Denial – “I feel fine.”; “This can’t be happening, not to me.”
Denial is usually only a temporary defense for the individual. This feeling is generally replaced with heightened awareness of situations and individuals that will be left behind after death. [Translation: I'm voting for "hope and change. Yes we can!"

Anger – "Why me? It's not fair!"; "How can this happen to me?"; "Who is to blame?"
Once in the second stage, the individual recognizes that denial cannot continue. Because of anger, the person is very difficult to care for due to misplaced feelings of rage and envy. Any individual that symbolizes life or energy is subject to projected resentment and jealousy. [Translation: I'm going to the Washington Monument to demonstrate with Glenn Beck].

Bargaining – “Just let me live to see my children graduate.”; “I’ll do anything for a few more years.”; “I will give my life savings if…” [Translation: Find me a politician who can get me out of this mess!].
The third stage involves the hope that the individual can somehow postpone or delay death. Usually, the negotiation for an extended life is made with a higher power in exchange for a reformed lifestyle. Psychologically, the individual is saying, “I understand I will die, but if I could just have more time…”

Depression – “I’m so sad, why bother with anything?”; “I’m going to die… What’s the point?”; “I miss my loved one, why go on?” [Needs no translation, but it means that I won't spend anything and save everything I can, and since everyone else is doing the same, I don't have a job, and therefore no income to save].
During the fourth stage, the dying person begins to understand the certainty of death. Because of this, the individual may become silent, refuse visitors and spend much of the time crying and grieving. This process allows the dying person to disconnect oneself from things of love and affection. It is not recommended to attempt to cheer up an individual who is in this stage. It is an important time for grieving that must be processed.

Acceptance – “It’s going to be okay.”; “I can’t fight it, I may as well prepare for it.”
In this last stage, the individual begins to come to terms with their mortality or that of their loved one. [Translation: I hope that Overstock.com has cat food on sale today].

We’ve been taking about the comparison to Japan for quite some time. During Japan’s “lost decade” of the 1990s, everyone was working, everyone kept their homes, everyone maintained their lifestyle (minus some shopping trips to Paris), and life carried on more or less the same. America enters the second decade of the millennium with un- and underemployment around 20%.

Japan went through its great retirement wave in the 1990s, just as America must during the 2010s. But the Japanese for years had saved massively, and exported massively in order to do so. If a country’s population ages rapidly, the soon-to-retire cohort will shift from consumption into savings. Japan had insufficient young people to absorb the investment requirements of the 40- and 50-year-olds, and therefore had to invest overseas. Japan’s industrial genius made it the world’s premier exporter, and Japan was able to save successfully to fund the retirement wave–even though consumption remained weak and real estate prices fell and the stock market fell to a third of late 1980s peak.

How are Americans going to save? They can’t buy home mortgages; they could buy US Treasuries at 2.5% for a 10-year maturity; they can buy the junk bonds now flooding the market; or they can leave their money in cash at a fraction of a percent. As aging American shift from consumption to saving, they must do so by reducing domestic purchases. The Japanese could save by exporting and remain close to full employment. American’s savings requirement cannot be met in the same way, because Americans have forgotten how to export. There aren’t enough soybeans and corn to make much of a difference; with a few exceptions, America has lost its edge in capital goods as well as consumer goods, excepting commercial aircraft and a few other pockets of strength.

As Reuven Brenner and I wrote in First Things in December 2009

Today, America is coming out of a decade without savings and years of borrowing from the world instead of lending to it. Rather than exporting and saving, America is vacuuming capital out of the rest of the world and going further into debt. Once we exclude the option of admitting a few million skilled, entrepreneurial young immigrants—as Israel did from Russia two decades ago—the present crisis can be solved only by opening the world to American exports and restructuring the American economy to create the necessary export capacity.

We proposed a number of measures to accomplish this, none of which has much chance of adoption. That leaves Americans fighting for a dwindling supply of available savings instruments (in effect, old people fighting for the few young people available to support them).

And that drives down the level of returns across the board. Pension funds will have umpty-zillion-dollar deficits once they recalculate their liabilities at a 3% rate of return rather than the fictional 8.5% return assumed by most of the defined-benefit plans during the 2000s. The equity risk premium will remain depressed for a generation. The banks can’t make money after the short-lived boom in distressed assets because demand for yield has flattened the curve to the point that their old trades are less economical. Hedge funds can’t make money because they are behind the banks in the queue for assets.

Perhaps the only thing that would get the US pumping again would be an infusion of 10 or 20 million Chinese or Indians with doctorates in quantitative subjects. The Chinese and Indians, though, do not need to come to America, as they did only a dozen years ago, and if they do, they do not need to stay here. And with the economy and markets in the miserable condition they appear, why should they? There are more opportunities to build wealth in Shanghai and Mumbai than in America.

We opened yet another bottle of Pinot Noir and congratulated ourselves for having been clever enough to be born in time to catch the last wave of wealth accumulation. And we laughed at the miseries of the liberal establishment. Federal Reserve Chairman Ben Bernanke seems authentically perplexed; he followed the instructions to the letter, mixing the eye of newt with the tongue of bat, and adding $2 trillion in securities to the witches’ brew–but nothing seems to have happened. He sits up night in his tower studying ancient manuscripts: was it a she-goat or a he-goat that he is supposed to sacrifice on a moonless night?

And we felt some sympathy for the Tea Party types who want to march on Frankenstein’s castle and burn it down. If they ever have the misfortune to get into power, they will discover how much of the problem stems from the sloth, complacency, ignorance and incompetence of ordinary Americans. We’ve had the financial ride of our lives during the past fifteen years courtesy of the rest of the world, and now it’s over. We have to learn how to export again–and that is not going to be easy.

Dave’s February Top Ten Reasons to Fade the Recovery

10) There is no recovery at all in Europe.

9) China won’t collapse, but government efforts to stop overheatingby raising reserve requirements make clear that the world’s second-largest economy can’t be the locomotive for world growth.

8. Greece and its prospective rescuers in the European Community are at loggerheads over conditions for EC help.

7. State fiscal crises continue to worsen.

6) Commercial real estate is nowhere near bottom, with some sectors (e.g. hotels) at delinquency rates of nearly 10%.

5) Regional banks continue to drop like flies, with 702 banks holding assets of $403 billion on the danger list.

4) Bank credit continues to shrink. Total bank credit is still falling at a 5% annual rate, an unprecedented decline.

3) What bank credit is available is funding the US Treasury deficit in the mother of all crowdings-out, replacing commercial loans on banks’ balance sheets.

2) Industrial production has bounced of the bottom, but manufacturing is only 15% of US employment.

1) Employment won’t come back. Today’s consumer confidence number is one more nail in the coffin of exaggerated hopes for a cyclical recovery.

All of these reasons remain in place. Here are ten more:

10) Households have figured out that with the 10-year Treasury at 2.5%, they have to save twice what they would have before (and hadn’t begun to save in any case) — so consumption will drop as savings spikes.

9) State and local pension funds are being called out on their $3 trillion deficit (actually higher if returns remain as dodgy as I think they will be).

8.) State and local tax increases will be required in huge volume, either directly, or indirectly through privatization of municipal services, which in turn will lead to layoffs of bloated staffs and price increases.

7) Rising health care costs are making miserable position of small business even more untenable.

6) The double-dip housing recession will cut spending power, and, perhaps most importantly, wipe out the bootstrap capital available to small business.

5) The European debt crisis will return with a vengeance in 2011, as Germany shifts its economic orientation towards China and Russia, reducing its incentive to bail out the Club Med deadbeats, while German voters veto any more subsidies.

4) Investors will begin to notice that corporate pension funds that appeared well-funded with a return assumption north of 8% look like a massive drag on future earnings. GM and Ford alone are underfunded by $17 billion under already-obsolete return assumptions. Mrs. Goldman didn’t raise any kids dippy enough to own auto stocks under the circumstances.

3) The financials will get burned as the flattening yield curve and the Fed’s hunger for mortgage-backed securities take the juice out of their curve and carry trades.

2) The cumulative effect of long-term employment will lead to more bankruptcies and foreclosures as the jobless exhaust their savings:

and Dave’s Top Reason to Fade the Economy is –

10) The Obama administration will rescind the Bush tax cuts, adding a federal tax increase to the miseries already conspiring to take the economy down.

Why are all these terrible things happening?
In a May 2009 essay entitled “Demographics and Depression,” I warned First Things readers that the great economic headwind of our time was demographic:

Our children are our wealth. Too few of them are seated around America’s common table, and it is their absence that makes us poor. Not only the absolute count of children, to be sure, but also the shrinking proportion of children raised with the moral material advantages of two-parent families diminishes our prospects. The capital markets have reduced the value of homeowners’ equity by $8 trillion and of stocks by $7 trillion. Households with a provider aged 45 to 54 have lost half their net worth between 2004 and 2009, according to Dean Baker of the Center for Economic and Policy Research. There are ways to ameliorate the financial crisis, but none of them will replace the lives that should have been part of America and now are missed….

In the industrial world, there are more than 400 million people in their peak savings years, 40 to 64 years of age, and the number is growing. There are fewer than 350 million young earners in the 19-to-40-year bracket, and their number is shrinking. If savers in Japan can’t find enough young people to lend to, they will lend to the young people of other countries. Japan’s median age will rise above 60 by mid-century, and Europe’s will rise to the mid-50s.

America is slightly better off. Countries with aging and shrinking populations must export and invest the proceeds. Japan’s households have hoarded $14 trillion in savings, which they will spend on geriatric care provided by Indonesian and Filipino nurses, as the country’s population falls to just 90 million in 2050 from 127 million today.

The graying of the industrial world creates an inexhaustible supply of savings and demand for assets in which to invest them–which is to say, for young people able to borrow and pay loans with interest. The tragedy is that most of the world’s young people live in countries without capital markets, enforcement of property rights, or reliable governments. Japanese investors will not buy mortgages from Africa or Latin America, or even China. A rich Chinese won’t lend money to a poor Chinese unless, of course, the poor Chinese first moves to the United States.

That the aging world population needs to save for retirement, and an imbalance of savings with respect to investment opportunities reduces returns in capital markets, finally has dawned on the commentariat.Goldman Sachs just issued a report on demographics and the stock market, noting, “The rise in ‘prime age’ savers globally may also have played an important role in the story of the ‘savings glut’, putting downward pressure on global  real interest rates. Here too, the demographic underpinnings of that story could intensify in the next 10-15 years.” There have been similar articles in the financial press and the client notes of Wall Street economists. Remember, folks: you read it here first.

Below I present a simple analysis indicating that the shrinking equity risk premium is due largely to disinflation or prospective deflation.

The S&P 500 has fallen by a bit over 12% from its April peak. But the 10-year Treasury yield, the usual proxy for the discount rate in the equation, has fallen much father, from 3.85% to 2.57%. Plugging this into the model, the equation tells us that expected earnings have fallen by 42% between April and August.

Of course, I don’t take that number at face value, but it seems intuitively clear that with the implosion of Treasury yields, stocks have become more attractive. The fact that stocks have fallen so far despite the decreasing attraction of alternative investments suggests that earnings expectations have fallen a good deal farther than the S&P index.

Something else is happening, though, to the relative attractiveness of stocks and bonds. This explains one of the reasons not to take the dividend discount model at face value. In the chart below, the blue line is the difference between the corporate Baa yield and the dividend yield on the S&P 500. The red line is the annual inflation rate over the preceding five years.

More than half of the change in the stock-bond relationship can be explained by inflation. I have kicked the econometric tires on this relationship, and it holds up under close scrutiny.

Inflation is bad both for stocks and bonds, but it is much worse for bonds, because even though inflation introduces inefficiencies into the economy, corporate earnings have a chance to keep up with inflation and fixed interest payments do not. If we actually move into deflation, as in the 1930s, we observe periods in which the dividend yield on equities exceeds the yield on bonds (which makes sense; why buy physical assets when they are likely to be cheaper next year?).

If we enter into a period of deflation, or extremely low inflation, the huge advantage of stocks over bonds may disappear; companies may have to pay a dividend yield comparable to their bond yield in order to keep equity investors in the game. And that would portend a prolonged period of low equity valuations.

In short, two things changed between April and August: lower earnings expectations, and the fear of deflation. There simply is no way to parse the data closely enough to quantify which of these two effects was more important for the stock market. The point is that neither of them are good, and neither point to a particularly rosy outlook for stocks going forward.

Asset markets, though, reflect considerable deflation risk. A preference for cash and fixed-income assets over brick and mortar is a statement that physical assets are more likely to be cheaper in the future. There is a huge demographic tailwind behind fixed income markets, as I mentioned on the Kudlow Report Wednesday evening. The population  is aging rapidly: between 2005 and 2020, the proportion of Americans aged 60 and over will rise from 16.7% to 22.8%, according to UN data. For “more developed regions,” the increase will be from 20% to 28%. That generates a huge demand for savings instruments. And that is inherently deflationary: aging savers buy future goods (securities) rather than present goods.

When the whole world wants to lock in fixed-income cash flows rather than buy physical assets, the income of pensioners also must fall. The rise in stock prices bespeaks a willingness to accept lower returns over time, as the fixed-income alternative pays less. This compels prospective retirees to save even more, in a self-feeding cycle. That in a nutshell is Japan in the 1990s.

Absent a fiscal reform that provides incentives to entrepreneurs to shift into physical assets, the Japan scenario is likely. There’s no more striking sign of deflation than private equity and real estate funds turning money back to investors. If the fund managers can’t find projects worth buying (which pay them handsome fees), it’s likely that corporate managers can’t either.

My answer: No, and the maturity to buy is 30 years.

http://www.cnbc.com/id/15840232?video=1564529110&play=1

In the midst of the biggest Treasury rally in a long time, banks have been net sellers of Treasuries. They have to be: banks can’t take the mark-to-market risk of owning 10-year Treasuries at 2.72%, and 2-year Treasuries now yield 0.50%. With the flattening of the Treasury curve banks are squeezed out. That’s why bank Treasury holds have been declining.

To whom are banks supposed to lend? Consumer credit is shrinking and the volume of business loans remains in free-fall. Banks’ topline performance is going to be miserable and the bottom line must follow eventually.

This morning’s productivity number was a disappointment to the market, although it should be taken with a grain of salt: GDP-based productivity data is notoriously inaccurate. Nonetheless, investors have to consider whether the profit formula that seems to have worked during the past half-dozen quarters–lousy top-line, good bottom line–can be sustained. US corporations aren’t hiring and they aren’t doing much investing; they are stripping down to skeleton crews and core operations and cutting costs. That produces a one-time bump in worker productivity. But it has a limit which may already have been reached.

An 8% earnings yield sounds great against 10-year Treasuries at south of 3% (or TIPS at around 1%), but there’s no upside, and a lot of downside. I haven’t been in the double-dip camp–my forecast for GDP growth as delivered on Larry Kudlow’s show in January was 2.2% and I’m sticking to it. But if the Bush tax cuts expire, it means that the 15% dividend tax rate jumps to nearly 40% at the federal level (add in the tax rate in the wealthiest states, and we are up to 50%). And capgains tax pops up as well. That means investors can expect to be taxed somewhere around 30% (if we assume that half the earnings are realized in dividends and half in capital gains). And that’s in a benign scenario; in a double-dip, stock prices could crash again.

I own plenty of inflation-hedge equities (against the possibility that my core expectation of deflation turns out wrong), but I’m happy with the bulletproof tax exempts I bought at higher yields than are presently available (no general obligation bonds–only ring-fenced revenues from self-financing entities) and the ultra-cheap bank preferreds that I urged everyone to buy when they were selling for next to nothing in the early spring of 2009. Of course, I will get a bigger tax bill on preferred dividends, but there’s no place to hide, completely.

The productivity number doesn’t mean much by itself, but it is consistent with the idea that the US corporate sector can’t get much more blood out of this stone.

The fact that private equity predators are giving money back (for example, Carl Moelis’ return of $750 million last week) and real estate funds also are unable to use the money they have ought to tell us something. There simply aren’t enough good projects to absorb the capital that is chasing them. If that’s the case for private equity, it surely is the case for large corporations considering investment. Small business, meanwhile, remains dead in the water, sunk by higher healthcare costs, nickel-and-time tax demands, and the death-by-a-thousand-cuts of regulation.

In short, the economy is going nowhere, and the stock market doesn’t have a second act after the heroic cost-cutting of last year.

http://www.cnbc.com/id/15840232?video=1562865433&play=1