Friday, August 22, 2014

"Shrinkflating" Our Debt

Every year during the hot, miserable days of August, central bankers from around the world gather in the cool mountains of Jackson Hole in Wyoming for their Economic Policy Symposium.  It is always a fascinating time for economic nerds.

This year, it looks like there will be friction over which priority of the Fed is most important right now.  You'll recall the U.S. Federal Reserve System is the only central bank in the world with a dual mandate -- control both unemployment and inflation, which is more difficult than it sounds.  Generally speaking, those policy moves to control inflation tend to increase unemployment, and those policy moves to reduce unemployment tend to increase inflation.

Janet Yellen is expected to stress the unemployment problem.  Some of the regional Fed presidents are expected to stress inflation.  I see it as a contest between good data and bad data.

It is clear that millions of people are still unemployed, but at 6.4%, we have already made a great deal of progress. However, the long-term unemployed present a special problem for policymakers, especially for monetary policymakers.  Of course, there is lots of good data to document these problem, and this unemployment problem has dominated economic discussion for some years.

With respect to inflation, the data does not reflect any problem.  In fact, the data suggests that deflation might be more of a problem, which is far more pernicious than inflation.  Despite the data, a number of surveys have shown that consumers don't believe this, as they see actual inflation in consumer prices.  In fact, inflation does seem to be more apparent in consumer prices than in industrial prices.  The popular new term being tossed about is "Shrinkflation" where consumers still pay the same price for a product, but that product is now slightly smaller.  For example, paying $1.59 for a 10-oz candy bar is cheaper than paying $1.59 for an 8-oz candy bar.

I hope Yellen is successful on keeping the focus off inflation.  Keep the focus on the unemployment problem, which is backed with good data,  by attacking the bad, inconclusive data on inflation.  A little inflation is good for debtors, and the United States is the world's biggest debtor.  There are always individual winners and losers with any economic policy, but the country-as-a-whole wins with a little inflation.  Yes, breaking inflation later is more painful than breaking inflation before it takes hold, but that pain is less than the pain of not deflating our debt -- by allowing a little inflation now.

Thursday, August 21, 2014

Summertime with THE Squid

Some people might describe Goldman Sachs as the most highly self-respected company in America.  I would argue their economics research department actually deserves to be respected.  Here are some of their latest predictions:

1.  GDP growth in the second quarter was a whopping 4.0%.  For the full year, it will only be 2.9%, due to the lousy first quarter.  Next year, full-year GDP growth will be a respectable 3.1%.

2.  Unemployment will drop to 5.9% by year-end 2014 and 5.4% by year-end 2015.  This is very close to full employment, which is normally described as 5% unemployment.

3.  Inflation remains nominal, with core CPI growing a mere 2.2% next year.

4.  The benchmark 10-year-Treasury rate will increase about half a percent before year-end 2014 and another half a percentage point next year.  (I disagree with this.)

5.  Corporate profits per share will rise 7.8% next year.

6.  The S&P 500 will end this year at 2,050 or up another 3%.  Next year, it will end at 2,100 or another 2.5%, which is a significant slowdown in growth.

7.  Oil will continue to fall both this year and next year.

8.  Gold will fall to $1,050 per ounce by year-end 2014 but bounce back to $1,200 by year-end 2015.

9.  The dollar should continue to strengthen.

10.  Small-cap stocks are very attractive now.

There is no mention of distant fires or bubbles building.  It is a bullish set of predictions.  Maybe, it is safe to go to the beach after all, but watch out for the "great vampire squid wrapped around the face of humanity,"  as Goldman Sachs was described in Rolling Stone magazine.

Wednesday, August 20, 2014

GDP Envy

I'm not sure it is human nature, but we always seem inclined to fret about how bad the economy is.  Does anybody ever rejoice about how good the economy is?

Consider the case of Finland:  It was one of the rapidly-growing Scandinavian bears until 2007 when Apple introduced the iPhone.  Huh?  What does the introduction of the iPhone have to do with the decline of Finland, you ask?  Well, Nokia was 4% of the country's GDP, and that company got killed by Apple and Samsung.  Over-reliance on any one company is begging for trouble, and they got it.

In addition, the country was overly-reliant on another industry -- paper.  Their two paper companies were two of the largest companies in Europe.  However, with the shift to digital media, the demand for paper has dropped worldwide.  Countries dependent on paper have suffered, like Finland.

Also, Finland is geographically flush against Russia, who is sinking into recession.  Ten percent of Finland's exports go to Russia and will be further hurt with the imposition of trade sanctions.  The future is not bright.

Instead of falling, unemployment is at 9.8% and rising.  Unemployment claims are up 15% over last year.  Their GDP fell 8.3% during the global financial crisis (much worse than the U.S.) and their economy is still stalled -- seven long years later.  I doubt there is a person in Finland who would not love to have an economy like the U.S.

The next time you're sitting around with people, fretting about the American economy, tell them to move to Finland.  At least, they still make the world's greatest vodka!

Tuesday, August 19, 2014

Ferguson Focus

Have you ever seen such a divergence between the mainstream media and the business media?  CNN and MSNBC are covering the Ferguson riots non-stop 24/7?  (Fox News is a little more balanced but not much.)

On the other hand, CNBC, Fox Business News, and Bloomberg allocate no more than 10% of their air time to Ferguson, instead spending their air time on geopolitical risks that actually matter to business and stock markets, such as the Ukraine, ISIS, Chinese purges, or even the spread of Ebola.  Most of their air time is allocated to corporate earnings, M&A, and other business matters.

Does that mean the business community does not care about any alleged injustices in Ferguson?  No, of course not!  It just means that this story of racial injustice is not new and certainly not news-worthy.  We've seen this story many times over the last 50 years without ever causing a recession or stock market crash.  It is just business-as-usual.  Is that right-or-wrong?  Well, you already know that answer!

It is just one of those times when the only place to hear "fair & balanced" news is on the business channels.

Saturday, August 16, 2014

The Groucho Marx Dilemma

My late mother always told me to be positive.  You can do anything you want in life, as long as you're positive.  A positive life requires a positive mind.  A glass is always half-full, never half-empty.  Frankly, I always thought that was good advice and have tried to follow it, which is not normal for an existentialist.

However, The Wall Street Journal had a disturbing article this week about the emerging scientific consensus that negative people are actually more happy than positive people.  It seems that happiness is inversely-related to disappointment, which is the real happiness-killer.  Since negative people already expect negative outcomes, they are not disappointed.  Since positive people already expect positive outcomes, they are much more likely to be disappointed and therefore unhappy.

Groucho Marx often begged the question:  Who are you going to believe?  Me or your lying eyes?

So, who should I believe:  Mom or The Wall Street Journal ?

Thursday, August 14, 2014

Teaching Reality ?

During the last century when I took my first course in economics, we were required to list both the advantages and disadvantages of capitalism.  Once done, it was almost always clear that capitalism had numerous advantages over socialism.  But, there were disadvantages!  First, Karl Marx was right that "the sins of management are visited upon the worker."  In other words, capitalism can be cruel.  It is efficient but cruel.  Second, capitalism does not price-in social costs.  In other words, the price you pay for gas at the pump includes the acquisition cost and processing of oil, the distribution of the product, plus the marketing and corporate overhead.  It does not pay for the environmental damage, which has very real costs.  Society as a whole pays part of your cost whenever you fill up.  Why don't you pay for the environmental damage your gas consumption causes?

To repeat, once this process of listing advantages and disadvantages of capitalism was completed, it was clear that capitalism was superior.  Facing the disadvantages did not change our conclusion!

John Komlos of the conservative University of Chicago just authored What Every Economics Student Needs to Know and Doesn't Get in the Usual Principles Text.  He argues that capitalism is now presented as "God's gift to humanity."  It is not!  It is an economic system that allocates resources efficiently, despite certain shortcomings.  But, it has become more like "that old-time religion" than analytic economics.  For example, all taxes are bad and damage the economy.  There are no exemptions, not even for research, nor Social Security, nor healthcare, nor anything else.  No revenue extracted from taxpayers can ever have any multiplier impact on GDP.

I have written often about Hyman Minsky and his Minsky Moment, which is no longer taught to economics students.  Instead, they are taught mathematical models.  Even the admission of Greenspan that his model didn't work -- failed to reduce reliance on econometrics.  The Fed has 300 Ph.D. economists on its payroll and still failed to see the global financial crisis, because they were fine-tuning their mathematical models.

One million students take an economics course every year and are taught about super-rationality, where all consumers of all products have 100% knowledge and never make irrational decisions.  (This is mirrored in investment theory where it is called the "efficient market.")  But, the world is not perfect.  Consumers/investors never have perfect information nor make perfect decisions.  Why teach a world that only exists in theory?

Wednesday, August 13, 2014

When Lighting Strikes

According to, the definition of endogenous is  "proceeding from within; derived internally."  The definition of exogenous is "originating from outside; derived externally."

This neat division helps one to understand the value of investment predictions.  Endogenous factors affecting the stock market include economic data, such as unemployment, and market fundamentals, such as advance/decline lines and market multiples, as well as the all-important corporate profits.  There is one set of analysts who can speak intelligently on endogenous factors.

Exogenous factors are primarily geopolitical events but also weather events or natural disasters, such as earthquakes.  For example, if Putin flagrantly invades Ukraine, the stock market will object by selling off.  To some extent, that uncertainty is already priced into the market, limiting the market's reaction.  However, if something from "left field" or totally unexpected happens, such as a Chinese invasion of Japan, it would produce an absolutely violent drop in the stock market.  There is a different set of analysts who can speak intelligently on exogenous factors.

The astute investor must listen to both sets of analysts and then synthesize their observations.  That is what I try to do.  Some try to take advantage of the tumult by "betting ahead" of the event.  If you are confident Putin will invade Ukraine, you could short the ETF for European stocks, but your potential losses are unlimited whenever shorting.  Or, you can simply increase your cash levels to match your personal level of uncertainty.     

When struck by an exogenous factor, limiting loss should be more important than profiting from it.  Converting to cash has a 100% probability of successfully limiting loss in the short run.  The probability of successfully betting ahead on exogenous events is much less than 100% and is much more risky.

An old Wall Street adage is that "nobody is smarter than the market."  Likewise, nobody is smart enough to out-smart exogenous events.  Smart people know that! 

Tuesday, August 12, 2014

He Who Hesitates . . . Loses?

I was wrong!  When Putin took Crimea, I expected it would only be a week or so before he invaded Ukraine.  After all, why wouldn't he?  Sure, it would be slightly more difficult than taking Crimea, but the Ukraine didn't have a chance against the superior Russian forces.  And, the West was merely being bellicose and nothing more.  But, he hesitated.  Then, it turned into a trade war - a trade war that has spooked markets worldwide, especially their own in Russia.

The Russian stock market is down 20%.  Their currency has lost 10% of its value against the dollar, contributing to an outbreak of inflation.  That inflation is easily visible in food costs, as Russian nonsensically announced trade sanctions against importing food.  To combat inflation, the Russian central bank has sharply increased interest rates.  Retail spending growth has dropped 50% since the Crimea annexation.  Investment spending has actually turned negative.  GDP growth was 7% from 2003-2007 but has already dropped to less than 1%.  It is hard to describe the Russian economic prospects as anything other than a train wreck!

There could have been a brief hot war when Russia took the Ukraine, with no American lives at risk.  Instead, we have a trade war, with the Russian people paying the price.  Sure, there would probably have been minor trade sanctions if he had invaded earlier but not a full blown trade war.  While this has spooked our market, the U.S. will be fine.  Sooner or later, our stock market will realize that.

Monday, August 11, 2014

A Bayonet's Edge

Saturday, I visited the National World War Two Museum in New Orleans.  While not exactly a pleasure, it was time-well-spent!  There was the usual array of weapons from pistols to tanks, of course.  There were also old airplanes, both fighters and bombers.  As the famous Higgins boats or "landing boats" that were used to deposit men on the beaches of Normandy were built in New Orleans, there was quite a bit of interesting information on that as well.

My strongest visual takeaway is an actual glider that crashed into one of the numerous hedgerows across northern France.  It was smaller than I expected and extremely flimsy - little more than canvas over plywood and no engine.  It is no wonder they were called "flying coffins."

My strongest intellectual takeaway is that Operation Overlord or the Normandy invasion had no contingency plan.  When I attended Infantry Officer Candidate School, we were trained to ALWAYS have a Plan B for every Plan A.  The biggest military operation in history had no backup plan!  Doesn't that imply Hitler would have won World War Two if the Normandy invasion had failed?  It is hard not to wonder how the world would be different.

My strongest perception inside the buildings of the Museum was the age breakdown of the visitors.  Certainly, the percentage of visitors in their 80's and 90 was far greater than their percentage of the general population.  This is not surprising since they can actually remember that war.  Also, the percentage of visitors in their 20's and 30's was far greater than their percentage of the general population.  They probably brought their children, as they should, to learn about their grandfathers and great-grandfathers.

However, visitors in their 50's and 60's were rare.  They are the Korea and Vietnam veterans.  Far fewer in numbers, they increasingly resent the continual accolades poured onto the older veterans from World War Two.  On an individual basis, their experiences are just as compelling, terrifying, and heroic as those in World War Two .  In fact, the greatest resentment exists among veterans of "black ops" or clandestine operations.

More interestingly, there were few visitors in their 40's.  This generation of "Gen-Xers" is increasingly resentful of paying their tax dollars for the many Medicare recipients who don't actively manage their own individual health care with diet, nutrition, and exercise.  The "Greatest Generation" to them, unfortunately, implies the greatest wasters of government money in history.

Veterans of the Greatest Generation rightfully deserve the greatest respect, but not all of it.  After all, the distance between respect and resent is only a bayonet's edge.

Friday, August 8, 2014

A Quiet Dog

The President has announced new airstrikes in Iraq.  The ceasefire in Gaza limped to an end.  Putin has launched economic sanctions against the West.  And, the authorities has declared the Ebola outbreak in Africa is now out-of-control.  As a result, portfolios worldwide will suffer, for awhile.

But, something worrisome did NOT happen!  Just like Sherlock Holmes taught us, a "dog that doesn't bark" can be telling the real story.

One of the sure signs that a stock market is" hot" is a high level of mergers & acquisitions (M&A).  So far this year, global M&A has been $2.2 trillion.  At this time last year, the level was only $1.3 trillion.  This year will probably be the best year for M&A since 2007, just before the global financial crisis.  In fact, one finds M&A highs are invariably indicators of both economic recessions AND financial crisis.  (Remember:  fear a financial crisis, not a garden-variety economic recession!)  An economic recession will be preceded by several large corporate acquisitions that do NOT happen.  An financial recession is predicted by the failure to finance one or more large corporate acquisitions.

Last week, a surprising number of M&A deals collapsed, and my crisis radar came out.  The bad news may be that the deals fell apart, but the good news is that they did NOT fall apart due to a lack of financing.

And, the rates on Argentina's credit default swaps have stabilized, another quiet dog that is good news for investors.

So, as you worry, be thankful for the quiet dogs and think about them as you fall sleep!

Saturday, August 2, 2014

Antenna Up !!

A market correction, an economic recession, and a financial crisis are very different things.  A market correction is routine in a healthy stock market and is a necessary step for the market to go higher.  An economic recession is a routine part of business cycle and is a necessary step for the economy to continue growing.  A financial crisis is much more sudden and severe.  Originating in the financial sector of the economy, it quickly cripples the entire economy and stock market.  Remember the Great Recession of 2009?  It started as the Global Financial Crisis of 2008.

I have no fear of market corrections nor economic recessions.  But, I am scared-to-death of a financial crisis, which will likely first appear as a derivative blow-up.

Argentina now poses such a risk, as they have been declared in technical default.  This is not a case of Argentina saying they will not pay their obligations.  They are saying that past bondholders demanding payment are NOT entitled to any payment now, as those bonds were "crammed down" to a lower value over a decade ago.  Then, a U.S. court said that U.S. banks acting as agents for the current bondholders may not pay out interest that is due on new bonds, unless certain past bondholders are repaid the full face value of the bonds.  Argentina has ample funds to keep the interest current but not to pay previously crammed-down bonds.  They have now been declared in technical default.  So, why is that important?

Bondholders who are afraid Argentina will never pay the bonds are free to buy insurance against a credit default.  This insurance is usually expensive but not outrageous.  Early last week, it would cost you $2.7 million to insure $10 million of Argentine bonds, which is outrageous enough.  By Friday, it would cost you $4.2 million.  This insurance is called a credit default swap.  If I sell you a credit default swap, I get $4.2 million but am still exposed for $5.8 million, because I may have to pay you $10 million.  To protect myself, I then buy a credit default swap from somebody else.  So, a credit default swap stands behind another credit default swap.

If I am a bondholder and bought the first credit default swap, I know who is responsible for paying me.  But, if he is unable to pay, I don't know who is behind him, if anybody.  The big picture is that we don't know who is on the hook for how much.  Who is holding the bag?

If you see any announcement next week that some financial institution has defaulted on a credit default swap, consider decreasing your equity exposure and increasing your cash.  There is a huge difference between a bond default and a derivative default.  Keep your antenna up this week!  I certainly will !!

Friday, August 1, 2014

Anxiety Overload

The stock market was ugly yesterday, with the Dow losing 317 points.  To be trite, the "straw that broke the camel's back" was the news report that a major bank in Portugal had some major unexpected losses, and their stock dropped a whopping 24%.  That's bad news but not necessarily big news.  But, it came when the market was already nervous about Putin's intransigence over the Ukraine and the resulting damage to Europe of trade sanctions.  The market was already nervous about Israel's invasion of Gaza and the possible damage to the world's energy markets.  Did I mention that Argentina has clouded the whole market for international finance?  Most of all, the market was nervous that the Fed was planning to hasten their withdrawal of monetary stimulus and doing so because of a good thing, i.e., the whopping 4% GDP growth rate in the second quarter.  If Friday's "Jobs" Report is good, the market is afraid that report might seal the fate of monetary stimulus.

While the Fed deployed numerous tools to combat the Global Financial Crisis (GFC) of 2008/9, only two are still effective.  One is quantitative easing, which has been tapering and will be ended in October.  Do you remember last year's "Taper Tantrum," when the market was overly-terrified that the amount of QE each month would start decreasing.  After that hissy-fit, the stock market recovered nicely and went on to record levels.  The other remaining tool is extremely low interest rates.  I don't think the Fed will start raising interest rates before the latter part of next year.  The stock market is now afraid the Fed will raise interests rates very late this year or early next year.  Once that announcement is made, I expect another hissy-fit, with the market dropping dramatically and scarily, before recovering to new record highs once again.

While the stock market is always "climbing a wall of worry," that wall is very tall at the moment.  There are many reasons to be anxious right now.  Unfortunately, that increases market volatility, and today's "Jobs" Report will likely cause an over-reaction or under-reaction.

Lastly, like an expectant woman waiting to deliver her baby becomes more and more anxious as the baby is later and later, the stock market averages a 10% correction every 19 months and hasn't had one for 33 months.  The correction is past-term.  Delivery might be induced by all this anxiety overload!  I hope so, because more record highs are on the other side.

Thursday, July 31, 2014

Good = Bad

The Dow was up slightly when the news hit The Street that GDP growth was a whopping 4% in the second quarter.  That's good news, right?  But, the Dow promptly drops a hundred points on that good news.  Why, because a stronger economy means the Fed is more likely to raise interest rates sooner, instead of later.  And, that's bad news . . . huh?

The Argentine government announces they will default on their debt.  Yet, the Argentine stock market went up, while the U.S. stock market went down.  Does that make sense?  As a result, Argentina will likely be locked out of the world's capital markets for years, but their country will NOT be stripped of all its liquidity right now, which was a big relief in that country, fueling their rally.  In the U.S., however, an Argentine default means the whole arena of international finance, which is dominated by the U.S.,  will now be clouded by this default, which is not really more than a technical default, but it greatly increased uncertainty.  And, we know that increased uncertainty is bad for the stock market.

Maybe, there is pure good or pure evil in this world . . . but, it is not that simple on Wall Street. 

Wednesday, July 30, 2014

Timing Is Everything

I cannot remember the last time that Consumer Confidence increased 4.5 points in one month, but it did this month.  That means more people are optimistic about their current financial position as well as their future financial position.  There is a close relationship between the labor market and consumer confidence.  As the labor market improves, consumer confidence increases, and both have.

Of course, the Confidence Survey was taken on July 17th, which was the day the Russian separatists shot down the Malaysian passenger jet, as well as the same day the Israelis invaded Gaza again.  Therefore, many analysts are suggesting a survey taken on July 18th would not be nearly so healthy.  I disagree and don't think many Americans are losing any sleep over foreign tragedies so far away.

As consumer confidence increases, consumer spending increases.  Consumer spending is almost 70% of GDP, suggesting GDP growth will increase.  And, lo and behold . . .

I cannot remember the last time that GDP growth was a whopping 4% during the second quarter.  That may sound miserly compared to China's 7.5%, but it is very strong for a mature economy like the U.S.  Of course, it was expected to rebound nicely after the winter-crushed first quarter GDP growth, which was a negative 2.9%.  But, it was not expected to grow at 4%.  Before we rejoice too much, let's wait until we see next month's revised estimate.

Nonetheless, economic data continues to look strong.  Most analysts believe the stock market is 6-12 month leading indicator of the economy, and that certainly seems to be the case again.

Party on, Garth . . . 

Tuesday, July 29, 2014

A Well-Oiled Machine ??

The Federal Reserve System is the only central bank in the world that has a dual mandate, i.e., combating both inflation AND unemployment.  With inflation virtually non-existent, the focus is on unemployment.  The closely-watched monthly "Jobs" report will be released this Friday.  Absent some exogenous factor, the stock market will just churn around the flat line until then.

For all of 2013, we created 195 thousand jobs each month, on average.  So far this year, we have created 230 thousand each month, which is a significant improvement.  It is even more remarkable if you consider that GDP growth in the first quarter was a whopping, negative 2.9%.

With the job creation "machine" functioning so well, attention is turning to wage growth.  Normally, at this point in the business cycle, wages would be increasing 3.9% annually.  However, wages are growing at only 2.3%.  This confirms that inflation is non-existent.  It also reflects just how severe the recession was and how much negotiating strength that workers lost.

Wells Fargo wrote an interesting piece on how big companies don't feel any need to raise wages now, since they didn't reduce them during the recession -- having just reduced the number of employees instead.  With the government's JOLTS report showing employees are increasingly confident in changing jobs, big companies may want to re-think that position.

One final caution on this Friday's highly anticipated Jobs reports.  It is normally issued on the first Friday of the month.  For August, it falls on August 1st, providing less time to massage the numbers, which increases the likelihood that it will be substantially adjusted in September.  This is not a bad thing, as it reduces the volatility following release of the report on Friday.

Since political considerations pollute and contaminate everything, one political consequence of an improving job-creating-machine is that it tends to benefit the incumbent President.  Fortunately or unfortunately, the President is not on the ballot this year.

Monday, July 28, 2014

Geopolitical Risk

The Old Ebbitt Grill at 15th & New York in Washington, D.C., is one of those classic old steakhouses frequented by Congressmen, bankers, and other shady characters.  I had lunch there one day with two analysts who got into an uncomfortable argument about whether Pfizer or Merck was a better investment.  They were even quoting footnotes from the annual statements of both companies?!?!

Sitting in the political capital of the world, I was amused that the subject of politics didn't even come up.  The best laid plans of mice, men, and analysts are easily waylaid by politicians.  That risk rises and falls, unrelated to any analysis of corporate balance sheets.

Here is the definition of Political Risk from Investopedia:

The risk that an investment's returns could suffer as a result of political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policy makers, or military control.

Obviously, that risk is quite high right now, but I am not overly concerned about it.  If Russia overtly invades the Ukraine, taking the eastern half, the stock market will drop.  If Isis holds it's position in Iraq and invades Jordan, the stock market will drop.  If Saudi Arabia issues an oil embargo due to the Israeli invasion of Gaza, the stock market will drop.  And, of course, there are other events that could cause the market to drop.

This too will pass!  I don't recommend selling stocks and going into cash unless there is a derivatives fiasco, which I don't see on the horizon.  Rejoice:  we still have time for uncomfortable arguments in fancy restaurants about things that don't really matter anyway.  

Sunday, July 27, 2014

A Guilty Pleasure

One of my guilty pleasures is taking long walks on the beach alone.  During beach season, it is fun to watch the visitors.  Ninety percent of them and 100% of the dogs are enjoying themselves.  I don't know why it is so enjoyable, other than the novelty of it.  Less than 50% of the adults but more than 90% of the kids actually go into the water.  They could more easily stay home and get wet in their bathtubs.  Some psychologists think there is an evolutionary need to remember the watery world of pregnancy.  My wife  thinks it is just a grand conspiracy to track sand into the house.

During non-beach season, I have the beach to myself and a few other hearty souls, as I watch the ships going in and out of the Chesapeake Bay.  I have seen many awesome aircraft carriers pass serenely, secure in the knowledge they could easily defend or destroy Hampton Roads whenever ordered to do so.  Several times, I have been inspired whenever I see the U.S.S. New York, which was forged from the steel girders of the World Trade Center.  The Chesapeake Bay also reminds me to take a long view -- of everything, especially when I remember the giant meteor strike hundreds of millions of years ago that formed the Bay.  We are merely a vapor.

Yet, this blog touches on things existential and things economic.  What is existential about this guilty pleasure?  Well, I like taking these walks alone and even do so during those forlorn winter months.  Remember:  every person is an island.

And, what is economic about this guilty pleasure?  Economics is a study of how scarce resources are allocated.  One very scarce resource is time.  How can I justify a 90-minute walk when I could spend the time solving the quadratic equations of the latest econometric analysis by some academic nerd?  If you have to even ask that question, you wouldn't understand the answer!

Oh, yeah . . . it is also good exercise . . . so, as Nike says . . . JUST DO IT!

Saturday, July 26, 2014

I Don't Understand

There are many things that I do not understand.  For example, I don't understand why it takes years to build a road.  I don't understand what makes window treatments cost so much money.  I don't understand why women are so obsessed with shoes.  But, most of all, I don't understand what happened to moderate politicians?  Maybe, they were a species of animals, like dinosaurs, that just became extinct?

No, wait -- I DO understand what happened to them!  It was a political purge to get rid of "compromisers" or those people who aren't true to the faith.  The tool used was called "redistricting."  Unfortunately, the purpose of re-drawing the boundary lines of political districts every ten years, based on data from the latest population census, is NOT to draw boundary lines of each district that are "contiguous and approximately equal in population, not square miles."  Theoretically, neither ethnicity nor past voting history should matter.  In fact, the ONLY thing that does matter is making the district SAFE for either an incumbent Democrat or an incumbent Republican.  Most Congressional district elections are determined in the partisan primary.  If it is a safe Democratic district, the Democratic primary effectively determines who will win the general election against a Republican, and the same process is true in safe Republican districts.  If I am running in a safe Democratic district, I need to appeal to left-wing voters and ignore the right-wing voters.  In that case, I would have to be a true-blue politician, who will fight everything the evil Republicans propose.  A moderate Democrat will not win the primary.  The same thinking is true if I'm running in a safe Republican district. A moderate cannot win the Republican primary.  Protecting the incumbent should NOT be the objective of redistricting . . . but it is.

If we don't allow foxes to guard the henhouse, why do we allow politicians to draw these all-important political boundaries?  Politicians say that they represent the people, when they represent only their political party.  Some states have appointed redistricting commissions that have been no better, UNLESS their final decision is binding on the state legislature, which politicians abhor.  The alternative is to let the state judiciary draw political boundaries.  Because both political parties oppose this, it is probably the only semi-workable solution.  It could not be any worse.

Otherwise, we'll have to see our moderate politicians in the museum . . . as fossils.

Maybe, that is not so bad as I understand extinction . . . better than I understand partisanship.

Friday, July 25, 2014

Inverted Thinking

The Democrats are correct in saying we need comprehensive immigration reform.  The Republicans are correct in saying we need comprehensive tax reform, especially reform of the corporate income taxes.

If you doubt the need for tax reform, consider the increasing number of "tax inversions" over the last three years  The U.S. has one of the highest tax rates on corporate income in the world.  Making a dollar's worth of profit in this country is worth less here than in other nations, because you're paying more in taxes here.  If you want to make your company more profitable, you can do so by paying less in corporate income taxes, and you can do this by doing a tax inversion, which means you buy a smaller company in Europe or anywhere with lower marginal corporate income tax rates.  Then, you make that foreign company your corporate headquarters and begin paying corporate income taxes to that nation, instead of paying taxes to the U.S.  One day, you're an American company.  The next day, you're a European company.  Nothing else changes.  You just change your corporate home-country on paper and begin paying the lower corporate income taxes in that country and stop paying higher corporate income taxes in the U.S.  That leaves you more money to pay dividends or pay employees or to invest in factory equipment or to buy another company.

The United States is expected to lose $20 billion in tax revenues over the next ten years from tax inversions. Want to increase the value of stocks by $300 billion?  Just cut expenses by $20 billion (assuming a price-earnings ratio of 15 times).  Don't forget -- the primary job of CEOs is to increase value.

Corporate income taxes are just another expense of doing business.  Businesses have an obligation to minimize expenses.  That includes all expenses, including energy costs, employees costs, occupancy costs, AND tax costs.  Any CEO who voluntarily pays higher costs will have to answer to his shareholders.

Are those corporations un-patriotic?  The Treasury Secretary said so at a conference in New York a week ago.  Yesterday, the President agreed.  I totally disagree!

Wednesday, July 23, 2014

Today, We Are All Dutch

On some days, I am actually proud to be part of the human race.  Today was such a day!

During the course of my workday, I routinely channel-surf between CNBC, Bloomberg, FBN, and CNN.  Today, because the stock market was so placid, I became transfixed by CNN's coverage of the arrival of corpses from Malaysia flight #17 back to the Netherlands.  The first forty corpses were ferried along deserted roads by forty hearses to a suburban location for forensic processing.  This tiny nation of 17 million lost 200 citizens on that flight.  Hundreds of thousands of them stood in respect along the road or upon the bridges and overpasses -- mostly in prayerful silence.  Tomorrow, there will be another procession of forty hearses.  And, on the next day . . . and the next day . . .

After being left to rot in the field for days, nibbled by animals and insects, the corpses were finally given the respect and dignity they deserve.  The Dutch rose to the occasion and exhibited the very best of mankind.  I salute them!

The contrast between the nobility of the Dutch compared to the barbarism of the Russian separatists is simply over-whelming.  But, it is too easy to describe the Russian separatists as mere thugs.  Harsher language should be reserved for their commanders and, more specifically, their Commander-In-Chief.

But, what is the crime -- the accidental shooting down of a passenger plane or the criminal neglect of the wreckage and the corpses?

Regardless, the Dutch people showed the world what class really is!  I just hope Putin was watching too.

Friday, July 18, 2014

Quarterly Column

For anybody waiting breathlessly by their mailbox for the latest issue of Inside Business, so they can read my quarterly column, you can also read it online at:

When It Rains . . .

Yesterday, a civilian plane was shot down over the Ukraine, killing all 298 passengers.  Within the hour, Israel invades Gaza.  The Dow drops 161 points, the biggest drop in two months, reflecting the increased uncertainty.

In addition, the civil war in Syria still rages on.  Despite our investment of lives and treasure, Iraq is sub-dividing itself.  We're still not out of Afghanistan, and they cannot agree on who won their Presidential election.  Massacres of the weak are still routine in the Sudan.  Only Putin knows why he has not already taken the eastern half of the Ukraine, to go with his seizure of Crimea.  The Shining Path is still alive and murderous in Peru.  Argentine is dangerously re-writing the rules of international finance.  Even the U.S. has a thorny invasion issue on its southern border.  And, just for good measure, there is another outbreak of Ebola in Africa.

I recall a professor in college saying it was not a constitutional requirement that the President of the United States be intelligent.  In fact, it is such a lousy job that no intelligent person would want it.  Anybody who actually wants the job is inherently unqualified for it.

The bright side is that this uncertainty spike may finally cause a much-needed dip in the stock market.  On average, the market experiences a 10% or more dip every 18 months.  We haven't had one in 32 months now and are long overdue.  (Frankly, I was surprised the Dow dropped less than 1% yesterday, which may indicate the underlying strength of the bulls.)

Without insensitivity to the human heartache involved, this uncertainly spike will resolve itself to a more normal level, and the stock market will resume its more normal long-term growth.  Until then, let it rain, let it rain . . .

Thursday, July 17, 2014

Fretting Each New High

The Dow set a new high yesterday.  Today, the world is worrying whether the stock market is over-valued and ready for a replay of 2008.  The answer is NO.  Take a look at this chart:

Chart of the Day

If you take the price of a share of stock and then divide it by the earnings per share of stock (EPS), you have the Price-Earnings (PE) Ratio, which is the measure of how "over-valued" the stock is or is not.  In other words, how many years of EPS are you paying for a single share?

Looking at this chart, you'll see the trend line is that the market becomes fully valued when each share of stock costs about 23 times the earnings per share.  Today, we're at 20 times, which means the alarm bell is not ringing yet.

Does that mean the stock market cannot take a bear swoon right now?  Of course not!  A dip of 5-10% is always possible at any time and is indeed healthy for the market in the long-run.  Since yesterday's new high was the fifteenth new high of the year, why is a sixteenth new high hard to imagine?

Paraphrasing the iconic Warren Buffet, I don't know where the market will be tomorrow, but I do know where it will be in ten years . . . UP!

Wednesday, July 16, 2014

Such Sweet Justice

If you live long enough, you might get to see history repeat itself.  When I first started studying economics, forecasting had a heavy dose of person-to-person interaction, where the thoughts of other thought leaders were at least as important as any independent information I might discover.  When I took my first course in statistics, I thought it would be an interesting sideline to either confirm or dispute a forecast.  Little did I know that statistics would evolve into econometrics, beginning a reign of terror over the whole field of economics.  Nothing mattered if it didn't have a formula.

Yes, I know that armies of Ph.D. economists have spent their lifetime constructing mathematically pure models of economic behavior.  I also know that the very best models of the Fed and other central banks did not foresee the Global Financial Crisis.  Of course, their response to this failure has been to construct "new & improved" economic models.

In fairness, all those things I was forced to learn about econometrics have been helpful in explaining market volatility to clients, but other than that . . . oh, yeah . . . it also helps me to understand political polling.

Still, it was with a certain glee when I saw the head of Canada's central bank admitted his disappointment with their economic models and instructed his economists to get on airplanes and go talk with industry executives face-to-face.  Econometrics may once again be used to test a hypothesis -- but not to make decisions or forecasts.

Oh . . . such sweet satisfaction . . .

Tuesday, July 15, 2014

Shooting The Survivors . . . and/or Shareholders

Another major bank just agreed to pay a $7 billion fine for actions leading up to the Global Financial Crisis (GFC).  In total, banks have now paid roughly $100 billion in fines, which is certainly a great deal of money.  However, estimates of the damage done by the GFC vary between $5 TRILLION to $20 TRILLION.  Assuming even the lower estimate, how does the $100 billion payment of fines make Americans whole?  All it does is make the current shareholders $100 billion poorer.

Corporations have a "legal" identity, but that still doesn't make them human.  No corporation said they were going to "put lipstick on this pig," as one banker described a security just before selling it to his clients.  It was a human being, who was never charged with any crime and then retired with his millions.  He was not unique.  All the decisions to knowingly sell trash to clients were made by human beings.

My conclusion is that a person can do things legally inside a corporation that would be illegal outside the corporation.  The logically-absurd-conclusion is that I can kill somebody when I'm employed but not when I'm unemployed.

Painfully few people have done the "perp walk."  Of course, I recognize it is a waste of time and money to allocate legal resources towards hopeless causes, but fairness sometimes demands it.  The defense asks "Did a senior employee decide to sell trash to clients because his boss told him so?"  That defense should be as useless as the Nazi defense that senior generals had no guilt because they were just "following orders."  They were executed.  Fairness demands "perp walks," if not executions.

  If we cannot punish the guilty employees, is justice then served by punishing the shareholders?