The Unfaithfulness of Numbers

Like all human relationships, my love affair with numbers has its "ups & downs."  Numbers are a useful shortcut thorough the blizzard of words that bombard us almost every waking minute.  But, when numbers become as vague and contradictory as words, the love affair suffers.

I've been trying to identify why the market has been so strong this year.  One strong possibility is that "The Great Rotation" has begun, meaning that investors believe interest rates will rise soon, which will drive down the values of bond funds, which means it is time to sell bonds and buy stocks.  Some of this is undoubtedly true as bond fund outflows spiked in Summer, when it was believed tapering of quantitative easing would begin in September.  But, the bull started running in the early Spring.

Another strong possibility is that the small investor is returning to the stock market, after fleeing during the financial collapse in 2008 -- five years ago.  However, the numbers aren't convincing either.  It looks more like the average investor, who remained in the market, is just increasing their account balance, not that the timid investor is returning.

Related to that, trading volumes have remained quite low, suggesting investors are not returning.  But, the ratio between BUY and SELL trades has shifted with more BUY orders and fewer SELL orders.  Sellers have slowed down considerably, but why?

Another possibility is that consumer confidence, while volatile, is still up for the year, as consumers become increasingly callous to the ideologues making Congress so impotent and are paying less attention to that set of event-driven risks.

The only thing we know for sure is that the rise in stocks has been much greater than the rise in corporate earnings.  The relationship should be much closer.  Maybe, investors suspect a substantial rise in earnings in the near future.  This is the more normal relationship, but doesn't seem to fit this year.

Maybe, it is just a weakness of numbers-lovers to look for an identifiable, quantitative reason for everything.  Maybe, it is time to accept that there will always be "unknown unknowns" that are not knowable and just enjoy the ride.  But, the search for a faithful, meaningful number never ends . . .

The Wisdom of Vampire Squids

You don't have to trust Goldman Sachs in order to respect their research department.  Here are their latest forecasts:

1.  GDP growth in 2014 will be almost 3%, which is a big improvement.  They expect both consumer spending and capital spending to pick up sharply.

2.  Congress will avoid the next round of sequestration, partially explaining the improved growth rate.

3.  Unemployment will average 6.6%, and the Fed will lower its trigger to end QE from 6.5% to 6.0%.

4.  While oil has stabilized, gold and copper will continue falling.

5.  Interest rates will finally make their move next year, with the benchmark 10-year Treasury rising from 2.7% to 3.25%.

6.  The Yen will continue to weaken, while the Euro has stabilized.

7.  Inflation will remain quiet.

8.  The S&P 500 will end next year at 1,900 -- up from 1,780 where it is now.

No Love For Google . . . or NSA

I have not been able to contribute to my blog in five days.  Once again, Google was denying me access, presumably because it didn't like my downloading their newest Chrome . . . I guess.  This is not the first time they have shut me down.  Once they denied me access because I was using Explorer, which is owned by Microsoft, instead of Chrome, which is owned by Google.  Although they have never written a word on the blog, they act like they own it.  Maybe, they do . . . technically.

Did anybody notice Google agreed to pay $17 million to 37 states for violating privacy of people who use Apple's operating system, Safari.  Oh, that was on top of the $22.5 million they agreed to pay the FTC for the same thing.  If you or I violate the privacy of our neighbors, we're likely to spend some time in jail.  If Google does it, they pay a fine that is insignificant to them.  So, why wouldn't they do it again and again??

Let's see . . . Google makes money by selling advertising.  They sell advertising by telling advertisers which internet users are interested in which types of products.  They have that information from planting "cookies" in YOUR computer to track your movements.  They have a monumental, obtuse, dense privacy agreement that everyone must agree with, in order to use anything remotely Google.  If you look for a new set of golf clubs, you get bombarded with advertisements selling golf clubs.  So, is Google doing you a favor??

And, who violates your privacy the most -- Google or the NSA?  Google does it for profit, while the NSA does it with abandon.  At least, Google knows what they will do with the information they get for violating your privacy.  They will sell it to the highest bidder.  The NSA gathers more information they can use, so leakers like Snowden can do what leakers do . . . leak it!  So, is Snowden the last leaker??

Maybe, it is time to go gently into the night, surrendering any appreciation for individual privacy.  If there is no place for chivalry in modern life, maybe there is no place for privacy either.  Every time you meet a new person, you have to wonder how much information he can immediately find out about YOU!  Will they know about your last medical procedure?  How about that embarrassing little social disease you picked up at age 18?  How about that time you typed in child proof furniture and somehow found yourself on a child porn website?  How much do you want strangers to know about YOU??

A Known Known at the Fed

Janet Yellen has been nominated by the President to be Chairman of the Federal Reserve System in January.  With all due respect to Ms. Yellen, I agree with Warren Buffet in wishing the President had re-nominated Ben Bernanke for another term.

Yellen will be grilled today by the Senate Banking Committee, as part of the nomination process.  More is already known about her economic views than we knew about Bernanke's views when he was confirmed.  For example, she clearly has a more dovish attitude toward inflation than most economists.

Every central banker in the world has a single goal, i.e., control inflation.  Our central bank, however, has two, i.e., control both inflation and unemployment.  The Fed was given this dual mandate when economists believed in the "Phillips Curve," which says there is a trade-off between unemployment and inflation.  In other words, if you want to lower unemployment, you must accept higher inflation.  Conversely, if you want to lower inflation, you must accept higher unemployment.  We have now learned the connection between the twin evils of unemployment and inflation is more loose than anyone expected many years ago.

A Fed Dove is a Fed Governor who accepts higher inflation more readily than a Fed Hawk who accepts higher unemployment.  By all accounts, Yellen is a dove.  What does that mean?

Inflation may rise.  Deflation becomes less likely.  Unemployment will fall or rise less than otherwise.  Money supply will continue to rise quickly.  The dollar will weaken.  Exports will rise.  The price of imports will rise, thereby reducing imports.  Both our trade deficit and our balance of trade will improve.

One can argue that the Fed is already doing all that, and they would be correct.  The difference is that nobody knew Bernanke would take us down that trail, but I believe Bernanke was a solid Republican pragmatist who was willing to do anything to keep the Great Recession from becoming Depression II.  Going forward, the difference between Bernanke and Yellen would be that Bernanke would limit monetary stimulus like quantitative easing sooner than Yellen.

Since Yellen is an extremely qualified economist, since she will be the first woman ever appointed to be Chairman of the Fed, and since I think she is the first Vice-Chair of the Fed to become Chairman, she is both exceptionally well qualified and well experienced.

As a footnote, it is simply stupid for Senator Graham to put a hold on her nomination until he gets satisfaction, if that is ever possible, on Benghazi, which Yellen knows nothing about.  If he thinks the Fed had anything to do with the tragedy in Libya, he is too stupid to serve.  Holding up anybody's nomination to be Fed Chairman because of Benghazi is as stupid as holding up the nomination until the government tells us "the truth" about UFOs in Roswell.

A Brave Perma-Bear

Readers know I have been mildly bullish about the economy for some time, despite its being constrained by our politics.  While recoveries from financial crisis are almost always longer than recoveries from recessions, this particular recovery has been painfully slow.  But, the economy clearly has the potential to grow much faster.

There is an old Wall Street adage that anybody can be a bear, but it takes courage to be a bull.

So, imagine my surprise that Dr. Doom himself (AKA Nouriel Roubini) has turned bullish.  He famously predicted the 2008 crash.  Because he has predicted so many dire events, he has been known as a "perma-bear," always full of gloom.

As reasons for his change of mind, he cites:  "One was the reduction of tail risk of a eurozone disaster, a reduction of tail risk of a U.S. massive fiscal cliff, a reduction of  tail risk of a Chinese hard landing, and a reduction of tail risk of a war between Israel and Iran."  (Tail risk is a favorite term of statisticians and refers to low-probability events that can be highly destructive.)  With an economy slowly improving and uncertainty falling, the markets logically begin rising.  

While he doesn't seem to share my concern about a sudden "Jim Fixx" moment or an economic cardiac event from our dark pool of derivatives, it is comforting to imagine that Dr. Doom may become Dr. Boom?

A Substitute Addiction

Ken Burns is arguably the greatest film documentary producer in our history.  Your perspective is always richer after viewing one of his films.  After viewing Dust Bowl, I was fascinated by the failure of science in causing this disaster.  Now, I just watched Prohibition and was fascinated by the failure of economics.

One of the tenets of classical economics, which was dominant at the time, was that, if you want more of something, you subsidize it and, if you want less of something, you tax it.  Intuitively, that makes sense.

As the perceived dangers of alcohol increased, the government kept raising the tax on it.  But, consumption kept increasing, along with government revenues.  At one point, taxes on alcohol were 70% of Federal revenue.  What a wonderful revenue source -- it was voluntary!  People were not forced to buy alcohol.  But, why were people drinking more, even with higher taxes?

What classical economists didn't know was called the "inelasticity of demand" or how will demand for a product increase or decrease in response to a change in price?  Take the case of cigarettes:  It is addictive, and addicts will pay almost any amount to have a cigarette . . . or alcohol  . . . or "illegal" drugs.  Increased taxes does not significantly reduce demand.

But, the government found itself in a paradox.  Taxing alcohol did not reduce alcohol consumption, but the government itself became addicted to alcohol taxes.  So, how to reduce alcohol consumption without bankrupting the government?  Obviously -- create a substitute addiction for the government to replace its addiction to alcohol and instead become addicted to something else.  The revenue had to be recovered!

And, the income tax was born.

Tortured Logic

On Thursday, we learned that GDP was stronger during the third quarter than we expected, with an annualized growth rate of 2.8%.  Interestingly, it was not because of improved consumer spending, which was 1.5% of the 2.8%.  Improved exports contributed 0.31%.  But, the most surprising increase was inventory levels, which contributed 0.83%.  That could be because businesses are not able to sell existing inventory, but it is more likely because businesses see greater sales opportunities ahead.  This is a good!

With this strong economic data, it was not surprising that futures on Friday morning indicated a 30-point jump in the Dow at the opening.  At 8:30 AM, the October Jobs Report was issued and was also stronger than expected, with 204 thousand jobs being created, far above the 125 thousand that were expected.

With that good economic news, you would expect futures to strengthen and gain more than 30 points at the opening.  Instead, the futures market immediately dropped 60 points.  Why?  Because an improving economy means reducing quantitative easing sooner.  Because the market faces withdrawal from the "sugar high" sooner, if the job market is stronger.  More jobs means less sugar!

Sure enough, the market opened weakly.  However, as analysts dug into the Jobs Report, the labor market didn't look so good after all.  As it turns out, almost half the jobs were minimum wage jobs in hospitality and leisure industry.  The number of government workers continues to decline.  There was scant improvement in the number of part-time jobholders who could not find full-time jobs.  Businesses are unusually reluctant to hire full-time workers for this stage in the recovery.  But, the most inexplicable number was the 720 thousand decrease in the labor force, reducing the Labor Force Participation Rate to a 35-year low of only 62.8%.  It is hard to believe so many baby-boomers retired in October or that many young mothers chose to be stay-at-home mothers or so many people gave up and opted for continued poverty.  Bottom line:  the numbers in the latest Jobs Report raise too many questions.

Sure enough, the market realized the Fed would continue quantitative easing longer after this confusing Jobs Report, and the Dow jumped 167 points to a new all-time high.

The teaching point is that the stock market does not reflect economic conditions solely but also measures those conditions against expectations.  That's why good economic news is sometimes bad news.

Got that?

Beware This Bull Indicator

Technical indicators are always interesting but not necessarily trustworthy.  It is a very bullish technical indicator when the 50-day moving average crosses above the 200-day moving average.  That just happened for gold.  Take a look at this:

Despite what all the commercials on Fox News promise, gold is not about to spike upwards, UNLESS you believe we are about to experience hyper-inflation or governmental collapse.  As we have discussed here before, we will not experience hyper-inflation until the velocity of money returns to some more normal level.  And, while we obviously face a real prospect of government paralysis, but I see no realistic prospect of governmental collapse.  Even if the government were to collapse, it would not happen in the middle of the night before we have a chance to buy all the gold we can afford when the market opens at 9:30 AM five days a week.

At the same time, I don't see gold going much lower either.  The nations that consume the most gold are China and India, both of whom have seen their economy strengthen this year.  While silver has gained some fashion status in India, as an alternative to gold, that is not apparent in China.  Goldman Sachs predicts gold will drop another 25-30% or so by the end of next year, but I don't expect that large a drop.  The nicest thing I can say about gold right now is that it is "dead money" -- doing nothing for awhile.

Technical indicators are interesting . . . but not your boss.

Just More Feckless Politicians ?

While nobody would ever confuse me with a Tea Party supporter, media analysis of the Tea Party's dismal performance during Tuesday's elections remind me of the quote attributed to Mark Twain about reports of his death being greatly exaggerated.  I hope so, because we still need the Tea Party . . . a little, maybe!

Born during Bush's $5 trillion increase in national debt and coming of age during Obama's $6.5 trillion increase, the Tea Party exploded into our national consciousness in 2010, producing the biggest realignment in the House of Representatives since 1948.

If every Tea Party member dropped dead today, they have already changed America.  Past discussions of deficit reduction quibbled about the need to increase taxes . . . but no longer.  (Obama was forced to make permanent the ruinous tax cuts of Bush, except for those earning over $400 thousand annually.)  Deficit discussion is now focused solely on cutting spending, with no discussion of tax increases.  The Tea Party should be happy, because, since 2010, the deficit has fallen more rapidly (percentage-wise) than any three year period since the demobilization after World War II.

But, I know of no economist who doesn't believe that current fiscal policy, frozen in place by the Tea Party,  is retraining growth of our GDP, anywhere from 0.5% to 1.5%.  This may sound small until you realize we're only growing about 1.5% to 2% now.  We could almost double our GDP growth, if we had a "grand bargain" and eliminated the deadening uncertainty we have now.  What would a doubled growth rate do to unemployment?  I believe the Tea Party stands in the way of any "grand bargain."

The Tea Party fancies themselves as fearless, and it is true they have little fear of other politicians, but they are as cowardly as other politicians on the subject of cutting entitlements.  All the spending cuts caused by the Tea Party and their sequestration program are cuts to discretionary spending.  The majority of this is muscle, not fat.  We're scalping Defense spending, infrastructure spending, and laying off food inspectors, for example.

Nobody suggests that grandma needs to be thrown in the street, but the growth in entitlements must be contained.  By 2038, entitlements will consume the entire Federal budget, that is 100% -- with $0 left for the military and food inspectors.  Most cuts are easy, such as cutting Social Security payments for people like myself and limiting heroic end-of-life treatments.  Finding the courage is not easy.

If the Tea Party really wants to do something fearless and actually constructive for a change, they should stand up to Seniors like myself and introduce a discussion on entitlements.  Without that, they're just routine, run-of-the-mill, everyday political cowards, that we already know so well. 

Wisdom of Sir John

Investment legend Sir John Templeton is best known for his emphasis on international investing.  However, he also said "Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria."  And, of course, he is right!

So, where are we today?  While I see a lot of political pessimism, I see even more economic optimism, especially on Wall Street.  But, I see no euphoria . . . yet.  Frankly, I don't expect to see any euphoria until some time after the politicians strike a "grand bargain." 

Lee Greenwood Is Right

With our daily deluge of negative news, it is easy to think America is falling apart.  Maybe, it is, but there are some places that are far worse.  If you think we have problems, consider the case of Greece:

1.  They are still in recession after six long years.  We've been a "weak" recovery for four years already.

2.  Their GDP has fallen an unbelievable 26%, while we're still growing about 2% a year.

3.  Unemployment is a staggering 27%, compared to our rate of "merely" 7.2%

4.  Greek wages are 30% less than 2008 levels, including some government workers.

The Greek economy is finally showing some signs of life.  They predict some minor growth next year, for the first time in seven years.

Still, there is much pain ahead of them.  23% of the workforce still works for the government, which is insane. Many thousands will have to lose their jobs in that small country, before Greece receives any additional financing.

Can you remember Lee Greenwood's pop classic "I'm Proud to be an American"?  He should re-record it as "I'm Thankful to be an American."

Remember this on Thanksgiving, November 28th . . .

What's Not To Like ?

Amid the love fest taking place on Wall Street, it was easy to miss the good ISM (Institute of Supply Management) reports of underlying economic data last week.  We learned that manufacturing improved nicely in October, with the ISM Manufacturing Index coming in at 56.4.  (Anything above 50 indicates an increase.)  While production increased 2% in the third quarter, most economists expect a 5% annualized gain in the fourth quarter.  This is big!

Also, foreigners strongly increased their orders from U.S. manufacturers, with the ISM New Orders Index rising from 52.0 to 57.0, and that is the eleventh straight month they have ordered more from us.  This is a very positive leading economic indicator.

Lastly, the ISM Prices Index showed only minimal inflationary pressure.  Just 8 out of 18 industries reported higher input prices.  This is very comforting, especially to the Fed.

Let's see:  production is up, foreign demand is up, inflation remains low, tapering of QE is postponed until Spring, China has avoided a hard landing, and unemployment is dropping, albeit slowly.  The love fest on Wall Street seems justified.

However, Wall Street is considered "smart money," and it seems unconcerned about the continuing charade in Washington, as well as the under-capitalized banks in Europe.  There is even talk of a dangerous "melt-up" in stock prices, when stock prices rise at an unsustainable rate.  While I'm aware that a "melt-up" merely lays the groundwork for a subsequent "melt-down," I don't think we're close to that yet.

So, I like it . . . for now . . .

More Than Money

It doesn't matter if you believe you are fortunate because you are a "doer" or "job creator" from the mind of Ayd Rand, or if you believe God has just blessed you (but not others), or that you had the good foresight to pick a rich father, or that you believe it was simply blind luck or even all of the above.  However, reflecting my natural Calvinism, I believe the more fortunate have a responsibility to help the less fortunate, period.  With money, of course, but also with more than mere money.

Through good organizations like Rotary and Kiwanis, I've been fortunate to help make repairs to the homes of the elderly, to repaint the abused women's shelter and the homeless center.  Once, we spent a day planting dune grass (which was a real back-breaker) to protect the critical sand dunes that protect us.  Once a month, we still deliver meals-on-wheels to "shut-ins," which also serves as a monthly reminder that we are indeed blessed.

The vast majority of financial advisors enter the business to make big money.  However, some of us see the need to do more and serve the "whole" client by becoming certified.  Yesterday, a dozen of us participated in Financial Planning Day, hosted by the City of Virginia Beach at their convention center.  It was designed to help the less fortunate who have no access to serious financial planners.  I was expecting to meet with the desperately poor and "welfare queens."  I was wrong!

Everyone I helped was female, and I saw the other financial planners helping very few men.  Just like the stereotyping joke about men not asking for traffic directions, they apparently don't ask for financial direction either.  Also, everyone I helped already had a job.  They were not the desperately poor, just the working poor, who are seldom welcomed by financial planners or even by financial advisors.

One person was genuinely despondent that she lacked the discipline to save.  My first conservative instinct was that her personal problem with self-discipline should not be a problem dropped on taxpayers.  Then, I realized she was reaching out for serious help.  Nothing in all my financial planning training prepared me for a situation like that.  Like an alcoholic who must first admit they have a problem before they can be helped, here was a woman admitting her problem and asking for help.  After much discussion, I suggested she start small and put the money where she could not get it, except for emergencies.  Because she had complete trust in her mother, she agreed to give her mother $5 weekly to hold for her.  I will pray for her.

One 59-year-old woman was remarkably well-prepared financially, showing up with all her bank statements, a rough balance sheet, and tax returns -- a very detail-oriented lady, indeed.  She didn't trust financial advisors but still wanted somebody who was both well-trained and impartial to tell her if she was prepared for retirement.  With no children, no inheritance, and, importantly, with no divorces, she and her husband were able to save, truly save by practicing self-denial, almost $600 thousand.  I was proud of her.

Helping the less fortunate should be more than mere self-serving, sanctimonious, smug "do-gooder-ism."  You may recall I recently reviewed the great existential film Ikiru, in which a dying bureaucrat learns that death is just the expiration date for your opportunity to do something good, something with meaning.  Amen!

When One Is An Ugly Number

For many decades now, Modern Portfolio Theory (MPT) has been the "gold standard" for investment management.  Basically, it shows that an investor can achieve above-average returns with below-average risks by spreading his risks or allocating his portfolio across many "asset classes," i.e. large company stocks, small company stocks, international stocks, bonds, real estate, cash, etc.  This was possible because all assets are not perfectly correlated.  For example, bonds might go up in value when stocks go down in value. Or, gold may move a different direction than international stocks.  If an asset class moved exactly like the S&P 500, it had a correlation of 1.0.  If it moved up half as much as the S&P 500, it had a correlation of 0.5.  If it moved down one-quarter as much as the S&P 500 moved up, it had a negative correlation of (0.25).

Critics of MPT have always known there were some unrealistic assumptions supporting the whole theory. For example, one assumption was that all investors are rational and making decisions in their own best interest, based upon complete information.  Do you believe that?  And, there were some other unrealistic assumptions as well.

During the financial collapse of 2008, all correlations went to 1.0, which happens only when there is a complete collapse and all asset classes are losing value.  MPT made no provision for this happening, because rational investors would scoop up the bargains.  MPT made no provision for investors being terrified and wanting only cash.

In 2009, I was invited to serve on a certification committee, to re-write a certification exam for financial advisors.  At first, I was excited for the opportunity to update financial advisors on what we had learned about MPT during the global financial crisis, as well as other techniques for investment management. However, it was like finding yourself in an old-fashioned religious revival with everybody competing in their enthusiasm to agree with the preacher.  They were continuing to preach the "old-time religion."  Disappointed in the intellectual dishonesty, I resigned from the committee and have had nothing to do with them since then.

Currently, I'm in Dallas attending an advanced but similar course and relieved to find that we are finally being honest about the limitations of MPT, as well as other techniques.  But, why did it take four years?

Thank You, Wells Fargo

Each month, the Bureau of Labor Statistics publishes the "jobs report," which the media and the markets watch closely . . . too closely.  It is a flawed measure for several reasons.  One is that people get discouraged and quit looking for jobs, which decreases the available pool of labor and therefore makes the unemployment rate rise.  This factor in the changing labor force is called the "labor force participation rate." In other words, what percentage of "able-bodied" people are looking for work?  Of course, there is no shortage of political rhetoric around this number.

Today, Wells Fargo released a new Labor Market Index.  It includes six key labor variables and, at first blush, looks very interesting.  Next week, they will publish the statistical backup for this index, and I look forward to studying it.  Hopefully, the media and the markets can be liberated from the over-hyped "jobs report."

In the meantime, there is one little noticed piece of jobs data that I have always found interesting, i.e., the number of unemployed for every job opening.  It has now fallen to only to 2.9, which is the lowest since 2003.  I have no doubt the job market is improving, but it is improving slower than the economy is improving.  While this is characteristic of recoveries from a financial crisis (as opposed to recoveries from ordinary recessions), this is still unacceptably slow.

I applaud Wells Fargo for this new step forward and look forward to studying it. 

Down-Shifting Social Expectations

Republicans tend to believe that marginal income rates will not be raised if we experience strong economic growth.  Democrats tend to believe entitlements can be increased if we experience strong economic growth.  While they disagree on the methods to achieve it, they agree that the solution to all our problems is strong economic growth.  What happens when both parties praying at the altar of strong economic growth realize they are worshiping a false god?

A friend recently sent me a column by Robert J. Samuelson that makes me wonder if strong economic growth is a pleasant memory.  Are we doomed to a future of slow economic growth?  And, most importantly, can our society withstand such a down-shifting?

Since 1959, the U.S. has enjoyed approximately a 3% annual growth rate in GDP.  A product of the Age of Enlightenment, we've always assumed that things would always improve.  The conservative Cato Institute think tank explained that our growth since 1950 resulted from (1) a larger workforce from female participation, (2) a better educated work force, (3) more capital, e.g., machines & computers, per employee, and (4) technological & organizational innovation.

Unfortunately, labor force participation by women has decreased from 59.9% in 2000 to 57.7% last year.  High school and college graduation rates have stopped increasing.  Capital investment by business has been lagging for years.

Today, we're only growing from 1.5-2.0%.  That's not much additional income to keep a population happy when faced with higher taxes, possibly higher health insurance costs, and worsening income inequality.  Is there a tipping point, at which the resentment boils over and irrationality prevails?  If so, how will we know it when we approach that point?

Always seeing a glass as 51% full, I'm praying that our workforce increases from Hispanic additions, that education becomes more STEM-centric, and that businesses will lose their fear of politicians and start investing capital.

Even England is growing more rapidly than the U.S.   How will this country be different if we must lower our social

Giving the Devil His/Her Due

The latest forecasts from investment banking giant Goldman Sachs predict the following:

1.  GDP growth this year will average only 1.6%, reflecting damage of the government shutdown, but will jump to 2.9% for next year and unemployment will be "only" 6.6% by the end of 2014.
2.  Inflation remains tame at 1.8% at the core level through next year.
3.  Interest rates will move up sharply from about 2.5% for 10-year Treasuries now to 3.25% next year.
4.  The S&P 500 will end this year about where we are now (1,750) but end next year at 1,900.
5.  Oil will continue to fall about 10% through next year.
6.  Gold and cooper will both fall.  Gold is expected to drop from about $1,325/oz to only $1,030, while cooper will drop from $6,600/ton to $6,200.
7.  The dollar will appreciate against the Yen but depreciate slightly against the Euro.
8.  Tapering of quantitative easing will not begin before March.

Any questions?

One Cost of Uncertainty

Due to the government shutdown, the all-important Jobs Report was delayed from October 4th to October 22nd.  While the delayed report showed the unemployment rate dropped from 7.3% to 7.2% and average hourly earnings up a bit, the other numbers were disappointing.

Private sector jobs grew 161 thousand in August and were expected to grow 180 thousand in September.  Instead, they only grew 126 thousand.  The anecdotal reports were that hiring decreased during the month as the fiscal cliff of September 30th approached, obviously a response to increasing possibility of a government shutdown.

I could die happy if I never hear another politician piously mouthing "jobs, jobs, jobs."  If I needed a job, I would be angry at all politicians, and I would be justified.  Politicians are not job creators but job destroyers.

Mommies, don't let your babies grow up to be . . . politicians!

Just Another 56-Year-Old Movie

I should have watched the film classic by the famous Ingmar Bergman called The Seventh Seal many years ago.  It plotted the emotional trail for so many combat veterans.

In the mid-fourteen century, a priest convinces a young Swedish knight to leave his wife and castle to serve in the bloody Crusades.  Seeing death up close, smelling it, feeling life leave others, and loathing his own fear of it, he finally returns from the Crusades to await his own death, whenever and wherever he finds it.  When he returns to his native Sweden, the Black Plague is ravishing the country he loved.  Sorrow is everywhere.  Before he reaches his castle, he meets Death on a beach.  Stalling for time, he invites Death to play a game of chess first, which they play intermittently throughout the movie.  He realizes he is stalling, not to just continue living, but to do something, anything worthwhile in his wretched life; so weary of war.  He befriends a young couple with a baby girl and an infectious love of life.  When they find themselves in danger, the knight distracts Death with their chess game.  Once the young family is safely away, the knight is then ready to die.  He had accomplished something worthwhile, and Death takes him.  The final scene shows the knight dancing joyfully on a hillside, liberated from the sorrow of life.

The title of The Seventh Seal refers to a passage in the Book of Revelation in the Bible when "the Lamb opens the Seventh Seal, there was silence in Heaven."  This refers to the knight's continual prayers for God to lead him, but he only hears from Death instead.

The best known themes in existentialism are the love of absurdity and the obsession with death.  While there are some delightfully absurd situations and dialogue in the movie, the obsession with death is overwhelming.  But, another existential theme is the individual's responsibility for his own life and his own death.  Doing something worthwhile in his life was more important to the knight than his death, and that's good advice!

I couldn't help thinking about my fellow veterans, who return from war more emotionally-damaged than physically-damaged.  Their feelings are not unique; just unbearably heavy.  Maybe, it would be helpful for them to view this movie, to see that doing something worthwhile in life is more important than their death by suicide.  Indeed, it is a predicate to dying.

The Joy of Unintended Consequences

Many laws have unintended consequences, whether at the national, state or local level.  Republicans believe that is proof the government never understands what it is doing.  Democrats believe that unintended consequences are a normal part of legislating.  Existentialists find unintended consequences to be absurdly amusing.

Over the last few years, there have many changes in laws regulating ownership of guns, especially at the state level.  This can pose a significant problem to executors of estates, as they try to distribute personal effects of the decedents to beneficiaries across state lines.  The executors can incur both financial and criminal liability for distributing guns illegally, even if innocently.

Rising to the occasion, a cottage industry is developing among lawyers to create "gun trusts."  While the details are fluid, the basic idea is that a person would transfer ownership of his guns before his death to a trust that would continue after his death, relieving the executor of any responsibility to transfer the guns.  The trustee of the trust would be whomever the decedent wanted to have the guns.  That trustee would have the right to pick his successor trustee, presumably based upon some exchange of money.  Of course, the trust would have to be established in a "gun-friendly" state, like Virginia.  Voila -- an end run around restrictive gun laws!

Republicans, who feel strongly about the second amendment, will undoubtedly applaud this evolutionary step.  Democrats, who feel 300 million guns in this country are enough already, will undoubtedly feel the need for more laws.  Existentialists will just chuckle.

Rationalized Irrationality

Novice investors either expect the stock market to be efficient, according to Efficient Market Theory where all information is known by all investors, or they expect to invest based on hunches or even inside information.  However, experienced investors know to study the specialized analysts, and make rational decisions supported by careful analysis, but always expect some irrational behavior.

For example, consider the example of IBM, a historic giant in information technology.  Morningstar gives it 4-stars, with a grade of A on financial position.  Thomson Reuters rates it a BUY, with its highest possible score of 10.  Standard & Poor's also rates it a BUY, as does Argus and The Street.  The Jaywalk score of 2.65 makes IBM a BUY.

Yesterday, the company announced an increase in its profit margin and got pounded by the market, losing a whopping 4% in one day.  Because the company is such a large component of the Dow Jones Industrial Average, the Dow was down most of the day, even though the S&P 500 was up strongly.  How's that for irrational behavior?  Since when is increasing your profit margin bad??

Here's the problem:  total revenue was down slightly because of a 40% drop in hardware sales in China.  Following the Snowden/NSA affair, the Chinese government has become worried about sales of American technology in their country and is pressuring Chinese businesses to only buy Chinese technology.  That's it!  A clear market over-reaction, making IBM an even better buy right now, I think.

Most pundits think it was Lord John Maynard Keynes who first warned that the stock market can remain irrational longer than you can remain solvent.  In other words, always expect some irrationality but don't fight it.  Adjust your investment decisions when irrationality presents opportunities.

Rational investors don't need to understand irrationality . . . just deal with it!

The Morning After

Congress finally did their job last night to prevent America from defaulting.  Yes, the international community had to get involved, with a host of "shame on you, America" comments and China asking the world to be de-Americanized.  The debacle in Washington was certainly not the best promotional piece for democracy.

But, that is minor.  Take a look at the loss in consumer confidence:

This is major!  After hitting a post-recession high in June, the horrors in the Capitol has really discouraged the American people.  Of course, this affects consumer spending, which is about 70% of our GDP.

And, did I mention that another of the three credit-rating agency put us on "negative credit watch," which is the last step before a credit downgrade?  

Now, refresh my memory, what was this debacle all about?

Falling Into Place ?

The pieces are already falling into place for the worst-case scenario to the current debt debacle in Washington. On Friday, mutual fund giant Fidelity announced they had sold all short-term Treasury notes and bonds, expecting they would be hammered if Congress cannot agree to raise the debt ceiling.

Yesterday, a small auction of Treasuries was poorly subscribed, as investors are starting to avoid U.S bonds.  Last night, one of the three credit ratings firms, Fitch, announced the United States was being placed on "negative credit watch," the last step before stripping us of our AAA rating.  Standard & Poor's has already stripped us of that rating, based not on our ability to pay but on our inability to govern.

Interest rates that we pay on short-term Treasuries have risen, while falling on long-term Treasuries.  This is called a "flattening yield curve" and is usually a predictor of recession.

Traditional interest rate analysis begins with the "risk free rate" (RFR), which reflects inflation and the demand for bonds versus other asset classes.    To that RFR, you add something to reflect risk of not being repaid, called the risk premium.  Whether you are comparing AAA corporate bonds with junk bonds, you start with the RFR and add a small risk premium for AAA corporate bonds and a large risk premium for junk bonds.  That's why junk bonds carry higher interest rates than AAA corporate bonds.

Around the world, the RFR has universally been U.S. Treasuries.  Now what, the RFR is no longer risk-free or is it?  Investors are avoiding short-term Treasuries, but buying longer-term Treasuries in the belief we'll eventually get our act together.

Many pundits are predicting our interest rates will rise sharply, because the RFR will rise, but that ignores the power of the Fed to keep interest rates low with quantitative easing.  Over the long term, the RFR will rise but no time soon.

Another piece falling into place are the lawyers circling Congress.  If interest payments are made while Social Security payments are not, there are legions on both sides saying that is an unconstitutional prioritization of equally-binding laws.  I don't venture a legal opinion, but, as an economist,  it is better to pay the interest.

Treasury workers are already hiding behind technology, saying they cannot technically pay interest without paying entitlements.  They're getting their excuses ready.

Another piece is the sophisticated cash-flow analysis for the Treasury, which predicts the end-of-the-world tomorrow.  Goldman Sachs predicts it will be next week.  Who knows?

The most annoying piece is the international ridicule.  China has called for the de-Americanization of the world, as America has proven that democracy is a joke.

Still, Wall Street remains optimistic that the debt ceiling will be raised and default avoided, as the futures market indicates a nice rally today.  I think they're right . . . until we do all this again in a few months!

A Refreshing Change of Pace

During the national embarrassments that Congress creates ever more frequently, it is nice to read a little good news, such as three Americans winning this year's Nobel Prize for Economics.  They were Eugene Fama and Lars Peter Hansen of the University of Chicago and Robert Shiller of Yale University.  Congratulations to each of them!

Although all three have increased our understanding of how asset prices are determined, it is also interesting that the two universities represent very different views of economics.  The University of Chicago is associated with the conservative view:  that government can only make an economy less efficient.  Indeed, their seminal work is called "the efficient market hypothesis."  Detractors have joked that Professor Fama was walking across campus with a student, when the student saw a $20 bill laying on the ground.  He pointed it out to Professor Fama, who said there was no $20 bill laying there.  Seeing it with his own good eyes, the student asked Fama how could he deny the existence of what the student could see?  The professor explained that if the $20 bill was really laying there, somebody would have already picked it up, because the market is efficient.

All joking aside, the efficient market hypothesis gave birth to and propelled the index industry of mutual funds and ETFs.  Why pay somebody to pick stocks for you, when that was impossible.  If a stock was undervalued, somebody would have already bought it.

Professor Shiller of Yale, on the other hand, is a very different type of economist.  While he doesn't argue undervalued stocks can be found, he does argue overvalued stocks can be avoided.  (Fama would argue stocks could not be overvalued, because investors would have already sold the stocks if they were overvalued.)  Shiller has done significant work in documenting "bubbles," which theoretically is impossible if the markets were really efficient.  He clearly predicted "dot.com" stocks were overvalued and later predicted home prices were overvalued.  Last week, he said home prices are again showing some signs of being overvalued.  Shiller is a big supporter of Janice Yellen as the replacement for Ben Bernanke as Fed Chairman.  (He also does economic research with Yellen's husband.)

Be it a "high five" or a glass of champagne, raise your hand today and be proud of being an American. Since the year 2000, Americans have won 21 out of 37 Nobel Prizes in physics, 18 out of 33 in medicine, 22 out of 33 in chemistry, and an incredible 27 out of 30 in economics.  Whoever said that America is in decline?

 Now, wasn't that refreshing??

Ceiling Uncertainty?

As someone who tries very hard to keep political opinions out of his writing, I've always respected The Kiplinger Letter for keeping their political opinions private.  However, their newest letter said "For now, Republicans favor ideological purity over winning . . ."  I'm trying to judge whether their political opinion is showing or whether that is a simple statement of the facts.

It also predicts more continuing resolutions than budgets to fund the government, which is unfortunate.  Without doing budget planning, there is no curtailment in entitlement spending.  We really do need a "grand bargain" with entitlement cuts and revenue increases.

Also, with small increases in the debt ceiling, there will be even more opportunities to create a crisis, and it will make it seem debt is rising faster than it really is.  "That, in turn, will embolden the staunchest conservative Republicans to fight against the increases."

While the latest newsletter doesn't speak to the potential default, if the debt ceiling is not raised this week, it doesn't seem overly-concerned about it, just mentioning it in passing.

If I were a historian, I would also treat the debt ceiling lightly, as Congress has always done the right thing and raised the ceiling to pay for the spending they have approved.

If I were a psychiatrist, I would argue that rational people connected to reality can never negotiate successfully with irrational people who have only a tenuous connection to reality.

If I were a market strategist, I would continue to buy all this week as the market goes down, as it will.  If we do break the debt ceiling on Thursday or Friday, the market will fall badly . . . for awhile, which is time to do even more buying.  After all, fourth quarter earnings are expected to rise 9.4%.

Make no mistake, breaking the debt ceiling is simply idiotic.  It is a self-inflicted wound and a seriously-bad economic event, but we will survive.  Prepare to be scared  . . . but keep buying slowly.