Friday, September 30, 2011

A Beneficiary of Political Indecision?

Take a look at this chart on gold:

Apparently gold is at an important point.  If it breaks below the green line, it is expected to drop substantially.  But, what if it doesn't?  Is this uptrend sustainable?  The chart covers only the last eleven years, omitting its $800 high some twenty years ago.

Gold could break its uptrend at any time, but I doubt it will happen before the high level of political uncertainty is reduced.

Good Riddance!

The third quarter ends today . . . Good! 

It was awful, with the S&P losing about 12.5%.  That's the good news.  The bad news is that October is usually the worst month of the year!  At 5AM, futures indicate the Dow will open about 90 to the downside, a fitting end to an awful month and beginning of a possibly worst one.

Back in April, I was expecting the bottom would be reached in Sept/Oct but now suspect it will be later.  Politics can mess up things quickly but fixes things only slowly.  I've studied the work of Joseph Schumpeter for years.  He was the famous Austrian economist who did early research into economic cycles and coined the expression "creative destruction."  While he was very successful in identifying economic patterns, he did so before the 24/7 news cycle gummed-up the political machinery.  Whether this has shortened or lengthened economic cycles is a subject of debate among economists.  It has certainly made it more problematic.

Since Europe is just now approving their July agreement and has not even started the approval process for their September "agreement", and since the July deficit debacle in the U.S. will return during the Christmas holidays, and since January is historically the best month of the year, I suspect politics trumps economic cycles . . . for now.

Thursday, September 29, 2011

The Underlying Economy

Realizing that the linkage between the economy and the stock market can sometimes be tenuous, it was good to see the latest economic releases this morning.  I've been saying the underlying economy was weak but not as weak as most people think.  Today, the final GDP growth rate for the second quarter was released.  It was increased from 1.1% to 1.3%.  This is up substantially from the 0.4% in the first quarter.  Make no mistake, this is not good, but the world is not ending either.

In addition, initial claims for unemployment dropped below 400 thousand for the first time since early April 2011.

The futures now indicate the market will open up 200 points, instead of the 100 points indicated earlier.  We are not going into recession, unless Europe pulls us into it!

Headlines, Theories and The Market

The market is often described as panic-depressive, because it over-reacts to most everything.  Maybe, it is just a matter of degree, but I have never seen it so headline-dependent.  (Of course, everthing is different in the face of a financial crisis, which is entirely different and much worse than a standard recession.)

Fortunately, the German parliament approved the July plan for the EFSF or stabililty fund.  Yesterday, the prickly Finns also approved it.  If they had not, the market would be down, probably a thousand points.  Instead, it looks like the Dow will open up about 100 points.

Another sign that this bear market is different is that Modern Portfolio Theory is not working.  That is the "gold standard" practiced by the vast majority of investment managers.  It was developed by Harry Markowitz in 1958 (So, how modern is that?).  He won the Nobel prize in 1972 for it. 

According to this theory, investment returns can be increased, while decreasing risk (the Holy Grail) by exposing the portfolio to many asset classes, e.g., big cap growth, small cap value, commodities, cash, etc.  In other words, when one asset class is losing value, another is gaining value, maintaining the value of the overall portfolio.  However, in 2008 and again this summer, all asset classes have lost value, even gold.

Some analysts say that means we are hitting the bottom, when all asset classes move together.  While I hope so, I'm convinced that is just a coincidence and that Modern Portfolio Theory only works . . . until it doesn't!

I'm still convinced nothing will get better here until the spectre of financial collapse is gone in Europe!

Tuesday, September 27, 2011

Out of Left Field . . . A Miracle?

The market "prices in" various risks.  For example, as the market worried increasingly about the European crisis, it continued to discount the value of stocks lower and lower.  It would stay low until worry about that risk subsided.  Yesterday, there was a surprise CNBC report, that seemed to come out of left field, saying there was a serious effort to put together a European version of our TARP.  The Dow promptly jumped 273 points.  Today, the futures indicate it will open another 180 points higher.  Europe is up 3-4%.  It looks like a very good day indeed.

Here is what is worrying me:  there are almost no details!  Given the inability of the 17-nations in the European Union to even agree on the definition of the problem, this "deal" could easily unravel.  The next vote is Thursday in Germany.  If they vote against it (whatever "it" is), you can expect an ugly drop in the market immediately afterwards.  The fat lady has not sung yet!

I do believe that our market will rally even more when we know the European debt crisis is resolved, because the chances of another full-blown recession in this country will drop dramatically.  This affects everything from unemployment, governmental revenues, and, oh yeah, the value of your portfolio.

Monday, September 26, 2011

The Market Will Open Higher . . . Darn It!

History is more interesting than instructive, unfortunately!  If you re-read Friday's blog, you'll recall the observation by the revered Art Cashin of the Thursday/Monday syndrome, whereby Thursday is very bad, Friday is choppy and Monday is terrible (reflecting "capitulation").  Then, a long bull market begins on Tuesday.

On Friday, I predicted this is unlikely without some hope of fixing the European crisis.  Over the weekend, I studied this historical phenomena and found there is some evidence of this pattern.  Loving history, I began to weakly hope today would be terrible, and history would repeat itself, with a bull market starting tomorrow.

The good news/bad news this morning is that the Dow will open higher about 100 points.  Maybe, sometime during the day, some horrible news will be announced, scaring the retail investors out of the market, producing a "crash," and the strong bull market can begin tomorrow.  But, I still think that, even if the market crashes today, there can be no recovery without hope of resolving the European crisis.

Maybe, history does repeat itself . . . but not often enough!

Sunday, September 25, 2011

A Society of Fear?

My frustration with the Tea Party has been their simplistic focus on spending, without making the critical distinction between entitlements (which consume the vast majority of government spending) and discretionary spending (which is a far smaller problem).  I've discussed in this space before that a 100% elimination of discretionary spending would not eliminate our deficit problem.  There is no mathematical way to solve the deficit problem without solving the entitlement problem first.

If the Super-Committee doesn't reach agreement by Thanksgiving and if Congress doesn't approve it by Christmas, then automatic cuts become effective . . . all to discretionary spending and none to entitlement spending.

Playing the Tea Party game of ignoring the 800-pound gorilla in the room that is entitlements, let's look at just one problem in discretionary spending, i.e., prisons, which consume a "mere" $200 billion of taxpayer dollars each year . . . to house, feed, clothe, and provide free medical care to 2.3 million Americans.  (In 1980, it was only 500 thousand.)

The median incarceration rate for all countries is 125 prisoners for every 100 thousand people.  In Japan, it is only 63.  In Germany, it is only 89.  In England, it is 153.  However, in the United States of America, it is a staggering 743!  Are we twelve times more evil than Japan and five times worse than England?  Shouldn't the Tea Party also ask why we are so much more evil than the rest of the world?

The U.S. has 5% of the world's population but has 25% of the prisoners . . . at a cost of $200 billion every year!

There are at least two problems in cutting this discretionary spending item.  First, we are bombarded with fear.  We spend unlimited dollars to reduce risk only a minimal amount.  There is no cost-benefit analysis for safety . . . but maybe, there should be.  Mankind has always lived with some degree of risk.  Why are we willing to bankrupt ourselves to eliminate it now.  Again, we are bombarded with fear!

Second, the elected cowards in Congress and state capitals also live in fear . . . fear of being called "soft on crime."  It is too easy to pass legislation increasing the number of punishable crimes or increasing the length of sentences and then let another generation of elected cowards pay for it.  If they could think beyond warehousing people to fixing people, it would help.  If the objective is to reduce costs, we can stop sending so many people to prison or make their sentences more "token" or we can try to fix them, and if that doesn't work, we can execute them more quickly.  What is the Tea Party position on this?

Perhaps, I am too skeptical of the Tea Party.  After all, it is not the duty of the Republican party members nor the Democratic party members to design legislation.  That is the role of the elected cowards.  But, maybe the Tea Party could focus their understandable ire toward the real spending problem, which is entitlements.

The Tea Party could help enormously if they would send a message to "Cut my Social Security check" or "I'll pay for my own health care, thank you."  It is cowardly to merely increase the bombardment of fear.  We have enough of that already!

Saturday, September 24, 2011

Are You Ready For Some Football?

This was a miserable week for Wall Street, with the Dow down 6.4%.  That was the worst week in almost three years.  It was like investors collectively but suddenly realized the whole world has a leadership vacuum.  In addition, a lot of other things were happening beneath the headlines.

World markets got hammered worse than the U.S. stock market.  With funds from selling their stocks abroad, foreign investors were buying U.S. dollars, driving the dollar up enough to drive down the price of gold, which had the worst week in almost twenty-eight years.  One of the characteristics of gold is that it is a store of value that can always be sold to raise cash.  That was certainly true last week as investors in the emerging markets, which are much less liquid than the developed markets, sold gold to raise cash for margin calls, etc.

In other words, money moved out of stocks and commodities into currencies, primarily the dollar, Swiss franc and Japanese yen.  Raise your hand if you think this is sustainable.

If you want to worry while the markets are closed for the weekend, pay careful attention to the G-20 meeting of finance ministers and central bankers in Washington.  The reason Thursday's slide didn't continue on Friday was (1) selling fatigue and (2) the eternal hope that the G-20 bureaucrats will fix the European crisis.  If the Sunday night announcement at the conclusion of the G-20 meeting is platitudinous as I expect, Monday will probably be ugly.

Frankly, I think your time would be better spent this weekend watching the gridiron games!

Friday, September 23, 2011

A Historical Precedent?

One of my favorite commentators is Art Cashin of UBS, who has been on the floor of the New York Stock Exchange for over fifty years . . . literally . . . 50 years!

This morning he spoke about the "Thursday/Monday" syndrome, which sets the stage for a strong bull rally.  On Thursday, the bears run wild on heavy volume, but the market recovers somewhat before the close, just like yesterday.  Next, according to this historical pattern, the market on Friday is choppy, which certainly describes today.  Then, there is no bullish news over the weekend.  When the market opens on Monday, there is heavy selling all day, which is "capitulation" or that moment when all the retail investors have sold out, and the bottom is reached.  On Tuesday, the market begins a long, sustained rally!

He compared the current market with other market turnarounds rather convincingly.  I don't know if the comparison is valid, but I sure hope it is!

I can foresee Monday will be bad, under any circumstances, but I cannot foresee a Tuesday rally unless there is some hope of resolution on the European crisis by then.

TGIF . . . Not

Yesterday was ugly, with the Dow dropping almost 400 points.  Earlier this morning, the futures market indicated the Dow would open up over 100 points but has been drifting down since then.  It looks like it will open slightly down right now.

Traders, especially high-frequency traders, are driving the market now.  (Investors try to pick good companies in good sectors of good countries.  Traders don't care about that.)  Traders don't like to be exposed over the weekend, especially if the weekend might bring bad news.

With the G-20 meeting and rumors that Greece will announce its default this weekend, today should be another down day for the market.

Frankly, I'm ready for Greece to default.  While it will be bad for the European banks, it will be worse for the Greek people, who will immediately be shut off from the flow of borrowing that keeps them afloat.  The banks will then be bailed out by their governments, and their taxpayers will pay the bill, as usual.

The question is whether it will be a Lehman-event.  Will it threaten the world's financial system?  Probably not, but the jury is still out . . . way out!

Life goes on . . .

Thursday, September 22, 2011

One-Two Punch?

As a lifelong student of the investment markets, I usually take comfort in understanding both it's cyclical behavior and its tendency to over-react to news.  When I don't understand, I get worried.

I'm worried!  The Dow lost over 100 points at closing yesterday, for no ascertainable reason.  It was certainly not the usual over-reaction to yesterday's meaningless Fed announcement.  Overnight, China released the PMI report, which showed a tiny contraction in growth.

Yet, Asia dropped almost three percent.  Europe is down even more.  The futures market is telling me the Dow will open almost 300 points down.

The hope for growth in the world is China, and the source of worry is Europe.  One is slowing down, and the other is experiencing crisis fatigue.

I'm not suggesting the sky is falling.  I am suggesting that great buying opportunities are still ahead of us.

Wednesday, September 21, 2011

Going To Extremes

I was raised as an Eisenhower Republican, i.e., distrustful of both big government AND big business, as well as deeply suspicious of foreign entanglements.  (Undoubtedly, the latter has fueled my lifelong interest in globalization.)

On Monday, I gladly attended a fundraiser for George Allen, whom I have supported in the past.  However, it was not about him.  It was not about his opponent.  It was all about Obama.

At the reception preceding the luncheon, I was talking with another candidate for a different office and asked him what he thought might reduce the damage to the economy from the intractable housing crisis.  His only response was to get rid of Obama.  I pushed by asking what should be done after Obama is then out-of-office, and he responded by "putting Republicans into decision-making roles."  He had no better ideas.

At what point does principled end and obsessed begin?

Can you remember when elections were a battle of ideas, not a clash of cults demonizing the opposition?  It has been 51 years since Eisenhower left the presidency, and I think he would be profoundly disappointed with the big-party politics of today.  Maybe, that is the reason  . . . I STILL like Ike!

Monday, September 19, 2011

The Morning After . . .

Last week, the markets rallied nicely, up 4-6%.  They were expecting something constructive from the G-7 finance ministers meeting this weekend in Poland, with the announcement last night.  That didn't happen, and the markets are peeved this morning.  Europe is down 2-3% already.  Our futures indicate the Dow will lose about 130 points at the 9:30 open.

I expect all week to be rough, as the Greek prime minister set the stage by saying the next 7 days are critical.

Another thing is worrying me, i.e., equity mutual fund outflows.  Saturday was the third anniversary of the collapse of Lehman, believe it or not.  In the last four months, investors have taken out more money than they did in the four months prior to the Lehman collapse.  One could interpret this as investors fearing the collapse of Greece will be worse than the collapse of Lehman, which I would doubt.  Another interpretation is that investors are "once burnt, twice shy," which I suspect is more likely. 

The most fear-based scenario is that the collapse of Lehman will be nothing compared to the collapse of Europe as a whole continent, which would be true.  However, even if the European decisioning process proves to be as impotent as our American process of making decisions, which is hard to believe, it is also hard to believe that China will stand-by and lose their two biggest customers, without even trying to use their financial strength to gain geo-political advantage.

I plan to keep my head down and my powder dry for at least another month or so.

Saturday, September 17, 2011

Reading the Fed

This week, the Fed will meet for a special two-day meeting.  Normally only a one-day event, Bernanke wanted to make sure any disagreements were fully explored.  So, what should we expect?

The market believes the Fed will announce Operation Twist, which means they will sell some of the shorter-term Treasury bonds (at a profit) and buy some longer-term Treasuries.  In other words, the average maturity will increase.  This is expected to lower long-term interest rates, which should make business investment somewhat more attractive, as well as lower the home mortgage rates even more.

Frankly, since the Fed is one of the few functioning institutions left in this country, there is a need to do something.  When I was in Officer Candidate School, they taught us the importance of doing something, anything really, when your men come under fire.  The Fed is doing this, unfortunately.  Operation Twist is the equivalent of yelling "hit the dirt!"

In addition, they may stop paying interest on the reserves maintained at the Fed by member banks.  By increasing the need of banks for income, it is hoped they might actually make a loan again.

Of course, they will probably "jawbone" the market, by promising to keep monetary policy loose as long as it takes to reduce unemployment, one of the Fed's dual mandates, along with preventing inflation.

Once the market realizes the hollowness of the Fed's announcement, I expect downward pressure on stock prices . . . darn it!

Friday, September 16, 2011

Guilty As Charged!

There are some people who watch every movement in the market and hope to glean some minute parcel of meaning from it.  Today will be a bad day for them!

First, Fridays are traditionally more volatile than other days, as traders decide whether to remain in cash over the weekend.  If dramatic news should break over the weekend (think Greece), they are more likely to sell stocks and hold cash.

In addition, today is a quadruple witching Friday, which is one of those few days when both options and futures expire simultaneously.  Anything can happen on such days . . . or nothing at all.

Lastly, Modern Portfolio Theory is the standard religion on Wall Street.  Originally developed by Harry Markowitz, who won a Nobel prize for this theory of mathematics, it concludes that investors can increase returns, while decreasing risk (which is the Holy Grail), by holding many different asset classes.  The mathematical reason for this is that different asset classes move in different directions or amounts at the same time.  In other words, your portfolio has greater diversification when assets are not correlated too much.

However, in times of financial stress, we've found all asset classes move alike.  In other words, the investor looses the benefits of diversification when he needs it the most.

We're seeing correlations increase right now, which skews most all other market technicals.  The market is driven by headlines out of Europe right now, not economics out of America.  So, whatever happens today, don't be one of those people who try to analyze it too much . . . like me!

Thursday, September 15, 2011

It's Morphine . . . Not Penicillin

In a remarkable piece of world-wide cooperation, many of the world's central banks have agreed to provide liquidity funding for European banks, mostly dollar swaps.  Not surprisingly, the European and U.S. markets are up nicely, and gold is down about $40/oz.  The markets feels good now, because they got a shot of morphine.

Unfortunately, this solved the problem du jour, nothing more.  The European problem is not a banking liquidity problem but is instead a banking solvency problem.  Since the last financial crisis, they have not increased their capital nearly as much as the U.S. banks have.

The accounting mechanics are this:  Assume you paid $1,000 for a bond that now appears as an asset worth $1,000.  However, if the market value of that bond drops to only $700, the bondholder has lost $300.  That amount has to be subtracted from income.  If there is no income, that amount has to be subtracted from the bank's capital.  If the bank lends twenty times the amount of its capital, then the bank has to reduce its loans outstanding by $6,000.  Because that is difficult to do, there is a real dis-incentive to making loans now, if you expect to take losses against capital later.

Eventually, the governments of Europe will have to inject capital into their banks.  They need a U.S.-style TARP.  This would go a long ways in restoring the confidence necessary before banks can actually raise capital from the market.  If the world's central banks did this, it would be a shot of penicillin!  (It doesn't make you feel better quickly but does actually fix the problem.)

Then, the bull rally will be believable but not yet.

Wednesday, September 14, 2011

Contrary to Popular Belief

A few years ago, the Governor appointed me to the Virginia Public Building Authority.  Technically, the job is to issue all bonds authorized by the legislature to construct public buildings.  Practically, the job is to make sure the investment community doesn't take advantage of the state bureaucracy.

Today, I was in Richmond attending the meeting to approve $398.5 million in new bonds, including $100 million to re-finance existing higher-rate bonds.  It was a tedious meeting, full of mind-numbing details.

Of course, I know it is fashionable during these times to hate the government and to ridicule the lazy people who work there.  Yet, that is certainly inconsistent with my observations.  I'm finding people who are as knowledgeable and sophisticated as any I've met in the trading rooms of money-center banks or broker-dealers.

Yes, they seem less harried, less aggressive, and less hungry than those on Wall Street.  But, they also seem more motivated by doing the right thing, not just working their compensation plan like they do on Wall Street.  I think the state of Virginia should actually be proud of them!

The bad news is that I was elected Vice-Chairman of the Board today . . . proving once again that no good deed goes un-punished!

Monday, September 12, 2011

Pricing In Armageddon?

As predicted, the G-7 meeting of Finance Ministers and Central Bankers this weekend in France produced another "mealy-mouth" statement, and the world markets are dropping in response.  Asia and Europe both dropped sharply overnight, and the futures market indicate the Dow will drop about 140 points at the open, on top of the 303 points lost on Friday.

The stock markets of the world alternate between absolute frustration and almost breathless fascination, at least for a few of us.  The world markets are now pricing in the certainty of a Greek default, followed by possible contagion among the PIIGS.  Those markets would be at one level without these problems and another level with these problems.  What level properly reflects the European crisis?

We are probably very close to reflecting a Greek default only.  We are probably very far away from reflecting a collapse of Europe.  The optimistic scenario is that the European Union will learn from the Greek default and learn how to govern.  The pessimistic scenario is that they will not. 

If Armageddon is truly upon us (which I don't believe is realistic), then "watch out below!"

The silver lining is that the Euro is dropping rapidly against the dollar, making it cheaper to take your European vacation . . .

Sunday, September 11, 2011

September 11, 2001

At the time, I was running SunTrust's wealth management office in Olde Town Alexandria, a surprisingly deep pocket of wealth.  I was at work early that day to prepare paperwork for a loan to a long-time friend and client that afternoon in Newport News.

About 9:30, an employee walked in my office, asking me if I had heard about a plane crashing into the World Trade Center.  Of course, I had not and wondered how such a thing could happen.  Making a mental note to pray for the victims that night, I resumed my work.

Shortly afterward, I heard a TV in another employee's office, which was highly irregular.  Investigating, I learned of the second plane crashing into the other tower.  Then, they asked if I had looked out my office window, which had a view of the Pentagon.  Returning, I saw the huge billowing smoke, and it was drifting toward my wife's office, also in Alexandria, where they eventually evacuated. 

Turning on WTOP, the local all-news radio station, I heard that a truck bomb had been detonated in front of the Federal Reserve, a short distance away.  Fortunately, it was untrue but it certainly helped set the tone of a massive terrorist operation.

Since there could be no focus on the job, I told anybody who wanted to go home that they could leave immediately.  Along with one assistant, I stayed throughout the afternoon, in case any clients wanted to talk.

Whenever I looked out of my window, I could see the smoke and flashing lights at the Pentagon.  Looking down, I could see the traffic was virtually grid-locked.  I saw smaller cars trying to drive on the sidewalks.  When I finally left the office, it took me 3 1/2 hours to get home.  Frequently, during the interminable delays on the road, I offered silent prayers for the dead.

The lady who lived next door to us worked in the Pentagon and was severely traumatized by the attack.  In fact, I doubt she ever recovered fully.  As she ran from the Pentagon, she lost one of the heels she was wearing and obsessed about the lost shoe for a very long time.  Maybe, that helped her to live with the memory, and I wish her well.

With ten years of perspective, I now think Osama bin Laden did to the U.S. what Reagan did to the U.S.S.R.  (Remember the Strategic Defense Initiative?)  That is, bin Laden forced us to choose between capitulation or bankruptcy.  The U.S.S.R. essentially capitulated but too late to avoid bankruptcy and no longer exists.  The U.S. will never capitulate and predictably chose the path to bankruptcy (or at least accelerated on that path toward bankruptcy).  I know we won't get there, but I am very glad that the insanely brilliant bin Laden is rotting in hell, where he belongs!

Saturday, September 10, 2011

The Austrian Perspective . . . Pain

I sagely predicted the market would drop on Friday.  My thinking was that Friday is the most volatile day of the week anyway, and everybody would be disappointed with the Presidential address on Thursday night.  However, in addition to that, there were a number of rumors coming out of Greece and Brussels, which deeply unsettled the market.  The Dow dropped 303 points.

The first rumor, which turned out to be true, was that an important director of the ECB was resigning over the ECB's continuing purchases of government bonds from Europe's weaker states.  Internal dissension like this rattles investor confidence.  The second rumor, which may be true or not, was that Greece will default on Monday.

At this point, I don't think Greece can be saved.  While Europe has the resources to do it, it doesn't have the decision-making capacity to deal with it.  It is not the United States of Europe!  In the U.S., numerous cities and counties have taken bankruptcy, and we already have a bankruptcy system to deal with it.  But, nobody knows what will happen in Europe.  Once again, we are plunged into the unknown!

Jim Rogers is a legendary investor who is so confident the U.S. is a failed state that he moved his family to Singapore.  Yesterday, he was hoping Greece would fail quickly and let Europe start cleaning up the mess.  In a display of pure Austrian economic thinking, he advocates letting the market function like a barracuda in the short run, inflicting massive pain for the sake of efficiency, but functioning like a benevolent dictator in the long run.  From the standpoint of economics, he may be right!  From the standpoint of a long-term investor, he may be right!  From the standpoint of a short-term investor . . . run for the hills . . . or Singapore.

Friday, September 9, 2011

How Low Can It Go?

We know gold has become expensive and that houses have become relatively inexpensive.  If you measure the average cost of a house divided by the price of gold per ounce, you get the cost of the house in ounces of gold, instead of dollars.  Now, take a look at this chart.

Does this suggest houses are under-priced, or that gold is over-priced?  If you tried to arbitrage assets, you would sell gold and buy houses.

I think the relationship is more interesting than meaningful.  Gold is primarily a measure of fear.  I don't think houses have anything to do with fear.  However, it may predict an inflection point in the economy, and I will study that more.

The Jobs Speech

One characteristic of existential observers is the tendency to see absurdity in many things and to find some wry humor in that.  I felt that way watching the Presidential Jobs Speech last night.

First, he walks into a room where at least a hundred people truly hate him but nonetheless stand there applauding anyway.  Then, he asks them to do something he already knows they will NOT do, i.e., approve his new jobs bill.  It gives the word "absurd" new meaning!

Until Republicans abandon this notion that high-income taxpayers, like myself, who do NOT create jobs should pay less taxes . . . AND SIMULTANEOUSLY . . . the Democrats abandon the notion that entitlements are so perfect and sacrosanct that future generations love to pay for our benefits . . . then, it is an exercise in absurdity.

The Co-Chief Investment Officer of PIMCO, whom I respect greatly, described the speech as a "Sputnik moment" when America wakes up and decides to catch up.  I hope he is correct!

However, during the speech, I watched the futures market leak slowly down.  Asia was down slightly, and Europe has just opened slightly down.  Maybe, they didn't get the memo this is a Sputnik moment??

Thursday, September 8, 2011

That Cat Don't Meow

Imagine standing on the roof over your garage and tossing the dead carcass of a cat onto the driveway.  It will hit the driveway and bounce up somewhat before falling back on the driveway.  That disturbing imagery is what Wall Street calls a "dead cat bounce" . . . or what I call . . . yesterday, when the Dow gained 275 points. 

The underlying U.S. economy is still struggling ahead alone without assistance from anybody, unfortunately.  At the same time, the U.S. stock market is being whipped daily by the headlines, mostly out of Europe.  We have become headline-dependent.  Yesterday, there were no bad headlines, and it was a good day to own stocks.

One of the many, many reasons I'm proud to be an American is our undying optimism.  I know, it is hard to see, especially during these times of national malaise, but it is there.  Take away the headlines, and the stock market wants to rise.

Now, how do we get rid of those depressing headlines?  Give it time!  Despite the childish wrangling of both last night's debate and the Presidential address tonight, this malaise will pass.  Just ask Jimmy Carter!  Remember him?  Do you remember the depths of Watergate?  Do you remember the Democratic Convention in 1968?  This too shall pass!

I keep thinking about the Turkish president's comparison of democracy with streetcars, i.e., when you get to your stop, you get off.  Of course, I've finally decided . . . that dog won't hunt!

Monday, September 5, 2011

Brace Yourself . . . September in PREview

When our terrible Jobs Report came out on Friday, the Asian markets were closed.  They opened today and starting dropping . . . and dropping.  Overall, it dropped about 3%, with Korea leading the way down at 4.4%. 

Over the weekend, Angela Merkel lost an important election in her home state, ramping up speculation that she would not be able to deliver Germany's essential support for any plan to save the Euro-zone.  When the European markets opened, they also started dropping . . . and dropping.  Overall, it dropped about 3.5%, with mighty Germany leading the way down at 5.2%.

It is too soon for the futures market to tell me anything, but I expect the Dow will lose not less than 200 points at the open tomorrrow morning . . . and probably more.

There is very little good news, but isn't that always the case when you need it the most?  And, don't expect history to help.  As bad as August was, September and October are the weakest two months each year, historically.

Thinking about this month, this week will be highlighted by the President's over-hyped speech on improving employment.  The only tool left in the Keynesian toolbox that could help would be another WPA or CCC (Civilian Conservation Corps), but that is a luxury for a nation without the crushing debt-load we have.  Anything else he recommends will be DOA anyway.  My suspicion is that the market will fall on Friday, after the disappointment of his speech Thursday night.

Next weekend, the G-7 finance ministers and central bankers will meet in Marseille, France.  If  there is no announcement of progress on the European debt crisis Sunday night, then I expect the markets will fall again next Monday.

On September 15th, the second tranche of the Greek bailout package is due.  It is 110 billion Euros.  Because Finland is still demanding collateral that will alienate other members of the Euro-zone who don't get collateral, because the recession in Greece is worse than earlier estimates, causing them to miss their first austerity targets, and because of Merkel's increasing weakness, there is a very high probability that Greece will then default. 

Winston Churchill is famous for saying Americans will always do the right thing but not before exhausting all other possibilities.  He could have said the same for the Europeans.  So, I hesitate making a prediction.  Nonetheless, the market has spoken.  Sovereign debt of Greece due in only two years now pays over 50% in interest.  (Imagine borrowing $100 thousand now but being forced to repay $225 thousand in only two years.)  By comparison, the U.S. pays only 2% on two-year Treasury bonds.

Probably, the most important date to write on your calendar this month is September 21st.  That is the day the FOMC (Federal Open Market Committee) of the Fed holds their next meeting.  Normally, it is a one-day meeting, but Bernanke has scheduled two days for this meeting, to give the dissenters ample time to argue their case.  The market will probably rise before the meeting, in hopes QE3 will be announced.  I'm confident there will be an announcement, but it will not be the politically-charged QE3 (to be discussed later in another blog).

Remember September 29, 2008 when Congress failed to approve TARP, and the market crashed 777 points that day.  On September 29th of this year, Germany's Parliament is expected to vote on the increase to the EFSF (European Financial Stability Fund).  If that fails to pass, I expect another big market drop, both in Europe and the U.S.

On the last day of this painful month, the short-selling ban on Spanish and Italian bank stocks expires.  They could easily plunge at that point, taking the European and U.S. markets on yet another ride to the cardiologist's office.

That's all the good news for September.  I'll bet you can't wait for October in PREview? 

Saturday, September 3, 2011

The Linebacker and the Cheerleader

Given my belief that Congress is inhabited by useless children who would rather fight than win, I often need to be reminded that it has actually passed two important bills to deal with the economic crisis.

First, during the waning days of the Bush Administration, it did pass TARP, albeit on the second try.  Although the money was never used as authorized to purchase mortgage-backed securities, it was nonetheless very successful.  The latest CBO estimate is that taxpayers will be repaid $675 billion, out of the original $700 billion authorization, most of which has already been repaid.  Indeed, some estimate the taxpayers will actually make a profit.  One primary reason for the success of this program was that Hank Paulson insisted on taking a bazooka to a knife-fight.  Although he didn't think we would need $700 billion, he demanded enough money to "shock & awe" Wall Street.  And, he did!

Second, during the opening days of the Obama Administration, Congress did pass a stimulus package of approximately the same size, i.e., $787 billion.  It was a failure.  There is an old Washington adage that Republicans would vote for a bucket of warm spit if it had a label reading "tax cut."  To win passage, the President agreed to allocate $275 billion of the total to tax cuts in order to buy Republican votes.  Next, recognizing the states and cities were in even worse shape than the federal government, he allocated about $220 billion to them, just to keep their doors open, merely postponing the inevitable, without stimulating anything.  That only left less than $300 billion to actually stimulate the economy.

The U.S. economy was approximately twice the size of the Chinese economy.  They also quickly implemented a stimulus package . . . of about $513 billion, entirely for infrastructure needs.  In other words, they invested a much larger proportion of their GDP into stimulus than we did.  Today, their economy is growing almost 9% annually, while our economy is growing at less than 1%.  There was no Hank Paulson in the Obama Administration demanding that we take a bazooka to a knife-fight, and we "stimulated" too little.

Imagine a 340-pound NFL linebacker has the ball and is running downfield to score.  Would you send a 120-pound cheerleader onto the field to tackle the linebacker?  Of course not!  The linebacker would easily run over her, and you would have wasted one cheerleader.  A pitiful $300 billion stimulus package was futile in an economy as big as ours, especially one in such a severe recession.

Yet, this is not an argument for another stimulus package.  When you take a knife to a gun fight, you don't get a second chance.  More importantly, we can no longer afford the $1 trillion stimulus we need, especially if we also have to spend another $2 trillion in payoffs to get the votes.

We had a chance, and we blew it!  Hank Paulson . . . where are you?

Friday, September 2, 2011

A Graph = 1,000 Words

Take a look at this graph.  The job problem is different than most investors think.  First, you will notice the graph covers only normal recessions, not any of the financial panics.  Second, job growth after recessions did not return to the "average" after 2001.  We have been growing jobs below trend for ten years already.  Third, the variance below trend is greater now than any time in this graph.  Bottom Line:  It is very grim, indeed!

This below-trend period coincides with the rise of globalization.  If we could measure the benefits of globalization as easily as we measure job growth, we would still remain committed to globalization.  The benefits will far exceed the costs. 

But, we could have done a much better job of preparing our workers, especially in entrepreneurship.  Now, it is too late, because we can no longer afford it??  Besides, who is "we"?

Don't Touch That Dial!

The world deserves a long holiday weekend!  After a horrific August, the worst since 2001, we head into September, which is historically a very bad month for the stock market.  The first day was a down day for the market, as the European tail wagged the U.S. dog again. 

Decision-making in Europe actually makes Washington look downright decisive.  They must deal with more than the typical right-left divide.  They must deal with issues of national pride and lingering ethnic issues over past wars.  (Interestingly, they don't have the divide between social conservatives and more secular voters?)

In addition, the most important monthly economic report is the Jobs Report.  Traders typically take money off the table in advance of that volatile report, pulling the market down.  This report will be even more volatile because the impact of the Verizon strike is so unclear.  Nonetheless, economists were expecting about 80 thousand new jobs but NO jobs were produced, which is about 300 thousand less than we need.  Last month's estimate was also reduced 32 thousand.  Private sector jobs created dropped from 156 thousand last month to only 17 thousand.  (The health sector lost 32 thousand??)  Futures plummeted indicating a loss of about 185 points on the Dow at the open. 

In the way of paybacks, the European markets dropped instantly when our Jobs Report came out.  Gold went up and the interest rates on Treasuries went down, as investors seek the safety of Treasuries for now.

More importantly, does this make a recession more likely?  Yes!  Does it mean we will have a recession?  No!  We knew the economy was bouncing along sideways, and that was confirmed this morning.  Does that mean the third quarter GDP growth rate will be negative?  Nobody knows!  Stay tuned . . .