Tuesday, February 28, 2006

Consensus?

Economists Predict First Quarter Rebound
Analysts Say Economy Is Rebounding in First Quarter, Prediction for Year Is Solid but Slower Growth
After digesting the latest batch of economic reports, released Tuesday, analysts predicted that economic activity is rebounding nicely in the January-to-March quarter and will grow by at least a 4.5 percent rate. For all of 2006, the economy will log another year of solid -- though slower -- growth, they said.

Be wary of this sort of article. Was it economists, analysts, or both who said these things? Who said them? Was it a consensus or just a few of the journalist's favorite contacts? Was it from a report? These things aren't explained, which makes it possible to spin such news any way the journalist wants.

posted at 6:12 PM 4 comments   

Hurricanes, Tsunamis, Earthquakes, and the Markets

Here's something to think about. What does last year's heavy hitting hurricane season mean for this year? If you're rolling dice the odds of getting a six are the same every time you roll. Each roll is independent of previous rolls. You might have got two sixes in a row, but the odds of getting a six is still one in six. You can, however, calculate the odds of getting three sixes in a row before you start rolling and those odds are one in 216, or 6 to the power of 3, or 6 X 6 X 6.

If hurricanes are independent events then the odds of having a season as bad last year are the same as the odds were that last year happened. If last year were a hundred year storm, in other words the odds were roughly one in a hundred, and hurricanes are independent events, then the odds of having as bad a season again this year would be reset to one chance in one hundred.

But are hurricanes independent? A hundred year storm might imply a hundred year weather cycle in which the weather becomes more volatile and prone to hurricanes approximately every one hundred years and lasting for X years. In this case there would be a positive correlation between last years hurricanes and this years. Perhaps last year was a peak and now the cycle is declining. Or perhaps the worst is yet to come.

Hurricanes could also be inversely correlated. Perhaps last year's hurricanes flushed out the conditions that promoted Katrina and other hurricanes. In this case a similar hurricane season would be less likely. Earthquakes relieve pressure under the earths surface, but there is also a strong correlation to tremors and smaller quakes before and after a major quake.

Other possibilities, however remote, could be outside interference with the weather systems. These possibilities include global warming, a more global change like a shift in the earth's axis, the pull of the sun, or the start of Armageddon.

Maybe scientists know the answer to this question. Maybe they think they do, but don't. Either way, there are important parallels to understanding the markets.

What did Google or geopolitics have to do with the Dow dropping more than a hundred points today? Did the last day of the month have anything to do with it? Has there been a shift in opinion? If so is it founded and justified? Is there any good reason to believe that the event implies a negative trend is forming? Or is it just a one off random event, or a little profit taking on the markets reaching new highs?

These are not easy things to answer. They may be impossible to answer. But that doesn't stop some people from offering, or selling, an opinion on it. You can also drive yourself crazy trying to figure such things out. I step back and ask myself if anything has changed from say six months ago, a year ago, 2, 3, 4, 5, 10, 20, 50, even 100 years ago. See what the answers to those questions tell you about a market blip. Then when everyone's losing their wits you can be on the wise side of the markets.

posted at 5:00 PM 0 comments   

Writing On the Wall

There are a lot of companies that should never go public. As I wrote recently Crocs will likely turn to be one such company. There have been many through the years, especially during the stock bubble of the late 90s. Most notable was FAO Schwarz, which attempted to go head to head against Toys "R" Us and failed miserably going bankrupt twice. Even Toys "R" Us didn't make it through the toy wars completely unscathed. In the summer of 2005 the company was purchased by an investment group and taken private. FAO's story was one of sheer greed.

They had a good thing going that had worked for more than a hundred years and then came the heady times of the late 90s, which deluded management into changing the mix that made them unique and putting expensive toy stores into malls across the U.S. containing mostly common toys that could be found cheaper elsewhere.

FAO's flagship NYC store barely survived, but in the end, not surprisingly, it was taken back to its roots of offering toys that could be found nowhere else.

Before FAO there was Planet Hollywood, another story of greedy management gone wild. It was the kind of business that did well in a few extremely touristy locations when the chain was small enough to actually get a few stars in the restaurants. But in the end it was just another restaurant chain in high rent locations and a bunch of movie posters. They might as well have hung some antiques off the ceiling while they were at it. Blowup was inevitable.

Fast forward to Google. The CFO told investors that the company's growth was slowing and it would need to find other ways to monetize its business. The problem as I see it is that just about everything Google is doing outside of its core ad business is revenue draining, not revenue enhancing. Scanning books, building little desktop widgets, etc… These are all things that a myriad of online companies have tried and failed at over the years. Google has a good thing going with its search engine and the ad revenue that generates. All the rest is greed. There's no indication that the company has a clear plan for growth. It seems very megalomaniacal to me. Ponzi might be another word to describe it.

Time and time again public companies succumb to the pressures put on them by investors and analysts to keep growing. The desire to please everyone, or for management to hold on to the wealth they have tied up in the company, entices and incentivizes companies to overspend on growth that never materializes, and in all too many cases falsify their books to keep everyone happy.

The writing is on the wall. Time will tell if Google will make this all too obvious mistake, but history suggest to me that they won't and haven't learned anything from the others. Their best hope is that investors will punish them brutally before they can get too far down the wrong road.

posted at 12:11 PM 0 comments   

Monday, February 27, 2006

Reflexive Reaction of the Housing Market

A big headline today has been slowing home sales and the rising level of unsold homes. We are getting some pretty clear indications of a slowing housing market. It's interesting to consider to what extent slowing it reflexive. One of the Fed's main concerns over inflation is that inflation expectations will cause inflation. It's the strange reality that when people expect inflation, even when there isn't any, they will react in such a way that they actually cause inflation. The same is true in the markets. If people expect stock prices to fall, they will sell stocks, causing the prophecy to be self-fulfilling. I think more than anything else, that's what we're seeing in the housing market right now. The media really made a mountain out of molehill late last fall over slight gyrations in home data. That coincided with blowing bird flu all out of proportion. The catalyst, I think, was Katrina news getting stale and the media's desire to keep coming up with comparable stories, even if they have to create them out of thin air. So how much of the housing slowdown is caused by our anticipation of a housing slowdown? I suspect most of it.

But, of course, that doesn't make it any less real and the wise speculator will to some degree see why it's happening, anticipate the extent of the effect, and profit from it. In the process they'll contribute to the impact initially, but they'll also take the other side if prices do start to fall. In other words the housing market is apt to see a spate of increased volatility and cyclicality.

posted at 3:45 PM 0 comments   

Beta

I'm not talking about relative portfolio volatility kind of Beta. I'm talking about the software testing kind of Beta. What's that have to do with the markets? I always try to be a better critical thinker, which I believe is a key skill to being able to see truths in the markets. Little things that don't make logical sense catch my attention, especially if they are funny.

I've noticed recently that beta has become a way for companies to remove accountability. I noticed today that when you go to MSN.com it diverts you automatically to beta.msn.com, but if it's the main site that everyone sees then it is MSN, not MSN Beta. It can't be a beta version unless there's also an alpha version.

I'm going to start calling this blog BlogginWallStreet Beta. That way if I'm wrong I can say my information is still being tested.

posted at 3:28 PM 1 comments   

Unexpected Consequence of Price Stability

Bernanke gave a speech The Benefits of Price Stability at Princeton University. In the speech he said, "When prices are stable, people can hold money for transactions and other purposes without having to worry that inflation will eat away at the real value of their money balances." This is an accurate statement, but from the consumer's perspective it initially seems counterintuitive because of the very low savings rate. Despite the relative safety of saving now compared to times past we are doing much less of it. Why is this so?

We call consumers 'consumers' for a reason. Individually, we spend and consume most of what we earn. One reason we are spending more and saving less these days is because there is less economic uncertainty, or at least we believe that is true. Even though inflation erodes the value of savings, when inflation is volatile so is the economy. When inflation rises the Fed tightens monetary policy and in times past has often inverted the yield curve at debilitatingly high interest rates, crippling the economy, at the cost of jobs. So during times of economic uncertainty consumers are forced to shoulder more economic risk and must be savers in order to weather economic storms.

Furthermore, investors and lenders are highly affected and reactionary to inflation. During times of economic uncertainty lenders have to charge higher interest rates, but higher interest rates price borrowers out of the market. Probably more than any other reason, consumers are saving less because lenders have made it far easier to borrow than in times past. They've loosened lending requirements for many reasons, but mostly it's because less economic uncertainty, stable prices and employment opportunities, means that borrowers can more consistently repay loans. And because lenders don't have to charge higher rates that come with the expectation of inflation they can lend to a larger and more diverse crowd of borrowers.

So one outcome of price stability is that lenders can lend more readily at lower rates of interest. The bears look at this sort of trend and see it as a sign of consumers and lenders being out of control. Even Greenspan has warned that perhaps these parties aren't weighing the risks properly. But that's a major oversimplification of the process and the times.

Lenders and borrowers aren't taking on any more risk than they ever have. It's not that we're overly complacent. What was the risk to lenders when they were lending at close to the same rates as today, almost entirely at fixed rates shouldering all the risk, and then inflation suddenly took off out of nowhere? The result was that major lending institutions failed. Comparatively, an economic hiccup today would first take out fringe lenders, those specializing in high risk and undiversified lenders. The economy could easily absorb the collapse of this group of lenders. But the big, globally diversified financial services companies would hardly be touched.

It comes down to a twist on the old question of whether it's better to have loved and lost than never loved at all. That defines well the difference between the glass half full person and the glass half empty person, or in market terms the bull vs. the bear. Is it better to have had and lost than to never have had?

I believe whole-heartedly and absolutely in the latter. Yeah, there probably will be problems in the future that will come out of loose lending practices. Variable rates at some point will likely burn some recent homebuyers in the future and some will even lose their homes and return to being renters. But what if that takes seven years to happen? Many of today's risky borrowers will have seven years of principle paid into a home. Though it won't show up in government statistics, these former renters have essentially been saving a whole lot more than they ever were in the past. The modernization of the lending system has enabled them to tap into this source of savings to better weather economic uncertainty.

Sure there will be those people who are and will be tapping into home equity and blowing it at Best Buy, Pottery Barn, and Home Depot. When those borrowers fail some company won't get their money back. But here's the thing, companies and lenders factor those events into their lending rates and product prices. There's a somewhat invisible equilibrium at work.

This equilibrium is similar to the one that Vegas has with gamblers. Imagine if there were no regulations governing how the casinos set probabilities. How would casinos then determine what odds to give gamblers? Would they take peoples money as quickly as they could? If they did the casinos now being run by major public corporations would see a drop off in visitors, revenues, and profits. They would cannibalize their customers in favor of short-term greed. There would, however, be an incentive for competing casinos to collude on price, or rather probability. They could collectively find the probability that maximized their revenues, while still keeping the customers coming. Assuming there's no collusion and perfect competition, casinos compete to draw gamblers. They do so by having the best locations, the most lavish accommodations and accoutrements, lots of choices, or smaller casinos in lower traffic locations compete by advertising things like having the loosest slots in town and dollar black jack tables.

The lending market is like Vegas in a lot of ways. Some borrowers will experience financial hardship just as some gamblers go broke. Some lenders will go belly up just as some casinos do. But so long as interest rates are at or near equilibrium borrowers will keep coming back for more, just as gamblers keep returning to Vegas. The end result is a win-win. More people can borrow and the industry grows. Is Vegas a win-win? Well, yes. That's not so obvious, but it is. Most compulsive gamblers would probably find some other way to feed their addictive personalities, so discounting that group, Vegas for most people is an entertainment substitute for discretionary income. People who didn't go to Vegas might spend / export the money on vacations in other countries, while others would spend it on various hobbies and other forms of entertainment.

There's probably a valid economic argument gambling, as having bad wealth transfer effects, but that's outside the scope of the example because it's a cost associated with gambling that's less prevalent in the lending industry. That aspect would be comparable at the payday loan end of the lending spectrum, predatory lending, which is a problem of both the lenders and the borrowers. But I think most home lending falls into the category of having found an equilibrium that represents increased productivity and economic efficiency and is a net gain for both parties.

posted at 2:58 PM 0 comments   

Friday, February 24, 2006

Complexity

I caught this analogy of blogging to punk rock in the latest issue of Wired and thought it disagreeable and ironically uninsightful enough to pass on to fellow blog readers and bloggers. Double ironically it was written by a blogger who's also produced Natural Born Killers. Here's a bit of the post:

I was chatting with a good friend of mine today who went to high school with Jack Abramoff and remembers him simply as a "weird fat kid" and we got sidetracked onto the subject of blogs and cultural energy in general. We both concurred that the blog world has the feel right now that the punk rock scene of the late 70's had, and for much the same reasons…

We thought punk rock and the energetic counterculture it produced would last for ever, but it didn't. It was over quite quickly. Enjoy the blogs while you can. These are the salad days.

Some bloggers and some conformist styles of blogging might be punk like, but blogs and blogging are nothing at all like the short-lived punk rock movement. Blogs are not a fad like Crocs and cabbage patch kids. Some individual blogs might be faddish, but to say that blogs in general are faddish is like saying that movies, the Internet, magazines, music, paper, books, the printing press, and desktop publishing software are faddish.

The blog is just another way to convey information. What I blog about is not governed by any sort of cultural rules. And while punk rock might not have lasted very long, there's always counter culture. It's just always shifting, flowing, changing and evolving like fashion and popular music. I'm not saying blogs will be around forever. Perhaps they will evolve and go the way of 8-Tracks. More likely the technology will improve so much that we will feel compelled to give the new medium a new name so we can laugh at the antiquated technology we knew as blogs.

But there's massive macro unceasing trend that blogging is a small part of. It's the free flow of information and ideas. For hundreds of years, pretty much for ever, people have sought out ways to convey information and ideas more productively. Telephones, pagers, email, cell phones, Vonage, pony express, the telegraph, Indian runners, smoke signals, CB radios, walkie talkies, shortwave, passing information down The Great Wall of China, the printing press to more quickly duplicate and share information, print-on-demand, the Websites, etc… Blogs are just another piece of all that. People were blogging long before we called it that through newspaper editorials, simple Websites, online communities, and radio talk shows.

I have to stretch a bit to tie this to the markets, but it's this kind of lack of ability to see the true nature of something that often causes us to oversimplify the markets. It's not immediately obvious to us to consider that a stock might be governed by supply and demand for stocks in general just as a commodity usually is. We likewise have difficulty understanding that a commodity can at times carry an intrinsic component in its valuation that has nothing to do with supply and demand and everything with speculation. What makes a rare painting worth what people are willing to pay for it? Not the canvas and paint. The value almost entirely resides in the idea that someone else might want to pay more for it in the future than the present price. Commodities and stocks are also priced this way. The influence of this intrinsic pricing component varies through time. Supply and demand for a commodity can be relatively over time, but the intrinsic component varies with the whims of speculators. Since there has yet to be any good way of measuring this component or forecasting its fluctuations, we often choose to ignore it, preferring to simplify the market down to fundamental information or trying to find patterns in the way prices change. Usually one way or the other, but seldom both.

The tie in is that being able to see the true complexity of what blogging is and its potential, is like being able to see the true nature of the factors that move prices in a market.

posted at 4:15 PM 1 comments   

Mortgage REITs

A reader asks what to make of mortgage REITs given the possibility that the Fed is nearly done hiking interest rates. Put simply mortgage REITs profit from in large part from the difference between short-term rates and mortgage rates. Many of them essentially engage in a form of interest rate arbitrage. They borrow, issue debt, at short-term interest rates and use the capital to purchase mortgages, typically securitized packages of loans, or Mortgage Backed Securities (MBS). They then use the incoming loan payments to pay their short-term obligations and the difference is profit, most of which by law has to go to be paid out as dividends to share holders.

These companies were very popular when the Fed took rates to 1% and they stayed popular through the refinancing boom a few years ago. The interest rate spread was good for them and they were especially attractive to investors given their high yields and the poor performance of most stocks.

However, over the past two years the stocks of the fifteen mREITs I've looked at have fallen off an average 24%, as the Fed has taken short-rates up and inverted the yield curve. Keep in mind that the inverted yield curve doesn't mean that REITs have been completely incapacitated, but they're being squeezed. What this means is that they are paying out dividends in large part from their existing portfolio of mortgages purchased in the past. Portfolio turnover is now their worst enemy. The average length of time a person stays in a home is about six years. That may go up some if long-term rates rise. In the meantime mREITs are going to see their portfolios dwindle and therefore yields.

In the short-term the outlook for mREITs looks terrible. However, interest rates are cyclical and therefore so are the profits and dividend yields of mREITs. And as I've said here many times, the best time for the long-term investor to buy a cyclical stock is when the largest number of people are selling them. It seems to me that the inverted yield curve might be marking a long-term cyclical bottom for these stocks. No doubt, they could go lower, especially if their dividends dwindle. Some could even go out of business altogether. I'd consider the largest and most resilient and those with sources of revenue other than from interest rate arbitrage. Some, for example, are also mortgage loan providers. Averaging in to the best is one reasonable strategy, in which you'd collect dividends along the way. Or I don't think you'd be missing much to wait a while either. When the time comes for the Fed to lower rates again, and that time will come, these stocks will be hot again.

But they aren't going to make you rich. The way to look at them is to ask what will be your average return if you have to wait a couple of years for them to come back into favor and then hang tight through most of an interest rate lowering cycle, assuming you were to cash out smartly just as the Fed started to raise rates the next time.

Say that's a five-year cycle during which you get 30% appreciation in the value of the stocks and an average annual yield of 10%. That's a damn good total return. It's sure a helluva lot better than taking the 10% yield and sitting through a 25% drop in the stock value, as many people did when they reached their height in popularity a couple of years ago. Of course you cannot sell these things at all and just hold them for the dividends through their ups and downs. Some of the ones in the table below have managed to live through a few interest rate cycles. But none of them have consistently risen in value. It's all about the dividends for these stocks. Timing the stock price fluctuations is just an added bonus.

Also bear in mind that I haven't researched each of these fifteen companies in the table in detail. I can only say that they are all REITs that are engaged in the mortgage business. Some of them may not fit well with my definition of what mREITs do. They can do a lot of thing so long as they are paying out their profits according to the laws that govern REITs. And I know that some of them do do a lot of things. Also, just nabbed the forward yields reported on Yahoo! Finance for those that were available. That information might not be entirely accurate or up to date and future yields might be less than reported.

posted at 3:02 PM 2 comments   

Bernanke and Monetary Policy

Just a quick thought on Bernanke and monetary policy. The biggest criticism of Bernanke before he took over the chairman position was that he might be soft on inflation based on previous statements about deflation. Not surprisingly the first time Bernanke spoke he came across hawkish. But how much of that was intended to counter the dovish perception people had of him and how much was truly hawkish on the inflation risks. He left the door open to stand fast or raise rates again at the next meeting.

The markets are pricing in a 100% probability of a quarter point hike at the next meeting, but really most inflationary economic measures seem to have stabilized and leveled off. He may very well take a wait and see approach. The biggest criticism of the Fed in general is that they overshoot. The last thing Bernanke will want to do is be blamed for killing the economy in his first year.

When the Fed took rates down during the recession they stopped at 1%, leaving room to go lower if absolutely necessary. They didn't want to go to zero and effectively relinquish control of the economy. The same thing might be true on the upside. The Fed needs room to react to inflationary data without taking rates too high and killing the economy. Generally, 6% and above is seen as a rate that's potentially damaging economically. Taking rates above 5% doesn't give the Fed much room to move up without being overly prohibitive to the economic growth aspect of its mandate.

I'm not saying I think the Fed will pause at the next meeting. I think it's probable, but it's certainly not the 100% probability now being priced into various markets, especially given some signs of slowing in recent economic data.

posted at 1:06 PM 4 comments   

Context Better Than Quotes

I wouldn't crack on the mainstream media (MSM) so much if they didn't make it so easy so much of the time. I'm not expecting them to be brilliant and genius. All I want is for them to report the news factually without trying to manipulate me. Instead of trying to spin the news into something it's not, I just want more of what I heard from CNBC's Phil LeBeau this morning when he had this to say about Venezuela's ban on flights from the U.S., "Keep in mind part of the reason they are trading down is because of oil. Not necessarily because of this flight ban in Venezuela… How much will this ban impact airlines like American? Probably not much. Even though shares of American are down today—and again remember that's more because of oil spiking higher than it is because of what's happening in Venezuela—keep this in mind. American has about two hundred thousand seats flying around the world every day. Just nine hundred of those go to Venezuela. So this is a drop in the bucket of its overall business."

Instead of spinning a dramatic situation poised to collapse the airlines he put the situation in context. Most of the time we just get some useless quote from an industry source or analyst. The information I so much more useful telling me that this is a drop in the bucket instead of interviewing someone telling me how terrible this is and how this just adds to the geopolitical situation.

posted at 12:38 PM 0 comments   

Larry McMillans Market Commentary

I am posting this as is.... check Larry out at http://www.optionstrategist.com

"Stock MarketThe ball is back in the bulls' court, since -- for the second time in recentmonths -- the latest downside breakout failed miserably. We highlighted this information in last week's Hotline update, noting that both in lateDecember and most recently in early February, $SPX broke belowsupport, but failed to follow through. Now, we are nearing the top of this year's trading range, and it appears that $SPX might be able to break outon the upside. It is time for the bulls to be similarly frustrated by a false upside breakout? The last upside breakout -- in early January -- really didn't carry very far (about 20 $SPX points) before failing. So, in general, it appears that a strategy of fading the breakouts is the best one this year.

We would expect any upside breakout to engender some follow-on buying from both short covering and from momentum traders (aided bythe boost the media will provide). Whether it would be worth more than 20 $SPX points is hard to determine, though. Such an upside move would be taking place without benefit of true oversold buy signals, and hence it is likely that it would run out of gas fairly soon -- just as theearly January rally did.

The charts of the major averages are currently as divergent as they've ever been. The Dow ($DJX) is leading the way, having broken out to 4-1/2 year highs over a week ago and continuing to add to thosegains. $SPX is lagging behind, though, having so far failed to exceed the January highs (which would place it at 4+ year highs, too, if it did). But worst of all is QQQQ, which is still struggling with its down trend line that has been in place since the January tops. At least $SPX has beenable to penetrate its similar downtrend line. When the Dow is the leaderfor too long of a period of time, that is often considered to be a negativefor the market (the "generals" are out in front of the "troops," who refuse to follow -- if you prefer a military analogy). So, the bulls need $SPX tomove to new highs and take over the leadership from the Dow. From alarger perspective, the market often does best when QQQQ leads, butthat doesn't seem to be in the cards right now.

If, for some reason, the bulls can't muster new highs from $SPX,then a decline toward the lower end of the trading range -- circa 1260 would probably materialize. This does not seem to be the most probable path at the current time.

The most negative of our indicators is the equity-only put-call ratio. Both the weighted and standard ratios moved to sell signals in early February and have not budged ever since. These are normally quite accurate indicators, and it is unusual to see both of them "fighting" the market like this. In any case, you can see from the charts at the top ofthis page that they haven't begun to roll over to buy signals yet. Furthermore, neither is what one would consider seriously oversoldthat would occur if they were near the top of their respective charts. Inthe past, when these indicators have been "wrong," they have generallybeen early (July 2002 buy signal and December 2004 sell signal). That is something to keep in mind.

Breadth (advances minus declines) has improved tremendously in the last week and half, as this market has basically put together this rallyon the back of four very strong trading days (Feb 14, 15, 16, and 22). Finally, volatility indices ($VIX and $VXO) have returned to very low levels -- breaking the bearish uptrend lines that had previouslyexisted. As a result, these $VIX levels are accommodative to a bullishphase.

In summary, only one of our indicators -- albeit an important one(the put-call ratio) is on a sell signal. Thus the market can certainlymove higher. However, it is doing so without the benefit of true buysignals such as we saw last October. For example, while breadth maynot be giving sell signals (especially, NYSE breadth), we are a long wayremoved from the last time that breadth was truly negative and oversold.Similarly, $VIX buy signals come when $VIX makes a spike peak. Thelast time that happened was over a month ago, and even that was alukewarm spike -- only to 14.50 on $VIX. So, while we feel that themarket can move higher, we are not really enthused with its underlying technical backing."

posted at 9:17 AM 1 comments   

Thursday, February 23, 2006

Spin, spin, and more spin

It's been a while since I've heard as much nonsense reporting on the markets as I've heard today. Simultaneously, earlier today Yahoo! Finance was running headlines reporting that stocks were up on inflation news and stocks were down on inflation concerns. The latter headline was later changed to say that stocks were mixed on inflation concerns. Now if you basically have a flat market, then how can you say that's a concerned market? A concerned market is a down market.

The spin CNBC was putting out today to make something out of nothing was the worst I've heard since the bird flu reporting. Though they've briefly mentioned or quickly flashed on the screen that 90% of fund inflows has gone overseas, they've proceeded to pretend like that information doesn't exist painting a picture of an individual investor that's over invested in U.S. equities, as if this were the late 90s, a comparison that was specifically made.

One commentator said, "Individual Investors have been flocking back into equity markets. But with the major markets at or near multiyear highs, how do you play this game? Are you too late for the U.S. markets? Should you go international? What kind of mix should you have?"

Since virtually all the money has gone overseas it would have been more accurate to say, "Are you too late for the international markets? Should you get back into U.S. equities?"

For the likes of me, I can't understand why our media and so many Americans want to spin the U.S. as such a horrible place to invest. They're so desperate to make us look so stupid and so bad, that they will make anything up to make the case. The grass is greener on the other side of the fence?

This commentator goes on to say, "With the Dow at a 4.5-year high are investors rushing in at the wrong time?" If you want to tell a lie without it being a lie the way to do it is to phrase it as a question. It's a trick of the trade. The idea is to make people feel as if they had said, "With the Dow at a 4.5-year high now is the wrong time for investors to be rush into the Dow, as they have been." Of course saying that would be a blatant lie, because individual investors have not rushed into the Dow. They've rushed into crazy risky emerging markets stocks, which Wall Street and the financial media has continuously prodded them to do. So you phrase it as a question. It's just a debate. But it's nothing more than spin. They're trying get us to feel and think a certain way.

Let me do the same thing. Why would the financial media do this? Are big Wall Street firms paying the financial media to spin the news in their favor? See how I've alluded to something going on that I have no evidence to support, without pointing to any one financial media outlet or any one Wall Street firm. If I'd singled out any particular parties and suggested directly that this were going on, then I'd rightfully get sued. But phrase it as a topic or question to be debated and I can get away with saying almost anything.

The spin was so blatant that it was humorously idiotic. One of the many minority perma-bear analysts the media likes to give undue airtime too, comes on and talks about how massive the inflows into stock mutual funds were in January saying that it was similar to 2000 and that's when the yield curve inverted the last time and that investors were making a mistake to be jumping in at such a time of economic uncertainty. The implication was that investors were jumping into U.S. stocks. What had me chuckling was that while he was feeding us this pack of lies up pops on the screen the statistic that 90% of equity inflows went overseas. Of course that makes his comments completely untrue. If there were legitimate issues with the U.S. economy, then it would be a good thing for individual investors to diversify overseas, which is exactly what they have been doing. So the entire debate was just completely insane. It made no sense whatsoever. It makes me want to beat my head against wall. Instead I laugh at the utter ridiculousness and incredible stupidity of it all.

And why is that the media will always call on the X year highs when they want the paint the bear picture? Markets are almost always at new X year highs because markets mostly go up. Over the last 50 years the Dow has been at a five-year high 83% of the time. Even going back to before the start of The Great Depression the Dow has been at five-year highs 80% of the time. You don't have to be a genius to understand those odds. What happens the next year after a five year high? The Dow has gone up an average of more than 7% every time this has happened since 1928. Since 1980 the average increase in the year after the Dow makes a five-year high is 11%! So the answer is clear, when the Dow is making records it's still a good time to invest.

posted at 2:45 PM 1 comments   

But Whose Stocks?

Individual Investors Shift Assets to Stocks
Individual investors are moving into the stock market at a stronger clip than seen in years.

If you don't take the WSJ, shell out the few bucks a month they charge for the online version so you can follow the links. The WSJ, in my opinion, puts out the least biased, most thought provoking, and best researched market information of the various mainstream media content providers.

In the case of this article you have to read further to learn that it's still foreign stocks individual investors are gravitating towards. What the WSJ article doesn't address is that recent data suggests the individual investor might be about to get their inevitable beatings. Even as individual investors sent record money overseas, overseas indices and ETFs fell, or were flat, suggesting that the pros were taking the other side of the individual investors. The S&P 500 rose more than 1.2%, in the week ending February 15 corresponding to the AMG fund flow data, which might not sound like much, but it's an above average weekly change that equates to an annualized gain of 62%. Individual investors didn't participate in the rally.

Naturally, the TV financial media can't read past the headline and completely misinterpreted and misreported the information. I'm in the middle of writing this post and CNBC's Melissa Lee catches my ear citing as a reason for today's market downturn, "Also of concern this article in The Wall Street Journal that individual investors are back. The Journal citing stats that individual investors' trades were up 30% to 40% in the month of January over December. This is troubling simply because the individual investor's usually used as a contrarian indicator. By the time individuals move into the market it may be time for the professionals to head for the exits."

This really bothered me that she reported the information totally out of context in effort to paint a bearish picture for stocks in general, implying that U.S. equities are overheated. This was a complete fabrication of the truth. What she didn't bother to report was the fact that 85% of the fund inflows in January went to non-domestic funds and ETFs, and in the latest week reported by AMG data it was 89% going overseas. The individual investor hardly put any money into U.S. equities.

But somehow CNBC came to the backwards conclusion that this information was bad for U.S. equities when in fact if it's true that the individual investor is a contrarian indicator then the information should bode badly for foreign equities and therefore be good for U.S. equities, which the pros have been buying recently.

Later Steve Liesman says of the fund flows and the WSJ article, "Here's the problem for U.S. stock markets. Much of this new money is flowing into foreign stocks." Well, at least he mentions this fact. But the first reporter says that all this money flowing into stocks, implying incorrectly U.S. equities, is a negative contrarian indicator, then the next reporter says it's bad because it's all going into foreign stocks instead of the U.S. So let me get this straight, it's bad that the money's not coming here, but if it was it would be bad because it's individual investor money. Geesh. C'mon.

Think of it this way, where would the S&P 500 be right now if all that money flowed into U.S. stocks instead of overseas?

The individual investor is going to get burned just like they always do. The fund managers will sell them out, just as they did in tech in 2000 through 2002. The Wall Street analysts will keep talking up international stocks while the fund managers are quietly lightening up their exposure. Sooner or later there will be a mass scramble to get back into the relative safety of the U.S. markets. It's just a question of when.

posted at 11:44 AM 0 comments   

Oil Inventories In and Up -- Again

It cracks me up every time I hear a frustrated energy bull say to watch out for gasoline because we're going into the summer driving season. IT'S FEBRUARY!! It shows how weak the bullish argument has gotten. They've plumb run out of excuses for the high prices with inventory builds across the board week after week. Funny how oil companies can manage to muster up quite a bit more oil at $60 a barrel.

posted at 10:43 AM 1 comments   

Wednesday, February 22, 2006

Ferguson Quits Fed

Fed Vice Chairman Ferguson Quits Effective April 28
Federal Reserve Vice Chairman Roger Ferguson, the last governor who wasn't placed on the board by President George W. Bush, resigned less than a month after Ben S. Bernanke succeeded Alan Greenspan as chairman.

He didn't elaborate on what he will do or why he decided to quit.

My guess is he's bitter about not getting the chairmanship.

posted at 2:36 PM 1 comments   

The Silent Majority

I've article after article recently calling for a recession or major slowdown, higher interest rates. They talk about things like the coming collapse for stocks. These articles run the gamut on advice; go to cash, buy emerging markets and commodities, buy gold, etc… However, despite making every imaginable negative point, none I've seen actually has the balls to suggest shorting U.S. equities.

The undercurrent is clearly still overall bullish going back to last October, as evidenced by the Dow holding above 11,100 and the S&P 500 pushing 1,300. There's a silent majority out there that's buying on fear driven dips, gradually climbing the wall of worry. The action in stocks isn't reflecting the common talk.

posted at 2:27 PM 1 comments   

Core CPI Comes In As Expected

The CPI data was a mixed bag. Not surprisingly the headline number was lifted by the pop in oil prices that we were hit with in January. The headline inflation number climbed 0.7%, compared to a consensus forecast of 0.4% and a decline of 0.1% in December. The headline number is being jerked around almost entirely by oil prices, which declined in December, shot higher in January, and has since fallen back and risen somewhat again. This is precisely why we turn to the core number. The core number tells what impact energy, and food, prices are having on the rest of the economy.

The core rate rose 0.2%, as expected. But an important data point that's not being keyed in on is that the core rate for last December was revised down to 0.1% from 0.2%. So there was less inflation than previously thought.

There were, however, higher prices in a couple of other areas worth noting. They just were minimal compared to the 5% increase in energy. Housing prices, which counts for 40% of the index, rose 0.5%. What happened to the slowing housing market? There's not much data to support that. And auto prices increased 0.6%. But healthcare costs, the one everyone thinks is constantly skyrocketing, only rose 0.1%.

But, I don't see anything in the CPI that increases the outlook for inflation or the Feds propensity to hike rates. The energy price influence really shouldn't have been a surprise. The Fed is concerned with the headline trickling down into the core rate. Clearly, thus far, that has not happened and we've had prices in the $60 range on and off again since the middle of last summer. If there's no trickle down, or increase in inflation expectations, then the concern turns to the impact of energy dragging on the economy and the 2nd of the Feds dual mandates of price stability and sustainable growth. This economy is like a ship dragging anchor.

I believe the Fed is a bit less likely to raise interest rates again, than is being projected, given this anchor and the fact that core price increases taking note of the December revision are virtually nonexistent after all these months of higher energy prices. Six months ago I thought we'd see price increases trickle down, but that hasn't been the case.

Traders are saying there's a nearly 100% probability of one more rate hike and a 50% probability of two more. The mainstream media, however, is talking about two being likely and a third possible. The irony of that typical exaggeration is that the MSM likes to criticize the Fed for overshooting. It's not what traders are saying. They are saying a 2nd hike is just as unlikely as likely in the next two meetings, but likely in three meetings. The Fed Funds futures have the Fed getting to 5% by next summer and holding steady. I think that the Fed will stop short of 5% if the data allows it too. It will be conscious of 5% having psychological ramifications. And so far the data doesn't point to higher rates nearly to the extent the media has been suggesting.

posted at 11:06 AM 0 comments   

Nasdaq CEO Podcast

Here’s a link to a podcast of Bob Greifeld, CEO of NASDAQ, talking about the new tier structures that make up the Global Select Market, introduced on February 15.

Apologies for being late on this

http://www.nasdaq.com/newsroom/NASDAQ2.mp3

posted at 9:28 AM 0 comments   

Tuesday, February 21, 2006

Another Perma-Bear Exposed

Paul Farrell, a Marc Faber follower, writes for MarketWatch Dr. Doom warns: 'Correction Time!' and cites Stephen Leeb's perma-bear doomsday book, "The Coming Economic Collapse,".

Late last year Paul wrote, "And the warning signs suggest a recession and market collapse: Out-of-control deficits, energy costs, understated P/E ratios, huge insider sales, underfunded pensions -- the list goes on."

Paul quotes Marc Faber saying, "…when all asset markets are as extended as they are now it does not take much for a vicious sell-off to get underway." The solution Faber offers? Emerging markets should be less vulnerable than the U.S. market to a stock market correction. He also suggests buying gold and other precious metals. Of gold Farrell says, "…a 'vicious' drop in the Dow coupled with a 'vicious' rise in gold, possibly pushing gold to an astounding $2,000 or more an ounce, by my rough calculations.

The contradiction of this advice is that if "all asset markets" are extended as Faber says then this would include emerging markets and commodities, which are far more extended than U.S. stocks and traditionally far more volatile. If any market out there is showing us the signs of a bubble it would be commodities and emerging markets. This is obvious just looking at this comparison of the Emerging Markets ETF (EEM) to the S&P 500 ETF (SPY) and the AIG Commodity Index (^DJC) to the S&P 500 (^GSPC). If that doesn't make you think twice about buying into these perma-bear arguments, nothing will.

posted at 5:20 PM 3 comments   

Globalization News

Companies' buying the assets of other countries is a massive global trend. With regard to the Arabs wanting to buy a U.S. company managing a major port, I used the example that we'd likely pay little heed to British company doing the same thing and I said that the foreign company we approved of could then turn around and sell it to a country we didn't approve of. It was an arbitrary example, but in reading more about the deal it turns out that that is exactly what is happening in this case. Dubai Ports World bought a British company we'd allowed to manage the port. The president has said that we're sending a bad message on this deal to allow a British company to act in this capacity, but not Dubai. It's exactly what I said, they should have been thinking about the asset and not the buyer in the first place and we wouldn't be in this mess. Now we've set the precedent by the president's irrational argument that we have to let anyone in.

Here are a couple other global deals in today's news:

Germany's E.On made a surprise $34.7 billion bid for Spanish utility Endesa, in a bold move to cement its claim as the world's largest power and gas company.

Australian Buyout Firm To Launch Bid for Eircom
In the latest example of private-equity firms snapping up large pieces of corporate Europe, Australian buyout firm Babcock & Brown Ltd. is planning to launch a bid valued at about €2.4 billion, or about $2.9 billion, for Eircom Group PLC, an Irish telecommunications operator, according to people familiar with the situation.

posted at 4:38 PM 0 comments   

Outlook for Interest Rates

My view is that the markets are currently overestimating the probability of the Fed raising rates in May. Another rate hike is nearly fully priced in to the fed funds futures. In a WSJ article today the take was, "The Federal Reserve's policy-making committee said Tuesday that with its latest increase in official interest rates the policy stance was just about right, but cautioned that further increases may be in store to keep 'continuing upside risks' to inflation in check."

I concur. Trader's are talking about three more hikes, while Bernanke and other Fed members have had to say recently indicates that they will be reacting to data immediately at hand going forward. That means first and foremost the core CPI. I think they'd like to see that number get back to the 0.1% increases we had all last summer. The 0.2% level, 2.4% annualized, we've been seeing isn't cause for great concern, but it leaves the Fed on guard for clues that it might hit the 0.3% mark, 3.6% annualized. Higher energy prices, wage pressures, the housing market not slowing as much as people seem to think it will, could all take core prices higher.

But if these factors stay steady between now and May there's a good chance the Fed will also stay steady. It's ironic because for a year traders kept saying one more hike and then done. Now that he Fed is saying it's done all things being equal, traders think there's two or three more hikes ahead. But that's what makes market go up and down. Traders are already pricing future rate hikes into stocks and futures so I believe this presents a contrarian buying opportunity with more upside potential than downside risk.

posted at 4:08 PM 0 comments   

Economic News

The markets are off modestly today. That's no surprise given that the CPI will be released tomorrow morning. The core CPI is an unknown that will be widely watched. If the change is different from the consensus forecast and previous month's 0.2% increase, either up or down, the markets will react to the data. A tick up to 0.3% would likely send stocks lower due to the expectation of inflation and higher interest rates to come. If the core number ticks down to an increase of 0.1% traders would likely reduce their interest rate expectations and take stocks higher.

The leading economic indicators also spooked traders today:
Leading Economic Indicators Rise in Jan.
A closely watched gauge of future economic activity rose sharply in January, suggesting the nation's economy could see robust growth in the spring, a private research group said Tuesday.

And we got the January Fed Meeting Minutes. The most noteworthy part of the minutes were that the Fed reported surveys of inflation expectations declined in January indicating less concern about immediate and longer-term inflation. That is telling because high inflation concerns would indicate a propensity for businesses to pass on high energy costs, while lower inflation concerns might keep businesses from increasingly passing on those costs. These paths show up in the core CPI data. So we're more likely to see a 0.2% increase, or even a drop to 0.1%, than an uptick to 0.3%.

posted at 3:41 PM 0 comments   

CNOOC Reincarnate

Frist Says U.S. Should Delay Sale of Ports to Dubai
U.S. Senate Majority Leader Bill Frist said the Bush administration should delay the $6.8 billion sale of a company that operates six U.S. ports to a firm controlled by the United Arab Emirates.

This is Unocal / CNOOC all over again. It represents the point where the markets meet politics, a crux. This is the result of bringing capitalism and globalization together. We're going to be facing more and more of these kinds of decisions and many of them won't be nearly so clear cut as this one and CNOOC. In the late 90s there was a similar controversy over what our aerospace companies were selling to the Chinese.

Another similarly moral debate has recently been over American companies complying with the Chinese government's censorship demands to do business in China, which I'm very much against. Chinese citizens can't even view Wikipedia or use Blogspot. Blogs that contain certain keywords are shut down and on a few occasions writers have been jailed. I couldn't write what I do for long if I were living in China or Hong Kong. China employs 30,000 censor police. And Marc "Dr. Doom" Faber thinks the U.S. is in decline. What a joke.

It's always going to be so clear where to draw the line. The focus should be on the strategic importance of the asset, not on the buyer. Would we be ok with selling these same assets to say Great Britain? Probably. The deal might have gone off without ever attracting media attention. I'll give the mainstream media credit for being pervasive. But then GB could turn around and resell it to any country they wanted too and we'd have little recourse. So it's nearsighted to focus on the buyer.

This is the point where markets meet politics because it's apparent that a completely free market is driven by short-term greed and will sell anything and everything to the highest bidder. Companies act in their own best interest, mostly in the best interest of the executives, which usually happen to be the largest shareholders. The extent to which they act in the best interest of the public is coincidental, the result of their being productive and producing goods and services people want to buy.

posted at 1:45 PM 2 comments   

Friday, February 17, 2006

Brother A / Brother B

A reader asks, with regard to my Brother A / Brother B example illustrating that it's generally better to borrow from someone else than amongst ourselves, if the problem is really that Brother B, or Americans, don't have any savings to invest and therefore have to borrow.

It's true that we have more debt than savings, but it's not true that we have to borrow from another country because we have no savings. The issue is that Americans tend to invest more and save less compared to other countries. To the best of my knowledge, without researching the specifics, the U.S. has a very high rate of homeownership compared to other comparable / competitor countries. And of course that also means much greater debt due to the mortgages. This has long been the case; as in a previous post a couple of weeks ago I related a quote by Keynes taking note of this. Mortgages are considered investments, not savings, though home equity is like savings. Anyway, individuals could choose to sell their homes, rent, and invest the capital elsewhere. So there is money available in investments, and those invested assets are far more liquid than they ever have been in the past and far more liquid than anywhere else in the world, which is in turn another reason why Americans choose to invest rather than save.

Back when the government set up the various measures of money supply and such, investments weren't considered to be liquid assets, but that is no longer true. Many forms of investment, albeit dynamic and difficult to quantify due to the variable nature of financial markets, are just as liquid as a typical old-fashioned savings account. I can sell some stock via my cell phone and write a check against the money market account the proceeds will be swept into, just as easily as I can move money from savings to checking. Often easier, as behind as many banks are.

So going back to the example, Brother B being a typical American, might not have $100k in savings, but he might have $100k in stocks he can sell, or in home equity he can tap into.

In the real world an American company issues bonds and doesn't care who buys them. It happens that foreigners buy a lot of those bonds paying say 6% instead of investing in other alternatives in their own country, largely because of the uncertainty in their own countries and lack of choices. We assume that it's foreign governments buying this debt, when in actuality a lot of it is coming from the unstoppable trend of other countries discovering the values of pensions and other types of social welfare to improve the quality of life for the elderly. It's a natural capitalistic evolution and productive for people at the prime of their working lives to move from tending to their elderly family members directly to outsourcing their care. By that I mean that elderly people with pensions are better equipped to care for themselves instead of moving into their child's home when they can no longer work. So foreigners are increasingly funding pensions. It's a global phenomenon and it's one of the main reasons that long-term debt is in such great demand, and therefore providing such low yields. It's supply and demand.

I don't think it's that foreigners are such great savers. It's just that the U.S. long ago built out it's retirement systems. The creation of a massive mutual fund industry, growth in the corporate bond market, etc… were the results of that. Now more foreigners than ever before are doing what we did 50 years ago.

It's win, win. All boats are lifted. Both the lenders and the borrowers are. Our companies make profits on the borrowed assets and the foreigners are getting much needed financial security. The companies are taking risk and the debt buyers are hedging risk. In many cases our companies are investing the money in the countries that are buying the debt in the first place. Our established companies go in and create jobs and improve their standard of living. On our end there is volatility in the job market, but despite the myth that our all our high paying jobs are going overseas a lot of high paying jobs are created to manage the complexities of globalization, more accountants, more corporate lawyers, more managers, more marketers, etc…

Another myth is that this is creating an over dependency on particular foreigners. The reality is that our exposure is becoming increasingly diversified. A government might decide to diversify it's holdings a bit, but then there are also say a hundred pension managers doing their own thing. Increasingly, what we are seeing is that a lot of companies each owe a little money to a lot of borrowers, all over the world, and the companies doing the borrowing are making direct investments all over the world so their revenues are also increasingly diversified.

Oversimplification of the process of globalization has lead to a lot of misunderstanding. For example, in my recent research on international trade I learned that despite the fact that all we hear about is investing in China and about our companies going into China and India, our direct investment in those countries is still very low compared to around the rest of the world. In 2004 direct investment in China was less than 2% and India only 0.5% of our total direct investment abroad. We invested as much in the Caribbean as both China and India combined, and that's not including Bermuda where direct investment was also more than in China. We invested five times as much in Canada, as in China, and nearly twice as much in Mexico, yet we never hear anything about what great investments there are to the north or south of us.

posted at 2:40 PM 3 comments   

What's Time Warner Buyback Worth to Icahn?

Carl Icahn reportedly wants Time Warner (TWX) to initiate a $20 billion stock buyback. Because it's good for the company? In Time Warner's case it probably would be since the company's capital investments have brought miserable margins. But, Icahn's 3.5% stake is worth nearly $3 billion. Taking 25% of the shares off the market equates to a dividend to Icahn of $750 million. The company has already agreed to buyback $12.5 billion by mid 2007. That alone is worth more than $450 million to Icahn, at least on paper.

posted at 12:42 PM 0 comments   

Stupid Investment of the Week

I need to come up with a catchy regular piece like this: Stupid Investment of the Week.
I get the kinds of ads Jaffe writes about all the time. They go straight in the trash.

posted at 12:05 PM 0 comments   

Thursday, February 16, 2006

The Savings Tradeoff

Bernanke's testimony to Congress today was significantly more upbeat and enlightening than yesterdays. He spoke at length on numerous relevant issues such as the deficits and savings.

Bernanke had this to say about our savings, or rather lack of:

The reason that we have a current account deficit is that we invest more, including housing, than we save, and we have to make up the difference by borrowing abroad. So our national saving is not sufficient to fund our domestic investment opportunities. It's a good thing in a sense that we are able to go to the capital markets and find funding for good domestic investment opportunities, but we'd be better off in some sense if we ourselves could fund those investment opportunities creating more wealth for Americans and greater capacity in the future for us to deal with the long-term challenges associated with demographic changes and the like.

I disagree that funding our own business opportunities would create more wealth. If this were true, then that's what we would be doing. The way our system works we maximize profit by default. If there were a more profitable way of doing things, we'd be doing that instead. It also isn't mathematically sound.

Brother A has a widget making business and takes in $100k a year exporting widgets. He needs $100k to double the size of his operations. Brother B has $100k in savings.

Brother A can borrow the money from Brother B at 10% annual interest and pay it back over a period of ten years. Brother A expands and doubles his revenues to $200k less $16k in loan payments to Brother B.

The aggregate income for both brothers is the $200k in revenue Brother A brings in.

Alternatively, Brother B goes into the widget business with his brother, putting in his $100k in savings, and Brother A borrows $100k from an outside investor. Together they triple operations and revenue less the same $16k in loan payments. The aggregate income is $284k.

Obviously, the brothers are significantly better off in the second scenario.

Now think about the two brothers as representing a country borrowing from another country instead of from itself.

The reason that the U.S. invests more and saves less than other countries is because we have more investment opportunities. Why save at 4% when we can make 10% in the financial markets, or a 25% profit margin in a business?

We contradict ourselves saying we should save more. If we did, we'd complain that consumers weren't spending and investing enough. We want more people to own homes. But when more people do buy homes, they hand their savings over to the banks and take on more debt, and then we complain that people have too much debt and aren't saving enough. We can't have it both ways.

It reminds me of back when I was working my way through college in a UPS package sorting hub. Management pushes the workers to move more packages per hour, but the more packages per hour the workers moved the more packages were damaged or misrouted. You can train the workers to improve their efficiency, but moving a hundred thousand packages a night through just the one hub, it doesn't take long to reach the maximum point of human capability or human willingness to improve.

We can't have more savings, more consumption, more investment, and more income. There are unavoidable tradeoffs. More investment means lower savings, but more income and consumption. More savings means less of everything else.

posted at 4:27 PM 1 comments   

Wednesday, February 15, 2006

Bernanke on Trade

During Bernanke's testimony the patent what if China et al stop buying our debt and funding our spending came up a couple of times. It was phrased so similarly to the way it's been poised here on more than one occasion that I assume there's a common mainstream media source for the expression of this fallacy and economic misunderstanding. Bernanke responded with almost precisely the answer I've given, which in short is why would they want to do that because it's not in their best interest to do so. Here's what he had to say specifically:

Congressman, China's not holding our debt because they want to be nice to us. They're holding it because they value the fact that this debt is being traded in deep, liquid, and safe financial markets and so they actually have an interest in holding this debt. And despite occasional rumors of diversification and the like generally speaking there's not been, as far as I know, any significant changes in the amount of debt, U.S. debt, or U.S. dollar assets being held by China. And any sharp change really would not be in their interest to undertake.

I think that the financial markets are really very deep and liquid for U.S. dollar assets if you include not only U.S. government debt, GSE debt (Fannie Mae, Freddie Mac, etc…), but also highly rated corporate debt, for example. The amount of, the size of the market for high rated U.S. dollar credit instruments is perhaps $40 trillion dollars, or something along those lines, which would mean that China is only holding a few percentage points of that debt. So I'm not deeply concerned about this issue. I think that realistic changes in China's portfolio are not going to have major impacts on U.S. asset prices, or interest rates.

The issue is not so much the change in China's portfolio. The issue really is the fact that we are consuming more than we are producing domestically. That means that foreign debt is increasing and there may come a period when foreigners are not willing to continue to add to their holdings of their dollar assets and that will in turn lead to perhaps an uncomfortable adjustment in the current account.

It has not too much to do with the portfolio choices in the short run, it's really, over long period, are foreigners willing to keep financing the consumption of their imports.

You envision them selling everything they currently own? They have to sell it to somebody.

Then my DVR ran out of rewind time and I went to live and didn't get his final comments verbatim. But he said something to the effect that it's not that foreigners would suddenly stop holding our debt, but rather they would gradually charge a higher price to hold it.

Obviously, I agreed with most of what Bernanke had to say. It certainly sounded a fair bit better than the political comments being made by various congresspersons such as: "…fiscal health in dire straits", "great uncertainty", "…the nation is in such a perilous state", "…terrible problem in unemployment in this country", "crisis", "real wages are flat", "this administration", "this administration", "the Bush administration", "record for deficits", "troubling trends", "saving too little", foreigners saving too much, risky homebuyers, homes to expensive, wage gap, minimum wage too low, etc, etc, etc… To listen to Congress you'd think we were right in the middle of The Great Depression II.

One thing Bernanke didn't mention was another reason China buys our debt, which is to manipulate their currency, something they also don't want to stop doing. They buy dollars to keep the dollar strong, yuan weak, and their goods cheap. They've responded to pressure to let the yuan float more, by pegging their currency to basket of currencies instead of just the dollar, but there's little doubt the yuan is still strongly tied to the dollar and the basket is designed to keep the yuan cheap.

It was also clear from Bernanke's comments on the funding of the trade deficit that our Fed still hasn't come to the realization and understanding of the impact of globalization and how much of consumer spending is actually being funded by our own companies importing money from other countries under the radar of the official trade figures, as opposed to the current economic understanding that the trade deficit is solely funded by foreign investment in U.S. debt. It's a conclusion that doesn't make much economic sense, but has reached a level of uncontested mythical status.

posted at 5:25 PM 2 comments   

Economic Insanity

I've watched quite a few of these semiannual Fed testimonies to Congress and it seems like (statistics aside) the economic ignorance of our elected officials just gets worse and worse every six months. Jeez it's painful too watch. I like to write down the stupid things I hear people say on TV. I'm now sorting through 16 pages of steno book notes picking and choosing what idiotic comments and questions contain lessons worth passing on. It was more comments than questions, as many participants used there entire time to give speeches, and Bernanke more than once looked relieved to hear the moderator go on to the next congressperson before he had to try and answer questions that in most cases weren't really questions at all and often traps.

My favorite Bernanke response was to a congressman who kept prodding him to say what he wanted to hear, which was meaningless and obvious but felt like something intended to later be used out of context. Bernanke saw the trap and responded with the most pointed, politically incorrect, and appropriate comment of the testimony. After having been hammered time and again with questions about what he was going to do about things that weren't even within his job description he responded to the policy trap on taxing and spending by saying, "This is why these are value judgments and there's no scientific way of answering your question. It's up to congress to decide what are the priorities you want to address, be it on the tax side or on the spending side. This is what the people have elected you to do and clearly that is your responsibility."

Most of the comments and questions had little at to do with monetary policy or macroeconomics, but Bernanke did comment specifically on the trade deficit and other matters of relevance. And I'll relate my take on his comments in another post.

posted at 4:41 PM 0 comments   

Another Perma-Bear Put in His Place

A reader recently passed on comments by Morgan Stanley's chief economist Stephen Roach. Despite his respectable position and illustrious career Roach is just another perma-bear. In November 2004 the Boston Herald reported Stephen Roach: Economic `Armageddon' Predicted. The title sums up the perma-bearish gloomy outlook of Roach. But it didn't take long to pick apart the analysis and find a fatal flaw, which actually reverses the forecast.

How someone of such high caliber could make this sort of mistake is beyond me. So analytical errors like this one strike me as suspicious. When a guy of this education and resources makes such blatant errors with such important ramifications and potential to negatively influence investors, then I want to know why. I seriously doubt that it's because I'm that much smarter than the best in the industry. I'm no genius. That, I know. What then are the possible explanations? Resting on laurels, a hidden agenda, true incompetence, or just plain lazy work taking government economic statistics at face value?

One of the reasons Roach says that the consumer, and therefore the economy, will collapse is that household debt is supposedly at record levels. He said then, "Twenty years ago the total debt of U.S. households was equal to half the size of the economy. Today the figure is 85 percent."

But what he's not telling us is that homeownership also increased from 63.5% to 69% over the same period. The average home price is nearly $260k. There are now 69 million homeowners. If we were still running at a rate of 63.5% homeownership there would 8% less homeowners, or roughly 63.5 million homeowners. That's a difference of 5.5 million homes. At an average price $260k that comes to a value of $1.4 trillion. If you figure an average down payment of 10% on the initial loan then that puts the additional debt at about $1.25 trillion.

The additional down payments of $140 billion also goes a long way toward explaining our supposed savings rate problem too. We have less savings because more people have shelled out to buy homes. The incredible irony of this is that we are told incessantly that homeownership is a good thing and we need more homeowners in this country, the poor can't afford homes, etc, etc, etc… Interest rates drop and homeownership rises from 67% to 69% in five years. Now all we hear is how unstable recent homebuyers are buying on variable rates, how they've bought more expensive homes than they can afford, there's a speculative housing bubble, etc, etc, etc… Which is it? Do we want more homeowners or not?

Back to the calculation at hand. The GDP at the time Roach made these offhanded ignorant comments was about $12 trillion putting his debt figure of 85% of the economy at $10.2 trillion. Over the twenty-year period illustrated debt then increased from $6 trillion to $10.2 trillion, or $4.2 trillion. In other words if we were still running at 50% of the economy, as Roach says we were twenty years ago, assuming that figure is truthful and accurate, then we'd be $4.2 trillion less indebted. Subtract off the $1.2 trillion in additional homeownership debt and we're left with an increase of $3 trillion, or $20k per employee. That might sound like a lot, but if much of that amount is part of a 30-year mortgage it amounts to a whopping $120 more a month on average. Then you have to figure in that the wealthy with high levels of disposable income are reason for most of that increase leaving the middle to lower classes paying say $30 to $60 a month.

Finally, when you figure in that BLS figures show that income is increasing faster than major expenses, it's no wonder the consumer is taking on a bit more debt. The additional debt is more than offset by other decreased costs. And the consumer is still left with more money to spend on entertainment and other purchases.

That's not exactly describing a consumer on the verge of financial Armageddon, which of course, jives with all consumer trends.

posted at 4:08 PM 2 comments   

Tuesday, February 14, 2006

Money, money, money

I'm motivated by money, but I'm not fond of being bound by it. Money is paradoxical. It simultaneously frees us and fetters us. This bit from the movie Office Space illustrates both sides of the paradox:

PETER: Lawrence, what would you do if you had a million dollars?
LAWRENCE: I'll tell you what I'll do, man--Two chicks at the same time.
PETER: That's it? If you had a million dollars, that's what you'd do, two chicks at the same time?
LAWRENCE: Damn straight, man. I've always wanted to do that. I figure if I were a millionaire, I could hook that up. Chicks dig guys with money.
PETER: Well not all chicks….
LAWRENCE: Well, the type that double up on a guy like me do.
PETER: Good point.
LAWRENCE: NOW, WHAT WOULD YOU DO?
PETER: Besides two chicks at the same time?
LAWRENCE: Oh yeah.
PETER: Nothing.
LAWRENCE: Nothing, huh?
PETER: I would relax, I would sit on my ass all day, I would do nothing.
LAWRENCE: You don't need a million dollars to do nothing, man. Take a look at my cousin. He's broke and don't do shit.

Up here in ski country bums are better known as couch surfers. Instead of scrounging through litter they scour the parking lots looking to nab a free lift ticket from someone leaving early and when they get one they are just as apt to resell it as they are to hit the slopes. There are real bums too, living in shanties up in the national forest lands, though they have to be completely crazy to homeless in such a hostile climate when they could hop a freight down to a warmer latitude. It's a subtle difference between the bohemian and the bum. This is depicted well in the movie Joe Gould's Secret, a true account of a bum who's supposedly has devoted his life to writing "An Oral History of Our Times", which turns out to be a long running scam to get handouts from the New York City's elite and art crowd.

In all the Mafioso movies it strikes me how enslaved the characters are to the money. They have nice things—in the movies—but they are not at all free. But, the greed extreme is best epitomized by those closest to Wall Street. Hardly anywhere else can there be found an example of people so addicted to money and so willing to do anything to get it. Balance to them on the whole is not one of morals, but tends toward the maximizing their own money intake, while minimizing the chances of getting caught cheating other people out of theirs.

Just because someone important says something about the markets doesn't make it true. The more idolized a person is the more skeptical I am. It's not that I'm inherently distrustful of successful people. Quite the opposite. I admire success and achievement greatly. Rather I am distrustful of the masses blind penchant for idolatry and the ability of those being idolized to manage the power they are provided in a honest, moralistic, and forthright manner.

posted at 4:04 PM 1 comments   

The Last True Contrarian

I'd prefer to be thought of as a rugged individualist, but probably he main reason that I'm reasonably good at not being drawn in by the smoke signals rising up out of that den of thieves meant to lure us to their lair is because I'm too much of a boorish bumpkin to be as extremely motivated by money as most people engaged in the markets. Though this aspect of human nature fascinates me to no end.

Everyone knows that this is how Wall Street is. It's no secret. It's always been this way. Yet the bourgeois are as ready as ever to believe whatever those on the street want them believe. There is little less mysticism and mesmerism to be found in the markets today than there ever has been. There's just more of everything. With computers and the Internet there's simultaneously more truth and more lies. Similarly, there's always been a minority of people with the particular mental facilities, whatever those may be, necessary to see things from above the crowd, as opposed to from amidst the crowd.

In the 1800s Gustave Le Bon wrote in The Crowd, "He (the leader) has been hypnotized by idea whose apostle he has since become. It has taken possession of him to such a degree that everything outside vanishes, and that every contrary opinion appears to him in error or a superstition. An example in point is Robospierre, hypnotized by the philosophical idea of Rousseau, and employing the methods of the Inquisition to propagate them."

People will believe whatever they want to believe and the markets are sufficiently complex enough for them to be able to hide from the truth indefinitely.

First published in 1954 Humphrey B. Neill wrote in The Art of Contrary Thinking, a compendium of his earlier newspaper articles going back into the 1920s, "Take chart-reading ideas, as an example. One can interpret charts almost any way he wishes. He can read into their "formations" just about any probable result he hopes for. Which is to say, that if one is bullish at heart his chart reading is likely to be interpreted optimistically; if bearishly inclined, charts accommodatingly will 'say' that the market is going down."

This mentality is not limited to chart reading. The economics of the markets are also deep enough to bury the truth where it is unlikely to be found. I have dug up the truth time and again and put it on display in my writings, yet there are consistently those that will deny these uncontestable facts. There is nothing new about this observation either. In this regard Neill writes, "…be contrary to words and not to facts. It is words that mislead, distort, and delude. To be contrary to words is a most wise and often profitable practice, but to be contrary to facts (although a universal habit of the Crowd and others who should know better) is to invite disaster."

Fortunately, for the rare speculator who can view the markets in this manner, such wisdom makes for popular reading and is usually found to be insightful, but is seldom put into practice. The majority of people will always prefer to follow their idolized leaders of high finance. Sir Francis Bacon said it best, "Watch your idols. Doubt all before you believe…"

Being contrarian has taken on a new meaning. It has come to mean taking the other side. But the modern version of contrarianism is like belonging to one of two political parties. It's been over simplified to mean going against the crowd. But these days there's a crowd going against the other crowd. Contrarianism used to mean truth seeking. The fact that seeking the truth happened to cause one to go against the crowd was somewhat coincident.

posted at 3:54 PM 0 comments   

Monday, February 13, 2006

Honing in on the True Trade Picture

If I'm right in my newfound understanding of trade and how it relates to the GDP and our economy in general, and I think that I am because it's the most plausible explanation for what we're actually seeing in the economy, then the next thing to think about is how do we reconcile the trade deficit and make the measuring tool meaningful once again.

Hypothetically, lets say we calculated trade counting not just the goods and services made here and sold elsewhere, but also goods and services both produced and sold overseas by American companies. The S&P 500 companies have total revenues of about $8 trillion per year. Now lets pretend that 10% of those revenues come from goods and services that are currently unaccounted for in the trade data.

I'm uncertain just how close to the truth that is, as some companies don't do distribute goods and services in this manner at all, while others such as ExxonMobil and Caterpillar make large portions of their revenues this way. I'm also not sure how the trade data deals with goods made by U.S. companies in other countries, but then are imported back into the U.S. by our own companies. It could turn out that they are getting this all wrong and simply accounting for the value and where the goods are arriving from, in which case this would be another huge plus on the imports side for which the overall economic benefits are not considered. I'm assuming they have this right and are only accounting for goods that are sold into the U.S. by foreign companies, but this is also rapidly becoming a gray area, as there are many U.S. companies that have exotic and unusual profit sharing arrangements with Chinese companies that are partially or wholly controlled by the communist government. What is clear is that our trade calculation methods are not sophisticated enough to account for such arrangements.

At any rate I'm just using 10% for illustration purposes, which comes out to $800 billion in revenues that goes unaccounted for in the trade data.

Now imagine that these companies made the goods and somehow ran their services from the U.S. instead. In that case they'd be importing more goods from overseas and we'd need to add those additional resources to the import side to be balanced. I'm going to use 20% of the accounted for revenues, or $160 billion, which is also a hypothetical estimate of the amount of goods a company might have to import to manufacture finished products.

For all of 2005 the BEA reported exports of $1,271 billion and imports of $1,997 billion. Adding $800 billion to exports and $160 billion to imports gives us $2,071 billion in exports and $2,157 in imports. That's pretty darn near to balanced and no I didn't work it backwards so it would conveniently come out this way. Obviously, this isn't even close to accurate, but it illustrates how much of a difference unaccounted for overseas business might be skewing the true picture of trade and more importantly the impact on our overall economy.

Some other factors to consider are that the S&P 500 companies are only a small portion of all the companies with unaccounted for trade, but that is also offset because a portion of unaccounted for trade benefits the U.S. directly. In these cases companies are large amounts of foreign labor.

I think the point we've come too is that trade has become too convoluted to measure with any real accuracy. We could count all the revenues for U.S. companies that come from goods sold outside the U.S., regardless of whether or not those goods and services are actually exported from within the country, but then we'd have to call foreign companies making and selling goods within the U.S. an import. Since there are many more U.S. companies making and selling goods outside the U.S. than there are foreign companies doing the same here, then I suspect calculating trade by that method would actually show a trade surplus for the U.S., but it would also exaggerate the benefit to the country since foreigners are getting most of the wages. However, it would I think exaggerate the positive by about the same amount that we're underestimating the positives with the current methods. So the true picture for trade should be somewhere close to the middle between the two, and nearly balanced.

posted at 3:42 PM 1 comments