Wednesday, December 29, 2010

Shorter is Better

Today's auction of $29 billion in 7-year Treasuries was average, with a bid-to-cover ratio of 2.88, almost exactly the rolling ten average of 2.86.

Of the three auctions this week, there was lots of demand for the 2-year issue, less demand than usual for the 10-year issue, and average demand for the 7-year issue. Investors don't want to hold longer term debt.

Some analysts think today's issue was worse than it appears, because it is the last issue of this year, and portfolio managers wanted to get cash off their balance sheet before their investors saw it. Maybe so, but it is clear that the appetite for debt owed by the U.S. is limited. Rates are rising rapidly, making interest carry heavier for taxpayers.

This is a problem that would quickly be corrected by adopting the recommendations of last month's Deficit Commission!

Tuesday, December 28, 2010

What a difference 8 years make . . .

Yesterday, there was a very successful auction of 2-year Treasuries. Today, there was a barely successful auction of 10-year Treasuries. The bid-to-cover ratio dropped from 3.71 to 2.61. In addition, foreign interest dropped significantly.

The market is saying they don't want to hold any bonds longer than 2-years because longer-term bonds will lose value due to inflation sometime after 2-years but within 10-years.

Forewarned is forearmed.

Monday, December 27, 2010

Almost Too Good . . .

The market can be much more volatile when few people are trading. That's because one big trade can really push the market one way or the other. The period between Christmas and New Year's Day is always a slow trading time.

When I realized the U.S. was planning to sell $35 billion in 2-year Treasury bonds today, I was a little worried and wondered why they didn't wait until next week.

Fortunately, the auction went far better than expected. The last ten auctions produced a 3.31 bid-to-cover ratio. That means the Treasury could have sold 3.31 times as much as offered. Today, it was 3.71 times. The strong demand for our debt is amazing. While the Fed has been buying some of the Treasury bonds, foreign governments have actually started to increase their purchases. Those who worry the bond vigilantes will stop buying our bonds didn't find any support for that argument today.

By the way, I am one of those who worry about bond vigilantes! What kept the vigilantes at bay was that the interest rate paid to the bond buyers today increased from about 0.71% to 0.74%, which is a big one-day jump.

Tomorrow, the Treasury will be auctioning off another $35 billion in 5-year bonds, and I'll be watching . . .

Sunday, December 26, 2010

Zombie Christmas?

I spent Christmas reading John Quiggin's new book titled "Zombie Economics: How Dead Ideas Still Walk Among Us." It began with Keynes' great belief that "Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist." I believe that statement is true.

Since Quiggin is a Keynesian economist, I expected he would lambast the Austrian school of economics, the Supply school, the Monetarist school or some other school. Instead, he took pointed aim at certain investment beliefs. While such beliefs do reflect some views of "defunct economists," investment strategy really in a separate discipline.

For example, he took aim at the notion of "The Great Moderation," which was a popular belief before the Global Financial Crisis and was popularized by Fed Head Ben Bermanke. That notion suggests that the worst effects of business cycles have largely been curbed by the much more limited regulation of Wall Street, as well as the increased ingenuity of the Fed. It is clear that the de-regulation of Wall Street was excessive, which I wrote about years ago. However, it was not clear to me just how ingenuous the Fed had become. Bernanke was slow getting started but finally did a great job. Score one for Quiggin that The Great Moderation was a zombie idea that more de-regulation is always better!

Another example, he took aim at the notion of "Efficient Markets," which suggests that the market price of an asset is correct since it reflects all available information and that investors react to new information is similar, predictable ways. I've never believed that, although there is a possibility it might work for large cap stocks but nowhere else. Score another one for Quiggin that Efficient Market was another zombie idea that the market always knows better and understands more quickly.

Quiggin refers to these ideas and many others as zombies, because they still walk around despite being quite dead, i.e., that they are still practiced despite being wrong, that they are like practical men who are slaves to some defunct econmist.

For me, the take-away was one remarkable sentence that said "From the inside, ideology usually looks like common sense." Amen! That is why I believe in situational economics or selectively picking whatever makes sense from each school of economics, depending on the economic variables. If I am a slave to a defunct economist, then I am a slave to a very large number of them.

So, that's what I did for Christmas. Sometimes, I miss having kids at home . . . oh, well.

Thursday, December 23, 2010

Full Circle

Surviving veterans of the European front in World War II show pride in toppling Hitler. Few take any credit for establishing the dollar as the world's "reserve currency," but it was terribly important.

Immediately after the war, the victorious Allies met in Geneva to begin mapping the Marshall Plan for the reconstruction of Europe. One of the many things they did was to require international contracts that be denominated in dollars. In other words, if a French firm wanted to buy something from an English firm, there was no argument as to whether they would pay with French francs or English pounds. They had to pay with U.S. dollars. The thinking behind this was that it would remove any incentive for a nation to debase its own currency as a means to minimize their debt. It was a form of monetary discipline.

Because the dollar then became the world's sole reserve currency, we needed to supply the world with enough dollars to do business, which also created a huge demand to own our bonds. We certainly took advantage of that prerogative, didn't we?

Meanwhile, Europe witnessed the discipline imposed by a common currency, making it receptive to adopting the Euro in 1995, which immediately became another reserve currency, creating international demand for that new currency, as well as their bonds. I doubt the veterans sitting in Geneva in 1945 would have ever imagined how successful their work was. They created not only the world's first reserve currency but also the second!

Unfortunately, the Europeans took even greater advantage of having a reserve currency and issued enough bonds to get into trouble. In 2010, there has been lots of debate as to whether the Euro will survive, given the debt problems in Europe.

But, which nation would be most unhappy to see the dollar become the sole reserve currency again? China!
Does that nation have the ability to "save" the Euro? Yes!
Will it? Yes!
Should you worry about the collapse of the Euro? No!
Do you think the WWII veterans knew China would bail out Europe, after they had saved it . . . history is like a football, it bounces funny.

Wednesday, December 22, 2010

Q3 GDP Growth

Today, the Commerce Department announced that growth in the third quarter was slightly better than previously released, i.e., 2.6% versus 2.5%. It continues the stream of good economic news.

Growth in the first quarter was a whopping 3.7%, while the stock market was very bullish. Growth in the second quarter was a relatively sluggish (but still positive) 1.7%, and we saw a bear market.

With an accelerating rate for the third quarter and the stream of good economic news recently, I expect the fourth quarter GDP growth will be well over 3%.

Most analysts expect our GDP growth for all of 2011 to be about 3.5%. I listened to one this morning who expects 4.5% growth, which would be huge for us but puny compared to the 10% growth rates China and India have grown accustomed to.

With all the bullish news, it is not surprising that the Volatility Index has gotten quite low, suggesting the market is over-bought, which supports my expectation that the bear will return in late Winter or early Spring but won't be here long.

Season to Celebrate

The S&P is now at the highest level since September of 2008. The Dow has been up ten out of the last eleven days. The Bull is back?? Of course, the volume of trading has been very low, making the recent good performance of the market less reliable. Obviously, traders and investors are taking the rest of the year off and good for them!

The market mood right now is like the warm afterglow from a good bottle of chardonnay. Enjoy it, but get ready for next year!

This is a good time to look at your portfolio for tax planning. Most people have some tax loss carryforward from previous years. If so, consider taking some of this year's capital gains, as they will essentially be tax-free, and reposition that cash. Some analysts fear next week will be a bad week in the market for this reason, I doubt that. The Obama-McConnell tax deal postponed tax hikes on capital gains (and dividends) for another two years. So, a pending tax hike is no reason to sell before year-end.

I'll be discussing next year's forecast in this space, but the reader should be developing their own thoughts as well.

Lastly, do your financial advisor a big favor and start asking yourself if your investment objectives have changed? More importantly, has your tolerance for risk changed? If you are not sure, you need to call your advisor . . . now!

Monday, December 20, 2010

Crisis Investing

An investor takes a longer term view. He looks at those sectors and nations where growth looks most promising and then positions his portfolio to benefit from that growth.

A trader takes a short term view, sometimes in minutes. If war breaks out between the two Koreas, you can expect both the U.S. dollar and gold to rise together, which happens very seldom. You will see the Kospi stock exchange tank. All world markets will swoon for some period. A trader would be buying gold and dollars this morning and shorting the market indexes for Asia.

Of course, if there is no war, his gold and dollar investments will quickly lose value. More importantly, he could get wiped out by his short positions, where loss can be unlimited, if those Asian stock markets rally. His investment is based on some events happening and the fear that surrounds them. He is not interested in economics. This is not investing. This is called gambling.

Saturday, December 18, 2010

End Times ??

I was only thirteen years old in 1960, when establishment Republican Henry Cabot Lodge was the running mate of Richard Nixon in the presidential campaign, that they lost to John Kennedy. I recall Lodge being criticised by the John Birch Society and some religious groups as being supportive of a one-world government, which they believed was described in the Bible as the last step before the End Times.

Another establishment Republican, David Rockefeller, finally established the organization that Lodge favored, called The Trilateral Commission in 1973 to coordinate economic policies between the U.S., Europe, and Japan. It still exists today and does almost nothing except make each country more sensitive to the impact of its own economic policies on its two most important trading partners.

Recently, my mother asked me to read "The Coming Economic Armageddon" by Dr. David Jeremiah. Although it never mentioned the Trilateral Commission, I was reminded of it throughout the book. It begins with the classic (but true) argument from Austrian economics that we are living beyond our means, proceeding to the Bible's prediction of a one-world-government. It cites the current effort to improve international regulation of major banks as ominous. However, I reject the argument that globalization will cause the End Times.

Despite this ham-fisted effort to blend Austrian economics with Biblical prophecy, Dr. Jeremiah does an excellent job of discussing three very important subjects that seems to give laryngitis to elected politicians:

First, "we spend more on national defense than China, Japan, Russia, Europe, and several other nations combined."

Second, "the average federal worker's pay is now $71,206, much higher than the average private worker's pay of $40,331."

Third, he discusses at some length that politicians like to talk about the relatively minor problems with our annual budget, instead of talking about the much more serious problems with our over-promised long-term commitments to Social Security and Medicare.

While I cannot recommend this book to others, I did appreciate the trip down Memory Lane, especially with Henry Cabot Lodge, one of my all-time favorite politicians.

Should I Be Worried?

I've been predicting a slow but steady recovery for the economy. Of course, the stock market is only loosely related to the economy. The market has improved this year more than the economy has.

But, expectations for the stock market next year are awfully high. The S&P closed yesterday at 1244. Goldman Sachs predicts it will close at 1450 at the end of next year. That's up 16.5%. J.P.Morgan predicts it will close at 1425. Barclay's predicts 1420, while Bank of America predicts 1400.

The highest prediction is Deutsche Bank at 1550, up 24.6% from now.

If they are correct, we should substantially increase our allocation to stocks. (If they are not correct, what's new?)

I am bullish for next year but not that bullish. Probably in the early Spring, the market will get too far ahead of the economy and stall again, like it did this summer. Then, I expect it will recover and continue upwards . . . but not to 1550.

Historically, the third year of a presidential administration is the best year for the stock market . . . I hope so!

Thursday, December 16, 2010

A Patriot's Lament

Last night, I watched The History Channel. (Yes, economists do watch The History Channel but only because there is no Economics Channel.) The show was about the Third Reich and showed the suffering of ordinary people. Not to be disrespectful, but it also showed their inconvenience. They had shortages of consumer goods and electricity. They even had tax increases.

It reminded me of an evening a year or two ago, when one of my dearest friends and "forever clients" was sitting on my couch, lamenting the fact there was so little she could do for our warriors in Afghanistan and Iraq. A patriot, she wanted to suffer at least some inconvenience in their behalf. Instead, the President told her to go to Disney World and then gave her two tax cuts. While the President's instinct was to protect the status quo, he ignored the nobility of her emotion.

I think of her comments often. We are still a great people, and we deserve better government than we have. This lady would have taken a tax increase, a Social Security decrease, a Medicare decrease or whatever for her country.

Unlike Glen Beck, I have not given up on Americans. We are still a great people and will rise to meet the occassion. When austerity comes to America, there will, of course, be some riots, like the ones we're seeing in Greece and Ireland now, but we will handle it better than our politicians think. Bring it on!

Wednesday, December 15, 2010

Drumroll, please . . .

Yesterday, the stock market reached the highest point in over two years.

Does that mean the party is over? No, of course not!

Does that mean we will get back to our 2007 market high? Yes, but not in 2011.

Does that mean we face smooth sailing? Absolutely not! December and January are usually the two best months of the year for the market. We've been in a rally mode since July. It is time for the market to take a break and consolidate soon. February would be a logical time.

What about the market experiencing a double-dip? That is always possible. Market corrections normally occur because of cyclical factors, which I don't expect anytime soon. Sometimes, they are a result of an event, such as a financial collapss, which are sudden, like heart attacks. That scares me a lot and is the reason I hold so few bank stocks.

We're definitely in a recovery mode but remain subject to financial heart attacks.

Manana Economics

I love that expression . . . manana economics. It covers those areas of economics that can be dealt with tomorrow, i.e., where kicking the can down the road is a good idea.

Fareed Zakaria is a native of India with a Ph.D. from Harvard and writes a column for Newsweek, as well as being a CNN contributor. He coined the term referring to the inability of the U.S. to deal with its deficit problem, pointing out the new $900 billion tax cut extension only adds to the problem.

He also referred to the inability of the U.S. to tackle unpleasant and painful subjects as a disease of modern democracy.

Some drug addicts need an intervention by loved ones to deal with their addiction problems. Will loved ones provide the intervention that the U.S. needs or will it be bond vigilantes?

How time flies . . . it was only a week ago that the presidential deficit commission made their recommendations . . . seems like ancient history now?

Yesterday, for the first time, the bond rating agency of Moody's even put us on warning that we must deal with the problem. If we lose our AAA rating, the cost of borrowing will increase, making it even harder to manage the burden of our huge debt . . . tick . . . tick . . . tick . . .

Tuesday, December 14, 2010

A Grain of Salt

The Wall Street Journal just released their latest survey of economists. Generally, they are more optimistic!

The economy grew at 2.5% in the third quarter. Estimates for the fourth quarter were raised from 2.4% to 2.6% and 3.0% for the first half of 2011.

Also, they reduced the odds of a double-dip recession from 22% to only 15%, another good sign.

This survey was conducted prior to the tax deal. Presumably, the extension of existing tax cuts was "baked into" their thinking, but not the payroll tax reduction nor unemployment stimulus. A new survey would likely be more optimistic.

Things are certainly getting better . . . slowly!

Tax Cut Deal

Yesterday, the Senate took the first step in creating certainty about our tax burden next year. A believer in Supply-Side economics will be delighted because there are tax cuts. A believer in Keynesian economics will be relieved we didn't increase taxes during a recession. A believer in Austrian economics will be horrified that we made the deficit crisis worse.

I don't recall who said this but I've never forgotten the idea that "all great thinkers are mere followers of some dead economist." (Of course, the creator of supply-side economics, Arthur Laffer, is still very much alive.)

Putting aside all the pretty theories, the reality is that there will be a day within the next few years when the market will no longer buy U.S. bonds, unless the rate is very high and maybe not even then. We can argue the fine points of many economic theories, in addition to the Big Three. But, the bond vigilantes are not economists.

Monday, December 13, 2010

Half Full or Half Empty

When the Fed announced QE2, they expected interest rates would fall. At first, everything went as expected. Now, those rates have started to rise. Ten-year Treasury bonds now pay 3.36%, which is a six-month high.

One reason for interest rates to rise is that the Fed is causing it intentionally, which is not the case. Another reason is that the economy is improving, which makes it more expensive to sell bonds, and there has certainly been a great deal of good economic news recently. Yet another reason for rates to rise is that bondbuyers see inflation ahead, which I think is more likely.

In other ways, the rising interest rates may be sending a bullish signal or a bearish signal to the market.

Because long-term rates are moving up faster than short-term rates, I suspect the market will continue to rise slowly for some extended period, before encountering the obvious signs of inflation.

Wednesday, December 8, 2010

Attack of the Vigilantes

We've often mentioned the bond vigilantes who could cause unimaginable trouble for the U.S. and greatly increase the burden of paying interest on our huge national debt.

Today, our Treasury Department auctioned off $21 billion in 10-year bonds. Fewer bidders wanted the bonds. The bid-to-cover ratio was 2.92 compared to a recent average of 3.12. And, those bidders are demanding we pay a higher rate of interest, now 3.34% up from 3% a few weeks ago.

It could get a lot worse!

We've been running huge deficits for 8 years. We've spent hundreds of billions on stimulus. Yesterday, we learned the President and the Republicans added to the deficit by extending the tax cut. Today, a senior official at the Chinese Central Bank said Europe was a better credit risk than the U.S. We have no plan to deal with the growing deficit. Is it any wonder that bond buyers are worried about inflation and demanding higher rates to take risk of inflation and credit?

The bond vigilantes may get here before we expected. If so, sitting in cash would make me comfortable.

Tuesday, December 7, 2010

Reducing Uncertainty

Last night, the President announced a bi-partisan deal to extend the tax cuts for another two years, which reduced uncertainty. This morning, the Dow futures are up 81 points at this hour. You'll recall the inverse relationship between uncertainty and the markets.

It should be a good day for the markets! It is probably not significant enough to say it should be a good week, so let's enjoy the day. Of course, uncertainty will start to rise again before the two year extension comes up for renewal, and we'll have to re-invent the wheel.

Since there is now some faint hope that bi-partisanship may actually be possible, I do hope they will tackle the more thorny deficit problem, where every ox will be gored, including Social Security and Medicare.

Nonetheless . . . Good Start!

Monday, December 6, 2010


Normally, I am careful to avoid any discussion of politics, finding it seldom helpful. Both parties spin shamelessly. So, it may have been surprising to see me quoted twice in The Virginian-Pilot last Friday, referring to comments I made to a Senate hearing on redistricting.

Redistricting is as exciting as watching paint dry but terribly important. Because the borders of voting districts had been gerry-mandered years ago to limit the black vote, it was necessary to correct that wrong. But, in doing so, we have produced "safe" districts, i.e., districts that are safely Republican or safely Democratic, districts where incumbents oftentimes don't even face a challenger.

I summarized a book called "The Tipping Point" which pointed out how a single small change can produce a very large change. My point to the Senators was that the tipping point was the design of safe districts, because it eliminated moderate politicians. Safe Republican districts will not produce a moderate Republican, as they must pander to their base. Likewise, safe Democratic districts will not produce a moderate Democrat for the same reason.

I described this as "the politicians picking their voters instead of the voters picking their politicians".

I also likened the current situation to "an alcoholic who cannot be helped until he admits he has a problem. I suspect legislators will not be able to to fix this problem until they articulate it themselves and admit they have a problem. It is called partisanship."

Sunday, December 5, 2010

The Schizophrenic Economist

It has been fascinating, if saddening, to observe the political spinning around expiration of the Bush and Obama tax cuts this month. (Don't forget a third of Obama's $787 billion Stimulus bill was also a tax cut.)

My inner-Keynesian economist is afraid consumer demand will decrease if they are paying more in taxes, so the tax cut should be extended. My inner-Austrian economist is afraid of the mounting deficit and a possible attack by the bond vigilantes, so the tax cut should NOT be extended. My inner-Suppy-Side economist knows there is NEVER a good time to raise taxes, so the tax cut should certainly be extended FOREVER.

Maybe, we shouldn't be so harsh on politicians when economists cannot even agree on an economic problem.

I was wrong . . . I hope!

When was the last time you heard the word "deficit" used so often? I'll bet I heard it or read it more often last week than the last two years combined. That's a good thing!

When President Obama first appointed the Deficit Commission, I was disappointed the Republican Party did not support that effort and felt it would therefore just be another waste of time, like the 1987 Social Security Commission chaired by Alan Greenspan.

Like an alcoholic cannot be helped until they admit they have a problem, America has actually started to talk seriously about the problem of our deficit and the tradeoffs of each solution. That's a good thing!

I tend to think of our political system as too impotent to do more than talk, but maybe the beauty of our "system" is that we can deal with tough problems . . . but not until we are on the edge of the abyss. That's a bad thing!

Friday, December 3, 2010

There are tides . . . and there are tides

Recently, I blogged that market reflects tidal changes in certainty and uncertainty. The market goes down when uncertainty goes up and vice versa. Increasing certainty is good for the market.

An old and dear friend sent me a Shakespearean quote from his play Julius Caesar saying
There is a tide in the affairs of men, which, taken at the flood, leads on to fortune;
The context was that Brutus and Cassius were debating whether to continue attacking with exhausted troops or to rest for awhile. Brutus argued above that it was time to strike, even with tired soldiers.

From an investing perspective, it may suggest taking larger individual postions when the level of confidence is higher. However, from a geo-political perspective, it suggests China should not be reluctant to exert its economic influence. It is still pre-mature to exert military influence, but that day is coming.

Hopefully, the Chinese do not read Shakespeare!

Awful . . . but fishy

Today's Jobs Report was awful! Economists were expecting 144 thousand jobs were created and were stunned when they learned only 39 thousand were created. Given the steady flow of relatively good economic data over the past few months, this is a surprise . . . a fishy surprise.

Data for last month's Jobs Report was increased from 151 thousand to 172 thousand. So, we created 172 thousand jobs last month, had a month of good data, but only produced 39 thousand this month . . . something is wrong.

In addition, the unemployment rate jumped to 9.8%. It is normal for the unemployment rate to increase when the job market turns around, as people begin flooding back into the market and start looking again. So, why did so many people start looking again, since we were producing fewer jobs.

I expect next month's report will show a substantial upward revision to the 39 thousand this month.

In the meantime, this report increases the likelihood that the Fed will continue its quantitative easing program, that Congress will extend the Bush & Obama tax cuts, and that unemployment benefits will be extended.

Thursday, December 2, 2010

Like A Colossus

It was no secret that small, unassuming, professorial Ben Bernanke straddles the U.S. like a colossus. I have long felt that his "out-of-the-box" thinking and long study of The Great Depression made him extraordinarily effective as head of our Fed during the dark days of the Global Financial Crisis. I think he did a great job!

But, who knew he was also straddling the world? We learned yesterday that the Fed made $3.3 trillion in short term liquidity loans during the crisis, almost all of which have been repaid in full. While most of that went to U.S. firms, a surprising amount assisted foreign firms. (Because the report is 2,100 pages long, describing all transactions in all programs, the total is not yet available.)

In addition, there is now a rumor that the Fed will contribute to the European bailout fund, so it could handle a bailout of bigger nations, like Spain or Italy, probably preserving the European Union. The power of a "reserve currency" is greater than reasonable, but not unlimited.

Like a colossus . . .

The Miyagi Market

Back in 1984, there was a popular movie called "The Karate Kid". Mr. Miyagi was the mentor, teaching karate to a kid. Because karate moves are complicated, he simplified one move by telling the kid "Wax on, wax off".

The stock market has become "Risk on, risk off". Yesterday was obviously "risk on", as investors flooded into the market, taking risk. All day, good economic news rolled out, and investors continued taking risk, driving the Dow up 249 points.

The ISM Index came in better than expected. The ADP report on jobs was much better than expected. The Fed issued its Beige Book showing 10 out of 12 regions of the country are growing economically. Even the automakers reported good sales increases. Cyber-mondays sales were up 16% over last year, which is a good indicator that the consumer is getting healthier, finally! And, there was a strong rumor that the European Union would start a quantitative easing program like the U.S. With all that bullish data, it is not surprising that taking risk was more attractive to investors.

Not so surprisingly, all asset classes rose, which shouldn't happen under Modern Portfolio Theory.

For someone who studies the market daily, it is amusing to see it reduced to a simple rule-of-thumb like "risk on, risk off". Even Mr. Miyagi would be amused!

Wednesday, December 1, 2010

Thinking About Friday

The first Friday of each month is the most important Friday to the market, because that is the day that the monthly "Jobs Report" is issued. The current forecast is an increase in jobs of about 144,000 and the unemployment rate holding at 9.6%.

Creating that many jobs is certainly much better than losing 700,000 jobs a month, like we were doing just two years ago. We're going in the right direction but way too slowly.

This morning, we learned that productivity is still growing strongly, at 2.3%, while employment costs were down 0.1%. That means business is still getting more and more work out of the existing workers, who are grateful for the job and not complaining or asking for raises.

As I've said many times already, the bottom of this recession is not V-shaped, suggesting a sharp rebound. It is not U-shaped, suggesting we'll bump along the bottom before enjoying a sharp recovery. It is not W-shaped, suggesting we'll slip back into recovery. Instead, it is shaped like the Nike Swoosh, suggesting a long, slow recovery.

That also means unemployment will remain high a very long time. While painful, compare our 9.6% with Spain (20.6%), Ireland (14.0%), Greece (12.2%), or Portugal (11.1%). Frankly, that's a painful comparison, because those nations are teetering on the brink of financial ruin.

Recent forecasts of our Jobs Report have been overly pessimistic. Let's hope we do better than 144,000 this Friday! Go Team, Go!

Credit Default Swaps . . . Not So Boring

If I own a bond issued by AT&T, there is a possibility AT&T will not repay the bond at maturity. If I get worried about that, then I can buy insurance to protect me from that possibility of AT&T defaulting. Essentially, it guarantees I'll get repaid. The risk of the bond issuer defaulting is transferred or swapped to another company, often an insurance company. Of course, I have to pay for this insurance by paying a fee to the new company. They're not going to take on that risk for nothing.

Say, a year later, I'm no longer worried about AT&T being able to repay the loan. But, I still have this insurance or credit default swap that I purchased earlier. To recover some of the money I spent, I can sell it to someone who is still worried about AT&T. They may pay me more or less than I paid. It is a market driven price. If more investors have become worried about AT&T, then I will probably be able to sell it for more than I paid, making a profit. Some firms make a very good living just trading in Credit Default Swaps.

Are you asleep yet?

You can do the same for bonds issued by the U.S. government. Fortunately, the cost of buying such insurance against a U.S. default is very cheap, because we still have a AAA rating. If I own a bond issued by the government of Portugal due in 5 years and want insurance or a CDS that I will be repaid, the current price is about $54,490 per million. For Greece, it is $95,480, indicating investors are still more worried about Greece than Portugal.

Here's the interesting part . . .

Watching the changes in these prices tell you a great deal about the expected financial stability of other countries. When the bond market turns against you, this is where it shows up first. When the cost of Credit Default Swaps start rising, somebody out there in the marketplace probably knows more about something than you do, and it is time to start digging!

Now, was that really so boring?

Tuesday, November 30, 2010

One More Time . . .

The most frequent question I get is "So what? Jim, your analysis is interesting, but you don't say what we should do now."

The reason is that I am not permitted to give investment advice to anybody who is not a client, as well any anybody whose investment needs are not clearly understood. That is the law!

In most cases, it's probably better that I don't anyway, because a reader might slip into trying to out-smart the market with market timing. That is a fool's mission.

Monday, November 29, 2010

The Real Money Boss . . . maybe the only one?

When the financial markets didn't behave the way he expected, President Clinton famously said "You mean to tell me that the success of the economic program and my re-election hinges on the Federal Reserve and a bunch of xxxxing bond traders?"

He was complaining about the bond market, often considered wiser and more exacting than the stock market. Watching the bond market is very important.

That's worrying me now, in light of the continuing European debt crisis. Sure, the EU has come to the rescue of Greece, and the bond market rallied. Yesterday, it came to the rescue of Ireland, and the bond market has not rallied. The bond market doesn't believe this will contain the problem. One would expect the cost of insuring Irish bonds or CDS spreads would decrease as a result of yesterday's bailout. They did but only slightly. Meanwhile, the cost for Portugal's bonds continues to increase.

Portugal will be next. That may be the last stand. After that, Spain's bonds will get hammered. As they are 20% of the GDP of the EU, that would probably be fatal to the Eurozone. Not even mighty Germany could bail them out.

Not surprising, the Euro has been dropping this morning. As investors sell the Euro, the dollar has been increasing, which is bad for our exports. Over the last year, a strengthing dollar has been strongly linked to a weakening stock markets.

Like cholera in Haiti, the fear of loss by bond traders spreads quickly. If the Eurozone comes apart, the bond traders will then focus on U.S. bonds . . . may God help us!

Saturday, November 27, 2010

Politicians . . . Step Aside . . . Please!

One of my favorite bureaucrats is Sheila Bair, Chairman of the FDIC. She just wrote an excellent editorial in The Washington Post, asking "Will the Next Fiscal Crisis Start in Washington?"

That's a fair question. The fair answer is that the next one might start somewhere else but one is certainly coming out of Washington, and it will be terrible, far worse than the last one!

She lays out the clear economic facts. She cites both current deficit commissions as producing effective solutions. Both have called for entitlement cuts and tax increases.

While economists may quibble about shades of gray, politicians make decisions, and that's the problem. Half of them don't understand economics and the other half is only interested in being re-elected.

Our best hope is that the recommendations of either deficit commission are given an "up or down" vote, meaning no amendments. I don't agree with either set of recommendations 100%, but neither will anybody else. Whatever we do, if we do anything at all, will require pain. However, doing nothing requires far more pain.

The economists of the deficit commissions have almost completed their job. My Christmas Wish is that politicians would step aside, salute, and say "Yes, Sir"!

Don't count on it!

Wednesday, November 24, 2010

Two Steps Forward and One Step Backward

Yesterday morning, the Commerce Department looked in their rear-view mirror and raised their estimate of this year's third quarter GDP growth rate. We did better than expected.

Yesterday afternoon, the Fed looked thru their windshield and lowered their estimate of GDP growth next year, saying the economy is doing worse than they expected previously.

Conflicting economic data makes it tricky to read the market. That's why no one piece of data is ever conclusive. Just remember, we're in a long hard slog out of The Great Recession. When it is over and we look in the rear-view mirrow, we will once again swear . . . "Never Again!"

Tuesday, November 23, 2010

The Wall of Worry

The stock market is always trying to climb a Wall of Worry. Today, the Wall was very tall, indeed!

The day began with North Korea rattling a very loud saber. It continued with lots of unrest in Ireland about the pending, distasteful austerity package they have to swallow. It finished with conflicting economic data in the U.S, as well as the realization that our stock market has already gone up enough and needed a pullback.

As a result, the Dow dropped 142 points today. I'm surprised it was not worse.

The Value of Rhetorical Questions

How will you know if you deserve a better car? When it leaves you standing beside the road in a bad neighborhood!

How will you know if you deserve a better form of government?

No, it is NOT un-American to ask! No, the question is NOT what should replace it. No, the question is NOT what's wrong with either Republicans or Democrats. The question is HOW will you know if you deserve a better form of government?


Attack of the G-Men

Over the weekend, we learned the SEC was launching a major crackdown on insider trading. On Monday, they raided the offices of three hedge funds. Good!

After the Global Financial Crisis, the 52% drop in the stock market, and the mysterious Flash Crash in May, it is no wonder that retail investors are distrustful and still on the sidelines, missing this year's rally.

To restore confidence, retail investors must be assured there is a level playing field, and the SEC knows this. After the earlier market crash, G-Men went after the executives of Enron, WorldCom, and many other companies. Retail investors have short memories and soon returned to the market after the prosecutions.

Because the last crisis was financial in nature, we can expect the G-men to focus on the financial firms, which will slime all of them. I certainly don't plan to increase my exposure to any financial stocks.

Friday, November 19, 2010

The Hidden Inflation

The Fed is justifiably worried about deflation,which is more worrisome and tenacious than inflation. That is the reason they launched the latest round of quantitative easing. Many people don't see the danger. Even the most recent data shows no serious indication of either inflation or deflation.

Yet, if you look deeper, you see the U.S. is becoming bifurcated into one section that is part of the globalized world and another section of the country that is less touched by globalization.

Today, Fed Chairman Bernanke will speak of a "two-speed global economy." Because the recession was started by the U.S., it is worst here. The rest of the world was pulled into it and are recovering faster. As a result of their rapid recoveries, their inflation is increasing. (Yesterday, China slapped price controls on certain food items.) Their exports are our imports, which means we are importing their inflation.

In addition, because commodities such as oil and gold are priced only in dollars, the cost of those commodities is increasing as the value of the dollar continues to decline. The more value the dollar loses, sellers of gold will demand more dollars for the ounce of gold.

That section of the U.S. that does not consume large amounts of imports or commodities is not seeing inflationary pressure. The other section is.

Of course, averaging the two sections of the U.S. produces a non-worrisome CPI. However, I do worry it will show real inflation within another year or so.

Tuesday, November 16, 2010

The Grim Reaper

If you do nothing else today, read the article titled "China's State Capitalism Sparks a Global Backlash" on the front page of The Wall Street Journal. It is the secret to China's success and the reason we should be afraid, not merely worried.

China has the ability to put the entire force of their nation behind a particular industrial policy. The U.S. cannot even agree if we need an industrial policy or not!

Monday, November 15, 2010

The Unpredictably Predictable Tide

As I sit here on the shore of the Chesapeake Bay, I know there will be a high tide twice a day. If I watch TV, I will know the exact times of the tide. It is so predictable.

As I watch the stock market, I recognize the same tidal changes, as the level of uncertainty go up and down. As uncertainty about the election decreased, as uncertainty about the Q3 economic performance decreased, and uncertainty about the Fed's quantitative easing decreased, the stock market has been bullish the last several months.

Over the last week, the tide of uncertainty has begun to rise again. Will the Fed be able to maintain its quantitative easing in the face of withering criticism abroad and at home? Will the Bush and Obama tax cuts be extended or not? Will the problem now becoming apparent in Ireland cause the same damage that the problem in Greece caused earlier this year? Will the surging inflation in China cause their government to stifle its growing demand for the world's resources?

It is often said that the market is always climbing a Wall of Worry, but that implies a predictability that doesn't exist. Likewise, the market is usually quite bullish this time of year, but that is not a certainty and is easily de-railed by a tidal change in certainty and uncertainty.

Changes in the level of uncertainty will always occur, changing the market. The unpredictable part is whether the change in uncertainly will be long-lasting and profound . . . or just another tidal change.

Thursday, November 11, 2010

In Your Eye, Mr. President

It has never happened before. The credit of the United States was downgraded yesterday. While this is considered inevitable if we continue to run such deficits, it was nonetheless a surprise yesterday.

But, the timing was interesting. It is not unusual for lots of acrimony before a G-20 Summit. This one is worse than usual. On the eve of the Summit, it was China who downgraded our credit. Coincidently, Moody's upgraded the credit rating of China. This is an embarrassment to the U.S. President and improves the negotiating position of the Chinese at the G-20.

Fortunately, the final communiques signed by the G-20 leaders is always conciliatory. Hopefully, this one will be. It will probably focus on the need for infrastructure development in all countries, a source of minimal rancor. A few years ago, it focused on the need for rich countries to donate more aid to poor countries. (Then, the recession hit and no nation made its promised contribution.) Again, no rancor.

The final communique will also probably condemn competitive devaluation of currencies. Both China and the U.S. will sign it with dirty hands.

Wednesday, November 10, 2010

Don't Call My Kettle Black!

Regardless of who the President is, he needs a thick skin. Certainly, President Obama does as he begins the G-20 Summit in Korea. It may even be deserved.

For years, we have criticized China for maintaining an artificially cheap currency, which helps their exporters. With QE2 or quantitative easing, we are greatly increasing the supply of dollars, which reduces the value of each dollar. Not surprisingly, the dollar has been declining for months. This is good for American exporters. It is also good for those nations who have pegged their currency to rise and fall with the dollar. But, it is very bad for everybody else, which is the reason Obama is arriving at the Summit amidst a firestorm of criticism.

It is another reminder that each nation will behave in their own best reason. Now, why is that news? Did anybody expect us to behave differently, just because the dollar is the world's only reserve currency? Well . . . yes!

Don't call me a currency manipulator . . . you currency manipulator!

Monday, November 8, 2010

The N-11

Did anybody see the new IMF report raising the estimated GDP growth rate for the 47 countries of Sub-Saharan Africa for the second time this year . . . from 4.5% to 5%?

Those traditionally poor nations are growing more than twice as fast as the U.S. Does that bother anybody else? As an economist, it is not surprising, as it takes longer to get out of a recession when you must also pay down debt, like the U.S. As an American, however, it makes me sad.

One major reason the U.S. stock market is up this year is because it is a very multi-national market. Most of the huge multi-national companies are listed on the U.S. exchanges. As the rest of the world booms, we get some derived bounce. So, be glad the rest of the world is beginning to boom. They're enjoying the fruits of capitalism, and we get a little as well!

We are all familiar with the BRIC acronym, originated at Goldman Sachs to describe the rapidly growing giants of Brazil, Russia, India, and China. Their new one is the N-11 or next eleven countries to boom, i.e., Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey, and Vietnam. They believe countries will rival the G-7 developed nations in this century. Wow, that is quite a statement!

Historically, we have referred to those markets as "frontier markets." Maybe, we have arrived at the frontier, which can be a frightening, dangerous, and lawless place, especially to invest hard-earned savings! Be very careful!!!

Sunday, November 7, 2010

Enjoy the Ride . . . Again

After a highly eventful week, the stock market is at a two-year high, about the same level as we were when Lehman was allowed to collapse. Nonetheless, that is some three thousand points on the Dow -- below our all-time high in 2007. The market is still down 21% from those heady days.

Think back to last Spring when the market was moving up daily. The pundits were almost univerally bullish. But, I said then the market had disconnected from the economy and needed to wait until the economy caught up, which I expected would be in the fourth quarter.

The economy is starting to show life again, and as usual, the market is getting ahead of it. Winter is traditionally a good time to be fully invested. By Spring, we will be due for 10-20% correction.

So, enjoy the ride . . . for now!

Friday, November 5, 2010

An Economist's Lament

The study of economics has always been an enjoyable intellectual pursuit. There are lots of arcane terms and inside jokes that economists enjoy discussing and sharing.

But, it seems we have reached a tipping point where economics is becoming polluted by politics, and I'm sad about that. Should I parse my thoughts to support one political side over the other?

As I've said many times, economics is not religion. There is wisdom in all schools of economic thought, and we should pick and choose as appropriate for the economic situation.

Politics = pollution . . . dammit!

Good Jobs Report . . . finally

The most important monthly economic report each month is the "Jobs Report." The last few months, the report has shown a sadly weak economy, producing few jobs. Voters took the President to task for that on Tuesday.

Today, the Labor Department announced that the private sector created 159 thousand jobs, twice what was expected. This was great news, and the Dow futures immediately jumped 40 points.

I'm sure the President wishes this report came out before the election, and I'm equally sure the 14.8 MILLION people who are unemployed wish it was even better news, as they need YEARS of equally good reports to get back to normal.

All year, I 've been predicting the fourth quarter would be good, and it certainly looks that way . . . thank God!

Wednesday, November 3, 2010

Fire Up the Printing Presses . . . Again

Today, the Fed announced another round of quantitative easing, which means they will buy Treasury bonds, which means the Treasury then gets that amount of money ($75 BILLION per MONTH over the next 8 months) deposited into Treasury's checking account, which Treasury can then use to write checks for Social Security, infrastructure, anything . . . even interest payments to the Fed for having bought the Treasury bonds. In other words, the right pocket buys the bonds in the left pocket. Of course, it is all "smoke & mirrors", but it can have huge economic effects.

Milton Friedman, father of Monetarism, believed that inflation is caused by "too many dollars chasing too few goods". Another way of saying this is . . . if money supply increases faster than productivity, you will get inflation.

The Fed is worried about deflation. So, today's Fed action does make sense!

Plus, the Fed handled it well. You can tell . . . because the stock market barely reacted. That means the Fed properly telegraphed with market. When it doesn't, the market over-reacts, which is what it does best!

Political Pundit George Carlin ?

I think the late comedian was the first to describe our electoral process as "political masturbation", a very intense, focused effort to accomplish nothing. The Libertarian view is that elections merely change the Masters, with the slaves remaining the same. It is just a different set of thieves. Maybe, that's a little cynical. OK, that's a lot cynical.

Wall Street traditionally likes divided government, and I expect the stock market will reflect that. That's the silver lining. But, there are turning points in history. We may "kick the can down the road forever," but forever is over. There are some deadly serious decisions to be made, and I don't see that we have the process for making those decisions.

How are we going to keep borrowing money from our grandchildren to pay for our Social Security, for our Medicare, for endless far-flung wars, and for interest on the trillions we've already borrowed?

What changed yesterday that will help us make those decisions? What happened two years ago that helped us? What will happen two years from now that will help us? Or, will it be just another Master?

WHEN will we know . . . and HOW will we know . . . that "political masturbation" is no longer working for America? The American people deserve better!

Tuesday, November 2, 2010

Election Day . . . Finally!

In this world of 24/7 cable news, which spin the news as well as report the news, it is easy to become both confused and depressed. Therefore, I recommend a disinterested foreign perspective to balance the right-wing Fox News and the left-wing MSNBC. Religiously, I read The Economist, a newsweekly magazine from England and recommend it.

Sometimes, it is helpful to read things like this, which appears on page 11 of the current issue: "Despite its problems, American has far more going for it than its current mood suggests. It is still the most innovative economy on earth, the place where the world's greatest universities meet the world's deepest pockets. Its demography is favourable, with a high birth rate and limitless space into which to expand. It has a flexible and hard-working labour forces. Its ultra-low bond yields are a sign that the world's investors still think it a good long-term bet. The most enterprising individuals on earth still clamour to come to America."

Too bad politicians never remind us of anything good about America . . . but, if they did, would we even listen? Have we become programmed to process only negative news? The nation that made the world safe for democracy, put a man on the moon, and still is all the things cited above . . . simply deserves better!

Saturday, October 30, 2010

Rest Up This Weekend

Next week, the market could be exciting, maybe too exciting! As I've been predicting all year, the market will begin to rally when the election outcome comes into focus. I expected that in October and was pleasantly surprised when it started in September. Historically, the market likes gridlock, which appears to the outlook.

Another reason for the recent rally is the expectation that the Fed will announce another round of "Quantitative Easing" this week. While this is inflationary in the long term, it may jumpstart the economy in the short term. I expect the market will fall after the announcement. (There is an old market axiom about "buy on the rumor and sell on the news".) If the Fed announces less than $500 billion, expect the sellout to be more violent.

On Friday, the Department of Labor will issue the single most important economic report of each month, i.e., the "Jobs Report". Expectations are low, about 75-80 thousand private sector jobs. If significantly more jobs are created, expect the rally on Friday to be strong.

Only one thing is certain . . . it will be an exciting week!

Friday, October 29, 2010

Nailed it!

Economists get ridiculed frequently and richly deserve it. In fact, they usually enjoy it!

However, today was a good day, in that they accurately predicted the GDP growth rate in Q3 would be 2.0%, compared to 1.7% in Q2.

This makes it even less likely we will see a "double-dip" or experience the worst of the recession again. This makes my forecast of a "long, hard slog" even more likely, darn it! I was still hoping we would sharp a sharp rebound, which is more typical following a recession.

Sometimes, economists don't want to be correct ...

The Halloween Indicator

Of all the many market indicators, this is the most useless but must be fun, as it rolls out year after year. Here it is:

Since 1950, the stock market performs best from the last trading day of October to the end of April. (Of course, there are always obvious exceptions, like the oil embargo of 1973-74, the dot com bust of 2001-2, and the Great Global Financial Crisis of 2007-9.)

It is not news that the market does better during the winter and spring than it does during the summer and fall. In fact, it does a lot better!

The only thing scary about this is that we call it The Halloween Indicator. Let's just hope it works this year, and the market does as well as it usually does after goblins go away!

Thursday, October 28, 2010

Baking a Cake . . . or Baking a Market

When you look at a cake, you are seeing the end result of whatever ingredients went into it. The same is true when you look at the market. Instead of flour, butter, mix or whatever goes into a cake, information and expectations go into the market.

Most people understand why information moves a market, but expectations about information are just as important. Yesterday's roller-coaster market is a good example.

Yesterday's Wall Street Journal reported the quantitative easing by the Fed to be announced next week would be much less that expected and over a longer period of time. The market promptly dropped almost 160 points. That afternoon, legendary Abby Joseph Cohen of Goldman Sachs predicted the Fed would do more than the Journal reported, about $500 billion as earlier expected. As a result, the market rallied over a hundred points, finally closing down only 43 points.

Expectations are important. Just imagine how you would feel if you expected a German chocolate cake from Neiman Marcus and only got a Twinkie from 7-11. You might lose your appetite for sugar . . . and for stocks.

Wednesday, October 27, 2010

Paddling Hard . . .

Arthur Conan Doyle once described how Sherlock Holmes unraveled a mystery because of the "dog that didn't bark". That's reminds me of the G-20 meeting in Korea. China is clearly manipulating its currency, but so is the U.S. But, there was little furor about this.

While the finance ministries are warning of a currency war, there was no furor that we were already in it.

U.S. Treasury Secretary Geithner proposed measurable goals for the emerging markets to reduce their trade surpluses, which is as ridiculous as the U.S. promising to reduce our trade deficit. Again, no indignation, no furor?

There must be an unusual amount of behind-the-scenes negotiation going on, but we won't know anything until the dog barks.

If logic prevails, China will revalue their currency. Since that has nothing to do with the only thing China does care about, i.e., internal tranquility, don't expect to hear the dog bark anytime soon.

Tuesday, October 26, 2010

Please Take My Money?

Yesterday, the Treasury Department issued $10 billion in five-year bonds. In other words, they borrowed another $10 billion. But, something was different . . . very different. Instead of repaying $10 billion at the end of five years PLUS interest earned by the bond-holder, the government will repay $10 billion LESS interest paid to the government for holding the money. This has never happened before! The lender or bondholder doesn't get paid regular interest.

What made this possible was that the bonds were TIPS or Treasury Inflation Protected Securities, which means the principal amount ($10 billion in this case) will be increased to offset inflation. It is a good way to protect investors with minimal income needs from inflation. Yesterday's investors were willing to take a negative interest rate in order to get protection from inflation.

What makes this significant is that it clearly shows the market is expecting inflation. The Fed is widely expected to begin another round of quantitative easing on November 3rd, which the market expects will create inflation. Actually, this is a good thing, as deflation is much worse than inflation. Now that an inflationary psychology has developed, the fear of deflation is reduced . . . hallelujah! That's a good thing!!

Friday, October 22, 2010

A Benefit of Aging

One of the benefits of aging is that a person has had time to benefit from all the good advice they have received over the years. One of the disadvantages is that you cannot remember who gave you the advice . . .

Some of the best advice I received as a young investment advisor was to be an "economics agnostic and a political atheist".

Long time readers know I have written often that there are lessons to learn from Supply-side economics, Keynesian economics, Monetarism, Classical economics, etc. No one school of economics has a monopoly on forecasting, truth, realism, or logic. I'm agnostic on economics.

Whomever it was that gave me this advice also said "The Repubican Pary and the Democratic Pary both make whorehouses look respectable." A person may hold conservative or liberal philosophies, but neither political party reflects well on either political philosophy. I'm an atheist about politics.

What does all this mean? Don't expect predictability in economics and don't expect truth in politics. Trust only in unpredictability.

And, if you are the long forgotten person who gave me this advice . . . Thank You!

Keyboarding Burnout?

With regret, I have noticed my blog gets neglected whenever I finish doing my quarterly column for Inside Business. (You can receive copies by email at no cost by signing up at

To be even more confessional, I have also been working on a book, which is still another excuse for my keyboard burnout. No more excuses, just apologies!

With the highly important G-20 meetings in Korea this weekend, amidst a bull run in the market, there will be much to blog about. So, stay tuned . . .

Friday, October 8, 2010

S.O.S. = Same Old Song . . . Whew!

The famous fat lady sang this morning, and, thankfully, didn't sing anything surprising. The rate of unemployment remained constant at 9.6%, instead of increasing to 9.7% as expected.

Total non-farm jobs decreased by 95 thousand, far better than the 600-700 thousand monthly decreases we saw last year but way below the 250 thousand a month increases that we need. Tragically, 6.1 MILLION people have been out of work for six months or more. If job growth were 250 thousand monthly, it would still take over two years to get them back to work, and that doesn't count the millions unemployed less than six months or those millions who have quit looking. This is one of two major reasons I've forecast a long, slow recovery.

Private sector jobs were up 64 thousand and is probably the most important number released today. This is slightly better than the expected 55-58 thousand.

Government jobs decreased 159 thousand, which were mostly census jobs. Except for this, there would have been actual job growth last month.

Because the numbers were close to expectations, the market didn't react nor over-react. Whew . . . ! Of course, Friday afternoons are notariously unpredictable.

Wednesday, October 6, 2010

. . . Waiting for the fat lady . . .

She will sing this Friday morning, when the monthly Civilian Unemployement Report or "Jobs Report" will be released. To the market, this is the single most important economic report each month, probably too important.

But, it is even more important this month. Yesterday, the Non-Manufacturing ISM Report indicated there was more job growth in the services sector than expected. As a result, the Dow roared upwards, almost 200 points. This morning, the ADP National Employment report was released, showing job growth in the private sector at only 20 thousand, compared to 60 thousand the market was expecting. Getting two contradictory reports in two days makes the report on Friday even more important to the market.

In addition, Friday's report will be the last one before the all-important mid-term election. Politicians of one side or the other will make a bigger deal of this report than normal, which is already too big a deal. Since Friday afternoons are normally the most volatile part of the week, expect anything this week!

Friday, October 1, 2010

Sometimes . . . The Truth Hurts!

For years, economists and financial analysts have talked about the BRIC countries, i.e., Brazil, Russia, India, and China. As a group, they were rapidly growing economies dependent upon export growth. As a group, they need to curb their internal savings by individuals and increase consumption spending by those individuals. This is a happy problem.

Now, economists and financial analysts are talking about the HIIC countries, i.e., heavily indebted industrial countries, like the U.S., England, Europe and Japan. As a group, they are well-established democracies with a high level of social benefits, such as Social Security and Medicare, which creates a high level of debt. As a group, they are growing slowly and are dependent upon consumption spending to power their GDP. As a group, they need to increase internal savings at the expense of consumption spending and to increase exports. This is not a happy problem.

So, which set of countries will have the best performing stock markets? Here are the BRICs for the third quarter: Brazil (+22.1%), Russia (+12.3%), India (+16.1%) and China (+12.1%). The U.S. stock market gained a relatively puny +11%. Of course, one of the reasons foreign markets beat us so badly is because the dollar has resumed its expected depreciation. But, since it is easier to increase consumption spending than to increase exports, I continue to believe the emerging markets are very attractive for investors. The depreciating dollar will only magnify the difference.

Talk about an inconvenient truth . . . we need to save more, export more, and consume less!

Saturday, September 25, 2010

Final Thoughts on China

All of my life, the U.S. has been the engine of growth for the world. That is no longer the case, as China has clearly taken our place. While that may be sad, I don't think it is anything to be feared.

During my travels over the last two weeks or so, I've focused on China, but it is time to move on. For now, here are some concluding thoughts on "The Chinese Century".

In the near term, China's importance is clearly growing. Investing there is a smart thing for growth investors. However, the Shanghai stock exchange is not transparent and very volatile. If you have a weak stomach, stay out.

In the mid-term (5-8 years), I especially like consumer oriented stocks in China. However, don't do this on your own. Find a good, specialized mutual fund for this targeted exposure.

In the long-term, China faces enormous problems, with the fastest aging population on the planet. Their centralized government has done an excellent job of guiding the economy so far but are only human. No centralized government can consistently allocate resources more efficiently than the market. They will screw this up! "Buy and Hold" is not the right strategy for China.

Now, back to the U.S.-- my beloved America!

Friday, September 24, 2010

Save Your Breath, America!

The Bush Administration started applying pressure on China years ago, to allow their currency to increase in value. This makes their exports more expensive to foreigners who buy them, like the U.S. As a result, foreigners buy less, which means China produces less, and fewer Chinese workers are needed. Layoffs increase and so does social unrest.

The Obama Administration has substantially increased that pressure on the Chinese currency. Yesterday, Chinese Premier Wen said a 20% appreciation of the Yuan would cause widespread bankruptcies in China. As their bankuptcy system is rudimentary, the impact would be far greater than we would expect.

The single more important takeaway from this series on China is how critical it is to understand the driving force behind all their decisions, i.e., stay in power by avoiding social instability. Any discussion of China without that clear understanding is wasteful.

So, Wen has made it clear that a 20% appreciation is not going to happen. Most currency analysts believe it needs to appreciate 20-45%. If Obama pushes for a fairly priced Yuan, he is far more likely to get a trade war, which would be far worse for the U.S. Like a rat, Wen is backed into a corner and likely to bite!

Thursday, September 23, 2010

What Chinese and Americans Have In Common . . . Taxes

The Chinese have a progressive tax on income, which means your tax rate increases as your income increases, similar to ours. However, they have no estate tax, at least not yet.

As income inequality increases, so does social instability, which is the greatest fear of the Chinese government and can hardly be emphasized enough. To take more from the rich, there is now growing pressure to tax the estates of the rich.

What amuses me is the argument by the Chinese Academy of Social Sciences that says "Before imposing inheritance tax on the rich, the government must study international taxation laws and practices thoroughly. What happens if some countries do not impose inheritance tax at all or have much lower rates and China decides to implement it hastily? It could cause many rich Chinese to migrate abroad and lead to unnecessary outflow of domestic capital, harming the national tax revenue and even the national economy."

This is pure classical economics, which says capital flees taxation and goes where it is appreciated. Funny, I haven't noticed too many Americans leaving our great country just to avoid taxes . . . that aren't even paid until after they're already dead anyway. Let me know if you do!

Tuesday, September 21, 2010

Peeling the Onion....

Last week, I marveled that China was making the same mistake as the U.S. by letting its Social Security system get as out of control as ours. Digging into this has not been easy, but I have learned that:

1. It started in 1978, when China was still a "socialist-paradise".

2. By 2030, it is expected to be the oldest, on average, population on the planet.

3. By 2040, over 28% of the population will be 60 years old or older.

4. Today, each recipient is supported by 3.5 workers, which drops to 2.0 workers in 2035.

5. Men working in "arduous conditions" can retire at 55 and women at 45.

6. They do have to pay into the system 15 years, compared to 10 years in the U.S.

7. But, the people don't see the problem coming, i.e., 90% are opposed to raising the eligibility age.

Remembering the single most important objective of the government is to maintain social stability, in order to maintain control, it is unlikely China will make the necessary changes, maybe more unlikely than the U.S. to make those same needed changes. I just wish both our governments would peel back the onion on this problem and actually address it...silly me...

Deja Vu.....Not This Time

Back in 1986, I was a Vice President with Citibank out of New York, and based in Dallas. With no data to go on, except a general sense of unease about the possibility of serious over-building, I rented a large van for a full day and invited all the best bankers I could to spend a day . . . sightseeing in our hometown. Collectively, we came to the judgment that the office building market in the North Dallas market and the condo market in far east Dallas were headed for big trouble. Fortunately, we immediately stopped lending to those markets. Because we knew there had to be “spillover” damage, we reduced overall lending all over north Texas.

For the last few days, I’ve remembered that experience, as I’ve driven around east China with businesspeople from the Chamber of Commerce. We are seeing an awful lot of construction, epic levels of construction in fact. There are countless “see-thru” buildings. I’m told that one of every three construction cranes in the world are working in China and have been for many years. Based on our experiences back home, most Chamber leaders think China is headed for big real estate problems.

I’m not so sure. Remember: The PRIMARY function of the Chinese government is to prevent social instability and thereby to remain in power.

One of the principle complaints of young professionals is the high cost of housing. Finally, after a long climb, residential sale prices in Shanghai have fallen about 2% since last year, to $2,971 per square meter or about $330 per square foot. Not surprisingly, sales are up 9%. Their unstated policy, I suspect, has been to increase the supply of housing enough to stop the inflation in housing prices. Even if they cause some deflation in home prices, it is unlikely to create a credit problem, since most mortgages require a 40% down payment, unlike the U.S.

Driving around north Texas in a van and east China in a bus . . . are very different!

Sunday, September 19, 2010

Strutting With the Best of Them.......

I was born immediately after World War II. It was a time when America became the most powerful nation on the planet. We had triumphed over evil during the War and “deserved” to be #1 among nations. We were truly “exceptional”. As a young man (and especially when I wore my Army uniform), I walked with a swagger . . . because I was an American and damn proud of it!

As I travel through the provinces around Shanghai, I am again seeing that swagger but from the Chinese, of course. I recall that airy confidence of young men who believe they are exceptional but don’t think I recall seeing that back in the U.S. in a long time. Strutting with an attitude is not the same thing as walking with a swagger.

After being occupied by the Japanese from 1933 to 1944 and suffering thru a four year revolution between the Communists from 1945 to 1949, before the Cultural Revolution when 30-40 million of their countrymen starved to death, and then created the greatest economic leap in history, the Chinese feel they have the right to walk with a swagger. I agree!

Friday, September 17, 2010

The Triumph of Madison Avenue

Certainly, one of the most apparent changes in China from my last visit in 1987 is the western style of clothing, which has been completely adopted by the Chinese. It is not unlike a typical walk thru Chinatown in San Francisco. Who said advertising doesn’t work?

Yet, this is one of those discussions where business bleeds into ethics quickly. If advertising works for clothing, why should we assume it does not work for credit card companies? Anybody is savvy enough to buy clothes, but is everybody savvy enough to manage credit, when advertisers constantly encourage us to use it?

Oh, yeah . . . it is the consumer’s choice, I forgot. But, it’s odd that I haven’t seen a single advertisement for Master Card or Visa since I got here . . .

A Day in the Life of ....China

This nation boasts the greatest number of newspapers, with over 400. It is also accused of having jailed the most jounalists, number unknown. Still, a good read of one day's edition offer insights into Chinese thinking see

1. Pressure from the U.S. to allow the Chinese currency (Yuan) to appreciate is not motivated by any trade protection of Chinese exporters but entirely by the mid-term elections in the U.S.

2. With Beijing selling 1,500 cars every day, it is getting more dangerous to ride bicycles (duh).

3. A widely used form of contraception for young Chinese women is the "morning-after" pill, where it is available at roadside pharmacies without a prescription.

4. If you kill a person with an auto, the driver pays a one-time penalty. If you cripple that person, you may have to pay the person for the remainder of their life. In the city of Xinyi, a man driving a BMW was videotaped running over a 3 year old boy before doing it several more times, to make sure the boy was dead.

5. There is a summit underway in Brussels on how the 500 million strong European Union can cooperate more closely with the stronger 1.3 billion Chinese.

6. Eight tourists from Hong Kong were killed in the Philipines.

7. One of the fastest growing businesses in the urban areas is "online snacks", where office workers call for delivery of snacks, not just food but snacks.

8. The Shanghai Composite Index or CSI was down 1.9%.

9. Life goes on......

What Mao Meant.....?

Mao said that all great men have climbed The Great Wall. What he meant to say was “All great financial advisors have . . . “

Thursday, September 16, 2010

A Rocker Got it Right

As a child of the Cold War, I just assumed I would die in a nuclear war. When I first heard the song by rocker Sting, called “Do the Russians Love Their Children Too?”, I was caught a little off-balance by the question.

Yesterday, I watched an older lady stop a young mother to admire her baby. I saw a man photographing his wife and then she photographing him before a stranger asked if he could use their camera to take a photo of them together. I missed my wife as I watched couples walk down the street holding hands.

Yes, Sting’s rhetorical question is important. The Russians do love their children, just as much as Americans or Chinese or everybody else. It is easy to forget that people are more alike than different . . . Thank God!

We’re #1, We’re #1 . . . Today!

Last month, China passed Japan to become the world’s second largest economy. At current rates, it should bypass the U.S. in 2020, which is a mere ten years away. It may do so, but it is interesting that they are not learning from our mistakes. Already, they are allowing retirement for women at age 50 and men at age 55, along with a comparable Medicare plan. Just ask Greece how that worked out for them!

There is a difference between a budget deficit and a structural deficit. A budget deficit looks at one year. A structural deficit looks at much longer time periods. For example, we all know that Medicare, Medicaid, and other health care costs are ballooning out of control, with or without Obamacare. Politicians talk about the budget deficit but simply resort to partisan name-calling on the structural deficit.

As we all know, China is running enormous annual surpluses, but I would love to see some numbers on their swelling structural deficit. To make their problem even worse, the U.S. permitted a huge social safety-net partly out of mere humanitarian interests, and because we could afford it at that. China has a far different problem. They face a much greater risk of social instability than the U.S. and politicians may be forced to pander even more to the disaffected.

At this point, I don’t see any scenario that will prevent China from over-taking us, but I am confident they won’t be #1 forever.

Wednesday, September 15, 2010

Paging Gloria Steinam

The flight attendants for Air China are young and pretty, obviously a proven branding campaign for generations. However, just like all flight attendants everywhere, they were over-worked, harassed, and annoyed. Rolling their eyes seemed to be a primary job requirement. Yet, they seem to have more authority than U.S. travelers normally see. When they tell you to close the window, it is not a request. When they tell you to clear the aisles, they mean NOW!

We were served two meals during the 14-hour flight, and I ate the steamed carrots in each . . . nuff said!

Of course, the highlight of the flight was watching the movie of “Alvin and the Chipmunks” in Chinese . . .

A Troubled Economic Paradise

In 1987, I made my last trip to China. Mao had only been dead 11 years, and Deng was still trying to figure out how to use Soviet-style Five Year Plans to unleash the Chinese economy. To me at that time, it was a large, Second-World nation with an agrarian economy. My principle take-away was military, i.e., that China really could field a ten-million man Army, which is still amazing.

Yesterday, as the Air China 747 left JFK over the Atlantic before making a U-turn for the 14 hour flight across North America and the Pacific Ocean, I was expecting the take-away on this trip would be economic, not military. After all, I routinely study most every economic report China issues. One of my concerns has been that China’s economic statistics are less than unbiased and I hoped to get a better feel for it on this trip.

I was thinking how their economy has been growing 3-4 times faster than ours . . . every year for twenty years. It is no wonder they are now the world’s second largest economy. But, how have they done it? The conventional wisdom is that their government has an industrial policy and can actually govern. Furthermore, Deng visited Singapore frequently to see their combination of capitalism as an economic system with dictatorship as a political system and adopted it for his country.

The Free Enterprise system has capitalism as an economic system and democracy as a political system. That didn’t make sense to Deng, who was justifiably fearful of social unrest. The GINI index measures the gap between upper income Chinese and lower income Chinese. It is bad and getting worse, more like a Latin American Banana Republic. Social unrest is an inevitable result of increasing income inequality.

But, is dictatorship the answer to effective governing? Take a look at India, whose economy is growing almost as rapidly as China’s. Yet, they have a firmly established democracy. They are almost as Free Enterprise as we are. Democracy does not preclude a good industrial policy. However, maybe there are democracies, and there are democracies. While they have many political parties, they “ebb & flow” together to make things happen. Maybe, there is a lesson there for us.

I came to China to think about their economic reports. Maybe, I should be comparing political reports between the U.S. and India, not China.

Monday, September 13, 2010

Chinese Water Torture or Capital Torture

Regulators for the world's central banks meet in Basel, Switzerland. On two previous occasions, they have re-written the rules for banks worldwide. Now, we have the third revision, called Basel III.

The more capital a bank has, the less likely it is to fail and need taxpayer dollars. So, why not require banks to have lots of equity? Because it is an expensive source of funds! Banks make their profit on the difference between what they charge borrowers to borrow and what they pay for the funds they lend to borrowers. Checking accounts, for example, are a very cheap source of funds for banks to lend out. Investors who put capital into a bank demand much higher rates of return than checking account holders, reducing bank profits. Not surprisingly, regulators want a lot of capital and banks want very little.

Basel III does require more capital, but not as much as the banks and Wall Street feared. In addition, the new banking requirements are scheduled to phase in over the next seven years. Banks and Wall Street feared something much sooner. So, Basel III is not as tough as Wall Street feared, and bank stocks will likely rise nicely.

Basel III is another step in the right direction, just too slow. Like all generals who keep fighting the last war, regulators are still too focused on having capital to absorb inevitable loan losses, and not focused enough on non-banking activities done by banks using FDIC-guaranteed dollars, like proprietary trading in derivatives.

Saturday, September 11, 2010

More breadcrumbs leading to . . .

Yesterday, it was announced that wholesale inventory levels rose 1.3%, which is the best performance in two years. Sometimes, a rise in inventory means sales have decreased, causing inventories to backing up. However, it was also announced that sales at the wholesale level increased twice as much as expected.

This means wholesalers are re-stocking their inventories . . . because they have reason to believe that they will be selling more out of their inventories. And, I hope they are right!

The trail of economic data seems to be improving again, and I hope it is right, leading to a real, sustainable recovery! This is consistent with my expectation that the market will improve by year-end.

Friday, September 10, 2010

Stealth Globalization

There is no good measure of globalization, a fact that drives economists crazy. Traditionally, we have used the Baltic Dry Index, which measures the cost of shipping dry goods around the world. It's a good start, but here is another.

Every three years, the Bank for International Settlements in Switzerland measures the volume of trading, not in stocks or bonds or commodities, but in currencies. Their latest study found that $4 TRILLION of currencies trade every day. This is more than twice as much as it was five years ago.

Obviously, the more international trade there is, the more international currencies that need to change hands. Does that mean international trade has doubled in the last five years? Only partially!

It also does mean currencies have become another asset class, where investors can make or lose fortunes by simply investing in currencies, like investing in stocks or bonds. Of course, smart investors usually lead the way. They are betting that increased globalization will increase demand for foreign currencies, and they are investing in those currencies.

Lastly, if the dollar resumes its long decline, as I expect, that will also make foreign currencies more valuable. It's just not prudent to be dollar-centric in a globalized world!

Thursday, September 9, 2010

A Good Morning, Indeed!

It's nice to start the day with two pieces of good economic data. First, initial jobless claims dropped more than expected, down 27,000 to 451,000. That makes three jobless reports in a row that have been better than expected. It certainly smells like a bottom in an awful jobs market.

Second, the trade deficit shrank more than expected, from $49.8 billion last month to $42.8 billion this month. Exports were up significantly, and imports were down. This could reflect the improving dollar, but it is premature to make that judgement. If our imports are down because our consumers cannot afford to buy foreign goods, that would be a bad thing. Or, it could reflect improving quality in U.S. made goods. But, exports are clearly up, because the rest of the world is recovering faster than we are.

Futures immediately jumped about 50 points on the news. This looks like the sixth up day out of the past seven. I've been expecting the market to rally, once the election reduces uncertainty, but this seems a bit too soon for that. Interestingly, famed investor Mario Gabelli said this morning that he thinks the market will be up 5% by year-end. I hope he's right!

Friday, September 3, 2010

Economic Rolaids

The Market has been holding its breath, fearful of today's Jobs Report. Coming just before Labor Day, it seemed to be even more important than usual. Hopes started to rise Wednesday when the ISM (Institute of Supply Managment) manufacturing index actually rose more than expected.

Still, most economists were expecting that the U.S. economy had lost about 110 thousand non-farm jobs last month, for the third straight month of losses. Instead, we lost "only" 54 thousand jobs. Additionally, we learned that June and July were not as bad as we thought. About 122 thousand jobs were NOT lost during those months! Things appear to be better than we thought?

More good news is that average hourly earnings were up 0.3%, which was more than expected, exceeding last month's 0.2%. This may also explain the higher-than-expected retail sales announced this week.

While the official unemployment rate went up to 9.6% from 9.5%. But, even that was a good thing, because 551 thousand workers re-entered the workforce, which is a good indicator that individuals have again become hopeful of finding a job and for good reason, since the private sector added 67 thousand jobs last month.

A lot of economic heart-burn got better at 8:30AM this morning!

Did Anybody Notice?

In 1988, I took my daughter to Cozumel to scuba dive. While there, I spent some time on the beach reading a book whose name I no longer recall. What I do recall is its strident insistence that stock analysts pay much more attention to the "P/E Ratio" or Price-earnings ratio. This is a measure of how much investors are willing to pay for a company's earnings on a per-share basis. For example, if a company earns $1.50 per share, and the stock is selling for $15.00 per share, then we can say it has a P/E Ratio of 10 or 10X. When investors are feeling optimistic, they will pay more than $15 for a $1.50 of annual earnings. They might pay $16 or $17 a share or more.

The importance of this metric was originally pointed out by legendary analysts Benjamin Dodd & David Graham back in the 1930's. The author of the forgotten book in Cozumel emphasized it is The Most Important metric. The Media (and therefore everybody else) clearly believe the monthly jobs report is more important.

The P/E Ratio has fallen from 23.1X last September to only 14.9X now. This 35% drop is the sharpest since 2003. What this tells me is that, absent some strong external shock, The Market is currently over-sold, which means it is more likely to go up . . . or even just bump-along . . . than it is to go down.

The Way It Should Be!

Late last night, I returned from board meetings in Chicago of the National Association of Personal Financial Advisors (NAPFA). Like any board of any national organization, they were grappling with all the normal issues, such as budgets during the tough times. But, no matter the issue, the focus always remained on what was both fair and best for "people". Occasionally, someone would use the word "client" or "customer" or even "investing public" but rarely. It was reassuring, comforting, and a little surprising to see such a collective sense of duty to "people"!

Unlike the Financial Planning Association (FPA), which is dominated by salesmen for insurance companies, and unlike the Investment Management Consultants Association (IMCA), which is dominated by salesmen for brokerage firms, NAPFA is dominated by servants of the fiduciary standard, that we must always act in the best interests of "people"! Our mission is not to sell products to customers but to actually serve their best interests.

I am proud to also serve NAPFA . . .

Tuesday, August 31, 2010

Trying to Understand the Allure of Gold?

As I've long predicted, the President has now determined that a massive increase in exports is necessary to bring our balance of payments deficit under control. The best way to do this is to de-value the dollar, make it depreciate, which makes U.S. goods cheaper for foreigners to buy.

Don't believe any politician who says they "support a strong dollar"! No politician in Japan is saying they "support a strong Yen". The Yen is now at a 15-year high against the dollar and killing their exports. Two-thirds of Japan's businesses are now losing money as a result.

The strongest country in Europe right now is Germany, whose exports surged 8% in the second quarter alone. Make no mistake: this largely reflects the 20% decrease in the value of the Euro. Currency prices matter!

The problem is that every heavily indebted nation needs to depreciate its currency, and we may see "competitive devaluation", which is an invitation to inflation.

Maybe, that's why gold is up 13% this year?

Monday, August 30, 2010

50 Safest Banks

Each year, the highly respected Global Finance magazine publishes its list of the 50 Safest Banks in the world, and the 2010 list came out today. The highest rated U.S. bank was JP Morgan at #39. Wells Fargo was only #42. Only two U.S. banks made the Top Fifty. Bank of America was a pitiful #103.

The U.S. was the center of financial innovation during the boom and became the epicenter of the financial crash. Maybe, that's the price of innovation? Unfortunately, it will take years for our nation to become the leaders we were.

There is always a silver lining, and I was pleased to see Toronto Dominion Bank, who wisely avoided "the latest hot,new financial innovations", was rated as the 14th strongest bank in the world. And, since they are the largest shareholders of TDAmeritrade, who is custodian for my clients' funds, I've especially pleased. But, I am not surprised. I made sure their funds were in strong hands!

Sunday, August 29, 2010

"China, Inc."

In anticipation of my upcoming trip to China, a good friend & client graciously loaned me her copy of "China, Inc. "How the Rise of the Next Superpower Challenges America and the World" by Ted C. Fishman.

Although published in 2006, it is still required reading for serious geo-political observers. Alternating between history and travelogue, it poignantly describes the tidal flow of people between farms and cities, and how this drives policy-making.

It describes their transition from a government driven by ideology to one driven by practicality. Instead of their formerly "Imperial" attitude of exporting communism, they accuse us of remaining "Imperial", trying to export capitalism or still driven by ideology. The difference is their own unique version of "State Capitalism", with an aggressive industrial policy, which is anathema to our Free Enterprise system.

Fishman also speculates that the last century was the American Century, but this one is likely to be the Chinese Century. Another recent read was "The Next 100 Years: A Forecast for the 21st Century" by George Friedman. He believes the last 50 years of this century will be a return to U.S. economic domination. Unfortunately, he agrees with Fishman about the next 50 years.

As scary as this indispensable book is, I thank Arlene Lindsey for loaning it to me!

Friday, August 27, 2010

A Good Graph is Worth a Thousand Blogs?

Several recent blogs have referred to the month of September being a traditionally lousy month for The Market. Take a look at this graph:

Clearly, September has historically been the worse month of the year, but notice how much better November and December have been. While this historical pattern is a minor part of my belief that The Market will improve in Q4, it is nonetheless some additional comfort.

Thursday, August 26, 2010

Totally Unscientific . . .

One of the daily jobs of a financial advisor is to check on stocks that have been either up-graded or down-graded by the nerdy analysts.

Normally, there are more downgrades than upgrades when the economy is weakening, but that is definitely not the case now. I'm seeing probably 5 upgrades for every downgrade, which indicates a strengthening economy, at the same time that economic data indicates the opposite.

Maybe, it is just another reflection of the difference between The Market and The Economy. Or, maybe it is that the nerdy analysts are forward-looking, while economic data is backward-looking.

Even though the Dow just closed under 10,000 points for a seven-week-low, the sky is not falling. The Market is normally listless and meaningless in August, with less than a billion shares traded today. I'm far more concerned about September and early October. However, by late October or November, levels of uncertainty will be less, and stocks reflect that by rising, normally!

Like I said . . . totally unscientific!

Wednesday, August 25, 2010

Summer Doldrums?

August is normally one of the best months for The Market, while September is normally one of the worst. Conventional wisdom is that most traders are on vacation during August but thinking about their portfolios. When they get back to work, they start selling to re-position their portfolios, which triggers the "September Slump". But, that is mere conventional wisdom.

Yesterday, the bad economic news was that existing homes sales fell 27%, much greater than the 13% economists were expecting. Today, the bad news is that durable goods orders dropped 3.8%, ignoring the wildly volatile transportation sector, when economists were expecting a small increase (0.5%). In addition, new home sales dropped 12%, while economists were expecting an increase of 12%.

Months ago, I predicted The Market had greatly out-paced the The Economy, and that The Market would be lackluster this year, until The Economy had a chance to catch-up. Now, it looks like it will take even longer to catch-up. I've also been expecting the S&P to fluctuate between 1050 and 1150 this year. It is now slightly below that, which could mean the The Market is under-valued. Or, it could mean the The Economy is over-rated.

Ken Langone is a highly-respected investor (think Home Depot), who believes there will be no "double-dip" recession, because we never exited from the last one. The good news last Fall and this Spring were simply "sugar-highs" from the Stimulus Bill. Now that the stimulus is being exhausted, we are still stuck with the same old recession.

The continuing flow of economic news confirms that The Great Recession was deeper than anybody expected, which means it will take longer to dig our way out. Certainly, a tax increase makes no sense now. However, cutting spending/stimulus also makes no sense now. But, the combination means we will have a bigger deficit later, with even larger tax increases then.

I prefer the more boring Summer Doldrums of August and dread September!

Tuesday, August 24, 2010

"Real" Stimulus

Last year, Congress approved a stimulus package of $787 billion.

Since Q2 of last year through June 30th of this year, profits of the S&P 500 have risen 52%. Productivity has soared to 3.5%, compared to 1.6% in 2007 and only 1% the next year. Still, the private sector has added only 630,000 jobs this year. We need at least 125,000 monthly, just to stay even, without even reducing overall unemployment. We desperately needed a minimum of 875,000 new jobs in the last seven month, not a mere 630,000.

Today, the amount of cash on the balance sheet of the S&P companies is almost $2 TRILLION and rising. It will soon be three times greater than the "stimulus" package by Congress.

Yet, it is not the function of business to produce jobs. They will only hire when the incremental cost of a new employee is less than the increased revenue offered by end-users from their increased demand. In other words, each new hire must produce a net gain in revenue.

Supply-side economists say more hiring would occur if we decreased income tax on high-income owners, giving them extra money. The problem is that their increased tax savings would simply be added to their existing cash levels. This is a situation where decreased employment taxes on employees & employers, i.e., social security and unemployment taxes, would decrease the incremental cost, making it cheaper to create new jobs. Cutting the right taxes is more important than simply cutting taxes.

Now, that would be a "real" stimulus!

Saturday, August 21, 2010

The Eye of the Hurricane?

I have long been a fan of Nouriel Roubini, a highly regarded economist more commonly known as "Dr. Doom", for having predicted The Great Recession back in 2006. He has teamed up Stephen Mihm to author the new "Crisis Economics", which I just completed.

It is not a book for the casual reader, nor the typical investor, nor the serious economist. However, it is a book for serious students of geo-economic policy.

There is a long, very readable history of what caused the last crisis. A large part of the blame was laid at the feet of Alan Greenspan for lowering interest rates too low and keeping them low for too long. Additional blame is laid at the feet of economists who believed in the "Great Moderation", believing the inherent market efficiency from minimal laissez-faire regulation and never-ending financial innovation (think derivatives), would preclude any future crisis. They argue we are entering the "Great Instability" and are now in the eye of a financial hurricane.

Yet, the authors make the point that a financial crisis is normal, similar to Minsky's argument that credit bubbles expand until they implode, that there is never a good outcome to bubbles. Keeping interest rates too low for too long creates bubbles.

The authors also talk about the problem of democracy, citing India as the example, being too slow and cumbersome to address structural reform on a timely basis. Who would have ever suspected democracy could be a problem?

Certainly, vigilance never sleeps, and financial advisors must keep on eye open for the next hurricane.

The Devil in the Details

I was enthusiastic about the $787 billion stimulus bill approved by Congress last year. Obviously, infrastructure development was necessary -- with or without an anemic economy to stimulate. Infrastruture is a real investment in the future that increases demand in the short run and pays for itself in the long run.

Unfortunately, of that amount, $237 billion was for tax cuts, which did not create any new demand. Only $140 billion was spent on infrastructure! Most of the rest went to support state & local spending.

Our economy is still many times larger than the Chinese economy. Yet, they spent $586 billion on infrastructure last year & this year, to stimulate their anemic economy. Today, their economy is growing over 9% annually, compared to the U.S. which is growing less than 2% annually.

Our "stimulus" package had little to do with stimulating and only increased our borrowings from the Chinese, to pay for the tax cut.

A bold plan would have been more effective. To get us out of the Great Depression, Congress enacted the Works Progress Administration, Public Works Administration, and Civilian Conservation Corps. They build 24,000 miles of sewer lines, 480 airports, 78,000 bridges, 780 hospitals, 572,000 miles of highways and almost 15 thousand schools, courthouses, and other public buildings. That worked! Our current "stimulus" plan did not, unfortunately. It created no real, new demand for anything.