The Value of Rhetorical Questions

How will you know if you deserve a better car? When it leaves you standing beside the road in a bad neighborhood!

How will you know if you deserve a better form of government?

No, it is NOT un-American to ask! No, the question is NOT what should replace it. No, the question is NOT what's wrong with either Republicans or Democrats. The question is HOW will you know if you deserve a better form of government?

How?

Attack of the G-Men

Over the weekend, we learned the SEC was launching a major crackdown on insider trading. On Monday, they raided the offices of three hedge funds. Good!

After the Global Financial Crisis, the 52% drop in the stock market, and the mysterious Flash Crash in May, it is no wonder that retail investors are distrustful and still on the sidelines, missing this year's rally.

To restore confidence, retail investors must be assured there is a level playing field, and the SEC knows this. After the earlier market crash, G-Men went after the executives of Enron, WorldCom, and many other companies. Retail investors have short memories and soon returned to the market after the prosecutions.

Because the last crisis was financial in nature, we can expect the G-men to focus on the financial firms, which will slime all of them. I certainly don't plan to increase my exposure to any financial stocks.

The Hidden Inflation

The Fed is justifiably worried about deflation,which is more worrisome and tenacious than inflation. That is the reason they launched the latest round of quantitative easing. Many people don't see the danger. Even the most recent data shows no serious indication of either inflation or deflation.

Yet, if you look deeper, you see the U.S. is becoming bifurcated into one section that is part of the globalized world and another section of the country that is less touched by globalization.

Today, Fed Chairman Bernanke will speak of a "two-speed global economy." Because the recession was started by the U.S., it is worst here. The rest of the world was pulled into it and are recovering faster. As a result of their rapid recoveries, their inflation is increasing. (Yesterday, China slapped price controls on certain food items.) Their exports are our imports, which means we are importing their inflation.

In addition, because commodities such as oil and gold are priced only in dollars, the cost of those commodities is increasing as the value of the dollar continues to decline. The more value the dollar loses, sellers of gold will demand more dollars for the ounce of gold.

That section of the U.S. that does not consume large amounts of imports or commodities is not seeing inflationary pressure. The other section is.

Of course, averaging the two sections of the U.S. produces a non-worrisome CPI. However, I do worry it will show real inflation within another year or so.

The Grim Reaper

If you do nothing else today, read the article titled "China's State Capitalism Sparks a Global Backlash" on the front page of The Wall Street Journal. It is the secret to China's success and the reason we should be afraid, not merely worried.

China has the ability to put the entire force of their nation behind a particular industrial policy. The U.S. cannot even agree if we need an industrial policy or not!

The Unpredictably Predictable Tide

As I sit here on the shore of the Chesapeake Bay, I know there will be a high tide twice a day. If I watch TV, I will know the exact times of the tide. It is so predictable.

As I watch the stock market, I recognize the same tidal changes, as the level of uncertainty go up and down. As uncertainty about the election decreased, as uncertainty about the Q3 economic performance decreased, and uncertainty about the Fed's quantitative easing decreased, the stock market has been bullish the last several months.

Over the last week, the tide of uncertainty has begun to rise again. Will the Fed be able to maintain its quantitative easing in the face of withering criticism abroad and at home? Will the Bush and Obama tax cuts be extended or not? Will the problem now becoming apparent in Ireland cause the same damage that the problem in Greece caused earlier this year? Will the surging inflation in China cause their government to stifle its growing demand for the world's resources?

It is often said that the market is always climbing a Wall of Worry, but that implies a predictability that doesn't exist. Likewise, the market is usually quite bullish this time of year, but that is not a certainty and is easily de-railed by a tidal change in certainty and uncertainty.

Changes in the level of uncertainty will always occur, changing the market. The unpredictable part is whether the change in uncertainly will be long-lasting and profound . . . or just another tidal change.

In Your Eye, Mr. President

It has never happened before. The credit of the United States was downgraded yesterday. While this is considered inevitable if we continue to run such deficits, it was nonetheless a surprise yesterday.

But, the timing was interesting. It is not unusual for lots of acrimony before a G-20 Summit. This one is worse than usual. On the eve of the Summit, it was China who downgraded our credit. Coincidently, Moody's upgraded the credit rating of China. This is an embarrassment to the U.S. President and improves the negotiating position of the Chinese at the G-20.

Fortunately, the final communiques signed by the G-20 leaders is always conciliatory. Hopefully, this one will be. It will probably focus on the need for infrastructure development in all countries, a source of minimal rancor. A few years ago, it focused on the need for rich countries to donate more aid to poor countries. (Then, the recession hit and no nation made its promised contribution.) Again, no rancor.

The final communique will also probably condemn competitive devaluation of currencies. Both China and the U.S. will sign it with dirty hands.

Don't Call My Kettle Black!

Regardless of who the President is, he needs a thick skin. Certainly, President Obama does as he begins the G-20 Summit in Korea. It may even be deserved.

For years, we have criticized China for maintaining an artificially cheap currency, which helps their exporters. With QE2 or quantitative easing, we are greatly increasing the supply of dollars, which reduces the value of each dollar. Not surprisingly, the dollar has been declining for months. This is good for American exporters. It is also good for those nations who have pegged their currency to rise and fall with the dollar. But, it is very bad for everybody else, which is the reason Obama is arriving at the Summit amidst a firestorm of criticism.

It is another reminder that each nation will behave in their own best reason. Now, why is that news? Did anybody expect us to behave differently, just because the dollar is the world's only reserve currency? Well . . . yes!

Don't call me a currency manipulator . . . you currency manipulator!

The N-11

Did anybody see the new IMF report raising the estimated GDP growth rate for the 47 countries of Sub-Saharan Africa for the second time this year . . . from 4.5% to 5%?

Those traditionally poor nations are growing more than twice as fast as the U.S. Does that bother anybody else? As an economist, it is not surprising, as it takes longer to get out of a recession when you must also pay down debt, like the U.S. As an American, however, it makes me sad.

One major reason the U.S. stock market is up this year is because it is a very multi-national market. Most of the huge multi-national companies are listed on the U.S. exchanges. As the rest of the world booms, we get some derived bounce. So, be glad the rest of the world is beginning to boom. They're enjoying the fruits of capitalism, and we get a little as well!

We are all familiar with the BRIC acronym, originated at Goldman Sachs to describe the rapidly growing giants of Brazil, Russia, India, and China. Their new one is the N-11 or next eleven countries to boom, i.e., Bangladesh, Egypt, Indonesia, Iran, Korea, Mexico, Nigeria, Pakistan, the Philippines, Turkey, and Vietnam. They believe countries will rival the G-7 developed nations in this century. Wow, that is quite a statement!

Historically, we have referred to those markets as "frontier markets." Maybe, we have arrived at the frontier, which can be a frightening, dangerous, and lawless place, especially to invest hard-earned savings! Be very careful!!!

Enjoy the Ride . . . Again

After a highly eventful week, the stock market is at a two-year high, about the same level as we were when Lehman was allowed to collapse. Nonetheless, that is some three thousand points on the Dow -- below our all-time high in 2007. The market is still down 21% from those heady days.

Think back to last Spring when the market was moving up daily. The pundits were almost univerally bullish. But, I said then the market had disconnected from the economy and needed to wait until the economy caught up, which I expected would be in the fourth quarter.

The economy is starting to show life again, and as usual, the market is getting ahead of it. Winter is traditionally a good time to be fully invested. By Spring, we will be due for 10-20% correction.

So, enjoy the ride . . . for now!

An Economist's Lament

The study of economics has always been an enjoyable intellectual pursuit. There are lots of arcane terms and inside jokes that economists enjoy discussing and sharing.

But, it seems we have reached a tipping point where economics is becoming polluted by politics, and I'm sad about that. Should I parse my thoughts to support one political side over the other?

As I've said many times, economics is not religion. There is wisdom in all schools of economic thought, and we should pick and choose as appropriate for the economic situation.

Politics = pollution . . . dammit!

Good Jobs Report . . . finally

The most important monthly economic report each month is the "Jobs Report." The last few months, the report has shown a sadly weak economy, producing few jobs. Voters took the President to task for that on Tuesday.

Today, the Labor Department announced that the private sector created 159 thousand jobs, twice what was expected. This was great news, and the Dow futures immediately jumped 40 points.

I'm sure the President wishes this report came out before the election, and I'm equally sure the 14.8 MILLION people who are unemployed wish it was even better news, as they need YEARS of equally good reports to get back to normal.

All year, I 've been predicting the fourth quarter would be good, and it certainly looks that way . . . thank God!

Fire Up the Printing Presses . . . Again

Today, the Fed announced another round of quantitative easing, which means they will buy Treasury bonds, which means the Treasury then gets that amount of money ($75 BILLION per MONTH over the next 8 months) deposited into Treasury's checking account, which Treasury can then use to write checks for Social Security, infrastructure, anything . . . even interest payments to the Fed for having bought the Treasury bonds. In other words, the right pocket buys the bonds in the left pocket. Of course, it is all "smoke & mirrors", but it can have huge economic effects.

Milton Friedman, father of Monetarism, believed that inflation is caused by "too many dollars chasing too few goods". Another way of saying this is . . . if money supply increases faster than productivity, you will get inflation.

The Fed is worried about deflation. So, today's Fed action does make sense!

Plus, the Fed handled it well. You can tell . . . because the stock market barely reacted. That means the Fed properly telegraphed with market. When it doesn't, the market over-reacts, which is what it does best!

Political Pundit George Carlin ?

I think the late comedian was the first to describe our electoral process as "political masturbation", a very intense, focused effort to accomplish nothing. The Libertarian view is that elections merely change the Masters, with the slaves remaining the same. It is just a different set of thieves. Maybe, that's a little cynical. OK, that's a lot cynical.

Wall Street traditionally likes divided government, and I expect the stock market will reflect that. That's the silver lining. But, there are turning points in history. We may "kick the can down the road forever," but forever is over. There are some deadly serious decisions to be made, and I don't see that we have the process for making those decisions.

How are we going to keep borrowing money from our grandchildren to pay for our Social Security, for our Medicare, for endless far-flung wars, and for interest on the trillions we've already borrowed?

What changed yesterday that will help us make those decisions? What happened two years ago that helped us? What will happen two years from now that will help us? Or, will it be just another Master?

WHEN will we know . . . and HOW will we know . . . that "political masturbation" is no longer working for America? The American people deserve better!

Election Day . . . Finally!

In this world of 24/7 cable news, which spin the news as well as report the news, it is easy to become both confused and depressed. Therefore, I recommend a disinterested foreign perspective to balance the right-wing Fox News and the left-wing MSNBC. Religiously, I read The Economist, a newsweekly magazine from England and recommend it.

Sometimes, it is helpful to read things like this, which appears on page 11 of the current issue: "Despite its problems, American has far more going for it than its current mood suggests. It is still the most innovative economy on earth, the place where the world's greatest universities meet the world's deepest pockets. Its demography is favourable, with a high birth rate and limitless space into which to expand. It has a flexible and hard-working labour forces. Its ultra-low bond yields are a sign that the world's investors still think it a good long-term bet. The most enterprising individuals on earth still clamour to come to America."

Too bad politicians never remind us of anything good about America . . . but, if they did, would we even listen? Have we become programmed to process only negative news? The nation that made the world safe for democracy, put a man on the moon, and still is all the things cited above . . . simply deserves better!

Rest Up This Weekend

Next week, the market could be exciting, maybe too exciting! As I've been predicting all year, the market will begin to rally when the election outcome comes into focus. I expected that in October and was pleasantly surprised when it started in September. Historically, the market likes gridlock, which appears to the outlook.

Another reason for the recent rally is the expectation that the Fed will announce another round of "Quantitative Easing" this week. While this is inflationary in the long term, it may jumpstart the economy in the short term. I expect the market will fall after the announcement. (There is an old market axiom about "buy on the rumor and sell on the news".) If the Fed announces less than $500 billion, expect the sellout to be more violent.

On Friday, the Department of Labor will issue the single most important economic report of each month, i.e., the "Jobs Report". Expectations are low, about 75-80 thousand private sector jobs. If significantly more jobs are created, expect the rally on Friday to be strong.

Only one thing is certain . . . it will be an exciting week!

Nailed it!

Economists get ridiculed frequently and richly deserve it. In fact, they usually enjoy it!

However, today was a good day, in that they accurately predicted the GDP growth rate in Q3 would be 2.0%, compared to 1.7% in Q2.

This makes it even less likely we will see a "double-dip" or experience the worst of the recession again. This makes my forecast of a "long, hard slog" even more likely, darn it! I was still hoping we would sharp a sharp rebound, which is more typical following a recession.

Sometimes, economists don't want to be correct ...

The Halloween Indicator

Of all the many market indicators, this is the most useless but must be fun, as it rolls out year after year. Here it is:

Since 1950, the stock market performs best from the last trading day of October to the end of April. (Of course, there are always obvious exceptions, like the oil embargo of 1973-74, the dot com bust of 2001-2, and the Great Global Financial Crisis of 2007-9.)

It is not news that the market does better during the winter and spring than it does during the summer and fall. In fact, it does a lot better!

The only thing scary about this is that we call it The Halloween Indicator. Let's just hope it works this year, and the market does as well as it usually does after goblins go away!

Baking a Cake . . . or Baking a Market

When you look at a cake, you are seeing the end result of whatever ingredients went into it. The same is true when you look at the market. Instead of flour, butter, mix or whatever goes into a cake, information and expectations go into the market.

Most people understand why information moves a market, but expectations about information are just as important. Yesterday's roller-coaster market is a good example.

Yesterday's Wall Street Journal reported the quantitative easing by the Fed to be announced next week would be much less that expected and over a longer period of time. The market promptly dropped almost 160 points. That afternoon, legendary Abby Joseph Cohen of Goldman Sachs predicted the Fed would do more than the Journal reported, about $500 billion as earlier expected. As a result, the market rallied over a hundred points, finally closing down only 43 points.

Expectations are important. Just imagine how you would feel if you expected a German chocolate cake from Neiman Marcus and only got a Twinkie from 7-11. You might lose your appetite for sugar . . . and for stocks.

Paddling Hard . . .

Arthur Conan Doyle once described how Sherlock Holmes unraveled a mystery because of the "dog that didn't bark". That's reminds me of the G-20 meeting in Korea. China is clearly manipulating its currency, but so is the U.S. But, there was little furor about this.

While the finance ministries are warning of a currency war, there was no furor that we were already in it.

U.S. Treasury Secretary Geithner proposed measurable goals for the emerging markets to reduce their trade surpluses, which is as ridiculous as the U.S. promising to reduce our trade deficit. Again, no indignation, no furor?

There must be an unusual amount of behind-the-scenes negotiation going on, but we won't know anything until the dog barks.

If logic prevails, China will revalue their currency. Since that has nothing to do with the only thing China does care about, i.e., internal tranquility, don't expect to hear the dog bark anytime soon.

Please Take My Money?

Yesterday, the Treasury Department issued $10 billion in five-year bonds. In other words, they borrowed another $10 billion. But, something was different . . . very different. Instead of repaying $10 billion at the end of five years PLUS interest earned by the bond-holder, the government will repay $10 billion LESS interest paid to the government for holding the money. This has never happened before! The lender or bondholder doesn't get paid regular interest.

What made this possible was that the bonds were TIPS or Treasury Inflation Protected Securities, which means the principal amount ($10 billion in this case) will be increased to offset inflation. It is a good way to protect investors with minimal income needs from inflation. Yesterday's investors were willing to take a negative interest rate in order to get protection from inflation.

What makes this significant is that it clearly shows the market is expecting inflation. The Fed is widely expected to begin another round of quantitative easing on November 3rd, which the market expects will create inflation. Actually, this is a good thing, as deflation is much worse than inflation. Now that an inflationary psychology has developed, the fear of deflation is reduced . . . hallelujah! That's a good thing!!

A Benefit of Aging

One of the benefits of aging is that a person has had time to benefit from all the good advice they have received over the years. One of the disadvantages is that you cannot remember who gave you the advice . . .

Some of the best advice I received as a young investment advisor was to be an "economics agnostic and a political atheist".

Long time readers know I have written often that there are lessons to learn from Supply-side economics, Keynesian economics, Monetarism, Classical economics, etc. No one school of economics has a monopoly on forecasting, truth, realism, or logic. I'm agnostic on economics.

Whomever it was that gave me this advice also said "The Repubican Pary and the Democratic Pary both make whorehouses look respectable." A person may hold conservative or liberal philosophies, but neither political party reflects well on either political philosophy. I'm an atheist about politics.

What does all this mean? Don't expect predictability in economics and don't expect truth in politics. Trust only in unpredictability.

And, if you are the long forgotten person who gave me this advice . . . Thank You!

Keyboarding Burnout?

With regret, I have noticed my blog gets neglected whenever I finish doing my quarterly column for Inside Business. (You can receive copies by email at no cost by signing up at www.baycapitaladvice.com.)

To be even more confessional, I have also been working on a book, which is still another excuse for my keyboard burnout. No more excuses, just apologies!

With the highly important G-20 meetings in Korea this weekend, amidst a bull run in the market, there will be much to blog about. So, stay tuned . . .

S.O.S. = Same Old Song . . . Whew!

The famous fat lady sang this morning, and, thankfully, didn't sing anything surprising. The rate of unemployment remained constant at 9.6%, instead of increasing to 9.7% as expected.

Total non-farm jobs decreased by 95 thousand, far better than the 600-700 thousand monthly decreases we saw last year but way below the 250 thousand a month increases that we need. Tragically, 6.1 MILLION people have been out of work for six months or more. If job growth were 250 thousand monthly, it would still take over two years to get them back to work, and that doesn't count the millions unemployed less than six months or those millions who have quit looking. This is one of two major reasons I've forecast a long, slow recovery.

Private sector jobs were up 64 thousand and is probably the most important number released today. This is slightly better than the expected 55-58 thousand.

Government jobs decreased 159 thousand, which were mostly census jobs. Except for this, there would have been actual job growth last month.

Because the numbers were close to expectations, the market didn't react nor over-react. Whew . . . ! Of course, Friday afternoons are notariously unpredictable.

. . . Waiting for the fat lady . . .

She will sing this Friday morning, when the monthly Civilian Unemployement Report or "Jobs Report" will be released. To the market, this is the single most important economic report each month, probably too important.

But, it is even more important this month. Yesterday, the Non-Manufacturing ISM Report indicated there was more job growth in the services sector than expected. As a result, the Dow roared upwards, almost 200 points. This morning, the ADP National Employment report was released, showing job growth in the private sector at only 20 thousand, compared to 60 thousand the market was expecting. Getting two contradictory reports in two days makes the report on Friday even more important to the market.

In addition, Friday's report will be the last one before the all-important mid-term election. Politicians of one side or the other will make a bigger deal of this report than normal, which is already too big a deal. Since Friday afternoons are normally the most volatile part of the week, expect anything this week!

Sometimes . . . The Truth Hurts!

For years, economists and financial analysts have talked about the BRIC countries, i.e., Brazil, Russia, India, and China. As a group, they were rapidly growing economies dependent upon export growth. As a group, they need to curb their internal savings by individuals and increase consumption spending by those individuals. This is a happy problem.

Now, economists and financial analysts are talking about the HIIC countries, i.e., heavily indebted industrial countries, like the U.S., England, Europe and Japan. As a group, they are well-established democracies with a high level of social benefits, such as Social Security and Medicare, which creates a high level of debt. As a group, they are growing slowly and are dependent upon consumption spending to power their GDP. As a group, they need to increase internal savings at the expense of consumption spending and to increase exports. This is not a happy problem.

So, which set of countries will have the best performing stock markets? Here are the BRICs for the third quarter: Brazil (+22.1%), Russia (+12.3%), India (+16.1%) and China (+12.1%). The U.S. stock market gained a relatively puny +11%. Of course, one of the reasons foreign markets beat us so badly is because the dollar has resumed its expected depreciation. But, since it is easier to increase consumption spending than to increase exports, I continue to believe the emerging markets are very attractive for investors. The depreciating dollar will only magnify the difference.

Talk about an inconvenient truth . . . we need to save more, export more, and consume less!