Tuesday, June 25, 2013

One - Two Punch

Last week, the stock market got pounded when Ben Bernanke repeated his plan to begin withdrawing quantitative easing.  This means the Fed would buy fewer government bonds than the $85 billion they are buying each month . . . like, say, $84 billion.  In other words, no big deal!  Still, the market did what it does best . . .  over-react.

This week, more attention is being paid to the news out of China that there is a liquidity crunch among the banks.  Monday morning, a noted bear on China predicted that China would experience a Lehman-like collapse in three weeks to six months, because of this liquidity problem.  First of all, Lehman did not have the ability to print all the dollars it needed, while the Peoples Bank of China can print all the Yuan it wants.  There will be no Lehman moment in China!

A little background on China might help.  They have been experiencing a dangerous level of growth in their "shadow banking" system or system of non-bank lenders, such as private banks, pawnshops and payday lenders.  The shadowy lenders were borrowing cheaply from banks and then lending to the non-creditworthy at much higher rates.  We might call that "loan-sharking" in this country.  To curb their growth, China is raising its short-term rates to squeeze the profit margin of these shadowy lenders by reducing money supply.  This caused the interbank-lending-rate in Shanghai (SHIBOR) to spike suddenly and dangerously.  The increase was so large that it was frightening to those who did not understand it.  While still high by historical standards, SHIBOR has fallen considerably since Friday.  China may be many things, but it is not stupid enough to realize their worst fear, i.e., widespread public anger, which would result from a systemic collapse due to a liquidity crisis.  They will flood the country with Yuan, if necessary, just like the Fed has flooded this country with dollars.

Even Rocky Balboa got knocked down after a one-two punch from Apollo Creed but still got up.  The stock market just got a one-two punch and will also get up . . . like it has done so many times before!  

Saturday, June 22, 2013

Another Giant Sucking Sound

Wall Street's infamous Vampire Squid, AKA Goldman Sachs, has issued their latest quarterly assessment.  I take their thoughts seriously, even though I don't trust anything they say.  Here are some of their current thoughts:

1.  "Global markets have started to worry that the US economy is moving a bit too nicely over the hump of fiscal contraction."  Paging Congress -- are you listening?  Never mind . . .

2.  "We disagree with the emerging 'good news is bad news' view."  Forgive me, but I agree with the Vampire Squid on this.

3.  They expect the Fed to begin tapering in December, which is reasonable, since Bernanke wants to start the process before his term ends in January.

4.  GDP growth will slow this year to 1.9% but will jump strongly to 2.9% next year.

5.  Unemployment will drop from its current 7.6% to 6.6% at the end of 2014.

6.  Gold will rise to $1,450 by year-end.

7.  The dollar will strengthen compared to the Yen but weaken compared to the Euro.

8.  Interest rates have finished rising for this year but will add another half-point next year.  They also presented an interesting analysis of the impact of rising interest rates on stock prices.  As long as GDP growth remains strong, stocks will continue to rise despite a rise in interest rates.  (Generally speaking, interest rates can rise because borrowing has increased or interest rates can be raised to tamp down inflation.)  In this environment, dividend-paying stocks out-perform and small-cap stocks out-perform.

Seriously, Goldman Sachs enjoys an excellent, respectable research department, which is independent of the rest of the company . . . thank goodness!

Friday, June 21, 2013

Welcome to the Twilight Zone

Republicans use the word "taxes" too much.
Democrats use the word "fairness" too much.
Existentialists use the word "absurd" too much.

Thursday's market convulsion was absurd, losing 354 points!  Yes, yes, it was partially due to bad data coming out of China, but it was primarily due to the absurd reaction of U.S. traders (not investors) to Ben Bernanke's press conference on Wednesday.

In the real, rational world, the stock market would go up whenever the Fed Chairman says the economy is improving.  In the Twilight Zone, the markets goes way down simply because the Chairman repeats that he will begin phasing out quantitative easing when the economy gets better, and, by the way, the economy is getting better.  That started the sell-off -- before he even finished speaking.  The approaching change in monetary policy increased uncertainty, which always drives down stock prices, but the magnitude of this price drop was absurd.

It is absurd when the stock market goes down . . . because the economy is improving.  

Wednesday, June 19, 2013

The Tragedy of Traders

It takes thousands of hours studying economic textbooks and decades of experience to be even a fair economic forecaster.  Last week, a noted hedge fund operator, whose expertise was forecasting, said his skills were irrelevant in this market.  His argument was that Ben Bernanke, Chairman of the Federal Reserve System, has suspended the laws of economics.  He said the trading game is now fixed . . . by Bernanke.  Forecasting now requires more psychological skills in analyzing Bernanke than economic skills in analyzing the economy.  Another pundit observed that traders have become a "bunch of squealing school girls" about Bernanke.

Clearly, the bullish run over the last few days indicates the stock market expects Bernanke to delay the gradual tapering of quantitative easing until later.  However, if Bernanke indicates, in today's press conference, that now is the time to start, then I expect a rout on Wall Street, easily dropping 200 points.

How should the long-term investor, as opposed to the short-term trader, think about all of this?

Yes, the game is fixed by Bernanke -- the short-term traders game that is.  But, that's not new.  Short-term traders often try to fix the game themselves.  Long-term investors, like Warren Buffet, largely ignore the short-term gyrations of the markets.  Buy something you like and hold it, until you find something you like better.

The fact that the short-term market is now "fixed" by Bernanke, instead of by the traders, was the price we paid to avoid a depression in 2008-09.  He is clearly quite anxious to take the training wheels off the economy by decreasing the amount of quantitative easing.  When that happens, short-term traders will panic and sell on the news, but don't forget Bernanke will not begin the tapering until the economy is stronger, which is good for long-term investors.

Buy something you like and hold it, until you find something you like better.  And, yes, that includes . . . cash!

Tuesday, June 18, 2013

Work Is Not Evil

I have a relative whose only ambition in life was NOT to work.  It was a negative ambition that I never understood. Sadly,it is also a "luxury" that fewer and fewer people have.

The Great Recession has many older Americans considering the prospects of staying in the workforce past their normal retirement age. But, working past your normal retirement age is not a new necessity. According to the Social Security Administration, more than 30% of individuals between the ages of 70 and 74 reported income from earnings from a job in 2010, the latest year for which data is available. Among a younger age group, those individuals between 65 and 69, nearly 49% had income from a job.

Some remain employed for personal reasons, such as a desire for stimulation and social contact; others still want a regular paycheck. Another new survey found 51% of baby-boomers expect to work after retirement.  Of those, 28% expect to work part-time and 18% want to start an entirely different career. Whatever the reason, the decision to continue working into your senior years will have a positive impact on your financial future.

Working later in life may permit you to continue adding to your retirement savings and delay making withdrawals. For example, if you earn enough to forgo Social Security benefits until after your full retirement age, your eventual benefit will increase by between 5.5% and 8% per year for each year that you wait, depending on the year of your birth. 

Depending on the circumstances of your career, working enables you to continue adding to your retirement nest egg. If you have access to an employer-sponsored retirement plan, you may be able to make contributions and continue building retirement assets. If not, consider whether you can fund an IRA. Just remember that after age 70 1/2, you will be required to make withdrawals, known as required minimum distributions (RMDs), from traditional 401(k)s and traditional IRAs. RMDs are not required from Roth IRAs and Roth 401(k)s.

Even if you do not have access to a retirement account, continuing to earn income may help you to delay tapping your personal assets for living expenses, which could help your portfolio last longer in the years to come. Whatever your decision, be sure to apply for Medicare at age 65. In certain circumstances, medical insurance might cost more if you delay your application.

Work doesn't have to be a chore. You may find opportunities to work part time, on a seasonal basis, or capitalize on a personal interest that you didn't have time to pursue earlier in life.  Most of all, don't feel sorry for yourself.  There's more to life than NOT working!

Oh, by the way, 6% of those planning to work after retirement just want to avoid being around their spouse.  Your bank account doesn't care what your reason is . . . as long as you keep working!

Sunday, June 16, 2013

The Second Time Around

I just re-read one of the best investment books ever written:  Unexpected Returns:  Understanding Secular Stock Market Cycles, written by Ed Easterling in 2005.  When I read it the first time, the most interesting lesson was what he styled the "Y-curve effect."  He demonstrated pretty clearly that PE multiples decrease whenever there is a change in the rate of inflation.  In other words, investors will pay less for every dollar of earnings-per-share whenever inflation either goes up or goes down.  Change or uncertainty of any sort scares investors and stops them from paying top price for a stock.

Easterling has been in the investment press quite a bit recently, discussing two things:  (1) that the current stock market is NOT over-valued but (2) we remain in a long term bear cycle, despite much recent discussion that we have finally entered the bull part of the cycle.  We often say the market is over-valued based on the price-earnings ratio (P/E), i.e., the stock price divided by the earnings-per-share.  However, there is research from Yale's Robert Schiller that 10-year cyclically adjusted P/E, or CAPE ratio, is more meaningful.  Using that measure, investors are currently buying stock for 23.2 times each dollar of earnings-per-share of stock, or $23.20 per share for a stock with $1 earnings-per-share, which is relatively low.  During the tech boom of 1999, the CAPE ratio was 44.2 times.

But, that doesn't mean the secular bear cycle that started in 2000 is over yet.  Market cycles can be as long as 24 years, according to Easterling.  Hitting a market high now is not proof that the bear has returned.  He recalls the market setting a record high in 1972, even though the bullish part of the cycle didn't begin for another decade.

This caused me to read his book a second time and, of course, absorb even different lessons.  One is that long cycles are harder to identify and predict than short cycles.  The second is that "buy & hold" only works well during the bull cycle but not during the bear part of the cycle . . . duh!

Some people say marriage is better the second time around.  I won't touch that line, but a book is often much better the second time around.

Friday, June 14, 2013

The Sky Is Falling . . .

Yes, yes, I know the sky really is falling this time!

Europe still tries to maintain one currency with seventeen different fiscal policies.  Derivatives still present a clear and present risk to both the market and the economy.  Still, nobody knows what caused the infamous Flash Crash on May 6, 2010 or how to prevent another one.  And, we just learned that traders can buy breaking information seconds before the rest of us, giving them a totally unfair advantage.

We are jerked around by a tinhorn dictator with nukes in North Korea.  China is attacking our cyber-body.  Europeans are facing great austerity.  There is a general strike going on in Greece, with demonstrators taking to the streets again.  Egypt continues to flounder on the edge of despair.  Almost a hundred thousand people have been killed in Syria, where that war is escalating with more U.S. aid.  And, we just learned our government is no different than Google in shredding our privacy.

But, what really worries me right now is Turkey.  Typically, the trigger for the current street demonstrations was a relatively minor affair involving the destruction of a city park.  Unfortunately, the Turkish president, Erdogan, is handling the situation badly.  Turkey is important to us!  It is a longtime, dependable ally of the U.S. with borders on Syria, Iran, and Iraq, which sounds like a horror movie for sure.  Russia is also close by and covets the seaports of Turkey.  Turkey is in the geographic position to dominate the sea lanes and oil transport in the Mediterranean.  Several pundits have described Turkey as our replacement for the world's "essential nation."

Despite having a significant Kurdish population, who insist on their own nation, Turkey has remained a democracy . . . until now.  You will recall I have mentioned Erdogan's famous comment that "democracy is like a street car.  When you get to your stop, you get off."  My fear is that Erdogan has now reached that stop, and we are seeing the end of democracy in Turkey.  If Turkey becomes just another brutal dictatorship under Erdogan, he will be a very powerful person indeed . . . but more powerful than dependable.

How do I know the sky is really falling this time?  Because it always is!

Wall Street analysts are fond of saying they are facing a "Wall of Worry."  They always are!

Monday, June 10, 2013

The Ingrate Gatsby

Years ago, I realized that I was working for a crook.  After carefully nailing down the details, I went to the FBI and later testified against him.  Although he is probably out by now, the last I heard, he was serving time in a Federal prison in California.

During the infamous Savings & Loan crisis in Texas, the Governor appointed me to the Texas State Depository Board, along with the State Treasurer, the State Controller, and the State Banking Commissioner.  During that service, I saw all manner of financial crimes; some clever and some stupid.

A few years ago, I wrote a novel about a Ponzi scheme, which surprisingly earned several awards.  It explained the mechanics of Ponzi schemes, which are always doomed to fail, which makes the criminals extremely stupid to even try the impossible.

So, it was with some annoyance that I watched the latest movie version of F. Scott Fitzgerald's classic book The Great Gatsby.  The movie made clear something nefarious supported the lavish lifestyle and parties of Jay Gatsby.  There were veiled references and insults, along with some shady characters.  But, I could not put my finger on what exactly what was the crime.

It was time to re-read the classic book, and I did.  Remembering this story took place during the Prohibition Era, it seems young Gatsby aligned himself with a seedy mob boss, who put up the money for Gatsby to buy a string of drug stores that sold prescription bottles and "Carter's Little Liver Pills" full of moonshine.  During that time, he also realized that financial crime was easier in small towns than large cities.

Eventually, he graduated to more sophisticated crimes.  During the time of the book, I think his mob friends were counterfeiting "bearer bonds."  I have only seen a bearer bond once in my lifetime, but they were commonplace during the Gatsby period.  With a bearer bond, one only had to walk into the local bank with the bond, and the bank would pay the bearer or whomever presented the bond.  Again, Gatsby's plan was to stick with banks in small towns.  As the movie ends, it appears some of his cronies got greedy and tried to cash their bearer bonds in big city banks, who were too wise and experienced to fall for the scheme.

While most critics see this classic story as a social commentary on the upper crust of society "who retreats into their vast wealth" whenever they damage regular people.  It is a world where "rich girls don't marry poor boys," as we were told twice by Gatsby's love interest, Daisy.  Originally, I saw a Pygmalion-quality to the story, whereby a young barbarian from North Dakota learns urbane manners but still never "fits" into the upper crust.  Now, I see it as a sad story about a pathetic student of the superficial, who is so obsessed with one woman that he cannot see the rest of his shallow world crumbling.

Next weekend, we will attend a "Great Gatsby Party."  I'll be wearing a tuxedo, and my wife will be wearing a flapper dress with long necklaces.  We will raise money for charity and re-live the famous parties at the imaginary Gatsby mansion.

In the book, Gatsby famously insists we really can re-create the past.  I think that is wrong, but, of course, we will make a humorous attempt next weekend.  However, I will not forget that Gatsby was just a cheap criminal with expensive tastes and no understanding of society in general nor women in particular.  

Saturday, June 8, 2013

The Joy of Aloneness

When I was a boy, there was a turnip farm about an hour's walk away.  In those pre-citified days before I learned fancy ways, it was not unusual for me to simply pull a turnip out of the ground, brush the dirt off with my pants and eat it raw.  But, the reason I went to this little farm was that there was a small, maybe 50 feet by 50 feet, stand of pine trees on the edge.  Chasing my dog into the stand one day, I realized what a magical place it was.  The pine trees were so thick a person could not see inside more than a few feet.  Once inside, it was impossible to see outside the pines.  I would often lie on the pine needles with my dog, Pal, and just think.  I can remember trying to count the small dots of sunlight breaking through the tree canopy above.

I wondered why this small stand of pine trees had been allowed to survive.  I marveled at the softness of pine "straw."  I learned that air is sweeter if it doesn't have words floating in it, with no talking.  Silence is made golden with the sound of wind or birds but not words.  I learned to enjoy my "aloneness" or enjoy my own company.  That was probably the first time I had existential thoughts about individualism.  Over time, that dense stand of pines, that place of aloneness would always come to mind whenever I heard the word "privacy."

In 1961, I read George Orwell's classic book 1984, which told the story of a nation in a perpetual state of war with government surveillance of everything and everywhere.  I tried to imagine my little stand of pines under surveillance by a camera, and it made me shudder.  There was nothing to conceal in those pines, except aloneness, which is hardly visible anyway.  Another boy in another age would never experience the aloneness I learned to love.

My daughter is a member of the Facebook generation and chuckles at my quaint old-fashioned concept of privacy.  Facebook knows more about her than she does.  Google knows more about me than I do.  And, you too!

So, it is with a deep sadness that our worst fears of government snooping are confirmed.  While I'm sure President Obama and, before him, President Bush are both fine and decent people, who would never use any information against us unreasonably, I know there is another President Nixon in our future at some point who will.  But, it is not the stolen information that is important, it is the right that was stolen, i.e., the right to privacy.

Of course, in a state of perpetual war, it can be justified . . . of course!  But, are there no limits to the destruction of privacy?   To reduce my risk of injury in a terrorist attack by 1%, must I give up 2% of my privacy?  What is the ratio?  Would you permit cameras in every room of your home, as in 1984, if it reduced your risk by 1%?   How about 20%?  Define the limits.

Today, a house sits where my little stand of pine trees taught me so much.  Now, where can a little boy find that joy of aloneness?  Maybe, it is just another intangible cost of perpetual war?  It is too bad economists cannot quantify that cost . . . it is not a small cost.

Friday, June 7, 2013

Jobs, Interest Rates, and the Summer Swoon

The stock market has been drifting down over the past few weeks, almost entirely due to the concern that the Fed may start "tapering" or reducing QE3 from $85 billion monthly to something lower, like maybe even $84 billion.  The stock market is afraid of this!  And, because the Fed has said they will begin this when unemployment hits 6.5%, the monthly Jobs Report this morning took on a surprisingly cosmic importance.

Waiting for the release at 8:30 AM, the futures market indicated the Dow would open slightly down.  By 8:45 AM, futures indicated it would jump 60 points.  What happened during the interim was that we learned the economy produced 178 thousand private sector jobs last month, when most predictions were about 130-140 thousand.

That's the good news, i.e., news for Democratic boosters.  The unemployment jumped from 7.5% to 7.6%, which is good news for Republican critics.  The work force increased by 420 thousand, which is good news for both partisans.

The futures market jumped simply because the uncertainty -- of having an important number unknown -- was reduced.  Reducing uncertainty almost always boosts the market.

I don't expect a decisive move in the market for the next month or so, as we consolidate some of its recent gains.  During that time, we will continue to fret about how QE ends.  Former Fed head Alan Greenspan calls it the "terminal rate problem."  As soon as the Fed allows rates to move up a little, the bond market will immediately assume rates will go up a great deal, and bonds will therefore lose a great deal immediately.  So, how can the Fed prevent this?  My guess is that the Fed will take the long-term view and spank the bond market in the short-term.  They will announce a quarter-point increase, knowing the market will assume a much larger increase, pushing down the market value of bonds terribly.  Then, the Fed will hold rates steady with only a quarter-point increase, creating huge profits in the bond market.  That is the only way the Fed can take control again.

With respect to selling all the mortgage bonds on the Fed's balance sheet, overwhelming the bond market and driving down prices, remember this:  the Fed doesn't have to do anything.  They can simply hold the bonds, which are amortizing every month.  Time will solve that problem.

It is time to enjoy the summer.  Go to the beach.  Cook a few steaks on the backyard grill.  Wander around some part of this wonderful country you've never seen.  Don't worry about the stock market.  After all, it doesn't worry about you.

Wednesday, June 5, 2013

Watching Glaciers Move

The economy is clearly showing signs of recovery, albeit a weak one.  Investment pundits on Wall Street are mostly enthusiastic about a continued bull run.  Yes, the market over-reacts to any comments about quantitative easing (QE), forgetting that reduced QE means the economy is getting better.  But, of course, that's what the market always does:  it over-reacts.

Against this generally bullish environment, I have feared a "Jim Fixx" moment or a derivatives blow-out, which could make the now-famous Flash Crash look pint-sized.  A financial advisor at Carey Financial said it best:  The difference between investing using a derivative versus investing in a business is comparable to the difference between starting a football team and betting on the outcome of the Super Bowl.  Nothing is produced with derivatives, nothing is built.  It is 10% prudent hedging and 90% Las Vegas.

Derivatives are like icebergs, i.e., you cannot see how big a threat they really are.  Here are the latest estimates from Bain & Company (yes, that Bain & Company).  In 2010, GDP was $63 trillion, while total real assets (public companies, private companies, real estate, etc.) totaled $210 trillion.  Total derivatives were estimated at $600 trillion -- many times greater than GDP or total real assets.

By 2020, they estimate GDP will rise to $90 trillion, while total assets will rise to $300 trillion.  Total derivatives will rise to a whopping $900 trillion.

Here is the first problem -- not even a highly sophisticated company like Bain knows how much exposure we  really have to derivatives.  This is just an estimate.  Nobody knows for sure!  Unlike stocks and bonds which are traded on the exchanges, such as the NYSE or the CME, derivatives are traded in the dark, despite the fact they can impact the nation immensely.

Knowing the problem is huge and seeing no action, I feared the Jim Fixx moment of a healthy economy running down the road when it suddenly has a heart attack.  But, some recent developments have given me a tiny bit more confidence.  One good thing that came out the Dodd-Frank legislation is that the Commodity Futures Trading Commission (CFTC) is attempting to regulate the type of derivatives known as swaps.  (An example of a swap is I will pay the floating interest rate on your debt if you will pay the fixed interest rate on my debt, because I think interest rates are going down and you think they are going up.)  This may be a tough sell as it would involve regulating branches of foreign banks in the U.S. and foreign branches of U.S. banks.  Foreign government might have a problem with this, but most of the huge multi-national banks would not.  But, the important thing to me is that, after five long years since the 2008 collapse, we are seeing some movement - at a glacial rate perhaps but still movement.

Also, the Financial Stability Oversight Council created by Dodd-Frank wants to increase their regulation of systemically important financial companies that are not banks, such as AIG, Prudential, and GE Capital.  (AIG alone nearly destroyed our financial markets.  Even though taxpayers have now been repaid, only a huge controversial bailout saved it and maybe saved the market too.)  The glacier just moved another inch.

Has the danger passed?  Absolutely not!  But, I think I can see which way the glacier is moving, and I'm happy about that.