Monday, October 31, 2011

The Indignation of Crybabies

Let's see . . . you expect full retirement benefits at age 55 and one of the best health care systems in Europe as well.  Oh, and paying taxes is only for chumps.  You are renowned across Europe for not filing your income tax returns, and the government barely tries to collect them.  For the 20% of the workforce that "works" for the government, you have lifetime job security until you get your full retirement at age 55.

Sorry to hear your government cannot afford to pay all of this, but don't worry, your government can issue bonds and borrow as much money as they need from the rest of the world.  After all, you deserve it, right?

Sorry to hear the world stopped buying any new bonds of your government, cutting off the flow of borrowings to support your entitlements.  But, the world was glad when the European Union rode to your rescue last week, effectively cutting your national debt by almost 30%.  Stock markets around the world rallied strongly on the news your bonds wouldn't destroy the European banking system.

But, I don't understand why you are indignant, just because it does require changes in your entitlements and really collecting taxes from you.  Today, your government announced a referendum on whether to accept the largess of the European Union.  Whether to accept it . . . ARE YOU NUTS?  I can understand the importance of indignation.  I can understand that you want to believe somebody stole all the Greek money.  But . . . ARE YOU NUTS?  Without it, your government will collapse and may take the European banking system with it.  It only took fifteen months to negotiate your bailout, and now you want to vote on it?  ARE YOU NUTS?

As a result, the U.S. stock market dropped 276 points today, primarily because of you!  THANKS!

Yucky Muddy Water

Last week, Europe developed their template to resolve their financial crisis.  Stock markets around the world rallied and rallied strongly on the breakthrough.  I knew it wouldn't last, as markets cannot go straight up without falling back for consolidation.  Plus, there had to be lots of details in the template that would concern the market.

So, I'm not surprised nor concerned that the stock market is down today, about 150 points on the Dow as I type this.  What does concern me is that the bond market is less happy than the stock market.  An old adage in the bond markets is that it is smarter than the stock market.  My experience is that there is some truth to that.

Italian bond rates have actually risen, which is worrisome.  In addition, the TED spread has increased, which means LIBOR rates have also risen.  This means banks don't trust each other, even after the template.  Something is wrong!  Maybe, the concern is that the template may work for Greece but would not be replicated for Italy or Spain, who are much bigger problems.  Maybe, the concern is that the Greeks have gotten off too easy, creating a "moral hazard," whereby irresponsible behavior is rewarded.

Complicating the market today is the bankruptcy filing for MF Global, a huge futures trading company.  While not completely unexpected, it did put the taste of Lehman Brothers in everybodys mouth, prompting stockholders to say "yuck" and "sell."  MF Global is tiny compared to Lehman Brothers, and it is pretty clear that it failed as a result of one very bad trade.  (They bought a huge amount of bonds issued by European governments, just before they crashed.)

Increasing uncertainty this busy week will be a two-day Fed meeting (where nothing will happen), another G-20 meeting (where anything could happen), and the market-moving monthly Jobs Report on Friday (let us pray!).

The MF Global bankruptcy filing is a sideshow.  The lack of love in the bond market for the European template is the main attraction.

Saturday, October 29, 2011

Goose and Gander

Clients frequently ask me about making investments in businesses or real estate outside the stock market.  I am required to tell them that I have a conflict of interest, because my fee income could decrease if they reduce the funds under my management in order to make the outside investment.  In other words, it is theoretically possible I might recommend against a good investment just because it would cost me.  While it seems silly to my clients, it is still a good rule.

But, taking off my advisor hat and putting on my economist hat, there is no such rule.  A former Fed governor was paid by the Iceland Chamber of Commerce to write a glowing report of Icelandic economy shortly before it collapsed.  Companies often pay economists to write glowing reports on the economic impact of some new project or rule, and those economists are not required to disclose they were paid.

At long last, that is starting to change, and I'm glad.  The American Economic Association is currently writing ethical guidelines for economists.  Those guidelines will require we disclose all "relevant and material financial relationships."  Although it would not unfortunately be binding, it would certainly change the tone. 

If financial advisors have to disclose conflicts of interest, so should economic advisors!

Friday, October 28, 2011

So Far, So Good

When I turned on Bloomberg at 4 AM, I expected to see something about the European financial crisis, as usual.  Instead, it was a discussion about the earnings of some company.  After breathless 24/7 coverage of the crisis for months, I found this discussion of earnings to be refreshing.  (Maybe, we'll get back to economics as well?  I miss writing about economics!)

As expected, the devilish details of the plan are coming out and causing stomach pain to many.  The futures market indicates the Dow will lose about 50 points at the 9:30 AM opening.  After the enormous 339 point relief rally yesterday . . . who really cares about 50 points this morning?

Over the weekend, more details will emerge and likely cause more pain.  I expect the market to be down early next week.

The most worrisome development so far is something that didn't happen . . . interest rates on Italian sovereign debt have not fallen.  This suggests the market may believe the Greece problem may be under control but are still not sure about Italy.  Still, a template for the Euro zone has been created.

I remain much more optimistic than I was last week, but I'm watching those devilish details closely.

Thursday, October 27, 2011

The Hook Is Set!

It took a slow 18 months and a long 10 hour marathon negotiation last night, ending at 4AM, but Europe has done it!  Of course, they have not solved all their problems, but they have taken a huge step toward fiscal integration.  The hook is set, and there is no getting away.

Basically, the banks have agreed to take a 50% haircut on their Greek bonds and raise their capital to 9% by next Spring.  In addition, the EFSF will be leveraged to provide the bazooka needed to quell the crisis or $1.4 trillion.

This is without the IMF, China, or Brazil;  all of whom have strongly hinted additional help will be available.

The interesting thing to me is that the haircut will be called voluntary in order to avoid triggering the credit default swaps.  The haircut only applies to Greek bonds held by banks.  If you are a pension fund holding Greek bonds thinking you are safely protected by the credit default swaps you purchased, you are not happy this morning.  While your bonds are now somewhat less likely to default, because Greece can more readily service the reduced debt held by the banks, you still must be wondering why you paid good money for the swap originally?

If you are a free-market purist, you are not happy.  If you are an investor, you are probably happy today.

I've estimated the chance of a double-dip recession in the U.S. at one-in-three, depending on Europe.  Now, I expect it is one-in-five.  The GDP growth rate for the third quarter will be released this morning.  Q1 was 0.4%.  Q2 was 1.4%.  Q3 is expected to be 2.3%.  I like the trend . . .

The European markets are up strongly, almost 4% on the news.  Dow futures indicate the market will open up about 190 points.  There should be a strong relief rally.  Then, the devilish details of any deal will pull it back, probably Monday.  The level of risk in the economy has decreased modestly.  The level of risk in the market has decreased significantly.  I'll probably start deploying cash again on Monday.

On the horizon, however, don't forget the traumatic cuts in government discretionary spending (preserving all entitlements) scheduled for January 1st, if Congress doesn't approve whatever agreement comes out of the SuperCommittee now meeting.  Several members of Congress have already proposed a new bill preventing the arbitrary cuts in discretionary spending at year-end.  I cannot imagine even the intransigent Tea Party taking the blame for shutting down the government, including Defense.

The European debt crisis has been caught and will take several years to reel it in, of course.  But, it has been caught!  Enjoy the relief rally today and then get to work! 

Wednesday, October 26, 2011

Cat on a Hot Tin Stock Exchange

Did you ever hold a cat over the water?  It explodes with energy, with all four paws in frantic motion and all claws ready to hang on to anything.

That's how the market is behaving today, swinging from 150 point gains to 50 point losses within minutes.  The production of so much adrenalin is caused by Europe's meeting this afternoon to finally end their financial crisis.  Rumors are that it could last until 3AM their time, if necessary to produce a plan.

If they fail, as I expect, the market will drop significantly but not crash, because they can come back to the negotiating table once again.  Hopefully, you're sitting on a good amount of cash.

If they succeed, however, the market will jump dramatically.  Yet, once the details are studied, the market will come back down somewhat.  That would be a good time to commit some cash.

The next 24 hours could be exciting!

PS:  If you have never held a cat over water, please don't do it now.  It's cruel to torment the cat, and you might get clawed . . .

Pick a Bunny Trail

The good news is that national leaders in Europe have finally realized the grave condition of their financial system and are committed to saving it.  The bad news is that they don't know how!

In July, they agreed to set up a European Financial Stability Fund (EFSF), with about 440 billion euros or $600 billion.  Now, there is general agreement that is too little but no agreement on how to increase it.

Most Europeans favor a quantitative easing approach by the European Central Bank (ECB), which would buy unlimited amounts of sovereign debt.  (Greek bonds are not included, which will get a haircut of about 60%)

The Germans favor an insurance approach, whereby the EFSF would guarantee the top 20% of most soverign debt.  This extends the power of the EFSF to almost $3 trillion  ($600 billion times five)  But, doesn't this smell like AIG?

Another trail is to simply let the defaults occur.  Since the bondholders are mostly European banks, this would require the governments to re-capitalize the banks by injecting new taxpayer money.  Some estimates are that this will only cost about 140 billion euros, which is the cheapest scenario.  The problem is that the bondholders are not evenly dispersed across Europe.  Most are German and French, placing the burden on northern Europe and excusing the profligate southern Europe.

A new trail is to set up a Special Purpose Vehicle (SPV), whereby a separate entity would raise money by selling bonds to the EFSF, as well to the IMF and to the market.  While there are few details, the idea is that they would then use this money to leverage up enough to take the place of the ECB in quantitative easing. The thinking is that this would save the ECB.

Remembering Alan Greenspan's prediction that the European Union will eventually fail because it has no unified fiscal policy, will this finally force that next step in European integration?  Or, is that just a bunny trail?

Then, Somebody Yanked on the Carpet !?!

I was not expecting much action in the market yesterday; expecting low volume in anticipation of the important EU meeting of finance ministers today, and that's how the day started.  The market had been promised by Merkel that Wednesday's meeting would produce the final comprehensive plan to end the European crisis.  Then, there was a rumor yesterday that the meeting of finance ministers had been postponed.  Then, there was confusion as to whom was meeting, finance minister or chiefs of state.  Then, the media started pointing fingers at each other for not having the facts right.

In the end, it was a dark reminder of how dependent the American stock market has become on news out of Europe, and investors panicked.  By the close, four billion shares had been traded, and the Dow was down 207 points.

After the close, Alan Greenspan predicted the European Union was doomed to fail, because there was no unified fiscal policy.

Overnight, there was a rumor that Italy agreed to raise its retirement age from 65 to 67, which had been a big stumbling block.  (FYI  -- we did that several several years ago.)  This was good news, indeed!

Ignoring Alan Greenspan, the Ayn Rand-disciple who fueled the American real estate debacle, the futures market indicates the Dow will rise about 60 points at the open.  Again, I expect light volume until there is some announcement out of the EU meeting this afternoon.  Stay tuned . . . somebody in Europe may yank the carpet at any minute!

Tuesday, October 25, 2011

The Radical Centrist

I attended the dinner meeting at the World Affair Council last night, where Senator Mark Warner was the speaker.  Normally, our speaker discusses some international issue.  Senator Warner spoke more about domestic issues.

He talked about his experience on the Gang of Six moderate senators who tried to build on the Simpson-Bowles work to break the debt ceiling debacle, complaining the press is more interested in the extremes than the moderates in the middle.

He asked fans of Fox News to spend more time watching MSNBC and asked fans of MSNBC to spend more time watching Fox News.

He asked Republicans to find a Democrat who supports entitlement reform and to support that Democrat.

He asked Democrats to find a Republican who supports taxes on the "rich" and to support that Republican.

(He did not speak about redistricting, which I believe is the root of all evil in our political culture.)

When an obvious Tea Partier asked some inflammatory questions, he answered them with aplomb and respect.  That told me he was not another liberal Democrat and may be exactly how he describes himself as a "radical centrist."

Monday, October 24, 2011

Nag . . . Nag . . . Nag . . .

I know I have done this before, but it is really important to remember this website:

The market is discounting the problem of Europe and will soon face the challenges of our SuperCommittee.

The Sarko & Merko Show

At 4AM this morning, futures indicated the Dow would open up about 40 points.  Then, it dropped down to negative 6 points.  At 7AM, futures are flat.  The market is slowly twisting in the wind, waiting for the G-20 in general and Sarkozy & Merkel in particular to announce their "bazooka plan" to save the European financial system.

In July, they agreed all bondholders of Greek debt should receive 21% less than the face amount or take a "haircut" of 21%.  Now, they are arguing whether it will be 50% or 60%.  The first concern is that European banks will not be able to take such losses without collapsing.  The current estimate is that they will need at least another $140 billion in capital.

The second concern is who is holding the bag on the credit default swaps (CDSs)?  As over-regulated as the financial services industry claim they are, there is still precious little transparency to the derivatives market.  If I own bonds issued by Greece and am worried they might not be repaid in full, I can buy insurance called a credit default swap, that will repay me if the Greeks cannot.  So, I have transferred my risk of loss to somebody else, which is a good thing.  The bad thing is that somebody else now has that risk of loss.  The question is who?  In all probability, it is another bank, insurance company, or hedge fund.  But, which one?  Which bank am I safe owning?  Which insurance company is safe?  Are there any safe hedge funds?  There is very little transparency; too little!

The third concern is whether they are focusing too much on the size of the haircut and not enough on ring-fencing the problems of Greece from Italy and Spain, which would be many times worse than Greece.

"Sarko & Merko" did not produce their "bazooka plan" this weekend as hoped, promising to release it this Wednesday.  So, stay tuned for the show.  It will be on channel G-20.

Lessons From Lunatics

This weekend, I was fortunate to have my daughter visit from Texas.  I had to promise to participate with her on Saturday in the Virginia Touch Mudder, which I knew nothing about.  For info, click here:

In the middle of 15 thousand screaming lunatics, one gets a different view of the economy.  These enthusiastic participants spent on average well over $300 each to attend something with no prize money.  They made decisions with economic consequences but without regard to money or even taxes.  They didn't have any Keynesian concern about stimulating demand.  Likewise, they didn't have any Austrian desire to save their money.  Finally, they couldn't care less about needing some Supply-Side tax cut.  The lesson re-learned is that economics isn't as important to individuals as economists like to think . . . darn it!

The second lesson re-learned is that those 15 thousand screaming lunatics represent the American spirit, full of fight, sardonic wit, and a zest for life; none of which has ever been quantified by economists.  They were young, forceful, fit, and aggressive.  As I've said here many times, the American economy is stronger than it appears.  We are burdened with the huge uncertainty of Europe, intimidated by China, but mostly just hobbled by politicians of both parties.

As Moses said . . . "Let my people go!"

Friday, October 21, 2011

On the Other Side of the World

While world stock markets are being whip-sawed by every announcement out of Europe, it is easy to miss what is happening in the Chinese stock market.  Take a look at this:

If China is the growth engine of the world, the world could be stalling badly!

Of course, we don't know how much to trust this graph.  In the U.S., we believe our stock market predicts our economy six to nine months down the road.  The Chinese stock market is too new and too state-controlled to trust any such prediction.

Still, this is probably not a good time to buy cooper or other industrial commodities.

For the last century, the U.S. has been the growth engine of the world.  Our economy is certainly doing better than Europe.  It may be holding up better than China, relatively speaking.  But, wouldn't it be wonderful for us to still be the world's growth engine. 

Thursday, October 20, 2011

e & e & E

Earnings season is almost half over.  Generally, the earnings reports have been slightly better-than-expected.  Normally, when  a company's quarterly earnings disappoint, that stock gets hurt, but that doesn't drive the overall market down a hundred points.  Yet, the market remains painfully volatile.  Something else is causing that!

Yesterday, economics actually mattered briefly, when the "Beige Book" report was released at 2 o'clock.  The economic report showed the economy had slowed down, and the Dow immediately followed it down.

Sarkozy nearly missed the birth of his child to fly to Frankfurt for an emergency meeting, which means it must have been a very important meeting indeed.  The early morning rumor is that the European Financial Stability Fund can buy sovereign bonds of the "good" European governments, who have kept their deficit cutting commitment.  That caused the European markets to rally strongly.  Futures now indicate the Dow will open up about 50 points.

earnings still matter, economics still matters, but Europe is what really matters!

Just Another Sophie's Choice

While listening to a Republican candidate for President on Fox News, he stated that the top 5% of the taxpayers pay 80% of the taxes.  While directionally correct, that didn't sound close enough to make good policy.  So, I did some research on Kiplinger and found this.

To be in the top 5%, you only need an Adjusted Gross Income of $154,643 in 2009.  That group received 31.7% of all the income and paid 58.7% of all the taxes.

To the Republican mind, this raises the question of why shouldn't 5% of the people pay 5% of the taxes?

To the Democratic mind, this answers the question of who has the money to pay taxes, connecting with their inner-Willie Sutton, who said he robbed banks "because that's where the money is."

While Michele Bachman is not my favorite candidate, I do agree with her that everybody should pay something, even if it is only one dollar.  After all, according to Kiplinger, the bottom 50% of all taxpayers only paid 2.25% of the total taxes.

Still, extracting more taxes from the poor is not unlike withholding medical care to those who cannot afford it.  I guess life is all about choices . . . tough, painful choices!

Wednesday, October 19, 2011

Kicking the Dog . . .

I feel guilty kicking a sick dog, but I have this love/hate perspective of Goldman Sachs.  Their earnings came out yesterday, and they are definitely sick.  Fortunately, I don't buy stock in any company that I don't trust and do NOT have their stock in any portfolio I manage.  And, I certainly would never permit my daughter to date anybody who worked there.

Nonetheless, I love their research!  Here are their latest predictions:

If we have a recession, it will be mild, only a 1.5% drop in GDP compared to an average of 2.3%

GDP growth will be 1.7% this year but only 1.4% next year.

Unemployment will rise to 9.5% next year, from 9.1% now.

Gold will hit $1,860 per ounce next year, compared to $1,658 now.

The Euro will strengthen to $1.48, compared to $1.38 now.

Although quite independent in their past predictions, this one seems more in-line with other firms on Wall Street.  When everybody on the Street starts thinking the same, it can become a self-fulfilling prophecy, which is a little worrisome to me.

They also predict the S&P 500 will hit 1,300 by next year-end, up from about 1,225 now.  That is about a 6% increase over the next year or so -- hardly the "rip-your-face-off" bull rally that many firms are predicting and is more consistent with my own expectations.  Maybe, that's why I love their research . . . ??

Thru the Looking Glass

Everybody sees the world thru their own prism.  Often, that prism can be mass-produced by the media.

Watching the Republican Debates last night, I saw agreement that the "Occupy Wall Street"  (OWS) crowd was just a bunch of left-wing extremists.  My Democratic friends see the Tea Party as just a bunch of right-wing extremists.

Rather than viewing either movement as left or right-wing extremists, maybe we should look at them as a symptom -- a symptom that "something" is wrong.

We didn't lose our AAA credit because we are too liberal or too conservative.  Importantly, we did NOT lose it because of any inability to pay our debt.  Standard & Poor's reduced our credit rating because it thought we had become ungovernable.  I suspect the left and right-wings extremists agree with this, concluding the "system" is not working for them.

Maybe, it is not a question of either spending or economic justice.  Maybe, both wings just want the government to lead, to be responsive, to make decisions . . . once again.  Neither is crying for more government or less government, just effective government.

I'm still puzzling over the recent comment by the President of Turkey, who compared democracy with a street car, saying "when you get to your stop, you get off."  It is inconceivable to me that anything is better than a street car named democracy, but what does happen when that street car breaks down?  The first step would be to stop blaming each other!  After all, nobody else can see you clearly either . . .

Tuesday, October 18, 2011

Embracing the Enemy

Today's Producer Price Index was worse-than-expected, 0.8% vs 0.2% in September.  Also this morning, England announed their consumer inflation was running 5.2%, which is worse-than-expected.  In addition, China announced their GDP growth rate dropped from an incredible 9.5% to a worse-than-expected but still incredible 9.1% . . . because they are fighting inflation.

Inflation is good!  For a country that is trying to de-leverage or reduce its debt, inflation makes the money you owe cheaper & easier to payoff.  It causes interest rates to rise, which is good for savers and those who depend on bond income.  Inflation causes the value of hard assets, like homes, to appreciate.

Inflation is bad!  It causes long term rates to rise, making it more difficult to finance a new home.  It hurts those on fixed income but with inflating living expenses.  Some companies benefit from inflation while others get hurt. 

Inflation is like heroin!  It may feel good in the short run but can destroy you in the long run.  Nonetheless, I am hoping for inflation now and trusting Bernanke to keep it controlled later.  If it does get out of control, Bernanke can repeat the success of Paul Volcker and raise interest rates enough to kill it, perhaps creating a recession but one with less debt in real terms, which is still a better place than we are now.

Bring it on . . . embrace it . . . we need it!

Monday, October 17, 2011

Extra, Extra . . . Real All About It

Long-suffering readers of this blog know that I also write a quarterly column for Inside BusinessThe Hampton Roads Business Journal.  The newspapers are being mailed today, but you can read it here:

Saturday, October 15, 2011

Is It Real . . . or Is It Memorex?

Any recovery is better than not, but only some recoveries are sustainable.  The ideal recovery would gain only 20-30 points on a daily basis for a long time, with heavy volume.  (Heavy volume means lots of shares were traded, which usually means lots of people are buying and is very bullish.)

The Dow has moved more than 100 points each day, up or down, for 57 of the last 58 days . . . that ain't good!

Yesterday, the Dow rose a whopping 166 points but on the lowest volume in six weeks, only 3.6 billion shares, compared to this year's average of 4.4 billion.  And, this ain't good either!

It looks like the sellers have just gotten tired of selling to the few buyers out there.  It does not look like U.S. buyers have retured.  More likely, foreign investors just like the relative safety of our market and have returned to the U.S. market.  The two best performing stock markets in the world this year are the U.S. and Venezuela . . . ours because of its safety and Venezuela because that market is rigged.

One of my favorite billionaires is Wilbur Ross, primarily because of his wry sense of humor.  He believes the U.S. is "over" the European crisis and ready to go up.  I agree with him that economic data out of the U.S. has been better and better, but my read is that while the U.S. stock market is anxious to escape the burden of worries over Europe and return of the debt debate, it cannot escape the anxiety of politics.   

This rally is obviously much more than a mere dead-cat bounce and is more likely a bear market rally.  Some think the current rally is just anxiety exhaustion.  Or, it may be the real thing -- a real "rip-your-face-off" bull market rally. 

It would be nice to sell all stocks at the top and buy them back at the bottom, but that also requires perfect knowledge and more than a little luck.  That's why I never make a 100% bet.  As my uncertainty rises, my level of cash rises.  I'm still not a believer this stock market recovery is sustainable.  It is still better to miss 50% of a recovery than to catch 51% of a collapse.

Friday, October 14, 2011

Under the Radar . . .

The G-20 is the international organization of the twenty largest economies that meets periodically to coordinate primarily trade policies and secondarily fiscal policies.  Each meeting gets lots of media attention, as twenty chiefs-of-state deserve.  The next meeting is in two weeks.

Before each meeting, the finance chiefs get together to actually work out deals to make their bosses look good later.  They are meeting today and tomorrow.  This is very important!

There is a credible rumor that Brazil and China might be willing to backstop a new IMF facility to deal with the European crisis.  This arises from the fear that Europe cannot deal with it alone.  This would effectively end the European crisis.  Of course, the IMF always requires certain behavior changes, and it is not clear if that plan will work for the seventeen national personalities of this European Union.

Originally, it was thought that the U.S. was too weak to be a prominent player in this argument.  But then, the U.S. Senate passed a trade bill that puts tariffs on imports from nations that maintain an artificially low currency exchange rate.  Read:  CHINA!  An unintended consequence of this action is to infuriate the Chinese when Europe needs them most, making the U.S. a prominent player only because we may have forced the Chinese to demand even more protection.  In other words, we made it worse.

From our standpoint, the artificially cheap Chinese Yuan makes their exports cheaper for Americans to import, which creates jobs there and kills them here.

From the Chinese standpoint, the central government is barely holding onto power, with a highly-restive population, who are mounting public demonstrations with a frequency that was unimaginable a few years ago.  Now, the U.S. wants to increase Chinese unemployment!  The action in the Senate is a direct threat to the Chinese central government.

No news will come of the meeting of finance ministers this weekend, but lots of rumors will.  I'll be listening carefully.

The Wisdom of Thinking Long-Term

I had a long conversation with my favorite bull yesterday.  He is a long-time friend and client, who is anxiously looking forward to celebrating at his 90th birthday party in the near future.  The reason he called me was that he was curious why I was removing risk from his portfolio, when the market was going up.

After reminding him that I raise cash as my uncertainty rises, I shared my concern that (1) while Europe seems to finally understand the problem, it is not clear that they may have the mechanism to deal with it, (2) that the debt debacle will return in 6 weeks, testing ideological purity against practical governance, with potentially catastrophic consequences, and (3) my free-floating anxiety that the failure to regulate derivatives makes banks vulnerable to serious heart attacks.

It is always amusing to financial advisors when older clients urge us to take more risk.  But, there is an important object lesson here.  My bullish friend has lived through the Great Depression, World War II, and countless recessions.  Thru it all, he has watched America recover and watched the stock market produce greater and greater value for investors.  He is willing to take a long a long-term view, even at age 90, and that is indeed great wisdom!  I salute him!

Thursday, October 13, 2011

The Battle of Thermopylae: Act Two

There are numerous investment theories, with Modern Portfolio Theory being the most common.  Advisors often advertise that their individual investment theory is better than everybody else's.  Almost all were developed in the United States.

The Battle of Thermopylae was fought in 480 BC, when legend tells us that a mere 300 Spartan soldiers withstood the one-million man army of the Persian emperor Xerxes.  Obviously, that took great courage.

Currently, ten of the top financial advisors in Europe have started The 300 Club, citing the courage necessary to say "investment theory is over complicated and often wrong."  I expect the academicians will attack The 300 Club in the way the Persians attacked the Spartans.  The criticism will be strongest in the U.S.

It is a basic tenet of existentialism to be suspicious of systems, thinking anything that comes from the mind of man could never deserve religious conviction.  An example is Modern Portfolio Theory.  Another is econometrics.  There is value in all theories, but theories are not religion.

It is enough to know the theories of investment, to give perspective;  not as religions to be practiced.  I salute The 300 Club and will lend my support.

Wednesday, October 12, 2011

Should Have Worn My Love Beads

Harry Markopolos is the tenacious whistle-blower that tracked Bernie Madoff and tried unsuccessfully for many years to get the SEC to investigate Madoff.  Unfortunately, the SEC had more important things to do, and Madoff was exposed by the market crash of 2008, not by Markopolos.  Tonight, we went to see the worth-seeing movie Chasing Madoff, which described his long ordeal to do the right thing.  Although he was unsuccessful, Markopolos is nonetheless a hero! 

The movie played tonight-only at the Naro Theatre in Norfolk.  After the movie, some teaching economists gave their surprisingly superficial analysis of the film and then took questions from the audience, including advocates of the "Occupy Norfolk" crowd.  Because I live in the solidly-Republican enclave known as Virginia Beach, I was amused to hear relics of my college years in the 1960s.  There was even one speaker that I swear was a born-again socialist.

One example was the assertion that the Sherman Act and the Clayton Act (anti-trust legislation) was a conspiracy by big business to limit competition.  It was also used to hinder the growth of unions.  I've written before that conspiracy theories are usually the product of a lazy mind.  Tonight, I thought that person's theory was a product of something bordering on just really dumb.

There were other flashbacks to the 1960s, but the hour is late.  I guess it is more re-assuring than distressing that a flashback to my college years is still possible at my age.

The Love of Blinders

Yesterday, Slovakia decided to kill the EFSF, which would be a huge setback to ending the European crisis.  One would expect markets to tank worldwide, but one would be wrong.  Asia was up.  Europe is up.  Futures indicate our Dow will open up about 75 points.

Most experts assure us that Slovakia will replace their government and pass the law next week.  While I hope that happens, it is a reminder that every step in fixing this crisis can be torpedoed by any one of seventeen nations. 

Still, the stock market is becoming ever more sanguine about the risk and rising.  The blinders must be exactly the right size?  (The rising Euro is even more inexplicable.  Does anybody believe the ECB will not decrease interest rates, which will depress the Euro?)

While the sky is definitely not falling, it is not rising either.  Even if the market can see beyond the European crisis (which I doubt), can it also see the return of the debt debacle in only six weeks?

Tuesday, October 11, 2011

Market Rhythm

The SEC requires public companies to file financial reports on a quarterly basis, so that shareholders can have needed information about their investments.  September 30th was a quarter end for the vast majority of companies.  During the month of September, companies that expected to post results different from their earlier guidance usually guide those earnings estimates up or down.  This is called the "confession season." 

For the first two weeks of the following month (this month), the accountants frantically work on producing the quarterly statements.  The last half of the month is "earnings season," when companies tell us how they did and "guide" us, as to what they expect for the current quarter.

Earnings season starts today, with Alcoa first and then the rest.  It takes 2-3 weeks.  Don't pay attention to earnings only.  We need to hear about total revenue growth, as that tells us more about the overall economy than earnings alone. 

So, you can expect to hear a lot about individual companies for the next weeks.  Maybe, that will get politics and Europe off the front page for awhile, which would be very bullish!

U.S.A. . . . U.S.A . . .

I'm proud that the Nobel prize for economics was awarded to two Americans yesterday and salute Thomas Sargent & Christopher Sims on their accomplishment.

For decades, I have watched the profession of economics sink into the black hole of econometrics, which is an almost religious belief that everything can be quantified.  If only we could get more & better data, as well as bigger & faster computers, we could predict how many people will have eggs & bacon for breakfast next Wednesday.  First, that degree of accuracy will never be available, and second . . . who cares?  Rational computers cannot calculate irrational human behavior, not even statistically.

There is now a renegade branch of economics, trying to bring the profession back out of the black hole.  They believe economics is many things, including behavioral, econometric, and random probabilities.  Known as the Institute of New Economic Thinking or INET, their website is

Yesterday's selection suggests a turning point in this evolution of the profession.  For the first time, the honorees are econometricians who are focused on the "real world" instead of a computerized fantasy-world. 

I'm proud of America for capturing the award, and I'm proud of my profession for taking a step out of the darkness.  U.S.A. . . U.S.A.

Where . . . Who??

Yesterday, on the promise of Merkel and Sarkozy to resolve the European Crisis this month, the Dow was up 330 points.  Overnight, Asia also rallied on that good news.  Then, the European markets opened with a rumor that Slovakia would not approve the July agreement to create the EFSF (European Financial Stability Fund), which would effectively kill it.  Europe is down about 1% pending the vote.  The Dow looks poised to open down about 65 points.  If Slovakia kills the EFSF, the market will be down dramatically.

When the world's stock markets depend on a vote in Slovakia, something is wrong!

Monday, October 10, 2011

Love It or Hate It

I remember watching two existential "philosophers" discussing the importance of absurdity.  One said the only thing more commonplace than air . . . was absurdity. 

That crossed my mind this morning as I watched CNBC discussing the "Occupy Wall Street" movement, that does seem to be growing.  When the Tea Party movement was born during the 2010 elections, the left wing was disgusted with the mindless chant about spending, ignoring the problem of entitlements.  Now, the right wing is disgusted with the mindless chant about fairness, ignoring the benefits of capitalism.

So, which is more absurd?

New Beginnings

In the 24/7 investment world, every Monday is a new beginning, a time when everything is possible.  The weekend provides time for almost anything to incubate and begin anew on Monday morning. 

Overnight, Asia was up almost 1%.  Europe is also up.  Futures indicate our market will be up about 150 points at the open.

The primary reason is that Merkel and Sarkozy "promised" that they will detail a plan to re-capitalize European banks and will resolve the problem with Greece by the time the G-20 meets in Cannes on November 3rd.  They did this to end the perception that they were clueless as to the seriousness of this financial crisis.  Their announcement was enough to turn worldwde markets up.

The surprise to me is that the markets are not up even more, suggesting the market does not really believe that the well-intentioned leaders of Europe can actually do as they promised.  If they do, the market will have many more good days.  Pray for them!

Sunday, October 9, 2011

Too Simple To Do?

There is a raging debate inside the investment industry between the fiduciary standard and the suitability standard.  Under a fiduciary standard, an investment advisor must always act in the best interest of the client and must always disclose any potential conflicts of interest beforehand.  Under a suitability standard, an investment advisor must not make any recommendations that are not suitable for clients.  The classic example of a "suitable" recommendation is, when a client needs a large-cap growth mutual fund, can the investment advisor recommend any large-cap growth mutual fund?  And, does the advisor have to inform the client that the mutual fund company will send the advisor and his wife to Hawaii for a week if clients put their money into that mutual fund?

Investors prefer a fiduciary standard overwhelmingly.  They don't want their advisors getting secret compensation.  They want to sleep at night with the knowledge that someone is at least trying to take care of their assets.

Brokerage firms have steadfastly opposed the fiduciary standard, and here's why:  It is much more difficult to act as a fiduciary and much easier to get sued.  Stockbrokers are commissioned salesmen, while the fiduciary liability would be on the brokerage firm, not the brokers.  How would a brokerage firm manage every action by every commissioned salesman?  They argue their increased compliance costs and sales expenses would prevent them from serving the vast majority of Americans.

Last week, the Department of Labor announced they would need yet another year to define fiduciary standard, while the Securities & Exchange Commission needs another year to do a cost-benefit analysis.  The brokerage industry has done a great job of slowing down something badly wanted by clients.  It is an age-old legislative game to delay and delay until the other side gets tired.

In the meantime, many investment advisors have chosen to become Registered Investment Advisors (RIA), gladly accepting the heavy fiduciary responsibility . . . simply because it is the right thing to do!

Friday, October 7, 2011

Jail -Time

Last night, my Rotary Club was given a private, behind-the-scene tour of the Virginia Beach Jail.  It was a sobering and provocative experience.  We saw the "in-take" area, where police turn over custody to the jailers.  There were tiny, barren cells with a seat and toilet only.  We saw the three different types of cells, i.e., linear, dormitory, and pod.  We saw the special holding area for violent criminals, called "the Shu."  It was chilling, indeed!

There are about 1,400 prisoners at any given time.  About 300 of them are mental patients and should not be there.  The 300 beds used by mental patients in the Virginia Beach jail is more beds than the state of Virginia has across the entire state.  Our Sheriff, former state senator Ken Stolle, believes incarceration of mental patients in jails reflects poorly on our society.  I think he is right.

I was also struck by the large number of "gang" prisoners.  Gang violence is something I've associated with larger cities, not Virginia Beach (even though we are the largest city in the state).  Gang members tend to be the most violent and are the primary occupants of "the Shoe."

Sheriff Stolle said the two primary contributing factors to becoming a prisoner are (1) drugs and (2) the lack of a high school education.  The sooner you leave school, the more likely you are to end up in jail.  I hate cuts in education spending but, at the same time, hate to keep funding the status quo, which is obviously not working.

Lastly, I asked the Sheriff about a recent article in Bloomberg magazine that pointed out that the U.S. has more people in prison as the rest of the world combined.  As a percent of population, we are twenty times more likely to put our citizens in jail than Japan.  Bloomberg asked the question, is the U.S. twenty times more evil than Japan?  I put the question to the Sheriff, and his response was that we are twenty times more free and therefore more likely to make bad decisions on our own.  While I don't believe this is correct, I greatly respect and do appreciate Sheriff Stolle for all that he does! 

Don't miss an opportunity to study this problem up close.  With costs estimated at hundreds of billions of dollars each year, it will be subject to the cuts in discretionary spending if Congress cannot pass the report of the Super Committee by year-end.  It is chilling, indeed!


When the Dow futures change from a negative 45 to a positive 100 points within ten minutes, it is a safe bet that the monthly Jobs Report was better than expected.  That was certainly the case this morning!

A survey of economists indicated job growth in September would be about 63 thousand, which would be better than the zero growth in August.  Instead, the U.S. economy produced 103 thousand in total, about 137 thousand in the private sector and a loss of about 35 thousand in government jobs.

In addition, more jobs were produced in July and August than previously reported by the Department of Labor, about 99 thousand more!

Make no mistake, while this is better than expected, it is still not enough.  To maintain the current level of unemployment (9.1%), we need to create approximately 125-150 thousand jobs each month.  Although the hole didn't get deeper this month, it didn't really get much better either.  More interestingly, if you look at U-6 employment, which is the unemployed plus the under-employed (people who want to work full-time but are forced to work part-time), that number increased to 16.5%.  That tells me that things are getting better for the short-term unemployed but not the long-term unemployed, which may reflect a more systemic than economic problem.

Still, it was a good report, and we should celebrate . . . OK, that's enough celebration . . . for now!

Tuesday, October 4, 2011

When Politics Trumps Economics

Years ago, I was asked to write a quarterly column on the economy and the stock market for Inside Business.  It is that time again, and my deadline is Monday.  Subject to change, I'm thinking the theme will be the triumph of politics over economics.

Yesterday was a good example.  Even though the ISM data and car sales exceeded expectations, the stock market ignored both and tanked anyway.  All that matters is the inability of Europe to control their crisis, which has metastasized from being a financial crisis into a political one.  This follows on top of the inability of U.S. politicians to agree on much of anything either.  Don't forget we have the return of Debt Debacle II in December, after the Super-Committee submits their report at the end of November.

Benjamin Franklin once said "it profits a man little to see either his sausage or his laws being made."  Frankly, watching sausage being made would be beautiful in comparison in this environment.

The commonly accepted definition of a bear market is a 20% drop.  Today, the S&P is down 19.4% from its April high.  Asia was down badly overnight, and Europe is down another 2-3%.  Futures indicate the Dow will open down another 120 points this morning.  Wouldn't you rather watch sausage being made?

I miss economics!

Monday, October 3, 2011

A New Quarter . . . Same Old Problems

Historically, September and October are the worst months of the year.  Further, either the first or fourth quarters are usually the best quarters each year.  Today, the world started the fourth quarter on a weak note, with both Asia and Europe down about 2%.  At this hour, futures indicate the U.S. markets will open down slightly.

Given the continuing crisis in Europe and nagging impotence in Washington, as well as slowing growth worldwide, it should not be surprising that I'm looking forward to the first quarter next year more than the fourth quarter this year.

In the meantime, this first week of each month is usually one of the most interesting, as the market goes into a state of semi-suspended animation until the all-important Jobs Report is released on the first Friday of each month.  That number easily moves the market, and traders are afraid of making big bets before that release, especially on Fridays, normally the most volatile day of the week anyway.

Although it will drift up or down before Friday, the current consensus forecast is that 63 thousand jobs were created in September.  Percentage-wise, this is up considerably from August when zero jobs were created but still far, far below the 300 thousand jobs we need to create each month.  If we are significantly above the consensus forecast, Friday will be a good day.  If below, Friday will be another bad day, probably like the fourth quarter.

Maybe, we'll get the usual "Santa Claus Rally" this year . . . keep your fingers crossed!