Sunday, January 31, 2010

Prepare for Boredom...?

Wall Street attaches some significance to the “January Effect”, which basically says that January predicts the whole year. In fact, when the market is up in January, it is usually up 10.4% for the whole year. If it is down in January, the year is essentially flat. January 2010 was down 2.9%, suggesting a flat year. Since the market was so hot the last part of 2009, a cooling off period is quite appropriate and probably good for us.

Another rule of thumb is that, during election years, the second half of the year is better than the first half. The thinking is that uncertainty about the election outcome is greatest early in the year, but the “smart money” already has the election figured out before it happens, reducing uncertainty.

This suggests that 2010 will be a boring year for traders, who make short term bets, and a good year for investors, who invest in long term trends, so they can think about those long term trends. For those who need to worry, think about the problem of sovereign debt in general and Greek bonds in particular, as well as the continuing lack of transparency for the derivatives, which Warren Buffet defined as “financial weapons of mass destruction” and were a huge contributing factor to the Great Recession.

Worry is never boring . . . darn it!

Friday, January 29, 2010

Successful Rehab?

Today’s announcement that the GDP grew at 5.7% was clearly good news. In addition, the Chicago Purchasing Managers Index jumped from 58.7 in December to 61.5 in January. If that wasn’t enough, consumer sentiment increased from 72.8 in December to 74.4 in January. What a great day!

OK, celebration over . . . the question immediately becomes whether the good news is sustainable? Or, is this just an inevitable snapback from inventory levels being depleted during the Recession and now being re-built?

As I’ve written before, this economy is showing a Nike-shaped recovery, i.e., a rounded bottom with a slow recovery. The damage was too profound for a rapid recovery, and the current political disarray is not helping. Nonetheless, the recovery will continue, just not as sharply as today’s numbers indicate. But, as cardiac patients can progress successfully before having another heart attack, I am currently concerned about the problem with Greek bonds. Their debt substantially exceeds their GDP (roughly 120% vs 80% in the US). Their profligate ways have caught up to them, and they are having trouble selling more bonds, to keep spending without raising taxes. Holders of existing bonds have gotten crushed. Farmers are already blocking roads to demonstrate against cutting farm subsidies and other governmental services. It is all too reminicient of the “Asian Contagion” in the late 1990s. This could be different, if the European Union will use this opportunity to show a benefit to membership, like providing tax benefits for Europeans who buy Greek bonds, for example. But, it bears careful watching!

In 2007, the world economy had a cardiac event, originating from the financial systems. If we have another one in the near future, it will be from soverign debt. But, how do you make a soverign government rehab itself?

Monday, January 25, 2010

A Thousand Points??

CNBC super-star Jim Cramer said the loss of either Fed Head Ben Bernanke or Treasury Secretary Tim Geithner could cause the Dow to immediately drop a thousand points. If either happened un-expectedly, Cramer might be right, but I doubt either will happen. Ben Bernanke is clearly guilty of not seeing the recession coming, but very few economists did. However, once it happened Bernanke was extraordinarily innovative combating it. He used everything in his toolbox and then invented some more. If only to unwind what has been done, it is in the best interest of the United States that he be re-appointed, and I’m confident he will be.

I’m more agnostic about Tim Geithner. There is no pending Senate action on him anyway. However, he has done a good enough job to keep his job, but this is an election year, and a sacrificial lamb may be required. The market will most assuredly not drop a thousand points if he resigns “to spend more time with his family”. He will then be inundated with job offers and become a wealthy man.

President George H. W. Bush used to talk about a “thousand points of light” illuminating our nation’s future. Two of them would be Bernanke and Geithner.

Thursday, January 21, 2010

More Form Than Substance

The Tea Party demonstrators were livid at the big banks, especially when the taxpayers had to bail them out. It is fair to say that profits were privatized, while losses were socialized. This means the banks and their shareholders got to keep the profits, while the taxpayers got to pay for their losses. Their anger is understandable. President Obama, anxious to prove he has heard the Tea Party complaints, went on the attack today.

During the Clinton Administration, the Glass-Steagall Act was repealed. This law kept commercial banks separate from investment banks. Commercial banks accept consumer deposit and commercial loans. They are more conservative, and commercial bankers make decent salaries. Investment banks help companies raise money from the stock and bond markets. Most of the new financial products like derivatives were developed by and traded by the investment banks. They are not as conservative, and investment bankers make huge, maybe obscene, salaries. The President’s comments would start separating the two functions again.

Today, the stock prices of the big banks got crushed, but a curious thing happened. The regional banks, like SunTrust, did great. Clearly, the market sees them as the winner in this effort to re-regulate an industry that needs to be re-regulated. Bringing back Glass-Steagall would help reduce risk but is also unnecessary, if we would start by enforcing the existing regulations. (The Bernie Madoff scandal is a perfect example of that.) Many analysts agree with that position. But, we ALSO need meaningful punishment for excessive risk-taking. There are many bond salesmen who lost their great jobs and are now unemployed, but sitting on some beach AFTER making millions of dollars. Why wouldn’t they take excessive risk?

Today’s comments by the President were required political theatre, and I expect the big banks to recover shortly, once the uncertainty wears off.

Monday, January 4, 2010

Good News = Bad News?

Hyman Minsky was an economics professor at Washington University in St. Louis. He pointed out the credit availability is cyclical, i.e., that credit will expand until it bursts. In other words, credit doesn’t slowly deflate or get paid down. It bursts! Describing the 1998 financial crisis that began in Russia and ended with the collapse of Long Term Capital Management, Paul McCulley of Pacific Investment Management in California described that bursting as the “Minsky Moment”. Currently, analysts argue whether that Moment for this crash was in June or August of 2007.

Of course, that was in a pre-globalized world. Today, credit to Americans is going down, while credit to America is going up. Neither Presidents, professors, nor economists have any control over the world’s “bond vigilantes”. To sustain an annual deficit of $1.4 trillion, we need to sell a record amount of bonds, but who will buy them? The Chinese have politely said they are starting to get “a little worried”. (Of course, the Fed could buy them all, but the dollar would get crushed.)

Here’s the good news: There is no immediate problem. Estimates are that our debt level, as a percent of GDP, will not catch up to Japan for at least ten years. Here’s the bad news: There is no way to fix a problem, under our method of governing, unless it is an immediate problem.