Monday, February 28, 2011

NABE Forecast

Economists are generally a boring bunch. Because I have been a long time member of the National Association of Business Economics, I am frequently surveyed by them on the economy. Their latest forecast was released this morning. But, was it boring enough?

It predicts solid GDP growth for this year, 3.3%, which is up 2.7% in our November forecast. Unemployment is expected to improve somewhat, with monthly job creation exceeding 200,000 by the end of the year -- a big improvement -- but don't expect the unemployment rate to drop below 8.4% until the end of NEXT year -- another jobless recovery. And, the housing market will not improve significantly this year.

Their biggest worry is the Federal deficit, which is a polite way of not saying "entitlements". Last week, Governor Christie actually used the word and didn't get evaporated, which is his word for what happens to people who discuss the Federal deficit in terms of the non-discretionary part of the Federal budget.

My only disagreement with their concensus is that they predict no movement in interest rates this year, but long term rates are already increasing. The Fed controls only short-term rates and have very little control over long-term rates. Long-term rates normally increase in an expanding economy, like we have, but they also reflect inflationary expectations. Our survey sees no increase in inflation this year, but they are silent about the next few years. It would have been a more interesting report if they had discussed inflation prospects beyond 2011!

As I write this, futures indicate a flat open. Last week, we ended three straight UP weeks in the market. Another DOWN week would be good for the market long term. Or, a series of FLAT weeks would also allow the economy to catch up with the market. A little boredom right now is not a bad thing!

Friday, February 25, 2011

Reagan People ?

Remembering our eternally optimistic former President, consumer confidence came out this week, and it was higher than expected. Consumer sentiment (a close cousin) came out today, and it was much higher than expected. Why is there so much optimism?

In 1980, average income was $24 thousand, compared to $40 thousand today. Life expectancy has gone up from 78 to 81 years. Crime has decreased from 17 violent crimes per 1,000 people to only 5 crimes now. Maybe, there is more to life than the stock market?

To the surprise of most analysts, consumer spending has picked up more than expected, which is critical to the economy. Apparently, those people who still have jobs are now confident enough of keeping their jobs that they are loosening the pursestrings slightly.

While inflows to equity mutual funds have also picked up, it is still far below historic norms. When that returns to normal, the Good Times will be back! And, President Reagan will be happy for this!


Remember the late 1970's days of stagflation, when the economy was stagnant at the same time prices were inflating. (By the way, under Keynesian economics, this should not happen.)

Today's news that growth in the fourth quarter was less than expected, while inflation was higher than expected. As I've said repeatedly, this will be a long, slow recovery, because we are de-leveraging. Recoveries from financial crisis are different than recoveries from normal recessions. And, as I've said repeatedly, you cannot have this level of deficit spending, plus increases in money supply, without creating inflation. I still think we face stagflation in the short term, before becoming inflation in the long term.

You would expect the combination of this, plus the potential for oil supply disruption in the Middle East, would have a big impact on the market. While the stock market has declined 2.4% since the beginning of the current Middle East crisis, it is still up 2.6% so far this year, and futures indicate the market will open up strongly again this morning.

If the market is up, what could be wrong? The answer is . . . a lot could be wrong.

If the volume of trading was heavy, I would be more inclined to believe that the market is right, that everything is okay. Well, the trading is not heavy, and I'm not inclined to believe that!

Thursday, February 24, 2011

Ongoing Debate

There is honest disagreement on Wall Street about the emerging markets. For the last several years, the U.S. market has substantially under-performed the stock markets in the emerging nations, like Brazil, China, and India. This changed in the fourth quarter of last year. Many analysts believe 2011 will be the year the U.S. market beats the rest of the world. I have previously written I don't agree, because there is still too much deleveraging needed in the U.S. before it can really grow, relative to emerging markets.

Since the Tunisia/Egypt/Libya crisis, emerging markets have suffered even more. Most of those nations are even more energy-dependent on oil from the Middle East than the U.S. -- which is somewhat amazing itself. There is a new report this morning that oil could reach $220 per barrel. As a result, the stock market in emerging nations are getting hammered. As I type this, the market in India is down over 3%, which is a big one-day move for any market.

I don't worry that the report of $220 oil is true. The Saudis can easily make up the lost production and have promised to do so. Short term, an increase in gas at the pump is bad for America but good for us in the long term, as we might finally then move to renewable energy sources.

What does worry me right now is the change in the behavior of the dollar. Long term, I have been dollar-bearish, which means I think the dollar will continue to be weak and lose value. That's one of the reasons I've favored international companies. As I've told clients many times, the dollar will always appreciate during a crisis, as it is THE safe haven currency. Yet, that barely happened during the last sovereign debt crisis in Europe and not happened at all during this crisis. Instead, the Swiss Franc has appreciated nicely. With the dollar as the world's only reserve currency, we had the luxury of playing "fast and loose" with our fiscal policy, and we did!

If the world doesn't rush into the dollar during a crisis anymore, can the bond vigilantes be far away? That worries me a lot!

Tuesday, February 22, 2011

A Mixed Blessing?

At 6AM, it looks like the Dow will drop about a hundred points at the opening, reacting to the fear of oil sky-rocketing due to the unrest in Libya. Nobody will notice that Home Depot just released their earnings, surpassing expectations for both revenue and net income, in addition to raising their dividend. On a normal day, that would lift the market. Consumer confidence will also be released this morning, and it will likely be ignored by the market as well.

The fear is that reduced supply will increase the price of gas at the pump, smothering the economic recovery. But, when the market is afraid, it doesn't listen. For example, Saudi Arabia announced this morning they would pump more oil to make up for any lost Libyan oil production. If price rises while supply and demand for any product are unchanged, you can blame speculators. The price spike in oil we're seeing today is temporary.

The market is over-reacting because it needs to over-react to something. It needs to take a break, while the economy catches up to it. Thank you, Mr. Gadhafi!

Monday, February 21, 2011

What Could Go Wrong?

Let's see . . . we have increasing estimates of inflation . . . we have an amazing amount of unrest in the oil-producing Middle East . . . we have slowing growth in corporate profits as they are squeezed by rising commodity prices . . . we have a rising level of foreclosures . . . and, nobody understands our system of national governance.

Nonetheless, the stock market is up 6.8% so far this year. A significant number of analysts believe it is the Fed who is driving up the stock market. Under QE2, the Fed buys bonds to keep down interest rates (and the cost of funding our national deficit). Interest yields are now so low that income investors find better income in stock dividends than bond interest. In addition, when interest rates begin to rise, the value of the bonds will decrease. As they shift into stocks, that drives up the stock market.

So, thank you, Mr. Bernanke! But, here is the bad news . . . QE2 ends in June. The jackrabbit stock market is too far ahead of the tortoise economy and needs to take a vacation by summer. But, what if the Fed decides on doing QE3? It will provide a "third wind" to the exhausted bull, which is not good!

Saturday, February 19, 2011

What . . . no balloons?

Back in the dark days of March in 2009 when the S&P reached its low of 666, many questioned the American system of Free Enterprise. Since then, the S&P has DOUBLED! That's right, if you had invested 100% of your portfolio into the S&P then, you would have a 100% profit now.

So, how come you haven't seen any big parties or celebrations? That's because we measure success against the all time high-water mark of 1,565.15 on October 9, 2007. After a long, painful three year recovery, we are still down 15%. Obviously, the Global Financial Crisis was not your garden-variety recession.

We are now twenty-three months into a bull market. The average is 103 markets, which means we have plenty of room to run. Usually, the deeper the recession, the longer the bull market that follows it. However, I cannot over-emphasize how different this last recession was. We remain vulnerable to "heart attacks" -- those sudden irrational dramatic drops like last year's "Flash Crash." Until the international financial system stabilizes, the average duration of past bull markets is a lousy predictor of the future.

This weekend, the Finance Ministers of the G-20 are meeting, laying the groundwork for their chiefs-of-state to meet later. This could be a big step forward in stabilizing the international financial system, or at least I hope so . . .

Friday, February 18, 2011

When is a Right not a Value?

I don't remember ever having a day when I was not concerned about my privacy. Even in the Army, I always knew I would regain my privacy one day. It is a Value that I still treasure. Before it became irrelevant, Congress even cannonized that Value into a Right to privacy.

Wednesday night, I decided to clean out the "cookies" on my computer, which allow my internet usage to be tracked by strangers. (You have them on your computer right now!) As a result, I could no longer access my own blog . . . go figure??

Seeking assistance from my IT pro, as well as my daughter, I noticed they didn't share my concern. I might as well have asked them if the world was flat. Seeking privacy in the internet age is as silly as saying the world is flat. Now that Congress gave us the Right to privacy, the younger generation shrugs its shoulders and laughs at our antique Value.

It is sad . . . for them. They don't know what they don't know!

Wednesday, February 16, 2011

No Shotgun in This Wedding

Yesterday, a "merger" was announced between the fabled New York Stock Exchange (NYSE) and the mighty stock exchange of Germany or the Deutsche Borse. With the majority of board seats going to the Germans, it is more like an acquisition of a American institution. At first, I was simply sad, as an American, to see the grand old NYSE owned from abroad.

However, now I'm more worried than sad. During the legislative battle over financial re-regulation last year, I was hoping to see more effective regulation of derivatives, that murky world where astronomical bets are made that nobody knows about. Unfortunately, the tiny additional regulation of these dangerous investment vehicles was testimony to the enormous lobbying power of derivatives dealers and exhanges, including the New York Stock Exchange.

The combined NYSE and Deutsche Borse will be the largest derivative dealer on the planet. If we couldn't get adequate regulation of this risk when it was based in the U.S., we have no chance now. The danger is both bigger and harder to regulate!

In the past, I've watched the relationship between 50-day and 200-day moving averages as a primary technical indicator that a major correction was possible. Given my increased concern following this merger, I will add a LIBOR "trip-wire" as well. This will take awhile to devise.

If I was invited to this wedding, I'd probaby bring a shotgun to STOP the marriage/acquisition!

Finding Non-Fiction Inside Fiction

For years, I have tried to read everything written by investment guru Barton Biggs. He was a senior partner at Morgan Stanley for decades and now runs a large hedge fund. For the first time, he has now written a work of fiction, called "A Hedge Fund Tale of Reach and Grasp."

It is an easy read that I can recommend to non-investment professionals. While you will agree it is not the writing of a Steinbeck or a Hemingway, you will nonetheless learn a good deal from this work of fiction. He explains some of the things that happen inside hedge funds in a breezy, understandable manner. It is also a good primer on the causes of the last financial crisis, which are easily recognizable. Lastly, he also looks into the psyche of the hedge fund kings, how consumed they are by their work, how dedicated they are to ostentation, and how awful their lives are. At the end, the former kings of finance suffer as mere mortals. But, one thing I didn't learn from this book was how to feel sorry for them . . .

Producer Level Inflation

Core inflation for January was 0.5%, the highest in over two years. That was at the producer level. Tomorrow, we'll hear about the consumer level. We traditionally look at the core PPI, which ignores changes in energy and food costs. Tomorrow, we worry more about those costs at the consumer level.

So, is inflation coming? Yes, you cannot maintain such a high level of both fiscal and monetary stimulus, by deficit spending and quantative easing, without creating inflation. The question is when will it arrive? When the government and the Fed began their fight against the inflation, I suspected the inflation would get here in a few years, about now. However, I now think it will be another year or so before it becomes apparent.

There is a monetarist formula that MV = PT = GDP. In other words, if you multiply all the economic transactions (T) by the average price of those transactions (P), you can determine Gross Domestic Product (GDP). Likewise, if you mulitply the money suppy (M) by the velocity of money (V) which is the number of times a dollar is spent each year, you can also determine the GDP by this method.

The problem is that M has increased but V has decreased. The decrease in the number of times that consumers will spend a dollar during the year reflects their change in behavior. In other words, consumers were so traumatized by the global financial crisis that they are less reluctant to spend. This delays the onset of inflation. But, it is coming . . .

Tuesday, February 15, 2011

No Profile in Courage

The President has published his budget for the next year without mentioning the 800-pound gorilla in the room, which is entitlements. If we eliminate every single discretionary dollar being spent in the budget, the nation will still go bankrupt unless we address the ballooning cost of Social Security, Medicare, and Medicaid.

The President knows this but is afraid to "touch the third rail of politics" or entitlements. Nobody wants their own benefits cut. The Republicans are equally as cowardly!

Since the President missed this historic opportunity for honesty with the American voters, I hope the Republican version to be published by the House of Representatives will show more courage.

Numerous surveys have shown Americans know what is coming. Nonetheless, whoever raises the subject first can expect a great deal of abuse from the voters. This may be one of those issues that cannot be resolved before term limits are instituted . . . darn it!

Christmas Hangover?

Retail sales for January were released this morning but were disappointing, staying flat with December's growth rate of 0.3%. Since consumption spending is 65-70% of GDP, it matters . . . a lot!

The mystery to me is why anybody expected the higher growth rate of 0.5%? Despite last week's rise in consumer confidence, the consumer is wisely more interested in reducing debt than increasing spending. The ratio of debt obligations to income has dropped to levels not seen since 1985. That is one of the primary reasons that confidence is up. Increases in spending do depend on increases in confidence, but confidence can increase without an increase in spending.

Still, this is the seventh straight month that retail sales have increased, which is very good, but it is rising very slowly . . . just like the economy. There is no logic to the continued rise in the stock market. Futures indicate the market will be down slightly today . . . good! A slowdown in market appreciation now is far better than a sharp drop later!

Monday, February 14, 2011

InsideETF Conference

I've just returned from the annual conference on Exchange Traded Funds in Florida, often called ETFs. They have several advantages over mutual funds. For example, they can be bought or sold anytime during the day, not just at the close like mutual funds. Since their investment objective is to match some index, like the S&P 500, they don't need a lot of high-paid portfolio managers. As a result, their expense loads to investors are often much less. The primary reason I like to use ETFs is the targeted exposure I can give investors. An example would be GDX, which is limited only to the miners of gold and is diversified among them. (I don't have to make a bet on one gold miner being better or more honest than other gold miners.)

Nonetheless, I was concerned during last May's "Flash Crash," when it appeared that ETFs were more affected than regular stocks or mutual funds. I have now learned this was due to the problem of being matched to an index. For example, if 1.4% of your index is XYZ Company and that company got mired in a mechanical crash, you may or may not be able to balance the ETF to match the index. Bottom Line: There is no reason to avoid ETFs.

The conference was excellent with lots of optimism about the economy, about the stock markets, and about the future of ETFs. I'm glad I went . . . but I missed my blog.

Friday, February 4, 2011

Too Much Anticipation and Too Little Meaning

Easily, the most anticipated economic report each month is the Jobs Report, which was issued this morning by the Bureau of Labor Statistics. While much anticipated, it is becoming less meaningful.

Historically, the Jobs Report for January is the most difficult to measure and most often corrected the following month. Today's report showed only 36 thousand jobs were created last month, far less than the 121 thousand jobs created in December and the estimated 138 thousand jobs that were expected for January. Some of this disappointment is due to the severe weather. The construction sector lost 32 thousand jobs, which was almost certainly weather-related. Transportation lost 38 thousand jobs, which was probably weather-related. Another problem with the report in January is that firms often wait until their new budget year to hire people, which has an upward bias on jobs. That doesn't seem to be the case this year.

At the same time, the rate of unemployment dropped from 9.4% to 9.0%. This seeming contradiction that fewer jobs were created at the same time the rate of unemployment decreased . . . means the labor force has gotten smaller. In other words, people have given up, which is not good.

I know of no economists who expected such a small number of jobs. A recurrent complaint by economists is that the tired old methodology of the Jobs Report fails to capture those former workers who are now self-employed, which is thought to be substantial but nobody knows.

An interesting "second derivative" effect of this report is that long-term interest rates rose, with 10-year Treasury bonds the highest since last May. With unemployment still so weak, it is less likely the Fed will end QE2 and more likely the Fed will do a third phase of quantitative easing, which is undoubtedly inflationary. Long-term interest rates react to inflation expectations much more than short-term rates.

My take is that the uselessness of this month's Jobs Report will only increase anticipation of next month's Report. Hopefully, it will be more meaningful.

Tuesday, February 1, 2011

The January Effect

Well, it is official . . . the markets in January were mostly positive. According to the old Wall Street axiom, "so goes January, so goes the year." For the month, the Dow was up 2.7% and the broader-based S&P was up 2.2%. Both are very healthy gains for only a month!

While there is clearly a relationship between the markets performance in January and then for the full year, it is becoming less true every year, probably as investors adjust to it. Also, it seems to be more true for the stocks of smaller companies than larger companies.

The most popular theory for this behavior is that taxable investors sell stocks in December to take tax losses and re-invest the money in January. The rule on "wash sales" may be impacting this as well.

Another axiom is that Dow movements must be confirmed by the Dow Transports Index to really be meaningful. That did NOT happen this year, as it was down 1.6%.

Nonetheless, unless we have a financial "heart-attack" induced by the derivatives market, I think this will be another good year of recovery. A long bull market following such a market crash is not surprising. We are still 19% below our highs of 2007. I expect we'll see those highs again in 2012, but not this year.