Thursday, April 17, 2014

Asset Protection Trusts

There are many good reasons to transfer assets into an asset protection trust, such as protection from creditors, from ex-wives/husbands, and from personal-injury lawyers.  My only observation until now has been there are more crooks selling asset protection trusts than anywhere in the arena of personal financial planning.  For those clients who need asset protection, I insist on helping to pick the trustee, because you lose everything if that trustee is a crook.

Now, I've received some marketing materials from an asset protection trustee whom I believe to be legitimate.  What bothers me is that he is arguing clients should put their money into asset protection trusts to protect that money from pollution claims arising from fracking.

It just seems like some things are so awful that you cannot hide from them.  If I kill a person, should my assets be protected from the claims of the decedent's family?  If I pollute the Chesapeake Bay, should my assets be protected.

I have avoided asset protection trusts as much as possible, because there are so many crooks. Now, there is another reason.  We don't allow people to hide from their college loans by filing bankruptcy.  Why do we allow major-league polluters to hide from their environmental liabilities by using asset protection trusts?  I find that morally repugnant!

Wonder if the crooks selling asset protection trusts also find that morally repugnant?

Wednesday, April 16, 2014

Risen From The Dead ?

There are those who believe the global financial market is just as precarious now as it was five years ago.  They are wrong!  As proof, it was little noticed last week when Greece returned to the market after four years of misery and was able to actually sell $4 billion of government bonds.

Their GNP has shrank over 25%.  Unemployment is 27%, which is a depression level.  Suicides have soared.  A quarter of the population lives in poverty.  Imagine this is America!  It has been a terrible price to pay, but, in all likelihood, it is still not enough.

The turning point is that the Greek government has finally passed some badly needed legislation to curb excessive pension costs and business regulation.  Of course, implementation of these changes will be critical for long term success.

Importantly, the leaders of the EU paved the way for this successful sale by NOT ridiculing the Greeks.  Merkel even flew to Athens the day after the sale to congratulate everybody.  "High Fives" were everywhere!  EU leaders wanted Greece to have access to the financial markets.

But, who would actually buy the government bonds of Greece?  To everybody's surprise, demand for the bonds was brisk.  They sold out quickly.  One reason is that 4.95% interest rate for five-years is high, compared to 2.5% and 1.4% for similar bonds of Portugal and Ireland, respectively.  In addition, you will recall existing Greek debt was restructured to longer maturities, mostly 30 years.  That means these new bonds will have to repaid before the existing debt, effectively making it senior debt that pays almost 5%.

I'm glad to see this success and hope it continues.  It reflects well on the global financial markets for sure.  It is also a reminder of what happens to economies who borrow money to pay for entitlements.

Tuesday, April 15, 2014

Is Enough Fair ?

Occupy Wall Street revived the discussion about income inequality, i.e., that the top 1% have an unfairly large share of the income.  While there are very few numbers quantifying the issue, it is generally assumed that a person needed $500,000 in adjusted gross income to be included in that top 1%.

However, there is some new research from the London School of Economics and the University of California relating to wealth owned, as opposed to income.  Using information from the IRS, they have concluded:

1.  The bottom 90% of Americans own 25.6% of the wealth.
2.  The next 9% own 34.6% -- thus, the bottom 99% own 60.2%.
3.  The next nine-tenths of 1% own 18.3% -- thus, the bottom 99.9% own 78.5%
4.  The next nine-tenths of one-tenth of 1% own 10.4% -- the bottom 99.99% own 88.9%
5.  The top one-tenth of one-tenth of 1% of Americans own 11.1% of the wealth.

The vast majority of the top 1% don't feel their wealth has expanded that much.  The top 1% of the top 1% have seen their share of the wealth quadruple since the Reagan Revolution.  Therefore, 99% of the top 1% have not benefited as much as the top 1% of the top 1%, so they feel maligned by Occupy.

The methodology of this research is a little suspect.  While they had good data from the IRS:  because the data was available annually, because the income is broken down by asset class, and  because of the huge sample size-- translating those income levels into asset values requires a changing capitalization rate every year.  There is a lot of subjectivity with that, although I'm not sure yet how it could be skewed by political bias.

Stated differently, the 16,000 families in the top 1% of the top 1% own 11.1% of America's wealth!  Fairness is an unfair word is describing this process of increasing wealth in fewer hands.  However, it does beg the question of when will too much wealth be in too few hands.  If the top 1% owns 39.8% of the wealth now, is it OK for them to own 49.8% of it?  How about 59.8%?

Nobody argues that the top 1% of the top 1% owning 100% of the wealth is good for society?  At what point does this concentration of wealth become harmful to social stability?  How will we know when enough is enough?  What has to happen first?  The question is begged . . .

Sunday, April 13, 2014

Name of Nation

Yesterday, I asked readers to guess the name of which nation has a very popular leader despite having a very bad economy.  The answer is Russia.

$63 billion of capital left the country in the twelve months of 2013 but $70 billion has already fled the country in the first three months of this year.

In the mid-1990s, 50% of its exports was energy.  Today, it is 70%.  The nation is terribly vulnerable.

I don't know who originally said that people vote their wallet, but suspect they only do that in the absence of patriotic fervor.

So, if the economy is lousy, start a war? 

Saturday, April 12, 2014

Name The Nation

The leader of this nation has an 80% approval rate, something any U.S. president would envy.  Yet, the economy is not doing well.  In fact, it is doing very poorly.

GDP growth has slowed for four straight years.  They are hoping for zero growth this year but may well slip into recession.

Capital is leaving the nation at a faster rate, i.e., more capital has left in the last three months than all of last year.  The government is considering capital controls.  Naturally, the stock market is down, and the currency is also down badly.

It is increasing dependent on a single export.  The economy is terribly vulnerable to this one export, and it is getting worse.  This indicates extremely poor long-term planning.

Whoever said that people vote their wallets?

Tune in tomorrow for the name of this nation . . .

Quarterly Column

I have been writing a quarterly column for Inside Business, the regional business journal, for some years now, and the latest column can be found at: 

Friday, April 11, 2014

Bring It On !!

The Dow dropped 266 points yesterday.  The "Fear Index" or VIX is up.  Is the sky falling yet?  No!   Of course, after surviving the near-collapse of the world financial system only 5 years ago, it is a fair question.

Let us remember that almost every year has a 5-10% correction, and we are overdue.  I've been hoping for one for some time now.  We're only down 4.5% from our high last month.  The longer we wait, the greater the correction.  So, bring it on!  It will be good for the stock market in the long run.

How do I know this is not the "big one," as we saw in 2008/9?  The basis of Modern Portfolio Theory teaches us that higher returns are available with lower risk if the portfolio is diversified by asset classes instead of by stocks.  In other words, a portfolio of 25 healthcare stocks is definitely NOT diversified.  A portfolio of different asset classes, such as large company stocks, small company stocks, international stocks, long-term bonds, short-term bonds, cash, gold, real estate is much better diversified.  The reason is correlation.  While all healthcare stocks are likely to move in the same direction by approximately the same amounts, stocks will usually move differently than gold or real estate, because they are not correlated. However, during the global financial collapse five years ago, everything became correlated, which is a fancy way of saying everything goes up or down at the same time.  When everybody sells everything and heads for the exit, asset classes become correlated, and this is bad.

Today, we see some stocks moving up, some nations moving up, and some bonds moving up, despite the fact that the vast majority of stocks are falling.  Different asset classes are behaving differently, which is normal.  Correlations are still working, which means that asset classes move independently of each other.  When they don't work, it is OK to get nervous . . . but not now!  Embrace the short-term pain!

Monday, April 7, 2014

Class Condolence

I have been blessed over the past week with many moving condolences on the loss of my mother and have appreciated every one of them.  However, there was one that seemed particularly insightful, from a good friend and gentleman-farmer.  Here it is:

Two nights ago the farmer put some of his herd in the field just below our house.  The rest of the cows were left in an adjacent pasture separated from the first  by our driveway.  Immediately there was this incessant … bellowing.  Mooing doesn’t begin to capture the sound.  It seemed that every cow was joining in - from both pastures.  The sound lasted all night.  It was stressful.   And distressful.  

The next morning I saw the farmer and asked about what we had been hearing.  He said they had separated the young calves from their mothers for the first time.  That was the cause of all the noise.

It seems odd - all this bellowing.  And then it doesn’t.  It’s something I can understand.

I was sorry to hear about the loss of your mother.  

Sunday, April 6, 2014

MPC + MPS = 100%

A new survey shows that food prices are expected to rise about 3.5% this year, about twice as much as the Fed wants . . . Who Cares?

Without discussing with my wife, I expect we don't spend 5% of our income on food.  So, a 3.5% increase increases that 5% to only 5.175% of income.  A local social worker tells me that her clients often spend one-third of their income on food.  So, 3.5% inflation in food prices increases that to 34.155%.

In other words, food expense for a poor person increased 1.155%, while mine increased only 0.175%. The increase for a poor person is 6.6 times as great as the increase for me.   Food inflation hurts poor people more than the more fortunate.

Economists like to talk about the Marginal Propensity to Consume (MPC) and the Marginal Propensity to Save (MPS).  They measure what percentage of new income will a person consume/spend or save/invest.  If you get another dollar of income, will you buy half a cup of coffee at Starbucks or toss it into your piggy-bank?  If you spend 70% of that dollar, your MPC is 70%.  Since you either spend/consume your money or you save/invest your money, a 70% MPC means your MPS is 30%.  Some people, unfortunately, consume/spend 100% of their income.  Those people are more directly impacted by inflation.

This is the "logical" basis for our progressive income tax system.  You tax most heavily those people with the higher MPS.  After all, they don't need every dollar of income to survive.

I know, I know . . . now we have a system whereby high income taxpayers pay the overwhelming majority of income taxes to run the government, but get less than they pay for, while poor people get more government benefit than they pay for.

One more time . . . why did Willie Sutton rob banks . . . because that's where the money is . . .

Saturday, April 5, 2014

The Need For Speed Is Greed

There is a firestorm on Wall Street, ignited by author Michael Lewis, with the release of his new book Flash Boys.  It is an explanation of how “high-frequency traders” (HFT) have rigged the stock market by getting buy-and-sell information literally nanoseconds before the stock exchanges, where trades actually take place.  

Knowing a good number of BUYS are coming in, which will drive up the price per share, they buy just ahead of those orders and then sell at the higher price to those sending in the BUY orders.  They might buy and then sell the same stocks in nanoseconds.  

It is estimated that 70% of all trades are now by HFT.  Are buyers getting ripped off?  Yes!  Is it enough to matter?  No!  If you are a long term investor, it should not matter if you pay an extra two cents per share.  Is it illegal?  If it is not, it should be!  Even Charles Schwab agrees it should be illegal.

But, the petty theft, albeit on a grand scale, is not my primary concern.  Long time readers know I have cautioned about high-frequency trading since the “Flash Crash” of May 6th, 2010, when the Dow suddenly dropped a thousand points.  That was due to a technology problem.  HFT is steroids for technology problems on Wall Street.

The only way to underwrite or minimize this risk is to avoid panic if/when it happens!.  Just like the Dow recovered those thousand points, we will survive an HFT-Crash, but it will seem like a near-death experience at the time.

Friday, April 4, 2014

On Eulogies

A chore is something mildly unpleasant that needs to be done.  A burden is something quite unpleasant that must be done.  A chore is going to a funeral.  A burden is delivering the eulogy.

People who knew the decedent want a pleasant insight into the decedent's life.  People who loved the decedent want to feel the warmth of that love one last time.

Delivering a eulogy comes disguised as an honor but really is a heavy burden.  Because a funeral can be ruined and the memory of the decedent can be stained by a bad eulogy, there is a great deal of pressure to do it right.  In addition, the person delivering the eulogy usually knows the decedent well enough to have emotions of their own, that should be suppressed during the eulogy.

My advice to those who must deliver a eulogy is to share lighthearted vignettes that each reveal a lesson-learned or a character trait of the decedent.  Facial expression is also important.  Smile with fondness, not with giddiness.  But, smile!  Don't be tempted to read or talk fast.  Slow down!  To control the emotions, avoid eye contact with the loved ones closest to you.  Lastly, don't expect applause, as that is considered inappropriate at a funeral.

Tomorrow, we return to the more pleasant world of economics and investments . . .

Sunday, March 30, 2014

Time Out . . . And A Time To Grieve

My mother died tonight.  I guess a person can only say that once in a lifetime.  Right now, we are scrambling to pack and leave shortly.

She spent a long seventeen months in hospice and died a miserable death, begging the question of why a good God would make good people suffer so much . . . for so long?  She deserved better!

Somehow, it seemed appropriate that we were watching a special on Amelia Earhart when the call came.  My mother was always a strong advocate of women's rights, even voting for Margaret Chase Smith for President back in the 1964 election.  All three women were strong, opinionated, and feisty!

Proving that actions speak louder than words, I never heard her say to me that she loved me, but I always knew it anyway.  She taught me so much!  I miss her already!

It is now time for me to help my father deal with his loss and to prepare her eulogy.  I expect to be offline for awhile.

Bad Good-News ?

During the 1990s, corporate profits averaged 5.4% of GDP.  Today, it has doubled to 11.1%  How can you not be happy that corporations are doing so well?  CNBC great Larry Kudlow likes to say that "profits are the mother's milk of stock prices."  It is good for stock prices!

From a historic standpoint, during the global financial crisis of 2008/9, banks shut off the flow of money, which badly frightened corporations, especially those who immediately faced a liquidity crisis.  Survival depended on slashing costs and increasing short-term profits.  From many C-suites, there were loud cries of "never again!"  The behavior of corporations has been totally reasonable.  Unfortunately, no level of liquidity is now unreasonably high.  This is not good.

From the standpoint of the corporations, they are still under increasing pressure to keep increasing profit margins and liquidity even more.  At some point, there is too much pressure.  There is more to valuing a stock than the latest quarterly earnings report.  It encourages short term thinking -- to defer capital improvements and to postpone training new workers.  This is not good.

From the standpoint of society, this pressure to keep expenses low -- by keeping unemployment high and by allowing inflation to continue eating away at the pay of employees -- continues to squeeze the already shrinking middle class.  This is not good.

From a political standpoint, these "excess profits" could create a backlash, citing the increasing share of GDP going to companies and decreasing share going to people.  Likely, this would mean delaying badly needed cuts in the corporate income tax rates and encouraging additional regulation.  This is not good.

Aristotle is usually given credit for saying "moderation in all things."  That should include corporate profits and liquidity as well.  I just pray that, when profit margins do start decreasing, that the resulting bear market will be both short and moderate.

Saturday, March 29, 2014

My Refrain ?

I know I've said it too many times already, but doesn't every good song have a refrain that is repeated over-and-over.  Here is mine:  we are over-regulated and under-punished!  There, I feel better now . . .

Bernie Madoff was exposed in 2009 after his Ponzi scheme collapsed.  He could have been arrested years earlier by the SEC, which ignored both anonymous and non-anonymous tips.  Recently, his employees were found guilty on 59 counts and will be sentenced in June.  Sentences are expected to be "light" since they cooperated with the prosecutors.

Today, Madoff sits in a North Carolina prison, which specializes in better health care for federal prisoners.  Sure, it would be emotional hell for a normal person to think of your wife divorcing you and your son committing suicide, both out of shame about you.  Raise your hand if you believe Bernie is in emotional hell.  He lives as a respected master criminal and receiving better health care than millions and millions of working Americans.

So, should we pass more laws saying "don't do like Bernie did?"  Or, should he be executed?  Oh, by the way, there are about fifty Ponzi schemes discovered every year . . . I guess there is no need to send them a warning message?

I know, I know . . . civilized societies don't need to kill their citizens . . . in a perfect world!  But, don't we need perfect people to have a perfect world?

A Chance Meeting In The Backcountry

In the remote southwest corner of Texas, separated from Mexico by the muddy Rio Grande river, lies the vast Big Bend National Park.  It is larger than the whole state of Rhode Island;  a desert flatland of wide vistas colored in brown and tan, with a few smudges of green, smothered by a brilliant blue sky and punctured by the majestic Chisos Mountains.  It is a hostile environment where visitors are warned that everything they see "either pricks or stings."

Many years ago, I was backpacking the mountains with two buddies.  We had plans to camp that night in a place called the "Meadow," because it was a relatively flat area between two mountains that sometimes had wild grass growing.  When we arrived, we were surprised to find three other backpackers already there.

The tallest one was immediately recognizable, but we said nothing.  In the backcountry, there are only two questions.  The spoken one is "are you OK?"  The unspoken one is "do you know what the hell you're doing?"  They were OK, and the two companions clearly knew what they were doing.

Since there is no wood in the desert for fire, backpackers must carry tiny propane stoves to cook dinner.  The six of us pooled our resources and sat around the stoves that evening.  Knowing he was also trained as an economist, I tried to make light conversation, but he was uninterested.  He was not rude.  He was just absorbed by the hostile beauty around us.  In particular, he was studying how much brighter the stars became as he walked away from the tiny stoves.  It seemed to me that he was sad, because he had discovered so late in life, that there is more beauty outdoors than indoors.

James Schlesinger died Thursday.  A brilliant, blunt intellectual, he could never be mistaken for a Jim.  He  held three different cabinet positions (Defense, Energy, & CIA) for both Republican and Democratic presidents.  He is probably the only person who can say he was fired by three different presidents.  Watching him that night, I realized that it is not sufficient to be smart, that it is not sufficient to be right -- if you cannot "sell" it.  That chance meeting seared the lesson into my mind!  I thank him for that lesson and hope he died with intellectual peace -- that he was able to rationalize an irrational world.

Thursday, March 27, 2014

A Peek Ahead from NABE

I've been a member of the National Association of Business Economists for many years now.  They are mostly working economists, not academic economists.  And, I always look forward to their economic survey of members.  According to the latest:

1.  Due to weather primarily, GDP growth in the first quarter was only 1.9%, but it is expected to accelerate to 3% for the next three quarters.  For the full year, it should be 2.8% in 2014 and 3.1% in 2015.

2.  The probability of recession is only 15%.

3.  Unemployment averaged 7.4% last year and is expected to average 6.4% this year and 6.1% next year.

4.  Interest rates will rise 50-75 basis points by the end of next year.

5.  Housing prices will gain 5% this year nationwide and another 4% next year.

6.  The dollar will hold relatively steady but increase modestly against the euro.

7.  "The federal deficit is expected to total $557 billion in Fiscal Year (FY) 2014 and $536 billion in FY2015, well below the $680 billion deficit recorded in FY2013."

8.  The S&P 500 should end this year at 1,950 and end next year at 2,047.  This is an increase from their December prediction of ending this year at 1,850.  Corporate profits are expected to grow 7% both this year and next year.

All in all, it is a pretty sanguine forecast . . . almost boring . . . which is good, very good!  We've had enough drama in the stock market and the economy over the last six years.

Wednesday, March 26, 2014

Economics, HIV, and Cupcakes

It is for good reason that economics is not-so-lovingly referred to as "the dismal science," because it is so focused on budgeting limited resources.  As a result, economists tend to see the world dismally or at least differently.  I appreciate those who can make the subject interesting, entertaining, and relevant.  Therefore, I highly recommend an economist's review on that dismal but Oscar-winning movie Dallas Buyers Club. 

After watching this short 8-minute movie review, see if you can define the term:  Regulatory Capture.

Tuesday, March 25, 2014

The Cost of Economic Ignorance ?

I'm trying to feel sorry, without much success, for Vladimir Putin.  After all, he grew up in the old Soviet Union, with no understanding of capitalism.  When communism fell, it was replaced with "cronyism" which created the oligarchs . . . but certainly not replaced with capitalism.

Following his invasion of Crimea and imminent invasion of eastern Ukraine, the Russian people are going to pay a price for Putin's ignorance of economics.  Their economy was already weak, with less than 0.3% over the last twelve months.  Inflation is running at 6.9%.  The stock market is already down 13% this quarter.  The ruble is the second (after Argentine) worst performing currency in the world.  And, even their own Economy Ministry estimates $70 billion of capital outflows during the first quarter alone, which means it will be much more.

This is grim!

You'll recall Reagan was able to crush the Soviet economy by forcing them into an arms race they could not afford.  Putin could well be making the same mistake of trying to out-duel the U.S. economy.

Nothing brings the mobs into the street faster than inflation and unemployment.  With inflation already running almost 7%, just wait until their imports soar in price due to the falling ruble.  Russian doesn't report unemployment like the U.S., but just wait until the sanctions start to bite.  Unemployment is certain to rise!

Of course, maybe the Russian people deserve the hardships ahead of them, since they now give Putin a 71% approval rate.  But, they've already suffered greatly after the fall of communism, leaving them with a poor first impression of what they thought was capitalism.

If history repeats itself, -- is it because history MUST repeat itself?

Sunday, March 23, 2014

Thoughtful Views From Wall Street

Morgan Stanley is another highly respected investment firm on Wall Street and is NOT a huge vampire squid sucking on the face of mankind, as others are known.  Their monthly updates are less concise than that of Goldman Sachs but more thoughtful.  Here are some thoughts from their latest:

At the end of 2013, analysts (including their own) were overly-confident that the market would continue rising forever.  They remind us that "corrections are born of complacency."  There was too much back-slapping and not enough hand-wringing, which is always worrisome.

They looked at the relationship between forward price-earnings ratios and rising interest rates.  Right now, that ratio is 15.7X, compared to a historical average of 13.8X since 1976.  They plotted that ratio against real long-term Treasury yields and found that the ratio can continue rising until it passes 4%.  My reaction is that it is interesting -- but too little history to produce too firm a rule.  Also, one reason interest rates rise is because the economy is improving, which increases the demand for money and therefore the price of money or interest rates, and the rise in stock prices will continue until such time as the pain of increased interest rates begin.  In other words, there is a time lag that should be included in their discussion.

A good sign is that companies are starting to re-invest their cash into their businesses rather than return it to shareholders.  In other words, CEOs are starting to see real opportunities.  Right now, 84% of the companies in the S&P 500 pay dividends, which is a 17-year high.  However, the ratio of capital expenditures is only 6.8%,compared to a historical average of almost 8%.  If correct, the industries that should benefit most are commercial construction, especially industrial/warehouse building, real estate investment trusts, railroads, and select tech companies.

Finally, there is an interesting comparison between the U.S. and China.  Both nations have been "suffering" from financial repression, i.e., denied a free and open capital market.  In the U.S., the capital markets have been largely controlled by the Fed since the global financial crisis in 2008, causing its balance sheet to balloon.  With tapering, the Fed has clearly indicated it is lessening its control and will allow interest rates to rise.  The U.S. is losing it's training wheels.  Will the economy continue to grow?

In China, there has never been a free and open capital market.  However, as part of their ongoing effort to become more consumer-dependent and less export-dependent, they are increasing transparency or honesty in their financial sector.  Recently, they even allowed a company to default on its bonds for the first time in China's recent history.  But, a whopping 45% of all debt in China needs to be renewed or repaid in the next twelve months.  How much default will the government tolerate?  China is also losing it's training wheels.  Will their economy continue to grow?

Friday, March 21, 2014

From the Depths of Squiddom

Here are some of the latest forecasts from one of the most feared, I mean, most respected investment houses on Wall Street:

1.  The lousy winter weather has probably taken a half percentage point off GDP growth in the first quarter, with the inventory correction taking off another half point.  Still, they expect a healthy 3% growth rate beginning in the second quarter.  Next year, they expect a full-year GDP growth rate of 3.2%
2.  They expect interest rates to remain basically unchanged through 2015.  (No mention is made of Janet Yellen's comments yesterday.)
3.  They don't expect the price-earnings ratio to increase but do expect earnings-per-share to increase from $108 last year to $116 this year and $125 next year.  This should drive the S&P 500 from 1,872 now to 1,900 at year-end and 2,100 at year-end 2015.
4.  Gold will drop from $1,342 per ounce today to $1,050 by year-end but rise to $1,200 by year-end 2015.
5.  The recent first-ever bond default in China is no big deal.
6.  The dollar will rise somewhat this year against the Euro and weaken somewhat next year.
7.  The dollar will continue to rise against the Yen, getting 115 Yen/$ by year-end next year.

They also repeated their earlier observation that there is a 57% probability of 10% correction in the stock market in any given year, but that probability increases to 63% in years when the market is already up, like right now.

Think about it - there is a 63% probability of a 10% drop this year - get happy with it - it is good for us!

Thursday, March 20, 2014

A Cost of Honesty . . . or a Rookie Error ?

Poor Janet Yellen!  Americans lost billions of dollars yesterday, when she held her first press conference as Chair of the Federal Reserve System.  But, she really did great!  She explained that the unemployment rate alone will no longer be binding on the Fed's decisions, which is smart.  She explained the reasoning for the next $10 billion cut in quantitative easing (QE), which was expected.  She explained why the Fed would not start raising interest rates until a "considerable period" after the end of quantitative easing.  She was doing great!

Then, a reporter asked her how long is a "considerable period?"  The correct answer would have been vague like . . . it depends and could vary anywhere from three minutes to three years, depending on the economic circumstances at the time.  Instead, she said "six months," and the stock market promptly dropped over a hundred points.  Traders quickly did the math, i.e., dropping $10 billion every six weeks from QE means it will be over by year-end and interest rates will therefore start increasing next June.  Interest sensitive stocks, like utilities and REITs, immediately sank - taking the market down with it.  (Short-term interest rates increased about 10 basis points immediately, which is a big move.)

Paraphrasing English philosopher Samuel Johnson, "nothing focuses the mind like your hanging in the morning."  We all know we are going to die but, fortunately, we don't know when.  Traders thought they heard that their death sentence would be carried out next June.

Of course, this is ridiculous!  The stock market is rational in the long run but not in the short run.  Yesterday, it was irrational.  Chair Yellen did great.  The stock market embarrassed itself.


A relatively new technique being used on Wall Street is called "word algorithms."  In other words, if the word "considerable" is used in the same sentence with a number, then interest sensitive stocks would automatically and instantly be sold by the computer.  It is not known how prevalent word algorithms are, but I cannot believe this is any more healthy for the stock market in the long run than high frequency trading is.  They both trouble me greatly.


Finally, one note on a personal level:  I suspect Janet Yellen is one of those rare individuals who thinks, speaks, and writes the same, i.e., in complete sentences, with careful clauses, and no exclamation points.  She even separates thoughts into separate paragraphs.  She is very gifted!

Saturday, March 15, 2014

Worry #2

I am often asked what I primarily worry about, or what keeps me awake at night.  Certainly, I worry about the possibility of cascading defaults by counter-parties in the lightly-regulated, heavily-cloaked derivatives industry.

After that, however, I have been worried about the economic consequences of a successful terrorist attack on our national electrical grid.  A new report by the Federal Energy Regulatory Commission (FERC) states that successful attacks on just nine of the nation's 55,000 electrical transmission substations could plunge the nation into darkness for weeks and maybe up to 18 months.  The economic effects of the 9-11 attacks would seem insignificant in comparison.

Late one night last April, a car pulled off a freeway near San Jose, California.  Somebody or some people hiked over one hill to the Metcalf substation and spent nineteen minutes firing assault rifles into the substation, destroying seventeen transformers.  This was the substation that serves the critically-important Silicon Valley.  If this had happened during daylight hours in August, when air-conditioning puts greater demands on the system, it is widely believed that Silicon Valley could have gone dark for weeks.  And, that was using regular 7.62 mm ammunition.  Imagine the damage if they had used a .50 caliber with armor-piercing ammo, which is available to almost everybody in the U.S.

These substations tend to be remotely located and unprotected, except for barbed-wire fencing and cameras.  The FERC has required utilities to respond by June on how to "harden" their substations.  Dominion Resources (D) here in Virginia plans to spend $300-500 million over the next seven years to improve protection of their substations.  The "Happy Face" spin is that it looks like something is finally happening.  Another spin is that why have we waited over twelve years since 9-11?

Maybe, Worry #3 can move up to the second position soon . . . I hope so!

Friday, March 14, 2014

Another Veil . . . Already ??

With so much conflicting information to study each month, it is already tough enough trying to rationalize and reconcile the behavior of both the economy and the stock market.  Then, some geopolitical veil descends, making it even more difficult to foresee anything.  Remember the European financial crisis?

With the renewal of the Cold War by Russia, bad possibilities are now considered possible, such a nuclear war.  (If that happens, your portfolio may be one of the least important things to you.)  A ground war with Russia is equally unlikely.  But, if Russia invades eastern Ukraine next week, as I expect it will, another Cold War is certain.  The last one lasted over 30 years.

This uncertainty is already weighing on the stock markets worldwide, as uncertainty always does.  Analysts refer to this as "headline risk."  The stock market ignores traditional indicators, such as corporate earnings and GDP growth, and reacts to the headlines instead.  Headlines containing the word "Russia" are seldom good for stocks!

However, the difference between Cold War I and Cold War II is that there is a capital market to punish the Russians this time.  Their stock market and their currency have both plummeted terribly.  How much financial loss will rich Russians sustain before pressuring Putin?  Soon afterwards, the Russian people will begin complaining about inflation from rising import prices.  Some analysts suspect Putin is among the top ten richest men in the world.  If so, he has already sustained huge personal financial losses.  Cold War II will NOT last 30 years.  Finding a face-saving way for Putin-the-egomaniac to exit will determine the length of Cold War II.

I've been hoping for a 10% correction, as that is good for the stock market in the long run, but I never expected to thank Russia for it.

Thursday, March 13, 2014

Good Deed, Crazy Consequence

Sometimes, it takes awhile to find and identify the devil hiding in the details.  Back in December, demonstrators were in the streets of Kiev, pushing out the pro-Russian government.  To make themselves less unattractive, Russia then agreed to make a $3 billion loan to the Ukraine.  While it was odd that the loan was in dollars and agreed to be governed by the courts in England, the Ukraine needed the money and took the loan anyway.

Now, the Ukraine needs another billion dollars, and we have agreed to make the loan.  But, the devil is that any additional borrowing puts the Russian loan into default, because their total debt will then exceed their pre-agreed limit.  Default makes the Russian due and payable immediately, which they cannot repay.

Normally, such a default would just be ignored by the borrower, because the court in another country like Russia would be ignored in the Ukraine.  In this case, Russia knew this and sited the loan in England, where it could be enforced -- very smart, indeed!  It cannot be ignored.

So, if we make the billion dollar loan . . . it could technically go straight into the Russian treasury.  I doubt it will, but it will certainly give more leverage to the Russians in setting prices for the natural gas the Ukraine needs so desperately.

I think Newport News Shipbuilding needs to start building LNG tankers . . . lots of them!

Sunday, March 9, 2014

Happy Birthday To Us, Happy Birthday . . .

It is hard to believe but it has been five years since the ugly days of March 9, 2009 when the stock market finally bottomed out, following a horrendous 57% drop.  Since then, the market is up almost 180% -- an object lesson to never panic nor to get 100% out of the market.

However, because Wall Street climbs a "wall of worry" everyday, there is now much clucking that we are due for another bear market, which is defined as a 20% drop.  I don't think that is likely, unless we fail to get a routine correction, which is defined as a 10% and is actually quite healthy for the stock market.  We NEED a correction.

On average, the average bull market is slightly under four years, suggesting we are overdue, but some bull markets have lasted almost ten years, like the 1990s.  Sam Stovall of Standard & Poor's said it best:  "age alone doesn't kill a bull."

Bull markets die because of recessions, bad monetary policy, over-pricing, or external shocks.  Recessions bother me the least, because they are fairly easy to foresee.  Bad monetary policy doesn't bother me either, as the Fed is committed to merely taper the growth of its quantitative easing program without actually reducing their holdings.  Plus, any rate increase will be minimal and probably not before the end of this year.  Over-pricing of stocks is a constant concern but doesn't appear worrisome yet.  The price-earnings ratio of the S&P got as high as 28.2 before the 1999 correction.  At the peak in 2007, it got up to 17, which is about where it is now.  So, stocks are high but not seriously high.  However, I do worry about some external event, often called a "black swan" event.  Commonly cited examples would be the fall of Lehman Brothers in 2008.  Some fret about a sudden collapse of the credit bubble in China.  I worry about a derivatives blow-up, where literally trillions of dollars become due overnight.  Of course, a black swan event cannot, by definition, be forecast.  We can only watch for it and sell quickly if we suspect such an event.

So, for now, sing Happy Birthday off-key, wear a silly hat, eat some cholesterol cake and count your blessings!