Wednesday, August 31, 2011

A Divided Fed . . . So What?

To understand the Fed, one has to understand their "dual mandate."  They are charged with minimizing both inflation AND unemployment.  What could be wrong with that?

This dual mandate came about when Keynesian economics was the dominant school of thought.  One Keynesian principle is something called the "Phillips Curve," which looks like this:
You can see that the inflation rate falls as the unemployment rate goes up and vice versa.  In other words, there is a tradeoff between two evils.  Congress, in its wisdom, gave the Fed the responsibility to navigate between these evils.

So far this year, we've seen inflation rise with no drop in unemployment.  The Keynesian response is that it takes time to turn an aircraft carrier.  The Supply-Side response is to cut taxes on the "job creators" who will then bring the unemployment rate down.  The Austrian response is to balance the budget and these evils will fix themselves.

That is all fine and good but is not helpful to the Fed, who is actually saddled with the responsibility of managing both evils.  Is it any wonder that there is disagreement inside the Fed over how to handle the dual tasks?

Yesterday, the Fed released the minutes of their last meeting three weeks ago.  It showed honest disagreement in a complex environment with conflicting data.  Now de-sensitized to the cost of gridlock, Wall Street was not frightened by this dissension.  Instead, it saw that some members of the board are still arguing for QE3, which is expected to be as good for Wall Street as QE2 was.  The Dow took heart and closed up 20 points.  Surprise, surprise . . .

Tuesday, August 30, 2011

Reports, Breaking News, Rumors . . . and Silence

Yesterday, the Dow rose 254 points.  It was a perfect storm of sorts.  The early morning economic report on consumer spending was surprisingly strong.  There was breaking news that three Greek banks were merging, thinking that they would have better access to the market.  (Today, they will look more like three drunks trying to hold each other up.)  By the afternoon, there was a totally unconfirmed rumor on the floor of the exchange that the Obama Administration had developed a set of comprehensive reforms to breathe life into residential real estate, that bypassed the "do-nothing" Congress.  All of this helped propel the stock market higher and higher.

However, the most beautiful thing heard on Wall Street yesterday was the Sound of Silence coming out of Europe.  The auditors are on their way to evaluate how much progress the Greek government has made.  There is no resolution to the demand of Finland for collateral on their portion of the bailout.  Angela Merkel's government struggles harder each day to hold together.  But, yesterday, there was no bad news from Europe.

The U.S. economy is stronger than the stock market indicates, but it is very vulnerable to the European financial crisis.  Globalization is not all good!

The futures market indicates the Dow will open today down about 60 points.  Attention will start turning toward Friday's monthly Jobs Report.  The consensus forecast is that 65 thousand jobs were created in August.  Of course, this number will be clouded by the Verizon strike and may not be as dramatic this month.  That's fine, as we don't need anymore drama right now.

Saturday, August 27, 2011

Head in The Cloud

Years ago, when I was thinking about retiring from banking and starting my own investment advisory business, a good friend and client suggested I spend some time at her cabin high in the mountains of Wintergreen.  Unfortunately, the weather was not great.  There was a low ceiling, and we found ourselves inside the cloud, literally.  I could not see the other side of the 8 foot deck!

I thought that must be the view of the average investor . . . thick, impenetrable, and scary.  With only a fuzzy concept of their objectives, a minimal understanding of economics, and little experience with the stock market, their investment view could easily be cloudy.  I even toyed with the name of "CloudVest" for my new firm, but that idea was quickly dismissed by my wife.

Since then, the Cloud has taken a far different meaning.  It means I am able to access the Internet from almost everywhere and need very little that is on the hard drive of my own computer.  (To my surprise, I was able to access everything I needed, on a secured basis, even from China last year.)

Today, as Hurricane Irene approaches and rain pelts the windows, I watch the news reports of electricity outages.  With two laptops each with 3 hour batteries, a netbook with a 6 hour battery, and a fire station with generator across the street, complete with a battery/phone charging station, it amazes me that we could still access the Cloud and manage portfolios for a considerable length of time, even if Hurricane Irene was a Category Five.

Many people are resentful of the technological progress, but I love it!

Friday, August 26, 2011

The Joy of Disappointment

Today, Wall Street waited and prayed that Bernanke would save us from another recession by announcing another round of quantitative easing or QE3.  He disappointed us, and the Dow promptly dropped over 200 points.

But, then somebody wondered why he refused to do anything else to help us and noticed it was because we don't need anymore help.  He believes the economy is better than we think, and the Dow closed up 134 points.

As long as we keep making money, he can keep disappointing us!

It's Showtime!

For the first three days of this week, the stock market coasted serenely past earnings surprises, merger announcements, and economic reports.  We were secure in the knowledge that "Uncle Ben" Bernanke would once again preserve our economy, as he has done since the Global Financial Crisis in 2007.

Yesterday, the realization began to sink in that even Uncle Ben has only a finite list of options, and the market began to sink . . . down 170 points on the Dow.

Today, at 10AM, it is finally showtime!  Bernanke will take the stage in Jackson Hole, Wyoming, in what used to be a wonkish, rustic retreat of people who actually found monetary policy interesting.  It has now become the stage for monetary policy.

Faithful readers know I suspect there is already a stealth QE3, being carried out by foreign central banks for each other, instead of the Fed taking all of the political heat.  My hope for today is that he will open his trench coat and show lots of options that he still has.  While it is unlikely he will announce implementation of anything new today, my prayer is that he discusses the firewall between the U.S. and European banking systems..

Adding to the drama is that the GDP estimate for the second quarter will be revised before Bernanke's speech.  A big surprise, up or down, could easily move the futures market, which is predicting a flat open right now.

Maybe next week, we can pay attention to earnings surprises, merger announcements, and economic reports again, I hope??

Wednesday, August 24, 2011

Still in the Rear View Mirror

When a deal falls apart after the handshakes, you can usually blame the lawyers.  You may have thought the Greek bailout was behind you, and Europe was now focused on the bigger problem of Eurobonds to bailout the whole of Europe.  You would be wrong, unfortunately.

The bailout of Greece will NOT happen, and the fault goes to the Tea Party of Finland.  Enraged that the profligate Greeks were being bailed out with the savings of hard-working Finns, their Tea Party has doubled their representation in Parliament and has forced the government to demand cash collateral for the Finnish funds loaned to Greece.

Of course, if the Greeks had the cash for collateral, they wouldn't need to borrow money from the Finns.  Now, the Finns are demanding real estate as collateral.  The Greeks have been trying to sell that real estate to pay off their debt to everybody. 

Even worse, other nations are demanding that all creditor nations be treated the same and are beginning to demand collateral as well.  Germany and France are pushing back, but we know the Tea Party doesn't compromise.

I expect Finland to drop out of the deal, as well as a few other nations.  That increases the burden on German and French taxpayers, who will understandably not be happy.  This is likely to force the Germans to act more unilaterally, while demanding more fiscal sovereignty over all of Europe.  If you don't like the way European headlines have whip-sawed U.S. stock markets so far, don't look in your rear view mirror.

Tuesday, August 23, 2011

Checking In With The Vampire Squid

While I don't like Goldman Sachs, I do respect their research.  Reading their latest "Market Pulse" is always interesting.

They expect our GDP growth will slow to 2-2.5% through the end of 2012 but still expect the S&P to reach 1400 by year-end, which would require one raging bull very quickly.  They believe the stock market has already priced-in a recession, that has only a 1 in 3 chance of happening.  At the same time, they see no change in unemployment for at least a year.

Their 12-month target for gold is $1,860.  That means it has already peaked.

Most interesting, they expect the Fed to resume quantitative easing.  The relatively blissful attitude of the stock market this week is sweet anticipation of Bernanke's speech in Jackson Hole this Friday, when "something" is expected.  I'm afraid the market will over-react, as it tends to do, when Bernanke does not roll out anything new.

The Fed tries to preclude the nastiness of our political children and will, unfortunately, be somewhat timid for now.  Still, Bernanke has traditionally used his annual Jackson Hole speech to make some new announcement.  If he does roll out something new, it will certainly not be called quantitative easing.  I think it is more likely he will list some of his remaining options, hoping to provide the market with some comfort that he is not out of bullets.

Learning yesterday that the CEO of Goldman Sachs hired a high-powered defense lawyer for himself  reinforced my belief that only their research department deserves my respect.

Monday, August 22, 2011

Calm Before the Storm?

World markets were mixed overnight but generally calm.  The Dow will probably open up about 80 points this morning.  Despite the good news out of Libya, oil is not reacting strongly.  Only gold is showing any drama, back up to $1,880 again.

On the calendar, the most important item this week is Bernanke's speech at Jackson Hole on Friday.  Bernanke has used this annual retreat to make major announcements in the past.  There is speculation that he will announce QE3, but I think that is unlikely.  The popular consensus is that he is impotent, out of bullets, and has a divided board.  Still, he has proven himself to be quite creative several times already.

Off the calendar, we remain vulnerable to the news flow out of Europe.  Merkel said the idea of Euro-bonds, guaranteed by all members to increase their bailout fund, is "not yet" ready to proceed.  She has been strongly opposed to this idea, and this could be a tectonic change.  Maybe, she is looking from a quid pro quo??

There could easily be a relief rally this week.  In a normal economic environment, stocks are deeply over-sold and ready to rebound.  In this economic environment, the absence of headlines are more likely to create the rebound.

Enjoy the calm . . . stop watching the stock market . . . do something fun!!

Sunday, August 21, 2011

Could Greek Retirees Do For Germany . . . What World War II Could Not?

Accepting the premise that "he who has the gold makes the rules,"  I've been thinking about the most likely end-game for the European crisis.

The Euro zone is not the United States of Europe.  We have one monetary policy and one fiscal policy.  They also have one monetary policy but twelve fiscal policies.  A unified monetary policy was key to the development of the Euro, replacing the currency of twelve different nations and facilitating greater trade.  There were also some halting steps toward governance and standardizing trade agreements, but that was essentially the end of the unification process.

Greece (as well as Portugal, Spain, and others) squandered their budget surpluses by being nice to their voters.  As an extreme example, hairstylists in Greece were permitted to retire at age 53, because that job was considered hazardous.  The Greek government kept borrowing more Euros to lavish greater benefits on an aging population.

When the United States plunged the world into recession in 2008, the Greek tragedy began unfolding, with other nations soon following.  When Germany was asked to help with the bailout, the German worker reasonably asked why he had to work and pay taxes until he was 65, so the Greeks could retire at 53?

Fighting and screaming as they went, the rest of Europe collectively agreed to bailout the weaker members of the Euro zone.  Suddenly, Finland has said they will contribute to the bailout but only with cash collateral.  The whole deal could possibly un-ravel over this, but I doubt it.

But, what happens to Greece if they are thrown out of the Euro, and they are forced to use the Drachma again as their currency.  First, the value of the Drachma would drop terribly.  Imports, such as oil and food would skyrocket in price.  With less international trade, unemployment would rise from already heart-breaking levels.  In short, it would not be pleasant.

And, what happens if the European Union dissolves, and the Euro is no more?  Germany's Deutsche mark would skyrocket in value, quickly killing 30% of their GDP, which is their export sector.  Again, international trade would plummet, and unemployment will rise even more.  In short, it would not be pleasant. 

Germany simply cannot allow the Euro to collapse.  Given they have no option, they will eventually provide the funds necessary to save the Union.  Of course, they will extract their pound of flesh, which is understandable.  Having seen the negotiating strength the Finnish have just shown, the Germans will be even more emboldened.

Losing control of your fiscal policy is a major loss of sovereignty, which is surrendered only to the country who has the money to buy it.  The major power centers of the world will be Washington, Beijing, and Berlin!

Friday, August 19, 2011

A Technical Prediction

Warren Buffett once said he would rather be the broker than the partner of anybody who thinks they can predict the market.  That's good advice!

Yesterday, John Bollinger, who is a highly respected market technician and developer of the Bollinger Bands, predicted we are now putting in the bottom of this bear market.  Also, Rick Santelli, CNBC expert on bond markets and intellectual firebrand of the Tea Party, predicted the bottom would be in August.

Of course, there are always plenty of pundits who predict the sky is falling, but Warren Buffett would not be their partner either.

The Joy of Insomnia

At 3:00 AM this morning, I was watching Bloomberg as the European markets opened and heard "stocks slide around the world as the U.S. slips into recession."  Talk about a rude awakening!

The U.S. may slip into another recession, especially if Europe cannot get its act together, but the odds are no worse than 1-in-3.  While the Philly Index yesterday was surprisingly bad, GDP growth increased from the first quarter thru the second quarter.  Economists almost uniformly predict positive growth in the third quarter as well. 

What Bloomberg meant to say, I think, is that the U.S. is slipping into a bear market, which is different than a recession.  Unemployment doesn't rise during a bear market, except on Wall Street.  GDP also doesn't fall, just because there is a bear market on Wall Street.

Technically, a bear market is when stock prices fall 20%, and the S&P has only fallen 17% . . . so far!

I expect we will officially enter a bear market today.  Futures indicate the S&P will open lower about 15 points, and the Dow will open lower about 130 points.  In addition, Friday afternoons are often ugly as traders sell everything to stay in cash over the weekend, when headlines are unpredictable.  Lastly, it is a "witching" Friday, meaning some options and futures contracts rollover, which also adds to volatility.

Don't watch the market today!  Enjoy the waning summer season this weekend!  I'll be watching the futures market for you . . .

A Tale of Two Commodities

Normally, we talk about commodities as a single asset class, as they have the common characteristics of benefiting from both growth and inflation.  In other words, they're normally good to own during the expansion part of the cycle but not the contraction part of the cycle.  They're also reasonably good inflation hedges. 

But, take a look at the dis-similar recent behavior of gold and oil.  Gold just passed another record high of $1880, while oil is dropping below $80.

Clearly, gold is a store of value during tumultuous times, while oil is not.  Oil is a consumable, like corn or wheat.  Also, oil may not be not profitable during the contraction phase, when demand is falling. 

That last sentence is worth reading again.  The Arab world usually prices their oil off Brent prices, not WTI like the U.S.  Brent oil is now selling for about $105 per barrel.  While it varies considerably among producers, the average cost of production is about $85.  Adding credit problems in the Middle East to the credit problems in Europe will not be helpful to the world economy.

Like people, commodities have very similar characteristics . . . except when they don't.

Thursday, August 18, 2011

What's Up with Gold?

Gold barrelled thru $1,800 an ounce again today, setting yet another new record. 

Gold has long been considered a safe haven during tumultuous times, which these times certainly are.  Gold has long been considered a hedge against inflation (see blog earlier today). 

With the continuing depreciation of the dollar and the downgrade of the U.S. credit, central banks around the world have been adding more gold but fewer dollars to their reserves.  When gold began its run-up two weeks ago, its frantic pace was broken only when the Chicago Mercantile Exchange (CME) raised the margin requirement for gold, meaning buyers could not use as much credit to buy it.  Gold prices quickly fell.

What makes today special is that Chavez of Venezuela has said he will nationalize gold mining in that country to raise cash for his failing government!

I expect the CME will again raise the margin requirement in the near future and that Chavez will try to flood the market in the medium term.  In the long term, the biggest threat to the price of gold is a responsible U.S. government.

The Cost of Rumors

What went wrong overnight in Europe to cause such a major sell-off?

First, there was concern that the Greek bailout could fall apart, if Finland requires additional collateral from Greece.

More importantly, there is a rumor that some bank had to borrow $500 million from the ECB overnight, paying a high 1.1%, compared to the normal cost of 0.7%.  That strongly suggests some bank is in serious trouble, but nobody knows who that bank is.  Therefore, since European bank stocks cannot be shorted, all European bank stocks got sold.

The fear of a European "Lehman" is over-whelming!

Bad = Good ??

Today, we learned that core consumer prices (CPI) have risen 3.6% over the last twelve months, way above the Fed's stated goal of 1.5% to 2.0%.

Tuesday, we learned that core wholesale prices (PPI) have risen 7.2% over the last twelve months.

Monday, we learned that import prices have risen 14% over the last twelve months.

Looks like a lot of inflation in the pipeline . . .

Despite our painful memories of the 1970s, inflation is not all bad.  It is the easiest way to de-leverage or to reduce the percentage of our balance sheet that is financed by debt.  For example, if you have a $200 thousand house with a mortgage for $150 thousand, your loan-to-value is 75% and your debt-to-equity ratio is 3-1.  Now, if your house appreciates from inflation to $300 thousand, your loan-to-value ratio drops to 50%, and your debt-to-equity improves to 1-1.  Inflation depreciates debt.

Governor Rick Perry slammed Fed Head Ben Bernanke for letting money supply increase too rapidly.  I don't believe for one second that Bernanke is trying to help re-elect President Obama, since he was appointed by President Bush.  He is increasing money supply to help create inflation, which will help the economy to de-leverage or reduce the heavy burden of debt that we have currently.  While this can never be admitted, it is being done.  And, I'm glad!

Of course, this can easily go too far!  Fortunately, we know inflation is much easier to control than deflation.  Inflation does have advantages!  

Another Day, Another European Thrashing . . .

It looks like Europe will trash the U.S. stock market again today, with futures indicating a loss of about 190 points on the Dow at the open.  All their markets are down substantially, with banks hammered the worst.  (Banks are the largest holders of sovereign debt of European countries.)

If you feel anger toward the Europeans for doing this to us, just remember that we sent them into a terrible recession in 2008.  Paybacks are hell!

Even if our elected children in Congress were NOT impotent and useless, our stock market will still suffer from the ills elsewhere in the world.

Globalization has many benefits, but this is not one of them.

The good news from Europe is that Merkel & Sarkozy ("Merkozy") proposed greater fiscal unification on Tuesday, reducing soverignty of each nation.

The bad news is that will take many, many years to accomplish . . .

Wednesday, August 17, 2011

Longing for Fundamentals

There is no 12-Step Program for Wall Street junkies!  Therefore, it is good to simply get away from it occasionally.  Over the weekend, I remembered what I've been missing, i.e., the interplay between economics and investment strategy.  A change in the Index of Leading Economic Indicators tells me something.  So does a change in inventory levels or the Beige Book or M2 or . . .

Recent economic data has indicated a slowing economy but with no recessionary indication.  The financial data from the S&P 500 companies for the second quarter has been quite strong, giving no sign of recession.

So, why is the stock market so volatile?  The skittish paranoia doesn't reflect the fundamentals, either of the American economy or American corporations.  Instead, it reflects what strategists call "headline risk."  Despite largely good economic and corporate data yesterday, the market reacted to the headline that the meeting between Sarkozy and Merkel didn't produce any other headlines. 

During such times, it is normally best to ignore the headlines as much as possible and use the dips as buying opportunities.  However, don't forget that extremely volatile days, both up and down, such as we had last week, usually indicate a change in market direction.

While I Was Gone . . . .

As I was scrambling to make a quick road trip last Thursday, I was contacted by a reporter for Inside Business about the impact of the U.S. credit downgrade on commercial real estate.  When I got home late last night, it was amusing to see I was quoted so extensively.  For your snoozing pleasure, you can read the article by clicking on this link:

Saturday, August 13, 2011

Sound & Fury Signifying . . . 1.5%

After four historic, horrifying days of at least 400 point moves, the week ended down an insignificant 1.5%.  When you try to estimate how many millions of people lost how many billion minutes of sleep over the week, you must remember the post-traumatic impact of 2008.  Investors looked death in the eye three years ago and still remain terrified.  In the end, did it really matter?

Next week is likely to be volatile as well.  The VIX is still a relatively high 36.  Uncertainty over the downgrade has decreased while uncertainty over Europe has increased.  The meeting between German and France chiefs of state on Tuesday could easily be market moving.  Anticipation of Bernanke's speech on the 26th will also start building. 

Para-phrasing Warren Buffett, I don't know where the market will be tomorrow, but I do know where it will be in 5 years . . . UP! 

Friday, August 12, 2011

Market Corrections 101

Since 1900, there have been 26 major stock market corrections ( at least 15% loss) or once every 4.3 years.  The vast majority (62%) dropped less than 40% and lasted less than 400 days, increasing to 78% since 1950.  The trend is clearly toward more frequent but less severe and less lengthy market corrections.

So, this one is not so bad.  What are you complaining about?

Class dismissed . . .

Thursday, August 11, 2011

Historic Week

Today, the Dow closed UP 423 points.  This is the first time the market has moved more than 400 points in each of four consecutive days.  It is somewhat exciting but even more exhausting!

So, does it give us any indication of where the market is going?

There are three related dynamics playing out in the market right now.  First, the U.S. economy is growing slowly, as is typical after a financial crisis.  It is possible the economy could be pushed back into recession, but the market may well have already priced that into current price levels.

Second, the technical characteristics of the U.S. stock market present another dynamic.  Such volatile market moves usually indicate a change in direction.  It was announced today that insiders are buying eight times as many shares as they are selling.  This is very bullish.  In addition, share buybacks have not been this high in three years.  This is also very bullish.  However, the volatility index (VIX) is still close to 40, indicating continuing volatility, which suggests no net change in the market . . . yet.

Third, the headline risk of the European financial system is jerking our market violently.  Investors are drawing unreasonable comparisons with the U.S. financial system  in 2008.  It might get ugly there but not as ugly as it was here.  This is the wild card.  Tell me the headlines out of Europe tomorrow, and I'll tell you how the market will perform.

Once we get back to the fundamentals of the U.S. stock market reflecting the U.S. economy, albeit with careful regard for the world economy, I will be more excited and less exhausted.

Whipsawed Again

This is no fun!  Here is the Dow over the last seven trading days:
                                    August 2nd . . . . down 265
                                    August 3rd . . . .  up 29
                                    August 4th . . . .  down 512
                                    August 5th . . . .  up 60
                                    August 8th . . . .  down 634
                                    August 9th . . . .  up 429
                                    August 10th . . .  down 510

As I type this, it is UP 287 points, but I'm not happy about that.  Normally such volatility means a change in direction, usually after a few days of stability.  The only normal day in the last ten is August 3rd, when it was up only 29 points.  I'm ready for a few stable, boring days . . .

Boring is good!

Blood in the Water . . . Across the Atlantic

European authorities are considering a ban on the short-selling of financial stocks, just as U.S. authorities did in 2008.  Short selling is the practice of selling stocks you don't own at today's price, with the expectation you can buy the stocks at a cheaper price on the delivery date, putting the difference in your pocket.  Although it is very dangerous and definitely not recommended, it is a way to make money when stocks are dropping.  However, it can become a self-fulfilling prophecy.  Because short-selling is public information, other investors can see more people shorting a stock, increasing doubt about that particular stock, increasing sales of that stock.  Sometimes, short-sellers can force the stock price down in this way and make a great deal of money for themselves.

The bond vigilantes are now circling European banks, like they did Bear Stearns and Lehman.  If one big bank goes down, it will be very ugly for Europe.  It will also be ugly for the U.S. but not nearly as dramatically.  We have used the past three years to improve capitalization of our banks, much more so than the Europeans have.

Letting Lehman fail was a terrible mistake by the U.S.  Hopefully, the European authorities learned a lesson from our mistake.

This is the dark side of globalization.  There is no place to hide from problems elsewhere in the world.  Our stock market is trying to react to the American economy but keeps getting pulled down by Europe, just like we pulled the European makets down in 2008.

Wednesday, August 10, 2011

A Word from Wells . . .

I just read the latest economic commentary from Wells Fargo.  While the tone was somewhat downbeat, expecting the economy to grow slowly and inflation to rise slowly, they still expect GDP growth this quarter will increase to 2.2% from 1.4% last quarter.

They also chastise the complainers.  Finding somebody to blame for our economic mess is not helpful.  Wells Fargo describes our current situation as a "MacGyver economy."  That means we must do with what we have, not what we wish we had, concluding "During every tough economic period, entrepreneurs have found a way to succeed."


Compare and Contrast

I've been reading Fed announcements for decades but found yesterday's to be as inscrutable as any.  They recognized the economy is weaker than they expected.  They said they were still expecting greater growth.  They didn't raise interest rates.  They didn't promise any more quantitative easing.  They didn't promise anything, other than to keep interest rates low until mid-2013. That made interest rates drop immediately, as it reduced the possibility of loss from bonds for the next two years.  They did admit they discussed other policy tools they have available, if growth doesn't resume, but didn't suggest what the tools might be.  Finally, there was a small rebellion in that three members of that committee (FOMC) voted against Bernanke.

Today, I watched an interview with Jamie Dimon, CEO of giant JPMorganChase.  As you know, I don't like money center banks, as that invisible "great white shark" known as derivatives could take them down with little notice.  Nonetheless, I respect Mr. Dimon.

He was straight-forward and clear.  America has hit a soft patch, and our best days are still ahead of us.  He described the debt-ceiling debacle as a shot in the foot.  He sees so many good things as he visits bank facilities and clients across the country that he thinks we need to pay less attention to Washington and the stock market.  The greatest constraint on our economy is the cumulative effect of regulation, not taxes nor spending but regulation.  Excessive regulation creates too much confusion, increasing uncertainty. 

Jamie for President!!

Still Loving Instability?

The Dow is down 390 points as I write this.  It is normal that the market falls the day after a big rally, as some investors are always waiting to "sell into a rally."  After such a roaring rally at the close yesterday, a rumor hit the market in the wee hours that the French banks were being downgraded.  It was a rude reminder that the current bear market reflects primarily European problems, not U.S. problems.  There is a specific rumor on the French bank, Socgen.  Even though the ratings agencies has re-affirmed the AAA rating of France and its banks, the market is still shaken rudely.

The specifics are not as important as the strength of the reaction.  This is enormous instability.  The Dow flucuates a hundred points in only minutes.  It may be that the bond vigilantes are circling French banks the same way they did U.S. banks in 2008.  If so, Europe will continue pulling us down.  If not, there is a good chance we could be putting in a floor.

Putting some money into the market now is a defense against missing the bottom.  Having a good deal of cash right now is a defense against further declines.  Pick your defense!

I still think a parabolic move down is no more sustainable than a parabolic move up, i.e., that we are over-sold and have more upside potential than downside.  We'll see . . . 

Tuesday, August 9, 2011

Loving Instability

The market started off strongly this morning, then stabilized and drifted down in anticipation of the Fed announcement at 2:15PM.

The Fed announcement was largely a non-event, in that they didn't announce any new measures to stimulate the economy or the stock market.  The market immediately tanked, losing over 200 points, before recovering and finishing up 429 points, with a "rip-your-face-off" rush of the bulls at the closing.  Confirming this move was extremely heavy volume of almost nine billion shares.

This is the day after losing 634 points yesterday.  The market is very unstable, but is that a bad thing?

Such instability usually predicts there is a fundamental change in market direction.  Either we're going down strongly at this point . . . or going up strongly.  Let's pray the bulls are right!  Regardless, it sure is nice to see them again.  In fact, I love the bulls!!

A Dead Cat Bounce?

Imagine standing on your garage, holding a dead cat, which you then toss onto the driveway.  It will likely hit the concrete and bounce up slightly.  That does not mean the cat is alive.  It just means the dead cat bounced.

That tasteless old Wall Street adage describes that situation where the market is dead but suddenly bounces up . . . like today.

So, is today's positive opening a dead cat bounce?  I don't think so.  The last twelve days have been remarkable and rare.  If we saw the market bounce up as much as it declined, we would be saying this is not sustainable, and we should sell.  I actually did a little buying this morning.

Also this morning, I met with a representative of Goldman Sachs, whose research capabilities I respect, who still expects the S&P to end the year at 1400 or up a whopping 23% from here!  They believe this is a correction, not a collapse.

I think they are right.

Monday, August 8, 2011

Thud . . . Hitting the Bottom?

According to Investopedia, capitulation occurs "when investors give up any previous gains in stock price by selling equities in an effort to get out of the market and into less risky investments.  True capitulation involves extremely high volume and sharp declines.  It usually is indicated by panic selling."

Going further, it says "after capitulation selling, it is thought that there are great bargains to be had.  The belief is that everyone who wants to get out of a stock for any reason (including margin forced selling due to margin calls) has sold.  The price should then, theoretically, reverse or bounce off the lows.   In other words, some investors believe that true capitulation is the sign of a bottom."

We certainly witnessed investors getting out of the market today with extremely high volume and sharp declines, but was it panic selling?  I don't know if we are there yet, but we are in the neighborhood!

According to Warren Buffett, "be greedy when others are fearful, but be fearful when others are greedy."

Just remember:  You make money when the market is up, but you earn it when the market is down . . . if you have the courage to buy . . . when everyone else is fearful . . . including yourself!

$100 Million of Free Advertising?

Admittedly, I know nothing about advertising, but I do think the S&P downgrade of our short-term credit was a brilliant marketing move!

There are three primary bond-rating agencies, i.e., S&P, Moody's, and Fitch.  All three did a miserable job of rating bonds secured by sub-prime mortgage bonds.  Last year's financial re-regulation bill aimed to correct some of their worst abuses but is now mired by lobbyists in writing regulations.  I still don't trust them.

To my dismay, nobody in any ratings agency has been indicted for anything!

Now, everybody is talking about S&P.  They have separated themselves from their competitors by being the toughest.  In the future, their rating of bonds will be more important and more valuable than ratings by Moody's or Fitchs.  They could not afford to buy such advertising!

If you care more about what the market thinks about our credit than what "sub-prime lovers" think, save this link to your Favorites.  This shows the real cost of credit default swaps.  It is the cost of buying insurance on bonds.  You'll see we are still the cheapest, except for maybe Sweden or Norway.  To paraphrase Warren Buffett, as long as I own a printing press, I'll be a AAA!

The market doesn't need to advertise . . .

Sunday, August 7, 2011

Triangulating Economics

Everybody agrees that we need economic growth.  Originally, the Austrian or Classical school of economics argued that profligate spending by governments depresses growth.  Following the Great Depression, conventional wisdom found that the deficit spending of Keynesians really helped end the ten-year depression.  Following the stagflation in the late 1970s, Supply-siders successfully created some economic growth by cutting taxes.

Once again, we are in desperate need of growth.  The Supply-siders argue for yet another tax cut, but academics has largely discredited the Laffer Curve, which is the foundation of Supply-side economics.  So, that's out.

There is a rebirth of interest in the typical Keynesian solution of deficit spending to increase demand, but that doesn't work when there is already so much debt that our credit rating is damaged.  So, that's out.

That leaves the old-fashioned Austrian approach of cutting the deficit with both spending cuts and tax increases.  Certainly, that is a great idea, but Americans seek instant gratification, and this old-fashioned approach will take far too long.

Economists are fond of debating the "Liquidity Trap," which occurs when there is a sea of cash but interest rates (and investment returns) are too low to be worth investing.  The investor doesn't care if he holds cash or income-producing investments, as both produce zero.

The two ways out of the Liquidity Trap are debasing the currency or creating significant inflation.  Debasing the currency or dollar makes our manufactured goods cheaper for the rest of the world to buy.  This causes our export industries to boom.  We have exported our way out of recessions in the past, but this was a very severe recession.  In addition, it is a foreign policy disaster for our trading partners.

Creating significant inflation for a few years would speed the recovery by reducing loan-to-value ratios on homes and by making enough assets appreciate in value that investors are willing to borrow money to buy those assets and benefit from that appreciation.  Debasing the currency also helps cause inflation, as imported goods are then more expensive.  Inflation is not all bad, but it is like letting a camel stick its nose into your tent.  It moves in quickly and takes over.  Inflation is very painful to eliminate once started.

This is probably a time for the Austrian approach but with more inflation and a depreciating dollar.  Economists have to triangulate economics, while politicians have to navigate voters, and which politician can say he is in favor of raising taxes, depreciating the dollar, and increasing inflation.  Maybe, that's why politicians have to be so vague and economists don't?  "Vote for me, you'll get a weaker dollar and higher prices!"

Friday, August 5, 2011

Apologies to Mr. Spock

Do you remember Mr. Spock, the Vulcan on the original Star Trek TV series long ago?  He prided himself on being entirely rational and devoid of human emotion.  Being an investment advisor, I've always tried to emulate that thought process.  However, his dirty little secret is that he sometimes felt those emotions, and so do I.

Tonight, Standard & Poor's downgraded the credit rating of the United States of America to only AA+.  (Yes, this is one of those rating agencies that rated sub-prime mortgage backed securities as AAA.)  Hearing that, it was like the first time you heard one of your daughter's ex-boyfriends was bad-mouthing her.  It hurts!

Putting on my best Mr. Spock face, the market will not over-react to this, as it is not a surprise.  Besides, the two other ratings agencies, i.e., Moody's and Fitch, have not downgraded us.  Normally, this would increase our cost of borrowing or the rate of interest that we taxpayers pay on Treasury debt.  Because these are not normal times, especially in Europe, our bonds will pay lower interest as scared investors hide in our Treasury debt, at least until the European storm blows over.  When things get normal, the interest expense paid by taxpayers will increase.

Yeah, yeah, we will survive.  Since the market was expecting it, this is really not a big deal.  Besides, this was not a downgrade of our long-term credit, just short-term.

Still, putting on my best father face, I just wish I could get my fingers around the neck of that ex-boyfriend!!

I'm sorry, Mr. Spock . . .

Pass the Dramamine

What a day!  Before the market opened, the Jobs Report was unexpectedly strong, and the Dow went up 172 points.  As the morning passed, that euphoria also passed as the mounting fears of European sovereign debt increased.  The Dow lost all 172 points and then lost another 245 on top of that, a spread of 417 points.  At mid-day, the European Central Bank (ECB) announced they would begin buying bonds of Italy and Spain, which is essentially quantitative easing for those members of the Euro-zone who are "too big to fail and too big to bail."  After that, the market bounced up and down all afternoon, finally ending up 61 points.  Although it was the worst week in the last two years, losing 5.7%, it still ended on a surprisingly good note.

I applaud the ECB's action today and hope they will become more imaginative, as well as protective like our Fed.   The first step in a twelve step program of recovery is to admit the problem.  I think the ECB did just that today.  Now, the risk is that they will use a .22 pistol when they need a bazooka!  We'll see . . . as soon as the floor stops moving!

"A Pause in the Negative Feedback Loop"

That's how investment legend Mohamed El-Erian described today's Jobs Report, which was a pleasant change indeed.  According to the Department of Labor, America produced 117 thousand new jobs in July, well ahead of the expected 60-80 thousand.  Subtracting the continuing losses in government jobs, the private sector produced 154 thousand.  Even better, the poor jobs report in May and June were upgraded by another 56 thousand.  

Make no mistake:  we need 200-250 thousand jobs produced each month to make a dent in the legions of unemployed.  The good news is that we are doing better than expected!

At this time, the futures market indicates that the Dow will open about 120 points higher, which makes a dent in the 512 point loss yesterday.  While the average investor's stomach feels like it is 2008 again, it is important to remember that the problem was caused by the United States, and we suffered the most.  The 2011 problem was caused by Europe, and they will suffer the most.  We have been far more aggressive than Europe in forcing banks to increase capital, and we will fare better as a result.

At some point (probably next week), somebody will press the Play button on the negative feedback loop and the average investor will have another stomach-ache, but the U.S. market has more underlying strength than they think.  Has anybody noticed that corporate earnings have been excellent, surpassing expectations?

Thursday, August 4, 2011

Euro Whiplash

It is one of those long-time market truths that the market must hit the point of capitulation before recovering.  Today, the Dow fell 512 points, the worst daily performance in 2 1/2 years.  We are now down 10% from the April highs, which makes this an official "correction."  (An official bear market is a 20% decline from the top.)  The volume was also very high, almost 6 billion shares traded.  Heavy volume usually indicates the strength of the move, which means this is a real market slide.  But, are we close to the point of capitulation, when retail investors sell just to end the emotional pain, so the market can start improving?  I hope I'm wrong, but I don't think so.

Today was not the point of capitulation.  It was a day of realization.  For the last month, the American mindset has been so focused on the ugly, demoralizing debt deal that it didn't notice the growing severity of the European sovereign debt problem. Even worse, we realized today that the European officials are in a state of denial about their own problems. 

The Euro-zone is bigger than either the U.S. or China and even harder to govern.  We are being whip-sawed by their problems.  If you are an active trader (as opposed to an investor, who thinks longer term), you will go to bed tonight without knowing what Europe will be doing to your portfolio tomorrow morning at 4AM local time.  In that case, you are better off holding cash tonight.  Therefore, you sell your U.S. holdings today.

Even more problematic, Friday afternoons are the most volatile part of most weeks.  But most problematic is that tomorrow is "Jobs Friday."  If the report is much different from 80 thousand jobs, the market could be very volatile.  Then, there were rumors in Chicago this afternoon that tomorrow's Jobs Report will show a negative number.  If so, your printer will probably need a new red ink cartridge!

While today may not be the day of capitulation, it is a good time to remember Warren Buffett's timeless advice to be greedy when others are fearful and to be fearful when others are greedy.

Cozumel, 1988

After getting her certification as a scuba diver, I took my daughter to Cozumel for some breath-taking reef dives.  Although I'm not a person who normally reads at the beach, I packed a very small book on investing.  While I don't recall the title, it was one of those "the only thing you need to know about investing" type of books.

It said if the PE ratio for the market is 10 or below, it is a raging BUY.  If the ratio is 15 or more, it is a raging SELL.  For example, if the average earnings per share is $10 and the stock price is $110 per share, the PE ratio is 11.  Add up all the stocks in the S&P 500 to get the market's overall PE ratio.  That's all you need to know about investing, according to that book anyway!

Since then, most analysts think the range is now between 15 and 20.  This is because stocks compete for funding against other assets, such as bonds.  When interest rates are so low, stocks look more attractive and go up.  Thus, the range has gone up.

Today, the S&P has a 12.7 PE ratio on next year's projected earnings.  This is very low, historically, and suggests the market is a strong BUY.

Now, if we could just get Europe out of the headlines, maybe we could all go back to Cozumel and read investment books.

Wednesday, August 3, 2011

A Bigg Legend

One of my favorite Wall Street legends is Barton Biggs, who was the Chief Global Investment Strategist for Morgan Stanley compiling an impressive record over many years.  I managed the portfolio of his father-in-law, who was a dear man that died at the tender age of 99, just three months short of the century mark.  During that time, according to his father-in-law, Barton never criticised nor nit-picked management of his portfolio.

I have great respect for Mr. Biggs and have read all of his books.  Today, I watched him on CNBC as he said that stocks are greatly over-sold and are poised for a 7-9% rebound within the next 3-4 weeks.  He felt the "farce" in Washington on the debt deal and continuing anxiety about Europe have made us overly-pessimistic.  He feels the GDP growth rate could recover nicely, approaching 3%.

Still, the questions remain . . . is it too early to pull the trigger and start putting money back into the market?  Or, is the U.S. on the precipice of social and economic collapse? 

In my opinion, yes and no!

Non-Volatile Volatility

Something interesting is happening.  Normally, the stock market falls when volatility increases or vice versa. It is not uncommon for investors to buy the volatility index (VIX), which would go up when the market goes down.  But, that longtime relationship is not working right now, why?

One thought is that the VIX moves quickly during the day, while most "hedge" buyers have VIXM, which has a longer time frame, creating a mis-match in time.

Technically, the VIX measures the price people pay for options to protect their portfolios, e.g., buying a put to sell the S&P or put it to the seller if the market crashes.  Another thought is that so many people have left the market for the sidelines that nobody needs to buy portfolio protection, causing the price of options to decrease.

The most interesting thought is that the sell-off is caused by retail investors leaving the market.  The VIX is primarily used by more sophisticated investors, who don't feel they need it now, because they have turned bullish.

If the retail investors are in a panic leaving the market, while the "smart money" is turning bullish, there may be a very important signal here.  I'm studying . . .

Jobs, Jobs, Jobs

For some reason, politicians always say the word "jobs" three times.  Coincidentally, there are three jobs reports this week.  Two of them were today, neither of them good.

The Challenger report showed that job cuts are up 60% over last month.  The ADP report showed that net job growth continued for the 18th straight month, with 114 thousand new private sector jobs in July, down from 145 thousand in June.  While that sounds good, since there is some growth, we need at least 200 thousand new jobs monthly to make a dent in unemployment.  (The only good news is that small business has produced jobs for twenty straight months.)

The third jobs report this week is the grandfather of all economic reports and comes out this Friday morning.  Last month, the survey of economists were expecting 100 thousand new jobs and were surprised to find only 18 thousand were created.  The survey now indicates 80 thousand new jobs will be reported this Friday.  If we are much below that number, it will likely be another ugly day on Wall Street.

At least, we are not losing 700 thousand jobs each month . . .

Digital Terrorism

The conservative estimate is $1.4 trillion, and the liberal estimate is $3.1 trillion for the cost of wars in Iraq and Afghanistan.  That doesn't include the nearly 7,000 dead and tens of thousands of wounded.  An economist would also have to add to those totals the taxes the dead will never pay and the cost of caring for the wounded during their actuarial lifetimes.  I don't know if we are winning or losing those wars, but that is not the point.

I'm very concerned we are not waging another war, one that has greater economic consequence i.e., Operation Shady RAT.  (RAT means remote access tool, which is a type of software hackers use to attack computer systems from afar.)  It began in mid-2006 and has attacked many governmental organizations and corporations, such as the U.S., Taiwan, India, South Korea, Canada, Lockheed Martin, Citigroup, and Sony.  According to the computer security firm, McAfee, there is a "state actor" behind it.  Hackers attending their annual conference in Las Vegas are convinced it is China.

One executive at McAfee said "this is the biggest transfer of wealth in terms of intellectual property in history."  Isn't that worth defending?  More importantly, computer control of practically every government and corporate function is vulnerable to foreign control.  Isn't that worth defending?

Tuesday, August 2, 2011

The Binary World of Economics

One of the main purposes of this blog is to provide readers with the perspective of all three primary schools of economic thought in the United States.  The first is the Austrian school, which argues a "tough love" approach to budgets, which must be balanced every year.  The second is the Keynesian school, which argues that deficit budgets are fine when the economy is weak, as long as surplus budgets are maintained when the economy is strong, in order to balance the national debt.  The third is the Supply Side school, which argues that taxes weaken an economy and that the best way to stimulate the economy is to reduce taxes.

Supply Side economics is almost unique to the United States.  The rest of the world has a more binary view between Austrian and Keynesian economics.  Most European nations have adopted more Austrian budgets, with lots of austerity measures.  With approval of the U.S. debt deal, it is clear that austerity is coming to the largest consuming nation in the world.  Austerity reduces demand.  To Keynesians, reduced demand leads to reduced prices, which leads to reduced supply of products by manufacturers, which leads to high unemployment, which leads to even more reduced demand.

With China trying to reduce growth or demand in that nation to control inflation, where will growth come from?  If not Asia, Europe, or the U.S, where?  Since nobody has a good answer to that question, all those portfolio managers and investors of the Keynesian school have no reason to risk capital by leaving it invested.

With Friday's weak report on the GDP, with yesterday's surprisingly weak ISM report, and today's report that consumers are saving more and spending less, Keynesians could see no hope for demand growth.  As they continued to leave the market, the Dow dropped 265 points today. 

Risk-Adjusted Returns

Suppose you buy a stock and sell it one year later for a 6% profit, including dividends.  Was that a good investment or a bad investment?  The answer is that it depends . . . on how much risk you took.

If you took a lot of risk, it was probably a bad investment.  If you took minimal risk, it was probably a good investment.

If you bought a large cap value stock producing consumer stables, paying dividends for 40 years, like Altria, it was probably a good investment.  If you bought a start-up tech company, you deserved a much higher return, making it a bad investment.

America is definitely in a better place with the new budget deal.  The spending curve has been bent a small amount, which is a good thing.  The conversation has changed, which is a great thing.  But, was it worth the risk we took?

Monday, August 1, 2011

Nice Whiplash!

The market opened up strongly this morning with a rally that lasted about thirty minutes.  First, the ISM report came in weaker than expected but still expansionary.  More importantly, as mentioned in this morning's blog, the European sovereign debt crisis raised its ugly head again, with the rumor that the president of Italy (who faces embarrassing charges about younger women) has fired his finance minister who was pushing their austerity program.  The Italian market was up 1.4% but closed down 4.3%, which is a huge turnaround and the 2011 low for that country.  It didn't help the U.S. market either!

How long will it take to get this final crisis behind us?  Not anytime soon, unfortunately!

Plop, Plop, Fizz, Fizz . . . Redux

You might re-read the July 2nd blog for the definition of a Relief Rally.  The world markets have been terrorized (and I do mean terrorized) by linking the debt ceiling with budget negotiations.  Now that a deal appears to be in hand, the world markets are rallying strongly.  Does this mean it is party time?

No, while there are still lots of details we don't know, it is reported the deal will set up a "committee" of partisan children who will hammer out the actual budget cuts by Thanksgiving.  I'm not optimistic about this.  As the Simpson-Bowles Commission could not reach agreement, I'm not optimistic that this one can either.  This will trigger automatic cuts that are unclear.  Rather than cut intelligently, it will be done automatically.  For example, Rand Paul would cut everything 1% per year every year for seven years, including Social Security and Medicare.  Go tell your grandmother about that!

Also, don't forget there has been two other problems weighing on the markets.  First, there was the end of QE2, which expired quietly with other central banks picking up the slack.  More importantly, the problem of European sovereign debt remains.  We have not heard the conclusion of that one.  Stay tuned . . .

(Some analysts argue there is a fourth problem, i.e., that the recent weak economic data suggests another recessionary dip, but I disagree.  Recovery from a financial crisis just takes longer than recovery from a normal recession.  Bank lending has finally started to rise, albeit minutely.) 

So, enjoy the Relief Rally for a few days!  Futures indicate the Dow will open up about 160 points.  What's not to enjoy . . .  for the moment?