Tuesday, April 30, 2013

Individually Innocent . . . But Cumulatively Guilty

Yesterday's report that personal income rose less-then-expected, while personal spending rose more-than-expected, made me wonder about our rate of savings.

As everybody knows, cigarette companies were held legally responsible for the misfortunes caused by smoking, even though the cigarette companies didn't hold a gun to anybody's head.  Smokers smoked because they chose to do so.  So, why did cigarette makers owe damages?  And, why did all cigarette makers owe damages?  Why should the manufacturer of Marlboro cigarettes have to pay damages for someone smoking Salem cigarettes?

So, why do Americans save so little?  Financial planners like to see clients save 10% of their income, and Americans have often done that but not since the early 1980s.  During the financial crisis of 2008/9, our savings rate briefly touched a respectful 8%.  Today, it is only 2.5%.

Graph of Personal Saving Rate

Compounding the problem of declining savings, companies have discontinued most pension plans.  When Americans need to save more, they are saving less.  This is bad for individuals, bad for families, and bad for America.  Many see this problem as a moral issue, i.e. that people don't have to self-discipline to save.

Another theory is that, as Americans spend more and more time watching hundreds of cable channels, they are not only getting fatter but also more susceptible to advertising, which means they can "have it all" by charging more on their credit cards or they can "find happiness and fulfillment" by again charging more on their credit cards.  Stated starkly like this, the stupidity shows.

Of course, people could spend less and save more, if they wanted to.  People could also exercise and live longer, if they wanted to.  Instead, they engage in harmful practices, like spending and smoking.

Some make the distinction that addiction is only physical -- never emotional nor spiritual.  Cigarettes create a physical addiction, and their manufacturers had to pay damages.  But, psychologists tell us there are different types of addiction.  Some have deep-seated needs I cannot pretend to understand but accept.  I do know that some people are more susceptible to advertising than others.

So, should the Madison Avenue advertising agencies pay damages for harm done to people who spent too much and saved too little?  If advertising does this, shouldn't they pay?  If advertising doesn't do this, why do companies spend billions to advertise?

No one advertiser wants to hurt anybody, but doesn't the cumulative effect of billions of dollars spent to influence behavior . . . actually influence behavior?

Of course, Madison Avenue advertising agencies convinced us that smoking was sexy and sophisticated, before convincing the courts that the manufacturers were the guilty parties.  Now, they have convinced us that spending is sexy and sophisticated, before blaming it on the victims.

Does the advertising industry have any liability for anything they do?  Do they have a moral compass?

Sunday, April 28, 2013

Patiently Awaiting Inflation

A year or so ago, I read the excellent book This Time Is Different:  Eight Centuries of Financial Folly by Carmen Reinhart and Ken Rogoff.  One of the interesting conclusions from the ponderous 463-page study was that nations are condemned to slow economic growth, once their ratio of debt-to-GDP passes 90%.  (In fact, economic growth became slightly negative at -0.1%.)  Because the U.S. is experiencing slow growth and because our ratio is already about 100%, this study offered strong support for the Austrian approach to economics, i.e., balance the budget at all costs and reduce the debt-to-GDP ratio.  This was especially true in Europe, where pensions and social services have actually been cut somewhat and taxes have actually been raised.  This approach was also acclaimed by the Republican party during the November election campaign.

Then, a young doctoral candidate from M.I.T. was given the routine assignment this year of checking the research methodology of the work done by Reinhart & Rogoff.  As it turns out, the original research omitted five nations that had high economic growth AND high debt-to-GDP, such as Canada, Australia, and New Zealand.  This skewed the data suspiciously.  Even more amazing, there was a simple programming error in the Excel spreadsheet that nobody noticed until this young doctoral student came along.

When these oversights and the error are corrected, we find economic growth improves from a negative 0.1% to a positive 2.2%.  This is a huge difference!  Suddenly, the anti-austerity crowd in Europe became emboldened, fortified by the revised Reinhart & Rogoff study.  Everywhere, Keynesian economists feel reborn and recharged.

With central banks in the U.S. and Japan expanding the money supply so rapidly and with the expectation that Europe's central bank will soon begin the same and with the expectation that Austrian or austerity economics is "on its heels," I just don't see how hyper-inflation can be avoided in the long-run.

But, how long is the long run?

Wednesday, April 24, 2013

Computers, Lawyers, and The Limits of Expertise

At 1:07 PM on April 23rd, the respected Associated Press announced on their Twitter account that there were explosions at the White House and the President was injured.  Within three minutes, the Dow lost 143 points but then recovered -- leaving a bad case of whiplash.  No harm, no foul -- right?

What happened is that some group of sick hackers (who have identified themselves as Syrians?) hacked into the AP's Twitter account and sent out a fake tweet.  Ha, Ha!

It's not funny!  It is not a victimless crime.  There were investors who were selling and received less than a fair price, and there were investors who were buying and paid less than a fair price.  People with Stop-Loss orders got sold-out needlessly, possibly with tax consequences.

Two things bother me about this story.  First, hackers are hard to catch but are under-punished when caught.  Second, this incident illustrates the market's vulnerability to algorithmic trading by computers.  When you saw the tweet, how long did it take you to think "What, this can't be?  How can I check this?  If true, what are the consequences?"  In that short time, the high-frequency trading computers who read ALL news feeds, including tweets, saw the words "explosions" and "White House" in the same message and immediately sold stocks, avoiding the loss in nano-seconds,while humans were still scratching their heads.

Certainly, this is not in the same league as the Flash Crash on May 6, 2010, when the Dow dropped almost a thousand points (9%) within minutes.  That was a failure of technology.  This time, technology performed exactly as expected.  The point is:  whether computers work as expected or not, the average investor is at a disadvantage.

Computerization of the stock exchanges has clearly been beneficial to the average investor, by increasing liquidity and reducing costs.  But, the technical complexity has over-whelmed the lawyers who run the S.E.C., who simply have not idea how to regulate something they don't understand.  In the meantime, the high-frequency computerized traders have the advantage . . . and we have the lawyers.

Tuesday, April 23, 2013

BlackRock Speaks

Depending on what you measure, BlackRock is the largest asset manager in the world.  To some extent, this actually makes their predictions of market behavior self-fulfilling; which means they manage so much money they could theoretically cause the market to behave as they suspect.

Anyway, here are their latest predictions:

1.  They believe the market will continue upwards over the coming months but volatility will also increase.
2.  Don't think emerging markets are yesterday's story.  They will still out-perform developed markets.
3.  The Fed will begin tightening credit conditions before year-end.
4.  Generally speaking, they don't like bonds, except for bank-loans and some municipal bonds.
5.  They like mega-cap U.S. stocks, global technology stocks, and energy stocks.
6.  The dollar remains too strong to expect much improvement in oil or gold prices, but they didn't predict how long the dollar would remain so strong.

There has been much speculation lately that the U.S. is the "best-looking horse in the glue factory" because the rest of the world is so deeply mired in debt and other troubles.  My observation is that the U.S. is recovering better than most of the world but remains too hide-bound for the significant growth expected in many foreign nations.  I was gratified to see BlackRock agree.  Remember:  over half of the world's stocks are outside the U.S.

Their enthusiasm for mega-cap U.S. stocks also reflects a way to invest in international growth, since most of the business of mega-cap companies is international.

Lastly, BlackRock deserves the "truth-in-predictions" award for saying a market drop could result from "unknown unknowns" . . . well, duh!  That is just a stylish way of saying "I don't have any idea what else might happen to hurt the market."

Situation normal!

Sunday, April 21, 2013

Voices in the Wilderness

Being a voice in the wilderness can be a lonely experience.  So, it can be nice to hear another voice and even nicer if that voice agrees with you.

I have been worried for some time that we will experience a "Jim Fixx" moment, remembering the highly trained, low-body fat runner who suddenly dropped dead from a heart attack.

According to Investment News, "Jeffrey Gundlach is known as one of the best bond fund managers on the planet, but he also has a remarkable knack for predicting where markets are headed."  He just predicted we will have a "ka-boom" moment.

I think we are saying the same thing, i.e., that the market will continue upwards, after our Spring swoon, until it has a sudden extreme fall.

He believes it will happen when debt, mostly government debt, reaches an undetermined point, at which time the market collapses under the weight of so much debt.  I expect it will happen due to a derivative blow-up that could easily predict an immediate debt collapse.  It could also result from a technology collapse or inside a "dark pool" with the same result.

In other words, everything will be fine . . . until it isn't!

It sure is nice to have a little company . . .

Saturday, April 20, 2013

The Vampire Squid Speaks

One of the companies that I respect the most but trust the least is Goldman Sachs, which was once famously described as a vampire squid sucking on the face of mankind.  In no particular order, here are some of their latest predictions:

1.  GDP growth will slow to 2.1% this year but accelerating to 2.9% next year.
2.  Unemployment will drop from 7.6% now to 6.9% by the end of next year.
3.  It is time for interest rates to begin rising.
4.  The S&P will end this year at 1625 or up another 4.5%.
5.  Gold will end next year at $1,270 or down another 9%.
6.  Stock markets worldwide will rise over the next 3 years, from 9% in the U.S. to 21% in most of Asia.

It was refreshing to read a market analysis that ignored the circus in Washington.  Their predictions were not hedged on which political party does what.

And, their analysis ignored the "heart attack" factors that worry me.  They didn't discuss any potential impact from a derivatives collapse or a technological collapse or the "dark pools" . . . as they are on the cutting edge of all three.

Still, except for those ignored risks, it is comforting that they continue to see continued growth in both the economy and the stock market.

Thursday, April 18, 2013

Let The Battle Begin . . . as usual

While there are many schools of thought on economics, we have, for convenience, concentrated on the Big Three.  First, there is the Austrian school, which advocates a balanced budget at all times.  It is often called the "tough love" school.  Then, there is the Keynesian school, which advocates deficit spending when the economy has slack and budget surpluses when the economy is doing well.  It is often called the "sin now, repent later" school.  Lastly, there is the Supply-side school, which advocates tax cuts to stimulate growth.  They are often ridiculed for advocating a tax cut to cure the common cold.  Supply-side economics is U.S. based and largely ignored outside the U.S.

Europe is now having a heated debate between Austrians and Keynesians -- between austerity and stimulus.  As the European crisis worsened, the Austrian economists have prevailed in pushing austerity.  However, Keynesian economists are staging their own "surge".  The leader of the International Monetary Fund has urged European leaders to back off austerity and begin stimulating the economy -- by increased deficit spending.  The battle has been joined.

There are many protests against austerity all over Europe.  After all, nobody wants to work another year before retirement or for Grandma to take a 1% retirement cut.  Voters don't like austerity, and the bad news for  European politicians is that . . . voters vote!  The politicians will be pushed toward the Keynesian school.

The European financial crisis is off the front page today, but the parliament of Cyprus has just decided to vote on the Troika package, which it will probably reject, putting Cyprus back on the front page.  The Cypriots may pull Lord John Maynard Keynes out of his grave to lead them.

Part of the intellectual basis for pushing austerity has been the highly-regarded 2009 book by Carmen Reinhart and Ken Rogoff called This Time is Different:  Eight Centuries of Financial Folly.  They concluded that a nation is condemned to slow growth once the debt-to-GDP ratio reached 90%.  (The U.S. is now at 100%.)  However, there is recent scholarly criticism of their research, including mathematical errors.  While I cannot speak to that criticism, I can see it powering the new "surge" by the Keynesians in Europe.

It is an unexplained oddity that the stock market has swooned during the Spring for the last three years, each time due to some European misstep.  Can we expect the same this Spring?  Why wouldn't we? 

Wednesday, April 17, 2013

Emptying the tank . . .

Philosophers debate whether people have an infinite capacity for emotion or merely a finite capacity.  Clearly, some people feel more emotion longer and more strongly than other people.  However, most philosophers will agree that existentialists have a smaller capacity than most.  If that is the case, then emotion becomes "a terrible thing to waste."

It is probably then a waste of emotion to spend it on anger, but that is what I feel about the Boston Marathon tragedy.  So many good and decent people killed and maimed by some lunatic!

Of course, a society is judged by the mercy it shows . . . or so some people think.  I do not!

Capital punishment is too good for this lunatic.  If it was a foreign terrorist, he should be publicly executed on television.  If it was a domestic terrorist, he should also be publicly executed on television.  Showing compassion for the insane, if he was merely a crazy American killer, he should be privately executed off-camera.  There can be no circumstance that Americans should provide this guy with free room & board plus health care the rest of his life.

Yes, I know the Bible says we should "turn the other cheek" and forgive.  But, that is the same Bible that says "an eye for an eye."  Frankly, justice demands more, but execution is enough.  Some advocate that the lunatic be locked into a room with the surviving family members.  That would be real justice.

Okay, that's all the emotion I can spare for anger . . . my tank is getting empty.  I may need to feel some other emotions today or tomorrow?

Tuesday, April 16, 2013

Linking the Stock Market with the Economy

Long-time readers know whenever there is a lull in blog posting, there is a column in the near future.  And, here it is:


In this quarterly column for Inside Business, I discuss economic and investment performance during the first quarter and offer thoughts on the second quarter.  The question posed in this column is:  How can the stock market do so much better than the underlying economy?  One answer is that the stock market predicts the future economy while the economic data reflects past economic conditions.  In other words, the stock market looks through the front windshield, while economic data looks in the rear-view mirror.  This suggests good times are coming.  

However, it is more likely that the wedge separating the stock market from the economy is the Fed, which may have done a great job of holding up the economy in the short term but may be producing great inflation in the long term.  We'll see . . .

Wednesday, April 10, 2013

Guilty Pleasure

If confession is good for the soul, I confess to enjoying the AMC award-winning series Mad Men, which just returned to the air last Sunday.  It is perhaps the most existential TV program ever.  The lead character is Don Draper, who is a big-time advertising executive.  He is also a brooding, unhappy person.  Surrounded by both talented men and beautiful women, he is still miserably alone.  Despite his material success, he could easily sing the old Peggy Lee song, Is That All There Is?.

Existentialists realize we are all islands, connected only by such undependable links as small boats in a storm.  They realize that "yes, that's all there is."

However, just like Christians believe you must be "born again" to be happy, existentialists have to achieve "authenticity" to be happy.  Don Draper is miserable because he doesn't know he has an existential perspective.  Once he accepts his flawed perspective or once he becomes authentic, he will sing, "yes, that's all there is, and that's okay!"

Existentialism is not a philosophy.  It is not a religion.  It is merely a perspective, that colors our view of the world.  For Don Draper, his perspective darkens his world and isolates him from the joy in that world.  Once he realizes his perspective has merely discolored the world he sees, he will be "authentic" . . . and then he will be happy enough to enjoy the talented men and talented, beautiful women around him . . . and that's okay too!

Monday, April 8, 2013

Adding Up Intangibles

Democrats were happy enough with Friday's Jobs Report, because the economy has been adding jobs for 37 straight months.  And, the unemployment rate dropped from 7.7% to 7.6%.  What's wrong with that?

Republicans were worried that job creation dropped two-thirds in one month.  They were angry that the labor participation rate dropped to the lowest level since May of 1979.  That means more people are NOT even looking for jobs; suggesting some people are cheating the system.

Economists were confused.  Job growth has slowed dramatically during the Springtime for the last four years.  There is no handy economic explanation for this, so they are looking at the routine seasonal adjustments made each month.  Are they skewing the seasonal data somewhat?  What changed four years ago?

However, sociologists were convinced that we are building a generational sub-class of young people.  Almost 500 thousand people dropped out of the labor force in March.  (There is always some rotation in and out of the labor force, as people drop out to care for families, go back to school, retire, etc.)  But, 500 thousand is huge.  And, half of those dropouts were under the age of 25.

Sometimes, being old and achy is not too bad.  It is probably better than being a recent college graduate with college debt but no job and facing the prospect of moving back into your parents home as a permanent adolescent, stranded in a fictional world of cyber-combat and other digital games.  All of us now know somebody like this.

There was an article in today's newspaper that young people are no longer anxious to get their driver's license.  It's not as important to young people anymore, as they connect with each other via social media, instead of the "malt shop" or whatever.  There was a recent article in The Wall Street Journal that young women are finding it more difficult to find men their age, who act their age.

What is the economic cost of losing part of a generation?  What is the economic cost of immaturity?  What is the economic cost of defeatism?  Is there an intangible offset to GDP?

Thursday, April 4, 2013

Embracing the Baby Bear

The stock market hit another record high on Tuesday.  The next day, it lost 111 points on the Dow.  Is the rally over?  Of course not!

On average, the market has at least five pullbacks of 5% or more each year.  We are due for one and, frankly, need it to consolidate our gains.

Yesterday's 1% drop partially reflected some weak economic data but mostly reflected bellicose talk of nuclear war from the crazies running North Korea.  (If a nuclear strike actually occurs, the market will likely plummet, which would be a good time to buy more stock, especially defense stocks.)

I am a little worried about the market.  The best performing sectors are health care stocks and consumer staples, which are usually the best performing sectors in a bear market, not a bull market.  And, trading volumes remain suspiciously low.  There is also "Dow Theory" which suggests a bull rally is not sustainable if the Transportation Index is not also rising.  So far, that Index has supported the Theory but has now reversed itself.  All of this makes me expect that a 5-10% pullback is due and appropriate.

With respect to gold, it is definitely in a downward spiral, not because demand has fallen, but because the dollar is strengthening.  Who would ever expect the dollar to strengthen when the Fed is printing vast amounts of money?  The reason is that the Bank of Japan, Bank of England, and European Central Bank are printing money even faster, making us the best-looking horse in a glue factory.  Our Fed looks like the adult at a children's party, compared to the other central banks.

This doesn't change my analysis that we are vulnerable to a "heart attack" or Jim Fixx Moment over the longer term.  But, right now, a baby bear market would not be bad for us.  Besides, aren't baby bears cute?

Monday, April 1, 2013

Avoiding The Light

Readers know my expectation is the U.S. economy will continue to improve:  faster with help from Washington and slower without it.  However, we are increasingly vulnerable to a "Jim Fixx moment," recalling the father of running who suddenly dropped dead while running in his neighborhood, despite having a long body-mass index.

The most likely event that might trigger this heart attack is a derivatives blow-up.  Nobody is certain how big the problem is or, more importantly, who will end up holding-the-bag after the blow-up.  When this happens, it will happen suddenly,

Secondarily, the complex technology systems used to trade can still breakdown.  Remember that awful day  on May 6th, 2010 when the Dow suddenly lost almost a thousand points in twenty minutes, due to computer problems.  While it recovered quickly, what if it didn't?    Does high-speed trading (HST) make this scenario more likely and suddenly?  Of course, it does.

Third, I'm increasingly concerned about the "dark pools," which are those thirty unregulated exchanges run mostly by large banks among its customers.  Suppose a large pension fund wants to sell a million shares of Apple without any prior notification and causing the price to fall.  They contact their local bank who arranges the sale to another customer.  There is nothing illegal about that.  But, isn't that information important to the market?  How about if somebody is building a position to take control of a company, whose stock you own?  It is an unlit market.  The New York Stock Exchange is a lit market, where investors see what other investors are doing.

Here is the problem:  "dark pools" are growing.  In 2009, only 18% of all stock trades were hidden.  Today, it is approaching 40%.  In other words, the portion of stock trading taking place in secrecy and without regulation has doubled in just four years.  Soon, half the trading will be without regulation and in the dark.

Does that mean we should avoid investing in the improving U.S. economy?  No, but it does mean we should have a clearly defined "sell strategy," which clearly identifies events that will trigger a sale.

The next time you are taking a run through your neighborhood, think about developing your sell strategy.