Friday, September 30, 2005

Econ Update

Two important pieces of the economic puzzle came out today; the Department of Commerce’s Personal Income and Outlays report and the Chicago PMI. The personal income numbers for August weren’t pretty, but at least we weren’t frustrated by data we didn’t expect to see such as we’ve been seeing with the subdued core CPI recently. We’ve expected to see energy prices taking a toll on the consumer and that’s what we got. Personal income decreased $5.3 billion, or 0.1%, and disposable personal income fell $7.4 billion, also 0.1%.

Both measures of personal income increased in all of the past four months, so the August data clearly that the consumer is being taxed by higher energy prices. And though just one tenth of a percent doesn’t seem incredibly significant, the number is an average that varies significantly according to income levels. Persons with low income are impacted by higher energy prices much more so than persons with high incomes. But, there’s no breakdown according to income level. Just ask anyone who has to commute significant distance whether gas prices are taking a bite or not.

Somewhat surprisingly, however, the Chicago Purchasing Managers Index rose to 60.5 after sinking to 49.2 last month. The index was driven higher by a rebound in new orders. I wasn’t able to find a reasonable explanation for the jump in the index. Perhaps there are already orders coming in from the rebuilding in the south. The flooded areas of New Orleans are slow to get the rebuilding going, but there has been much damage done all across Mississippi, Louisiana, and Texas for which there is nothing to prevent rebuilding efforts. I don’t know if this is the explanation or not.

The Institute for Supply Management (ISM) report comes out Monday, which will be another important piece of the puzzle. This report will provide composite data form the various regional PMI. The St. Louis Federal Reserve tracks the index and it’s a sure bet that the Fed will be watching this measure closely for any significant up ticks, which indicative of increased spending related to rebuilding and would be seen as a potentially inflationary trend.

posted at 5:47 PM 0 comments   

Wild West Window Dressing

Today is the last day of the quarter for many companies. With that comes what is known as window dressing, a technique used by fund managers to alter the list of holdings that are reported in quarterly, semi-annual, and annual reports to clients. This in my view is one of the dastardliest practices in the industry that has gone ignored by regulators. It’s every bit as bad as anything that came to light in the scandals a couple of years ago.

Portfolio managers often sell losing stocks and buy highflying stocks so that they will show up on their holdings lists. There’s nothing wrong with selling bad stocks and buying better ones, except that in the case of window dressing the intent is to deceive their customers.

Worse yet is when portfolio managers have to adjust portfolios to get back within the confines of their prospectuses. During the recession when tech stocks were extremely out of favor, there were large rallies in the sector just before the end of the year and at the halfway point. At that time managers didn’t want to own tech stocks even if they were running a tech fund, so they would operate heavy on cash or buy securities outside of sectors specified in their prospectuses, which is known as style drift.

Since portfolio managers only report their holdings periodically they can get away with a lot in the interim. I know this goes on, but to what extent I’m not sure. I do suspect that at some point in the future it will be the next big scandal for the industry.

The problems that it causes are several. First off, the mutual fund managers contributed heavily to the downturns for stocks and particularly in the tech sector in 2000 and 2001. If a mutual fund at any time held a larger percentage of cash than is allowed by the prospectus, then it contributed to the downturn and contributed to losses of other shareholders by exacerbating the selling. Those funds could and in my opinion should be libel for damages.

Similarly, it has been said that years of rampant cheating on the part of AIG contributed very little to its profits. At least that’s what the company wants people to believe because otherwise it could potentially be libel for damages to its competitors for the business that it would not have otherwise been able to obtain. Competitors could probably start a class action suit, but I’ve yet to ever hear of a case along these lines most likely because many of the competitors aren’t squeaky clean either and would prefer not to draw attention to their own problems.

But individual investors ARE squeaky clean. If big mutual funds sold them out collectively contributing to the downturn effectively delaying a person’s retirement then there may be some serious liability. I’d love to see this come to light, because I know too many average Joes who held on just like the mutual fund industry told them to do and watched their account values decline substantially. There are a lot of reasons for why stocks sold off so badly, but I do believe this is one of the major ones.

Window dressing and other forms of deceptive portfolio practices were being called attention to by the SEC in the late 90s, but have since fallen by the wayside, probably because accounting irregularities took priority. This article Shining the Sun on Mutual Funds Portfolios from 2000 details many of the ruses that mutual funds are guilty of. But just recently I’ve been hearing the term used again. A very recent Wall Street Journal article Lifting the curtains on hedge-fund window dressing brings the practice back to front and center.

I’d really like to see these deceptive practices being scrutinized more heavily. The mutual funds complain about the costs and competitive disadvantages of reporting more frequently, but this is just an excuse. I wouldn’t expect that funds should have publish their current holdings so that the public and competitors can just follow along in their own portfolios, but it is reasonable to expect that funds be independently audited just as companies have to have their accounting audited.

Such a practice would very likely remove volatility from the markets. Some people would argue that stocks would then have to carry less risk premium, but actually PE ratios would ratchet up.

If this topic interests you here are a few more articles worth reading:

The Calendar Favors Stocks
Out last night regarding yesterday’s moves.

WHAT DOGS CAN TEACH US ABOUT SECURITIES REGULATION: Why Fining Two Mutual Funds For "Window Dressing" Was A Mistake
This is a great article. I highly recommend everyone read it to understand the economic incentives that promote window dressing. The title is somewhat deceiving because the article does not defend the practice, but rather points out just how rampant it is.

Return on Your Research Investments
Mandatory information disclosure regulations may negatively affect product innovation in the mutual fund industry.
This article makes the typical defense, or rather excuse, for the practice. The obvious solution is to have all trades audited or reported with a significant lag time. That way the funds cannot be copycatted, yet the managers are still incentivized to act appropriately knowing that their actions today will be scrutinized in the future. What we have now is a Wild West situation where the managers don’t want complete freedom and no accountability for their actions. It is comparable to if there were no audit system in place to enforce corporate accounting standards. In that case companies would just report anything they wanted. Heck even with standards and accountability, as we’ve seen many companies were still sufficiently incentivized to cheat. That’s not as true any longer with CEOs and CFOs having been sent up. Where are the disincentives in the mutual fund industry?


White Papers (large PDF files)

Do Funds Window Dress?
Evidence for U.S. Domestic Equity Mutual Funds
We analyze the semi-annual holdings and daily net asset values of 4,025 U.S. domestic equity mutual funds over the period from 1997 to 2002 and find strong evidence of window dressing. In particular, we show that growth funds and funds with poor recent performance are more likely to report misleading holding. Furthermore, the window dressing activity is not associated with trading strategies that on average provide any added value to investors even before accounting for expenses. Neither liquidity costs nor momentum trading can explain these findings.

Window Dressing in Bond Mutual Funds
We detect differences in factor loadings on days surrounding disclosure dates that indicate systematic tilting of the portfolio toward higher quality instruments.

posted at 12:30 PM 0 comments   

Thursday, September 29, 2005

2 Hedge Fund Execs Plead Guilty to Charges

2 Hedge Fund Execs Plead Guilty to Charges
Founder and CFO of Beleaguered Hedge Fund Plead Guilty to Conspiracy and Fraud Charges

Two top officers of the scandal-ridden Bayou hedge fund suddenly emerged from hiding Thursday and admitted engaging in a fraud that totaled hundreds of millions of dollars.

posted at 7:11 PM 0 comments   

What really moves the markets...

To make up for all the nonsense I’ve posted today, I’ll give a hint about what to consider investing in right now.

The markets have been very uncertain. There are concerns about the possibility of stagflation, recession, slowing growth, slowing consumer spending, and eventually corporate earnings as well.

The consumer is running out of money. Mortgage rates are apt to go higher and therefore refinancings and borrowing against real estate appreciation is likely to slow, sapping the consumer even further. Many companies have cash, but they won’t let go of it. They won’t give it back to investors, and they won’t invest it themselves until they are more certain the investments will pay off. So they’ve got it tucked under mattresses, but don’t think that means you should buy Tempur Pedic.

In times of uncertainty look to what’s certain. Look to companies that have steady streams of profits and return them to investors. And look to companies that have had increased earnings from volume growth instead of just price appreciation as the energy companies have benefited from. These will likely be companies that haven’t been hit hard by higher commodities costs or retail spending cuts. Some software companies, for example, could be seeing renewed interest because they’re biggest expense is human capital, rather than commodities. The catch there is that many companies have still got a tight reign on IT spending. But think along these lines.

Investors have been distracted. They haven’t been talking about the next quarters earnings much yet. And when they do the conversation will be focused on which companies will be hurt or helped by the hurricanes. Little attention will go to those companies that have steered through the wreckage unfazed. It will be like a wreck in a car race. Everyone’s looking at the wreck, the drivers pit, and when they come out again there’s a new leader. Investors will be taken by surprise by the positive earnings of some companies and those stocks are likely to get a nice pop and even drive sector rotation.

posted at 4:23 PM 0 comments   

Anyone, anyone?

In 1930, the Republican-controlled House of Representatives, in an effort to alleviate the effects of the... Anyone? Anyone?... the Great Depression, passed the... Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act? Which, anyone? Raised or lowered?... raised tariffs, in an effort to collect more revenue for the federal government. Did it work? Anyone? Anyone know the effects? It did not work, and the United States sank deeper into the Great Depression. Today we have a similar debate over this. Anyone know what this is? Class? Anyone? Anyone? Anyone seen this before? The Laffer Curve. Anyone know what this says? It says that at this point on the revenue curve, you will get exactly the same amount of revenue as at this point. This is very controversial. Does anyone know what Vice President Bush called this in 1980? Anyone? Something-d-o-o economics. "Voodoo" economics.

Bein Stein as the economics teacher in Ferris Bueller's Day Off 1986.

IMO Mr. Stein would probably be better off playing economists on movies and TV than offering up his real opinons given some some of the things I've read. But he was hilarious in this movie.

posted at 3:46 PM 1 comments   

Because I can...

Since I can pretty much say anything I want in this blog I thought I’d do something a little different and tell you about my experience today with how the Sprint / Nextel merger is going from a customer’s perspective.

I have a wireless data card for my notebook that connects through the cell network. It works great anywhere you can get out on a Sprint cell phone, which includes our local coffee shops and cafes allowing me to get out of the house away from the TV and thus preserving my sanity at least on a relative basis. It’s great for working from the road in most places, with the exception of the I-70 corridor most of the way from Denver most of the way through KS where unbelievably there’s still no cell service. For the most part though the card works reliably, more reliably than the cell phone or dial-up actually and at about the same connection speed as dial-up.

As long as I don’t need any kind of support I’m good to go. But the reliability stops there. I use the card frequently enough to be going over my 40MB a month and getting dinged at the strong arm per kilobyte overage prices similar to going over cell minutes. I’ve had the card for about year and a half and conveniently for them they still don’t provide a way to check your usage, either via the skimpy software or the web.

Sprint’s web site treats the card as if it were a cell phone. When you click on the Sprint PCS Vision link under the heading Internet / Data it takes you to phone plans. Numerous links take you to the wrong place. You have to click on the link that shows you their different phones to find information about their data cards. I can pay my bill online, but where it says I can change my service it offers me different phone plans.

When you finally do find their cards online there’s a number you can call to order, which is the last thing you want to have to do, but it’s the only functioning choice. Of course they’re experiencing higher than normal call volume. Companies have no understanding of basic statistics because all companies are always experiencing higher than normal call volume and all companies make you wait on hold for several minutes. Waiting five to fifteen minutes is the norm for the vast majority of companies. So waiting is the norm. Like their fooling us into believing that the rest of the time they answer your call immediately and waiting is the exception. I’ve almost never gotten through to a corporate customer service person without a significant wait. When it does happen it invariably catches you by surprise and you’ve got to sprint back to the phone from the fridge or the john or wherever you are other than waiting patiently by the phone.

And companies make the waiting process as painful as possible blasting you with the worst jazzy muzak possible. It’s as if they got the music from some sort of muzak clearance bin of music recorded by the same prisoners making license plates, or else they have a work release program for people in purgatory that they contract with the devil. I think the latter because being on hold and listening to that music has to be just about as close to purgatory as the living can get.

When you finally do get through to a person they are so hard to understand that you have to guess what they are asking for. They ask for something and you give your name. They ask for something else and you give your account number. If they repeat the same question again you give them a different answer hoping that you’ve guessed right the second time. Try your address, the last four digits of your social, your mothers maiden name, or the name of the pet hamster you had in the third grade. One of those will usually satisfy them. As bad as the customer service experience is, it’s better than the automated touch-tone systems, which are still better than the latest attempts at voice recognition systems.

If you ever get into one of these systems I recommend that you talk gibberish or push buttons randomly. The computer won’t understand you and will usually kick you out to a human being in India or Mexico, which is where you’ll end up anyway when the computer can’t understand you or can’t do what you want it to. Fortunately for the Indian’s and Mexican’s there’s still too much of a language barrier for the Chinese to do the work even cheaper. If the computer asks you to repeat your information try pushing zero, which is often the top-secret password that will get you to a customer service person.

Why is it that customer service is inversely correlated to technological advancement? The better technology gets the worse customer service gets.

So at last I’ve got a hold of a human being who asks me for my password to verify my account. But we’ve been told over and over again all the way back to when there was no Internet and just Compuserve, AOL, and Prodigy that you should never give out your password. Yet more and more recently I’ve had customer service people asking for this information. Unless it’s buried in some fine print privacy statement that no one ever actually reads these companies never make it clear in advance that the password you assign will be visible to their customer service people. The whole concept of a pass ‘word’ is that no one else is supposed to know what it is except you. It wasn’t all that long ago that all you had to remember was an ATM pin number and your home phone. These days, however, trying to remember every phone number, username, password, and pin we use in our daily lives is like trying to remember the capitals of all fifty states that you had to learn in fourth grade and forget by the fifth.

By the way, just so you learn something from this rambling post, it’s state capitAls and the state capitOl building.

So now I know that this person who may have took such a miserable customer service to sell peoples identities on the identity exchange is staring at the very same password that I used for bank account and just about every other service that requires a SECRET word. Now I wish I’d been talking to a computer instead.

So not only am I now upset about my password being infiltrated, but also I’ve been tricked. The number on the website to order services takes me to someone in finance who wants to take a payment. But I just made a payment online a half hour ago and it was the only thing that worked well in all of my experience. Even making a payment can often times be impossible with big companies, but if there’s one thing they do get right it will usually be taking your payment. So I tell them I don’t want to make a payment, that I already made a payment and they ask me how much it was for. Shouldn’t they know this? Why should I have to tell them? It certainly doesn’t instill confidence that my payment has been handled properly. After leaping this pitfall I’m told that I’ll have to be transferred to customer service, and I’m thinking “but I thought this was customer service.” Apparently, it wasn’t. So now I’m on hold again.

When I’m connected with a REAL customer service person with no exaggeration we can barely communicate. My guess is that companies put their best English speakers on the lines that take payments and relegate the barely English speakers to the problem lines. It’s a retention strategy. People who want to quit their service will become so frustrated with the process that they will rather just keep making monthly payments for a service they don’t even use than go through customer service hell. Only I didn’t have a problem until I tried calling to actually buy something and this really caught them off guard.

The customer service person didn’t even know what a wireless data card was and I had to explain it to him. He looks it up and proceeds to ask me if I knew I could get a $75 dollar rebate. I ask, “for what?” It’s for a new card and there’s an upgrade available, I’m told. I ask, “How much does the card cost?” and I’m really not at all surprised when the person doesn’t know how much the card costs. But what a great deal, ay? I tell him that I just want to increase my megabytes. I’m on hold again. When he comes back he actually says to me, and I’m not making this up, that they have an unlimited plan with 80MB for $80 a month. I’m thinking that this makes about as much sense as the energy markets and I ask how is it that the plan is unlimited when it only comes with 80MB?

He couldn’t answer the question. I really did want an unlimited plan because I hate having to guess how much data I might have downloaded. I pull in a few white papers or emails with image files attached and I go over. But I sure as heck didn’t want to pay $80 for a plan that I could still go over on.

Well, the guy tells me that their still working through the merger with Nextel, stilling working on the data plans, and that I should call back in a couple of weeks. So we agree on that, because I really just wanted to scream at the guy or hang up on him. I go back to their website and find after many clicks that they do now have an unlimited megabyte plan, something they hadn’t had when I originally signed up. With this new information I’m now better informed than the companies customer service representatives.

So being customer service savvy I know that this guy was just trying to get rid of me and another person will give me a completely different answer. So I call back again and it’s like the movie Ground Hog’s Day with Bill Murray. The computer asks me for my account info. The financial person asks me for it again and asks me to make a payment. I have to tell them again that I already have. They have to transfer again to a real customer service person. Again I’m connected to a person whose native language is not English, but goes by the name Kate. I tell her exactly what I want to buy and where I found it on their website. She doesn’t know anything about it, but by the luck of the draw I’ve got a hold of a rep who was able and willing to find out and quite reluctantly I’m able to change my plan. I quite certain that I could driven to town and purchased a new car and been back home in it, in less time than it took to increase my megabytes on my wireless Sprint card. Process took longer than it took me to write about it.

What does this say about how the merger is going? Actually, very little. I experienced the normal, not longer than normal customer service experience times.

posted at 3:27 PM 0 comments   

Wednesday, September 28, 2005

Fannie Hit by Accounting Report

Fannie Hit by Accounting Report
Fannie Mae plunged 11% late Wednesday after Dow Jones reported that investigators probing the mortgage giant's accounting had uncovered "pervasive" accounting violations.

posted at 4:52 PM 4 comments   

Link to Fed Papers

On this Fed page you can find recent economic papers if that’s something that floats your boat. The paper Estimates of Home Mortgage Originations, Repayments, and Debt on One-to-Four-Family Residences lists Greenspan as an author and was referenced by him in his recent speech on the housing markets and mortgage industry. I haven’t read it yet, but will do so report back anything worthy of summarization.

posted at 2:57 PM 0 comments   

Durable Goods See Biggest Rise in 3 Months

Durable Goods See Biggest Rise in 3 Months
Orders for Big-Ticket Durable Goods Rise by 3.3 Percent in August, Fastest Pace in Three Months

posted at 2:37 PM 0 comments   

The laws of supply and demand don't apply to gasoline prices

Apparently, fundamental laws of supply and demand don’t apply to gasoline!

As you can see in the chart below comparing oil and gas data pre and post hurricanes that the industry supplied 7.4% less gasoline than a month ago, yet managed to increase inventories by 2.5%. This can be explained in one or both of two ways. The first is that perhaps there has been disconnects between production and distribution so that refiners are finding it necessary to store product. This explanation is unlikely. The more likely explanation is that consumer demand is down by more than production.

It’s very possible that consumers are demanding say 10% less gasoline with prices hanging out near $3.00 a gallon. A reduction in demand could be coming from the higher prices and from a conscious effort to conserve.

What it does say is that gasoline prices should actually be lower than before the hurricanes hit. It doesn’t one iota if refining production is down 7.4% if demand is down 10%. The net result would be climbing inventories, which should be accompanied by falling prices. In fact, oil prices should fall too since the majority of oil gets cracked into gasoline. If less gasoline is being demanded and refineries are actually producing more gasoline than consumers want to buy, then refineries will want to buy less oil.

No one expected that we would actually see an increase in gasoline supplies because no one believed that we are capable of conserving. Everyone was wrong. At $3.00 a gallon, it turns out that we are very good at conserving. Gasoline inventories have increased steadily every week since Katrina hit a month ago.

What does this say about the natural gas and heating oil situation? I’m not sure about natural gas because of the extent of the damage to the infrastructure and I haven’t looked at the data for that market, but I’d expect the same thing to happen with heating oil as with gasoline, regardless of the weather. We had a big storm come through last night that dumped quite a bit of snow up on the high peaks here in Colorado. I’ve been using the wood stove every night for the past few weeks and I’ve turned the thermostat way down on my natural gas furnace. I’ve barely even used the furnace, when up here even in the summer time it would normally kick on just about every night.

Whether it be the prices or an elevated level of consciousness, I suspect that I’m far from alone in making a significant effort to save. As we move from fall to winter I suspect that consumers are going to demand much less oil and gas to heat with than in recent winters. I’m not sure though, if it would be cheaper to heat with electricity or not. If it is then there will most certainly be a run on electric heaters this winter.

	Week ending 9/23	Week ending 8/19	% Change
PRODUCTION
Crude oil production	4.3	5.4	-20.4%
Crude oil inputs	14.6	15.7	-7.0%
Refining capacity	17.1	17.1	0.0%
Refining capacity utilization	86.7	93.4	-7.2%
Gasoline production	8.6	8.6	0.0%
Distillate fuel oil production	3.7	4.2	-11.9%
INVENTORIES
Crude oil inventories	305.7	322.9	-5.3%
SPR1	695.5	700.2	-0.7%
Total motor gasoline inventories	199.8	194.9	2.5%
Distillate fuel oil inventories	133.6	132.5	0.8%
Total stocks excl SPR2	1,014.8	1,022.1	-0.7%
Total stocks incl SPR2	1,710.3	1,722.3	-0.7%
IMPORTS
Total crude oil incl SPR	9.7	10.6	-8.5%
Crude oil excl SPR	9.7	10.6	-8.5%
Total motor gasoline	1.2	1.2	0.0%
Distillate fuel oil	0.2	0.2	0.0%
Gross imports incl SPR	13.3	14.0	-5.0%
Net imports incl SPR	12.2	12.8	-4.7%
EXPORTS
Total	1.1	1.2	-8.3%
PRODUCT SUPPLIED
Finished motor gasoline	8.8	9.5	-7.4%
Distillate fuel oil	3.8	4.0	-5.0%
Total product supplied	19.7	21.5	-8.4%

posted at 12:46 PM 0 comments   

Tuesday, September 27, 2005

Economic Flexibility

If you missed Greenspan’s inspiring speech Economic flexibility given to the National Association for Business Economics today I highly recommend you take the time to click over and read it, then come back here and read my comments.

Sounded familiar didn’t it? It’s as if he’s been reading the blog. Perhaps an underling has. He covered almost every point I’ve delved into in recent posts. I shouldn’t let myself get a big head about it, but it was highly coincidental that he spoke so extensively about the technological improvements in our financial systems, yesterday about the liquidity created by home equity, and even indirectly about the relationship of insurance and reinsurance. These were unique thoughts sparked in part by the consideration of the meaning of money measures such as MZM. They were not topics being discussed openly on other sites or written about anywhere that I’d ever seen.

I was a little too hard on the Chairman in a recent post calling for his retirement given what he had to say in the speech. I’ve tuned in to many of his speeches over the years and almost without exception they are thought provoking and intellectually stimulating.

I did note though that while he applauded the advances made by financial institutions and the economic flexibility that it brought, he didn’t quite extend that flexibility to include the mortgage industries advancements and product enhancements. That was a contradiction that I think it was an accidental coincidence.

As the MSM proceeds to parse through the details of the speech it’s doubtful that they will pick up on the very important overriding message. The speech was a pep talk intended to counter the concerns over the hurricane damage and stagflation. But the fact that it was about economic flexibility was targeted. The overriding intent was to prep us for higher rates.

I have a new evolution (or was it intelligent design, but let’s dare not traverse that slippery slope) in my thinking in this regard to the rate increases. It’s clear that analysts and the Fed different on what a neutral rate is. Today I heard several analysts say that the current rate was either already to the point of being depressive or on the edge of neutral listing heavily to that side. It’s delusional and wishful thinking on their part driven by their desire for the Fed to halt its rate hikes so that their stocks can increase in value. The Fed clearly does not see it this way. It continues to say that it is removing policy accommodation, implying that the current rate is still accommodative. And as I’ve written in the recent past the Fed has viewed rates of more than 4% as being accommodative.

Four percent seems like a lot when we’ve come up from 1%. But it’s well below the historical average of 6% and still below the average over the last 20 years when rates have been kept lower. Anyway, regardless of inflation, I think that Greenspan would like to leave his replacement with a rate that is truly neutral. From that point the new charge will have the ability to move rates up or down as needed to respond to future economic changes. Without any inflation a neutral rate is just that, it’s not overly stimulative nor depressive of economic growth. Without any signs of inflation the optimal level for the Fed should be just a tad on the side of accommodative or stimulative. Too stimulative and inflation creeps into the picture, while neutral does not promote growth.

Another aspect of this speech was the caution given about complacency with regard to risk premiums. While this speaks to the difference between short and long rates, the yield curve, it also speaks to interest rates in general as they relate to other forms of investments such as stocks and even the yields on stocks. For example we’ve increasingly been accepting of lower yields from stock dividends. Most dividends with exception to those derived from REITs and utilities are inconsequentially and ridiculously low.

I don’t believe that all companies should dole out dividends, but very many should that don’t for all practical purposes. Particular no or low growth companies. Not every company should try to grow its business. Many a great company has been built on micro niches that succeed in enriching their owners and employing dozens, hundreds, or even tens of thousands of employees dependably at a happy point of equilibrium.

Think of companies like FAO Schwartz, which tried to tap into the competitive business of retail toy sales forgetting its roots as a seller of high-end unique toys and tourist destination. It took only a few years to destroy a company that existed harmoniously for something like 200 years. Then there was Planet Hollywood, which did well in HOLLYWOOD where they could actually get stars in the restaurant. They got greedy and started putting them up in podunk cities all over the country. They’d bring in a star or two to cut the ribbon and after that all they were left with was just another restaurant with exceptionally high rents.

Another good example is private company that’s still around, sort of. Radio Flyer has been in the process of outsourcing the last of its U.S. production to China. I don’t know about you, but a Chinese made Radio Flyer wagon just doesn’t do it for me. It loses much of the nostalgic mystic that has made it almost a mandatory gift from baby boomer grandparents. But Radio can’t be in the big boxes at specialty prices. My suspicion is that Radio Flyer could have jacked prices sky high, sold them online only, and baby boomers would be ordering them from nursing homes for the next 30 years keeping a significant number of jobs here in the U.S. and preserving a piece of every American’s childhood and keeping the cycle going. Instead it’s an all too familiar story. Winston the third takes the reigns and runs the company into the ground when greed takes hold, and it becomes all about increasing volume.

So there are lots of companies that should be paying out a substantial part of their profits to investors that do not. And this relates back to our acceptance of lower risk premiums that Greenspan refers to. Even if a company brings in consistent profits, if it does not return something to investors either growth or dividends there’s no reason for investors to own the stock. In theory the stock of a company with zero growth and zero dividends should be worth just that, zero, because there’s zero incentive to own it.

From that perspective the broader stock market is probably still actually overvalued, but not stocks with real growth or that payout profits. But it stays that way consistently for two reasons. First is that there is a demand for stocks as an investment vehicle that isn’t perfectly correlated to the companies that the stocks represent a part of. In other words if people have $200 billion to invest in stocks and there are only $100 billion worth of stocks to be had, prices will rise regardless of the relationship of prices to earnings, dividends, growth, etc…

Though there are far to many ignorant investment advisors telling average people to send 25% of their assets overseas we still have tremendous demand for owning stock in the companies in this country and that demand is by no means exclusive to American investors. One of the reasons, among many, for the stock market bubble in the late 90s was the fact that online trading companies brought the markets to the masses. They made it easy for anyone with a few thousand dollars to get in to stocks. But it didn’t just open the markets to guys like me sitting in a Starbucks in the mountains Colorado. Suddenly, very suddenly, people from all over the world could buy American stocks easily. In other words there was a sudden leap in demand or stocks that overrode valuations. Boom. Bust.

So there’s an equilibrium in the demand for stock. And if it wasn’t for the ignorant advisors taking the path of least resistance were telling average Joes to send as much as a quarter of their assets overseas and invest in communist government owned companies when the market was bottoming out and ready to go higher, then the markets could have gone down a lot less and up a lot more for companies with good growth and dividends.

Where would the S&P 500 be today if many billions that’s flowed into foreign funds in the last few years went there instead? It would make for an interesting study.

In a sense Greenspan is right that we should be concerned about risk premiums. We should expect more from stocks than from bonds. We don’t.

Speaking of bonds, recently yields on long bonds have been perking back up. Why? Bond yields are as much related to the demand for bonds as they are based on economic speculation. One of the reasons long bond yields have stayed low even as the Fed has raised rates continuously and gradually enough to give the various maturities time to adjust has to do with the limited supply and the demand from foreign governments who are awash in dollars due to the trade deficit. In order keep yields on long bonds high there has to be sufficient supply. As prices go down yields go up. But that’s a catch-22. In order to meet the supply we have to issue more debt. Then investors complain about our debt level.

In the end though it probably all balances out. If government bond yields are low, then interest in corporate bonds goes up and corporate bond yields fall too. Demand for corporate bonds means that companies can borrow cheaply and that’s stimulative because companies are very productive entities.

Really this is all part of our economic flexibility.

posted at 5:57 PM 0 comments   

The Fed is Literal

When John Snow or Ben Bernanke speaks it’s political. They work for a politician. They tell people what they want to hear. The message is massaged.

The Fed is very literal in what it says to the public. It may be manipulative, but it’s literal. So if you want to understand what the Fed is really saying all you have to do is turn off the TV, get a dictionary, and parse the words.

In the most recent Fed statement is the following line:
However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.

Here’s the similar sounding line from the August statement:
Core inflation has been relatively low in recent months and longer-term inflation expectations remain well contained, but pressures on inflation have stayed elevated.

Every change in Fed language is very intentional. The FOMC votes on approving the statement. There were two changes in the latest statement. First was the dropping of the ‘well’ in describing ‘contained’. The Fed also dropped all of the part after the comma about inflationary pressures.

The dropping of the word ‘well’ to describe the word ‘contained’ was most certainly intentional. In August the Fed saw “long-term inflation expectations” as remaining “well contained”, but this month the Fed only saw it as being contained, not well contained.

The word contained describes the Fed’s expectation for inflation in the long term. It’s important to realize that the Fed doesn’t see inflation expectations contained based on the actions it has already taken alone, but rather as the cumulative result of all actions, past and future.

If the statements had just been using the word contained all along, then the word could be taken to have an either/or meaning. In other words contained would mean either it is contained or its not contained. But in this context I think contained implies a degree of containment.

The definition of contain:
To have within; hold.
To be capable of holding.
To hold or keep within limits; restrain: I could hardly contain my curiosity.
To halt the spread or development of; check: Science sought an effective method of containing the disease.
To check the expansion or influence of (a hostile power or ideology) by containment.

The Fed’s use of the word ‘contain’ means that it is capable of holding inflation in check. This again is very literal. If inflation is not contained, then it means that the Fed has lost control of inflation and does not have the power to manipulate it. So when the Fed says that long-term inflation expectations remain contained it means that it continues to believe it will be able to keep inflation to a reasonable level, but it’s less confident than a month ago, thinks inflation will be harder to contain, or will be less contained. Any way you parse it, they all mean that the Fed believes it needs to raise interest rates more now than it did in August.

I will remind you that in the July meeting minutes and the August statement the Fed was very clear that it intended to remove its accommodative policy. In the July meeting Fed members even expressed frustration that Fed watchers, pundits, investors and such weren’t listening or getting what they were saying. Watchers believed that the Fed was almost done, when in reality it had been saying all along that it had a long way to go.

In order to remove accommodative policy the Fed has to raise rates to a level that is in their view not accommodative. That doesn’t mean it will take rates to a level that is intended to depress economic growth. But it does mean it intends to take rates to a level that is at least balanced in between the accommodation and depression. By depression I mean it literally as in this definition: To lessen the activity or force of; weaken.
Feared that rising inflation would further depress the economy.

Sometime after 2000 when the recession started to kick in and the Fed began to lower rates Fed statements talked about rates between 4.5% and 3.75% as being accommodative. One FOMC member went against a vote to lower rates by 50 basis points from 4.5% to 4% because he preferred a quarter point move and felt that 4.25% was sufficiently accommodative.

In summation the Fed has expressed that is less certain of its ability to keep long-term inflation in check, thinks it will be harder to contain, or thinks it will be less contained. It has said that it will likely continue to remove accommodation and in the past it has said that rates in the 4.5% range are accommodative to economic growth.

Fed watchers are still overly optimistic about the Fed halting its rate hikes, per fed funds futures and interviews with economists and company. I believe some of the comments made today and in recent days with regard to the housing market, mortgages, etc… were intended to prepare investors for further rate hikes. The Fed could even make a 50 basis point move if it thinks it needs to get rates higher faster ahead of all the inflationary reconstruction spending that’s coming.

posted at 2:16 PM 0 comments   

Banks and Yield Curves

The banks will struggle in a yield curve inversion to be sure. Two-year to ten-year are the terms most often compared because they represent the average of short and long rates. Bank leaders are concerned. I recently sent yield data bank analyst who was asked by the CEO to find out how long inverted yield curves last.

There are some offsets however. First off, banks can hold diverse fixed rate loan portfolios. Car loans, for example, are fixed and typically 3 to 5 years. If curves invert they still have those loans that were entered before inversion. The banks teased people into billions in variable rate mortgages, second mortgages, and home equity loans when rates were low. The refinance industry boomed for several years. I knew several of out-of-work Denver tech workers who were sucked into refinance selling frenzy that peaked when the Fed turned rates higher. If both short and long rates climb, even if short rates climb faster than long rates, the banks’ income increases on existing variable rate loans.

Finally, banks are less dependent on the rate differential than in the past. They are more dependent on other sources of income. I think ATM fees are now one of their biggest sources of revenue. Then there are fees on negative balances, which basically amount to loan-shark rate loans. Also, the larger banks are diversified into brokerage and other financial services.

Typically, when the Fed hikes rates people talk about that being negative for the banks. This is because the short rates are more volatile than the long rates. As the Fed moves short rates higher, long rates do not move up as quickly. Consequently, when the Fed lifts rates the yield curve gets squeezed, pretty much every time. When the Fed lifts rates a lot, the yield curve inverts. This time around the Fed is likely to make a total move of up to around 4%, from a low of 1% up to a less accommodative neutral level of say 5%. But as I said the banks have more offsets than in the past and the data does not show a tradable relationship between rate hikes and bank stocks being down. The Fed has hiked rates I think it’s been 11 straight meetings now and that hasn’t sucked the life out of bank stocks.

The financial companies that get squeezed the hardest are the mortgage REITs because most of them make money in only one way, which is via an arbitrage on the differential between long and short rates. When those rates invert, they basically shutter the windows and wait out the curve to do any new borrowing. However, they too have an offset. When the Fed took overnight rates down to nearly free, the rate differential was very favorable and the mREITs borrowed big time. New mREITs were popping up like mushrooms. For a couple of years they were IPO leaders. They bought huge portfolios of long-dated loans so the interest keeps coming in even when they can’t buy new loans.

Next to yield curve inversions another risk to mREITs is portfolio turnover. When rates bottomed the mREITs profits were good, but the high level of refinancings were a drag. One thing that can help mREITs weather a yield curve inversion is if portfolio turnover slows, which it should. That way they lock in more of the loans that were bought with low interest short rate loans. It’s a cyclical business and data may show a consistent relationship between the interest rate cycle and high and low points for those stocks that is worth dredging up for the longer-term investor.

As an aside I recommend reading this speech given to Texas bankers by the Dallas Fed President Richard Fisher.

posted at 11:10 AM 0 comments   

Monday, September 26, 2005

As Yuan Reform Heat Fades, Asian Currency Bets Struggle

As Yuan Reform Heat Fades, Asian Currency Bets Struggle
Analysts at Goldman Sachs Inc. (GS) have closed their Asian currency basket trade and their short dollar-yen position, both of them at a loss, after hopes that China would allow greater yuan strength finally died.

It appears Goldman was also expecting a yuan 'Super Spike' : )

posted at 8:21 PM 0 comments   

Greenspan: Time to Retire

Greenspan warns on mortgages
The booming US housing market has led to a worrying decline in standards in the mortgage lending industry, Alan Greenspan, Federal Reserve chairman, has warned.

Previously, I've cited numerous ways in which technology has aided the mortgage industry in understanding, diversifying, and reducing its risks. Greenspan seems more than a bit out of touch and uneducated on this matter. Think of it this way. Life insurance companies can give just about anyone a life policy for hundreds of thousands of dollars. They have sophisticated underwriting and reinsurance that enables them to take on just about anyone who wants to buy insurance. And they can do so even without collateral. Ironically, until insurance companies got into variable products and the stock market (think social security and the stock market) they seldom had problems and were one of the most secure and economically stable sectors.

Only recently has the mortgage sector begun to utilize some of the same techniques as the life insurance industry. Financial institutions by and sell mortgages and invest in bundles of diversified mortgages through the use of financial products such as MBOs. This relationship is somewhat similar to the insurer / reinsurer relationship.

And unlike the insurance industry the mortgage financiers to the best of my knowledge don't set up phony Bermuda companies to reduce their reserve requirements.

To me Greenspan is sounding more and more like an old fogy that can’t understand the new changes going on in the world. Yield curve inversions are a conundrum and improved mortgage products are irresponsible. The fact that he ignores is that the mortgage industry has for all of its history been extremely cumbersome and inefficient with governmental like hoops to jump through.

posted at 8:04 PM 4 comments   

American fury over Greenspan leak

This is article referenced in comments. Note that statement is alleged. Who you gonna believe? I should probably remind that we've been hearing the same thing for the last 20 years. Part of the deficit change has to do with economic cycles. Not to suggest there's not a potential problem. But it seems that no one really knows what the problem is, what the ramifications are. They just say that it's troubling.

American fury over Greenspan leak
French claim Fed chairman admits US has lost control of budget
Bitter disagreements over global economic policy broke out into the open yesterday as the French Finance Minister claimed that Alan Greenspan had admitted America had "lost control" of its budget while China warned the US to drop demands for radical economic policy changes.

posted at 7:44 PM 2 comments   

Fed still targeting inflation

I continue to believe the Fed will continue to hike rates steadily up to around 5%. They've given no indication thus far that would lead us to believe that they are near their target. In their last statement the Fed made it clear that it is looking past the hurricanes.

It I’m sure it’s true that MZM and other old measures of money are among the many indicators that the Fed looks at. Greenspan has expressed concerns about savings rates on numerous occasions, indicating that he’s not likely seeing previously illiquid money that has become increasingly liquid, as substitutes for traditional liquid moneys. But, it’s uncertain how those indicators are weighted against others.

The Chicago Fed President said today that inflation indicators continue to be at the upper end of his comfort level. I think the Fed is more concerned about inflation than recession. We may very likely have a recession on paper, due to the number of people out of work in the south and energy prices robbing from consumer retail spending. But such a recession may be more of a numbers phenomenon, rather than a pervasive recession.

Going forward economists and the Fed will be increasingly interested in geographically limited economic indicators such as the Philly Fed Survey, employment numbers by location, isolated prices, etc… If most major cities in the north are growing jobs, for example, then we can overlook a recessionary blip in the GDP as not having the same meaning it typically would have.

posted at 1:28 PM 2 comments   

Friday, September 23, 2005

The Ms aren't what they used to be...

Enough about myself, hurricanes, and politics. A reader astutely writes about inflation:

Mark, do a Chart of MZM from 1974 to date and tell me if you see an unusual or worrisome trend there in money available to the economy or rather a stable increase over time representing cash in the economy? One theory of inflation is 'too much money chasing too few goods' and I don't see too much money (MZM) and I certainly don't see too few goods (except in certain RE Bubble areas).

The first thing that popped into my head when I read this was what exactly is MZM. I knew what the acronym stood for and I knew that it’s one commonly watched measure of money supply. That’s not what I found myself asking. Immediately, questions started running through my head such as; how does MZM relate to inflation, to goods and services, and to investments?

For everyone’s convenience I will define the various measures of money supply. M1 is the narrowest. It includes all cash and checking accounts. It’s the most liquid measure. M2 is M1 plus some time deposits, savings and non-institutional money markets. MZM is a new measure. It stands for Money of Zero Maturity. It doesn’t count time deposits, but does count all money market funds. It has become a popular measure because supposedly it’s a better measure of money immediately available to be spent. M3 is the broadest measure of money including some other forms of liquid assets.

Economists tend to be very set in their ways. Economists are very conservative with their measurement tools and aren’t very open-minded to recognizing when things have changed. The problem here is with the definition of what a liquid asset is.

The Internet and other technological advances has turned many previously non liquid assets into liquid ones, and these newly liquid assets still aren’t accounted for in any of these old stodgy conservative measures of the money supply. For example, securities aren’t counted in any of the measures. Once upon a time securities weren’t a liquid asset. But that has changed drastically in just the last few years. Many brokers are making it easier and easier to get at that money. You can now sell a stock with your cell phone and the same day go out and write a check against the money swept over into the money market account. Stocks have become just as liquid as savings accounts.

Bears like to whine about our lack of savings. But really think about why people used to save more of their income in real terms than they do today. Twenty-years ago people had have 10% to 25% of the mortgage to buy a home. Banks wouldn’t even let people borrow the money or have it gifted to them. Banks acted like they were our dads trying to teach us a lesson about money. They actually said things like having to save 20% showed responsibility. What a bunch of B.S. that was. The truth was that having 20% down was the only way they could be sure that if they foreclosed on you in six months, they’d still come out ahead on the deal. Back then they knew far less about the people who they were lending to. So they had to offset that risk with larger down payments. The result of that was that every young couple in America was simultaneously accumulating large amounts of money. Today people can buy homes with zero down.

Another reason people saved more was for emergencies. Whether you think it’s a good thing or not, people didn’t have access to as much cash through credit cards in the past as they do today. Thirty-years ago when the refrigerator went kaput if you didn’t have savings for a new fridge dad was getting out the tools or calling a repairman. Today it’s far more common for people to walk into a Best Buy, pick out a new fridge and pay the store back a month at a time. People had to have more emergency money on hand.

These days a more accurate measure of liquid assets would have to include lines of credit. After all, they are funds available immediately for consumption. And that measure would have to include home equity lines of credit (HELOCs). People don’t need to save in case of a broken fridge when they’ve got $50k immediately available through a HELOC.

Whether or not people should be saving is a different matter altogether. The point here is that measures like MZM no longer accurately reflect the true money available for immediate use. My view of the fluctuations in MZM in the last five years on the chart below is that they are inversely correlated with the stock market. Look at how MZM jumped up between 2000 and 2002. That was money coming out of securities and into money market accounts. There was an increase in MZM money, but it wasn’t inflationary. I don’t think MZM is a very good indicator of inflation.

If you want to know if there’s been inflation just ask any working stiff with a pick up truck who drives 30 miles one-way to work each day if he’s experienced inflation. The answer you’d get might go something like, “If this keeps up I’m going to have to give up smoking” or “Hell yes, I had to give up my season tickets this year, and I don’t know how we get through Christmas.”

I’d expect some bad numbers from come January from the companies that depend on Christmas to make their year.

posted at 5:14 PM 6 comments   

Thank you...

I do appreciate all the feedback and the debate, even those that have disagreed with me or misunderstood me. I’ve been doing this day in and day out since the beginning of the year and without missing a single market day yet. Early on it wasn’t easy knowing there were probably very few people actually reading. I don’t want any booyah nonsense here.

I want people to tell me when I’m wrong. If you think I’m full of it, I’m OK with being told that too. I don’t take it personally. If you debate me civilly you’ll get a civil debate back out of me. If you flame me, I’m going to come right back at you, unless I’m wrong. If I’m wrong, I won’t hesitate to admit it. I’ve done so in the past. But if I’m not wrong, if you want to win an argument with me, you’d better have checked your sources closely because I’m an expert at using the Internet to research things and find the truth.

I’m wrong about a lot of things, but I’m not wrong in the blog too often. That’s not being cocky or arrogant, it’s just because I have the advantage of making sure I’m right before I publish and writing about things I know about. If there’s something I don’t know the about I don’t write about it. I don’t know a whole lot about the bond markets, except that the bond king is a manipulative salesman, and don’t know a lot about politics, and I don’t know the slightest thing about biotech stocks. I have a mediocre comprehension of finance. Consequently, my posts are biased toward being right.

My approach to the markets is to keep things pretty simple. I try not to allow myself to get bogged down by too many fundamental details or snowed by technical B.S. For example, I look at a company like say Adobe and I think things like the company is market leader with a near monopoly in a growing market. It has a loyal following of customers and a very strong brand name. It doesn’t have an overly egotistical megalomaniac CEO like Oracle. The Macromedia fit is a great combination. The company hasn’t gone crazy buying up every company in sight. It isn’t acting desperate for growth the way eBay is doing with Skype and has done with past forays into live auctions and payment systems. It isn’t spreading its wings to far beyond the scope of its core expertise. It strives to be the best at what it does. It’s products offer much more than they have to, to compete. The stock isn’t cheap, but it’s comparable to other somewhat similar companies. I think the company has a lot going for it. I don’t see a lot of competition heading its way any time soon. I don’t see the company being usurped by new technologies or even open source any time soon. Margins are good and so on and so forth.

Basically, I can’t find much bad to say about the company. The stock hasn’t done that great recently, but I think it’s only a matter of time before people start paying attention to it again. The interest in stocks like Adobe goes in cycles. If you own it when it’s out of favor then when the cycle comes back around you’ll be in the right place at the right time. The companies I like the most are the ones for which I can find the least fault.

I do believe that with practice some people can get good at seeing the red flags in a company nearly instinctively. Most people can’t. The statistics show this to be true. I know many traders that only trade on statistics and mechanics for this reason. But I do believe that some people have a knack for seeing things others don’t. Peter Lynch was probably one of those people. His techniques were simple. What was unusual about Lynch, though, was that he admitted it. Most professionals try to impress people with fancy double talk and overly complicated analysis. But behind closed doors it’s a different story.

My wife worked in marketing in the mutual fund industry. One of the things she did was help the portfolio managers put together the commentaries that were sent out with quarterly reports. She would come home with all kinds of stories of whacked thinking those guys were using in their analysis that wasn’t fit for print. If their customers knew the truth, well they wouldn’t have had any customers. In print it was all fundamentals. In reality there was a whole lot of chartist mumbo jumbo going on way outside of their expertise and training.

posted at 2:48 PM 0 comments   

Allow me to clarify...

Politics, religion, and war are the kind of topics that are hard to parse without ticking some people off in the process. They are mired in impenetrable beliefs. The handling of New Orleans is reaching that level.

Whether or not I’m warped or not is debatable. I certainly don’t think like the average person. If I did I wouldn’t come up with many of the alternative perspectives that I do. I often think that the majority of people are warped for so readily believing so much of the B.S. the media feeds them. But that’s a different topic.

And I’ll be the first to admit that I’m not the most compassionate or emotional person in the world. I’m very analytical. Do you remember Aron Ralston, the guy who got his arm stuck under a boulder in Utah and hacked his own arm off with a multi-tool? People get in car accidents and have just as bad of injuries, or worse yet die, every day somewhere in the country. Right or wrong those events are barely even newsworthy. It wasn’t that long ago that it was quite common to see old farmers with missing appendages. Early farm equipment was extremely dangerous. Farmers worked very long to the point of delirium at hours at put in and take out times. They took risks and made mistakes.

Ralston’s story didn’t catch our attention so much because of what he went through, but rather because his story made us think about ourselves and whether we had it in ourselves to do what he did. It was a very comment worthy story. I remember many people saying things like, “no way, I’d die for sure.” And likely they would. Few people could do what he did under even the direst of circumstances. Most people would just die.

I’m more of the kind of person that would do something about it rather than just die. That’s not a brag, rather it’s just how I am. The other side of being like that is that sometimes people like me can come off as being course or callous thinking that everyone else should be as willing to take matters in their own hands as we are.

Recently, I read a story in a ski magazine about a guy who was backcountry skiing and kept heading down into a valley. When he finally stopped he found that he was unable to climb back out. He quickly exhausted himself trying to wallow his way through the deep snow. If you’ve never been in really deep snow before, it might be hard for you to imagine how difficult, no impossible, it is to move any significant distance through. Going up hill is out of the question. Being a backcountry skier this person should have known this, and should have understood the risks. He should have had a pack equipped with survival gear and snowshoes strapped to his pack. And people should have known where he went. He had none of those things and didn’t tell anyone where he went.

He didn’t do a single thing right. He just wandered around in the woods for several days until he began to hallucinate. At some came the bright idea of removing his ski boot liners. He then put his already frozen feet back into the boots.

Rescue workers found him near death after I think four days and I forget whether he lost just one or both of his legs up to his knees.

I go into the woods even when there’s no snow and I go prepared for sudden hypothermic change in the weather at a minimum. On two recent weekends I’ve climbed several miles up into the mountains to elevations of 12,000ft scouting elk herds. On each occasion I’ve been prepared to spend the night in the woods if need be, I’ve made sure people could know roughly where I went in and in what direction I headed, and told my wife not to worry about me until the middle of the next day. By the time I got back into cell phone range again on one of the excursions it was quite dark. Nearly back to the truck I realized that I’d left my favorite hiking stick where I’d last stopped in the middle of an area thick with fallen trees. I went back for it and didn’t come out of the woods until dusk. I thought my wife would be worried, but she wasn’t in the slightest because she knows that I’m resourceful and that to me being stuck in the woods overnight would be an adventure, not a calamity.

I tend to be of the mindset that I’m responsible for my own actions and when I go into the woods and take risks I don’t expect someone to come and rescue me. I expect to have to be able to get myself out of a predicament. Early pioneers, explorers, and miners understood this better than people do today because there was no one to help them. They took risks, they died, and no one was there to cry for them. But they were also very self-sufficient, knew where their food, water, and shelter were going to come from, and knew how important it was to protect their legs, feet, etc… As a society, we’ve become much less self-sufficient and much quicker to blame someone else for our problems. That’s not in political view. It’s just a fact.

I’m not callous or uncompassionate towards the victims. Nothing I wrote previously had anything to do with that. It was just misconstrued in that way, because of the differences in the way we think. I never argued that things couldn’t or shouldn’t have been done better. That was never even something I was thinking about in my writing. People just assumed that’s what I was talking about because they’ve had that debate thrust at them so belligerently by the MSM. Not that it’s not important. It is. Not that there weren’t things that could have been done better. There were. But that’s not the point. And it’s not really relevant to this forum or what I’m saying. That is political. I’m not writing about something political.

For me to say that no one else would have handled it significantly better does not imply, as has been assumed, that I think things were handled well or right. It’s understandable how people would assume that, but don’t because it’s not true. I know it’s pretty deep stuff, but stopping that kind of thinking as it pertains to the markets is what I’m preaching. When you can stop thinking like that you’ll stop being a sheep in the markets and you’ll start to see things much more for what they are rather than for what the media wants you to think they are. Then you’ll start to question things more, and when you do you’ll discover just how often the media pulls things out their butts or at least lets their interviewees get away with pulling things out of their butts. How many times do you suppose in the last year do you suppose the media has had people come on the air and tell us that oil prices are being driven by increased demand from China? Dozens. How many times have commentators asked the interviewees to back up that statement? Never.

The media doesn’t know whether it’s true or not because no one ever bothers to look at the data, and when the data backs up their assumption they never bother to question the validity of that data. No ever bothers to ask how data on China’s consumption of oil is calculated. I think you’d find that the level of accuracy is quite abysmal and that even the Chinese don’t know with any significant level of accuracy. People just keep regurgitating the same information over and over again. As an investor or trader you owe it to yourself to ask yourself what that bozo on TV knows that I don’t know. More often than not the truth is that he doesn’t know jack shit, and he’s talking out his ass. He’s just has the developed a talent for making things that come out his ass sound good. He makes music from his wind, if you will. In other words he’s charismatic, and we are charmed by his charisma.

Here where I live near Keystone, CO my neighbors and I are facing a New Orleans like problem of our own, albeit on a much smaller scale,. We have a very serious problem with pine beetle infestation that’s killed six trees in my yard alone including the only two large and stately lodgepole pines on the property. Fortunately, as of yet the beetles haven’t overtaken the one that grows up through my deck. The whole area around here is spotted with dead trees everywhere you look. I’m talking tens of thousands. The area between Frisco and Breckenridge seems more brown than green now and every time I driven by that way I’ve thought that it’s only a matter of time before a major fire hits taking out perhaps hundreds of homes. Just this last Monday everyone’s attention was turned to a fire that started in there. Firefighters were able to get it put out without any damage to homes after slurry bombing one.

What are people doing about it? Absolutely nothing. For many years they’ve built homes all throughout the woods. They’ve not done much to cut buffers around the homes. And most are built of wood siding, which I find ironic because in Indiana where I grew up the material of choice was brick, but here where fires are always a threat they side homes with just about the most flammable building material imaginable. With a little buffer and a tile roof, a stone or brick home might be able to ride out a forest fire. But a wood sided home is just going to go up in smoke. I’m aware of the very real risk and I live here anyway. My home would probably survive a fire because though the area is treed I’m not in the woods per se and there are buffers such as a golf course and lake nearby. But, to some extent I feel accountable for myself for choosing to live in a fire zone. If my home burned down or course I’d accept the assistance of others and be grateful for it. But I couldn’t help but feel a little guilty about it for not being more resourceful, prepared, or as a society for doing nothing to solve the problem.

What are we going to do about it? Probably nothing. There are so many dead trees across such a wide area that no one wants to spend the money to get them out of there. It probably wouldn’t help much but the forest service should at least open the area up to wood cutting without having to buy a permit from them, especially as we’re now being told that we might not have enough natural gas to heat our homes this winter. As you can imagine many people up here have fireplaces and wood stoves, so it would make sense to combine the need to thin the forests with the need for an alternative heat source. As far as the polluting aspect is concerned, which is worse burning the dead trees now, or having the whole forest both dead and alive go up?

When will something be done about it? It depends on how big the fire is. If the fire is really big, the problem will solve itself. All the dead trees will be burned along with the homes. If we lose a few homes, we probably still won’t do anything about it. If we lose a few hundred, then it will be declared a natural disaster area and people all over the country will send us money and supplies and we’ll have the funds to cut the dead trees and buffers around the remaining homes.

The reality is that we all know the risk and we aren’t going to do anything about it until something really bad happens. And when something bad does happen I’m sure we’ll all complain about what should have been done to prevent it. We’ll point fingers and we’ll blame the forest service for not clearing out the dead trees. It won’t have to be rational. But it will be darned ironic if say we indirectly slash the forest service’s budget to pay for rebuilding New Orleans, the forest service says it was a priority that was set on the back burner, and hundreds of homes go up in smoke because the tree cutting money was reallocated to rebuilding another disaster area. Don’t ask me why we’re like this, we just are.

Sounds an eerily similar to the New Orleans dilemma doesn’t it? New Orleans clearly new it was at risk and it did nothing about it, which is what people always do. It’s nothing new. It’s a fact of life. It goes beyond politics. It’s easy to say what could have or should have been done in hindsight and it makes for great news because it really gets people going. But it’s not a very realistic perspective. People should be talking more about what they’re going to do to make sure it doesn’t happen again and less about what should have been done in the past.

So when I say that no one else would have handled it significantly better and when I say that Clinton wouldn’t handle it better, I’m not saying it’s because Bush is or isn’t a better president. It has nothing to do with that. It has to do with the fact that pretty much no matter who was president nothing would have been done about it. What if the hurricane had moved just a little more eastward and just one levee had sprung a leak, a single neighborhood flooded, and they got the problem fixed in a couple of days? Realistically, in that scenario people would have praised the levee system for saving the city, and they would have done little except to patch the damaged levee. It’s only in hindsight with the entire city flooded that we are saying that the levee system should have been improved long ago. In hindsight, I look at the aerial photos of those levees maybe only 50ft wide and then houses sitting right on the other side, and I think what a bunch of morons, if the levees were just wider they would have saved the city. To my knowledge, the water didn’t come up and over the levees. The walls just weren’t thick enough to hold the water on the other side. We’re just talking about more dirt, maybe two walls with a canal in between, we’re not talking about advanced technology. But that’s all in hindsight.

When I look around where I live and see all the dead trees looking like their just going to spontaneously combust at any moment, we’re a bunch of morons for not doing anything about it. And in hindsight after a few hundred houses burn, we’re going to look back and say why the hell didn’t we at least cut out the dead trees and thin the live trees a few hundred feet around the neighborhoods. It will look incredibly stupid on our part and cutting the trees will then seem so much easier and worthwhile.

But it’s hindsight, which is also one of the most difficult perspectives to overcome in investing and trading.

Again, I’m not saying that who could have handled things better whether it be a leader or country. I’m saying that no one would have handled it better, because no one would have done anything about it. No one will do anything about these trees until a bunch of homes burn. No one did anything about The Netherlands until 2,000 people were dead. The Great Wall of China was built to solve the problem of marauders ransacking, raping, and pillaging, not in case there might have a problem with marauders in the future. How many Chinese do you suppose died at the hands of marauders before the wall was built? I’d guess millions.

So I don’t think I’m being whacked, warped, political, or any of those things on this issue. I’m just stating facts about the way we think. It’s very hard to step back and realize what we thought about something in the past without seeing it from the perspective of hindsight. In hindsight we looked like a bunch of idiots for buying dotcom stocks in the late 90s. Some people thought that people were idiots for buying those stocks then. It’s damn hard to step back mentally and see things for what they were then. Trying my best to do so has helped me to see what has really happened in the energy markets. But as I say, it’s not easy. It takes practice and most people don’t think that way. If they did oil prices would have never gotten so out of hand in the first place. Rita is tagging everything Katrina missed in the gulf. Rita is finishing the job of decimating the oil and gas infrastructure in the gulf, doing as much damage as can be done given the extent that rigs are built to handle pretty bad conditions. Yet oil prices are below where they were several weeks before anything bad happened. The markets didn’t price in two hurricanes doing this magnitude of damage. No one anticipated things being this bad.

The thing that’s keeping prices down now is that many people have decided that the game has gotten a little too rough for them. Like kids playing backyard football. It’s fun until someone gets hurt. Then the game breaks up and everyone goes home. That leaves behind the more rational traders hedgers that were participating in the markets long before things got so crazy. Did you notice that just before Rita became an issue that oil was starting to creep back up again? The amateurs were getting back into the game again after things started to settle back down. They’ll be back. You can bet on it. The game’s not over, it’s just on hold. The energy markets won’t stabilize until it destroys the economy or better game comes along. In that regard we have the same mentality towards the energy markets as New Orleans had before the hurricane and we have here with our trees. I think most people really know what the problem is, but they aren’t going to do anything about it. They’re just going to let things break and worry about it after the fact. What should people do about it? Simple, don’t invest in bubbles where all common sense and fundamental economics are being ignored. We do it anyway. I will be very tempted to get long oil futures after things start to settle back down again in anticipation of the hedge funds getting back into the market again. I’m not above it, even though I know I’d be contributing to the problem, just as I live with the possibility of my home burning down. I’m human. The only difference between me and the majority of people, is maybe I’m a little more aware that I’d be contributing to the problem.

There’s one other point I was trying to make, which is to what a great extent our views are shaped through the narrow lens of a camera. In New Orleans saw the part of the chaos that the media showed us. What we were not shown much of because the media wasn’t there was the very many people stuck on rooftops and in homes in just as bad or worse circumstances than those at the convention center. We saw aerial shots of people on roofs, but no one was down there asking them what they felt, how bad things were for them, how hungry or thirsty they were. Again, whether or not we should have been able to deal with all the suffering simultaneously or more efficiently is a different matter. The only other thing I’ll say about that topic is that I wish the media and the public would have given more credit and respect for tireless, beyond exhausting, efforts of the rescuers. That has been completely overshadowed by all the whining about what was done wrong.

One reader agreed with me about the media altering our perception of the markets, but not about Katrina. But they are the same. The only difference is that people are understandably more emotionally charged over Katrina than the markets. The media skews our view of markets, but not of hurricanes and human suffering? Again, that’s not to say that things couldn’t or shouldn’t have been done better. No doubt, such events will be taken more seriously in the future and handled far better. Lessons have been learned on that front. But that’s not the lesson I’m conveying.

I realize that Katrina is a sensitive subject, but I make no apologies for using it in my analogy because it illustrates my point so well. Imagine if you can if we had a president that catered to the media throughout the rescue mission to the point that rescuers were assigned to follow the media around and clean up problems wherever they went. What then would our perspective have been? I hold that it would have been very different. If the first thing the rescue mission did was to drop in a massive amount of supplies at the Convention Center, never mind whether or not the city of New Orleans should have had ample supplies there already or whether the feds should’ve stocked them there before hand, but then the perspective we would have had through the media’s eyes would have been that everything was going great, even if people were being left stranded on roof tops and in attics. The sad fact is that if the media happened on a kennel full of dying animals the less level-headed and rational-minded in our society would demand that those animals be rescued, even if it meant that off-camera five people perished as rescue workers attempted to save those animals. Many people would put the life of an animal before that of a person. It’s not necessarily that they value the life of an animal more, it’s just that they are driven by their emotions to such an extent that they are incapable of looking past the suffering in front of them, to perhaps even greater suffering just beyond their line of sight and range of hearing. If such a person and myself were walking through New Orleans and we came across such a kennel, but I thought there were people trapped on the next street over, I’d suggest we leave the animals and go after the people. But that person likely couldn’t do that. They’d freeze up and go no further. So whose really more compassionate? I don’t think I’m uncompassionate for thinking that way. Yes, I’m less driven by emotions, in part because as a trader that’s something I’ve practiced a lot. But I’m no less compassionate. I’m just more levelheaded. I put aside my emotions to see what can’t be seen with my eyes. To envision something beyond what the camera shows us. I do the same thing in the markets.

Our perspective on New Orleans was largely shaped through the lens of a camera. If the media went out in boats and interviewed thirsty and hungry people stranded on their roofs for many days, then that would have been the problem instead. The problem as we saw it was the Convention Center because that’s where the media was. In reality there were people suffering all over the city, not just at the Convention Center. So I think in some ways I am actually more compassionate for trying to understand what those other people must have been going through.

Try to understand that the slit-eyed view that the media presents to us often doesn’t paint a very accurate picture of reality. Where are the interviews of rescue workers? The media seldom has asked them what they thought about the situation. They ask political commentators and politicians what they think. I’m guessing we’d get a very different perspective from the people who were actually down there in the thick of things. Again that’s not to suggest that things couldn’t have been done better or more expeditiously, or even that another less impoverished city wouldn’t have fared better. The point is that that’s somewhat irrelevant because we’re never prepared for these things.

After 9/11 every major city in the country spent a great deal of time and money planning for terrorist attacks, dirty bombs, and the likes. Though in reality we aren’t really prepared for such things at all. If that ever does happen it will be very bad and it will be very ugly and all the preparation in the world will do little to minimize that. That’s got nothing to do with my level of feelings, compassion, or political views. It’s just being realistic. Actually, I’ve never once expressed my political views on this blog. Some of you might think you know what they are, but you’re only making assumptions. I’ve not given you enough information to come to any accurate conclusions about that. It’s not relevant to this blog as I envision it. I want this blog to be about thinking logically and critically about the markets. On occasion readers have imagined that I’ve expressed political views, but I never have. They imposed politics on certain things I’ve said. They’ve chose to view them as political.

The reality is that I have no interest in debating politics and I think bringing politics into the fray would make it difficult for people to understand what I’m saying. That’s what’s happened here. People have politicized Katrina and New Orleans and I’ve been accused unjustly of being uncompassionate and warped politically. But that was because those people are thinking of it as a political issue, whereas I was not.

I’m sure if you’re taking the time to read this blog everyday, then you’re curious about my political views. That’s understandable. The truth is that I’m sort of a political atheist or chameleon. I think about individual things without caring what political faction backs them or not. My dad was an union electrician who grew up farming in rural Indiana and was in the Navy. My mom was from Chicago. She was a homemaker. She got her bachelor’s degree at the same time I did going to a community college in Indianapolis. She’s worked for a Federal Home Loan Bank for many years. My parents had absolutely nothing in common and were divorced a long time ago. I had family in rural Indiana, Kentucky, and Chicago. Trips to Kentucky were spent fishing for crappie in creeks and ponds. Trips to Chicago were spent eating ethnic foods, visiting museums, etc… My great-grandfather on my mom’s side came over from Czechoslovakia. My Irish last name is a perversion of Mahoney and my Irish kin have been here since the 1700’s. A man named Mahoney had a bunch of sons one of whom changed the last name. I figure he must have been in trouble with the law or some such thing. At least one Mahorney fought in the revolutionary war. Two other quarters of my heritage is Scottish.

I grew up in a neighborhood surrounded by fields. My friends and classmates included kids in the neighborhood and out on the farms. My neighborhood was a mix of both white-collar and blue-collar workers. Consequently, my political views have been diversified. Politics isn’t something I know a lot about. I try to write about things I know about. I don’t write about biotech companies because that’s not something I know anything about. I have a degree in economics. I know a little about the fundamentals of supply and demand, mathematics, statistics, probabilities, computers, and so forth. Many of the professionals I’ve met in the markets are libertarians and followers of Ayn Rand. I don’t count myself among them. I consider myself to be an independent thinker whether it be politics or religion. I’m not a follower.

I never really could see what was the big deal of Ayn Rand was. Her points just seemed like common sense to me. They weren’t enlightening and here stories were too flowery and dramatical for my taste. It occurred to me at some point that people that those people who found her work enlightening were those who didn’t really understand fundamental economics to start with. So they had their eyes opened by it. I was a math major for awhile and switched to economics because it seemed easy for me and it seemed to make a lot of sense to me. I wasn’t a good student. I never really got chemistry or physics. And I was an absolutely horrible writer. I learned to write in chat rooms and email lists. I only learned to write by forgetting everything that I was taught in school.

I don’t consider myself a good writer now. I try to improve myself in that regard. But I’m also aware that many writers put art and artifice get in the way of the truth. That, in my view, is the problem with so much of journalistic based writing in the markets. They say a whole lot of nothing really well. I have to skim through dozens of articles before I come across one that offers up any kind of independent or insightful thinking on the part of the author. It’s rare to find articles that are thought provoking. I’d like to think that from time-to-time readers have found my work thought provoking even if it’s been presented coarsely with typos and grammatical errors, and even when they do not agree.

posted at 2:03 PM 5 comments   

Thursday, September 22, 2005

Out of the darkness, or somewhere...

Within a recent post I wrote:
For all the problems, the realistic rational and logical-minded person has to step back and ask whether any other city would have handled the situation any better, whether any other president would have handled it any better, whether any other country would have handled it better.

A reader ignorantly and insultingly responds:
Yes, a city not mired in 26% poverty surely could have handled it better than New Orleans did. Yes, i can think of many past presidents that may have handled it better. Yes, the Dutch did a great job in evacuating and later housing their people when their dikes broke. Do you just pull this stuff out of your butt?

You can believe me when I say that I have much better things to do than spend my time pulling things out of my butt. I live in a wonderland for hiking, fishing, hunting, and soon again skiing among other things, all of which I would rather be doing any day of the week. Anyone who has been actually reading this blog for any length of time knows that one of the main themes here is pointing out the many things the mainstream media pulls out of their butts primarily as it pertains to the markets, which is precisely where all the whining over Katrina has came from. And the relationship to the markets is the lesson that can be derived from the extremity of the sensationalism and manipulation by the media.

The lesson in this is to think for yourself instead of believing everything the whining liberal media tells you to believe. It’s this kind of skewed view of reality that is the target of much of what I write about on this blog as it relates to how I view the markets. I’ll try and explain myself more clearly.

If Lance Armstrong had come in second in the Tour de France would that mean he sucked? Of course not! He’d still be one of the very best cyclists in the entire world. If he came in dead last he’d suck compared to his competitors in that particular race, but just being in the Tour de France would mean that he’d still be one of the top 200 or so riders among perhaps many thousands of professional riders worldwide by virtue of his entrance in the race, selection bias aside. But had Lance came in 20th people certainly wouldn’t have seen it this way. They came to expect nothing less than first from him. Anything less than total domination would have been seen as a failure.

That’s precisely how people are wrongly viewing the aftermath of Katrina. It took far less significant events to spark riots and looting in Los Angeles and Cincinnati that rivaled similar problems in New Orleans. LA couldn’t likely experience the kind of flooding that New Orleans did, but imagine that it was struck by an earthquake of such a magnitude that it laid waste to the entire city and rendering it just as uninhabitable as the flooding did in New Orleans. I’m quite certain that the state and federal government would be completely overwhelmed and rendered ineffective and the media would be singing the same song with constant footage of looters and rioters running rampant, suffering, and people in need of assistance for days on end.

There is no government in the world SIGNIFICANTLY better equipped to handle devastation of the magnitude that Katrina caused. Yes The Netherlands has a better system of dikes and levees to keep out floods. But they only built a better system after they were hit by a massive flood of their own. They had a dirt system just like New Orleans until it failed in a storm in 1953 that killed nearly 2,000 people and flooded most of the country. Fifty percent of the country lies below sea level. In the 1800s there were many thousands of windmills pumping water out of the country.

It’s not likely that the Dutch would have built such system if that flood hadn’t happened. It was the worst storm in 300 years. If the Dutch storm came 55 years later and the New Orleans storm came 55 years earlier very likely it would be New Orleans with the intricate flood protection system and The Netherlands still with vulnerable dirt dikes and levees. The system in the Netherlands was built after the fact. New Orleans will likely get a better and safer system, AFTER the fact.

There has been no president that COULD have handled the situation SIGNIFICANTLY better than Bush did. This is not a political debate. It has nothing to do with politics. Florida has tended to prepare better for hurricanes than the local government of New Orleans did because Florida is much more used to getting hit by hurricanes. Texas is doing a better job now AFTER THE FACT. Texas wasn’t nearly this prepared as Katrina came in and there was no way to know for sure then which way Katrina might have gone. Late in the week before, if you recall, experts still thought it might go east of Florida and miss the gulf altogether. Just overnight Rita has shifted quite a bit to the east from its trajectory early yesterday. Rita could still turn more to the east towards New Orleans or it could still turn more to the West. Up until the last day or so Katrina could have went towards Houston as well. Had Katrina slammed into Houston at a class five level, we’d have been seeing footage of looting and suffering in Houston instead of New Orleans.

People talk about Brown’s lack of qualifications. Politics aside, conveniently no one in the media ever bothers to compare the qualifications of appointed officials in this administration to past administrations. You can readily find the same fault in past presidents’ appointed officials.

But it’s not a political issue because it’s an issue with our information infrastructure. The infrastructure failed in an unprecedented and unexpected way. People had come to rely on an infrastructure, much of which didn’t even exist prior to the Bush and Clinton presidencies. Anyone who actually believes that Clinton would have handled the situation significantly better, or more importantly believes that the argument is relevant or important, doesn’t have the intellect to comprehend the larger message I’m trying to convey and unfortunately I can’t help them or convince them otherwise. They might as send me a check, or send it to a charity, because if their playing the markets the people who do get it are going to take their money sooner or later.

Before the Internet, email, satellite uplinks, and cell phone networks past administrations would likely have been more in the dark as to the magnitude of the devastation and likely would have been even slower to respond. The main difference would have been that we wouldn’t have had such a constant barrage of footage depicting the chaos.

Our perspective on such events has been skewed by the plethora of 24-hour news-only broadcast stations that do nothing else but cover such events, hone in on every minute detail, and compete to out sensationalize each other.

Very likely twenty years ago no one would have even known enough to complain about Brown, how long it took for people in the Convention Center to get supplies, or any other whining, sniveling, complaining detail. People would have focused solely on the tragedy, solving the problem at hand, and making sure it didn’t happen again. The mass media has turned the perspective of its viewers from a rough-and-ready, deal with any problem that we’re confronted with attitude to an overanalyzing whiny crybaby attitude.

This same kind of skewed perspective promoted by 24-hour, minute-by-minute, information sources is incredibly pervasive in the markets and financial information. The minute-by-minute media outlets have a constant need for new ever-more sensational information and all too often when they don’t have it they will make it up by telling half-truths. The mainstream media (MSM) will report to us that protestors have shut down oil production in Ecuador and they will intentionally tell you that say 40% of the countries oil is shipped to the U.S., but they will intentionally leave out the fact that the oil production amounts to a hundredth of a percent of the world’s total production. That 40% is much more shocking, albeit deceiving.

After ten quarter point rate hikes in a row the MSM was begging and pleading for a new story. Katrina gave them one. The story the MSM ran with was that the Fed should pause. That story quickly evolved into the Fed will likely pause. A couple weeks later the MSM was again back to saying the Fed will likely hike rates for an eleventh straight time.

Markets regress to the truth. The MSM presented an emotionally charged perspective that had little to do with the truth. The MSM created the story and gathered up people to interview that went along with the story. If it weren’t for the MSM creating it, there wouldn’t have been any Fed should ‘pause’ story because it wasn’t a logical or rational argument. As the Fed meeting grew closer the ‘pause’ story held less and less water. So the MSM began to gradually back off of offering its own opinion and conveniently then turned to the opinion of experts. You can go back at the post Katrina posts and you will see that I argued repeatedly about the absurdity of the pause argument and I said that I thought the Fed would continue to hike. Either there were very few people who thought it right after the hurricane, or it was just that there were very few people who believed it being brought forth by the MSM. I think the latter.

A savvy trader who saw past the biased perspective presented by the MSM could have done very well with a contrarian short in the Fed Futures market. I never came right out and recommended the trade, because I don’t do that here, but it was implied. I was extremely clear vocal in my belief that the ‘pause’ crowd had it all wrong. The astute reader and trader should be able to draw their own conclusions about what to do with that information. The less astute can get specific ideas on how to play such information in the accompanying newsletter The Market Spectator. Yes that’s a shameless and intentional plug.

I’m trying to help people to see the truth. There are fine examples of this outside of the markets. Katrina is a good example and a good exercise in clear thinking. People often see a thing the way the MSM wants them to see things. The media is biased by its need to compete and sensationalize. The media often presents what it thinks people want to hear, rather than the truth. Seeing the truth can make you money in the markets because eventually the fundamental laws of economics force people to see the truth. The Fed is more economically savvy than the public. The Fed understands the fundamental laws at work. It’s not a perfect predictor. No one is. But it has a better understanding than the average person. The Fed understood that pausingm for the reasons that people were saying it should, defied fundamental and irrefutable laws of economics and mathematics.

Hopefully I’ve explained myself more clearly and this will help explain some of the other things I write that might otherwise seem cryptic or pulled out of my butt.

posted at 2:24 PM 5 comments   

A reader asks:

What inflation, Mark?

I suppose it was a rhetorical question because core CPI has recently been quite subdued. The core CPI has increased a mere 0.1% in each of the last four months, which amounts to just 1.20% on an annualized basis. That is historically well below the average increase in core prices. Core prices as you probably know are prices excluding more volatile food and energy.

The CPI and PPI are important measures of prices. Economists often talk about inflation as it relates to core prices. Historically, food and energy prices have been far more volatile than core prices. This is true for a number of reasons. Weather is one. Speculation on commodities and the various related futures contracts is another.

Similarly the Producer Price Index (PPI) is more volatile than the Consumer Price Index (CPI). This is because many core prices are sticky at the consumer level so that producers typically absorb some of impact of changes in prices for the commodities they purchase to produce goods. For example if the price of aluminum goes up, consumers will likely pay higher prices for aluminum siding because that product is very directly tied to the raw material. However, the price of soft drinks and beer would not likely change much in the short run because prices are very competitive and sticky. Consumers feel they are paying for the contents, not the can. When packaging costs rise producers will often try to shift to another form of packaging such as glass and plastic rather than raise prices.

So the producer often absorbs the impact of higher prices, while the consumer pays the same price. This is true mostly in the short run. However, in the longer run producers might begin to pass on such higher costs. For example, companies such as UPS or FedEx that have high fuel expenditures might absorb a blip in higher fuel prices, but if prices stay high for a long period of time they will eventually raise shipping rates to offset increased fuel costs.

Though core prices have remained subdued economists and the Fed don’t expect them to stay that way for much longer. In fact economists have incorrectly expected core prices to begin to tick higher in each of the last for months. The consensus expectation has been for core prices to increase 0.2% vs. the 0.1% we actually got. That’s still low, but it reflects the fact that economists are expecting higher energy prices to begin to trickle down into core prices any time now.

Market commentators constantly debate whether increased energy prices are inflationary or a tax on the economy. The answer is that they are both. Lets take a closer look at a low-margin, high-volume package shipper. Such a company is very sensitive to higher fuel costs. The company wants to pass on the higher costs to its customers in the form of increased shipping rates. But it faces two problems in doing so. First off, it’s operating in a very competitive market where people aren’t very sticky. About the stickiest thing package delivery services have going for them is how cute the office girl thinks the delivery person is. Beyond that if the company raises rates its customers will switch to the competitor. The second problem the company faces is lower demand. If the shipper is facing higher fuel prices, then so are its business and individual customers. If people are paying more money for gas, then they have less money to spend in say a small local store that uses the shipper to bring in the goods it sells. So the shipper is very reluctant to raise rates in such an environment and it certainly doesn’t want to be the first to do so. But eventually, one company breaks rank, gives in, and raises rates. Then all its competitors, with a big sigh of relief, follow suit.

The way this plays out in the PPI and CPI is that the overall PPI numbers would be elevated for while, the overall CPI numbers would be somewhat elevated reflecting higher consumer energy costs, but the core CPI would remain relatively unchanged. Then quite suddenly core prices start to rise as producers one after the other start to raise prices like falling dominos. So the consumer takes it on the chin both at the pumps and at the stores. Unless the consumer’s income increases in enough to offset price increases or they are able to borrow at low rates against home equity and whatnot, recession then becomes inevitable. Consumers simply can’t buy as many goods with the same amount of money. If they are buying less, then companies lay off and consumers have even less money. Then the GDP falls for a few quarters, which is the economists’ definition of recession. This is also what is meant by stagflation.

Investors are complacent about this very real possibility of this happening because it hasn’t happened in such a long time. We think that producers won’t raise prices. But, while energy expenditures are a lower percentage of GDP than they once were, we are still very deep into risky territory.

Looking at the charts I’ve attached below you can see the relationship between the PPI and CPI. Also look at what’s happening with energy prices recently compared to historically. It’s not a pretty picture. The thing to realize is that it doesn’t take much of a blip at the core CPI level to really hit the consumer hard. We’re already hearing a lot of talk about the impact of energy prices on the low-end consumer. And while higher energy prices might not impact the buying of basic goods and services among wealthier consumers, any amount spent on energy is money not put to other uses. The rich and poor alike will spend less at Wal-Mart or send less to their mutual fund family of Choice.

Core CPI might be low, but that doesn’t mean that there isn’t any inflation from the consumer’s perspective. The consumer doesn't care whether he's hit across the board or all in one place. It's the same. And high energy prices will hit core prices. It's only a question of when. The Fed knows this.

posted at 1:33 PM 1 comments   

Oracle Ends Its Shopping Spree

Oracle Ends Its Shopping Spree
Larry Ellison says the software giant will now focus on integration, not acquisition.

After several recent multibillion-dollar acquisitions, Oracle CEO Larry Ellison said Wednesday the growing business software empire he runs will hold off on any major acquisitions for some time, focusing instead on integrating the products it amassed in the past year.

posted at 10:06 AM 0 comments   

Wednesday, September 21, 2005

Pundits have it backwards

Why do investors always want lower Fed rates? Investors incorrectly believe that low Fed rates are always preferable to high fed rates where stock prices are concerned. This isn’t always true. Keeping rates too low can lead to increased inflation, which leaves consumers with less discretionary income to invest in stocks. Stocks can only go up when people can buy more of them. If people decrease their stock buying or even worse sell liquidate stocks, markets can’t rise. I’ve got CNBC on right now and I’m just hearing one misunderstanding after another. As I’m banging away at the keyboard Bob Pisani pipes tells me from the floor of the NYSE that “Stocks need to get oil or the Federal Reserve off of its back.” No Bob, stocks need to get inflation off its back.

We can talk all we want about core price inflation, but the fact is that to the consumer inflation absolutely includes energy prices, which are really taking about and leaving less left over for investing. It seems that the common belief is that high energy prices aren’t enough to impact people wealthy enough to buy stocks. But remember that a lot of the reason that stocks went up so much in the late 90s was the fact that the Internet made it easy for financial companies to tap into the small investor. That added dramatically to the total amount of money flowing into the markets. Average Joes started having say $50 a month taken straight out of their checking account every month and put into mutual funds, and when they had a couple thousand to spare they sent it to E*TRADE and Ameritrade. I’d expect a slow down in the online brokers going forward.

We get energy prices back under control and the consumer will have more money to invest in stocks. Ironically, energy prices are high in large part do to an increased interest in alternative investors, which tend to be the wealthy. It was the wealthy who best weathered the recession and were in the best position to take advantage of loose and cheap credit. So it was probably the ultra low Fed rates during the recession that has lead to inflationary energy prices, while average Joes were concerned with finding jobs.

Low rates stimulated investment among the wealthy, which in turn brought back jobs for the average Joes, but unfortunately it increased alternative investment in hedge funds, which ran up energy prices prior to the hurricanes. Now the Fed is having to raise rates to fight back the wealthy alternative investors. It’s a vicious cycle.

This morning I looked back at the voting records of the FOMC back to the beginning of 2000. It was very enlightening. Particularly interesting was the fact that some Fed members dissented in 2001 and 2002 protesting that rates were being taken too low too quickly. It was clear that some members felt that rates of 3.00% to 4.50% were sufficiently stimulative and accommodative. Assuming that the Fed hasn’t changed its perception about what rate levels are neutral vs. accommodative, then it’s clear that the media and analyst’s perception is fickle and volatile. This group seems to measure rates with a different measuring stick than the Fed. The public always wants rates to be lower and almost always thinks rates are too high. The public seems to think that a neutral Fed rate is around 3.5% to 4%, when in actuality the Fed views such a rate as stimulative. The historic average is around 6% and the Fed likely views a neutral rate as being around 5%, but that probably fluctuates somewhat depending on the yield curve.

It’s humorous to listen to interviews with ex Fed governors because they always seem to no be more dovish now than when they were deciding rates themselves, even though Fed rates have been kept very low over the past fifteen years compared to historical averages.

My view is the Fed is heading for 5%.

posted at 4:29 PM 1 comments   

Stop the Sensationalism

CNBC’s economist Steve Liesman:
“Picture this: You’ve lost your job and your house in New Orleans. Even though you have some forgiveness on repaying your loans yesterday you learned the Federal Reserve just raised interest rates and increased what you will owe on your variable rate consumer and mortgage loans. Said one Fed observer the actions yesterday by the Federal Reserve put it in danger of being seen as unfriendly to the Katrina recovery efforts. That and unfriendly to the stock market and economy. Since yesterday’s Fed meeting the Dow was off about 184 points or 1.7%. The bond market though has rallied. The ten-year yield, which moves in the opposite direction from the bonds prices, falling nearly nine basis points since the meeting yesterday. Before the meeting the ten-year was trading at 4.26%, now it’s 4.17%. That’s a sign the market is most concerned about inflation, or it could equally be a sign the bond market is increasingly worried about economic strength after the Fed hints it’s worried about economic weakness.”

This was typical sensationalistic reporting. They talk about the plight of the hurricane victim as if there is real correlation. The Fed has first and foremost a responsibility to the entire countries price stability and sustainable growth, not to the individual hurricane victims. First off, the math and the relationship between rates is all wrong. He reports that the hurricane victim will have to pay more on his variable rate loan because of the Fed’s rate hike. First off a quarter point rate hike isn’t going to make darn bit of difference to someone who has lost his job and home. That person is apt to be filing for bankruptcy. He’s got bigger things to worry about than a measly quarter point hike in interest rates. Secondly, the Fed’s rate hike mostly just served to squeeze the curve. In the same report they talk about how ten-year bond yields dropped a whopping 9bp after the Fed hiked rates. The ten-year bond rate applies more closely to the hurricane victims variable mortgage rate than does the Fed’s overnight rate. In the near term the rate hike squeezes the lenders, not the borrowers. In the short-run as you can see by the ten-year the borrower’s variable rates are more likely to go down than up after the rate hike. And I think it’s safe to presume that if the Fed had paused the ten year would have moved in the opposite direction.

I don’t know about you, but I’m getting pretty darn tired of all the sensationalism and blame games surrounding the hurricane. For all the problems, the realistic rational and logical-minded person has to step back and ask whether any other city would have handled the situation any better, whether any other president would have handled it any better, whether any other country would have handled it better. The answer of course is no to all of these questions. It is what it is, a very bad situation to be learned from.

Hurricane Rita is thrashing the Dow, not the Fed.

posted at 3:37 PM 1 comments   

Things truly have changed

It was nearly unanimously expected that the Fed would hike rates by a quarter point for the 11th straight time yesterday. And another quarter point hike was nearly unanimously decided among FOMC members as expected, with exception to a single member who preferred a pause.

The Fed has a longer-range goal of getting to a less accommodative level. It wants to get there before high energy prices start to trickle down into core prices. But it wants to get there slowly to give longer maturity interest rates a chance to go higher. The Fed knows that in the past when yield curves have inverted it’s been because the Fed has raised rates aggressively while long rates have remained relatively stable and slower to adjust. An inverted yield curve puts lending institutions in a bind because they can’t borrow money at short rates and lend at long rates profitably. They have little incentive to take deposits and little incentive to lend. Essentially, the money spigot is turned off.

The Fed doesn’t want to shut the flow of money off completely. It just wants to slow it down. And the best way to accomplish that is by raising rates at a ‘measured pace’.

But I’m not sure that the common measures of yield curve inversion are as meaningful as they once were. It’s a fact that lending institutions are far less particular about who they lend money too than in the past. Many pundits and perma-bears have pointed to this as major problem with our economy. These people believe that lenders are acting recklessly. No doubt some are, but I think there’s much more too it.

It seems to me that the lending institutions have undergone a significant amount of productivity gains of their own in recent years. The entire lending process far more streamlined than it once was, yet simultaneously lenders are able to know far more about they’re borrowers. Consequently, they are able to far more accurately predict the various risks to which they are exposed. The information improvements and efficiency gains allow them, like any other business, to operate at higher volumes and lower margins. Additionally, the lending institutions are far more geographically diversified than they ever were in the past. Thirty years ago, for example, every person with a home in New Orleans would have borrowed from a local bank. Many small banks would have been completely wiped out by the high number of foreclosures on devastated properties.

Today, however, lending institutions are telling us that their New Orleans exposure is only a small percentage of their total holdings. Even small banks sell their loans at a much greater rate than in the past. And then organizations like Fannie and Freddie turn around and pool diverse portfolios of loans into Mortgage Backed Securities (MBO), which pension and hedge fund investors, financial institutions, and mortgage REITs can invest in a diversified package of loan exposure.

Then too, I have a neighbor here in ski country Colorado that makes his living as a mortgage broker over the Internet. Nearly all of the loans he closes are in Florida and California. And that’s so typical today.

Essentially, lenders have reduced much of the risk they were once heavily exposed too. With this repackaging and diversifying of loans lenders can now profitably lend to higher risk borrowers. They have better data to know what rates to apply and more information about what default rate to expect and can diversify their default risk. That’s not to say that some serious market shock couldn’t take lenders by surprise en masse and cripple the system. But clearly it would take one helluva shock, because a recession, terrorism, and a serious catastrophe haven’t been enough to even cause a dent in the industry.

As a society we’re increasingly becoming more like an ant colony able to collectively deal with any problem that comes along.

posted at 3:01 PM 2 comments   

Fed Dissention Not Unusual

Too much is being made of Mark Olson’s dissention in voting for no change at yesterday’s FOMC meeting. It’s not surprising that there would be some emotionally driven decision making involved. One emotional blatantly biased article I read called the rate hike “…an unusual non-unanimous decision criticized as ‘insensitive’…”

Non-unanimous voting is infrequent, but I don’t think it could be classified as unusual with a tone connoting a serious problem. The last time FOMC members voted non-unanimously was the September meeting three years ago when two members preferred rates be lowered from the 1.75% as the war in Iraq loomed. There was a one-vote dissention December of 2001 as a member felt 2% was low enough. In June of 2001 a single member voted against a reduction in rates to 3.75% because he believed that the rate of 4% was sufficiently stimulative. And in May of 2001 one member preferred easing by a quarter point rather lopping 50bp off of the 4.5% rate.

So it may have been a while since the last time an FOMC member dissented it is actually quite common for members to dissent during times of uncertainty such as war, recession, or in this case catastrophe.

posted at 12:45 PM 0 comments   

Tuesday, September 20, 2005

Fed's Hidden Message

The Fed had nothing surprising to say in the FOMC statement. The obvious thing that changed was the addition of a statement indicating its belief that the impact of Katrina on the economy would be temporary. What remains to be seen is whether the markets will rally on the Feds modestly optimistic take on the economy in the longer term beyond the immediate impact of Katrina and volatility in energy prices.

However, the less obvious and more important new phrasing that the media isn’t picking up on as of yet was, “Higher energy and other costs have the potential to add to inflation pressures.” This was the first time that the Fed specifically stated in a statement concerns about increased energy prices trickling down into core prices. It says that the Fed is still very much in inflation fighting mode and looking much longer term than traders tend to.

posted at 2:29 PM 0 comments   

FOMC Statement Contents

FOMC Statment


The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 3-3/4 percent.

Output appeared poised to continue growing at a good pace before the tragic toll of Hurricane Katrina. The widespread devastation in the Gulf region, the associated dislocation of economic activity, and the boost to energy prices imply that spending, production, and employment will be set back in the near term. In addition to elevating premiums for some energy products, the disruption to the production and refining infrastructure may add to energy price volatility.

While these unfortunate developments have increased uncertainty about near-term economic performance, it is the Committee's view that they do not pose a more persistent threat. Rather, monetary policy accommodation, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. Higher energy and other costs have the potential to add to inflation pressures. However, core inflation has been relatively low in recent months and longer-term inflation expectations remain contained.

The Committee perceives that, with appropriate monetary policy action, the upside and downside risks to the attainment of both sustainable growth and price stability should be kept roughly equal. 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. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.

Voting for the FOMC monetary policy action were: Alan Greenspan, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Roger W. Ferguson, Jr.; Richard W. Fisher; Donald L. Kohn; Michael H. Moskow; Anthony M. Santomero; and Gary H. Stern. Voting against was Mark W. Olson, who preferred no change in the federal funds rate target at this meeting.
In a related action, the Board of Governors unanimously approved a 25-basis-point increase in the discount rate to 4-3/4 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of Boston, New York, Philadelphia, Richmond, Chicago, Minneapolis, and Kansas City.

posted at 2:14 PM 0 comments   

Goldman Sachs 3Q Rocks

Goldman Sachs’ third quarter rocked. The firm reported net earnings of $1.62 billion, compared to $865 million in the previous quarter, and revenues of $7.3 billion versus $4.8 billion respectively. Goldman Sachs revenues are largely attributed to its own trading activity, with 70% of total revenues coming from trading in 3Q. Of the $5.1 billion in trading revenues 51%, or $2.6 billion, was derived from trading in the fixed income, currency, and commodity (FICC) markets. FICC revenues increased $1.1 billion from 2Q. The firm attributes the increase to credit and currencies with commodities coming in lower than in 2Q.

That is interesting because in 2Q the firm had said in sources that have conveniently disappeared from the Internet that it had been expecting more volatility in the oil markets. Evidently, after taking a hit in 2Q on some sort of spread trades the firm backed off its volatility expectation. It took quite a PR thrashing when myself and others pointed out the likely not so coincidental timing of its now somewhat famous super spike oil report calling for $105 a barrel and the expectation of increased volatility in the oil markets. Conflict of interest? Yes, of course. But, the firm got around that with a disclaimer actually saying that it may have a conflict of interest! How nice.

It really got my goat that such an influential firm is able to get away with putting out such blatant and obvious potentially favorable manipulative information. So I’m not too fond of the firm.

But the quarter was a smash and with interest rate spreads increasing a bit recently it’s possible that GS could have an even better 4Q. That will depend in part on what the Fed does.

posted at 2:03 PM 0 comments   

No one is talking about a 50bp rate hike

What no one is talking about is the remote possibility that the Fed could increase its rate of tightening to 50 basis points starting today. Prior to the hurricane the Fed was clearly leaning more towards this possibility than towards being done. Within Fed meeting minutes concerns were expressed about whether or not the ‘measured pace’ of quarter point hikes would get rates to a non-accommodative level fast enough to keep inflation under control. Economically speaking a 50 basis point hike would make sense. But there’s a psychological aspect that the Fed must be concerned with. A 50 basis point hike could harm sentiment and shock the markets to the downside. Many people think the Fed should pause because of Katrina. So a 50 basis point hike would be a real shocker. Watch out for the next meeting though.

posted at 1:15 PM 0 comments   

Mortgage REITs cut dividends

Mortgage REITs cut dividends
Few investors have more riding on the Federal Reserve's interest-rate decision today -- and the next few to follow -- than shareholders of real estate investment trusts that borrow to buy securities backed by residential mortgages.

Many of these so-called mortgage REITs have been clobbered by the triple whammy of higher short-term rates, falling long-term rates and a continuing wave of mortgage prepayments.

posted at 12:24 PM 0 comments   

Where do we go from here?

Right after Katrina flooded New Orleans it seemed just about everyone said the Fed should pause. Now hardly anyone thinks the Fed will pause. Fed futures have hikes priced into two of the next three meetings. One reason that a third hike isn’t priced in is the retirement party contingency. Some traders seem to think Greenspan will want leave on a pause. I don’t buy into that argument.

Regardless of what the Fed will do the rest of the year. If the Fed hikes today that’s what everyone is expecting so I don’t see any reason for that to drive markets lower. Some pundits are speculating that if the Fed pauses that the economic situation must be very glum post-Katrina.

If we get through hurricane Rita unscathed and the Fed hikes rates the markets could take off again. Especially, if the Fed puts in wording about the economy’s strength and resiliency as I expect it will. The Fed needs the strong growth that comes with positive sentiment to keep hiking rates. So I expect it will want to say things that will restore sentiment.

posted at 11:55 AM 0 comments   

Monday, September 19, 2005

Against all reason

Even if OPEC released an additional 500,000 barrels per day of oil we don’t need it right now because we couldn’t refine it all. Refiners likely already have contracts for most of what they need locked in at much lower than spot prices. But much more importantly is just how ridiculous today’s OPEC driven rally of more than $4 a barrel was. The 500,000 barrels in question only amounts to about one half of one percent of the world’s daily production!

Will the rally hold? It could because the buyers are moronic trend followers who could care less about basic economic fundamentals, which is what makes this a bubble. Eventually, the truth will rule out just as it did for dotcoms and most stocks in 2000 – 2001. During the bubble the prices of stocks in the S&P 500 increased at nearly triple the rate of earnings. It was quite simply an unsustainable growth rate. The increase in energy prices is no exception. In the end the production of oil is a competitive business. In a competitive market fundamental economics dictates that producers will compete and find a way to bring their product to market cheaper.

Is it possible that oil companies have been speculating on futures contracts on their own oil, like a shill in the crowd or a plant driving up auction bids? Of course it is. Energy bulls have been making money hand over fist. Oil companies are naturally big players in these markets. Oil companies, now flush with cash, can get a quicker profit punch from speculating in the futures markets, than from production investment, which would only serve to depress prices. High oil prices certainly haven’t hurt the refiners because they also speculate in the markets, many are owned by oil companies, and others own retail distribution networks where they are able to pass nearly all of the increase in oil prices.

Oil companies that pump oil out of the ground, wholesale it, refine it, distribute it, resell it, and speculate on it benefit by higher prices at every point in the distribution network.

posted at 5:51 PM 0 comments   

Energy Idiots On the Loose Again

Question (rhetorical):
How can traders reconcile oil prices rising more on NON News from OPEC than from the real supply disruption of Katrina?

Answer:
Katrina presented an unknown and therefore a risk. The energy markets are crowded with amateur newbie hedge fund managers moved over from shuttered mutual funds, the most single and closed-minded group of investors in the markets. They’re trend followers. Katrina scared some of them out and now their back with a vengeance. It’s these guys that are killing the consumer and the economy and the Fed can’t do anything to stop it.

posted at 5:23 PM 0 comments   

Ex-Tyco Execs Get Up to 25 Years in Prison

Ex-Tyco Execs Get Up to 25 Years in Prison
L. Dennis Kozlowski, the former CEO of Tyco International Ltd., and former Tyco finance chief Mark Swartz were sentenced Monday to up to 25 years in prison for stealing hundreds of millions of dollars from the company in a case that outraged the public with its tales of executive greed and excess.

posted at 4:30 PM 0 comments   

Oil now up $3.45...

...and getting more ridiculous by the minute.

posted at 11:13 AM 2 comments   

Newbie oil traders: ignoramuses

The government offers to sell oil out of the Strategic Petroleum Reserve (SPR). Refiners only wanted to buy a small portion of the oil that the government offered to release. Why? The refiners likely have futures contracts they bought long ago before the energy speculation got completely out of hand. Thus the price the government wants is expensive compared to the price the refiners have locked in. After all, that’s what futures contracts are for.

So the refiners just get their oil from the usual channels. It’s simpler for them that way. Also, their refining capacity was reduced by the hurricane, so they don’t need to buy as much oil.

Now OPEC says they’ve got oil, and they’d love to sell it to us, but we don’t want to buy it. It should come as no surprise that the energy speculating newbie hedge fund managers would take this to mean less supply, therefore higher energy prices and run oil up $2.70 at last glance. Still, the magnitude of the ignorance and lack of fundamental economic understanding within the group of speculators driving the oil market is something I can’t get used too. It’s incredibly frustrating to see the market behave so irrationally. It’s money in the bank, because they are consistently ignorant, but it’s no less frustrating to witness.

There’s no demand for the oil we already have out of the ground. Oil prices should be crashing, not going higher! These are near-term contracts. The world isn’t going to run out of oil in the next two months. No one wants to buy all the oil that’s on the market, but everyone wants to be long the futures contracts. Even China has said that it won’t use international oil supplies to fill its SPR at the current prices.

posted at 11:08 AM 0 comments   

Friday, September 16, 2005

Fed Funds Futures Tumble

Thank goodness for the market rally! I’ve got an aching back, a popcorn kernel in my teeth, a piece of dental floss stuck next to it, and my notebooks hard drive crashed last night.

I’m watching forward fed funds rates and they dropped like a rock late in the day indicating increased likelihood of further rate hikes, but I don’t see any specific news for it. I know I’m supposed to be telling you why, but I’m all out of sorts and ready to call it a weekend. Anyone out there have any insight on this?

Today, the first time I did hear a couple of sources talk about the possibility of the Fed actually increasing its rate hikes to 50 basis point increases after the September meeting.

posted at 4:05 PM 3 comments   

Markets regress to the truth

Indulge me in a bit of data mining. I don’t very often talk about individual stocks on this blog, as I don’t want to be accused of hyping and I don’t want to give away the farm. Therefore, I don’t track results of the things I write about in the blog. But I do think the things I’ve written about on average have done well. The only stock I can recall ever specifically arguing in favor here was Caterpillar (CAT) in the spring. And I was mainly using it to make a point about when to buy cyclical stocks. If you want to go back and read the series posts on that topic the search tool at the top of the page will dredge them up for you.

Early in the year I went on a rant about increased long-side speculation in the energy and commodity markets. Well, I’m still ranting about it. Please note that I’ve never ever said that speculation was bad or that there should be anything done to stop it. All I’ve ever done is point out the truth because I believe markets regress to the truth. For example, we hear over and over again that oil prices are being driven by growing demand from China. What I rant about is the fact that supposedly professional journalists and analysts never cite their sources or give any proof of their claims. So I very often don’t get my first post up on the blog nearly as early in the day as my readers, my publisher, and a Barron’s reviewer would like. More often than not I’m crunching numbers in spreadsheets and sifting through data. And more often than not I discover that the journalists and analysts are talking out there rear ends without anything to back up their claims. And all too often these theories become accepted as facts to be repeated by the press over and over again until nearly everyone takes the claim as indisputable fact. But this is all background for newer readers to get a feel for the tone and intention of this blog.

Anyway, one of the ideas I presented early in the year was that coal was a substitution play for oil. I said basically that as oil prices rose interest in coal would increase. There was some debate as to how a coal was a substitute and I explained how that works in a post titled Economics 101: Supply and Demand. Since then the DJ US Coal Index has rocketed higher. I did caution about electric utilities having trouble passing on higher coal prices, but I haven’t looked at what’s happening to the profit margins for these companies. Utilities stocks have done well, however, in part because Warren Buffett has been buying them and there is certainly no shortage of books telling average Joes how to invest like the oracle. Does the tail wag the dog? The DJ US Electricity Index has risen about 14% in the past six months. But the coal index has risen 65%. I’m kicking myself for not adding any of the positions to the model hedge fund in The Market Spectator letter. That’s what I get for thinking “they look expensive”.

I try not to allow myself to be influenced by fundamental or technical analysis, but I’m not above succumbing on occasion. The philosophy that I come back too, though, is that markets regress to the truth. For example, with Katrina’s shock to crude and natural gas there’s now an increasing level of talk about coal as a substitute. Naturally, investors are going to buy coal related stocks on such stocks. The newfound recognition of coal as a substitute overrides fundamental or technical valuation measures. It is simple. If suddenly there’s increasing interest in coal, investors are going to buy coal stocks regardless of where prices were when the interest increased. That is the truth. Forget PE ratios and moving averages. Common sense wins out every time.

More recently, there’s been increasing concern about flattening or inverting yield curves. In a post titled On Yield Curves I explained that a flat or inverted yield curve would squeeze certain interest rate sensitive organizations such as mortgage REITs. Markets regress to the truth. By chance I happened on the following article this morning.

Market Pulse: Annaly slips 10% as firm cautions about rates
Shares of mortgage REIT Annaly Mortgage Management slipped more than 10% Friday after the firm said the contraction of the spread between short-term and long-term interest rates has hurt its profitability.

posted at 12:37 PM 2 comments   

Thursday, September 15, 2005

Fisher Taken Out of Context

Richard Fisher, President and CEO of the Dallas Fed, spoke to the Texas Department of Banking on Monday. I just read the text of his speech, which was in my opinion consisted of levelheaded independent thinking. It was clear that Fisher was inclined to wait and see with regard to monetary policy. A comment that the media picked up on has been mischaracterized. “With the nation’s already large fiscal deficits, I personally believe it would be ill-advised for the Fed to monetize any fiscal profligacy.” Fisher was referring specifically to spending on hurricane relief and rebuilding.

In short Fisher meant that the Fed shouldn’t support wasteful spending. He said it more clearly in the preceding sentences. “I have asked my staff to carefully monitor this spending. Obviously, the political authorities, not the Federal Reserve, have the power of the purse.” Taken in the context of the overall economy and the Fed’s monetary policy such a statement would be seen as hawkish. But in this case I think he simply meant that if spending is wasteful it could be inflationary and the Fed would need to consider such spending in future policy decisions.

posted at 4:34 PM 0 comments   

Economic Barrage

There has been a barrage of economic data come out today, all of which is being closely scrutinized as it relates to the markets and post Katrina economic forecasting. I know it’s boring stuff, but bear with me because it’s moving the markets. Everyone’s still trying to figure out what the hurricane really means for the overall economy in both the short and long run.

The CPI out before the open came in mundane on the core side with an uptick of just 0.1% for the fourth month in a row, and the overall CPI increased by the same amount as last month and as consensus estimates at a 0.5% increase. So that didn’t really do much for the markets and they opened mixed. However, December and January fed funds futures climbed 0.0200 at the open with traders now expecting two more interest rate hikes sometime between now and next March. Thus traders felt that the information indicated that the Fed would be less likely to continue hiking rates.

I’m not too sure about that presumption. All else being equal the Fed had nearly identical inflation data for July, but raised rates in August and basically stated that it intended to continue to hike rates at a ‘measured pace’ unless things changed. The question then is whether or not Katrina changes things in the Fed’s view. That’s debatable and of course it’s being debated heavily.

So despite the fact that traders felt that the data meant the Fed would be less likely to hike rates, they weren’t certain enough to take the markets higher and chose to remain in a wait and see mode.

We also got July business data from the Commerce Department before the open. Inventories fell by 0.5%, the largest amount in two years, while sales rose 1.1%.

While we have yet to see higher overall CPI and PPI data trickle down into core prices to any significant extent that doesn’t mean that we won’t in the future. Falling inventories and rising sales could give sellers pricing power. Traders were likely primarily focused on the CPI this morning, but the Fed watches data indicating pricing power or potential pricing power closely.

The fact that prices haven’t trickled down more is surprising to me, and the consensus of economists who have called for upticks of 0.2% for all of the last four months. I wondered if recent strength in the dollar could be behind the low core prices. Globalization has been noted for keeping consumer prices low. So it seems logical that as the dollar strengthened many foreign goods would be cheaper. Unfortunately, that doesn’t include oil, which is traded in dollars. I tried comparing CPI and PPI data against the dollar index, but was unable to find a noteworthy correlation. Still, the hypothesis seems logical to me.

Later in the morning the markets tuned into the September Philly Fed Business Outlook Survey, to a much greater extent than typically. This makes sense because the data is post Katrina and hones in on the economy and business environment of a single major city, including the macro implications of the hurricane, but excludes the geographically isolated impact.

The Philly data came in week substantially weaker, but it has been falling for a couple of years now, roughly in correlation with higher energy prices. One TV economist is trying to blame Katrina on the fall off in the index to 2.2 from 17.5, but I’m not sure the connection is clear other than with regard to the gasoline shock early in the month.

Overall there are indicators of both inflation and slowing growth. The ugly word stagflation is being used once again. The thing to realize about stagflation is that it’s worse than inflation alone and serves to make the impact of the same amount of inflation worse than if there’s growth to offset price increases. The Fed isn’t going to wait and see whether the economy will slow enough to get prices under control. It’s obligated to fight inflation directly.

posted at 2:19 PM 0 comments   

Wednesday, September 14, 2005

That's why they call them perma-bears

Last night the 1987 movie Wall Street was on the gazillion bajillionth time and a particular Gordon Gekko line caught my attention: “Our trade deficit and fiscal deficit are at nightmare proportions.”

The perma-bears have been crowing over the deficits for over twenty years now. It has become their rallying cry. You can tell when things are going well for the economy because that’s when you hear about the deficits the most, when they’ve got nothing else to complain about. Mostly though, it’s just a way to sell newsletters.

Sure it’s ‘just a movie’, but the line typifies the thinking at the time. Reagan’s deficits were talked about at dinner tables all across the country. How is it that with such deficits and declining savings we managed to embark on the longest period of prosperity and low inflation in the history of the country? Remember my post Most Research Papers Wrong? I hypothesize that much of what we think we know about macroeconomics will be rewritten, and the rewrites will be rewritten.

Not surprisingly I was able to find the entire “Wall Street” transcript online. Here’s the speech in which the line above came from:

Well ladies and gentlemen, we're not here to indulge in fantasies, but in political and economic reality. America has become a second rate power. Our trade deficit and fiscal deficit are at nightmare proportions. In the days of the 'free market' when our country was a top industrial power, there was accountability to the shareholders. The Carnegies, the Mellons, the man who built this industrial empire, made sure of it because it was their money at stake. Today management has no stake in the company. Altogether these guys sitting up there own a total of less than 3% and where does Mr. Cromwell put his million-dollar salary? Certainly not in Teldar stock, he owns less than 1%. You own Teldar Paper, the stockholders, and you are being royally screwed over by these bureaucrats with their steak lunches, golf and hunting trips, corporate jets, and golden parachutes! Teldar Paper has 33 different vice presidents each earning over $200,000 a year. I spent two months analyzing what these guys did and I still can't figure it out.

posted at 4:30 PM 3 comments   

Just tell me what I want to hear, please

The most successful politician is he who says what everybody is thinking most often and in the loudest voice.
Theodore Roosevelt


The same can be said of market pundits and analysts, which points to our own shortcomings and our attraction to being told what we want to hear.

posted at 3:50 PM 0 comments   

Ex-Merc broker gets 18 months

Was it worth it?

Ex-Merc broker gets 18 months

posted at 3:42 PM 6 comments   

Timing of Stock Issuance Raises Eyebrows After Upgrade

Timing of Stock Issuance Raises Eyebrows After Upgrade
The April 2003 settlement of charges that Wall Street issued biased stock research to win investment-banking business severed many ties between research and stock underwriting.

But a $79.5 million stock issue last week by NPS Pharmaceuticals Inc. shows how an analyst's upgrade on a stock can still have an impact on the timing of a new issue. In this case, within two days after a Lehman Brothers Holdings Inc. analyst upgraded NPS, Lehman bankers won the right to lead a stock issue for the biotech company.

posted at 3:22 PM 0 comments   

Interwoven Indicators

Today’s economic news included; Industrial Production and Capacity Utilization from the Fed, Advance Monthly Sales For Retail Trade And Food Services from the U.S. Census Bureau, and Weekly Petroleum Status Report from the Energy Information Administration.

The industrial production data was rather moot, but production did fall off at the end of the month due to the hurricane. If a person were inclined to do so they could work the fall off into a reasonable estimate for September keeping in mind that the trend would be from zero production to some small portion of the production pre Katrina. Then the data could be looked at from an ex Katrina perspective. It is important data because the Fed will no doubt be watching for any signs of a slowing trend in the economy. This data alone won’t give all the answers. For example, if the consumer is still spending, but industrial production wanes it could mean that companies are trying to reduce expenses money by producing less, which could lead to demand exceeding supply and therefore higher prices. But it could also mean that demand is slowing. So this data needs to be looked at in connection with sales, pricing, inventory, and other data.

The retail sales data is an indicator of how the consumer is doing and is no doubt a key piece of data for the Fed right now. There has been a lot of debate as to whether high energy prices are doing the Feds job by slowing down the consumer or whether high energy prices will trickle or ripple down into consumer prices. Actually, high energy prices will do both and simultaneously consumers will reduce their demand for energy to minimize the impact on disposable and discretionary income. What investors, traders, economists, analysts, et al are trying to figure out is which way the scales are tilting.

With gasoline prices rose relatively gradually we didn’t see a reduction in demand, but when prices shot up suddenly after the hurricane took out a sizable portion of the country’s refining capacity demand dropped significantly. In fact, this week’s petroleum status report showed build in gasoline inventories.

The build in gasoline inventories came as quite a surprise to energy traders. I was somewhat surprised myself. After the hurricane I rattled off a number of ways that the gasoline supply disruption would be offset. A lot of people have been asking me offline what I thought would happen with the energy markets. I’ve been telling people, and perhaps I’ve posted this but I can’t recall, that I thought in a couple of months we’d be awash in gasoline. When you combine the impact that sticky retail prices are having on demand, the temporary lifting EPA refining restrictions, oil being loaned from the SPR, a bump up in production at operational refineries, some affected refineries coming back online, etc… it all adds up to more gasoline despite the incapacitation of several refineries. But I have to admit that I wasn’t expecting a build quite this soon.

More than anything else the sudden price shock has made people more aware of their consumption and ways they can cut back. To be sure, teens all across the country are doing less cruising and more parking.

posted at 2:07 PM 0 comments   

Tuesday, September 13, 2005

Wall St. Wolves Endangered Species or Viral?

Westar Executives Wittig and Lake Convicted of Fraud
A Kansas jury convicted former Wall Street executives David Wittig and Douglas Lake of looting Westar Energy Inc. of $37 million when the two men ran the company, the state's largest utility owner.

posted at 3:30 PM 0 comments   

A drop in the bucket...

No new requests to borrow crude from US stockpile
The U.S. Energy Department has not received any new requests from hurricane-hit U.S. refiners to borrow emergency crude oil, Energy Secretary Sam Bodman said Tuesday.

Asked by reporters if the administration is considering any new loans aside from the 12.6 million barrels already loaned to six U.S. refiners, Bodman replied "No."

He and Interior Secretary Gale Norton were scheduled to visit on Tuesday a U.S. Gulf Coast refinery and one of the government's storage sites for emergency crude oil.

posted at 3:23 PM 0 comments   

Most Research Papers Wrong

If scientists can’t get it right even half the time, how reliable could unscientific information from biased market analysts and pundits be?

Most scientific papers are probably wrong
Most published scientific research papers are wrong, according to a new analysis. Assuming that the new paper is itself correct, problems with experimental and statistical methods mean that there is less than a 50% chance that the results of any randomly chosen scientific paper are true.

Referenced research paper (PDF):
Why Most Published Research Findings Are False

Try wrapping your mind around this accidental paradox: If the paper is correct and there’s less than a 50% chance that papers are correct, then this paper is most likely wrong and if the paper is wrong then there may be a better chance the paper is right. Getting a bad song stuck in your head is more comfortable.

posted at 2:36 PM 0 comments   

Inflation Illustration

I worked up the following charts comparing PPI to CPI and Core PPI to Core CPI data back to 1970. The chart helps to illustrate where inflation is now compared to past years. The data is the percent change in the index over the previous twelve months.

The Fed has expressed concerns about core inflation running near the high end of the range consistent with price stability. Typically, the CPI has not reacted to the more minor fluctuations in the PPI, but whenever the PPI has crossed the CPI it has led to higher consumer prices. I think the Fed is most concerned with the core PPI leading pulling up the core CPI. But, personally I don’t think that the indices do the pinch we’re feeling over higher energy prices justice. Remember, these are mathematical indices and don’t necessarily reflect well upon the actual allocation of personal expenditures and the impact on changes in prices on disposable or discretionary income.

posted at 1:51 PM 0 comments   

PPI down, CPI and Fed to go

The Producer Price Index (PPI) increased six tenths of a percent (0.6%) in August, while core prices were unchanged. The consensus expectation was for 0.7% and 0.1% respectively. Last month prices increased 1.0% overall and 0.4% at the core level. Thus the increase was more modest than expected, more modest than last month, and didn’t trickle or ripple down into core prices, which exclude food and energy.

However, the Fed is probably just as interested in the overall increase as an indicator of future core inflation because producers will increasingly pass on higher costs over time. The overall number of 0.6% amounts to an annualized rate of 7.2%. If you average July’s 1.0% with August’s 0.6% then the annualized rate is pushing 10%.

It’s definitely high enough to keep the Fed on track, though the Fed futures reflected the lower than expected data by decreasing the probability of a third hike in December back to near zero.

Next up is the CPI on Thursday. For the past several months the consensus expectation has been for overall price increases to trickle down into core prices by more than they have. The expectation for August is 0.5% overall and 0.2% core. July came in at 0.5% and 0.1% respectively. Traders will be particularly focused in on the core number as a sign of whether higher prices are reaching the consumer in products other than food and energy.

The markets are taking a pause and may continue to do so through until we see what the Fed decides to do with rates a week from today. Unless we get a surprise in the CPI data, or any other significant surprise for that matter, I expect the markets to be mundane over the next week.

posted at 10:39 AM 0 comments   

Monday, September 12, 2005

US Treasuries fall as market braces for rate hikes

US Treasuries fall as market braces for rate hikes

U.S. Treasury debt prices fell on Monday as the bond market saw increasing likelihood the Federal Reserve will raise short-term interest rates next week despite Hurricane Katrina's economic damage.

Reflecting that view, fed funds rate futures priced in an 84 percent chance of a rate increase at the Fed's Sept. 20 policy meeting, compared with a 78 percent chance at the end of trading on Friday.

Think about this for just a moment. If the Fed isn't going to pause this month on the heels of Katrina, then why would it do so at either of other two meetings this year? The Fed has said time and time again that unless there is data to the contrary it intends to remove policy accomodation. I doubt we're going to see any contrary data between now and the end of the year indicating a decline in inflation given the trickle down impact of energy prices and continued pressure on home prices.

posted at 3:34 PM 0 comments   

Fed Watch

The August PPI data released tomorrow AM and the CPI data out on Thursday will be more widely watched than usual. All eyes are on the Fed and since the Fed has been in an inflation fighting mode traders will be particularly interested in what the August inflation reports have to say.

After Katrina, with emotions running high, the consensus was that the Fed should and would pause. The thought was that Katrina could do the Fed’s job of slowing the economy. This was never my belief as I think the Fed is more concerned about high energy prices trickling down into core inflation than it is about slowing the economy. And I don’t think that Katrina will have nearly the negative impact on the economy that has been widely speculated on.

If inflation turns out to be greater than expected this week then investors are likely to go back to thinking the Fed will keep on keeping on with its rate hikes and we may see a sell off in the markets. Conversely, if inflation appears contained then we may get a pop in the markets. But I still think the Fed will raise rates through the end of the year at least because it will be focused on the impact of Katrina on prices next year, not last month.

posted at 1:59 PM 0 comments   

Oracle Gets Even More Complicated

Build a system that even a fool can use and only a fool will want to use it.
Murphey’s Law

Statements like this sound great, but generally over simplify reality. One of the key features of Oracle (ORCL) database products is complexity. Much simpler free open source database solutions threaten Oracle’s core offering. Larry Ellison recognizes this and has been for the past several years striving to diversify its interests into other business back office related software solutions.

There has been quite a bit of debate as to whether the company has overpaid on some of its acquisitions. The battle for PeopleSoft got nasty to say the least, but Oracle conquered the beast.

Oracle’s diversification reminds me of IBM’s move from mainframes to services. It’s a good move and the acquisitions have all been good fits for the company. Most of the company’s that Oracle has acquired provide backend business systems such as accounting, inventory, and logistics management software. These systems offer specialized data entry software and report generation, but they are coupled to complex behind the scenes databases. So these companies do fit well within the realm of Oracle’s expertise.

Yet the company makes me uncomfortable. I’m concerned about the level of hubris and ego of its leader. I think Ellison really mishandled the PeopleSoft deal and I think he got a lot of unhappy employees in the process. Oracle products have been known for their complexity, as have PeopleSoft products. The combination of the two companies and now Siebel Systems (SEBL) for nearly $6 billion only further complicates the offerings and the products at least for the time being.

I want to see Oracle simplifying and merging its offerings, making it clear what it has to offer businesses and making the various back office-systems work well together. But I’m not convinced that Oracle will be able to pull that off as long as it continues to be focused on share price and monopolization of the back-office systems sector.

posted at 1:21 PM 0 comments   

Friday, September 09, 2005

General Re CEO Receives Notice From SEC

General Re CEO Receives Notice From SEC
The chief executive of General Reinsurance Corp., Joseph Brandon, has been notified that he could face civil charges as a result of a federal regulatory probe of the firm's nontraditional insurance products, its parent Berkshire Hathaway Inc. said Friday.

posted at 1:24 PM 0 comments   

Confidence Sinks in September on Katrina

Confidence Sinks in September on Katrina
Consumer confidence tumbled in early September as Hurricane Katrina made people feel increasingly anxious about the economy's prospects and their own in the months ahead, according to figures released Friday.

posted at 1:22 PM 0 comments   

Study: CIOs to increase hiring | CNET News.com

Study: CIOs to increase hiring
In the latest sign of better times ahead for techies, a new study has found that chief information officers plan to increase their hiring in the last three months of the year.

posted at 1:18 PM 0 comments   

The Other Side of Sears

Investor rolls up his sleeves to revitalize Sears
Edward Lampert, the billionaire investor who last year engineered the merger of Sears and Kmart into Sears Holdings, said yesterday he's replacing its chief executive and installing himself as the company's top merchant and marketer.

I have to say that I’m not a big fan of this outfit. In my opinion Sears and Kmart have seen their best days. Additionally, Kmart, like Wal-Mart (WMT), is apt to have its sales offset by high gasoline and home heating prices. They are further being squeezed by their own additional transportation costs and inflation trickling down into the goods they sell.

However, Sears Holdings (SHLD) sells a plethora of goods and services that New Orleans victims will be reimbursed for and want to replace. One area in particular that Sears will benefit from is the fact that they have long been in the replacement window and siding business. I suspect that rebuilding sales will more than offset an energy related slowdown.

But more importantly, I suspect that at some point in the near future investors and analysts will start to look closer at Sears as a rebuilding play and take the stock hire, which turn a position in Sears into a decently profitable trade over the next month to a year.

One way to play the position is as a pairs trade of long Sears / short Wal-Mart.

posted at 1:07 PM 0 comments   

On Yield Curves

Previous periods of yield curve inversion are different than the current period of possible inversion.

First off the average fed funds rate at the time of inversion has been about 10%, meaning that interest rates were very high for both long and short rates and meaning that the Fed was moving very high for a reason such as inflation being out of control, etc.

There is no indication at this time that the Fed will go anywhere near that high. All indications are that the Fed will continue to hike rates at a 'measured pace'. My feeling is that one of the ideas behind raising rates slowly and modestly is to give long rates time to adjust accordingly.

But I don’t believe the Fed has as much control over the entire gamut of rates as it once had. The Fed doesn't have much control, for example, over the demand for U.S. debt by foreign governments. If short rates invert to long rates then it's likely that foreign governments will simply buy shorter maturities pushing those yields back down again.

My sense is that we are heading into a long-term period of narrow yield differentials. Why? Because of globalization and the Internet. Yields are more competitive. When people want to borrow money they shop rates a lot harder than they ever did or could have done in the past. Banks and other lending institutions are competing harder and therefore have to operate at lower margins and now have to rely on dinging people with late payment, over balance, and other such gimmicks. Consequently, the yield is going to be flatter in a more competitive environment and simultaneously the lower than historical average rates are stimulating borrowing and creating a disincentive to saving.

The other day the Chicago Fed president was complaining about the low savings rate and saying that we as a country needed to save more and invest that money on capital and equipment. But that's a contradictory statement really. If people are busy saving then they aren't spending. I don't see the lack of savings as such a problem, but rather more of a shift in response to changing conditions. It's quite logical that people are going to save more and spend less when the cost of borrowing is high. Conversely, they are going to spend more and borrow more when the cost of borrowing is low. Which is more stimulative to the economy?

We're not necessarily heading into a period of inversion, but more likely a period of very low differentials and a very flat yield curve, which will cut into any organization that relies on these differentials for its profit margins such as banks, mortgage companies, mortgage REITs, and such. This is I think why the bond pimps go on TV calling for the Fed to lower rates. A flat curve hurts everyone that makes a business of arbitraging rate differentials.

posted at 12:17 PM 4 comments   

Thursday, September 08, 2005

Bill Gates: China has f****d Microsoft

Bill Gates: China has f****d Microsoft

Bill must have thought that no one, not even China, would dare f*** him over. The Chinese were only doing what they always do, protecting and fixing markets and stealing technology.

posted at 3:11 PM 1 comments   

Dollar firms as US rate rise talk rekindled

Dollar firms as US rate rise talk rekindled
The dollar hit a one-week high against the euro and the yen on Thursday as expectations grew the Federal Reserve could continue raising interest rates despite the damage caused by Hurricane Katrina.

posted at 3:02 PM 0 comments   

Chicago Fed Tows Line

I read the transcript from the speech given to the Futures Industry Association yesterday by the President and CEO of the Federal Reserve Bank of Chicago, Michael Moskow. Several things were noteworthy in that speech that didn’t make it to you via the mainstream media.

It was clear that like other regional Fed leaders Mr. Moskow was speaking on behalf of the Chicago Fed branch and not the Federal Reserve Board. It appeared that Moskow towed Greenspan’s line, but it wasn’t clear that he understood precisely what that line was. The speech was basically a slight variation on past Fed meeting minutes.

The comment most repeated by the media was, “Putting it all together, I’m concerned about core inflation running at the upper end of the range that I feel is consistent with price stability.” This is nearly word for word from the last Fed meeting minutes.

But in meat in the middle he also talked about not having much in the way of data to accurately determine what Katrina meant to overall economy. It concerned me that he thought market prices were the best source of information. He seemed to prescribe to ‘the markets are always right’ theory. But then he was speaking to a room full of futures traders.

The markets aren’t always right. Actually, they are never right. That’s why they are constantly changing and readjusting. Last week the consensus was that the Fed would pause. This week traders have backed off that belief. Traders are short sighted. I don’t put much stock in traders to know what Katrina means for the economy.

Moskow also looked to TIPS price data as an indicator of future expectations for inflation. He said of this, “Notably, TIPS data and surveys suggest that the private sector’s long-run inflation expectations remain stable.” But are TIPS traders a good judge of future inflation? First off TIPS haven’t been around long enough to study the hypothesis and secondly people have become complacent with regard to inflation. People haven’t experienced significant inflation in such a long time that whether they expect it now is independent of whether it’s actually coming or not.

posted at 2:37 PM 0 comments   

Wednesday, September 07, 2005

Oil: $35 or $105? Part 2

I’ve written here in the past about why I believe why oil prices have been pushed to such elevated levels over the past couple of years. But I think it’s an important enough topic to emphasize repeatedly because it illustrates so well just how difficult it is to predict market movements, but also how important it is for investors to understand the truths of the markets.

First there was the collapse of the NASDAQ and dotcoms, the decline of other major stock indices, the recession, and the corporate scandals that lasted from roughly 2000 through 2003 with the economic recovery still continuing half a decade later. Those events made people hesitant to own stocks and unusually open to diversifying into alternative investment vehicles.

Then more recently there were the mutual fund scandals. Two years ago this week Eliot Spitzer took on the multi-trillion dollar mutual fund industry for selling to hedge funds ways to profit at the expense of the fund companies’ retail clients. Janus, Putnam, and Bank of America were among more than three-dozen firms that investigators have found problems with since the scandal broke.

The scandal triggered billions of dollars in redemptions from the mutual fund industry, which amounted to a severe downturn for the industry. The redemptions led to numerous funds being consolidated or shut down altogether. It also led to layoffs of portfolio managers and analysts who were thrown into a job market that wanted little to do with them.

So what were the many unemployed portfolio managers and analysts to do when no companies were hiring in the mutual fund industry? Steal away their former employers high net worth customers and start their own funds. Since the customers dissatisfied and distrustful primarily of the companies and not the individual fund managers they were easily baited, and since hedge funds are much easier to establish than mutual funds we ended up with many billions of dollars flowing into a few thousand new hedge funds.

Unlike mutual funds, hedge funds do not have tight investment parameters well defined within investment prospectuses. Hedge fund managers can pretty much invest in just about anything and everything they want including commodities and real estate.

When you look at the chart of oil prices below going back to 1990 you can easily see that through mid 2003 prices were acting normally. By normally I mean sometimes they were exceptionally high or exceptionally low, but there was no significant long-lasting trend in either direction. What we had during that period was primarily the markets reaction to OPEC’s supply manipulations. When prices got very low in the late 1990s OPEC was sufficiently incentivized to make determined supply cuts. Take note that it was during a worldwide and economic boom and bull market for equities that oil prices were falling to all time lows.

It’s no coincidence that oil prices started to climb without looking back just as the mutual fund scandal and redemptions kicked into high gear in late 2003. You can see the same pattern in the broader CRB. The reality is that absolutely nothing of economic significance involving either the supply or demand for these commodities occurred at the end of 2003 to trigger these massive upward moves in prices.

When you look at what has happened from a very macro perspective this is obvious. There were no sudden shocks to either the supply or demand for these commodities over the past few years. On numerous occasions I’ve posted statistics on both global and national oil production and demand data that proves this fact beyond any doubt.

Nearly every day some analyst, and many days multiple analysts, come on the TV talking about strong demand for oil, how growing demand in China is driving the market higher, how there’s limited supply, such and such oil refinery fire is to blame, etc, etc... Yet when you listen to them carefully these analysts never, ever, ever, ever, EVER cite proper sources or statistics to back up their claims.

For well over a year now I’ve been listening to these yahoos yammer on day in and day out saying the same old idiotic, ignorant things over and over again driving prices yet higher. When enough people come onto the TV saying it day after day, people believe what they are saying, and even the people saying it believe what they are saying.

But again, the demand for oil didn’t suddenly change in the fall of 2003. Neither did China suddenly become an economic powerhouse and prolific user of oil in the fall of 2003. It’s true that China’s demand is rising, but what you never hear anyone say on TV is that China still only consumes somewhere around 8% of the world’s oil production and we don’t know how much of that 8% is actually being consumed versus being stockpiled.

Now look again at the oil chart below. Only this time take note of the price change since Hurricane Katrina hit the gulf. Notice what a tiny move it was compared to how much prices have risen over the past two years. Katrina is a REAL serious supply shock and prices haven’t budged. The price of oil is less than it was a few weeks before the hurricane hit. The lack of movement in prices was NOT because he hurricane was already priced into the market. In order for that to be true it would mean that traders were pricing in a 100% probability of a hurricane of this magnitude hitting. It is typical for traders to price in some level of risk premium, but no one anticipated that such a devastating hurricane would smash through the gulf and do so much damage to the energy infrastructure.

The relatively small move in prices related to the hurricane’s damage illustrates to just what an extent prices have been driven, not by supply and demand for the underlying commodity, but by the supply and demand for the futures contracts.

This is an abstract concept. People seem to have about as hard a time grasping it as they do calculus and consequently they avoid it to a similar degree. There is a supply and demand equation for oil and there is a supply and demand equation for futures contracts tied to oil. The two share a complex interrelationship that to my knowledge economists have yet to study thoroughly. Most people prefer to assume that the price of a futures contract is determined by the supply and demand equation for the underlying asset or commodity. While it’s certainly easier to visualize the relationship this way it’s not an accurate picture and thus you get situations like we’re in now where the equations and prices don’t seem to add up.

Prices of such things as a futures contract for oil tend to regress over time toward the equation for the supply and demand for the underlying asset or commodity. If we’re talking about oil then the price of the near-term futures contract should accurately reflect a price level at which the companies that produce oil operating in a competitive market can obtain a reasonable profit margin that allows them to continue competing in the market and discovering new oil.

People usually understand this concept with regard to stocks. A stocks price reflects the underlying companies ability to profit from the sale of goods and services. But they don’t always get it. They didn’t get it when they bid the Chinese Internet company with $2 million in revenues (or was it earnings, its trivial) up to around $130 a share on its first day of trading. And investors forgot this relationship when they bid up stock prices at nearly three times the rate of earnings growth in the late ‘90s.

But the relationship between supply and demand of an underlying asset or commodity and the supply and demand for a related investment contract is not a perfectly efficient one. In fact it is quite inefficient. And it’s this inefficiency that every trader and investor seeks to profit from, some just do better than others.

The point is that for the past two years demand growth relative to supply growth of futures contracts related to oil has outpaced the demand growth relative to supply growth of actual oil, just as demand for stocks outpaced earnings growth in the late ‘90s. This is why oil prices are in a bubble. The differential is unsustainable and thus the two equations must eventually converge.

What makes this really obvious is the fact that as traders and investors talk about how much the demand for oil will increase in the distant future, say one to ten years from now, they are buying up futures contracts that expire in a month or two or three from now as if the equation is going to change significantly in that short period of time. There’s no logical refutation of the fact that the market has been driven higher by speculative buying and holding of futures contracts. Instead of simply buying long-dated contracts the speculators are buying near-term contracts and rolling them over into the next month.

Prices will come down, eventually, and $35 is more likely than $105 in my opinion. In fact $35 isn’t unlikely at all when you consider the number of speculators long oil contracts that have no intention of taking delivery on the actual commodity. As speculators they would be just as likely to short the contracts all the way back down to $10 a barrel, as hold long to $100 if they thought they could profit from it. The thing I think working against that happening is that much of the money being invested in the energy markets is being run by people with business and finance backgrounds used to running long only funds. Consequently, they are more prone to buying and holding long than short.

posted at 3:45 PM 1 comments   

Oil: $35 or $105? Part 1

The other day I posted a link to an article that was sent to me in which the financial publisher and previous presidential candidate Steve Forbes called the energy markets a bubble and said that oil would be going to $35 a barrel inside of a year. That figure is in sharp contrast to the Goldman Sachs $105 super spike scenario.

Who’s right?

Fellow blogger Catablast! had this to say about the article:This is Bullshit - pardon my french. First the boys at Goldman with their $105 Oil Report, now this. I thought I was extreme in my calls -- this chicanery has to stop. Oil isn't going to $35 -- we all know that.

Most people would agree that $105 oil is probably now more unlikely than ever. As the thinking goes, if Katrina couldn’t push oil over $100, then what could? However, we should be willing to admit that as a ‘super spike’ point, $105 seems a bit less ridiculous now than before the hurricane. Neither would I go so far as to call the Forbes call Bullshit. There is little doubt though, that both calls had ulterior motives.

By Goldman Sachs’ own admission in its quarterly report for the period in which the now famous, case study worthy Super Spike paper was issued the company took a very large hit when oil prices weren’t as volatile as it had hoped. Goldman Sachs is one of a few large Wall Street firms that still relies on its own trading for the majority of its profits. As such its research can’t be considered independent. In fact the companies disclaimer at the bottom of the first page of the report states: The Goldman Sachs Group, Inc. does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

Yet Goldman Sachs is very aware that even when they flat out tell people that they might be acting in their own best interest by issuing such a report people still regard the firm’s information with a certain level of legitimacy, distinction, and respect.

In my personal view the report was beyond irresponsible to the point of being dastardly, cold, and callous to the people being impacted by oil prices that at around $50 a barrel at the time the report was issued were already unnecessarily elevated and damaging to common citizens of this country. In my opinion the company tried to take advantage of a fragile market for its own personal gain.

As a speculator myself who has recommended or traded in energy positions what’s the difference between what I do and what Goldman Sachs did? The answer is that there really is no significant difference between what this firm did and small time speculators going into chat rooms to talk up illiquid small cap and penny stocks. The only real difference is the size of the market, which is the firm’s out. It would likely argue that it couldn’t possibly influence the market for the most widely traded commodity in the world. And it would also likely argue that its research was legitimate research and only reflected what might happen under extreme circumstances. But the firm’s intentions, obvious to everyone, were at a minimum an irresponsible marketing plow.

In the Forbes case, it’s very likely that the call was politically motivated. If prices fall he’s a hero. If prices don’t fall, well then at least he tried to help the people. I don’t have such a problem with that because if he were able to influence prices to the downside that would be good for the majority of people except likely Goldman Sachs and numerous hedge funds and their investors.

Overzealous opportunists and office seekers aside what then is the truth of oil prices?

To understand where oil prices might be going we have to look at how they got so outrageously elevated in the first place. I think it might be a good time for a pause. I’ll continue with my explanation in the next post.

posted at 1:12 PM 0 comments   

Tuesday, September 06, 2005

Economic Predators or Entrepreneurs

Under the dire circumstances that New Orleans and other gulf coast areas have found themselves we should be forgiving about mistakes made and bouts of insanity. There have been calls for federal officials to be fired. In my opinion if anyone should be fired it should be the mayor of New Orleans. He has acted unbecoming of a leader. This morning he spoke on television about the problems they’re starting to see with economic predators and comparing them to the looters.

An economic predator is just as bad as a looter in my book. These scoundrels are more deceptive and harder to identify than looters that steal in plain site. Economic predators will likely do far more damage than looters have. I write about these wolves all the time here. Last week, for example, I explained how the aftermath of the hurricane made it clearer just what a weasel Hank Greenberg et al is.

But what the mayor of New Orleans had to say really got my goat. When he was talking about economic predators he talked about people coming down there trying to get contracts and make millions while they were still trying to rescue people and recover bodies. He didn’t say anything to differentiate legitimate entrepreneurs from thieves and clearly indicated his economic misguided thinking by identifying all contractors seeking to profit as the same vermin as common thieves.

If that kind of attitude is common place its hard to see how New Orleans could ever recover. The only chance that city has of recovering is the lure of getting a piece of the money the government and insurers will be infusing into the city. The vast majority of deconstruction and reconstruction will be driven by entrepreneurs willing to leave their families behind for many months at a time and go down their with their bulldozers, backhoes, and dump trucks. The migrant workers and illegal immigrants working under the table will play a huge role. Just as a queen bee depends on hundreds of worker bees the city of New Orleans will depend on luring workers equipment down there from all over the country. And for people to leave family and jobs behind to go down there, there has to be a sufficient economic incentive.

The fact that people hope to make millions is what will draw enough people down there to get what needs to be done, done.

posted at 4:07 PM 0 comments   

Testing 1 2 3

Testing 1 2 4

posted at 3:44 PM 0 comments   

Things had to break

Very often things have to break before they get fixed right or before people are willing to face the truth. Unfortunately, sometimes things break very badly before they are fixed.

Terrorists were able to take over airplanes because people had been led to believe the best strategy was to submit to hijackers. People all too often make the same mistake twice or a slight variation on the same mistake. Attacking the President for the war in Iraq is a variation. The strength of the United States has throughout its history been that Americans have not allowed them selves to be bullied. As our country becomes more sophisticated and technologically advanced we are becoming less willing to deal with ugly problems, less willing to face the truth, and quick to blame the government whenever things aren’t pretty, peaceful, and easy.

But the world is never as pretty, peaceful, and easy as we want it to be. The longer things are easy the more complacent we become. I’d rather be done in LA or MS helping out right now, and I’d much rather be climbing a mountain or fishing, but I have to work to pay the bills and I have to put my family first. I can’t afford to be too complacent.

New Orleans was complacent with its levees. There’s no doubt about that. The city had an obligation to protect its citizens. New Orleans shouldn’t blame the federal government for cutting spending. As an independent city New Orleans was accountable for its own weather defenses. Blaming the federal government is a liberal socialist thing to do. Our country is getting to socialistic as it is. To put New Orleans negligence onto the federal government is to expect it to be in charge of all aspects of our society and that goes against the foundations of our country.

The facts are that New Orleans is built on ground that is now mostly below sea level. The storm swelled the lakes and rivers around the city and the city was flooded. The levees intended to keep the water out were we are told designed to withstand a class three hurricane. Katrina jammed itself right up into the gulf’s stovepipe. The gulf funneled the storm straight up the Mississippi River. The levees should have been built to handle such a storm. They weren’t. Only the city’s government should be blamed for that.

Things broke and broke badly. Many thousands of people are dead. Tens of thousands have suffered. Hundreds of thousands are homeless and jobless not because of the hurricane, but because the city didn’t build walls strong enough to keep the floodwaters out of the city. An entire city was destroyed overnight. New Orleans is now New Pompeii.

But that’s not all that broke. Our refineries are still disabled because we had them lined up along the coast as a matter of convenience. Our enemies are probably taking note of this weakness and reprogramming their intercontinental ballistic missiles.

Sometimes things break just bad enough for us to see the truth without causing any serious harm. People suddenly become much more careful drivers after they’ve been in a car accident. Even if its not your fault you will probably find yourself being much more alert to other peoples mistakes, perhaps not following so closely, being more observant through intersections, etc…

I think that’s the point we’re at now with gas prices. We got a little scare. At over three dollars per gallon people just aren’t going to go for a Sunday drive anymore. Face it, it sucks to have to think about how much gas your using. It ticks people off to have such a seemingly small indulgence suddenly taken away from us. It feels like we’ve had a bit of our freedom relinquished, like we’re teenagers and had our car keys taken away. It’s a freedom we’ve taken for granted.

I think we just pushed people to the point of doing something about it, to the point that they will want to lynch anyone they think is responsible for taking their cheap gas away. Certainly the hurricane is the primary scapegoat, but I’m starting to hear more and more people speak up and ask why prices were so high before the hurricane. The thing is that when people are ticked off their not going to be so quick to excuse the patent answers without questioning them further.

When the supposed experts say that there just wasn’t enough refining capacity and blame government regulation, people are going to start asking why the refiners aren’t building refineries in Mexico. After all, when they lost their job with the car company a few years ago it was because the car company built a new plant in Mexico. And then there going to start to wonder how come we never had any supply disruptions before the hurricane.

Economists and the media have long asked what is the tipping point in which high gas prices really begin to hurt the economy. In reality, the tipping point price is the point that gets people pissed off enough to start asking the right questions about why prices are so high. It’s the point where they scare the speculators into some other market because they rightfully or wrongfully start of vilify the speculators.

posted at 3:18 PM 1 comments   

Forbes predicts oil will drop to $35 within a year

Thanks to a reader for sending the link to this article:

Forbes predicts oil will drop to $35 within a year
Steve Forbes, the billionaire business publisher, predicted that the oil bubble will burst inside a year and the price will plunge, as the impact of Hurricane Katrina sent the price of oil soaring to new record levels.

The inability of people to act rationally continually amazes me. But as I like to say markets regress to the truth, eventually.

posted at 2:12 PM 2 comments   

Friday, September 02, 2005

Katrina teaches many lessons

Hurricane Katrina has taught us many lessons already. One that is being overlooked is what it should be teaching us about bad business and bad people.

Insurable disaster losses are being estimated at $35 billion, which we are being told makes Katrina and the New Orleans flood the most costly natural disaster in the history of the country. The hurricanes impact on the gulf’s oil, natural gas, refining, and shipping interests has also sparked an energy crisis.

Perhaps one good thing out of it all is that people will get their priorities straightened out for a while. Suddenly, selling our oil companies to anybody at all doesn’t seem like such a good idea, does it? At least the EU has opened up its energy reserves for us. Where are our supposed friends the Chinese in our time of need?

But to be fair, where are we for the Chinese? How many people in the U.S. realize that China is dealing with serious natural disaster of its own? Typhoon Talim hit blew through Taiwan and then slammed into China’s coast this week. Almost 800,000 people were relocated over the past several days. Though the storm did not have evenly remotely close to the devastating impact that Katrina has had in our southern states.

Another observation I’m making has to do with the insurance industry and its obligations to pay claims. As Maurice “Hank” Greenberg’s ship was sinking a lot of corporate leaders came out to say what a genius Greenberg is, what an upstanding guy he is, what a great innovator and leader, etc… I wrote in this blog numerous times what a bunch of B.S. that was, how very wrong what his company was doing was, and how bad his desire for and obtaining of an ‘unfair advantage’ was.

Insurance regulators put reserve requirements in place to ensure that insurance companies would remain liquid and be able to pay claims under extreme circumstances such as the ‘perfect’ storm we’ve just witnessed. If it were not for these requirements you can be certain that many if not most shortsighted, profit-driven insurance companies would have much lower claims paying abilities. I worked in the insurance industry for quite a few years, so I know what I’m talking about on this subject.

As it was some insurance companies were figuring out ways to skirt the regulations and reduce their reserves. In the case of AIG, the company set up bogus offshore reinsurance companies that it secretly owned and controlled to supposedly transfer risk. The thing about the offshore reinsurers, however, was that they had much lower, if any, reserves or claims paying ability. The sole purpose of their existence was to take on the parent companies risks so it would appear that AIG held less risk than it actually did and could therefore maintain lower reserves.

If an event occurred that was more than the offshore reinsurance shells could pony up on, then AIG would have had to secretly pay the claims themselves as if the reinsurer had made good on the claim. But in catastrophic event it’s possible that AIG could not meet the obligations of both its own risks and the risks of the bogus reinsurer.

I don’t most people have realized just how slimy Greenberg is or the true nature of what he was doing wrong. The magnitude of the hurricane and the floods has certainly made people fearful about whether the major insurers will be able to meet their obligations. Imagine that you’re a policyholder whose home was destroyed and you find out that before you’ve been reimbursed the insurance company runs out of money because the company had been passing its risks to a Bermuda reinsurance shell company that couldn’t pay claims on the risks it reinsured. Effectively, your premiums then amounted to little more than being part of a large and complex Ponzi scheme. That really is essentially why AIG had been so successful and why it became an industry leader. It was dealing dirty in every way it could, and did so for many years.

AIG did not have the claims paying ability that the insurance rating agencies thought it had. If the rating agencies had known its true claims paying abilities it would have downgraded the companies ratings and brokers would have had difficulty selling its insurance. The company would have had to lower its premiums, would not have been as profitable, would never have become an industry leader, and Greenberg might have become a sniveling little Don Knots of a weasel with short man’s syndrome instead of an idolized corporate legend.


But worst of all, people who had a legally-binding contractual agreement with the insurance company could have been left with nothing after years of religiously making premium payments to the company only to further enrich a cold, callous, calculating, manipulative, and greedy business man.

Now the company would likely say that its claims paying ability was never significantly comprimised because the vastness of the organization and the diversification of its interests, or something to that effect as corporate leaders always do when they want to excuse their wrong doing. But that's really besides the point. The rules were there for a reason. AIG and I can only assume numerous other companies that haven't been caught chose to go around them.

This is the truth of the matter. People had better hope there insurers have been on the up and up. So far all the talk about the magnitude of damages has mostly been property and casualty related. As we move forward we’re going to start to hear more and more about the loss of life and then it’s going to become a life insurance issue as well.

posted at 5:04 PM 0 comments   

Life goes on

Lot’s of strange off-hand things are being said in Katrina’s wake and throughout the continued rescue efforts in the city of New Orleans. Yesterday I heard NPR suggest that perhaps New Orleans should declare itself a separate country so it can apply for international aid. Lots of talk has been focused on scrapping the city altogether. Before the levees broke turning New Orleans into New Venice overnight like Vesuvius burying Pompeii, the media attention was on grounded up riverboat casinos.

Most sources of communications were cut off and so the media was unable to capture the true horror of the situation. By Monday night the storm had subsided. The people of New Orleans and their homes had survived the hurricane for the most part. Imagine then the tens of thousands of people who were awakened by the sounds of rushing water as the entire city became engulfed in a single night. Perhaps many weren’t awakened until their mattresses and sheets began to wick up the knee-deep water beside their beds.

We’ve been seeing aerial photos on the television of water half way up the sides of homes. But realistically, if the entire city is filled with water then very many homes have to be completely under. The entire city can’t be that perfectly flat. I really don’t want to think about the people in those homes.

I’m sorry to paint that picture so vividly for you, but I think we need to understand the gravity of the situation in a more realistic manner than we’re being given by the media.

It makes me think about what’s important. A commercial for a cheesy nose hair trimmer was on a bit ago. Being more of a grab ‘em and yank sort of guy I couldn’t help but think how incredibly trivial the events down south make nose hair trimmers seem. But life goes on, albeit fewer. I suspect that it won’t be very many days before the first call comes into the nose trimmer 1-800 line for an order from a New Orleans area code and looted out drug stores will be replacing their stock of nose trimmers.

The point isn’t to buy stock in nose trimmer companies. The point is that people will go back to doing the trivial things they have always done. I can imagine that there are people right now sitting surrounded by water working crossword puzzles. Certainly many people will cut their losses and move on, but most people will go back to their homes and lives regardless of the less than ideal conditions. That’s just who we are. Even after the September 11th terrorist attacks it wasn’t very long before people went on with their lives as before, even those people living and working near ground zero. They soon went about their lives despite the fear, tears, noise and dust. The people of New Orleans will go back to their homes when the waters subside, open windows, rip out carpet and dry wall, and wait for their homes to dry. They will endure the dampness.

The conditions they will go back to and live with will certainly make all the thousands of sketchy mold and mildew remediation lawsuits and insurance claims seem trivial and frivolous to be sure.

The hurricane is not going to throw the country into recession. It’s actually quite amazing to me just how rational the energy markets have remained given the very real interruptions to the supply chain. Oil prices are back to the same place they were before the hurricane hit despite the fact that oil companies can’t even find all their gulf rigs. The EPA has lifted its reformulated gas restrictions and that has tankers diverting from around the world to deliver gasoline at our ultrahigh futures contract prices. The ships will be in our ports in a month or so, the ports and pipelines will be operational by then, and combined with the economic and conservationist impacts on demand we may be awash in gasoline by November. It’s even possible that prices could start to fall substantially, thus repelling the speculators from the market as interest turns to the rebuilding efforts and the companies that will benefit from it.

posted at 2:36 PM 2 comments   

I commend the hurricane's heroes...

I’ve been trying to be rational about the hurricane and its macroeconomic impacts. It’s a very confusing situation to say the least. I’ve spent a lot of time watching the news this week just as I’m sure many of you have been doing.

And I’ve been feeling frustration just as I’m sure many of you have been. We keep hearing news and all the reports of the problems at the convention center with people dying there and no food or water.

Then when I saw a commercial for a hurricane relief concert tonight, I thought it was strange that we could get together a concert faster than we could drop some food and water off at the convention center. I also thought about the President flying in and wondered what really was the point of it. But then when I listened to the president being updated on the situation, what steps the various agencies were taking, and some stories about what some of the rescue workers were seeing and experiencing it really changed my perspective.

I realized then that the mainstream media is unable to help itself from sensationalizing. How could the media possibly sensationalize the destruction of an entire city? If there’s a will there’s a way. Narrow mindedness and narrow focus. The media stations a reporter at the convention center and all we here about all week long is how bad things are at the convention center.

The truth of the matter is that a relatively few people have died at the convention center, but there’s more to New Orleans than the convention center and super convention center. The situation is dire everywhere and thousands are dead or at risk of dying throughout the city. The people at the convention center are high and dry. Rescue workers flying at night report that homes all over the city, half under water, look like stars lit up by the flashlights of people on the roofs awaiting rescue.

Who do you help first? People who were already wandering the streets before the hurricane now shooting at rescue workers because they don’t want their looting, raping, and pillaging party to come to a stop, or the police, firemen, and hospital personnel who are also victims, but once rescued will be able to contribute to improving the situation. It’s a rhetorical question.

All we here over and over again from the MSM is what a terrible job people are doing to solve the problem, when in reality the media is making there jobs harder by politicizing and questioning things they know absolutely nothing about.

When you talk to people about the situation as you go about your day and you hear people restating such ignorant information as they get from the MSM tell them the truth of the situation and explain to them how the rescue workers have bigger problems to deal with than those being sensationalized by the mass media down at the convention center and tell them how those rescue workers are working 24/7 in war like circumstances to help those most in need and get those who can help out of harms way so they can do their jobs instead risking their lives trying to rescue a bunch of looting rioters. That's not to downplay the tragedy or compassion for those good people stranded hungry and thirsty anywhere in the city.

posted at 12:34 PM 0 comments   

Thursday, September 01, 2005

Run on banks?

From the website of the Bank of New Orleans established in 1909:
Home Equity Loans or Equity Lines of Credit
You’ve worked hard for your home. Isn’t it about time that your home worked for you? By using the equity in your home to finance the major expenses in your life, you’ll not only save money by borrowing at a comparatively low interest rate, but the interest you pay could be tax deductible. Whether you need money for home improvements, debt consolidation, education expenses, or a well-deserved vacation, a Home Equity Loan or Line of Credit could be the answer you’ve been searching for.

I’ve never had a HELOC myself so I had to look up how it worked exactly. According to most sources I looked at they work just like a credit card giving the person with a HELOC access to cash and a way to pay expenses.

I’m envisioning a run on banks via electronic transactions that may be large enough to require intervention from the Federal Reserve. This may be why we haven’t heard from the Fed as of yet, with regard to the state of economy, if the Fed is more immediately concerned about the liquidity of the banks it supervises. With the advent of Internet banking certainly many people living in New Orleans shopped the Internet for HELOCs and obtained them from banks all across the country, banks that were not directly impacted by the storm. Could say a Citigroup even have the right to not allow a person access to a HELOC they approved previously, not knowing the present condition of the home backing the loan nor the nature of the homeowners insurance? This could be amounting to a huge run on money for some banks. Any one hearing anything about this?

I suspect it's a bigger story than not being able to get coffee out of New Orleans port storage. Though if there's a coffee shortage, being the addict I am, it will be more disconcerting to me than running out of gasoline.

posted at 1:45 PM 0 comments   

HELOC Hell for banks and mortgage companies?

It just occurred to me that when interests rates hit 1% a few years ago and everyone refinanced their homes banks were pushing home equity lines of credit (HELOCs). People who have an open HELOC essentially have a credit card tied to the a portion of the difference between their home’s value and their remaining mortgage principle balance. If I had such line of credit, my house was under water, and I needed cash fast to pay for food, hotels, travel, and loss of income I’d take cash from my line of credit if I could get it. Did banks shut off the tap? Were people able to access their HELOCs?

I’d also get as much cash as I could from credit cards so as not to rely on the card itself in such a time.

If displaced people were able to get access to these lines of credit then in many cases the banks are going to be left holding the bag. If people weren’t insured properly and their home was destroyed or badly damaged then the bank is going to foreclose on a worthless property and the homeowner is going to file for bankruptcy protection.

posted at 1:29 PM 0 comments   

Bond Fund bias and bogus blathering

Within the span of fifteen minutes CNBC had Paul McCulley of PIMCO bonds on saying that the Fed was done, then a commentator reporting on the trucking industry was talking about how hard the high gas prices were hitting trucking companies and how the prices of shipped goods would be going up to reflect higher shipping costs and that consumers would be paying the higher prices. See the contradiction? What’s the Fed to do? The Fed’s primary concerns are price stability and sustainable economic growth.

The media and traders are hyperactive, never focused on the long-term or well grounded in macroeconomics. The material question is whether the risk of recession as a result of the hurricane is greater than the risk of inflation. My view is that the risk of recession is low due to the infusion of cash in the rebuilding process, while the risk of inflation is an absolute certainty.

I actually read every word of the Feds August minutes, as opposed to the skimming analysis the media gives you, and it was clear that at that time the Fed believed that the current interest rate wasn’t enough to control inflationary pressures. The debate was whether or not the Fed could continue at a measured pace or should accelerate its rate hikes. There was even a comment to the effect of Fed employees not being able to understand why traders and investors kept thinking it would stop hiking rates when the Fed was making it clear that it had no intention of stopping any time soon.

The hurricane should actually compel the Fed to hike rates even faster. It will come down to whether the Fed will play into the public’s irrationality and misunderstanding of the macroeconomics of the situation and will therefore be sensitive to not damaging the publics fragile psyche any further, or whether it will be more concerned with the economic aspects.

Greenspan has not been above playing politics, but then he’s also retiring. So will he want to go out looking like a bad guy or a good guy? Will he take rates higher to try and control the increase in inflation we are about to see, or will he increase the money supply to help out with the rebuilding cause?

If one looks solely at the responsibility of the Federal Reserve its first concern should be price stability and the Fed should therefore increase rates further leaving it up to the White House to put forth the cash necessary to assist the people impacted directly by the hurricane. It would be inflationary for the Fed to infuse capital into the economy on a national level. The cash for reconstruction needs to be directed at the problem not spread evenly across the entire economy.

Take anything the bond kings say on TV with a grain of salt. In my opinion the information they convey is almost always self-serving, just as much so as the $105 call for oil was. Funny that we’ve had just about the worst possible market shock imaginable for oil and we still didn’t get anywhere near that $105 level. Well before the hurricane the bond kings were calling for the Fed to start lowering rates by the end of the year. So naturally their now pounding the podium for the Fed to get off its back.

The bond kings, however, are in my opinion trying to use their leverage to move the bond markets in a self-fulfilling manner. They make predictions in hopes that they will influence traders to make those predictions come true. The key is the yield curve. Bond fund managers need the yield curve to be steeper and they know that the only way for this to happen is for the Fed to stop raising rates and reverse course. Thus they hope to scare people into believing that the Fed should lower rates so that it might actually do so, or at least stop raising rates. The Fed has to stop for the curve to have any chance of steepening because short-term rates are always more volatile than long-term rates. The range of historic fed funds rates is much greater than for longer-term rates.

Bond funds typically rely on differentials between short and long rates for their profits. A flattening yield curve is bad for the profits of bond fund managers, banks, and mortgage REITs. These firms basically profit from borrowing at the short rate and lending at the long rate. Basically it amounts to borrowing money at low short-term rates and leveraging it by investing at long-term rates and capturing the difference, or the long-term risk premium. Thus when yield curves are flattening it cuts into their profits and when yield curves invert they can’t borrow at short rates and reinvest the money at a profit at all. They just have to rely on the income from their existing portfolio and wait for rates to go back into their favor.

As I’ve said, take anything you hear from so called economic experts and market pundits with a grain of salt when they’re speaking on behalf of a bond fund.

posted at 11:55 AM 0 comments   

Fed's role is balancing the money supply

If the Fed holds off on hiking rates it will be out of sympathy for the sensitivity of investor and consumer psychology, not for economic reasons. Based on economic reasons alone the Fed would actually raise rates even more! From the Fed’s perspective inflation is being driven by too much money supply being speculated in the real estate and energy markets. The Fed’s way of dealing with this is to take money out of the economy through its open market actions.

The hurricane will put more money into the economy, not less. The government will be doling out dollars to people without homes to go back to. Those people will be living in hotels and spending money they otherwise wouldn’t be. The insurance companies will have to dip into their reserves to fund the rebuilding. People have to dip into their savings and take out home equity loans to get by until they can get back to work. It’s possible that the cash released into the economy as a result of the hurricane

CNBC’s Steve Liesman was reporting that the shutdown of New Orleans would take away $50 billion from the national GDP. But this is a simplistic viewpoint, which doesn’t take into consideration the numerous offsets such as the increased revenues of the Home Depot and other home stores, many building materials companies, and service providers. Tradesmen will converge on the area to get in on the 24/7 work available at much higher rates than they are used to making. They will take that money back to small towns and cities all over the country and spend it on things like new pick up trucks. Ford and GM will likely be selling a whole lot more pick up trucks six months from now. For that matter, what about all the vehicles left behind covered by insurance that will have to be replaced. Then the there is the offset for all the commerce that gets back up and going. Grocers will likely be selling goods right off of trucks.

Another aspect to New Orleans national GDP contribution is that the vast majority of the $50 billion figure is internal. It’s money spent on goods and services solely within the community. Only a small part of that figure is related to exported goods and services. Only the part that was exported outside of the city amounts to a lost contribution for the national economy. There is the lost federal income and other tax revenues, but that’s a drop in the bucket for the federal government. New Orleans internal GDP serves primarily only to boost the overall GDP as a basis of comparison to other countries.

The Fed hasn’t said diddly doo about the hurricane and its impact on the economy. Greenspan does need to come out and explain his position as he sees it so far because the media is getting worked up into a frenzy over the expectation of relief from rate hikes that may never come.

posted at 10:55 AM 0 comments