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Five Things You Need to Know: U.S. Credit Downgraded by S&P


Also, inside the carry trade; cotton inflation and skinny jeans, the great Beefsteak Revival and more.


1. S&P Downgrades US AAA Credit Rating to 'Outlook Negative'

So Standard & Poor's downgraded the outlook of the U.S. AA credit rating to "outlook negative" this morning. "We believe there is a material risk that U.S. policy makers might not reach an agreement on how to address medium-and long-term budgetary challenges by 2013," S&P said in the report.

This is all part and parcel of the US budget talks and the window of despair we described that is opening between now and July 8.

"If an agreement is not reached and meaningful implementation does not begin by then, this would in our view render the U.S. fiscal profile meaningfully weaker than that of peer 'AAA' sovereigns." Okay, whatever. Rather than evaluating the terms of an agreement, S&P has chosen to base its analysis on the mere fact of an agreement. What if U.S. policy makers agree to expand the debt ceiling by $50 trillion and devalue the dollar by 40 percent? What would that do to the U.S. sovereign debt rating? Eh, who cares.

Regardless of the short term exogenous impact the literal terms of any policy agreement might hold, the long-term view I hold is that markets are governed entirely by endogenous forces. This is difficult for most people to accept. After all, did the S&P futures not just drop 10 points on 'news' of the S&P downgrade? Sure, but the long-term patterns of markets reveal in time that such apparent exogenous factors are a bit like gnats biting a buffalo. In my DeMark analysis, the US dollar needs a new low, below 72, and possibly even a move below 70, crossing the round to help foster more dire headlines and warnings. After that , it will be over.

2. The Carry Trade Never Dies, It Just Moves Along

Speaking of dollars, this morning I was scanning the Bloomberg Carry-Trade Tracker, a handy guide that shows at-a-glance the performance of various carry trade pairings. We'll get to that, but first, what is the carry trade? In simplest terms a carry trade is, literally, a trade that attempts to take advantage of a low carry asset by borrowing it while simultaneously selling a high carry asset.

Carry? What did you just say? Okay, let's back up. Nearly all financial assets, commodities, stocks, bonds, possess something called the "cost of carry." This is the cost of holding the asset. For example, physical commodities, such as gold and silver, have a storage cost. Even if you only own gold or silver coins, if you store those coins somewhere safe, which you should, like in a safe deposit bod, you are paying a carry cost of anywhere from $10 to $50 or even $200 per year to carry those assets. For other assets, such as stocks, the cost of carry may be the interest you are charged on a margin account. If you are short certain stocks, your cost of carry may be the dividend cost, if there is any, you are required to pay.

At any rate (heh), the carry trade is borrowing a low carry asset (because the cost of holding it is low) and selling a high carry asset. In the most popular form of carry trade, currency carry trades, which we're going to get to in just a moment, this is a trade where one borrows a low-yielding currency and then lends in a high-yielding currency. The risk, of course, is that currency yields may rapidly move in unanticipated directions, thus turning a good carry trade (free money!) into a disastrous position.

For example, below is the USD-based currency carry trade performance year-to-date and over the past 12 months where a trader is short the USD and long the Australian dollar, Brazillian real or other currency pairings.

As you can see, over the past 12 months these pairings have been like, literally, printing money.

3. Global Fiscal and Monetary Policy Mix

Another handy Bloomberg chart shows the mix of fiscal and monetary policy conditions across a number of important countries and regions. You can also see the structural budget balance (expressed as a percentage of GDP) in 2010 and present. The best conditions for any given currency (we're speaking here in terms of carry trade and currency movement and direction, not in local economic terms, remember) is a combination of tight monetary policy and expanding fiscal conditions.

4. How Hipsters Manage Extreme Cotton Inflation

Cotton is up 34% year-to-date. Never mind the fact that a MONTHLY DeMark sell setup 9 and overlapping TD Sequential 13 Sell Signal could record at any moment. The fact is cotton is up and so people need to figure out things to write about it. That's why I found this New York Magazine article on "Trouser Math: How cotton inflation means more skinny jeans" of interest.

"We think of fashion as driven by fancy; even in "hemline theory," which states that skirt lengths track economic health, it's the ephemeral public mood that's said to usher in minis with frisky stock prices and maxis with dropping indexes. But at the mass-market level, every garment is as much a product of a spreadsheet as the muse, and right now the former is showing cotton prices up 126 percent from last July."

Well, it's true. Some do think of fashion as driven by fancy or "ephemeral public mood." But the Socionomic viewpoint of causality holds that fashion, colors, pop culture, film etc. are driven by shifts in social mood and are cultural expressions of social mood that operate as lagging sociometers. If the stock market is most often a leading sociometer (that is, if rising stock prices are forecasting positive social mood shifts while falling stock prices forecast negative social mood shifts), then after a 90-some-odd percent rise in stocks from March 2009 we ought certainly be looking to fashion to express some elements of the counter-trend wave up in social mood.

The NY Mag article observes that there's an economic disincentive to adopt a wider-leg look in denim. And for now that may be true (a year from now, doubtful), but if skinny jeans, particularly for men, are expressing certain rising transition and peak positive mood elements in fashion, then regardless of any economic disincentive, after a massive rally in stock prices we should anticipate a resurgence in the acceptance of tight pants as a fashion statement for men and women.

Indeed, the backlash against skinny jeans had been growing, at least for a time. For example, the Facebook I Hate Skinny Jeans group page has about 1,900 followers so far.

While the Facebook I Love Skinny Jeans page has a mere 690 followers.

The association of skinny jeans for men with hipsters, the group itself indicative of a "weak male" cultural expression (not used here as a value judgment but merely as an observation of the cultural expression of hipsterism), has seen a backlash against the type, just as one would expect following a sharp rise in stock prices.

5. The Great Beefsteak Revival

In the Beefsteak Revival, Gluttony is Good, observed the Sunday New York Times yesterday. Again, after a 90%-plus rise in stock prices, it's only natural for echoes of Gordon Gekko's "Greed is good" message to begin resonating in popular culture. And from a Socionomics perspective, the rebound in social mood here should be expressed culturally as a re-emphasis of more masculine typecasting and imagery for men. Certainly, there's nothing like a good, old fashioned beefsteak to drum up some raw alpha male energy.

Check out this description of one of the beefsteak events from the article:

"As the meat and beer took effect, an air of satiation settled in. It did not last long. Beefsteaks move with a digestive rhythm. With the beer flowing freely and the platters flying in ("Sustain yourselves, people," Mr. Silverman yelled in back. "It's a long day ahead!"), the crowd's disposition soon lurched out of control.

A young man, with his apron flung behind him like a cape, began to jog about the room, pumping his fists and loudly shouting: "Beefsteak! Beefsteak! Yeah!" Empty plastic beer cups were erected into towers. Intoxicated beefsteakers placed their bread in piles and soaked the piles with horseradish, barbecue and chimichurri sauce. The band appeared for a second set in beefsteak aprons and butcher's hats. A food fight began."

Okay, now what exactly is a "beefsteak"? The New York beefsteak tradition began among the working class in the mid 1800s. It's defined as a "celebratory" meal, a "banquet," featuring cuts of beef eaten without utensils and served with bread and mass quantities of beer. The definitive article about New York beefsteaks, which enjoyed a resurgence in popularity in the late 1930s, is the Joseph Mitchell New Yorker piece "All you Can Hold for Five Bucks." Interestingly, the positive social mood beefsteaks were described, as one would expect, "manly, messy" affairs, while the negative social mood beefsteaks were "more formal" with the "cheerful gluttony of the past tempered by female sensibilities."

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