The graph below illustrates four bad bear markets over the last 80 years (from Doug Short, dshort.com, article), including the great depression (based on the Dow), as well as the 1973 oil crisis, 2000 technology crash, and the current 2008 credit/housing sell-off (each based on the S&P). Note: You should be able to click on each image to make them bigger.

Source: dshort.com

The second graph provides more specific return data for the current market, including the various rallies and sell-offs.

Source: dshort.com

When looking over the graphs and comparing to the current downturn to the 1973 and 2000 crashes, some may conclude that we are approaching the end game of the correction. If on the other hand they were to compare to the 1929 crash (graph below), it might be speculated that we may have another correction in the cards before entering into the long climb back from the abyss. Either way, the market certainly seems to be at an interesting point.

Source: dshort.com

Of course, this type of analysis often assumes some correlation/relation between the bear markets. Where it goes from here, and whether it follows the pattern of one of the other larger bear markets is just about any one's guess (even for most of those who claim to know otherwise). Yet, even without history being a perfect guide, it is interesting to see and learn about how things played out in the past. Regardless of their predictive nature, I recommend that you check out the dshort.com site if you have not already done so. There is a lot of good visual data of historical moves, each of which is easy to understand, interesting to look at, and of course fun to speculate about - even if you are not a technician, or someone who trades on past patterns. Most of the charts are updated daily and weekly.

Below are some links of interest (at least to me), just in case you missed them. Some have already been posted to Twitter. Not sure if I will keep this up daily, or update throughout the day as often.

• Economic calendar for Thursday, July 23rd (Briefing.com Economic).
• Earnings calendar for Thursday, July 23rd (Briefing.com Earnings).

• S&P 1500 most volatile stocks (Bespoke Investment Group).
• President Obama is proposing a new transaction fee for "far-out transactions," also known as derivatives, no doubt (WSJ). Of course, I guess this also includes any other thing that financial engineers can come up with. Less resulting risk, maybe. Less innovation, probably.
  
• Foreclosure activity by region (The Big Picture). California, Florida, and Nevada account for half of all foreclosure activity, with California roughly twice Florida's foreclosure level. And we wonder why the Terminator and his state are having problems.
• Speaking of California, Occidental Petroleum (OXY) discovered 150-250 million barrels of oil and gas in California (WSJ). Lawmakers are already looking for new ways to tax and regulate it - seriously.
  
• The (sorry) state of the M&A Markets (The Pragmatic Capitalist).
• Standard & Poor's adjustments in the way it accounts for certain loss and recovery assumptions is proving unsettling to the Commercial MBS market (WSJ). Some securities were re-rated as AAA days after sharp downgrades (Financial Times). Apparently, the Fed will only finance triple A securities. Whoops.
  
• Is the market exhausted? Check out the Divergence Index, and then you decide (Zero Hedge).
• AIG holds off on planned bonuses ...... for now, avoids pitchforks ...... for now (WSJ).
• That did not stop Morgan Stanley. MS's compensation soars to 72% of revenues (Clusterstock).
• Boeing has found a solution to the technical problem with the Dreamliner that has caused so many delays (WSJ). But you have to wait some more, as the company will provided updates a little later in Q3. Amazing. All kidding aside, the problem may be more serious than originally thought (Seattle Times Newspaper).
• A recent survey finds that investment advisers are predicting that clients will move more assets out of conventional mutual funds into ETFs (WSJ). The moves are being driven by concerns regarding both return performance and transparency. Past revenue-sharing-kick-back concerns probably did not help either.
  
• Edward Jones says no to offering leveraged ETFs (ETF Trends). They must not have been part of the previous survey.
• Some historical returns of the Harvard and Yale endowments, compared to other popular benchmarks, are provided over at World Beta. A bad year for the endowments, but diversification still helped over the long-term.
• Bottom line earnings beat rates are near highs, while top line revenue beat rates not so much (Bespoke Investment Group). How long can you cut costs, and jobs? Eventually the consumer is going to have to step up and buy stuff ... after they get a new job, or feel safe about their current job - may be a long time with a jobless recovery. Unfortunately, we cannot all help out by buying a new Camaro, even if we wanted to (Carpe Diem).
• Is Covestor Investment Management (A VC) the next big thing (Bull Bear Trader)? Basically, the system is designed such that you would have your own account, but could then choose from a number of investment managers that you want to follow. The investment managers could be in the financial industry, or more likely just an average investor like you. If you choose to follow the investment manager, funds in your account are used to mimic the trades of the manager. Check it out (Covestor). It sounds interesting (but there are concerns and questions).
  

There is an interesting post at the A VC blog on a new type of investment approach, called Covestor Investment Management (CV.IM). [Hat tip to all the Twitter tweets that pointed to the link]. The post describes the CV.IM as:

"The world’s first retail Multi Managed account or MMA. With an MMA you can invest directly alongside professional and retail investors, managing their own money in their own account. It is a new category of Investment product that gives you access to expert managers like a hedge fund with the security and transparency of a managed account."

Basically, the system is designed such that you would have your own account, but could then choose from a number of investment managers that you want to follow. The investment managers could be in the financial industry, or more likely just an average investor like you, but possibly with more experience, and with a track record or strategy to your liking. If you choose to follow the investment manager, funds in your account are used to mimic the trades of the manager. In return, the investment manager could get some compensation for sharing his/her data, although they can also continue to share their investment ideas for free.

It seems that such a structure could have some advantages. First, the fee structure is certainly less than a mutual fund or hedge fund for following the free managers, and also much less for even those charging a following fee (listed as $120 per person per manager). The system could also end up offering a number of investment options and strategy choices for free. For aspiring investment managers, there is also the opportunity to "prove yourself" and your strategy, and make a little money in the process.

Nonetheless, there are a number of questions. While the company does have a system in place to report performance, it is not clear how much data is available, or how accurate it will be if trading data/history is introduced for new managers. It is also unclear whether or not the managers could somehow game the system, or receive an unfair advantage by front-running the followers. One of the founders did respond in the post comments section that there will be minimum liquidity restrictions to prevent some abuse, but the managers could still have an initial advantage over new followers. The minimum daily trading volumes of 10,000 shares and $50 million in market cap also seem a little low. It is also worth noting that the managers will most likely be timing their buying and selling based on what is most beneficial to them, and not necessarily your current situation, causing you to possibly incur a commission and/or tax event at an inopportune time. Such a structure could also lose the ability to take advantage of scale with regard to transactions, unless a large number of investors are already following a particular manager (scale advantages are still possible given that most of the funds will be with only a few brokers - so far TD Ameritrade and Interactive Brokers). Nonetheless, new followers would most likely have to pay higher per share fees.

Although there are still numerous questions to be answered, the idea sounds intriguing, and is certainly worth pursuing more. Check out the Covestor website to learn more.

Below are some links of interest (some already posted to Twitter). I may or may not continue with this, given that there are already some good link pages on the web (in particular, Abnormal Returns). Nonetheless, I may at least organize some recent Twitter posts every day or so.

• Today's earnings calendar (Breifing.com).
• Overview of High Frequency Trading (Clusterstock). HFT in C, BAC, and CIT explained (Zero Hedge). Interesting, and scary stuff. Are high-frequency trading and liquidity rebates keeping CIT over $1 per share? (Zero Hedge, The Pragmatic Capitalist).
• Insiders at Smuckers have been exercising options and selling shares at highs for the last two summers (WSJ). Should you?
• Developers Diversified Realty (DDR) to be the first in commercial real estate to use TALF (WSJ). Are alternative investments to follow?
• Who is laughing now? Variable annuities have been one of the better investments over the last decade (WSJ). But they are still boring.
  
• A Bloomberg Global poll has 61% of investors saying the world economy is stable or improving, with almost 75% taking a favorable view of Federal Reserve chairman Bernanke (Bloomberg). So naturally, he is probably toast.
• Is the NYSE Bullish Percent Index approaching lunacy areas? (ES & EC Futures Analysis)
• Calpers in down 23.45% for the fiscal year (WSJ). Now there is some talk about whether governments will need to sure-up various pension funds. But where will the money come from?
• Inverse relationship between price and volume (The Pragmatic Capitalist). Will this summer be different?
• StockCharts.com Charts on the Blog (VIX and More).
• Bull market for emerging markets (Carpe Diem). Topping, or just getting started?
• Do superstition and eclipses matter for the stock market? (Marginal Revolution) Groovy man.
  
• Death and taxes, and the federal budget. Where your money is going (The Big Picture)?
  

The moves in the markets since the March lows, along with the recent winning streaks for the indexes (see Clusterstock article) and various stocks (see Bespoke Investment Group articles here and here), are causing some investors to begin thinking about cashing out and taking some profits. Yet as many investors know, buying is often the easy part, while knowing when to sell can at times be more difficult without some defined metrics and discipline. When things are going good, no one seems to want to jump off the momentum train, even if there could be derailment due to worries about top line revenue growth and earnings that may not be a good as advertised (see articles here, here and here).

So what should you do if you want to stay on the momentum train? One potential strategy is to consider a stock replacement strategy (see WSJ article), allowing you to lock into current profits while still maintaining some future upside in the stock. Replacement strategies are actually fairly simple, at least if you have some familiarity with options. To enter the strategy, you simply sell the stock of the company that has run-up, thereby locking in the gains. You then buy a call option on the stock, thereby giving you the potential to benefit from future upside moves in the stock.

As with any option purchase, you will need to define a strike price and expiration date. Fortunately, implied volatility has come down in in recent months, making the strategy a little more bearable, yet you will need to determine the cost effectiveness of the strategy at current premium levels. As a starting point, Scott Becker, derivatives strategist at Jefferies, suggest options that are at-the-money, with about three months until expiration (see WSJ article). ATM options will allow you to get in the strategy near your stock selling price, while the three months will take you to the beginning of the next earnings cycle, providing a little more information on the market and its reaction to current fiscal and monetary decisions - not to mention give you a little more insight was to whether the consumer finally steps up to the plate, allowing top line revenue numbers to start coming in higher. Others suggest deep-in-the-money options, causing the delta of the option to be near one, providing an exposure and movement that is closer to owning the stock (see Investopedia description).

As always, remember that while the strategy does allow you to offset some risk, and essentially stay in the position, entering any strategy will cause you to incur extra transaction costs and the bid-ask spread, with this strategy also generating a capital gains tax on your initial stock earnings (see Abnormal Returns article). Nonetheless, while no strategy is perfect, stock replacement may be worth considering as the market and your individual securities keep advancing, and corresponding implied volatility decrease.

Daniel Alpert of Westwood Capital and Jerry Webman of Oppenheimer Funds were recently on CNBC discussing the credit markets. Alpert mentioned that while the panic has left the market, and many banks are doing well due to widening credit spreads, the spreads are wide in-part since the assets on which many of the loans are made are still underwater. This gives room for some concern. Alpert also believes that while the recent funding for CIT was a positive, a bankruptcy at CIT is still about 50-50 given that their collateral will be difficult to collect upon. Alpert also still has some worry as to whether there will be enough capital available in the markets and banking system to absorb the level of losses that will still need to be taken.

Source: CNBC Video

Webman was a little more encouraging and believes that it is a positive that private funding was available for CIT. Nonetheless, credit spreads in the investment grade area are still pricing in defaults and poor recoveries at 4-5 times the historical averages, signaling that people are still cautious. Webman did mention one good trend that is showing up - people are breaking apart the "toxic" assets into their good and bad component parts, with the good assets being put back into less toxic and less complicated assets. This is good since banks are trying to become more capital transparent, which will allow them to make more loans of the type that CIT made. This makes a CIT-type of failure less difficult to deal with, and may explain the somewhat muted market reaction. Webman also believes that the latest earnings news is illustrating a gradual rebuilding of economic momentum, and strength in many parts of the financial world. With the current playing field, the big players will continue to be able to make money, even without the extreme levels of leveraged that were observed in the past.

Nouriel Roubini was recently on CNBC (the video is provided below) discussing his views on the economy, and clarifying his recent comments last week that were interpreted as being more positive than earlier in the year. Some comments/observations from the interview include the following:

• Roubini still believes the recession will last 24 months, causing it to be over by the end of this year.
  
• The recovery will be weak, sub-par, and below trend, with 1% growth for a few years.
• The "recovery" will feel like a recession, even if growth is positive.
  
• The unemployment rate will peak around 11% next year.
• Including partial employed/unemployed workers, the unemployment rate is over 16%.
• We have seen the worst, given that the free-fall in the economy is over.
• Nonetheless, even though we will not have an "L" shaped depression, we will also not have a "V" shaped recovery, and he has worries of a "W" shaped double dip recession.
  
• The slow and lower growth are being driven in-part by current debt and spending levels.
• There is a thin line as to when it is best to exit current monetary policy. This also adds risk.
  
• A second stimulus bill is needed by the end of the year (we need to wait until later in the year to let the current stimulus start working).
  
• The second stimulus should include more shovel-ready infrastructure projects.
  
• If the second stimulus is too small, it will not be effective. If it is too large, the bond market will panic. He believes it should be around $200 billion.
• He feels that the U.S. will be the first advanced economy to exit the recession. While China and India are seeing growth already, it will be weak until the G3 recover and start helping to drive their economies.
• Equities, commodities, and credit markets have gone up too far, too fast.
  
• There is possible downside surprise regarding marcoeconomic numbers, earnings, credit shocks.
  
• The risk in the market is still on the downside. Investors should continue to stay away from risky assets.
• The market will not test the lows of March (the levels of which were pricing in depression), but could see a sell-off below current levels and the March lows if his forecast of downward surprises in economic data come true (which he still expects to happen).
  
  Source: CNBC Video

According to the recent TIM (Trade Ideas Monitor) report, the TIM Sentiment Index (TSI) decreased 5.3% week-over-week from 54.03 to 51.19 (see previous post, youDevise website for additional information on the TIM report). For the five trading days ending July 16th, the number of new short ideas as a percentage of new ideas sent to investment managers increased to 38.63% from 25.90% one week earlier (see last week's post). To date, shorts represent 35.27% of ideas in July, and 41.14% of this year.

As for individual securities in the U.S. and North America, Johnson & Johnson (JNJ), Kraft (KFT), and Intel (INTC) were the stocks most recommended as longs by institutional brokers, while DigitalGlobe (DGI), Fairchild Semiconductor (FCS), and Advanced Micro Devices (AMD) were most recommended as shorts. The materials, industrials, and health care sectors had increased broker sentiment for the week, while consumer staples, utilities, and telecommunications had decreased sentiment.

ProShares is launching the first 130/30 ETF strategy (see Pensions & Investments article, Nasdaq article). The 130/30 ETF (CSM) will track the Credit Suisse 130/30 Large-Cap index. The Credit Suisse 130/30 index was developed by Andrew Lo (CIO of AlphaSimplex Group) and Pankaj Patel (director of quantitative research at Credit Suisse). The ETF has an expense ratio of 95 bps, with a strategy that will offer "investors a transparent, low-cost means of achieving 130/30 beta and, potentially, alpha superior to what a comparable long-only large-cap strategy would deliver over the long run." A First Trust 130/30 Large Cap ETN (JFT) based on the 130/30 strategy was released just over a year ago (see previous post, MarketWatch article).

Not familiar with 130/30 strategies? Basically, the strategy uses leverage to short poor performing stocks and then uses the proceeds, along with initial capital, to purchase shares that are expected to do well. If is a form of the general 1X0/X0 long/short strategy, although the 130/30 ratio funds have seem to generate the most interest, producing a 130% long, 30% short strategy. Investors using the strategy will often mimic an index such as the S&P 500 when choosing stocks for the strategy. You can find additional descriptions of the 130/30 strategy here and here. Lo paper here.

Keep in mind that with such strategies the managers must pick stocks to go both long and short. Often there is feeling that you are market neutral, given that you have both long and short positions, but this is not the case. While traditional hedge fund might utilize a long/short strategy that makes them market neutral (beta close to zero), the 130/30 strategy is usually compared to a benchmark, such as the S&P 500, giving 100% exposure to the benchmark. As a result, the strategies are sometimes referred to as beta-one strategies. Furthermore, if the manager gets it wrong in either, or both directions, you may end up losing more than expected. As with most funds, good management is essential, regardless of the strategy.

Given the market beta exposure, these funds are useful if you have a positive market view and you believe that the fund manager can generate alpha from the short portion of the portfolio. If your view is neutral or negative, a hedge fund with an appropriate strategy might be better. If you have a positive market view but are not confident that your manager can generate alpha from short selling, then a long-only fund, or index fund, would be best. Keep in mind that such funds also trade more often, making them less tax efficient compared to traditional long-only index funds.

Note/Update: As a follow-up, I just ran across an excellent article at Greenfaucet that also provides details about the ProShares launch, and the success, or lack of success of the 130/30 funds. Check it out here.

Trading in sovereign credit default swaps has risen fivefold since the demise of Lehman Brothers last fall (see previous post on tradable CDS indexes, and current Financial Times article). This increase in trading, and general levels of increased government debt, have caused CDS spreads to rise and somewhat fall back to earth over the last year (see figure below).

Source: Markit (by way of the Financial Times)

In the UK, the cost to protect sovereign debt soared to 164 basis points, compared to its pre-Lehman levels of 10bp last February (see Financial Times article). This means that at one point it costs $164,000 to insure $10m of UK debt, instead of the initial $10,000. Eventually, the cost fell back to 75bp as speculators began leaving the once volatile market. CDS spreads in Germany, the U.S., and Japan have seen similar rising and falling trends, although not as pronounced as the moves in the UK CDS market.

Even though the number of outstanding contracts are much less than many big companies, the moves are is still raising some concern, and highlight how investors now see "risk-free" government debt. And while it is also unlikely that sovereign CDS are being used for hedging in any direct, or large-scale way (after all, if there is a massive government default, good luck finding the counterparty), the markets do still provide information, even if the participants are not actually expecting large established governments to default.

So why waste a good financial product? Here is a suggestion (tongue in cheek - sort of). Given that governments around the globe are looking to rein in risk-taking by placing curbs on executive pay in companies that take on too much risk (see WSJ article), might it also be possible to do the same for governments that are spending too much and creating too much debt? In a rather ironic twist, maybe the sovereign CDS market could be used to place curbs on Congress? Now that is some market regulation that even Wall Street could get behind.

A recent AP article by Martin Crutsinger introduces and then answers the question "How did (the) $1 trillion deficit happen?" (see full AP article). Some highlights from the article include:

• The government's annual budget deficit has topped $1 trillion. With three months left in the budget year, it will get even worse. The administration is projecting that the deficit will hit $1.84 trillion for the current budget year. This is four times the size of last year's budget deficit.

• The deficit spending began with the 2001 recession, and got deeper with the 9-11 terrorist attacks as war spending started to ramp up.

• Until 2008 the deficit had been shrinking, hitting a five-year low of $161.5 billion in 2007, but was followed by the record deficit of $454.8 billion in 2008 as the current recession and financial crisis hit.

• The size of the deficit started to ramp up with the initial $700 billion TARP (about half spent in 2008, half in 2009), along with the recent $787 billion economic stimulus.

• In addition to stimulus spending,"automatic stabilizers," such as food stamps and unemployment compensation, are also increasing. Government outlays are up 20.5% through the first nine months of this budget year.

• All of this spending is occurring just as tax receipts are falling. Government revenues have fallen by 17.9% during the October-to-June period compared with one year ago.

• While large in dollars, current deficits are still not the largest in terms of GDP, but are the largest outside of WWII. Currently, the CBO is forecasting the budget deficit will equal 13% of GDP. As a comparison, the deficit was 6% of GDP in 1983 as we moved out of another recession and ramped up cold war spending, and 30.3% of GDP in 1943 during World War II.

• The CBO is projecting that the deficits will remain large for the foreseeable future, coming in at $1.43 trillion in 2010 and not falling below $633 billion over the next 10 years, ultimately adding $9.1 trillion to the national debt.

To tackle such deficits and debt, either spending needs to be curbed, or tax receipts need to increase - and quickly. Either way, the debt needs to be dealt with (see previous post), but the exit strategy will require hard choices (see Greenfaucet article). Given continued weakness in the economy, along with both health care reform and new global warming initiatives (such as carbon trading) on the docket, it does not appear that spending is going to slow down anytime soon (see previous post). The leaves tax increases on the wealthy and corporations, or additional tax cuts such as those recently targeted for the middle class. Expect the Supply Side - Keynesian debate to begin in earnest once again.

As pointed out in a recent Financial Times opinion piece by Nassim Nicholas Taleb and Mark Spitznagel (see FT article, concepts also expressed in a recent CNBC interview), the core economic problem that we are facing "is that our economic system is laden with debt." In fact, as pointed out by the authors, the debt load is about triple the amount relative to the GDP levels of the 1980s. Given that Tabel and his colleague have been betting on debt-induced hyperflation becoming the next black swan event (see previous post), and making them even more coin in the process, it might be easy to dismiss this as someone simply talking their book - which is probably somewhat the case. Yet the levels of the deficit spending and debt are unprecedented, and scary. Of course, what is possibly even more shocking is how making these levels know and pointing out their consequences is still looked at as a revelation, or at least finally drawing serious concern. It is simply no longer enough to point out the irony of using debt to solve a problem caused by too much debt. That train has already left the station. The focus is finally shifting to those trying to slow down the train before we all get run over.

As pointed out in the FT article, Taleb and Spitznagel believe the only solution to the debt problem is to immediately convert debt to equity. After all, companies in bankruptcy do this all the time - then again, I am not sure what that says about a country and its credit rating [Note: As a follow-up, see the recent Felix Salmon Reuters blog post about the unsustainability of debt-to-equity conversion]. To bolster their case, the authors given three reasons for their concern and reasoning. First, debt and leverage cause the system to become fragile - i.e., there is less room for error. Second, globalization has caused the system to be more complex, which in turn has caused business parameters to be more volatile. Third, and somewhat novel in perspective, is that debt is "highly treacherous." Loans hide volatility since they do not really vary outside of default. Such risk is hidden even more in highly complex derivative products, such as swaps and CDOs.

So what additional steps can governments do to reverse the trends? Tabel and Spitznagel list two options: deflate debt or inflate assets (once again, the authors are betting on the later). What have governments done? Deficit-based stimulus spending. And they are considering more (see previous post). Besides adding more debt, stimulus spending is likely to over- or undershoot since it is difficult to get just right in size and timing. This of course leaves economies vulnerable to inflation, and in some cases creates hyperinflation. Therefore, unless the levels of consumer and government debt are dealt with, and we consider other approaches for dealing with current problems, we are likely to experience another black swan - even one that is large and can be seen flying right towards us.

Hedge fund firm AQR Capital Management has launched a set of indexes designed to capture the returns of stocks that have positive momentum (see WSJ article). In addition, the firm launched three no-load mutual funds that will track the new momentum indexes. The AQR Momentum Fund, AQR Small Cap Momentum Fund, and AQR International Momentum Fund will track the AQR Momentum, Small Cap Momentum, and International Momentum indexes, respectively.

The new AQR indexes are constructed using the top one-third of stocks that have outperformed other stocks in their grouping over the last 12 months, with the stock weightings based on market capitalization. The large-cap index examines the 1,000 largest U.S. market cap stocks, while the small-cap index will examine the next largest 2,000. The indexes are rebalanced quarterly. The designers of the funds hope that investors will use them to represent the growth portion of their portfolio since momentum-based portfolios tend to do well when value strategies are not in favor. Pure growth strategies also tend to under-perform momentum strategies over time according to a principal at AQR. Nonetheless, each momentum strategy needs to be somewhat specific, making it difficult to do a direct momentum for growth substitution, but could still prove useful for those looking for diversification with their momentum investing.

Meredith Whitney was recently on CNBC (the video is provided below) discussing the banks and financials. Some observations from the interview include:

• This will be a tactical quarter for the banks.
• She has a bullish call on Goldman Sachs, but a bearish call on financial stocks in general.
• A huge refinance wave will create the "Mother-of-all" mortgage quarters, boosting earnings for the quarter for many banks, even though business in general is not getting better.
• Core earnings numbers may not be very good, but below the line numbers will be good due to all the mortgage activity. This will result in huge moves in tangible book value for the banks, even with unimpressive earnings numbers. These stocks trade on multiples of tangible book.
• A move from $18 billion in incentives to $75 billion in incentives to modify mortgages, with less modification liability, could cause some banks move 15% short-term.
• Mortgage modification numbers will increase logarithmically, causing past dues to become current, and allowing the banks to receive fees for the modifications.
• As a result of the fees and less litigation due to the current legislation, banks may even seek to modify mortgages which have not yet defaulted, or are not yet past due.
• Bank of America (BAC) is the cheapest of the banks, based on tangible book value (excluding Citi).
• Bank solvency has been off the table for a few quarters now, but main street has not been helped by the financial bailouts as much. A lot of refinancing is occurring, but not a lot of new lending. The new legislation and increased risk aversion is actually providing less access to credit.
• The next couple of years will be debt market-focused due to the tsunami of debt issuance needed to pay-off current spending.
• She also mentioned in the discussion (not included in the CNBC online video) that unemployment could reach toward 13%.
  
  
  Source: CNBC Video
  

The following graph from the Congressional Budget Office shows the projected output gap between actual and potential GDP with and without stimulus spending, i.e., the American Recovery and Reinvestment Act (see full CBO presentation). The CBO presentation highlights the implementation lags of fiscal policy, and illustrates why a stimulus package that stretches over 2 or 3 years seemed justified given that the CBO expected the GDP output gap to persist for longer than one year. Projections have only 24% of the money being disbursed in fiscal year 2009, 74% disbursed by the end of FY 2010, and 91% disbursed by the end of FY 2011.

Source: Congressional Budget Office

Given the back-loading of spending, and the realization that the recovery is not taking hold as quickly as most would want (except possibly by politicians up for re-election next year and looking for an election year boost), this is creating a problem now for both the administration and Congress. On the one hand, quicker, and more front-loaded stimulus seems warranted, yet data such as that provided by the CBO has been used to justify the huge delayed spending in coming years. Therefore, if the projections are correct, then patience is in order, but something tells me that is not going to fly as unemployment nears 10 percent.

So how do you speed things up? As outlined by the CBO, you could waive environmental reviews, award contracts without competitive bidding, or simply not dole out money by jurisdictions, but instead give money to those who can most efficiently spend it (shovel-ready project). The first one is a non-starter given the environmental shift of the current administration, the second is going to be difficult given the criticism that no-bid projects received in the last administration, and the last one is simply unacceptable to anyone in Congress - given their parochialism and the fact that it actually makes some sense (and of course, you need shovel-ready projects on a rather large scale - most are probably already funded).

So on the short-term, what needs to be done? The quickest way is through changes to taxes. This could come in rebates (which are relatively quick in non-tax months, but also somewhat ineffective when people are scared and the savings rate is increasing), or through lowering withholding (currently tried with the middle class, but not having the desired effect). This leaves suspending some income taxes for a period of time, or lowering income taxes on everyone, including the wealthy and corporations. Suspension is difficult to sell given the state, or perceived state, of social security and medicare needs, not to mention the growing deficit (even though lower rates can bring in higher receipts), while reducing taxes on corporations and the wealthy is anathema to most of those currently in power.

The limited real and political choices available has now caused the discussion to come full circle - backed to considering another stimulus. I forget - what was that definition about doing the same thing again and expecting different results? If President Obama is not able to convince the American public and Congress to be patient, we may find out the answer rather quickly.

While the focus on the recent June jobs report was on the number of job losses and the unemployment rate, the average workweek and average weekly earnings data was also not very encouraging. The average workweek fell to 33 hours, down 0.1 hours, taking it to its lowest recorded level going back to 1964 (see Business Week article). While hourly earnings remained flat, the shorter workweek caused average weekly earnings to also fall from $613.34 in May to $611.49 in June. With employed full-time workers scheduled for what is looking more like part-time work, consumer spending and consumer confidence will most likely continue to suffer. This will no doubt put pressure on consumer discretionary stocks and make the prospects of a jobless recovery more likely. Given that companies tend to increase the workweeks of existing employees, and even offer overtime to such employees before taking on the expense of hiring and training new employees, it may take a long time before consumer spending once again reaches the levels required to bring the average workweek back to normal hours. As a result, it may be a while before the Friday noon traffic is caused by workers once again going out for a business lunch, and not simply going home early for the week.

According to the recent TIM (Trade Ideas Monitor) report and the TIM Sentiment Index (TSI), institutional brokers increased 4.5% from 51.70 to 54.03 (see previous post or youDevise website for additional information on the TIM report). For the five trading days ending July 9th, the number of new long ideas as a percentage of new ideas sent to investment managers increased to 74.10% from 60.84% one week earlier (see last week's post). While the intra-week trend did fall, it later rebounded. To date, longs represent 58.64% of all ideas this year.

As for individual securities in the U.S. and North America, Western Union (WU) and DryShips (DRYS) were the stocks most recommended as longs by institutional brokers, while U.S. Steel (X) and Morgan Stanley (MS) were most recommended as shorts. The information technology, materials, and consumer discretionary sectors had increased broker sentiment for the week, while health care and energy had decreased sentiment.

Hedge funds posted their first inflows in nine months (see BarclayHedge article, free registration required). Based on a survey of over 1,200 hedge funds, it is estimated that the hedge fund industry gained $1.4 billion in May, or 0.1% of total assets. Nonetheless, funds-of-funds and CTAs are still experiencing outflows. Fund-of-funds, which did not do as good a job as expected picking hedge funds in order to justify their extra layer of fees, lost $5.2 billion, or 1.0% of assets in May. This makes their twelfth straight monthly outflow. Below is the hedge fund asset flow data by strategy for May 2009 (source: BarclayHedge, see article, free registration required). Next to fund-of-funds and managed futures, event driven strategies saw the biggest outflows. Equity long-short, fixed income, and multi-strategies saw the biggest inflows.

ALPS has launched a new Equal Sector Weight ETF of ETFs (EQL) that provides an equal weight position in each of the nine Select Sector SPDR ETFs (see IndexUniverse article). The fund rebalances the sector positions every quarter. The attraction of the fund, beyond not needing to invest in nine different ETFs in order to get sector diversification, is that it is designed to avoid over-investment in “bubble” sectors that may have run-up too far, too fast. When their strategy was back-tested over the last 10 years, the EQL strategy of reducing the spread in sector returns outperformed the S&P 500 by more than 3% per year. The EQL ETF charges 0.55% in annual expenses, which includes the assumed 0.21% in expenses for the underlying nine Select Sector ETFs. The EQL ETF sounds like an interesting and useful product, although it is not entirely clear how accurate one can measure when to reduce exposure to bubble sectors going forward.

There was an interesting interview on CNBC today with Ken Chenault, CEO of American Express. While Chenault spent half of the interview discussing the AXP brand and strategy, he also spent time discussing the economy in general, and credit card legislation specifically. Instead of simply pumping the economy and his company, Chenault was more sober and direct. In particular, during the first few minutes he mentioned that while recent government actions have produced stability and are giving signs that could potentially lead to "green shoots," it is too soon to call this a recovery. Around the 7:30 min mark he also comments on the proposed credit card reform. While he believes that some type of reform is necessary, he does not agree with some of the proposals regarding risk-based pricing, which could stifle growth and limit credit for those who may need it the most. As written, he is yet not convinced that the current proposed legislation will have a positive impact on the economy.

While Chenault has a dog in the fight, and company interest in the legislation, I believe he is right to expand the argument to the broader economy. While restricting the ability the price risk would reduce an extra source of revenue for the credit card companies, the impact on retail sales will also be negative, significant, and ultimately detrimental to growth (see previous post). Beyond the lost of revenue due to lower rates and fees, the inability to effectively manage risk can not be discounted, or its effect on helping to measure, control, and regulate systemic risk (see previous post).

Source: CNBC Video