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.

Friday, August 20, 2010

One Step Forward but . . .

Yesterday, the Conference Board said its index of leading economic indicators rose modestly in July. That's a step forward! At the same time, the Philadelphia Fed said manufacturing fell in the mid-Atlantic region to the lowest level in a year. Even worse, the weekly unemployment claims rose unexpectedly to a nine month high. That's two steps backward! Naturally, the Dow fell 144 points.

It is a safe prediction that markets consistently over-react to whatever news is available!

But, note only one piece of yesterday's data released was leading. The other two were looking in the rear-view miror.

This is consistent with my expectation that the Dow will trade in a band between 1050to 1150 but slowly start trending bullish in the fourth quarter. No economic recovery has ever been a straight line!

Thursday, August 19, 2010

On The Bubble?

Back in 1973, when I first walked into a stock brokerage office, I saw old men watching a ticker tape cross the wall behind a black & white television. They were "stock guys", who bet on the American economy. They made fun of the "coupon clippers", whom they derided as being cowardly, but we call them "bond investors".

The same year, I became a trust officer and noticed that the portfolios of widows and children were heavily invested in bonds, because that was considered less risky than stocks. After all, bond investors are lenders to companies and must be repaid before stock investors get anything. Those investors who were extremely risk adverse were usually invested in Treasury bonds.

Since the beginning of 2008 thru the end of June this year, investors have pulled $232 billion out of stock funds and put an incredible $559 billion into bond funds! What are they thinking??

Long time readers know how I feel about long term bond funds: They scare me to death! When interest rates rise, losses are certain in long term bond funds. With rates this low currently, a rise is inevitable . . . losses are certain.

Amazingly, the most dangerous bond right now appears to be the "safest", traditionally speaking, i.e., U.S. Treasuries. Unless you plan to hold a particular Treasury bond to maturity, which doesn't happen to investors in mutual bond funds, I don't see how losses can be avoided.

When there is a collapse in Treasury prices, there will be even greater psychological damage, as wounded investors wonder if anything is safe. Treasury bonds are just another asset class. Losses can and will occur. The same is true for corporate bonds.

I've had this feeling before . . . just before the tech bubble burst . . .

Friday, August 13, 2010

Where's the beef?

No question, deflation is a much worse problem than inflation. Once people think they can buy things cheaper if they wait, then they stop spending now.

At one time, economists believed deflation could easily be eliminated by doing the things that cause inflation, i.e., increasing the money supply and increasing deficit spending. Ben Bernanke was one of them.

We've since learned that increasing the money supply doesn't work if banks won't lend and people won't spend. We also learned deficit spending is much more difficult when the national debt was not already at astronomical levels. (It also doesn't help when politicians behave like selfish, spoiled children.)

Today's good news is that the latest inflation data doesn't show any deflation. The core CPI (consumer price index without highly volatile food and energy) was up 1.1% over last year. Of course, this is below the Fed's goal of 2%, which means it still bears watching, rather than worrying.

Long term, I continue to believe the government will over-shoot and creat inflation. When that happens, there will be much gnashing of teeth, but we should be grateful it is not deflation!

Wednesday, August 11, 2010

All form but little substance . . .

Today's 265 point drop in the Dow was not a great deal of fun, but it was also not all that important. The volume was less than 1.1 billion shares, which is quite light. It is much more significant when there is heavy volume, like 1.8 billion or more, because it suggests many investors are "voting with their stocks". This is August, investors are vacationing and not voting. The Dow is only down 2.5% from the first of the year. Lots of "sound & fury" this year, huh?

Today's rally in the dollar is also not significant, nor sustainable. After yesterday's decline, some bounce-back was normal. In addition, the dollar remains the "fear currency". When the world gets nervous, investors worldwide want to hold dollars, which causes the dollar to appreciate. The report out of China this morning showed some slowing but not much. Unemployment rose in Korea but not much. Investors got nervous worldwide and bought dollars. That's why the dollar got so strong earlier this year, during the Greek debt crisis.

My advice: Have a nice vacation!

Tuesday, August 10, 2010

. . . and, the Fed said what??

Today, the Fed left interest rates unchanged, which was no surprise and certainly no big deal.

However, they also said they would stop shrinking their balance sheet, by using the mortgage paydowns they've been receiving to buy more Treasury bonds. When that happened, the dollar dropped suddenly. The reason this happened is because the increased demand from the Fed to buy Treasuries caused the price of Treasuries to go up, which causes the yield to go down. When investors earn lower interest on the their money in the U.S., they clearly don't need as many dollars and sold them, driving down the price or value of the dollar.

Was the Fed action a good thing? While a weaker dollar will help our exports, the real message is that the Fed admitted the economy is slowing down and will do whatever it can to support continued growth.

But, how much more can the Fed actually do? It is like watching a fighter using only one arm. The "Fed-arm" is fighting as hard as it can. Unfortunately, the "Congress-arm" is broken!

Wednesday, August 4, 2010

The Paradox of Thrift . . . huh?

The good news is that consumers are now saving 6.4% of their after-tax income. The bad news is that consumers are saving 6.4% of their after-tax income!

Because most Americans have too much debt, it is good to see them saving more. It is good for them as individuals. However, consumer spending makes up about 67% of our GDP or national income. If they save more and spend less, our national income decreases. While increased saving is generally good for individuals, it is not good for the overall economy. Economists have long referred to this as the Paradox of Thrift.

Over the long-term, increased saving is generally good for the economy but not in the short-term.

Consumers in some nations, like China and Japan, save too much, depressing their national incomes. Their leaders are asking their people to spend more and save less. That is a luxury we do not have . . . darn it!

Tuesday, August 3, 2010

Is It Party-Time Yet ??

For July, the markets were up about 7%. Yesterday, on the first trading day of the month, the markets were up another 2%. While that is always pleasant, longtime readers will recall I expect we should trade in a band between 1050 and 1150 on the S&P for most of the year, but with real bullish momentum at year-end. The S&P is now 1125, approaching the upper limit of the trading band. I don't expect this strength to hold. The consumer is still moribund. This morning, even consumer staple giant, Proctor & Gamble, reported disappointing revenue numbers. The one mistake market strategists like myself keep making is forgetting that it takes awhile to de-leverage or reduce debt, which is required for consumers to become aggressive buyers again. There will be no double-dip recession. Unfortunately, there will be no quick recovery either. It is a long, sloppy recovery. So, put the party hats and balloons back in the closet . . . darn it!