A Light at the End of the Tunnel.........?

Long time readers know I have expected a retest of the March lows. While the stock market has remained strong during the traditional September/October correction . . . so far, . . . I’m still worried. The Great Recession did a great deal of damage, unemployment will come down very slowly, and the economy must become more export oriented and less consumption oriented. That takes time. The lows of the Great Depression came about fifteen months after the Crash of ’29.

Now, it could be the lows of the Great Recession came in March of 2009, only six months after the crash in September of 2008. I hope so . . .

Another factor arguing that the worst is past us is the inventory cycle. Inventory levels have fallen a record eleven straight months. At some point, inventories must be rebuilt. At that point, the economic recovery will begin. I hope so . . .

Lastly, the continuing decline in the dollar will accelerate our transition from a consumption oriented economy to a more export oriented one. I hope so . . .

Take a side!

Economists and securities analysts usually work together well. Sometimes, when they do disagree, it is more apparent than real. The current disagreement is such a case. Economists remain glum, while analysts are giddy. Why? Because U.S. economists have a consensus forecast of a 2.4% growth rate next year, while analysts expect earnings of the S&P 500 to increase 25%. How can there be such a difference? Two reasons: First, the S&P contains the 500 largest U.S. companies, and they disproportionately benefit from international growth. Their growth is not limited to the U.S. Second, the earnings growth we have seen this year has been from cutting expenses, not revenue growth in a shrinking economy. That means their earnings per share are “spring-loaded” to jump as soon as revenue increases drop straight to the bottom.

So, who’s right? I hope they both are!

Re-appointment of Ben Bernanke

Yesterday's re-appointment of Ben Bernanke as Chairman of the Federal Reserve System was wise a decision! Sure, he was slow recognizing the subprime problem, but he showed true innovative genius once he engaged. Although there is never any way to prove it, I am confident he prevented the Great Recession from becoming another Great Depression!

But, rewarding a person for a job well-done understates the significance of this re-appointment. If nothing is done to unwind all Bernanke has done, inflation is a certainty! Unfortunately, unwinding these actions will be politically unpopular. It will be easier to unwind them by Bernanke than someone else, who is more beholden or less familiar with the details. Bernanke knows his legacy is ruined if it doesn’t prevent inflation. This was the best thing President Obama could have done in the short run to prevent inflation in the long run.

What a difference a year makes.......

I learn so much from my friends. This is from one of them, i.e., Ben Valore-Caplan, CEO of the highly respected Syntrinsic Investment Counsel in Denver. He reminds us of our reality a mere twelve months ago.

• At market close on launch day, the Dow stood at 11,417, about 23% above the
current 9,315.
• George Bush was President.
• Oil stood at 113 versus 67 today.
• Barack Obama was en route to Denver to accept the Democratic nomination.
• Few people had heard of Bernie Madoff. Those who had heard of him thought
that they were lucky.
• Citigroup was trading at about 17.5 (now trading at 4.3), AIG over 400 (now
26.6), and GM at 10 (now trading as Motors Liquidate at 0.90).
• Sarah Palin was a relatively obscure governor of Alaska. Now she is neither.
• Many thought that the worst of the US stock market correction was over (the
S&P 500 actually rose in August 2008 before a precipitous September-October-
November 20 decline of 42%).
• Lehman Brothers was a major investment bank (until mid-September).
• Many hedge fund investors still did not know what “gates” were or how easy
they were to put up.
• Inflation as measured by CPI stood at 5.6% (the highest in 17 years), just
prior to massive negative changes in CPI in October and November. CPI this
week is at 0.0%.
• The Olympics in China were proceeding without the hitches many had expected.
Few outside the State Department had heard of Uighers.
• Health care reform was something from the early 1990s.
• Town hall meetings were generally confined to small towns in New England.
• Former Goldman CEO, Hank Paulson ran the US Treasury Department while former
Goldman Chairman, Stephen Friedman, ran the New York Federal Reserve.
Goldman stock was at 158 one year ago; it is at 158 today. Curious.
• The Tamil Tigers controlled much of north and east Sri Lanka.
Stanford Group was selling 10% CDs issued by their bank in the Caribbean.
• Housing starts of 950 million in August 2008 had economists wondering if the
housing market had stabilized at last.

Life moves on . . . thankfully!

Clap...clap...clap...

Was I the only person applauding Monday when the Dow dropped 186 points? It blew a little froth off the market, which is a good thing! There is a loose but direct relationship between the financial markets and the overall economy. The Conventional Wisdom is this: if the economy improves, the market usually senses this and starts improving 5-8 months sooner. While we have clearly enjoyed a strong V-shaped recovery in the markets, I expect a long U-shaped economic recovery. While we are at or near the economic bottom now, does anything expect a rapid rebound in the economy? The market is ahead of itself and needs to blow off steam . . . and froth too!

Linearism

I just finished reading The Fourth Turning by William Strauss and Neil Howe. It makes the point that generations have a predictable flow, starting with growth (the prophets) followed by maturation (the nomads) and then entropy (the heroes) and finally destruction (the artists). The World War II generation could not have foreseen that “America would soon become so confident and institutionally muscular, yet so conformist and spiritually complacent." My generation of Boomers could not have “predicted that America was about to enter an era of personal liberation and cross a cultural divide . . "

My daughter’s Gen-X could not have predicted “ that the nation was entering an era of national drift and institutional decay. And, the millennial generation could not have predicted “a decisive era of secular upheaval” or a period of unraveling.."

They then make the point this generational evolution has happened many times in the past and is not to be feared. It argues we think too much in terms of linearism, which sees the future as a straight line, instead of a series of cycles. Think of the next generation as being more like The Greatest Generation! (There is also a wonderful quote from Mark Twain that “nothing is older than our habit of calling everything new.)"

From an investment standpoint, it should offer solace to those who fear the sky is falling, that this time is different. We have been thru a crisis many times, and better times always follow. It means our asset allocation should not be for Armageddon but for the inevitable and eventual re-birth.

The Feast Continues...thankfully!

I attended a meeting yesterday and listened to the fear some investors have of China, particularly its ability to crush the dollar by dumping all their dollar-denominated holdings, such as US Treasuries. Their angst is understandable but misplaced. Dumping the Treasuries would create huge losses for themselves and risks sending the world, including themselves, into a genuine depression. Indeed, during a recent visit to the White House, the Chinese leadership expressly assured the President that they would continue buying our Treasuries, which is certainly not a warning to dump Treasuries.

But, such assurances are just pretty words. However, the proof is that they do continue to buy our Treasuries as promised, but there is a difference. They are now buying more 10-year issues and fewer 30-year issues, which limits their exposure to a collapse of the US. In addition, they are spending their huge dollar reserves, which are not invested in Treasuries, to buy assets around the world, especially in Africa. This also limits their exposure to a collapse of the US.

Today, the US Treasury issued another $15 billion in 30-year Treasury bonds. There are always more bidders for the bonds than there are bonds to sell. This is called the Bid-to-Cover ratio and is normally about 2.3 times. Today, it was 2.54X, which means there is considerable appetite remaining for those bonds. While that appetite is not infinite, there is certainly still plenty left.

While the world continues to feast on our debt, the Fed needs to provide us with an “exit strategy” very soon, to keep the guests at the dinner table.

Canary in a Coal Mine??

Nassim Taleb is the brilliant author of the “Black Swan”, which described how huge, unpredictable events occur, such as the current market collapse. This morning, he said the current Chairman of the Fed, Ben Bernanke, has performed poorly and should not be re-appointed when his tenure as Fed Chair expires in January. A survey of economists by The Wall Street Journal was also released today, showing 71% of them disagree with Taleb and think Bernanke should be re-appointed by President Obama.

I also think Bernanke has done a remarkably agile job and hope he will be confirmed. It was fortunate that we had one of the leading authorities on the Great Depression as Chair of the Fed during the Great Recession. But, the re-appointment of Bernanke is a “canary in a coal mine” for me. If he is re-appointed, there is a chance the inflation could still be controlled. However, if he replaced by someone less independent, as any President would naturally hope, I fear a return to 1970s-style of inflation. We'll see . . . .

No Champagne Yet!

Friday’s jobs report was great . . . or the headline was great, that unemployment dropped from 9.5% to 9.4%. Also, over 700 thousand workers were losing their jobs in January, compared to “only” 244 thousand last month. Still, how can the rate of unemployment decrease when 244 thousand workers lost their jobs?? Simply, hundreds of thousands of people have quit looking for work. They have gone to part-time work, gone back to school, gone home to live with Mom & Dad, given up, or whatever. If all those people are added in, the total “under-employment rate” is a staggering 16.3%.

Certainly, the financial markets are suggesting the recession is over, but whatever happened to the “toxic assets” . . . remember those? We may have "ring-fenced" them, but they are still a problem. Also, have we made the derivatives market transparent yet, which was the other primary cause of this collapse? There is still work to do, much work!

20/20 Hindsight

Last week, I watched as Hank Paulson was grilled by legislators about his actions last year as Treasury Secretary during the most frightening part of the Crash. Red-faced and obviously uncomfortable, it was clear he did not want to be there. I actually felt sorry for him. He was thrust into an unforeseen crisis last year that was different from anything we’d ever seen before. While I’m confident he would, of course, do some things differently with 20/20 hindsight, we were still fortunate to have him.

One of the reasons I remain so concerned about investing in Europe is that Eurozone banks are still more highly leveraged today than US banks were last year, but it does not have a unified banking regulator. Sure, it has the ECB or European Central Bank which sets rates but does not regulate the banks of each member country. Early in the last U.S. Administration, five banks were allowed to increase their leverage from 12:1 to 30:1. Three are now gone, i.e., Bear Stearns, Lehman, and Merrill Lynch. The other two, JPMorgan and Goldman, survived only because they were saved by the taxpayers. Many European banks now have 45:1 leverage, a recipe for collapse, and they have no Hank Paulson . . .

Madoff Justice

Longtime readers know my belief that our society is over-regulated and under-punished. Convicted swindler, Bernie Madoff, got off easy at 150 years. Assuming this 71-year-old man actually lives another 150 years, it means he will have to spend only a few seconds in jail for each dollar stolen and only 40 days for each victim swindled. He has lived 70 years in extremely fine style, funded by his victims. Now, he will live out his remaining years with no worries about food, clothing, housing, and even have better medical care than many Americans, all funded by the taxpayers. At some point, a person indeed becomes “above the law”.

Financial journals are now discussing the “lost generation” of investors, people so traumatized by Madoff that they have become paralyzed with fear and confusion. That would be the greatest damage that Madoff has accomplished. The $65 billion that may have already been lost by his victims is nothing compared to the profits that this “lost generation” will miss.

By the way, kudos to Sen. Jim Webb, who is crusading for a new perspective on our prisons. With 5% of the world’s population, we have 25% of the world’s prisoners. And, at what cost? How many hospitals could we build with the money we spend feeding, clothing, housing and caring for prisoners? Or, how many more aircraft carriers could we afford? Now, we must pay for a pampered swindler!

Change is coming.......

It was obvious last September when the markets crashed, following the Lehman failure. It became certain last December with the arrest of Madoff. There will be a re-regulation of the securities markets, which is desperately needed. Of course, “the devil is always in the details”!

Last week, the Obama Administration introduced their plan for re-regulation. It is large, complex, and far-reaching but certainly unlikely to be implemented as presented. The most interesting part to me is whether financial advisors should be held to a suitability standard or to a fiduciary standard. It is an important difference and could re-shape the industry. A stockbroker is currently held to a suitability standard, which only requires the advisor to present investment choices that are “suitable” for the client. On the other hand, financial advisors who are Registered Investment Advisors are required to act in the client’s best interest, not the advisor’s best interest, nor the firm’s best interest. Currently, neither the stockbroker nor the firm must act in the client’s best interest. The new chairman of the SEC recently advocated that all advisors be held to a fiduciary standard, which means every stockbroker of every firm will be incurring fiduciary liability for the firm. That is an enormous unseen and unknowable contingent liability to every firm. They may well sell pieces of their retail business to brokers and spin them off into separate legal entities.

Regardless, I don’t plan to own any shares in brokerage firms until this is made more clear. It is a BIG change!

The Wisdom of Crowds?

All year, I’ve been advising clients that the economy would “bottom-out” in the fourth quarter. Last week, the latest survey of the National Association of Business Economics (NABE) showed that 90% of economists believe the bottom will be late this year. (As a member, I naturally participated in that survey.) Maybe, I should feel comforted that so many economists agree with me, but there is an old joke among economists that the purpose of forecasters is to make astrologists look respectable.

At this point, my forecast for the U.S. economy remains the same, but something very different is happening to the financial markets. While there has never been a sharp V-shaped recovery from a credit-driven recession, this appears to be happening in the market now, and the only explanation I can believe is that the reversal is coming from the emerging markets, which are not as dependent on credit or capital. Stay tuned . . . we certainly do live in interesting times!

The Problem with Averages

I was reading a marketing piece from one of the mass market financial advisors. His argument was that since the average recession since the Great Depression has been 21 months and since the stock market has been up an average of 45% twelve months later and since this recession is now officially 19 months old, then it must be time to get fully invested in stocks. Averages can be so misleading!

Over the same period, recessions have ranged from 3 months (twice) to 62 months. Credit-driven recessions, like this one, tend to be longer than inventory-driven or trauma-driven recessions. Also, the average bounce-back of 45% twelve months later has been declining markedly. The first 3 recessions bounced-back an average of 72% while the last 3 only bounced back 25% on average.

Averages can be so misleading! Like every investor, every recession is unique and should be evaluated individually!

A Sainted Businessman

In the early 1990s, I was appointed by the Governor of Texas to the State Depository Board, where I served with the State Treasurer, State Banking Commissioner, and State Controller. We wrestled with the collapsing Texas Savings & Loan Associations, which had wrecked the Texas economy so badly. I was there when the legendary Bill Seidman arrived with the federal Resolution Trust Corporation. It was like Moses parting the sea. It was an experience I’ll never forget. Bill Seidman was a man I’ll never forget. America has lost one of those great businessmen, who made the life of every American even better, even though they’ll never know.

R.I.P. Bill Seidman

The Un-Stressful Stress Test

After all the stressful suspense, the "Stress Test" results were released last Thursday, and it wasn't as bad as I feared. Still, there are two lingering issues. First, the assumptions were 10.3% unemployment, GDP dropping 3.3% in 2009 and rising 0.5% next year, and home prices falling another 27%. I'll be surprised if unemployment doesn't exceed 10.3% by the first quarter of next year. I suspect GDP growth will not be as good this year nor as bad next year. And, with record low home mortgage rates, it is hard to forecast another 27% drop in home prices. Overall, the government did a good job.

The second lingering issue is that the Stress Test only looked at nineteen banks, but what about the thousands of other banks, many of which are heavily exposed to local commercial real estate loans? Many analysts believe that is the next big shoe to fall.

As always, the things we know that we don't know worry us the most!

Maybe Bernanke Is Right?

Today, I watched a speech by Ben Bernanke discussing the cause of the current Great Recession. For several years, he has been warning about the “savings glut”, i.e., those nations like China who run huge cash surpluses and lend the cash back to the consuming nations, effectively pushing up debt levels in our national economy. I’ve always felt like that was blaming somebody else for the mess we created. Bernanke gently hammered that point again today, and I’m starting to believe him. Regardless, it is one more reason we should become an exporting-oriented economy, which benefits from a weaker dollar.

Back To The Future

Yesterday we learned the U.S. trade deficit decreased unexpectedly. The surprise was not that imports fell for the seventh consecutive month, but that exports actually rose for the first time in six months, despite the strong dollar. Our trade deficit in 2006 was $681 billion compared with an estimate of only $373 billion this year. Nice trendline, indeed!

Early stage economies tend to grow by being export oriented. Mature economies tend to grow by being consumption oriented. The rest of the world has long envied our consumption based economy, which consumed their products. They were only too happy to continue lending us money to buy their goods. But, the world has changed . . .

To change our consumption orientation and again become an export economy, we need a cheaper dollar, which is the inevitable result of inflation. In other words, maybe we actually need inflation!

A Greater Wrong

While I am as disgusted as all those pontificating politicians about the AIG bonus issue, there is a greater issue than this additional instance of unfairness, and that is the sanctity of contracts.

While contracts can be set aside for a few narrow reasons, this is not one of them. Even worse, over-turning these contracts will have a very chilling effect on dealing with the many other financial problems we face, because the private sector won’t trust the contracts they negotiate.

The TALF plan is dependent upon contracts with funds to clean up the toxic assets. Would you want to do business with the Federal government, to help clean it up, when you don’t know if the contract will be honored or not?

Revenge may be sweet, but it has a bitter aftertaste!

Our future leaders are impressive

Last week, I spoke before 750 people for Virginia Beach’s annual “State of the City” address. It was a piece of cake!

I also spoke before the 24 brightest high school seniors in Virginia Beach, who are competing for a large scholarship. That was intimidating! These kids are so bright. They asked questions about the difference between Keynesian economics and Austrian economics. They asked how to protect themselves from people like Bernie Maddoff. Amazingly, they seemed resigned, but not angry, about inheriting all the debt we are piling on them. They were a much tougher audience.

Sometimes, it is nice to be reminded that our country’s future is in good hands, indeed!

Jobs Report reflects long year ahead

A year ago, I predicted unemployment would reach nine percent. On Friday morning, the Labor Department released the monthly “Jobs Report,” showing unemployment had already reached 8.1 percent, the worst in 26 years.

If you add in the under-employed, those people who are forced to work part-time or who have given up, 14.8 percent of the workforce is struggling. As if that wasn’t bad enough, don’t forget that unemployment is a “lagging indicator,” which means it will not improve until after the economy improves, which is not expected before the fourth quarter of this year.

That means unemployment is likely to rise all year, making a 10 percent level of unemployment almost a certainty. The rate of under-employment could even approach an unthinkable 20 percent. It will be a very long year indeed for millions of people.

Economics is not a religion

Sitting at a traffic light yesterday, listening to Rush Limbaugh’s speech to the Conservative Political Action Committee, I saw pick-up trucks go by, helpful for small cargoes. I saw 18-wheelers go by, helpful for large cargoes. I saw cement trucks, refrigerated trucks, and even a fire engine -- all helpful tools for specialized missions.

Some people, especially politicians, see economics as a religion, rather than a tool box. If you are trying to get the economy out of a deep ditch, Keynesian economics has a proven track record. If you are trying to stimulate a sluggish, under-performing economy, supply-side economics has a proven track record. If you are dealing with a specialized mission, such as inflation/deflation, monetarism has a proven track record.

There is a difference between a flathead screwdriver and a Phillips screwdriver, and each tool accomplishes a specific mission.

Stock market actions should be observed with steady hand

Yesterday, we learned that the fourth quarter was worse than we thought. In fact, it was the worst in 26 years. We thought our economy shrank 3.8% but learned it actually shrank 6.2%. Not too surprisingly, the stock market was disheartened and lost even more wealth.

The perspective of time is everything. When we were originally told last month that the economy shrank 3.8%, we were expecting to be told 5.5%. The stock market liked that and created wealth that day.

The stock market can be expected to over-react, which emphasizes the importance of not obsessing about any one report or any one day’s performance. If you have a real life outside your portfolio, this is a particularly good time to enjoy it!

Job loss mounts worldwide

The Jobs Report this morning showed another 598,000 Americans lost their jobs, the most in 35 years. The unemployment rate jumped from 7.2% to 7.6%. Totally heart-breaking! Don’t look for foreclosures to slow down . . .

So far in this recession, 3.5 million of us have lost our jobs. But, that pales in comparison to China, where some reports indicate 26 million workers have lost their jobs. The possibility of social unrest there should not be minimized. As they are our second most important trading partner, we need them to stay healthy enough to buy our goods, as well as to keep buying our Treasury debt.

Will the 'January Effect' ring true

Uh, oh . . . one of the oldest Wall Street adages is the “January Effect,” which states that … so goes January, so goes the year. The bad news is that the Dow lost 8.4% this month, the worst January in history, indicating a terrible 2009. A little piece of good news is that the “January Effect” is not ALWAYS correct.

More bad news was Friday’s report that the GDP decreased 3.8% in the fourth quarter, the worst since 1982. More good news is that we were expecting a decrease of 5.5%.

Oh, yeah . . . then there is Warren Buffett’s ageless and priceless advice to … be fearful when others are greedy and be greedy when others are fearful.