Tuesday, November 29, 2016

The Joy of Stimulus

The Organization of Economic Cooperation and Development (OECD) was not created for the sole purpose of criticizing the United States.  It just seems that way.

It is an outgrowth from the Marshall Plan, which oversaw the allocation of American aid to rebuild Europe.  Based in Paris, it was officially established in 1961 with 35 member-nations to "compare policies."  It has traditionally painted a picture of poor economic prospects, to encourage more assistance from the developed nations, like the "selfish" United States.

In the first major economic projection since the gridlock-ending U.S. election this month, the OECD has published a remarkably optimistic projection.  It projects world economic growth will rise from 2.9% this year to 3.3% next year and 3.6% in 2018.  For the U.S. economy, it projects growth will increase from 2.1% year to 2.3% next year and 3.0% in 2018.  As the President-Elect would say, this is HUGE!

It also predicts U.S. unemployment will fall from an already low 4.9% to 4.5% next year, with inflation rising from 1.2% this year to 2.2% in 2018, which will allow the Fed to increase interest rates from 0.5% now to a still-low 2.0% by the end of 2018.  All this good news is a result of Trump's stimulus plan, which he sees as Supply-side and which the OECD sees as Keynesian.

Elsewhere, it projects slightly slower growth in Britain and China.  The euro zone growth will only increase from 1.6% this year to  only 1.7% next year.  The difference between them and the U.S. is that gridlock has ended in the U.S.!  In other words, change has come to America . . . I hope!

My Prediction:  The OECD will be laying a major guilt trip on the United States in the near future to increase foreign aid.

Sunday, November 27, 2016

Emotional Void

It was early in 1960, when I was a boy, that I recall studying the photographs in the now-defunct Life magazine about the dashing young lawyer named Fidel Castro, who ousted a corrupt dictator named Batista.  My father told me that the corrupt dictator was taking from the poor and giving to the rich.  In later years, as an economist, I learned that such a problem was called the unequal distribution of wealth.  Castro's cure for this problem was not to redistribute wealth and/or opportunity.  His cure was to abolish wealth, which is what socialism does.

Two years later, I sat in class, looking out the window, toward the south, where I knew I'd see a mushroom cloud, as the missile crisis came to a head.  A decade later, there was even an intense military interest in Castro, and there were numerous assassination plots.   I was fully prepared to do my part.  It is fair to say we were obsessed with Castro.  However, as time passed, he faded into irrelevance.

When he died, I expected to feel some remorse -- remorse that we never administered the fate he deserved.  To my surprise, I felt no emotion about his death -- a typical existential reaction, I suppose.  For some reason, I feel obligated to despise the man but don't have enough emotion to spare or even to care about him.

He was the illegitimate son of a wealthy rancher and could have benefited from a continued Batista rule.  It is still unclear whether he was a closet-communist when he took power, but he seemed to convert quickly and conveniently.  Whereas communist leaders worldwide eventually accepted the futility of communism, Castro didn't.  This bright young lawyer became intellectually constipated after suppressing dissent and years of being surrounded by sycophantic yes-men.

Such a pity . . . what he could have done and what he did do to the people of Cuba!

Thursday, November 24, 2016

The Mystery of Thanksgiving

I remember hearing a sermon about Thanksgiving
The minister didn't give thanks . . .
for food or family.

he was thankful for
his freedom to worship . . . or not,
his freedom to pray . . . or not, and
his freedom to give thanks . . . or not.

He said the mystery of Thanksgiving is
how is it possible that
those with so much can be thankful for so little,
when those with nothing can be thankful for everything?

I like to think
whatever success that I have
resulted from being bright and working hard.
But, that ignores luck!

My good luck includes
good family, good friends,
and a great country!

Happy Thanksgiving!

Wednesday, November 23, 2016

Financing Stimulus

With the stock market in record high territory, you can guess the most common question:  Is it time to sell?  No, the stock market is high, but it is not nose-bleed high.  While the charts for the Dow, S&P, and Russell are all similar, the chart for the Nasdaq is easier to see.  Take a look at it:

Chart of the Day
You can see it has fluctuated within a "channel" since the global financial crisis in 2009.  At almost 5,400 now, you can see that a run to 6,000 is still within the channel.

So, from a technical standpoint, the market is not too high.  In addition, there is plenty of cash on the sidelines that has missed this strong rally, which means that the cash for increased demand is readily available.  In recent history, however, the stock market seems to react, make that over-react, to macro or larger environment.

For the last six years, the nation has merely treaded water. as Congressional gridlock stymied everything.  This was unnecessary, unfortunate, and unpatriotic.  What is driving the market now is the belief that Congress will finally approve a real stimulus plan.  Fortunately, gridlock has now been broken.  The Fed has fought a lonely battle to save the economy with its only weapon - Monetary Policy.  Finally, Congress may actually help, instead of obstruct, and actually use Fiscal Policy, like a stimulus plan.  

The battle to watch is between Supply-side Republicans and Austrian Republicans, not Democrats or Republicans.  Supply-side Republicans believe tax-cuts,especially to the affluent, gives a caffeine injection to the economy.  It is explained by a diagram popularized by Arthur Laffer.  Take a look at it:

You can see along the bottom axis that income tax rates can rise from 0% to 100%.  At each point on the bottom axis, go up to the red bell-shaped curve and then move to the left to see the government revenue at each tax rate.  In an ideal world, the tax rate should be at the midpoint, where government revenue is maximized.  If you are on the right side of the midpoint, government revenue will actually increase if you decrease taxes, according to Supply-side Republicans.  

So, why were the Kennedy tax cut and the Reagan tax cut successful, while the Bush tax cut failed, causing deficits to soar?  Presidents Kennedy and Reagan correctly thought the economy was on the right side of the midpoint, while President Bush was wrong.  Supply-side Republicans seem to think we are always on the right side.

Austrian Republicans are old-fashioned Republicans who follow the Austrian school of economics.  To get a visual understanding of what Austrian Republicans see, go to:


Do you want to finance a stimulus plan with tax cuts or deficits?  Can we afford a mistake by assuming a tax cut will NOT increase deficits?  A failed Supply-side tax cut is nothing more than Keynesian economics!

Tuesday, November 22, 2016

Long-Running Debate

One of the longest running debates in the investment community is whether passive investing is "better" than active investing.  Passive investing involves trying to match a stock market index, such as the S&P 500 or the Nasdaq.  Examples would be exchange-traded funds (ETFs) such as SPY or QQQ.  Active investing tries to do better than the index.  Examples are most mutual funds.  ETFs are also cheaper than mutual funds.  Passive investing has "beaten" active investing for 22 of the last 26 years.  Is that proof of anything?

Active or passive should not be a binary decision, like voting.  Both types of investing have a place!

First, most studies of relative performance are based on the S&P 500 over some period of time.  That index is entirely large-cap stocks or big companies.  Those companies are better known to analysts, and their financials have been closely audited by many analysts for many years.  There is little new to be discovered.  However, studies of the relative performance of active and passive investing are much less convincing for small-cap stocks.  It is not imprudent to use ETFs for large-cap stocks and mutual funds for small-cap stocks.  And, I cannot say that ETFs or passive investing is ever appropriate for international stocks.

Another distinction is the stage of the business cycle.  The last 26 years have, on the whole, been in a bull market, where ETFs have the advantage, because they are 100% invested.  Mutual funds usually maintain a cash cushion, such as 5%, which is a drag in a bull market but a blessing in a bear market.  Mutual fund managers can increase their cash when the market is going down, exchange fund managers cannot.  I would rather have a mutual fund in a bear market than an exchange-traded fund.

A hard distinction to describe is value of expertise, which drives up expenses.  In passive investing, you are not buying any investment expertise.  In active investing, you are buying the advice of a portfolio manager.  Many investors find comfort in this.  I often find comfort in this extra expense but not in all cases.  The value of that expertise increases in a bear market, especially among small or mid-cap stocks.

Most of all, this debate is too broadly-brushed.  Even if passive investing is superior at all times for all assets, that does not mean that 100% of all ETFs beat 100% of all mutual funds.  For example, so far this year, 30% of all large-cap mutual funds have beaten ETFs, even though ETFs have the advantage with large caps.

Lastly, the "odd-lot" theory applies to this debate.  That theory suggests that small investors invariably do the "wrong" thing.  Today, we see small or retail investors getting out of mutual funds and piling into exchange-traded funds.  They bought the "sales-pitch" of passive investing.

Like life, investing ain't that simple . . . even passively.

Saturday, November 19, 2016

The Power of Positivity

Many of us were raised in austere, utilitarian households, where frivolity was discouraged.  Your life should also be austere and utilitarian.  There was little need for others in your life, aside from the obviously utilitarian value of procreation.   Hermits were respected.

Education also isolated us from each other by increasing our cynicism, especially the "scientific method."  Words are not to be trusted, because they can either reveal or conceal, and you might misinterpret them.  The same is true for numbers.  They can either reveal or conceal.  Those of us in the investment business start from the premise that everybody is a liar, until proven otherwise.

The classic imagery of exitentialists is a forlorn individual stranded on an ice floe, floating down a deep and wide river of negativity.  Obviously, people can easily become isolated by negativity, and our society is full of it.

Recently, I had the opportunity to attend an NFL football game in a huge stadium, for which I had paid an obscene amount of money, to be surrounded by a hundred thousand strangers all screaming in support of the hometown favorite.  The point was not to watch grown men play a silly, frivolous game, with a funny shaped ball, that meant nothing.  It was neither austere nor utilitarian.  It was simply fun and positive.  A hundred thousand people paid an obscene amount of money, not to watch some silly game, but to briefly escape all the negativity and embrace positivity.

Friday, November 18, 2016

"Smartest" Expectations

The "Smartest People on Wall Street" were also surprised by the Trump election but have recovered enough to issue ten themes or expectations that might inform your investing decisions:

  1. "Expected returns: Only slightly higher."  (Probably!)
  2. "US fiscal policy: A pro-growth agenda."  (Only in the short-term  . . )
  3. "US trade policy: Concerns are likely overdone." (Probably!)
  4. "EM risk: 'Trump tantrum' is temporary."  (EM = Emerging Markets)
  5. "Trump and trade: Hedge with RMB."  (RMB = Chinese currency)
  6. "Monetary policy: Focusing the toolkit on credit creation."  (Leading a horse to water . . .)
  7. "Corporate revenue growth recession: Signs of inflection."  (Signs of ending already.)
  8. "Inflation: Moving higher across DM."  (DM = Developed Markets, like U.S.)
  9. "The next credit cycle: Kinder and gentler."  (Thanks to Dodd-Frank?)
  10. "The 'Yellen Call' 2.0: Now with contingent knock-in."  (Only if inflation surges.)
Now that you know what Goldman Sachs thinks, what do you think and why?  
Now, what will you do with that information?

Wednesday, November 16, 2016

Historical Clue

We tend to confuse normal business cycles with rallies.  A business cycle reflects the expansionary and recessionary phases of the economy, usually in the neighborhood of four-to-six years.  A rally refers to a recovering stock market (which should not be confused with economy) that occurs after a 30% decline in stock prices.  In the last 116 years, we have seen thirteen rallies, averaging about nine years each.

Chart of the Day

You can see the rally in the Dow since the bottom in March of 2009 is about average in duration but much weaker than the average rally, despite setting a new market high yesterday.  The bottom line is that history gives us no reason to suspect a market collapse is due.  There is still plenty of room for the bulls to run!

Tuesday, November 15, 2016


The Market Price (MP) of a stock is equal to Earnings-Per-Share (EPS) times the Price-Earnings (PE) ratio.

Conservative pundit and serious Supply-sider Larry Kudlow is fond of saying that "corporate earnings is the Mother's milk of stock prices."  As corporate earnings increase, market prices should logically increase.  (EPS is nothing more than the corporate earnings divided by the number of shares of stock.)

A year and a half ago, corporate earnings stopped growing.  During the third quarter of this year, earnings finally started growing again, at a respectable 2.9% pace.  Analysts now predict 3.5% increased earnings in this quarter, followed by a whopping 11.4% and 10.5% in the first and second quarter of next year.

So, we should expect stock prices to rise, right?  Don't forget you have to multiply EPS times the PE to get the market price.  If a firm's earnings-per-share is $1, and I'm willing to pay 20 times the annual earnings of $1 per share, the market price of the stock is $20.  ($1 X 20 PE)  This is where investor confidence and sentiment influence the market price.  In recent years, investors have been willing to pay 18-20 times the EPS.  Of course, in times of economic fear, the PE may fall, pulling down market prices, even with rising earnings.  This is not one of those times.  We have rising earnings and rising optimism, which is the recipe for a bull market.

I think the election of Trump will increase the PE, as the "sugar-surge" of a robust fiscal policy (read: deficit spending) spreads across Wall Street, lasting at least until Springtime.  With complete control of government, the gridlock over fiscal policy (taxes and spending) will finally be broken, lending some badly-needed assistance to an over-worked monetary policy.

Party on, Garth . . .

Saturday, November 12, 2016

Change or Anti-change

Aleksandr Dugin is a Russian political scientist and has been given credit/blame for convincing Putin to invade the Ukraine.  Indeed, he has been called "Putin's Brain" by the highly-respected Foreign Affairs.  Born in 1962, his father was a lawyer and senior military intelligence officer, while his mother was a doctor.  Dugin eventually earned a PhD and taught at Moscow State University, until he was fired in 2014.  He is a very bright person indeed!

He is also alleged to be the intellectual genius behind Breitbart CEO Paul Bannon, who was Trump's campaign manager.  Of course, that allegation comes from Glenn Beck.

Still, there is a subtle reflection between the two men.  Dugin is a strong nationalist and advocate of returning Russia to the stature it had during the USSR days, arguing forcibly for the reunification of all Russian-speaking populations.  He wants Russia to return to its past historic greatness, and he is leading the way.  To appreciate how he clings to the past, consider that when the Russian Orthodox Church split over procedures and liturgy, Dugin stayed with the side avoiding any change.  Is he just another anti-change agent?  Or, is he pushing Putin to change Russian reality to the way it used to be?

Is he dangerous?  The reason he was fired from the University was that, when asked about what should happen to the non-Russia-speaking people in the Ukraine, he said "Kill them, kill them, kill them. There should not be any more conversations."  And, this is Putin's Brain??

I pray Dugin is not an intellectual godfather to Bannon, but it concerns me that Breitbart predictably rails against things having changed, always suspecting there is a Fifth Column of sneaky people behind every change.

If change for change's sake is a bad idea, then why isn't no-change for the sake of no-change also a bad idea?

Prediction Post-Mortem

As is normal, I've been getting some ribbing about my election forecast that an unexpected Trump victory would cause the Dow to drop 500 points before rebounding in a week.  This prediction was informed by the Brexit election in late June, where the pundits were wrong, and the FTSE tanked, only to be normal a week later.

What happened here is that the U.S. pundits were also wrong, the Dow futures dropped 800 points before the Dow finally closed up 250 points - a thousand point swing in one day.

So, my prediction was correct directionally - there was a violent drop.  I predicted 500 points but it was 800 points, which was due to the fact that the markets were still open in Asia and Europe, where Trump is far less popular.  My prediction was correct that the stock market would snap-back quickly, and even I was shocked just how quickly it actually snapped-back..  (I give some credit to Clinton's gracious concession speech, which was probably the best speech of her career.)

All-in-all, I feel good about my prediction,but I am very curious as to why polling has become so much less reliable than even a few years ago.  I recognize many young people don't have land-lines, making them difficult to contact and therefore to include in the survey.  Even when contacted, an increasing number of people refuse to participate.  Are people less cooperative?  Are people just less available, working in a 24/7 global economy?  Maybe, people suspect the caller is not really a pollster and don't trust them.  I like to think that people are finally discovering how little of their privacy they still have and choose, at the very least, to keep their political opinions to themselves . . . I know that I never talk to pollsters.  

Friday, November 11, 2016

Over-reacting to a Reaction ?

How can the stock market have a strong Clinton rally, followed by a strong Trump rally?

One explanation of stock market behavior is uncertainty.  When the market thought Clinton would win, uncertainty decreased, driving up the market.  But, didn't uncertainty increase with a Trump victory?  Maybe not?

Another explanation is the "true-believer" argument, i.e., that Republicans are rushing to put their money back into the stock market, after sitting out the Democratic administration.

Another explanation is that the market is getting sucker-punched into believing all the "come-together" platitudes from both parties.

Another explanation is that the market is celebrating the death of gridlock.  Who cares how infrastructure improvements are financed?  There is a lot of money to be made, before the infrastructure bonds have to be paid.  The miracle of capitalism is being reborn in America, and everybody better get on the train now, before it leaves the station?

Personally, I think this rally is getting too far ahead of the economy and hope that President-Elect Trump will begin managing expectations.  He never promised to make America great TODAY!

Wednesday, November 9, 2016

The Morning After . . .

I confess to believing that Clinton would win the election.  So did Wall Street!  The bloody aftermath today proves that.  Readers will remember that I predicted, in the unlikely event of a Trump win,  an immediate 500 point drop in the Dow, followed by a Brexit-like recovery in a week or two.  I still believe that the stock market will recover from this in a relatively short period of time.

One can look at the election as a loss by Clinton.  However, I see it as a loss of gridlock.  There is a chance that Trump will actually be able to do something, which Obama could not do for the last six years.  As an old infantry officer who learned that the failure to command was the worst thing that can happen when you come under fire, I am delighted to see gridlock die.  Whether you approve of the direction of the change that is coming, it will be refreshing to simply be moving again.

The lordly investment giant of Goldman Sachs said this morning that "broadly speaking, our fundamental economic outlook is unchanged."  Long-term, I agree . . . but it could get choppy, even scary, in the short-term.

They also said "we think the chances of the Fed raising rates in December have diminished."  Unfortunately, I have to agree.

Continuing, "we see near-term pressure on the dollar versus core markets and downward pressure on Treasury yields."  I doubt this!

"Heavy fiscal stimulus may support growth and inflation, and benefit targeted infrastructure sectors, but may face considerable opposition from Republicans."  There will be a genuine battle between the Austrian wing of the Republican Party and the Supply-side wing of the Republican Party.

"Trump's proposed tax cuts may support growth."  Watch the $20 TRILLION national debt skyrocket, at least in the short term!

If your candidate won, celebrate modestly.  If your candidate lost, celebrate being an American.  But, know that this too will pass .. ..

Saturday, November 5, 2016

Celebration of Hyperbole

Next Tuesday, I'll vote in a presidential election for the 13th time.  In every single election, it was described as the most important election in American history.  Yet, after every single election, America survived.

In every single election, my family has advised me that my vote should be for the "lessor of two evils."  In other words, there has never been a worthy candidate.  Still, America has survived.

The only certain winner will be the media which hypes election season to sell advertising and increase profits.  Election season is a commercial celebration of hyperbole.  America will survive hyperbole, I promise!

So far, only five clients have called me with election anxiety -- from four Republicans and one Democrat.  Cable news would therefore argue that 80% of worried Americans are Republicans.  So much hype, so little significance . . .

Months ago, I decided that Saturdays would be my news-free day each week, and I'm so glad I did, because I still have the sanity to know that America will survive this election!

Friday, November 4, 2016

Get Out !!

Some people get songs in their head and hear those songs constantly.  Some thoughts get caught in my head, and I wish I could get them out.

For example, Turkish President Erdogan said "democracy is like a street car - when you get to your stop, you get off."  What does that mean?  Where is your stop?  What is post-democracy?

The senior Republican senator from South Carolina, Lindsey Graham, said "there'll come a time when love of country will trump hatred of Hillary."  What does that mean?  You don't love America if you vote for Trump?  If I do love America, I will vote for Hillary?  And, Graham is a strong Republican.

The presidential campaign manager of Republican senator John McCain was named Steve Schmidt.  He said (paraphrasing him) "when fascism came to power in the 1930's, it was not because fascism was strong.  It was because democracy was weak."  What does that mean?  How do you recognize weakness in democracy?  When does democracy become too weak?  How would you recognize it?  How would you strengthen it?

Yogi Berra would be proud . . .

Why don't moderators in presidential debates ask these questions like this?  

Thursday, November 3, 2016

Get It Over With !

It's not nice to fool Mother Nature . . . nor the stock market, which hates uncertainty.

I've written that the stock market has believed that Clinton would win the election since late Springtime.  In fact, I predicted a 500-point drop in the Dow the next day, if Trump pulled-off an unexpected win.  During that time (except for the Brexit Bear in late June), the market has just bumped along . . . until recently.

With the latest DOJ surprise and the narrowing polls, the stock market is questioning the belief that Clinton will win, which explains the 7-straight days of small losses.  Confidence is seeping out of the market.  You can see the sharp downturn in this chart of the gray line.

Chart of the Day

The 500-point drop in the Dow may already be happening.  

If you want to fret, you'll remember this presidential election has been wildly unpredictable and so is the stock market.  If you want to celebrate, look at how the market has historically ended during election years . . . UP sharply!

Wednesday, November 2, 2016

Big Trouble in Big D ?

Back during the 1980's, I was a vice president with New York-based Citicorp, primarily lending for large commercial construction projects in Texas, whose economy was booming at the time.  I'm proud to have financed construction of the iconic Infomart with $92 million of strip-funded eurodollars (see pic), as well as the very first Wyndam Hotel.  There was so much construction that we joked the official state bird of Texas was the crane . . . as in the many construction cranes above downtown.  Of course, such hubris almost always ends badly, with overbuilt markets and falling prices, as it did in Texas.

When visiting Dallas last weekend, I had the eerie feeling that I had seen this movie before.  While I have not yet seen any analysis of construction completion schedules and annual absorption rates, I've seen enough to be very worried.

So, I was relieved on Monday, when I read that nationwide private commercial nonresidential construction was 1% less than last year, the largest decline in nine months.  Public construction dropped to the lowest level in the last 2.5 years.  I would wish for a larger decrease, except that commercial construction contributed such  a large portion of the 2.9% GDP increase in Q3.

It may be that commercial construction is slowing down because it is getting overbuilt, meaning the rental market is over-supplied with space.  Or, it may be that "cap rates" are rising.  Remember that the value of commercial real estate is largely determined by dividing net-operating-income by the capitalization rate, which normally rises with interest rates (assuming the cost of equity remains constant).  The market believes interest rates will increase next month, and an increasing divisor decreases value.  This is an example of the classic self-correcting mechanisms of capitalism, i.e., too much demand for money to finance construction raises the "cap rate", which drives down the value of real estate.

I don't relish another Texas recession, as that hurts our national GDP disproportionately, but will not be surprised if that happens.  More specifically, the same rise in capitalization rates that hurts Texas commercial real estate will hurt such projects nationwide.

A lesson from the past is talking . . . and I'm listening!