Sunday, July 31, 2011

Let Us Pray . . .

Please re-read last Sunday's blog titled "A Soap Opera for Economists."  Watching the Asian markets open at 8PM tonight will also be "must-see" TV.  At this hour (1630 hours), Washington is swirling with rumors that a deal to raise the debt ceiling is imminent.  If true and announced before the Asian markets open, it will be fun to watch a strong rally.  If there is no announcement and the market believes there is no deal, it will continue to lose steam, drifting down.  If there is no deal at all and that is announced, you expect the bear to start eating Asia tonight and us tomorrow.

Without analysis, it is too early to comment on the deal.  However, I have been trolling the blogosphere of economists.  Just as politicians can quibble over any little thing (Witness:  Are rich people "fat cats" or "job creators?"), economists are already quibbling about the cost of the ugly process of raising the debt ceiling.  There is considerable debate over which did the most damage to the economy, i.e., the loss of self-confidence from the embarrassing debate or the Japanese tri-tragedy of earthquake/tsunami/meltdown.  While I have no answer to that question, I do believe both have had an impact, both bad.

However, the cost of this ugly episode may yet turn out to be profitable, if it really causes us to address the cost of waging unfunded wars and paying unfunded entitlements.  So far, it has done neither!  Since hope does spring eternal, let us pray . . .

Friday, July 29, 2011

So, What About Gold?

With gold hitting record highs almost daily, it is not surprising I get asked about it almost every time I go out. 

Most financial advisors are comfortable putting 5% to 10% of a client's portfolio into commodities, of which 1% to 2% would be gold.  I already have a higher allocation than that in most of my portfolios, but I'm not adding to it at these levels.

Gold reached a record $850 an ounce in January of 1980.  Adjusted for inflation and the depreciation of the dollar, that is equivalent to $2,200 an ounce now.  This makes the current price of $1,630 seem cheap, but it is not. 

I'm a long term bull on gold as a long-term investment, not as a speculative investment.  Whenever the basic relationship between gold and the stock of gold mining companies deviate, it is likely to be a short term price move that cannot be sustained.  You have to be a little smart and a lot lucky to get up before it falls, because it falls hard.  Normally, gold sells for 1.05 times the average price of gold miners.  Today, it is 1.49.  The price is artificially high entirely due to fear over the debt ceiling issue.  Once resolved, the fear will fall quickly, and gold will fall even faster.  At these levels, I'm more inclined to sell the gold I hold than to buy any more.

Who Are We Anyway?

Back in Dallas, I had a good friend named Lloyd.  He was 44 years old when his father died.  After the funeral, his mother called the kids together to tell them a deep, dark family secret that she had promised not to reveal until her husband had passed.  The secret?  They were Jewish.  Apparently, they lived in an anti-Semitic area and wanted to protect the kids.  Lloyd didn't care that he was Jewish, but he was badly shaken with the realization that he didn't really know himself.

I'm having a similar feeling right now.  What do we know that we can really trust? 

Theoretically, interest rates will rise when the U.S. debt gets down-graded.  After all, lower quality deserves a higher yield.  But, where will all that money go, if not into Treasury bonds?  Sure, some will go into precious metals, artificially driving up those prices even more.  With volatility rising, with stocks falling, and with fear spreading like wildfire, it is very possible investors will decide a AA Treasury bond in a deep, liquid market like this one is still a very safe parking place.  This might actually cause short-term interest rates to decrease, not increase.

Theoretically, the Commerce Department will produce fairly reliable data.  This morning, they reduced their estimate of the first quarter of this year's GDP growth from 2.0% to only 0.4%.  They further estimated second quarter growth at only 1.3%.  While not technically correct, the common definition of a recession is two consecutive quarters of negative growth.  We could be approaching that in this quarter.

Theoretically, debate among educated people would produce enlightenment.  Does anybody see that in Congress?  The Tea Party looks like it may drastically cut discretionary spending, without touching non-discretionary spending, which is the problem.  It is like watching the Army attacking the wrong town.  It is embarrassing!

I may track down my old friend Lloyd to see if he ever learned who he is.  For now, I know the market will over-react to the debt ceiling crisis, as it over-reacts to everything else.  I know we will survive and that there will be bargains in the near future.  This is not a TARP vote nor a Lehman failure.  But, it is embarrassing!

Thursday, July 28, 2011

Painful Priorities . . .

Assuming the worst case that the budget ceiling is not raised in a timely fashion, we have been somewhat flippant, making the choice of what to pay and what not to pay in a "guns or butter" format.  It is, of course, more complicated than "the bondholders or grandma."

I expect the bondholders will be paid first, as they should, and that Social Security checks will be mailed second.  There is enough for both.  That's the easy part!  Now, who gets cut?  I suspect the troops will be paid, but bills from the defense contractors, like General Dynamics, will be deferred.  They won't be happy.  I suspect all bills from medical care providers and drug companies will be deferred.  They won't be happy.  There is a very real possibility that government employees will get furloughed, and the regular transfers to states will be deferred, where more employees will be furloughed and bills not paid.  And, none of them will be happy either.

Instead of owing more money to bondholders, we will owe more money to contractors, to health care providers, to employees, and to states.  As we starve the government, we're substituting creditors.

Am I selling defense contractors or health care providers now?  No, it is not clear that no deal can be reached, and the market may rally strongly if there is a deal.  I don't like "all-or-nothing" bets!  And, I don't like betting on headlines!

Where's the Fear?

The TED Spread is the relationship between Treasury bond rates and the London Interbank Offered Rate (LIBOR).  Another way of saying it is the relationship between lending to the U.S. government and lending to the banks.  It has been a reliable predictor of financial crisis in the past, having been as high as 470 basis points in 2008.  As you can see from this table it is about 19 now. More importantly, it has been falling recently, suggesting no financial crisis is looming.  I have great respect for the wisdom of the bond market and believe there will be no financial crisis next week.
One-Year Chart for TED Spread (.TEDSP:IND)

Of course, that does not mean the world will be the same.  Change is coming.  Austerity is coming.  It won't be fun, but we will survive.  And, our grandchildren will be better off.

Wednesday, July 27, 2011

Debt, Default, Downgrades, Dollar and Debacles

Beware of economists making political predictions!  Nonetheless, I suspect there is now less than a 50% probability any deal will be reached to raise the debt ceiling and wonder what fool linked budget negotiations to the debt ceiling anyway.

Does that mean the U.S. will default on its debts for the first time?  No, I don't think so.  There will be plenty of money to keep the bondholders happy but not Americans.  It is a "Sophie's Choice," but the right thing to do in the long run is to protect future generations by putting bondholders before this generation.  Demand for goods & services will drop, making the fragile recovery more difficult.

Does that mean the U.S. will keep its credit rating?  I doubt that is possible any longer.  All three ratings agencies evaluate governance, for countries as well as companies.  With a AA rating, interest rates will increase.  That is not the end of the world, as it happened to Japan in the late 1990s, and they survived, albeit in a weakened state.  The longer the maturity, the greater the increase in interest rates.  So, it won't be good for the vulnerable housing market.  Already dead weight on growth, recovery will just be that much more difficult.

What will happen to the dollar?  It is already falling rapidly, and I expect it will fall even more after the credit downgrade.  However, as interest rates begin to rise, the dollar should make a brief rally, before continuing its long term decline.  Long term, this will be good for our exporters.

Is this a debacle?  Well, some well-meaning soul will tell us that "making sausage is not pretty."  Agreed, but making sausage is at least productive.  Congress is destructive!  Linking the budget negotiation to the debt ceiling was simply stupid. 

Remember:  the first step in a twelve-step recovery process is to admit there is a problem.

Tuesday, July 26, 2011

Comparative Debt Ceiling Economics

One of the main objectives of this blog is to increase awareness of the differences between the three main schools of economic thought today.  With respect to the current debt ceiling crisis, the Keynesian viewpoint would be the economy is stalling and needs a stimulus of deficit spending.  That only works when the nation has reserves or can borrow more money, which is certainly not the case now.  Keynesians, your opinion doesn't matter in this political environment.  Now, go away!

The Supply-Sider viewpoint would be we don't need to increase taxes on the wealthy or anybody else right now.  The one true way of increasing growth is a tax DECREASE, regardless of where we are in the economic cycle.  You see this in the Tea Party comments.  (Don't forget I've met and even had lunch with Arthur Laffer, the father of Supply-Side economics and also taught one of the first courses in this country on the subject.  So, don't tell me I don't understand.)

The Austrian viewpoint (truth in typing:  I belong in this school at this point in the economic cycle) is that a $3 trillion reduction in the deficit without a tax increase is NOT as good as  $4 trillion in the deficit with a tax increase.  We're more focused on the size of the deficit cut.  The bond vigilantes only care about the amount of the deficit, not how we reduced it.

Class dismissed . . .

Suspiciously Sanguine

Why is the market so calm?  One possibility is great confidence that the debt ceiling will be raised.  Another possibility is great confidence that it doesn't matter.  Another is that the credit rating is more important anyway and is going to be reduced under any circumstance, given our inability to govern sensibly.

While I agree that the last possibility is the most likely, it is hard for me to believe increased borrowing costs do not mattter.  As mentioned earlier, if interest rates rise only one-tenth of one percent, the increased borrowing cost for bonds maturing in August ALONE will add $500 million to our annual borrowing expense.  Then, we have to factor in the increase for September bonds, October bonds, etc.  Maybe, an additional six billion dollars is not a big deal in the Federal budget, at least to the bond market.  But, who believes the increase in rates will only be one-tenth of one percent?  What an insane waste of money!

There are three ratings agencies, i.e., S&P, Moody's and Fitch.  It is very likely S&P will reduce the United States of America from AAA to AA.  Ouch, that's expensive . . .

And, it is probably too late, as the partisan brinkmanship has demonstrated it is more powerful than prudent debt management.

My suspicion is that that, since the Speaker slammed the President so hard personally, by excluding him from direct negotiations, that the President will accept defeat and then hang the economy around the Republican's neck.  They will then own it, good or bad.  If the President does not accept defeat and prevents the debt ceiling from being raised on purely Republican terms, he will cause entirely unnecessary damage to the country.  Even if Obama can hang it around the Republican's neck, it will be morally unacceptable for him to ignore his defeat, just to increase the economic pain.

Sunday, July 24, 2011

Extreme Market Timing

Few financial advisors recommend market timing, calling it a "fool's mission."  With retail investors such a small part of the market, they cannot compete with the hedge funds and others guessing the exact top or the exact bottom of any stock, much less the market.

That is why most advisors recommend a "buy & hold" strategy, meaning that you should have a portfolio of mutual funds that is widely diversified across asset classes and is rebalanced to some pre-determined allocation on a predictable periodic basis.  That is one extreme.

Another extreme is making large investment decisions based on the breaking news.  This requires access to news quickly, a pre-determined execution plan, and the ability to trade immediately.  This is an even greater "fool's mission."

I prefer a middle course, which is a more fluid asset allocation of good mutual funds across the preferred asset classes, rebalanced as economic or financial conditions warrant. 

I don't see the logic in making bets on what will come from the budget talks underway at the White House as I type this.  In April, we predicted a weak stock market until the high level of uncertainty could decrease, which we expected by Fall.  As appropriate, we've increased cash or shifted more to "value" stocks or bought reverse volatility ETFs for downside protection.  We will sleep well tonight!

Managing risk should reflect business conditions and the business cycle, not breaking news! 

A Soap Opera For Economists

The Blame Game has started.  The elected children are already blaming the other side for being even more childish on the debt ceiling.  Unless something is cobbled together today, Bloomberg will be "must-see" TV at 8PM tonight.  That's our first opportunity to watch Asia react to America's inability to govern itself intelligently.

Will Asian markets collapse?  No, but they will be down heavily.  I'll guess a 3% drop could happen, which is a huge one-day move.  Once Asia gets comfortable with the fact that we will continue to pay our debts before we pay our people, their confidence will return . . . slowly but never completely.

Will European markets collapse?  No, but they could be down even more.  While they will also recognize we will pay our debts, they will be reminded that, if the U.S. cannot govern itself as one nation, how will the E.U. govern many nations?

Will the U.S. markets collapse Monday morning?  No, but the last time Congress failed us this badly was on September 28, 2008 when the House voted down TARP.  The Dow dropped 777 points that day.

Will borrowing costs go up?  Yes!  Even a small increase means big additional spending by taxpayers.  A one-tenth of one percent increase on the debt rolling over in August alone will mean we have to pay an additional $500 million in annual interest expense.  Imagine a Congressman proposing we spend an additional $500 million in interest each year . . .simply because we cannot govern ourselves?

For those of us who have railed about the deficit for years, it is no satisfaction that we have finally reached the tipping point. 

For those of you who tend to worry too much, please do NOT watch Bloomberg tonight.  If you insist on doing so anyway and don't sleep tonight, just remember America has been thru many things worse than this, and the market always reaches a new high afterwards.  We are only shooting ourselves in the foot, not in the head!

If you are angry and think Americans deserve better leaders, learn about the redistricting.

Saturday, July 23, 2011

Vigilantes Love Half Measures

When former Treasury Secretary Hank Paulson told Congress in 2008 that he needed a bazooka to convince the bond vigilantes that he had enough firepower to prevent any default, I knew he was right.  Bond vigilantes have made nations cower many times.  Half-measures can be fatal.  Just ask Britain what George Soros did to them!

Greece in particular and Europe in general are trying to develop a bazooka of their own.  Yesterday, the European markets rallied strongly on the news of new "deal."  It is a complex deal and has taken some time to get thru it.  Basically, it is another bailout of Greece, creating a bond exchange program for existing Greek bondholders.  Existing bonds can be exchanged for a new bond with a face value that is 21% less, payable in 30 years but collateralized with zero-coupon bonds.  For a lower interest rate, they can get a new bond with no discount but also with collateral.

If it stopped there, the bond vigilantes would start smelling blood and wait to pounce at the appropriate time.  However, the European Financial Stability Fund now has authority to act pre-emptively to prevent the same problems in the PIIGS (Portugal, Ireland, Italy, Greece, & Spain).  This could be important!  Unfortunately, while the authority now exists, it is unfunded.  Until funded adequately with a bazooka, the European sovereign debt crisis will continue.

The three pillars of uncertainty restraining the bull have been (1) the end of QE2, (2) the debt ceiling/budget issue, and (3) the European crisis.  The first has been eliminated.  The second will soon be resolved, one way or the other.  The third still has at least one more act before the curtain comes down, and the vigilantes back off.

Which Tipping Point?

A few years ago, I read an excellent book by Malcolm Gladwell called The Tipping Point.  It talks about how many small things can build up until finally one more small thing lights the match that burns down everything. 

The current president of Turkey said that democracy is like a street car:  When you get to your stop, you get off.

When will we reach the tipping point about our democracy?  How will we know when we are there?   Is it when an important agency like the Federal Aviation Administration loses it authority?  No?  How about when the world's greatest democracy can no longer function well enough to pay its bills?  Is it then time to get off the street car?  No!  That's easy, it is definitely NOT time now.

But, how will we know when it is?  What has to happen first?  How will we know the street car is at the right stop, and we need to get off?  Will we recognize the tipping point only when we see it in the rear view mirror?

Reading The Markets . . .

That's the title of this blog, because it is important to read the markets.  It is the closest we have to a real-time voice of the economy.  Although very imperfect, it is still the closest we have.

For example, if the market rises for four straight days, then we're happy about that.  But, if the trading volume is increasing each day as well, then we know more investors are returning to the market, which is very bullish.  The relationship between the closing price of the market and the trading volume is an important indicator.

For eight straight days now, the Dow has alternated between up and down.  Trading volume on Friday was 3.2 billion shares of stock (actually 3,207,341,094 shares to be exact).  Average trading volume is about 5 billion shares daily.  That is 36% below average.  For the whole second quarter, we've been running about 30% below last year.

So, what is the collective wisdom of investors telling us?  That they don't have a clue what the market is doing!

When the market is driven by the economy or when the market is driven by corporate earnings, investors find it easier to make investment decisions than when the market is driven by headlines, like now.  This is important to understand, because I suspect the market is spring-loaded for another bull run, if we can get back to the basics of economics and earnings.

In the first quarter of this year, we saw the market spring ahead of the economy, because it is so anxious to roar again.  After all, it has been four years since the market last peaked.  A dysfunctional Washington may yet produce a dysfunctional Wall Street.

Forget the dogs, will someone please let the bulls out?

Thursday, July 21, 2011

Paying Respect to the Devil

You don't have to like a person to respect them.  The same is true for companies.  I don't like Goldman Sachs, believing they have the same ethical blind spot of most stockbrokers, only worse.  Nonetheless, I do respect their research capabilities.

I just finished studying their expectations for the second half of this year.  In no particular order, here are some of the more interesting points:

1.  They have reduced their year-end S&P forecast from 1500 to 1450.  Still, that is way above the current level of 1325.  I agree the market should be up at year-end but struggle to believe it will be a 9.4% increase.
2.  The dollar will continue to lose value.  Amen!
3.  They don't expect the rate unemployment to drop below the current level of 9.2% this year and 8.8% next year.  I pray they're wrong!
4.  "U.S. bond valuations remain unattractive."  Couldn't have said that better myself.
5.  Oil will reach $115 by year-end 2011 and $127 by year-end 2012.  And, we'll still be dependent on Arab oil, if not more so.

Wednesday, July 20, 2011

The Melancholy Green Beret

As a ten-year-old in 1957, I remember the shock and dismay when the Russians beat us into space, with the successful launch of Sputnik.  I remember the bipartisan American resolve to catch up.  As a young officer in 1969, I remember the pride, watching an American walk on the moon.  As I write this, the last space shuttle is on its way back to Earth, never to fly again.

As a young boy growing up at the Beach, I remember my fascination with the vastness and mystery of the sea.  As a former geology major, I was not surprised to learn that the amount of undersea natural resources could far exceed the amount on land.  I remember taking my first scuba-diving class at age thirteen.  As I write this, the Chinese ship Jiaolong (named after the mythical sea-dragon in Chinese) is halfway between Hawaii and North America, preparing to dive 16,400 feet in search of undersea natural resources.  According to The Wall Street Journal, this will "propel it(China) past the U.S."

Sometimes, I wish I could crawl on my belly all the way to Washington, just for the privilege of strangling every single decision-maker up there!!

Step Away From The Punchbowl

In early Spring, I predicted the market would be weak until Fall.  So far, that has been correct.  I never thought a double-dip recession was possible, unless the U.S. defaults.

Since then, the all-important level of uncertainty has been dropping.  We survived European sovereign debt problems both last Spring and this one.  We survived the end of QE2.  Is it party time yet?

Yesterday, the Dow was up 202.  The futures market is predicting the market will open up about 40 points this morning.  Gold is dropping like a rock.  Is it party time yet?

Every market strategist will tell you to "buy on the rumor and sell on the news."  This means the market will move before the event actually occurs, as you can see the market is already moving up, even though there is no definitive deal on the debt ceiling issue yet.  So, is it party time yet?


First, when the stakes are this high, it is better to be late to the party than to be early to a tragedy.  I'll gladly give up some of the upside to sleep better at night.

Second, the level of uncertainty is lower but still high historically.  It is pretty clear that the U.S. will not default even if the debt ceiling is not raised, albeit with rioting in the street (which is preferable to default).  More importantly, the European sovereign debt crisis could heat up quickly and unexpectedly.

Third, the next critical data-point will be the Jobs Report on August 5th.  If the debt ceiling is raised, if some additional step is taken in Europe and if the Jobs Report is improved, it may be time to get more aggressive.

We'll see . . . just remember, there is always a party somewhere in the future!

Monday, July 18, 2011

This Month, This Week, and This Year

The first part of this month was spent worrying about the end of QE2.  That went well.

The second half of the first month of every quarter (right now) is called "the earnings season" when corporations announce their financial performance for the past quarter.  Remember breathlessly awaiting the earnings announcement of Alcoa or IBM, for example?  This is going well.  We're actually seeing revenue growth as well as earnings growth, indicating growth from only cost-cutting may be ending.

However, unless there is some big surprise from Europe again, the U.S. stock market performance this week depends almost entirely on budget negotiations in Washington.  While I will never understand why some rocket scientist thought it was smart to link the debt ceiling to budget talks, it will be the driver of this week's market.  If there is a "grand scheme" showing some ability of Washington to actually govern, the market will soar.  If failure to do anything becomes apparent, the market will slowly deflate, so that the actual default next month will be anti-climatic.

Maybe, I'm being "Pollyann-ish" but I don't expect either scenario.  I expect some version of the Senate kick-the-can, deniability-buying solution to pass the House with some minor token changes to save face for both parties.  Much sound and fury signifying nothing.

For the year-end, I still expect the market to be higher than now.  While much uncertainty will remain, it always does, and businesses are already quite adroit with handling this. The dampening effects from Japan will be drying up.  The fears of a double-dip recession will be less.  The long, slow recovery will have had a little more time to repair.  And, we'll be closer to the first quarter, which is historically the best performing quarter each year.

Sunday, July 17, 2011

Wonder if Mitch Read the Book?

Thinking about Saturday's blog on the importance of regulating the financial industry intelligently, I re-read The Squam Lake Report today.  Published last year, it helped inform the debate on the Dodd-Frank debate by summarizing a conference of fifteen of the nation's leading economists in Squam Lake in New Hampshire.  If there is a partisan bias in their discussion, I cannot detect it.  My belief is that it is the honest recommendations of nerdy economic academics. 

Some of their recommendations are interesting by what they leave out.  There is no recommendation for a Consumer Financial Protection Board, which seems to be the heart of Republican opposition.  But, there is a strong recommendation for a systemic regulator, which has been done in name only.  Currently, regulation is aimed at individual institutions, not the system.  They also recommend large financial institutions maintain a "Living Will" with regulators giving suggestions on how to take over each particular bank more favorably.  This arises from a conclusion that the liquidation of Bear Sterns and Lehman was done so poorly that it made the crisis worse.  This was also not done.

My primary interest was their recommendations on improving the "information infrastructure."  Not only do regulators need more and better information but also other financial institutions that do business with each other need even better information.  This is called counterparty risk.  You don't trade with another bank unless you are sure they are strong enough to pay their obligations.  I know many analysts argue bank stocks are cheap, and they are right.  But, I still think there is a hidden systemic risk that I will avoid.

They identified the single most important information needed was about derivatives, which I've been saying for years.  As the elected children in Congress try to preserve their election chances, I hope they leave this portion of the Dodd-Frank bill as it is.  Are you listening Senator McConnell?

Canary in a Mineshaft

Yesterday, a wonderful client of seventeen years came to visit.  Since it was a bit of a drive, she spent the night with us, which gave us time to think together, as well as to catch up.  Often, she has perceptions of such clanging clarity that I'm haunted for days.

For example, once she discussed her guilt that America had been at war for years and all she had been asked to do was "go shopping, go to Disneyland."  A good American, she wanted to do more, i.e., to see goods rationed, to see taxes increased, to see other spending decreased, etc.  (Instead, all we ask is that her children and grandchildren pay off the three trillion dollars we borrowed to wage simultaneous wars in Iraq and Afghanistan.)

Last night, it was disconcerting to hear her rising fear of socialism.  This is a discredited economic theory, since the fall of the Soviet Union, the embrace of capitalism by China, and punctuated by the fall of the Berlin Wall in 1989.  I assume her fear began rising with the nationalization of AIG and GM, followed by equity injections into most large banks, which was done with great fanfare.  Since then, those amounts have been quietly reduced to a mere fraction of the amount originally invested.

Did the government involvement in the economy skyrocket during the crisis?  Absolutely, but it has been decreasing ever since.  Did the government began regulating with a heavy hand?  Only in financial services, most of which regulation was long overdue.  After all, financial services caused the financial crisis.

So, why the rising fear of socialism?  I don't know!  My suspicion is that fear always rises during unsettled times like this, and we need to put a name on it.  Maybe, it is a rising fear of the unknown, because there is so much of it right now.  Whatever, I just appreciate her insight.  If she is scared, it tells me fear is more widespread than I expected.

Saturday, July 16, 2011

Latest Column

For those who cannot wait until Inside Business is delivered Monday, here is the link to my latest quarterly column . . .  

A Distant Ray of Sunshine

One of the principal causes of the Great Recession was derivatives, which are extremely useful in the daylight but extremely dangerous in the dark.  Because there has been no sunshine or transparency in this market, no one realized what a disaster AIG was, costing the taxpayers billions and billions of dollars.  We need that information, if only to protect the taxpayers.

A recent example is that nobody knows who will take the loss if the Greek government defaults on its debt.  Many of the bondholders have bought credit default "insurance" called CDSs to protect them from loss.  But, who sold that "insurance"?  They will take the loss, but who are they?  Is your bank one of them?

The Dodd-Frank Financial Regulation bill that passed last year would go a long way to controlling this risk.  It delegated the detailed rule-writing to the Commodity Futures Trading Commission (CFTC), with those rules to be published yesterday.  We knew the new rules would be delayed because the Senate Minority Leader, Mitch McConnell, is adamantly opposed to any regulation that is not perfect and respectful.  He said "anything we can do to slow down, deter, or impede" would be "good for the country."

He is wrong!

It is estimated that 3,000 lobbyists, at a cost of $1 billion have been hired to fight regulation.  Because of this obstructionism, nobody expected the rules to be released yesterday (which would have decreased uncertainty for business, after all).  However, we've learned the rules will not be delayed past year-end.  I am confident the rules will be imperfect, but rule-making is always a work-in-progress.  Transparency now is more important than writing rules that will only be perfect for one single point in time.

A little sunshine . . . life is good!

The CFTC cavalry is coming to rescue transparency. . .

Friday, July 15, 2011

A Good Report Card

After the Lehman collapse and the government injected hundreds of billions into bank capital, the wise decision was made to study the balance sheets of those banks to estimate losses in the event of another "stressful" event in the credit markets.  Although done hurriedly, it was detailed enough and serious enough to restore most of the faith banks had about doing business with each other.  Eventually, almost all of the goverment funds were recovered easily.

Soon afterward, the European Union decided to "stress-test" their banks as well.  Unfortunately, it was neither detailed enough nor serious enough to restore much faith.  Momentum finally built to stress-test again and do it right the second time.

The European stock markets were down this morning, as they awaited release of the latest round of stress-tests on their 90 largest banks.  Although the market was not expecting bad news, it was still a pleasant surprise that only 8 banks failed.  Nine others barely passed.  All of the big banks passed easily.  This was especially important in France and Germany, who have been driving the effort to save the Euro by containing the soverign debt issue.

During the first four months this year, European banks have raised 60 billion Euros in new capital.  Had they not done so, twenty banks would have failed today.  Yet, the eight who failed only need to raise a cumulative 2.5 billion Euros, which should not be a problem.

Five of the failing banks were in Spain, one in Austria, and two (only two) in Greece.

All in all, I'm relieved there were no unpleasant surprises.  It may be that the greatest benefit of today's report is that banks now have a great deal more information about other banks, which should reduce their uncertainty about which other banks it is safe to do business with.  (This is called counterparty risk.)

To my amusement, one commentator pointed out that over 60 percent of the debt of the Greek government was owned by Greek banks, meaning it is more of a Greek problem that a European problem.  What he doesn't understand is that we don't know which Greek banks shifted the risk of credit loss outside Greece by using credit default swaps.  Thus, it does remain a European problem, not merely a Greek problem.  Maybe, there will be a third stress-test to answer that question.  I hope so!

In addition, Italy surprised everyone by addressing their soverign debt problem and passed their first austerity measure today as well.  (I wish the U.S. was as responsive!)

If the European markets were to open now, I'm confident they would open strongly higher.  Of course, Monday morning is light-years from now . . .

Thursday, July 14, 2011

Question -- What Happens if the Debt Ceiling is NOT Raised?

Answer -- The truth is . . . nobody knows . . . because it has never happened before . . .that the nation with the world's only reserve currency defaults!

However, I expect interest rates paid by taxpayers on all types of debt will rise.  I expect banks will stop making loans.  I expect unemployment will increase.  I expect the dollar to fall, and the price of imports, including oil, to increase.  I expect uncertainty to spike upwards and the stock market to fall hundreds of points quickly.  This is a deathly serious situation.

This will also hasten the day when the Chinese Yuan becomes the other reserve currency, which is bad for America.

The Tea Party's simplistic assurance that everything will be fine is just plain wrong!  They're wrong, but the American people will pay the price.  They may not be re-elected, but real Americans will lose their jobs and homes.

If I were the president, I would continue to pay bond interest and stop paying Social Security payments and other entitlements.  In the long run, that is the cheaper alternative.  In the short run, it will be politically disastrous, and I'm not sure which party will pay the greater price.  Frankly, I don't even care about the politics or who gets the blame.  Any politician who thinks we should just default, so they can just blame it on the other side is either too stupid or too un-American to serve!

Will this destroy America?  No, because nobody ever died from shooting off their own foot . . . it's just stupid and retard our economic recovery by years!

Wednesday, July 13, 2011

Turning On A Dime . . . Again?

The bear returned to Wall Street on Monday and Tuesday and roared.  This morning, the bear is taking a nap.  Futures indicate the Dow should open up about 80-90 points.  What happened?

The week began with renewed and heightened anxieties about the European contagion from Greece to Italy, a much larger and more worrisome problem.  In addition, uncertainty over the budget negotiations creating a national default was rising, and the stock market hates uncertainty, as you know. 

However, late Tuesday, the Fed released the secret minutes from its recent meeting, which gave strong hints that they would readily begin QE3 if necessary.  The bull woke up.

Then, the Senate Minority Leader suggested ready agreement on raising the debt ceiling, which reduced uncertainty.

This morning, the ratings agency, Moody's, released a report that Italy was stable for now and was not in the same distress as Greece, further reducing uncertainty.

Remember the good, old days when we talked about company earnings, sector dynamics, and PE ratios?  Now, we ask if the news flow is positive or negative . . . if uncertainty is going up or down?

Maybe, all those years spent studying economics and investment analysis would have been better spent studying journalism and political science?

Falling In and Out of Love

I first fell in love with Ayn Rand in 1963, when I read Fountainhead.  That was a story of an idealistic architect who was willing to sacrifice everything in order to construct a building that was "correct," and he would not permit the architectural profession nor the development community to dissuade him.  It was a story of a man standing up for what he believed, and it resonated with me during the sixties. 

Soon afterwards, I read her classic Atlas Shrugged.  That was a story of an idealistic railroad owner who wanted to build a lighter, faster, more efficient train but was continually foiled by a gray, faceless bureaucracy that wanted only to crush innovation.  Over the years, I continued to read everything I could find, which was substantial.

In a college sociology class, I learned about social homogenization.  Just as government requires that milk from coast-to-coast be homogenized, so that it is safe and tastes the same, an unholy alliance between government, media, and culture is homogenizing Americans, creating coast-to-coast sameness.  I thought of Ayn Rand.

My parents strongly encouraged me to work for the government, but I thought of Ayn Rand.  My first wife strongly encouraged me to stay in the military, but I thought of Ayn Rand.  As the survivalist movement began in the late 1970s, I thought of Ayn Rand. 

Arguably, the greatest TV commercial of all time was the Apple commercial that appeared only once, i.e., during the 1984 SuperBowl game.  It showed a female athlete being chased by some military goon squad into a large theater where the gray, ashen, robotic people watched propaganda films.  The women threw a large hammer thru the screen, liberating the poor souls.  It was pure Ayn Rand imagery.

Over the years, I learned I had little in common with other fans of Ayn Rand and drifted away.  Then, in 2009, I learned that certain politicians, including Paul Ryan, required their staffers to read her books, which echoed the mind control she would have hated.

Recently, I was lucky to have obtained a rare, over-priced DVD of her 1942 film classic We The Living.  This is a story of a young, anti-Communist girl who is an engineering student in 1923 Russia and finds herself caught between two men.  One is a persecuted former aristocrat, and the other is an officer in the hated KGB.  Those who use Ayn Rand to further their purist political agenda will not find her film helpful.  The heroine falls in love with the tragic aristocrat who rails against the Communists but succumbs to profiteers.  She saves him by prostituting herself with the KGB official she loathes.  However, in the end, she realizes too late that she was really loved by the KGB official, not the idealistic fighter.  The KGB official stands up to the gray, faceless bureaucracy, announces he is prepared to die for his belief that Communism betrayed Russia, and he does.

I have written before that the tragedy of Ayn Rand is that her philosophy has been used to intellectually justify various purist political agendas.  Today, the Tea Party reflects her disdain for an oppressive government but inconveniently ignores the rest of her philosophy, such as rejection of what we now call "social values" and "safety nets."

R.I.P. Ayn Rand . . . if you can.

Saturday, July 9, 2011

The Whimpering Bull

Yesterday, I was worried about the market.  It is always more volatile on Fridays anyway, but yesterday would be a day of very little trading volume, as most of the big traders spend July spending big bucks in the tony Hamptons beach community, outside New York City.  (A few large orders can move the market on a day of low trading volume.)  Finally, the most important economic report of the month was being released, i.e., the "Jobs Report."

When the report came in awful, my first thought was that I'm glad my name is not Obama, but my second thought was that the market will surely over-react.  Within an hour of the open, the Dow was down 130 points.  Obviously, the sellers had not left for the beach yet, but would there be any buyers that afternoon?

To my pleasant surprise, the Dow was only down 62 points at the close.  It actually rallied somewhat and reduced its loss . . . on a Friday afternoon . . . during beach season in July . . . following a nasty Jobs Report . . . ???  My first suspicion was that a few large orders moved the market up at the close, but the tape doesn't show that. 

I've remarked several times in this blog that the market is showing a surprising amount of underlying strength in the face of a weak labor market, intractable partisanship, and a looming disaster when the government defaults. 

After a two year recession and two more years of anemic recovery, America wants to be raging bull again, as soon as Washington unleashes it!  I miss that old bull . . .

We can even afford to explore space again . . . Yes, we can!

Thursday, July 7, 2011

Things That Go Bump In the Dark

With the surprisingly strong ADP employment report this morning, good earnings from several retail companies, and hopeful comments on the budget negotiations, it is not surprising the bull was loose on Wall Street today, for 7th time in 8 days.  With the all-important monthly DOL "Jobs Report" due out tomorrow morning, my thoughts should be entirely focused on that.  Yet, they are not.  My portfolios are conservatively positioned if that report is bad.

What has been weighing on my mind is a phone call I received on Tuesday afternoon, while on my way to spend a few days with family in bucolic St Michaels, Maryland.  The caller was very agitated that Casey Anthony had been found not guilty.  While I was vaguely aware of some child murder soap opera in Orlando, I was taken back by the caller's conviction that this verdict proves America is doomed.  The caller wanted to know if they should sell everything and just sit on cash for now.  On Wednesday, I got a similar call from another client.

Enjoying the next few days with family, I wondered why they shared no similar fear.  They were barely aware of the Casey Anthony story.  I know some people just seem genetically inclined to see a glass as either half-full or half-empty.  But, there is more to it . . .

I know some people don't have enough curiosity to stay informed.  But, being informed is not the same thing as being fearful.  There must be more to it . . .

I know some people manage their exposure to negativity.  Once they receive their daily ration of negative news/opinions/thoughts, they consciously turn their attention elsewhere.  But, how did they know they could manage their own emotional state-of-mind?  Who gave them that permisssion?

My wife thinks people over-react to things they understand when they don't know enough to react to strange, arcane things that frighten them, such as the ISM report or Beige Book Report or labor force participation rate cycles.  Maybe, but I suspect there is still more to it.

For me, I cannot answer these questions.  These are not the type of questions economists are trained to answer.  But, they are the type of questions that keep me awake at night.  There must be more to it . . .

Monday, July 4, 2011

A Patriotic Thanksgiving

As someone who manages the savings of somebody else, I know it is deathly serious work.  We become achingly cynical:  believing no news release, no quarterly report, no analyst report and no economic analysis.  Still, there are those occasions when we must put aside our cynicism for something more simple, more naive.  Today is one of those days!  I'm thankful to be an American.  Of course, that implies so many things . . .

It is a democracy, an imperfect one but well-intended one.  The current President of Turkey once said that democracy is like a train -- when you get to the right stop, you get off.  I've thought about that comment a lot.  Assuming he is right, how will we know when we get to that stop, and what is the next train we take?

Readers know my frustration with our implementation of republicanism, whereby partisan children are elected to make the most important decisions for us.  Readers also know my conviction that this problem cannot be fixed until the problem of re-districting, which is done every ten years, is actually done in a non-partisan manner.

America also means capitalism, which we codified.  It is arguably the greatest gift to mankind in history, having lifted hundreds of millions of workers out of poverty.  Like anything man-made, it is imperfect . . . but still the greatest gift.

The marriage of the political system of democracy with the economic system is often referred to as the Free Enterprise model.  The Chinese model is a marriage between an economic system of capitalism with the political system of totalitarianism or fascism.  (The Israeli model was democracy married to socialism, but they have rejected it, in favor of our model.)

Which model will be the best going forward?  I hope it is the American model but suspect it will be whichever system is flexible enough to adjust.

But, on the 4th of July, I'm happy to be on this train and will always be both proud and thankful to be an American.  There will be no room for cynicism today, only hamburgers, baked beans, and potato salad.  Enjoy the day!

Saturday, July 2, 2011

Plop, Plop, Fizz, Fizz . . .

According to, a Relief Rally is defined as "a sharp upward spike in prices following a period of investor uncertainty."  Clearly, this past week was a temporary relief that the Greece tragedy did not explode in Europe -- yet.  Plus, there was a rumor that former central banks were secretly increasing their holdings of U.S. Treasuries to take up the slack for the Fed who had been lending the money to our government.  This is wholly unconfirmed, except for China who admitted a modest increase to their $900 billion portfolio of U.S. debt.

Whatever it was, the Dow rallied almost 6% or 650 points last week, the best week in two years.  It felt good . . . Oh, what a relief it was!

Do I believe the bull has returned?  No, but it does show there is a bull market waiting to emerge if it can just get free of the semi-political issues.  The politicians have not yet killed the bull, and that too is a relief.

The importance of not defaulting on our national debt cannot be over-emphasized.  Theoretically, the "drop-dead" date is August 2nd.  However, borrowing costs for the U.S. Treasury will start increasing before that date.  Wouldn't you want a little extra yield to be buying a U.S. Treasury bond on August 1st if the debt ceiling is not raised?  In fact, those costs are already rising.

Holding the debt ceiling issue hostage to the budget negotiations is like fixing a five-star dinner while walking a greasy tight-rope without a net.  It is simply stupid.  Nonetheless, that is the decision we've made.  While this reward of concluding the budget negotiations sooner is not worth increasing the risk of a credit default by the reserve currency nation, it may allow the bull to return a few months earlier than previously expected.
And, that will be a relief we all deserve!