it has fishing rights in waters claimed by Japan and the Philippines and oil drilling rights in offshore Vietnam. My view has been that China is not willing to go to war over these issues. Right now, the leaders are preoccupied with their reform program, which includes a vigorous anticorruption effort, regulatory changes and a rebalancing of the components of gross domestic product in favor of the consumer sector by diminishing investment in state-owned enterprises and infrastructure. That's a full plate of domestic issues which I think will be the primary focus of China's near-term initiatives. Foreign policy will be kept at a low flame.
I also worry about the dysfunctional democracy we have here in the United States. The current Congress is likely to prove to be one of the least productive in history in terms of producing legislation. That may please some gridlock zealots, but there is much that needs to be done in Washington. I do not expect this condition to change even if the Republicans gain control of the Senate in November. That's the bad news. The good news is that what happens in Congress over the next few months is not likely to have much of an impact on the economy or the market. The big worries are elsewhere. A market coasting on positive sentiment is, however, likely to overreact in the face of negative developments.

Wien is a senior advisor to Blackstone, the asset management and private-equity firm.

Mass default looms as world sinks beneath a sea of debt

Global debt is still rising strongly, crimping growth and threatening defaults around the world

By Jeremy Warner

6:36PM BST 29 Sep 2014


Countries face being swamped by a tidal wave of debt Photo: AP           
As if the fast degenerating geo-political situation isn’t bad enough, here’s another lorry load of concerns to add to the pile.
The UK and US economies may be on the mend at last, but that’s not the pattern elsewhere. On a global level, growth is being steadily drowned under a rising tide of debt, threatening renewed financial crisis, a continued squeeze to living standards, and eventual mass default.
I exaggerate only a little in depicting this apocalyptic view of the future as the conclusion of the latest “Geneva Report”, an annual assessment informed by a top drawer conference of leading decision makers and economic thinkers of the big challenges facing the global economy.
Aptly titled “Deleveraging? What Deleveraging?”, the report points out that, far from paying down debt since the financial crisis of 2008/9, the world economy as a whole has in fact geared up even further. The raw numbers make explosive reading.
Contrary to widely held assumptions, the world has not yet begun to de-lever. In fact global debt-to-GDP – public and private non financial debt - is still growing, breaking new highs by the month. 

There was a brief pause at the height of the crisis, but then the rise in the global debt-GDP ratio resumed, reaching nearly 220c of global GDP over the past year. Much of the more recent growth in this headline figure has been driven by China, which in response to the crisis, unleashed a massive expansion in credit.
However, even developed market economies have struggled to make progress, with rising public debt cancelling out any headway being made in reducing household and corporate indebtedness.
Reduced mortgage finance during the banking crisis temporarily succeeded in capping and partially reversing the growth in UK household debt. Yet with a reviving housing market, these reductions may have come to an end, with the Office for Budget Responsibility expecting household debt to income ratios to start climbing again shortly.
In the meantime, the government has been piling on borrowings like topsy, not withstanding attempts by the Chancellor, George Osborne, to bring the deficit under control. Total national non financial indebtedness has therefore barely budged since the start of the crisis.
The UK remains the fourth most highly indebted major economy in the world after Japan, Sweden and Canada, with total non financial debt of 276pc of GDP. The US is not far behind with debt of 264pc of GDP.
However, the real stand-out is China, which since the crisis began has seen debt spiral from a very manageable 140pc of GDP to 220pc and rising. This is obviously still lower than many developed economies, but the speed of the increase, combined with the fact that it is largely private sector debt, makes a hard landing virtually inevitable.

The only way the world can keep growing, it would appear, is by piling on debt. Not good, not good at all.
There are those that say it doesn’t matter, or that rising debt is merely a manifestion of economic growth. And in the sense that all debt is notionally backed by assets, this may be partially true. But when rising asset prices are merely the flip side of rising levels of debt, it becomes highly problematic. Eventually, it dawns on the creditors that the debtors cannot keep up with the payments. That’s when you get a financial crisis.

Crisis or no crisis, the Geneva Report’s authors – Luigi Buttiglione of Brevan Howard, Philip Lane of Trinity College Dublin, Lucrezia Reichlin of the London Business School and Vincent Reinhart of Morgan Stanley – argue that rising indebtedness in developed economies has been crimping potential output growth ever since the 1980s.

The crisis has made an already bad situation worse, caused a further, permanent decline in both the level and growth rate of output. This in turn makes it much harder to work off debt; when economies are not growing, debt to GDP tends to rise automatically.
We now see much the same thing happening in emerging markets with output growth slowing markedly since 2008, particularly in China. Buying growth with debt is reaching the limits of its viability.
It is possibly the case that Anglo-Saxon economies, the US and UK, have done better in managing the trade off between deleveraging and output than others. However, this may be largely a conjuring trick.
To the extent that meaningful reductions in private and financial sector debt have been achieved without greater damage to output, it is only because there has been a parallel and very substantial increase in public indebtedness.
Despite the deficit reduction rhetoric, George Osborne, the UK Chancellor, has in fact been doing the bare minimum to keep the markets off his back. He’s also had plenty of help from the Bank of England, which itself has become leveraged to the gunnels with government debt to ease the path back to fiscal sustainability. None the less, this is plainly a much better place to be than the Eurozone, which has imposed entirely counterproductive debt controls on governments and thus far at least, denied them the luxury of debt monetisation by the European Central Bank. The result is a crushing depression for much of the single currency bloc.
Historically, big debt overhangs have tended to be dealt with via inflation and currency adjustment, the natural, market based way of haircutting creditors. Both these options are denied to the Eurozone economies, and when everyone is in the same high debt boat may in any case no long work as they once did.
There is no sign of the inflation you might expect after such an unprecedented phase of central bank money printing, and judging by still historically low government bond yields, very little prospect of it.
The world economy may have entered a vicious circle where excessive debt constrains demand to such a degree that both interest rates and inflation, and therefore growth too, remain permanently low. This way of thinking may be unduly pessimistic, but it is also worryingly plausible.
And in conditions where excessive debt cannot be worked off through growth, restraint and inflation, adjustment will eventually be forced much more divisively through default. It’s a toss-up who is going to breach the dam first, but unless the European Central Bank rides to the rescue with debt monetisation soon, the betting has to be on Italy, where debt dynamics already seeem to have entered a death spiral. That this is not yet reflected in bond yields is down only to the assumption that the ECB will eventually oblige. Perhaps it will, but even if it does, it will only buy time.

September 30, 2014 1:53 pm

Why inequality is such a drag on economies
Big divides in wealth and power have hollowed out republics before and could do so again
Ingram Pinn illustration©Ingram Pinn
When should growing inequality concern us? This is a moral and political question. It is also an economic one. It is increasingly recognised that, beyond a certain point, inequality will be a source of significant economic ills.
The US – both the most important high-income economy and much the most unequal – is providing a test bed for the economic impact of inequality. The results are worrying.
This realisation has now spread to institutions that would not normally be accused of socialism. A report written by the chief US economist of Standard & Poor’s, and another from Morgan Stanley, agree that inequality is not only rising but having damaging effects on the US economy.
According to the Federal Reserve, the upper 3 per cent of the income distribution received 30.5 per cent of total incomes in 2013. The next 7 per cent received just 16.8 per cent. This left barely over half of total incomes to the remaining 90 per cent. The upper 3 per cent was also the only group to have enjoyed a rising share in incomes since the early 1990s. Since 2010, median family incomes fell, while the mean rose. Inequality keeps rising. The Morgan Stanley study lists among causes of the rise in inequality: the growing proportion of poorly paid and insecure low-skilled jobs; the rising wage premium for educated people; and the fact that tax and spending policies are less redistributive than they used to be a few decades ago.

Markets’ Rational Complacency

Nouriel Roubini

SEP 30, 2014

Hong Kong democracy protests

NEW YORK – An increasingly obvious paradox has emerged in global financial markets this year. Though geopolitical risks – the Russia-Ukraine conflict, the rise of the Islamic State and growing turmoil across the Middle East, China’s territorial disputes with its neighbors, and now mass protests in Hong Kong and the risk of a crackdown – have multiplied, markets have remained buoyant, if not downright bubbly.
Indeed, oil prices have been falling, not rising. Global stock markets have, overall, reached new highs. And credit markets show low spreads, while long-term bond yields have fallen in most advanced economies.
Yes, financial markets in troubled countries – for example, Russia’s currency, equity, and bond markets – have been negatively affected. But the more generalized contagion to global financial markets that geopolitical tensions typically engender has failed to materialize.
Why the indifference? Are investors too complacent, or is their apparent lack of concern rational, given that the actual economic and financial impact of current geopolitical risks – at least so far – has been modest?


A New Fed Playbook For The New Normal

  • Zero percent interest rates is the new normal.
  • Even if the Fed talks higher rates, they know that they can't without crashing the so called recovery.
  • When rates do rise, it won't be by choice, and the results won't be pretty.
While many economists and market watchers have failed to notice, we have entered a new chapter in the short and checkered history of central banking. This paradigm shift, as yet unaddressed in the textbooks, changes the basic policy tools that have traditionally defined the sphere of macroeconomic decision-making.

The job of a central banker is supposed to be the calibration of interest rates to achieve the optimal rate of growth for any particular economic environment. It is hoped that successful decisions, which involve perfectly timed moves to raise rates when the economy overheats and lower them when it cools, would bring consistency and stability to the business cycle that many fear would be dangerously erratic if left unmanaged. That's the theory. The practice is quite different.

Over the past thirty years or so, interest rates have been lowered far more often than they have been raised. This makes sense. Bankers, being human, would rather err on the side of good times not bad.

They would rather leave the punch bowl out there a little too long than take it away too soon. Over time, this creates a huge downward bias. But things have really become distorted over the past eight years, a time period during which interest rates have never gone up. They just go down and stay down.

Back in the early years of the last decade, Alan Greenspan ventured into almost unknown territory when he lowered interest rates to 1% and left them there for more than a year. But in today's terms, those moves look hawkish. In the wake of the 2008 financial crisis, Ben Bernanke brought interest rates to zero, where they have remained ever since.

But old habits die hard, and economists still expect that rates can and will go back to normal. They assume that since the economy is now apparently on solid footing, the period of ample accommodation is over. In reality, we have built an economy that is now so leveraged that it needs zero percent interest rates just to tread water.

Based on statistics from the Bureau of Economic Analysis, from 1955 to 2007 Fed Funds rates were on average 230 basis points higher than average GDP growth (5.7% vs. 3.4%). But from 2008-2013, Fed Funds rates have been less than half the rate of GDP growth (0.44% vs. .92%). Rates lower than GDP, in theory, should stimulate the economy. But instead we are stuck in the mud.

Twenty-odd years ago the textbooks still seemed to work. A recession hit in 1991, which brought GDP close to zero. In response, the Fed cut rates by more than 200 basis points (from 5.7% in 1991 to 3.5% in 1992.) As expected, 1992 GDP rebounded to a reasonably healthy 3.6%. But the rate cuts did little for asset prices. In that year the S&P 500 crept up just 4.4% and the Case-Shiller 10-City Composite Index of home prices actually fell almost 2% nationally.

Compare that to 2013. With Fed Funds still near zero, GDP actually fell to 2.2% from 2.3% in 2012. But asset prices were a different story. Stocks were up 26% and real estate up 13.5%. It would appear that interest rates have lost their power to move GDP and can now only exert pressure on asset prices.

As a result, rates are no longer the main attraction in central banking. The real action takes place elsewhere.

The Fed and other central banks have made the active purchase of financial assets, known as quantitative easing, to be their main policy tool. QE is a more powerful drug than interest rates. It involves actual market manipulation by the purchases of bonds on the open market. Whereas zero interest rates could be compared to a general stimulant, QE is a direct shot of adrenaline to the heart. When the next recession comes, the syringe will likely come into greater use.

Since 1945 the U.S. economy has dipped into recession 11 times. The average length of the recoveries between those recessions was 58.4 months, or just under five years. The current "recovery" is already 73 months old, or 15 months longer than the average. How will the Fed deal with another contraction (which seems likely to begin within the next year or two) with rates still at or very close to zero? QE appears to be the only option.

Given that reality, the big question is no longer whether the Fed will raise or lower rates, but by how much they will ramp up or taper off QE. When the economy contracts, QE purchases will increase, and when the economy improves, QE will be tapered, and may even approach zero for a time. But interest rates will always remain at zero or, at the least, stay far below the rate of inflation. This will continue until QE loses its potency as well.

Mainstream economists will be quick to dismiss this theory, as they will say that policy is now on course for normalization. Although economic growth in 2013 was nothing to write home about, the set of indicators that are normally followed by most economists, point to a modest recovery, exuberant financial markets, and falling unemployment. But if that is the case, why has the Fed waited so long to tighten?

The truth is the Fed knows the economy needs zero percent rates to stay afloat, which is why they have yet to pull the trigger. The last serious Fed campaign to raise interest rates led to the bursting of the housing bubble in 2006 and the financial crisis that followed in 2008. This occurred despite the slow and predictable manner in which the rates were raised, by 25 basis points every six weeks for two years (a kind of reverse tapering). At the time, Greenspan knew that the housing market and the economy had become dependent on low interest rates, and he did not want to deliver a shock to fragile markets with an abrupt normalization. But his measured and gradual approach only added more air to the real estate bubble, producing an even greater crisis than what might have occurred had he tightened more quickly.

The Fed is making an even graver mistake now if it thinks the economy can handle a measured reduction in QE. Similar to Greenspan, Bernanke understood that asset prices and the economy had become dependent on QE, and he hoped that by slowly tapering QE the economy and the markets could withstand the transition. But I believe these bets will lose just as big as Greenspan's. The end of QE will prick the current bubbles in stocks, real estate, and bonds, just as higher rates pricked the housing bubble in 2006. And as was the case with the measured rate hikes, the tapering process will only add to the severity of the inevitable bust.

So while the market talks the talk on raising rates, the Fed will continue to walk the walk of zero percent interest rates. The action has switched to the next round of QE. In fact, since none of the Fed's prior QE programs were followed by rate hikes but by more QE, why should this time be any different? The most likely difference will be that eventually a larger dose of QE will fail to deliver its desired effect. When that happens, who knows what these geniuses will think of next. But whatever it is, rest assured, it won't be good.

Investment Banking

JPMorgan Chase Says More Than 76 Million Accounts Compromised in Cyberattack

by Jessica Silver-Greenberg and Matthew Goldstein

October 2, 2014 12:50 pm   

The headquarters of JPMorgan Chase in New York.Credit Mike Segar/Reuters

A cyber attack this summer on JPMorgan Chase compromised more than 76 million household accounts and seven million small-business accounts, making it among the largest corporate hacks ever discovered.
The latest revelations, which were disclosed in a regulatory filing on Thursday, vastly dwarf earlier estimates that hackers had gained access to roughly one million customer accounts.
The new details about the extent of the hack — which began in June but was not discovered until July — sent JPMorgan scrambling for the second time in just three months to contain the fallout.
As the severity of the hack became more clear in recent days and new information was unearthed, some top executives flew back to New York from Naples, Fla., where many had convened for a leadership conference, according to several people briefed on the matter.
Hackers were able to burrow deep into JPMorgan’s computer systems, accessing the accounts of more than 90 servers–a breach that underscores just how vulnerable the global financial system is to cyber crime. Until now, most of the largest hack attacks on corporations have been confined to retailers like Target and Home Depot.
And unlike those retailers, JPMorgan has far more sensitive financial information about customers. Investigators in law enforcement remain puzzled by the attack on the bank because there is no evidence that the attackers looted any customer money from accounts.
The lack of any apparent profit motive has generated speculation among law enforcement officials and security experts that the hackers were sponsored by foreign governments either in Russia or  in southern Europe.
By the time JPMorgan first suspected the breach in late July, hackers had already “rooted” more than 90 computer servers– hacker-speak for gaining the highest level of privilege to those machines– according to several people briefed on the results of the bank’s forensics investigation who were not allowed to discuss it publicly.
It is still not totally clear how hackers managed to gain deep access to the bank’s computer network. By the time, the bank’s security team discovered the breach in late July, hackers had already gained the highest level of administrative privilege to more than 90 of the bank’s computer servers,  according to several people briefed on the results of the bank’s forensics investigation who were not allowed to discuss it publicly.
More disturbing still, these people say, hackers made off with a list of the applications and programs that run on every standard JPMorgan computer– a hacker’s roadmap of sorts– which hackers could cross check with known vulnerabilities in each program and web application, in search of an entry point back into the bank’s systems.
These people said it would take months for the bank to swap out its programs and applications and renegotiate licensing deals with its technology suppliers, leaving hackers plenty of time to mine the bank’s systems for unpatched, or undiscovered, vulnerabilities that would allow them reentry into JPMorgan’s systems.
In the filing, JPMorgan said there was no evidence that account information, including passwords or Social Security numbers, were taken.
The original hack sent ripples through the financial system and prompted an investigation by the Federal Bureau of Investigation, even as Wall Street, which has been a frequent target for hackers in recent years, worked to guard against the threats.
The bank was also forced to update its regulators, including the Federal Reserve, on the extent of the breach. The bank said at the time that there was no indication that any customer money was taken and that it believed it had secured all its systems.



Getting Technical

Will Stocks Suffer Death By a Thousand Cuts?

It's not just today's big, trendline-piercing selloff: The list of bearish technical indicators keeps growing.

By Michael Kahn

October 1, 2014 defines "death by a thousand cuts" as lots of small bad things happening, none of which are fatal in themselves, but which add up to a slow and painful demise. It's not just Wednesday's 238-point plunge in the Dow—the body of technical evidence suggesting a rough road ahead for the stock market is too large to ignore.
Over the past week or two, we've seen several traditional and a few esoteric indicators suggest that the market was not as strong as the recent record high in the Dow Jones Industrial Average might suggest. Even with the volatility and net loss over the past few days, the Dow is still within 3% of its high watermark.
But the chart pattern the decline has left in its wake was the first indication that something is wrong (see Chart 1). The Dow's mid-September breakout lasted but a few days before the index fell back into its previous pattern. Chart watchers have several names for such head fakes, including the ominous "breakout failure."

Chart 1

Dow Jones Industrial Average

The breakout happened when demand surged on Sept. 18. The failure happened two days later when supply surged to meet and exceed that new demand. Prices sagged, and as breakout failures often do, they led to a return, if not a breakthrough, to the bottom of the pattern from which they emerged.
The financial sector made the same move and had the same failure. So, too, did two other key sectors—semiconductors and retail.
These are the obvious changes on the charts. Less obvious was a 90% down day, Sept. 25, in which the lion's share of the market's volume and price movement was to the downside. Consider it the first shot across the bow as investors start to sell whatever is not bolted down.
Also in the financial news, albeit temporarily, was the moving average death cross as the small-capitalization Russell 2000's 50-day average crossed below its 200-day average. Critics were quick to point out its lack of statistical credibility as a sell signal, and in the postfinancial crisis era they were right. But indicators do not last over the years if they have never had any validity. The short-term trend via its 50-day average proxy is now below the long-term trend, and that is not a good thing.
But the Russell's chart has a more sinister feature than just a moving average cross, and it is probably the most important. This index has gone nowhere all year, creating a wide chasm between the performance of big stocks and small stocks. This divergence is not healthy, and tells us that fewer stocks have led the market higher. The same divergence occurred in 2007, and arguably in 2000, at the tops of previous cyclical bull markets.
This split between rising and falling stocks is the basis for another strange indicator that fired its warning signal last week. The Hindenburg Omen, named for the ill-fated dirigible that exploded over New Jersey in 1937, looks for high numbers of stocks trading at 52-week highs and 52-week lows at the same time. This split in the market makes it unstable and often leads to declines in the following weeks.
Market crashes do not necessarily follow, although they can. The Omen is only meaningful when it fires multiple times in a short time period. That has not happened, but its single occurrence is one of the thousand cuts that should make investors nervous.
On the heels of last week's Alibaba Group initial public offering, some market observers noted that record-setting IPO volume often coincides with major market tops. I understand the logic—that companies rush out to raise as much money as possible during a frenzied market advance. The data, however, do not support the idea. It is true that in 2000 and 2007 there were record numbers of IPOs coming to market, but one happened months before the top and the other happened months after. And throughout the 1990s, record-setting IPO numbers did not coincide with tops at all.
Also ripped from the headlines, one analyst plotted breakdowns in Bill Gross' former Pimco High Yield Fund as coinciding with major stock tops. Here, the logic that junk bonds break down ahead of stock tops is valid. While U.S. Treasury bonds remain in rising trends, junk bonds have indeed cracked in a "risk off" trade. Money is moving to safety, underscoring the market's mood.
Together, all of these factors put the market in a precarious position. And Wednesday, perhaps the most important factor of all was close to signaling a breakdown. The Standard & Poor's 500 traded marginally below its rising trendline from the key November 2012 low (see Chart 2). The New York Stock Exchange composite, which arguably represents the average stock, has already broken its trendline.

Chart 2

Standard & Poor's 500

How much can the market withstand before lapsing into a major decline? That line may have already been crossed.
Michael Kahn, a longtime columnist for, comments on technical analysis at A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.

U.S. gold output declines on back of Newmont, Barrick

Canada was the leading exporter of gold to the United States for the first half of this year, according to the U.S. Geological Survey.

Author: Dorothy Kosich

Posted: Tuesday , 30 Sep 2014 

RENO (Mineweb) -  Production of gold by U.S. mines was 17,700 kilograms (569,068 troy ounces) in June, down 10% from 19,600 kg (630,154 oz) in June 2013, the U.S. Geological Survey recently reported. Domestic gold production for the first six months of this year was down 8% than that of the first half of last year due to lower production from Barrick Gold’s Cortez Mine and Newmont Mining’s Nevada operations.

For the first half of this year, U.S. mines produced 103,000 kg (3,311,526 oz) of gold. Nevada led production with 74,100 kg (2,382,370 oz), followed by Alaska with 15,100 kg (485,476 oz), and other states combined at 14,000 kg.

The Cortez Mine in Northern Nevada produced only 13,800 kg (443,680 oz) of gold during the first half of this year, down 42% from the first six months of last year “owing to a drastic decline in grade in ore from the Cortez Hill open pit,” said the USGS.
During the same period, Newmont’s Phoenix operations, also located in Northern Nevada, “produced less gold owing to lower mill throughput and lower ore grade,” said the survey.

“The Twin Creeks Autoclave processed less tonnage, partially owing to the sale of the Midas Mine in the first quarter of 2014.”

The USGS also reported that U.S. imports for the consumption of gold for the first six months of 2014 were 5% lower than during the same period in 2013. While imports of ores and concentrates during the first half of the year were up 48%, imports of refined bullion increased 15%. However, imports of doré (a rough gold and silver alloy) and precipitates decreased by 14%.

Canada was the leading shipper of gold to the United States, supplying 27% of total U.S. gold imports in the first half of this year, followed by Mexico at 22%; Columbia at 13% and Bolivia, which supplied 10%, said the geological survey. Canada accounted for 73% of refined bullion and 97% of ores and concentrates for the first six months of 2014.

Total U.S. gold exports plunged 41% in the first half of this year, compared with those for the first half of last year, said the agency. “Exports of ores and concentrates decreased by 29%, exports of doré and precipitates decreased by 45%, and exports of refined bullion decreased by 40%.”

Hong Kong and Switzerland were the leading destinations for U.S. gold materials accounting for 42% and 34%, respectively, of the gold exports for the first half of this year and 58% and 20%, respectively, of bullion exports during the same period.

The leading recipients of U.S. exports of gold doré and precipitates for the first six months of this year were: Switzerland (74%), United Arab Emirates (15%), and India (10%), said the USGS.


Shadow Banking is Boon, Bane for Financial System
IMF Survey
October 1, 2014

  • Shadow banking differs between countries, shares same underlying drivers
  • Shadow banking contributes substantially to financial risks in United States, much less in Europe

  • Regulators should work together to avoid risks migrating

Shadow banking is both a boon and a bane for countries, and to reap its benefits, policymakers should minimize the risks it poses to the overall financial system.
Shadow banks act similarly to regular banks by taking money from investors and lending it to borrowers, but are not governed by the same rules or supervised. Shadow banks can include financial institutions such as money market mutual funds, hedge funds, finance companies, and broker/dealers, among others.

The IMF’s latest Global Financial Stability Report analyzes the growth in shadow banking in recent years in both advanced and emerging market economies and the risks involved.
According to the report, shadow banking amounts to between 15 and 25 trillion dollars in the United States, between 13.5 and 22.5 trillion in the euro area, and between 2.5 and 6 trillion in Japan—depending on the measure— and around 7 trillion in emerging markets. In emerging markets, its growth is outpacing that of the traditional banking system.

“We found that the same factors often seem to drive the growth of shadow banking across countries,” says Gaston Gelos, chief of the Global Financial Analysis Division at the IMF. “Shadow banking tends to take off when strict banking regulations are in place, which leads to circumvention of regulations. It also grows when real interest rates and yield spreads are low and investors are searching for higher returns, and when there is a large institutional demand for ‘safe assets,’ for example from insurance companies and pension funds.”

Risks, benefits

As the global financial crisis has shown, there are also risks associated with shadow banking due to their reliance on short-term funding, which can lead to forced asset sales and downward price spirals when investors want their money back at short notice.
In the United States, shadow banking accounts for at least a third of total systemic risk, (measured as extreme losses to the financial system that occur with a very low probability), similar to that of banks. In the euro area and the United Kingdom, their contribution to systemic risk is much smaller relative to the risks arising from their banking system. This largely reflects the fact that the latter are still more bank-based financial systems.

In advanced economies, activities traditionally considered less risky, such as non-money market investment funds, have been growing the fastest since 2009; from 35 to 70 percent of GDP in the United States, and from 35 to 65 percent in the euro area.

However, especially in the euro area, these funds are now holding a higher proportion of less-liquid assets, such as commercial loans, compared to five years ago. The IMF observed similar trends in the United States.

This can potentially cause problems if the claims given to investors are very liquid; if many investors want to sell at the same time, funds may not be in a position to meet these redemptions since they would not be able to sell assets quickly. This may result in runs and fire sales, as in the global financial crisis.

Among emerging market economies, the large size (between 35 and 50 percent of GDP), and fast growth (over 20 percent per year), of shadow banking in China stands out and warrants close monitoring. Recently, authorities have taken various steps to combat the excessive growth of shadow banking.

How to manage the boon

Shadow banking can be beneficial. It broadens access to credit, especially in emerging market economies, where traditional banking networks often face capacity or regulatory constraints, such as restrictions on lending or on interest rates.

In advanced markets, various types of funds have been stepping in to provide long-term credit to the private sector as banks have been lending less. Shadow banks also can improve the efficiency of the financial system by deepening market liquidity and risk sharing.

The IMF’s report calls for countries to monitor shadow banking as part of their policies designed to keep the overall financial system safe. The IMF said the degree of shadow banking oversight and regulation should depend on how much it contributes to systemic risk, in line with recommendations by the Financial Stability Board—which brings together national authorities responsible for financial stability.

This macroprudential framework would ensure that shifts in shadow banking to areas where regulation and policy frameworks are weaker would not go undetected. Macroprudential and microprudential supervisors need to work jointly to achieve this.

To assess risks properly, both supervisory authorities and statistical agencies need to provide much more detailed data on shadow banking.

International regulatory cooperation is also crucial. Risks are more likely to increase when regulatory initiatives are implemented by only a few countries, or when they are poorly coordinated. Regulatory tightening in one country, for example, might lead to migration of activities to others with laxer rules.

Governments have begun to put in place rules to address the risks through the work of the Financial Stability Board.


What Hong Kong Means for the Global Economy

Tuesday, 30 Sep 2014 08:57 AM
By Mohamed A. El-Erian
Will the tensions in Hong Kong be the straw that breaks the global economy’s back? That question is on many investors’ minds as they watch the Chinese government's response to one of the biggest sociopolitical challenges it has faced in recent years. The answer is far from straightforward.

It is already a tentative time for the world economy. Growth is faltering in Europe and Japan. The U.S. economy, while doing better, has yet to lift off. Emerging economies have slowed, and are unlikely to return to higher growth anytime soon.

Meanwhile, pockets of excessive risk-taking have multiplied in financial markets, adding to concerns about future volatility. And the central banks in advanced countries have already ventured deep into the terrain of experimentation; the effectiveness of their policies is far from assured. The world cannot afford a politically induced slowdown in China.

Some are quick to use history to dismiss any lasting economic impact, both domestic and global, of the Hong Kong protests. They rightly point to the repeated ability of the Chinese government to quash internal protests, and without altering the country’s growth trajectory. For them, it is only a matter of time until the current civil disobedience in central Hong Kong dissipates.

Yet this view ignores two more recent historical insights.

First, the combination of the Internet, social media and better mobility makes it easier to coordinate and sustain protests, while also reinforcing individuals’ confidence in meeting their aspirations. The outcomes of the ensuing collective actions become much more difficult to predict.

Second, China has been engaged in the delicate task of revamping its growth model. This includes reducing its reliance on external sources of demand and on excessive state and credit-led investments, and toward unleashing greater domestic grass-roots engines of growth, investment, consumption and prosperity.

This is not to say that the stability of the government is in any danger today from the protest movement and that an economic contraction in China is about to send tremors through the world economy.
Indeed, the Chinese government is likely to prevail over the Occupy Central movement in Hong Kong. But in doing so, it will probably be inclined to slow certain economic reforms for now, seeking instead to squeeze more growth from the old and increasingly exhausted model — similar to how Brazil's government responded to protests there ahead of the World Cup a few months ago. And while this would be part of a broader political strategy to defuse tensions and avoid an immediate growth shock to both China and the global economy, it would undermine the longer-term economic vibrancy of both.

viernes, octubre 03, 2014



Why the Fed Will Go Faster

Martin Feldstein

SEP 30, 2014

 Janet Yellen

CAMBRIDGE – The US Federal Reserve has emphasized that its monetary policy will be determined by what economic indicators show. But it would require some extremely unlikely data to change the Fed’s implicit plan to end its purchases of long-term assets (so-called quantitative easing) in October 2014 and to start raising the federal funds rate from its current near-zero level sometime in the first half of 2015.
The financial markets are obsessed with anticipating whether rates will rise in March or June. Although my own best guess is that the Fed will start to raise rates in March, the starting date is less important than the pace of the rate increase and where the rate will be by the end of 2015.
There is a substantial range of views among the members of the rate-setting Federal Open Market Committee. The midpoint of the opinions recorded at most recent FOMC meeting implies a federal funds rate of 1.25-1.5% at the end of 2015. Even by the end of 2016, the midpoint of the range is less than 3%.
In my judgment, such rates would be too low. At a time when inflation is already close to 2% or higher, depending on how it is measured, the real federal funds rate would be at zero at the end of 2015. Instead of ensuring price stability, monetary policy would be feeding a further increase in the inflation rate.