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Friday, July 29, 2005

More Rate Hikes to Come?

We got a solid GDP report today. Tony Crescenzi of The Street and Miller Tabak + Co. wrote a good summary of the report:

GDP Data Could Reset Yields
Today's report on the second quarter's gross domestic product clearly indicates that the U.S. economy is poised for additional strong growth in the quarters immediately ahead. As a result, the bond market is continuing to raise its year-end target for the fed funds rate, with odds now placed at 25% for a 4.25% year-end rate compared with zero percent odds two weeks ago. This is in sharp contrast to the view a month ago when a 3.75% year-end funds rate was expected.

Nothing against Mr. Crescenzi at all, but I am going to use him to toot my own horn a bit. Last week Mr. Crescenzi wrote for Barron’s Soapbox the following:

IN HIS SEMIANNUAL monetary policy report to Congress, Federal Reserve Chairman Alan Greenspan gave no indication of an impending pause in the Fed's rate campaign and instead affirmed market expectations for a 4% year-end federal-funds rate, spurring early weakness in Treasuries.

The testimony has prompted futures traders for the first time to price in the possibility that the Federal Reserve will continue to raise interest rates into 2006, with the odds of a rate hike at the February 1, 2006 meeting rising to 24%.

Despite the bearishness, Greenspan did not go much beyond what was already priced in, and he gave no indication that a shift toward a restrictive policy stance was planned. This should contain the rise in market interest rates.

By toeing the "measured" line, the condition of the financial markets is likely to be kept largely intact.

The markets would have been affected more by indications of either a pause in the Fed's rate hikes, or by the possibility that the Fed might eventually need to go beyond neutral toward a restrictive policy stance. Greenspan hinted at neither.

I disagreed with this analysis of the Feds statement and was prompted to write in with my own take and posted Sent to Barron’s Soapbox where I made the argument that the Fed intended to keep hiking rates farther than is currently being anticipated. Of course, my take didn’t make it to the site because I’m just a lowly blogger of Wall Street and not The Street. But that’s not intended to detract from my appreciation for the recent plug, rather to boost the ‘financial blogs are getting better’ trend even if we still are considered a inferior source of information.

I had come to this conclusion prior to writing this analysis and gave The Market Spectator subscribers a specific trading idea that is now doing quite well and likely to grow in profitability.

The gist is that the Fed is likely to see strong GDP numbers as meaning both that the economy can take the stress of further rate hikes and that it needs to due so because the robustness indicates strong demand and inflationary pressure. But Mr. Crescenzi points out astutely that next week’s ISM data will be critical to the interest rate markets. Positive ISM data will be taken to indicate an increased likelihood of further rate hikes.

posted at 4:51 PM 0 comments

Business as usual

Wages of scandal are death
One of Miami's best-known political figures, who had been beset by allegations of corruption and sleaze that had drawn increasingly garish headlines in the media, walked into the lobby of the Miami Herald newspaper on Thursday, raised a pistol to his head and shot himself.

Teele, an African-American, served as a city and county commissioner in Miami and once ran for mayor. But his reputation was ruined as legal challenges mounted around him. He was charged this month with multiple counts of fraud and money-laundering and taking bribes of US$60,000.

In America this is a scandal. In other parts of the world oft mentioned here this is business as usual.

posted at 4:06 PM 0 comments

China Stocks One Big Ponzi

CNOOC May Rise 1-2% On Unocal Withdrawal Rprt
0850 [Dow Jones] CNOOC (0883.HK) may rise 1-2% on SCMP report it preparing to walk away from US$18.5 billion Unocal bid, as management believes political pressure in Washington has made deal impossible; "there is literally no point to pursue this any further," report quotes person familiar with deal as saying. If CNOOC indeed withdraws bid, would remove a major overhang; investors have been concerned CNOOC would be paying too much and increasing financial burden. DBS Vickers says "time is running short" as Unocal to vote on Chevron offer Aug. 10; if CNOOC does not sweeten its offer, would indicate it giving up. Stock flat at HK$5 yesterday.(RLI)

Correction to the previous post this was the news that I saw referring to a rise in CNOOC if the bid is withdrawn. But it was only 1-2% rather than the 2-3% I stated off the top of my head. Not like it’s a huge difference and it was way off mark considering the stock is up more than 8% today.

The complete lack of logic is even apparent in this news blip. I don’t buy this stuff about investors being concerned that CNOOC would be paying too much. First off, investors never even brought the stock down on the prospects of the deal, which indicates how probable they thought the deal was, that being not probable at all. And secondly, how is it possible for a company that is majority owned by a centrally planned communist government pay too much? It can’t. The government was partially backing the deal. There are no rigid accounting standards or trustworthy system of independent audit and the Chinese stock exchange its shares trade on is rigged and corrupt. And the ADRs that we stupid Americans buy in the company don’t actually represent ownership in anything at all; not profits nor property. The company could never actually fail as long as the government doesn’t want it too. But if it somehow did would American shareholders have a claim in the sale of its assets? I think not. The company does pay a dividend, but it certainly doesn’t have too. It’s the epitome of the greater fool theory in which investors are ever dependent on someone being foolish enough to buy the stock at an even higher price. It’s gambling, not investing.

I may make calculated bets on the market, and admittedly sometimes those bets might not be calculated very diligently, but at least I recognize them for what they are. But there are thousands of supposedly professional and knowledgeable investment advisors all over the country telling small town average Joes to put their money in these companies. They are telling the Joes to put as much as 20% of their money overseas and telling them what a great investment China is for the long run.

How bad it is to fund and promote communism and how unpatriotic it is, or what a slap in the face it is to all the freedom fighting veterans is a another topic altogether.

But, it’s just about as dumb an investment as could ever be made. Any company that is owned by a centrally planned communist government is by definition corrupt. We don’t promote companies owned by the mafia here in the U.S., then why would we invest in a company owned by the communist government? Far less corrupt companies trade here in the U.S. for pennies. What do we think communism is? In China the government has a chokehold on business, what companies can earn, and what people can make. It’s little different than a mafia. If you want to do business you have to play by the communists rules. If you don’t, you’re sent to a labor camp where you’ll be made to pay by the governments rules.

posted at 3:56 PM 1 comments

CNOOC Insanity

Typically a company’s stock price will fall when it may be acquiring another company. The more premium acquirer is willing to pay, the greater the hit to the acquirers stock price.

Conversely, the stock price of the company to be acquired will rise by the amount of premium the acquirer is willing to pay. For example, Unocal (UCL) is up 50% since the beginning of the year partly because it is likely to be acquired, and partly because oil company stocks are up across the board. That’s to be expected.

Chevron’s (CVX) stock fell about 10% on the heels of the deal, but it hasn’t stuck and the stock is back to its pre-deal price. The move back up likely has more to do with earnings and oil prices than with the Unocal deal or the competition from rival bidder CNOOC (CEO). But it could also be the gradual realization that Chevron’s bid was for less than the market value. So there was no premium.

Investors are absolutely insane to be paying a higher PE for CNOOC than for similarly sized U.S. companies. They will get burned and they will have it coming. It’s only a matter of time.
Interestingly, CNOOC’s stock price did not fall back on it’s bid, even though Unocal is nearly as large as CNOOC and CNOOC is willing to pay more than Chevron. This suggests that investors don’t see the deal as being very likely or even within the realm of possibility.

So where things get really whacked is that today there have been widely reported rumors that CNOOC would be pulling out of the deal and the stock goes up 7%. One article I saw suggested previously that CNOOC could climb 2% or 3% if it backed out. Where’s the logic in this? There is none. The stock was never down on the prospects of the deal going through in the first place. So, therefore, it shouldn’t rise because the bid is cancelled.

Furthermore, owning Unocal would have been good for CNOOC, especially with the Chinese communist government backing it. I speak of it in past tense not because of the rumors that CNOOC will remove its bid, but because there isn’t a chance in H E double hockey sticks that it would go through even if they raise the bid. But if it could have gotten Unocal this would have effectively changed the perspective of CNOOC as a Chinese communist state owned company. It likely could have operated more effectively in the world markets under the Unocal name, doing other M&A deals, getting in on shared enterprise deals such as pipelines etc… with less political resistance. So there’s nothing good for CNOOC about having this deal fall through. And there’s nothing rational about the rise in CNOOC’s stock.

This is made even clearer when you consider that BP (BP) was flat on the week even as it announced a 25% dividend increase and an acceleration of a stock buyback plan that will have it repurchase $6 billion worth of its shares by the end of the year.

What has CNOOC got going for it? Nothing. It’s going back to China with its tails between its legs. It’s failure to Unocal and the widespread disapproval for the deal will likely make it more difficult for CNOOC to do deals beyond the borders of its state ownership in the future.

posted at 2:25 PM 0 comments

Thursday, July 28, 2005

What to make of the yuan reval...

I’m stepping back to this article I forwarded to the blog recently China Says No Yuan Change in `Foreseeable Future'. It’s interesting because it seems like everyone is still talking about what a revaluation of the yuan will mean for the markets. They’re actually talking about how it’s going to impact home prices of all things. Quite a stretch if you ask me. Yet China’s central bank is telling us they have no intention of strengthening the yuan further at all. Is it that people are ignoring this fact, that they don’t believe it, or that they just like going on TV and looking smart talking about the yuan when they know that the interviewers won’t even bother to bring this up?

The fact is that the 2.1% reval isn’t going to have much impact on much of anything. It’s insignificant. But, what I’m more interested in understanding is where things go from here. This article Reuters article Central bank said cooling yuan down on Chinadaily.com suggests that after last weeks reval there was a lot of yuan buying on speculation of further increases to come and China’s central bank had to intervene to keep the currency low. It could imply that the main purpose of the statement about no further changes in the foreseeable future was to stop the speculative yuan buying. That begs the question as to whether the Chinese are sincere or whether they in fact do intend to increase the value of the yuan further. My guess is that they will do so periodically between now and the 2008 Olympics, but probably not by as much as most people think it would move if it were allowed to float. My feeling is that at some point the speculators are going to give up and bring their investment home, as they see better places to put their money to work. This would equate to buying dollars.

Another interesting point made in this Chinadaily.com article is that the move in the dollar/yuan was very small, suggesting that the dollar is a large part of the basket the yuan is pegged to. But, as I have suggested previously, it could be that the basket now consists of other Asian currencies pegged to the dollar. This site lists world currencies and how they are managed. It seems to be up to date as it lists the Malaysia ringgit as being a managed float. Malaysia announced it would de-peg the ringgit from the dollar just after China’s announcement.

Malaysia pegged the ringgit after the Asian currency crises in the late 90s, which ironically came about as several Asian countries let loose of their countries. I can’t help but wonder why our government wants China to let loose of its currency all at once when they have to know that it would likely be disruptive. It could be that the government is bluffing, knowing that China won’t do it, so they are asking for more than they think they can get. Whatever is going on, there is no doubt more than we are being told.

This article De-Pegging Ringgit May Uncork Malaysian Boom explains Malaysia’s action. It’s also interesting to note that Forbes reportd Minister: Malaysia Won't Float Currency just last April.

posted at 4:55 PM 0 comments

Wal-Mart exec's frolic good for town?

Wal-Mart Sues Coughlin Over Alleged Fake Accounts
Earth's No. 1 retailer sued its ex-exec on Wednesday, seeking to void his multimillion-dollar retirement package. Wal-Mart (WMT), led by Chief Executive H. Lee Scott Jr., had previously disclosed in a U.S. Securities and Exchange Commission filing that it was terminating Coughlin retroactively for "gross misconduct." Coughlin had been the firm's No. 2 man before his retirement last year. In March, however, he abandoned his board seat when Wal-Mart disclosed that it was furnishing papers to the U.S. Justice Department, papers the retailer claimed proved he'd misspent $500,000. A federal grand jury is now probing the matter.

The former C-level exec supposedly ill-used the cards on a bizarre array of items including watches, Bloody Mary mix, headphones, sunflower seeds, a Toby Keith CD, underwear and a karaoke machine. Fake expense accounts also covered the purchase of snakeskin boots, a radio receiver for XM Satellite Radio (XMSR), truck accessories and airplane tickets, the suit said.

Hey, at least some small town (probably Glenwood Springs, CO, which has the closest Wal-Mart to Aspen) got the tax revenue. Reminds me of bad 80s movie with Jennifer Connelly. A kid takes a job as night janitor in a Target (TGT) store. Before locking him in for the night the boss tells him no ‘free grazing’ and explains that it means eating stuff off the shelves. The salacious Connelly was the only thing good about that movie. But I know I shouldn’t go there.

posted at 3:32 PM 1 comments

Free Trade Observation

The main problem with Free Trade Agreements is that they are never really free. We never actually need an agreement with countries that truly have free trade. We only need agreements when doing business with countries that don’t trade freely. Given the proclivity of these countries to bend the rules we ironically do not have free trade when there is an agreement and we do have free trade when an agreement when there is no need for one.

posted at 1:58 PM 1 comments

The right way to look at investment fees...

This article A New Get-What-You-Pay-For View of Money Managers is apt to make you think differently about fund fees.

The gist is that the excess fees you pay an active fund manager only count towards returns above market averages. For example, if you pay 3% for an active managed fund and you can get a passive indexed found for .5% and the active fund gains 14% while the S&P gains 13% then your actually everything you pay in fees above the .5% you would have to pay in an index fund pays for the additional 1% gain. But you paid the higher fee on all the funds in the account. So the extra amount you paid in fees for that one additional percentage point gain amounts to a much greater percent of the excess gain compared to the percent of the entire account.

Viewing investment fees from this perspective makes hedge fund fees seem more reasonable because alternatively a person could put some of their assets in an index fund and some in a hedge fund. The working paper cited in the article can be found here.

I don’t know why the traditional media hasn’t figured out how to use the hyperlink yet, given that it is the main reason we refer to the Internet as a web. I guess they don't think we're smart enough to want to read an academic paper such as this.

Ross Miller has also written a couple of good books on the markets.

posted at 1:32 PM 0 comments

Wednesday, July 27, 2005

The Evolution of ETFs

Here’s an excellent article on the evolution of the ETF industry: Are These New ETFs a Good Idea?

The author makes some good points about higher fees and the convoluted way expenses get paid in commodity ETFs, but I’m not sure I agree with him entirely. As I see it, the key feature of ETFs is that they are a basket of securities, or commodities as the case may be, that is traded on an exchange like a stock. Fee structures and other benefits are coincident and certainly good marketing tools, but I don’t think they are fundamental part of the product.

If ETFs can’t compete with mutual funds on price then people won’t buy them except that I think one of the main reasons people want to buy ETFs is because they know exactly what they are getting for their money. With mutual funds there is very little transparency with regard to holdings. During the recession, for example, there was a tendency for tech stocks to rally every six months, which I attributed to tech fund managers needing to bump up their holdings and clean up their portfolio mix before reporting periods.

The fact is that ETFs are a tool for speculation. From nearly the start ETFs have offered ways to speculate on various sectors offering sector diversification and low transaction costs compared to buying a basket of stocks out right. We’ve seen the same evolution in the futures markets with contracts such as the 30-day fed funds rate, or the euro dollar, and so on and so forth. With the ability to short most ETFs they becoming also a convenient and much simpler hedging tool.

In some ways this is similar to software and operating systems that hide the intricacies and complexity of programming languages. Computing systems have increasingly removed exposure to the back end. Similarly, I think ETFs will over time serve to remove the complexity of the futures markets. For example, if bank wants to hedge credit risk it might be simpler and more efficient to buy or sell an ETF based on credit derivatives than to employ futures traders. Such an ETF might reduce overall hedging expenses in a variety of areas.

All the better if this can be done via a typical stock investing account. Basically, it would amount to little more than outsourcing the management with very specific exposure and without the human risk of a managed futures fund. Now of course people are going to speculate on these contracts. There’s nothing new about this and in fact speculation adds necessary liquidity.

posted at 4:06 PM 0 comments

About this blog...

Knowing my new audience via the Barron’s plug, they will be quick to point out that I’ve seemingly made assumptions of my own in the previous post, such as the relationship between Fed rates and economies. See The Fed is recession culprit, not inverted yields!

Also so new readers know, I don’t care to hear about my typos or misuse of punctuation and how that relates to my intelligence. On the fly I will often leave out a word or mix up words like here or hear. Most published materials you read don’t get to the editors in much if any better shape than your seeing here. We don’t use an editor. It’s not in the budget, and I wouldn’t want one if it was. It’s a blog and I purposefully want it to maintain a conversational feel.

I have no desire to bias feedback in my favor. Nor do I intend to be automatically on the defensive with regard to comments less than complimentary to myself. I do appreciate civilized comments and debate of posts. If I didn’t it’s only a matter of a click to turn that feature off. Please do use the comments section if something I post catches your attention. Even if I simply post a headline, feel free to debate the contents of an article amongst yourselves.

Do keep in mind that people use the comments section for various agendas of their own. Some of these agendas are quite whacked in the head. We get emails from penny stock promoters and PR persons, possibly even the American PR engine CNOOC hired. And we’re on the email list of Hank Greenberg’s legal team. I’ll usually call such comments out when I see them, as they tend to stand out as they typically contain indefensible positions.

One of the key themes of this blog and something I’ve used for my own practice and self-improvement is to debunk market B.S., something of which there is no shortage. This makes for a solid foundation in developing investment and trading ideas.

We started a fee based newsletter service a couple of months ago called The Market Spectator. And there I go to the next step of translating such information into specific investing and trading ideas. It’s not the best or biggest investment letter ever written. I haven’t even had a great deal compelling ideas week in and week out. But as I tell my subscribers, over trading has always been my biggest mental enemy to investing and trading. So what I do is make a conscious effort to cut out any ideas that aren’t very compelling. I have failed at this more than once being tempted by the pressure of feeling compelled to provide numerous new ideas each week. But the attempt has paid off and the overall results have been very good thus far.

Anyway, shameless plug aside, I’d like to see us start to transition this blog away from a place to debate or battle the wits of the author and towards a place to call attention to the market misnomers and mischief my readers find around the web. I’m not talking about spam for OTCBB stocks. I get many of these every day. I’m talking about questioning assumptions such as that inverted yield curves cause recessions. If you have ideas or beliefs about the markets you’d like me to take a stab at testing I’d be glad to do so. I’m pretty good to about writing back and reading comments, though like most people I do tend to never have enough time for everything I want to accomplish.

My goal is to keep the blog productive and worthwhile.

Mark Mahorneymark@blogginwallstreet.com

posted at 1:21 PM 0 comments

A Statistical Starting Point

Why do we pay so much attention to consumer sentiment reports? The various reports are often called indicators or included in lists of market indicators, though it’s widely understood that they don’t indicate anything.

I’ve never seen anything showing sentiment to be predictive of future market direction. People like to say that very high sentiment indicates market tops and vice versa. But I don’t think the data provides anything like a tradable prediction. Rather it’s coincident to business cycles and the actions of the Federal Reserve. People are naturally in good spirits at the height of business cycles. They are employed with rising incomes, and their stocks are going up. So of course the sentiment is going to be running high at these times. Then along comes the inflation fighting fed and as usual it overshoots and spoils the party.

Still I found myself curious as to why consumer sentiment is such a bad predictor. The hypothesis I came up with is that sentiment is influenced heavily by less factors than are reflected in the markets. For example, Wall Street has often rewards job layoffs as being cost cutting and good for profits, yet this is certain to peeve off consumers.

With oil prices playing such a huge role in our economy at the moment I wondered if gas prices might be just such a factor. Hence I embarked on a post that would have been titled Has Gas Got You Down?

But the data didn’t show what I expected it too. In fact what I found was a slight (0.15) positive correlation between gas prices and consumer sentiment. This could possibly be the result of an increase in demand for gas during good economic times. However, when I plotted the data it was clear that many of the sharp rises in gas prices we’ve experienced going back to the late 70s were coincident or not so coincident with sharp falls in sentiment. I took this to mean that gas prices are only negatively correlated to sentiment when there are shocks in the system. Otherwise, consumers are focused on other factors, probably jobs, stock prices, war, etc…

The point I’m using the dead end data to illustrate is that you can’t rely just on a statistic like correlation of data alone. You’ve got to look at the data in more complex ways and refine the query to be more specific. I didn’t feel it was worthwhile to do so, but my next step would have been to compare sentiment to gas prices only during and just after sharp rises and declines in prices. In this case there likely would be the negative correlation I expected to see.

What is important is having at least a basic grasp of statistical techniques if want to be able to refute or question the many assumptions you come across in market information. A fairly decent starting point for the uninitiated would be with the little books by John Allen Paulos, such as A Mathematician Reads the Newspaper.

posted at 12:41 PM 0 comments

Tuesday, July 26, 2005

5000 Stocks to Buy Now

List articles are everywhere you look.

10 stocks to buy now
4 stocks poised to rise today
3 ways to profit from the yuan reval
Four REITs for income investors

It would be interesting to put all these lists from various financial media outlets and newsletters together over a years time and see just how many stocks we’ve been told to buy. I venture it would be a very sizable chunk of all available equities. And I also suspect the returns on these stocks would be no better, if not worse, than the average return for all stocks.

Without doubt I spend an above average amount of time scanning investment related articles on various Internet related sites, magazines, newspapers, etc… At some point I started to get quite tired of seeing these titles and they began to be an automatic turnoff. I don’t have a well-defined system of filtering information, but I suppose I’ve become adept at scanning and skimming. List articles are not only on my list of things that get filtered out, but the process has evolved to the point that when I’m skimming I don’t even mentally see them anymore.

Why? Because they’ve disappointed too many times. I know that it can be tough to make a living as a financial writer. For the most part only the top syndicated columnists make really good livings in the business. Many authors only write to promote some service or other. I’d include myself in that category, except that I derive much more pleasure and much less stress from writing a blog than a newsletter. The result is that in order to meet the demand for financial content there are a lot of low paid authors cranking out fluff and content with the sole purpose of getting people to click on a link. I’ve been guilty of this. It works. And electronic tracking tools make it easy for editors to determine what articles readers are clicking on.

The masses click on list articles. That’s why there are so darn many of them. The list article might be seen as a line between the retail investor and the ‘smart money’. The smart money tends to be a bit more discerning about what they read. Though I was certainly surprised at the number of professional money managers I heard from when I was writing for a popular retail investment site.

But in general I’d say that the smart money tends to read raw news and data with the intention of coming up with ideas of their own. That said, I sometimes do read generic market information with a critical mindset. What I do is identify incomplete research and the assumptions that are being made. This can often lead to ideas and a starting point for further worthwhile research. I’ll provide some specific examples of this in future posts.

posted at 4:16 PM 3 comments

Trader CEO discusses stake in China real estate classified site - From ChinaStockBlog.com

SouFun (TRDFF)

Trader Classified Media (ticker: TRDFF.pk), the world's largest classified media company recently acquired a stake in SouFun.com, a Chinese real estate classified Internet site. Here are extracts from an interview with Trader President and CEO John H McCall MacBain:
Continue reading...

posted at 2:16 PM 0 comments

Has China Appeased the Dems?

China Says No Yuan Change in `Foreseeable Future'

China's central bank said it won't revalue the yuan again in the "foreseeable future,'' damping predictions that last week's appreciation is the first of many.

posted at 1:53 PM 0 comments

Chinese bid seen as too risky

Chinese bid seen as too risky
Filing shows Unocal thought lower Chevron offer was safer

Unocal Corp. board members almost accepted an $18.5 billion buyout offer from a Chinese oil firm last week, despite congressional opposition, but decided the money wasn't worth the risk, according to documents filed Monday with the federal government.

posted at 1:51 PM 0 comments

Consumer Confidence Falls on Job Worries

Consumer Confidence Falls on Job Worries
July Consumer Confidence Falls on Job, Economy Worries, Breaks Three-Month Winning Streak

Americans' anxiety about the economy and their jobs resurfaced in July, sending a widely followed measure of consumer confidence downward and ending a three-month winning streak.

posted at 1:45 PM 0 comments

Monday, July 25, 2005

But what about the toy companies?

Rate reform won't slash trade deficit
China's move to cut its currency's link to the U.S. dollar would do little to narrow huge U.S. trade deficits with China, the head of the Chinese central bank said Saturday.

Well, he’s at least partly right. As long as the countries major companies are owned by the communist government and the Chinese people aren’t free to let the market determine their wages, then the Chinese aren’t going to have any more money to buy our goods even if relative prices fall. As it is now much of the profits go straight to inefficient central planning system.

As to what we will be paying for Chinese goods if the yuan rises significantly, this is entirely up to the Chinese government. They could let go of the yuan, but then subsidize the sale of its goods to the U.S., which would mean no real net change to us. If they don’t do that though, then there will most definitely be higher prices in here. If the Chinese simply keep their prices the same it will take more dollars to pay them for the same amount of stuff. There's no getting around the math.

We’ve had the same issue with Europe and the euro zone. It’s just that we much of what we buy from Europe is luxury items for which higher prices don’t hit home like high gas prices or having to 25% more for the same number of toys at Christmas time. Of course the toy manufacturers and retailers will absorb some of the exchange rate fluctuation.

Speaking of toys, all the time we hear about how Wal-Mart would be hurt by a higher yuan, but what of the toy manufacturers. The vast majority of toys are made of China.

posted at 3:45 PM 0 comments

Sent to Barron's Soapbox...

Subject: Greenspan Speeds Through Yellow Lights

In Greenspan Still Has Green Light Tony Crescenzi said that Alan Greenspan “…gave no indication that a shift toward a restrictive policy stance was planned.”

I have a different interpretation of Greenspan’s careful phrasing. The June 30 press release announcing a 25 basis point increase in the target federal funds rate to 3-1/4% contains several indications of future rate hikes possibly moving to a restrictive point.

Referring to the most recent rate increase the Fed states, “The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity.” The keys to this phrase are that the Fed believes it is still accommodative and that growth is ‘robust’ or in other words very strong. The Fed implies that it would take further rate hikes to get to a neutral level between being accommodative and restrictive. And it would take further hikes to begin to slow economic growth. This statement tells us a lot about how the Fed views the relationship between its actions and the economy.

Next the Fed speaks to inflation stating, “Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually. Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained.” Here the key is that the Fed believes inflationary pressures are still strong. The Feds primary purpose is fending off inflationary pressures. It’s not going to stop hiking rates until it inflationary pressures are no longer elevated. They will need to change this wording to something about inflationary pressures declining. Also, energy and commodity costs don’t have to decline to be inflationary. Relatively high prices are inflationary regardless of whether they move up or down. The phrasing also begs the question, what is containing inflation long term? Most likely this refers to future ‘measured’ rate hikes taking the target level up to a point that is adequate to contain inflation and eventually lower inflation.

The most telling Fed statement is, “With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured.” It is this statement that has been widely focused on by investors and Fed watchers, but I believe it has also been widely misinterpreted. The common interpretation has been that the Fed could stop raising rates. But they actually say the opposite. It says that inflation is expected to be contained and therefore it won’t have to hike rates at a faster than ‘measured’ pace. It further says that accommodation can be removed. This is tricky wording, but removing accommodation implies specifically that it intends to stop being accommodative, moving rates to a level that is neutral or even restrictive to keep inflation contained.

My feeling is that the Fed isn’t just raising rates to counter current inflationary pressures, but also to prepare our economy for higher prices on Chinese goods as the yuan is gradually allowed to strengthen. A significant rise in the value of the yuan, even at a gradual pace, would most definitely be inflationary and especially at the lower end of the income spectrum. This is the group most hurt by higher energy prices, which account for a larger percentage of income. It’s also the group credited with keeping the economy moving forward via consistent retail spending. Higher prices for goods out of China and other Asian countries following suit depegging their currencies from dollar could cause retail spending to slow.

posted at 2:03 PM 0 comments

Barron's Plug

We got a nice plug in Barron’s this week. The part about not posting early enough, uh yeah, that would be my fault. I tend to be a bit of night owl, often getting obsessed with various research efforts, and I’m two hours earlier than Wall Street time. If I can’t alter my behavior I’ll have to post at night and use Blogger’s nifty little Change Time & Date feature to have the post go out in the morning. Ha ha.

We appreciate the plug, Barron’s. Readers, cough up the six bucks a month for the online version of the WSJ and you’ll get all of this. I’m not sure if you can see it without a subscription as I’d have to delete my cookie to test it.

ELECTRONIC INVESTOR
By THERESA W. CAREY, KATHY YAKAL

THE QUALITY AND QUANTITY of financial blogs continue to improve, as do the variety of ways in which blogmasters are utilizing this burgeoning medium. BlogginWallStreet.com (www.blogginwallstreet.com) doesn't update as early in the morning as we'd like, but once it gets rolling, updates can come frequently. The blog is staffed by a handful of seasoned market professionals whose commentaries appear on other industry Websites and blogs. Founder and chief executive Eric Levitt, for example, has been instrumental in building WorldlyInvestor.com and OneFN.

If you prefer your blogs heavy on links to significant editorial content, this is a good place to regularly roost. Recent entries linked to articles covering, for example, a call by the U.S. to China to allow American companies more access to Chinese markets (BusinessWeek), a Reuters story on the euro's three-week high, and a series of oil-industry-related articles. The blog's writers often wax prosaic on topics, sometimes going off into lengthy tomes. With the kind of brain power behind this blog, we'd really like to see quick, short bites on a greater number of news stories. We'd guess that more blog readers than not are looking for a fast take on key topics that they can digest quickly.

posted at 12:17 PM 1 comments

Market got you down? Sue somebody.

Some Unocal Shareholders Reconsider Bid
Chevron Will Have to Offer More Money, Critics Say

Apparently the thing to do when the markets don’t go your way is to sue somebody. Google brings up litigation or threats of litigation against Hughes Electronics, Cendant, and PeopleSoft all related to mergers and acquisitions.

posted at 12:04 PM 0 comments

Friday, July 22, 2005

Bio: The Glossy Version

After many years working as an analyst for some of the largest financial companies in the world economist and financial engineer Mark Mahorney now combines his analytical skills with his passion for writing. His work can be found in many leading financial publications. You can read his scribbles as he dumps his every thought about the markets onto the BlogginWallStreet.com website. And you can find in depth and thought provoking analysis in his weekly publication, The Market Spectator at MarketSpectator.com.

Which version do you like better? There both pretty much true. This version makes me gag.

I get a kick out of reading between the lines of peoples bios because they’re all so trumped up. Be realistic. Do Ivy Leaguers at the top of their fields write blogs and newsletters? No, they run money, scads of it, and the live very handsomely off the profits. Nobody runs background checks on independent ‘supposed’ self-titled market experts and pundits. They can tell you anything they want or nothing at all. If you only knew how many market commentaries are written by English Lit and journalism majors that never expected to be writing about the markets. Or how many of these people came out of sales. It’s standard industry practice in financial sales for salesmen to have important sounding titles. So take it with a grain of salt when you read that so and so newsletter publisher was VP and Head of sales for some big name firm everyone has heard of. Most likely they were little more than just another broker or they were in charge of southwestern regional division 3, meaning just Albuquerque or the west side of Pheonix.

The irony of elitism is that elitists are supposed to be better and smarter than other people, yet they fall for phony elitism more than anyone else.

You have to think for yourself. If you do that you can learn to judge what you read on its own merit. One of the great things about the Internet is it has helped make knowledge for everybody instead of just for academic and professional elitists. On the Web if someone makes a good point it stands on its own. Who cares what college they went to or what company they worked for.

I’d be a hypocrite if I didn’t give you the real version because this blog is about seeing the truth in the markets, like the truth that consummate oil bull T. Boone Pickens with his 17,000 Google links operates a billion dollar energy hedge fund, that Goldman Sachs was counting heavily on volatility in the oil markets when the firm made its $105 a barrel call, or that there never was even the slightest tightness in the oil markets supply and demand equation, but there was 4,000 some odd new hedge funds, many of which were started by managers with long only experience, all desperate for the kind of rally only a bubble can bring.

China didn’t depeg the yuan from the dollar. They just tacked a bunch of other currencies on with it. We won’t know the net effect of that change until we know what that basket is. It could be that they won’t tell us what that basket is. In which case it could be 99% the dollar and we wouldn’t have a clue and the whole thing would just be a political masquerade to get the American Democrats off their backs. Or it could be that they just attached it to other Asian currencies that are still pegged to the dollar, in which case there would be no net change.

Much of the financial commentary is little more than one journalist rewriting what’s been written by another journalist who also didn’t have a clue. But you already know this, hence you’ve turned to blogs filling the niche between just-the-facts journalism and corporate analyst tainted PR.

posted at 7:19 PM 6 comments

A reader asks...

Who is Mark Mahorney and what make his scribblings expert advice?

To tackle the first part of the question, I’m uncertain how much people really want to know about me. I’ll tell you that I reside near Keystone, CO in the heart of Colorado’s ski country including Breckenridge and not far from Vail. At this very moment I’m sitting in Kickapoo Tavern in Keystone’s River Run Village with my six-year-old son. This morning I took him to see a Frog & Toad play. I’ve worked via a wireless card while he’s played on a nearby playground and stream. My wife works for a local business consulting firm.

For the past several years I’ve written about the markets professionally after transitioning from a career as a business analyst working for financial and insurance companies. For a period of time I wrote between working in various contract jobs. As an analyst I worked in corporate finance managing accounting data for one of the largest financial companies in the world, worked for IBM on a Global Services contract with another large financial company. I was a day trader before most people knew what that was. I worked for a couple of other large financial companies. I worked my way through college as a supervisor on the night shift at a UPS package-sorting hub and delivered supplies for an electrical contractor. I wasn’t the best student and didn’t like school much, but I stuck it out and got a degree in quantitative economics and studied math, statistics, and actuarial science. I’m finally putting my education to use.

Now I combine my experience working with massive amounts of financial data, corporate finance, systems, spreadsheets, and education in economics, mathematics, and statistics to test market ideas and beliefs.

Scribblings indeed. It’s not my intention to hold myself out as an expert in anything. If I am an expert at anything it is at getting people to pay me to scribble. I make observations. Some people seem to think my observations are insightful at times. I make an attempt to view the markets from a different perspective than the masses and convey my observations to the public. I don't think they should be construed as advice. I think for myself and suggest my readers do the same.

Generally, I question statements and assumptions about the markets. Very often I find that the facts and statistics don’t support common beliefs. I like to know truth of matters. It wouldn’t be much of an exaggeration to say I am obsessed with it. I will often find myself up all hours of the night seeking it.

When I was still bound to the corporate world I always had to pretend be a loyal company man. I had since college been avidly following the markets, reading the WSJ, Financial Times, IBD, and web commentary when it came available. I remember vividly the so called ‘financial reengineering’ of the early 90s. I followed with fascination the corporate raiders, Milken, Boesky, et al, and later LTCM and the downfall of the markets academic elite. So when my company, part of one of the largest financial companies in the world, sent in a senior executive from another recently acquired company for an “all hands meeting” I was naturally skeptical.

What sticks in my mind was one statement, “We’re committed to Denver”. I didn’t believe a word of it. What all the loyal sheep didn’t know was that companies always send in an outsider to do their dirty work. This man was an total outsider. After two years of reorganization and streamlining the staff had been hacked down by two thirds. My job was relocated to Pennsylvania.

Meanwhile the mutual fund company my wife worked for was being taken over by its larger parent, which proceeded to fold in the assets and fire every single employee.

We started jobs in Denver on the same week and were both let go within weeks of each other. I haven’t worked a ‘regular’ job since and haven’t wanted too. The next financial company my wife worked for was a spun off startup of another global financial company. It only existed for one purpose: to hide the lavish spending habits of the senior management. When the inevitable cutbacks came, it included anyone that new too much about relationships between the executives and their admins, which they still called secretaries.

We thought we’d escaped the hustle bustle of the corporate world moving to the mountains, but that’s an ongoing saga...

posted at 4:47 PM 0 comments

Some facts about the yuan..

You might have been asking what is the yuan and what is a renminbi? The two are used interchangeably. The yuan is more specifically the yuan renminbi, and there are yuan notes akin to our 1, 5, 10, 20, and 100 dollar bills. It’s the yuan renminbi that was revalued 2.1% to 8.11 to the dollar. There are also other renminbis that are fractions of the yuan.

It’s not an entirely accurate statement to say that China has stopped pegging the yuan to the dollar. The yuan will be pegged to a basket of currencies of which the dollar is presumably a significant part. Except for the fact that the currency will be allowed to float 0.3% of a percent per day against the basket, this does nothing to solve the problem with the currency being manipulated. It is still a pegged currency.

Actually we know very little about what the changes mean without knowing what the basket is. For example, if the basket is heavily weighted to other Asian currencies that are still pegged to the dollar then the yuan will be just about as pegged to the dollar as it has been for the past decade.

The Chinese have said for years that its financial system was too frail to manage a floating currency, however, this has nothing to do with the level of the peg. The Chinese could have over time chosen to strengthen the yuan against the dollar by lowering the number of yuans to the dollar. It chose not to do so for obvious reasons.

The markets are still trying to decipher what this means for the U.S. economy, the dollar, Treasuries, and stocks. Knowing the basket is key.

posted at 2:42 PM 0 comments

Thursday, July 21, 2005

A reader writes...

I agree wholeheartedly with well thought out comments below. I have always gone out at least a little bit out of my way to utilize local businesses, minimize the purchase of foreign goods, and particularly Chinese goods. I have doubled those efforts recently as my writing and research has only served to reinforce what I already believed to be true. Mark

During the last 18 years of living and working in China, I have become critical and skeptical of much of the Chinese business environment, fraught as it is with risk and corruption. Add to the business environment China’s authoritarian political system, with paternalistic practices so alien to our own, and the country indeed becomes a place in which great caution should be taken. Thus, like many others, this writer’s knee-jerk reaction to the China National Offshore Oil Corporation’s bid for Unocal was negative. The thought of this organization, or, for that matter, any company so largely identified with and controlled by the Chinese government, buying into US-held oil supplies, is discomforting to me. However, there is a problem with our, and American, unease with this bid. Can we, in fact, legitimately oppose a bid of this sort, without laying ourselves open to charges of hypocrisy and the application of a double standard? Why does China need more oil than it can produce? A very large part of the answer is that the US and Europe got their wish. China may have had the desire to open itself economically to the global economy, but that desire would have been largely unrequited had not the United States, Europe, and Asian tigers been willing to satisfy it. The bid for Unocal, and for companies like it around the world, is indeed worrying, but it is a natural extension of the policies which we ourselves have pushed China to accept in order to bring it into the global economic fold. We are the ones who demand low-cost manufacturing, and the power to sustain it in the economic zones to which American and other companies have flocked. It is the United States which pushed China for access to its automotive manufacturing market, with lobbying in the 1990s that went as high as then-President Clinton himself. Did we think that those cars we so wanted to make and sell to the Chinese would run on water?On the one hand, we don’t want China to use nuclear power. We don’t want China to build more dams. We don’t want China to buy our oil companies. But on the other hand, we do want China to have more power so that we can build factories to produce our goods with their cheap labor. We do want China to have access to more oil in order to be able to buy more of our cars, which, although built in China, still carry household American names and contribute to those companies’ bottom lines here in the US. We do want China to let us buy into their companies (such as the Bank of America purchase of 9% of the China Construction Bank).If we want to be freer to be critical of and oppose certain Chinese investments in the US, then we need to be less strategically invested in China, and less dependent on China to support our industrial requirements. It must be clearly understood – now – that dependency is the position in which we find ourselves. We have put entire industries, entire supply chains, into China, without a great deal of thought as to the ultimate consequences of this move. Perhaps the CNOOC bid for Unocal is a wakeup call we should heed.Some investment in China is a good thing, but dependence is dangerous. In order to overcome this dilemma, therefore, I believe we should increase our exposure in other regions. India is one of the countries which attracts me; stable African countries are also tremendously interesting. The infrastructure in India is no worse than China’s just a few short years ago, and in many regions, China’s is still just as far behind. The widespread use of English, a legal system that is recognizable in America, as it is largely based on English common law, a diversity of religions and peoples, freedom of the press, universal suffrage – all of these make India an attractive investment destination – and one in which we don’t have the serious security concerns that we sltill have with China.And then there is Africa. Perhaps the commitments made at the G-8 summit, perhaps Live8, will spur us to seriously approach previously unconsidered investment environments in Africa, giving us yet more opportunities to create a more balanced mix of investments abroad, and to therefore lessen our dependence on investment regimes with which we have serious policy concerns.Will we pay attention and take action on the principles and proposals that have come out of the G-8 summit? Will we take the risks associated with investing in countries whose abilities to create substantial ROI have not yet been proven? They were not only not proven in China when we began to invest there, in many cases they are not proven yet. From a purely self-interested point of view, it does not make sense to continue to put huge amounts of investment into China, to make ourselves virtually dependent on Chinese cheap labor, if we are not prepared to pay in strategic terms for the consequences of our actions.If we are not comfortable with Chinese global policies or intentions, then why are we financing them? The logical thing to do, therefore, is to divert some of our attention, and consequently some of our investment capital, into other regions of the developing world. Not only is it the right thing to do, it is the smart thing to do, as well.

posted at 2:55 PM 0 comments

Homes are just another commodity

Reader Jonathan makes some very good points:

Excellent diatribe Mark. Our wages are not capped in this country ... just eliminated if the company finds it cheaper to move production overseas. You see the Bush administration made a severe miscalculation in lowering interest rates. Bush thought he would prop up the manufacturing sector of the U.S. economy with low interest rates. Instead low rates lead to excess borrowing against real estate, an asset that provides capital gains but no capital investment. While this was occurring the manufacturing sector was slipping out of the country. So when the era of low interest rates ends, this whole economy based on debt and not capital investment is going to come tumbling down.

I haven’t talked about real estate on this blog in the past. It hasn’t been very directly relevant to the markets and I don’t know whether we have a real estate bubble or not. But something occurred to me about the true macro nature of real estate. When real estate prices rise this does not as most people want desperately to believe create wealth. It is purely and simply inflationary.

Homebuilders and some home improvements create wealth. Home price appreciation does not. From the perspective of the homeowner wealth seems to have been created when their homes value increases. But if you consider hypothetically that the value of all homes increase by the same amount, say 5% then there is no net gain by selling a home now worth 5% more than it was to buy another home that is also now worth 5% more than it was.

Homes are commodities like any other commodity. When you consider that the average length of time that a person owns a home is only six years it means that people are paying more in transaction costs than for just about any other supposed investment I can think of.

A home is two things financially. First it is a hedge against inflation. If your home price appreciates by the same amount as another home then you’ve been effectively hedged against the price increase of the other home. Secondly, it is a savings plan. As a home loan is paid down a portion of the loan value goes towards principle, or owning more of the homes full value.

When a person sells a one home for another home at a lower price that person realizes a gain. But there is no net gain for all parties involved. Somewhere along the line someone is paying more for a home and suffering from the homes price appreciation. The existing homeowner is hedged against price appreciation of other homes. But, again hypothetically, if all home prices increase by the same amount and all other things remain equal the only real result is that homes become more costly for new homebuyers. Owning a home after price appreciation means that purchasing the home requires a greater percentage of the new homebuyer’s income than previously.

People think that their home has created wealth when in reality all that has been created is financial leverage. If homes increase in value, while all other prices remain the same, a person can borrow a percentage of the values home and that money can buy more things than previously. If someone borrows 5% of the value of a $200,000 dollar home this amounts to $10,000. But if the house appreciates to $250,000 then 5% is $12,500. But in reality if wages stay the same the borrower has to payout a larger portion of their income to payoff the loan. This gives the illusion of wealth creation.

This illusion is promoted as many goods experience relative price deflation. Therefore, as the value of a home increases, borrowing 5% against its value equates to being able to buy more stuff. But sooner or later the piper must be paid. People are simple extending the length of time into their lives that they will be paying for their homes.

As nothing is being created of value there is no real wealth creation. By contrast companies create things of value. When companies create things and sell them they are creating and accumulating wealth. And when stocks increase in value it’s generally related to this wealth creation.

However, this isn’t always true. At times stock price changes reflect the demand for the ownership of stocks and supply of stocks available. Stocks differ from other commodities in the sense that there is both a supply and demand component and the creation of wealth, of which some portion may be returned to investors. The investor then experiences a true gain or creation of wealth related to the value of what the company has created.

Homes, on the other hand, are no different than any other commodity. There is only a creation of wealth when the home is created. Price changes after creation are simply supply and demand driven. This is no different than the price of oil. Wealth is created in the process of obtaining oil. Wealth is created when oil is refined and distributed. But the purchaser and consumers of oil do not experience wealth creation, rather only price inflation. Everyone uses oil and its easy to see how damaging higher oil prices are.

But it’s humorous to me that people accumulate and store real estate, but not oil. The fact is that people would have done far better to have bought actual barrels of oil and paid to store it given that oil prices have quadrupled in the past five years. That’s more than can be said for home prices thank goodness. This might seem silly, but the ridiculousness of it helps to illustrate the reality of the similarities. Imagine if home prices had quadrupled in the same amount of time. Very few people who didn’t already own a home would be able to buy one. And those who could would have to settle for much less home and pay out a far greater portion of their income. Existing homeowners would be hedged against the price inflation, but they would have difficulty stepping up to a better home.

Overall, home price appreciation is nothing more than inflation and an economic drag.

posted at 11:52 AM 0 comments

China Severs Its Currency's Link to Dollar

China Severs Its Currency's Link to Dollar
China dropped its politically volatile policy of linking its currency to the U.S. dollar on Thursday, adopting a more flexible system based on a basket of foreign currencies that could push up the price of Chinese exports to the United States and Europe.

In my view this amounts to little more than appeasing us, likely to promote the CNOOC deal and lessen anti-China sentiment. I prefer to think of it as seeing the reality of China as a country that openly says that if we interfered with it taking over Taiwan then we should be prepared for the destruction of our cities. I dont' think we should look past this reality of the relationship.

This move strengthened the yuan by a whopping one quarter of a penny against the dollar. By contrast the euro may move 2 or 3 cents against the dollar on any given day in the open market. At 12.33 cents per yuan a quarter penny move is about the same as a single days fluctuation in a floating rate environment. Really quite meaningless, especially when you consider that a free floating yuan would likely strengthen by as much as 50% or more. In other words if the Chinese would have to do what they have done very many more times to get anywhere close to a fair market value for the yuan.

posted at 10:45 AM 2 comments

Wednesday, July 20, 2005

The Economics of Semi-Free Trade

Our economy with its rapidly increasing globalization and $12 trillion dollar GDP has become so incredibly complex that we’ve forgotten what it is that drives it. Economists like to say that everybody is better off with free trade and globalization in the long run. And they are right. There is an undeniable overall benefit.

But what most economists miss in this global catchall perspective is that there are aspects along the way that are not beneficial. In other words economists over simplify the effects of globalization and free trade. What they don’t consider is that it is possible for one persons good business decision to lead to a collective bad decision or that maybe there are better ways to do something than just letting it run wild and free or that maybe there when one part of the equation is free and flexible while another part is not, then the final results aren’t going to be what they expected.

What, for example, would be the outcome of a poker game in which player one was required to play all his cards up for player two to see, while player two was allowed to conceal his cards from player one’s view? Very obviously player two would over time take all of player one’s money. Yet isn’t this the way we’re playing the game with China? We might have a lot of money to lose, but is that any reason to give it away? That’s exactly what we are doing. We are giving our money away to the Chinese every time they clone one of our products. And now they want to be able to buy a major American company, yet we cannot buy their companies.

Sure, we benefit from China’s cheap goods. But they wouldn’t be nearly so cheap if China played by the same rules. It’s not just because China has so many people that they are able to produce goods so cheaply. It’s because the communist government restricts wages. In other words the people are partially enslaved. They are not forced to work, but they must work to eat, yet they are paid barely enough to eat.

This is somewhat similar to the situation people found themselves in when they migrated their way to California from the dustbowl. Fruit picking wages so low that workers couldn’t afford gas to drive to the nearest town to buy reasonably priced food, so they had to buy from the company stores, which set prices such that it took all of the pickers wages just to stay alive long enough to get the picking done.

All wealth and prosperity is a product of resources. When all efforts go toward just existing nothing is being created that is not being immediately consumed. Therefore, no wealth is being created. Wealth can only increase after basic subsistence needs are met. And for that to happen something has to be created that someone else is willing to purchase. This might be as simple as growing more green beans than you can eat and selling the difference to someone else. It might be that a persons land contains a valuable resource such as trees or minerals. Or a person might have knowledge or artistic talents that are valuable to other people.

America’s small towns are struggling because so many of the people aren’t producing anything other people want to buy. Big companies have bought up the farmland so that many farmers can only hope to have a job farming for a company and all the profits go to the corporate headquarters in some big city. The farmer only has wages to spend in town, not profits from his entrepreneurship. This is so because the corporations are more competitive. They can do the work cheaper and charge less for what it produces. Everyone benefits incrementally from relatively cheaper groceries. They now have to work less to subsist. But this doesn’t mean that there aren’t people harmed by it. The small towns people most certainly are. With the land and the production in the hands of the corporation the people no longer have a resources to sell beyond their labor. And the corporations need to hire less and less people as productivity increases.

This gets to the heart of the problem that small towns are facing as Wal-Mart and other similar stores move in. Everyone benefits from the cheaper goods, to be sure. But all the profits from the sale of those goods aside low wages goes back to HQ.

Towns rush to be the one in five towns that has a Wal-Mart because they know that one people will come from the other four towns to shop in their town and they will get the tax revenues. But tax revenues are not a very efficient job creator. The net result is that some money is spent locally and converted to tax revenue that might have been spent in a larger community farther away, as small town people often travel to larger cities or now on the Net to make less common purchases. But overall, all five towns bleed every dollar they spend at a Wal-Mart. Very little of the money circulates or trickles down into the community.

People used to understand this concept better when the economics were simpler. Buying groups like the Independent Grocers Association (IGA) used to be very common. But they haven’t been able to compete with the buying power and concentrated efforts of Wal-Mart and big box grocers.

When you consider this problem on a more massive scale China’s mercantilist approach to trade and Wal-Mart have a lot in common. They both have the concentrated effort and financial backing to run their competition out of business and bleed their customers dry. To the small town this trend is like a virus that won’t have run its course until the towns people have no money left. Only then will the virus die.

But that’s just one side of the coin. The wealth that Wal-Mart obtains for the most part does at least remain in the U.S. and circulate back into the country, with the exception of profits returned to shareholders as dividends when the shareholder is a foreigner. But in general the people who work in the corporate headquarters and distribution hubs and the people that sell goods to Wal-Mart all profit from the companies wealth and spend the money in their communities. Except that many of the goods that Wal-Mart buys are produced in other countries like China.

Now though, imagine if the Chinese government bought Wal-Mart, its headquarters were in Beijing, and every bit of the goods it produced were made in China. The only portion of profits that would remain in the U.S. would be the wages earned from distributing the goods, managing the sales, and tax revenues.

This is the nature of the problem that we are facing with globalization. There’s simply no way we can compete with China’s wage manipulation. The Chinese people would be better off if they could earn a wage set by the market for their services. But in the short run it’s the communist government that reaps the rewards.

Unfortunately, we are all too accepting of a semi-free trade system. We don’t cap our workers wages and we don’t cap the dollar, but we willingly buy good from countries that do both. So what is free trade? Really having free trade should mean that we’re free not to trade if we want to. We’re free to choose not to buy goods from China if we want. Don’t let the free trade advocates tell you otherwise. It’s not free trade when governments tell the parties to a transaction who they can and can’t buy from and how much they can or can’t pay for it.

Unfortunately, our trade activities with China are not at all free and if we sell our companies to China we are selling them our resources like the farmer selling his land for to a corporation or a town selling out to Wal-Mart before its neighbor does. Economic fundamentals dictate that all Americans have a net gain from the cheaper agricultural goods produced by corporations even though the farmer may have a net loss. Americans have a net gain from Wal-Mart’s cheaper goods even though four out of five towns may have a net loss. By extension when you expand this to a global scale the world benefits from China’s cheap goods even though Americans may suffer.

In essence, under the guise of spreading capitalism, perhaps we are mistakenly promoting, condoning, and incentivizing communism and repression.

posted at 10:04 PM 1 comments

The Degradation of our Democracy

Are our representatives getting dumber and dumber? Every time I watch a congressional testimony I am astounded by the stupidity and economic ignorance of our representatives. It’s painful to watch. I cringe just about every time they open their mouths. Very seldom do they have a reasonable educated question to ask. And it seems to be getting worse over time.

There are many books filled with the wise words of our country’s founding political figures. When I listen to today’s leaders I don’t here any of that wisdom, nor any semblance of reason or rationality. We certainly don’t here it in the voice of our president however much wiser he may be than his still bitter opponent. About as close as anyone comes to speaking wisely and thoughtfully is, for all his faults, Greenspan.

Many of today’s leaders aren’t even courteous, polite, diplomatic, or civil. Perhaps this would be excusable if they had anything intelligent to say.

posted at 2:25 PM 1 comments

Tuesday, July 19, 2005

Earnings Review

I like to tally up upside and downside surprises during the earnings season. The markets don’t always reflect a clear picture of this, but rather tend to hone in on the earnings of a few key companies. In the past two days the reports have come in about evenly split with IBMs improved earnings setting the bullish tone. I think the tone is a little more bullish than it should be looking at the bigger picture. But I’m not bearish either. I’m just not sure how long the legs are under this rally. In other words I’m neutral to somewhat bullish. I’d be more optimistic if I thought investors were focused in on the long-term prospects for the markets. But I don’t see that. I see near-sighted fickle trading and that makes me nervous.

posted at 4:07 PM 0 comments

A Big Fat Told You So

Chinese General Threatens Use of A-Bombs if U.S. Intrudes
"If the Americans draw their missiles and position-guided ammunition on to the target zone on China's territory, I think we will have to respond with nuclear weapons," the official, Maj. Gen. Zhu Chenghu, said at an official briefing.

Many military analysts have assumed that any battle over Taiwan would be localized, with both China and the United States taking care to ensure that it would not expand into a general war between the two powers.

But the comments by General Zhu suggest that at least some elements of the military are prepared to widen the conflict, perhaps to persuade the United States that it could no more successfully fight a limited war against China than it could against the former Soviet Union.

I don’t think we’re going to be so anxious to play hero to the world if it means getting nuclear bombs lobbed into our laps. We defend Taiwan and it’s going to get very crowded out here in the country and the mountains.

We are so naïve when it comes to the Chinese. We think we can just put a few carriers around Taiwan and the Chinese will go home. We think they won’t do anything desperate because they won’t want to get kicked out of the WTO. That’s about as scary to Chinese as the SEC was to our companies before Enron.

Note that the this indicates an awareness on the part of the Chinese that it would not limit itself in anyway to win a war against the U.S. We aren’t prepared for that kind of warfare. We play by rules. The Chinese would not. It wouldn’t just be a nuclear weapons. It would mean; all manor of terrorism, massive attacks to our computer networks and financial systems, all shipments to Wal-Mart would cease, the Chinese buying up and stockpiling every sort of commodity it could get its hands on, selling down the dollar, etc, etc…

By contrast embargos and boycotts are going to do very little damage to a country with only one foot out of the fields. And speaking of feet, I’m not sure we could win a foot war with China. We’d be faced with the horrendous decision of whether or not to blow China off the globe. And if you don’t think it could come to that you are very naïve and very quick to forget the Cold War and how close we came to such an occurrence on numerous occasions with Russia. I’ve got news for you, the Cold War never ended. It’s a myth and merely a matter of skewed perception that it ever did.

The Chinese do not have the same value of life that we do. This is not a criticism. It’s just a fact. The U.S. has not been faced with the kinds of moral choices that the Chinese have with its overpopulation and starvation. If we were ever again to experience a massive epidemic or a really massive attack on our country such as a nuclear weapon making to NYC our attitudes about the importance of life would change very quickly. We only place such a high value on life when it is convenient to do so.

An all out war with China wouldn’t be anything like WWII, Vietnam, Iraq or Afghanistan, or even Russia in the ‘80s. Aside from the obvious yet inconceivable threat of nuclear warfare we’d likely experience massive supply disruptions and serious inflation. One of major weaknesses militarily speaking is that we’re completely dependent on other countries all over the world for just about everything we consume day to day, and many of those countries would not be our allies if push came to shove.

This might seem incredibly removed from the markets, but it’s not at all with the CNOOC deal on the table. It’s forcing us to take a good hard look at the true nature of our relationship with China. We’ve been buying up the stock of its companies and now some people want to sell the Chinese our companies.

If things were ever to get really heated with China, investors would be quick to sell the stock of Chinese companies. But what would that do to China? Absolutely nothing because most of the companies are SOEs and the stocks only exist as a way to get us to give the Chinese even more of our money. The ADRs could go to zero and it would matter one bit to the companies because the shares don’t really represent ownership in the companies they do in U.S. companies.

By contrast a massive sell off of our own shares would mean layoffs and recession. Our economy depends on public ownership of our major companies.

If things were to get heated with China what we now call free trade and capitalism would be seen as weakness and dependence. We simply have much more to lose than a communist government detached from its people.

posted at 3:53 PM 0 comments

Hedge Fund News

Gloom Over Hedge Funds, Convertible Bonds May Lift

Subscription required. As I often say the $6 a month for the WSJ online is a worthwhile expenditure.

posted at 1:46 PM 0 comments

How nice

Merck used 'dodge ball' game on Vioxx questions-lawyer
Merck & Co. (MRK) used a game called "dodge ball" to teach its sales force how to avoid questions about safety problems with Vioxx, a lawyer for plaintiffs suing the pharmaceutical giant told a jury on Monday.

posted at 1:19 PM 0 comments

Greenspan: Sage or Stage?

The article Five questions for Greenspan asks, “Should the next chairman keep his opinions to himself?” Congressmen have been “…eager to get his opinion on a wide range of topics.”

However, I suggest that they aren’t really all that interested getting Greenspan’s opinion as they are in using him to have their question and rebuttals broadcast over CNN et al.

posted at 1:10 PM 0 comments

Monday, July 18, 2005

The Fed is recession culprit, not inverted yields!

A couple of recent articles note that the flattening yield curve may not be the economic threat that it once was:

Misleading economic indicators

Treasuries Likely to Decline as Greenspan Signals Higher Rates
Greenspan may suggest that ``the yield curve is not as good a signal'' as it has been in predicting slowdowns ``and he continues to see robust growth,'' said Amitabh Arora, chief interest-rate strategist at Lehman Brothers Inc. in New York.

Another source focused on the weakness in the statistics with some recessions coming without a yield curve signal. This is however akin to an excuse and not a relevant argument. These sources all miss the most important piece of information buried in the data. This is something I wrote about more extensively in last week’s issue of The Market Spectator so if you want to get the details give the letter a try.

The conclusion of the research is as follows:

Data for past fifty years		%

Average yield for Treasuries with maturities of 10 or more years through 2000		6.07
Average yield for long-term Treasuries when inverted to fed funds rate		7.88