Wednesday, April 30, 2014

Beach Season . . . again!

Every year, we wrestle with this same issue -- the old Wall Street adage to "sell in May and walk away."  It goes back to the days before air-conditioning when Wall Street literally moved to the Hamptons for the summer, reducing trading volume which limits price action.

But, is there any truth to old adage -- yes!  Take a look at the market gains since 1950, and you will see most gains come between November and April.  The period from May to October is lackluster.

Chart of the Day

May to October time periods are the gold-ish line running horizontally across the bottom.  November to April time periods are the sharply increasing blue line.

Does that mean you should sell your assets and sit on cash on summer?  No, because that is a 100% bet, meaning you are betting that you know the exact day to exit the market and the exact day to re-enter the market.  More importantly, you are making the bet that history is 100% guaranteed to repeat itself, and the bulls will not run during the summer.

The way to deal with this market prospect is to manage your expectations.  Don't look for much appreciation this summer or any summer.  Sitting on extra cash shouldn't be a problem.  You should also go to the beach more this summer.

One semi-related thought is that the second year of a presidency is usually a lackluster 5.9%, almost entirely in the fourth quarter, after the uncertainty of the election goes away.  Like I said, you should go to the beach more this summer!!  Make your plans today . . . GO!

Monday, April 28, 2014

Day of Reckoning ?

A friend and client alerted me to an article in The Washington Post by Pulitizer-prize winning Steven Pearlstein, which cautions that we face another financial crisis in the short term.  As warning signs, he cites (1) corporate mergers & acquisitions are strong, almost all with borrrowed money, (2) private equity deals are closing at nine times cash flow, far above the traditional five times, (3) junk bonds are sell easily, too easily, (4) "dumb" money from dumb investors is rushing into equity funds, (5) analysts everywhere are too sanguine and glowing in reassurance, and (6) commercial real estate lenders are underwriting future rents instead of current rents.

All of these warning signs are the result of the continued cheap credit or easy money policies of Fed.  As we are at the end of the credit cycle, he recommends we sell everything and invest solely in cash!

While I agree with much that he said, there are some reservations.  For instance, I wish he had referenced Hyman Minsky, the great American economist, who studied why credit bubbles invariably expand until the point (called the Minsky Moment) when it collapses suddenly.  Deflating a credit bubble slowly is difficult but not impossible.  It just requires more discipline than we have seen from the Fed before.

While Pearlstein agrees that the innovative actions of the Fed were essential to "warding off another Great Depression," he argues that the Fed is much too concerned about unemployment.  Continuous large increases to money supply will not help the long-term unemployed, so it must be time to start extricating the Fed from its dominant role in the economy, allowing the market to operate more normally.  I agree the Fed needs a smaller role but am less critical because the Fed is legally required to be equally concerned with unemployment and inflation.  This is known as the "dual mandate."  To be fair, I think he should have given the Fed some credit for the tapering of quantitative easing.

He is silent on the Fed's war against deflation, which is a much bigger problem than too much inflation.  It is easier to decrease inflation than to increase it.  The massive increase in money supply was designed as much to fight deflation as unemployment.  You cannot understand the Fed's actions without understanding this.

I was curious about his concern that commercial real estate lenders were underwriting future rents instead of current rents.  This is not new nor unusual.  Lenders underwrite cash flow for the life of the loan, not today.

His advice to sell everything and invest in cash said nothing about gold, which is a more traditional hiding place.  There must be a reason he said nothing about it.

Don't forget that it is impossible to prove a negative, i.e., that a financial crisis is not imminent.  While financial crisis are more rare than recessions, two have never appeared so closely together, which doesn't mean it could not happen -- it just hasn't happened yet.

He closes with "We prefer the risk of lost opportunity to lost capital."  Being invested in only cash right now risks losing future appreciation in stock values.

My problem with his advice is that it is a 100% bet -- you are betting everything on one outcome.  I don't think that is prudent.  Being prepared to act quickly is more important.  When you read of a derivatives collapse, it is time to raise some cash.  When you hear of a second derivatives collapse, it is time to sell everything but not until then.  Sure, you may lose a little money on the way down, but that is the cost of not making 100% bets.

If you'd like to read his excellent article, here is the link: 

Sunday, April 27, 2014

"What's The Matter With Kids Today?"

I can remember my father telling me that I had to live in my own times, whatever that means,  (Today, it is called generational studies.)  He was the "greatest generation" that came of age during World War II, amid national harmony.  Boomers came of age during Vietnam, amid national disharmony.  It is small wonder we see the world differently.  Neither viewpoint is right nor wrong, just different.  How will other generations view the world?

Avi Tushman has just written Our Political Nature:  The Evolutionary Origins of What Divides Us.  There was one passage, in particular, that resonated with me.  Describing the Millennial Generation, i.e., those coming of age during the last 15 years, it said:

Today's young voter adheres more closely to the personality pattern shaped by evolution, though environment variables such as the social media revolution have left a mark as well.  As expected, millennials lean substantially to the left on most social issues, but slightly less on economic issues.  These "digital natives," who grew up steeped in social media, have also been dubbed the Selfie Generation.  and Selfie may be a more apt description:  The age group is characterized by individualism across the board.  According to the Pew Research Center, millennials are far less affiliated with traditional political, religious, and cultural institutions and less likely to be married than previous generations were.  Some commentators have accursed the Selfie Generation of having a sense of entitlement, interpreting their individualism as a kind of Facebook-induced narcissism.  Other observes have argued that millennials measure higher in cynicism and singleness -- and more often live with their parent -- because they face worse economic prospects than did the previous two generations.

Does that mean they will be less optimistic than the Greatest Generation, as well as even more introspective than Boomers?  Will they take even more benefits from the government than the Greatest Generation?  Will they hate the government even more than the Boomers?  Are they too individualistic to care about national harmony?  

Somehow, it makes me sad, but isn't that what other generations always do?

Saturday, April 26, 2014

An Aging Adage

Originally traced back to the Napoleonic wars, one piece of investment advice was to "sell when you hear rumors of war and buy when you hear cannons."  The thinking was that the market will lose value as uncertainty rises, and market prices are usually lowest when the war actually begins.  Of course, this presumes you have a good idea of who will win the war.  For example, once Russia formally invades Ukraine, is there any doubt who will win?

This adage seemed to work well in the days of conventional forces or standing armies.  In my Special Forces training, we were taught the ultimate weapon is not conventional forces, nor even an atomic bomb, but trained, motivated guerrillas, and I do believe that.  Unfortunately, this evolutionary change makes it unclear when wars actually start or end.

One side-effect is that it makes the old Napoleonic adage less useful.   Exactly, when did rumors of war in the Ukraine start?  Isn't uncertainty still rising?  There has been a few firefights and some people have been killed, but does that mean a war has started?  At one time, conventional Russia armies would have simply marched over the border and seized the country.  Today, they send small bands of Special Forces, disguised as guerrillas, to create trouble and provide an plausible excuse for the regular Army actions later.

Today, the old adage has been turned upside-down into "buy on the rumor and sell on the news."  An example of this would be an announcement that a company will make a major product announcement on a certain date.  As excitement over the announcement builds, you should own the stock.  Then, when the announcement turns out to be just major product news and not life-changing, the excitement ends and you should sell the stock.

I'm sure Warren Buffett would point out all this just proves the foolishness of trying to "time the market."  He has always argued you should buy companies you understand and hold them "forever."  Still, timing the market does not mean being 100% in the market or 100% out of the market.  It means increasing the percentage of cash in your portfolio as your anxiety increases.  That may or may not maximize investment performance, but it will maximize your anxiety-related performance.

Wednesday, April 23, 2014

No Distant Thunder . . .

Despite the seemingly-never-ending debt crisis in Europe, despite an impotent Congress, and despite a slowdown in China as the world's economic engine, the American economy has been growing for 58 months now.  That's the good news!  The bad news is that it has been growing at the puny rate of only 1.8% annually.

Most people think that is proof we are doing something wrong, but the proof is also pretty clear that recoveries from a financial crisis are longer and weaker than recoveries from an ordinary recession, which could result from imbalances in inventories, for example, or shocks to economy, like the Arab oil embargo.

Still, 58 months is significant because that is also the average length of economic recoveries since World War II.  At this point, this recovery is longer than usual.  Should we expect a recession in the near future? No!   Ordinary recessions usually experience a boom before the trouble begins, but we've had no economic boom yet, suggesting we still have room to run before the next recession.  (Of course, Cold War II might produce something unpredictable.)

Famed American economist Hyman Minsky died in 1996.  He was famed for his theory that credit continues to expand until the balloon bursts, which is called "the Minsky moment" and is followed by a financial crisis.  We had our Minsky moment in June of 2007, when two funds of mortgage-backed securities by Bear Stearns suddenly blew-up.

I'm not worried about another recession.  Despite an increasing capacity utilization, there is still too much spare capacity in our economy, as well as a lack of "boom" for an ordinary recession.  If it comes, it will pass.  Don't lose sleep over it!

I do worry about another financial crisis.  There is no historical precedent for one financial crisis to be followed quickly by another, but that is small comfort.  With an impotent Federal government, the only recession-fighter in America is the Federal Reserve.  Unfortunately, their only tools could create the very Minsky moment we want to avoid.

If we hear the distant thunder of a derivatives blow-up (probably in Europe), it will be time to do more than worry.  It will be time to invest in cash.

Tuesday, April 22, 2014

24/7 Inflation Watch

Although he looks to be a stereotypical absent-minded professor, Dr. Jeremy Siegel of Wharton remains my favorite absent-minded-looking-but-nonetheless-brilliant professor.

His latest commentary raises an eyebrow about the return of inflation.  The Producer Price Index for March was greater than expected.  Gas prices have risen to almost a 12-month high.  Factory usage as measured by the capacity utilization index has risen to 79.2% -- 80% is traditionally the minimum level for inflation to occur.

While inflation watch is a 24/7 job, I have not lost much sleep about this yet.  Until the velocity of money or the number of times a dollar is spent each year rises, I don't foresee inflation of the demand-pull variety.

You'll recall inflation may be demand-pull whereby the demand for a good or service is so strong that the seller can raise the prices.  Or, it can be cost-push inflation, which can occur when there are bottlenecks or supply shortages in manufacturing or delivery costs.  Dr. Siegel suggests that we watch cost-push inflation more closely.

Supporting this view, in a conference call yesterday with the National Association of Business Economics, I learned that 31% of businesses reported higher material costs, compared to only 15% a year ago.  Also, 35% reported higher wage costs, compared to only 23% a year ago.  Yet, the number that reported increasing their prices remained constant at 20%, which means profits are getting compressed.  That cannot last very long and could create a sudden outbreak in cost-push inflation.

Janet Yellen and the Fed are more worried about deflation right now, but my old professor should not be ignored.  

Monday, April 21, 2014

Invisible Muscles

Most people argue that the President of the United States is the most powerful person in the world.  After all, who else can drop more nuclear bombs at the same time?  But, what is the most powerful group of people in the world?  Could it be the U.S. Senate or the House of Representatives or the Supreme Court or, if not, which group?

During the campaign of 2008, candidate Obama promised to do something about loud TV commercials.  After all, the Federal Communications Commission receives more complaints about loud TV commercials than any other complaints.  In 2010, Congress passed the bipartisan but impotent CALM Act or Commercial Advertisement Loudness Mitigation, which became effective in December of 2012.  Did you notice any difference?  Are the commercials on your TV still louder than the shows you watch?  Mine are!

Advertisers are busily advertising that the number of complaints about loud commercials received by the FCC in December of 2013 were only one-seventh the number received in January of 2013.  So, obviously, the CALM Act is doing its job and the problem of loud TV commercials has been fixed  . . . right?

Advertisers somehow forgot to mention that the method of filing complaints became much more difficult and tedious in midyear than before.  Complainers have now become too frustrated with the process to continue complaining.  They have been defeated.

So, who is more powerful -- advertisers or lobbyists?  I would argue advertisers are the most powerful industry.  They can convince healthy people to eat unhealthy foods or even smoke deadly cigarettes or borrow money to buy things they don't need.  That takes real power!  But, I believe lobbyists are more powerful than the President of the United States or the Pope or anybody else.

Despite presidential support, plus overwhelming bipartisan Congressional support, plus overwhelming support from the American people, TV commercials are still louder than the programming.  To add insult to injury, the American people also find it more difficult to complain about those loud commercials now.  Lobbyists defeated the President, the Senate, the House,  . . . and the American people.  Now, that's power!

Despite many efforts to regulate them, they are more powerful than ever.  Whenever efforts are made to regulate them, they simply hire fellow lobbyists to protect their interests.

Thursday, April 17, 2014

Asset Protection Trusts

There are many good reasons to transfer assets into an asset protection trust, such as protection from creditors, from ex-wives/husbands, and from personal-injury lawyers.  My only observation until now has been there are more crooks selling asset protection trusts than anywhere in the arena of personal financial planning.  For those clients who need asset protection, I insist on helping to pick the trustee, because you lose everything if that trustee is a crook.

Now, I've received some marketing materials from an asset protection trustee whom I believe to be legitimate.  What bothers me is that he is arguing clients should put their money into asset protection trusts to protect that money from pollution claims arising from fracking.

It just seems like some things are so awful that you cannot hide from them.  If I kill a person, should my assets be protected from the claims of the decedent's family?  If I pollute the Chesapeake Bay, should my assets be protected.

I have avoided asset protection trusts as much as possible, because there are so many crooks. Now, there is another reason.  We don't allow people to hide from their college loans by filing bankruptcy.  Why do we allow major-league polluters to hide from their environmental liabilities by using asset protection trusts?  I find that morally repugnant!

Wonder if the crooks selling asset protection trusts also find that morally repugnant?

Wednesday, April 16, 2014

Risen From The Dead ?

There are those who believe the global financial market is just as precarious now as it was five years ago.  They are wrong!  As proof, it was little noticed last week when Greece returned to the market after four years of misery and was able to actually sell $4 billion of government bonds.

Their GNP has shrank over 25%.  Unemployment is 27%, which is a depression level.  Suicides have soared.  A quarter of the population lives in poverty.  Imagine this is America!  It has been a terrible price to pay, but, in all likelihood, it is still not enough.

The turning point is that the Greek government has finally passed some badly needed legislation to curb excessive pension costs and business regulation.  Of course, implementation of these changes will be critical for long term success.

Importantly, the leaders of the EU paved the way for this successful sale by NOT ridiculing the Greeks.  Merkel even flew to Athens the day after the sale to congratulate everybody.  "High Fives" were everywhere!  EU leaders wanted Greece to have access to the financial markets.

But, who would actually buy the government bonds of Greece?  To everybody's surprise, demand for the bonds was brisk.  They sold out quickly.  One reason is that 4.95% interest rate for five-years is high, compared to 2.5% and 1.4% for similar bonds of Portugal and Ireland, respectively.  In addition, you will recall existing Greek debt was restructured to longer maturities, mostly 30 years.  That means these new bonds will have to repaid before the existing debt, effectively making it senior debt that pays almost 5%.

I'm glad to see this success and hope it continues.  It reflects well on the global financial markets for sure.  It is also a reminder of what happens to economies who borrow money to pay for entitlements.

Tuesday, April 15, 2014

Is Enough Fair ?

Occupy Wall Street revived the discussion about income inequality, i.e., that the top 1% have an unfairly large share of the income.  While there are very few numbers quantifying the issue, it is generally assumed that a person needed $500,000 in adjusted gross income to be included in that top 1%.

However, there is some new research from the London School of Economics and the University of California relating to wealth owned, as opposed to income.  Using information from the IRS, they have concluded:

1.  The bottom 90% of Americans own 25.6% of the wealth.
2.  The next 9% own 34.6% -- thus, the bottom 99% own 60.2%.
3.  The next nine-tenths of 1% own 18.3% -- thus, the bottom 99.9% own 78.5%
4.  The next nine-tenths of one-tenth of 1% own 10.4% -- the bottom 99.99% own 88.9%
5.  The top one-tenth of one-tenth of 1% of Americans own 11.1% of the wealth.

The vast majority of the top 1% don't feel their wealth has expanded that much.  The top 1% of the top 1% have seen their share of the wealth quadruple since the Reagan Revolution.  Therefore, 99% of the top 1% have not benefited as much as the top 1% of the top 1%, so they feel maligned by Occupy.

The methodology of this research is a little suspect.  While they had good data from the IRS:  because the data was available annually, because the income is broken down by asset class, and  because of the huge sample size-- translating those income levels into asset values requires a changing capitalization rate every year.  There is a lot of subjectivity with that, although I'm not sure yet how it could be skewed by political bias.

Stated differently, the 16,000 families in the top 1% of the top 1% own 11.1% of America's wealth!  Fairness is an unfair word is describing this process of increasing wealth in fewer hands.  However, it does beg the question of when will too much wealth be in too few hands.  If the top 1% owns 39.8% of the wealth now, is it OK for them to own 49.8% of it?  How about 59.8%?

Nobody argues that the top 1% of the top 1% owning 100% of the wealth is good for society?  At what point does this concentration of wealth become harmful to social stability?  How will we know when enough is enough?  What has to happen first?  The question is begged . . .

Sunday, April 13, 2014

Name of Nation

Yesterday, I asked readers to guess the name of which nation has a very popular leader despite having a very bad economy.  The answer is Russia.

$63 billion of capital left the country in the twelve months of 2013 but $70 billion has already fled the country in the first three months of this year.

In the mid-1990s, 50% of its exports was energy.  Today, it is 70%.  The nation is terribly vulnerable.

I don't know who originally said that people vote their wallet, but suspect they only do that in the absence of patriotic fervor.

So, if the economy is lousy, start a war? 

Saturday, April 12, 2014

Name The Nation

The leader of this nation has an 80% approval rate, something any U.S. president would envy.  Yet, the economy is not doing well.  In fact, it is doing very poorly.

GDP growth has slowed for four straight years.  They are hoping for zero growth this year but may well slip into recession.

Capital is leaving the nation at a faster rate, i.e., more capital has left in the last three months than all of last year.  The government is considering capital controls.  Naturally, the stock market is down, and the currency is also down badly.

It is increasing dependent on a single export.  The economy is terribly vulnerable to this one export, and it is getting worse.  This indicates extremely poor long-term planning.

Whoever said that people vote their wallets?

Tune in tomorrow for the name of this nation . . .

Quarterly Column

I have been writing a quarterly column for Inside Business, the regional business journal, for some years now, and the latest column can be found at: 

Friday, April 11, 2014

Bring It On !!

The Dow dropped 266 points yesterday.  The "Fear Index" or VIX is up.  Is the sky falling yet?  No!   Of course, after surviving the near-collapse of the world financial system only 5 years ago, it is a fair question.

Let us remember that almost every year has a 5-10% correction, and we are overdue.  I've been hoping for one for some time now.  We're only down 4.5% from our high last month.  The longer we wait, the greater the correction.  So, bring it on!  It will be good for the stock market in the long run.

How do I know this is not the "big one," as we saw in 2008/9?  The basis of Modern Portfolio Theory teaches us that higher returns are available with lower risk if the portfolio is diversified by asset classes instead of by stocks.  In other words, a portfolio of 25 healthcare stocks is definitely NOT diversified.  A portfolio of different asset classes, such as large company stocks, small company stocks, international stocks, long-term bonds, short-term bonds, cash, gold, real estate is much better diversified.  The reason is correlation.  While all healthcare stocks are likely to move in the same direction by approximately the same amounts, stocks will usually move differently than gold or real estate, because they are not correlated. However, during the global financial collapse five years ago, everything became correlated, which is a fancy way of saying everything goes up or down at the same time.  When everybody sells everything and heads for the exit, asset classes become correlated, and this is bad.

Today, we see some stocks moving up, some nations moving up, and some bonds moving up, despite the fact that the vast majority of stocks are falling.  Different asset classes are behaving differently, which is normal.  Correlations are still working, which means that asset classes move independently of each other.  When they don't work, it is OK to get nervous . . . but not now!  Embrace the short-term pain!

Monday, April 7, 2014

Class Condolence

I have been blessed over the past week with many moving condolences on the loss of my mother and have appreciated every one of them.  However, there was one that seemed particularly insightful, from a good friend and gentleman-farmer.  Here it is:

Two nights ago the farmer put some of his herd in the field just below our house.  The rest of the cows were left in an adjacent pasture separated from the first  by our driveway.  Immediately there was this incessant … bellowing.  Mooing doesn’t begin to capture the sound.  It seemed that every cow was joining in - from both pastures.  The sound lasted all night.  It was stressful.   And distressful.  

The next morning I saw the farmer and asked about what we had been hearing.  He said they had separated the young calves from their mothers for the first time.  That was the cause of all the noise.

It seems odd - all this bellowing.  And then it doesn’t.  It’s something I can understand.

I was sorry to hear about the loss of your mother.  

Sunday, April 6, 2014

MPC + MPS = 100%

A new survey shows that food prices are expected to rise about 3.5% this year, about twice as much as the Fed wants . . . Who Cares?

Without discussing with my wife, I expect we don't spend 5% of our income on food.  So, a 3.5% increase increases that 5% to only 5.175% of income.  A local social worker tells me that her clients often spend one-third of their income on food.  So, 3.5% inflation in food prices increases that to 34.155%.

In other words, food expense for a poor person increased 1.155%, while mine increased only 0.175%. The increase for a poor person is 6.6 times as great as the increase for me.   Food inflation hurts poor people more than the more fortunate.

Economists like to talk about the Marginal Propensity to Consume (MPC) and the Marginal Propensity to Save (MPS).  They measure what percentage of new income will a person consume/spend or save/invest.  If you get another dollar of income, will you buy half a cup of coffee at Starbucks or toss it into your piggy-bank?  If you spend 70% of that dollar, your MPC is 70%.  Since you either spend/consume your money or you save/invest your money, a 70% MPC means your MPS is 30%.  Some people, unfortunately, consume/spend 100% of their income.  Those people are more directly impacted by inflation.

This is the "logical" basis for our progressive income tax system.  You tax most heavily those people with the higher MPS.  After all, they don't need every dollar of income to survive.

I know, I know . . . now we have a system whereby high income taxpayers pay the overwhelming majority of income taxes to run the government, but get less than they pay for, while poor people get more government benefit than they pay for.

One more time . . . why did Willie Sutton rob banks . . . because that's where the money is . . .

Saturday, April 5, 2014

The Need For Speed Is Greed

There is a firestorm on Wall Street, ignited by author Michael Lewis, with the release of his new book Flash Boys.  It is an explanation of how “high-frequency traders” (HFT) have rigged the stock market by getting buy-and-sell information literally nanoseconds before the stock exchanges, where trades actually take place.  

Knowing a good number of BUYS are coming in, which will drive up the price per share, they buy just ahead of those orders and then sell at the higher price to those sending in the BUY orders.  They might buy and then sell the same stocks in nanoseconds.  

It is estimated that 70% of all trades are now by HFT.  Are buyers getting ripped off?  Yes!  Is it enough to matter?  No!  If you are a long term investor, it should not matter if you pay an extra two cents per share.  Is it illegal?  If it is not, it should be!  Even Charles Schwab agrees it should be illegal.

But, the petty theft, albeit on a grand scale, is not my primary concern.  Long time readers know I have cautioned about high-frequency trading since the “Flash Crash” of May 6th, 2010, when the Dow suddenly dropped a thousand points.  That was due to a technology problem.  HFT is steroids for technology problems on Wall Street.

The only way to underwrite or minimize this risk is to avoid panic if/when it happens!.  Just like the Dow recovered those thousand points, we will survive an HFT-Crash, but it will seem like a near-death experience at the time.

Friday, April 4, 2014

On Eulogies

A chore is something mildly unpleasant that needs to be done.  A burden is something quite unpleasant that must be done.  A chore is going to a funeral.  A burden is delivering the eulogy.

People who knew the decedent want a pleasant insight into the decedent's life.  People who loved the decedent want to feel the warmth of that love one last time.

Delivering a eulogy comes disguised as an honor but really is a heavy burden.  Because a funeral can be ruined and the memory of the decedent can be stained by a bad eulogy, there is a great deal of pressure to do it right.  In addition, the person delivering the eulogy usually knows the decedent well enough to have emotions of their own, that should be suppressed during the eulogy.

My advice to those who must deliver a eulogy is to share lighthearted vignettes that each reveal a lesson-learned or a character trait of the decedent.  Facial expression is also important.  Smile with fondness, not with giddiness.  But, smile!  Don't be tempted to read or talk fast.  Slow down!  To control the emotions, avoid eye contact with the loved ones closest to you.  Lastly, don't expect applause, as that is considered inappropriate at a funeral.

Tomorrow, we return to the more pleasant world of economics and investments . . .