These days, I just can’t get away from geopolitics. While my investing bias is towards value, a lot of my research and writing is on the macro, and these days, geopolitical scene. Healthcare, reregulation, and unemployment are all at the centers of the main struggles: inflation/deflation, government intervention, regulations and limits on pay, etc. Quite honestly, the article below from the NY Times yesterday was a bit of a suprise. Widening income gaps are historically negative for political stability, broad based investments, and increasing productivity. Not good signs. I’m hoping that these numbers do not a trend make.
The wealthiest 10 percent of Americans — those making more than $138,000 each year — earned 11.4 times the roughly $12,000 made by those living near or below the poverty line in 2008, according to newly released census figures. That ratio was an increase from 11.2 in 2007 and the previous high of 11.22 in 2003.
Household income declined across all groups, but at sharper percentage levels for middle-income and poor Americans. Median income fell last year from $52,163 to $50,303, wiping out a decade’s worth of gains to hit the lowest level since 1997.
Poverty jumped sharply to 13.2 percent, an 11-year high.
http://www.nytimes.com/aponline/2009/09/28/us/politics/AP-US-Census-Income-Gap.html
In a follow up to Part I, looking for predictive factors to the current economic mess, the Federal Reserve Board of San Francisco came out with Part II. In part one, I mentioned my fear that bureaucracies are always reactive and addressing the previous crisis. Part II actually does a good job of highlighting the lack of predictive power of most factors that have been proposed:
Our results yield a plausible set of estimates for the severity of the crisis across countries. That is, we find that Iceland and Estonia were hit more severely in 2008 than, say, China. However, we have less success in linking crisis severity to its causes. We examine over 60 factors that have been advanced in the literature as potential causes of the 2008 credit crisis, but few emerge as robust predictors of its severity. Indeed, we find only one variable–the size of the equity market run-up prior to the crisis–that is a robust predictor of crisis severity. Other equally plausible variables fail to perform well, such as the magnitude of real estate price appreciation or the quality of the regulatory environment. Since early warning models must predict both the cross-country incidence of crises as well as their timing, our analysis bodes poorly for the success of such models.
http://www.frbsf.org/publications/economics/letter/2009/el2009-30.html
I actually view this as a positive…the FRBSF is at least looking forward and recognizing the difficulty of predicting, something that bureaucrats often underestimate.
Obama campaigned on talk and now he is delivering, on the “talk” that is. This is the headline from cnn.com: “US to Iran: Prove your nuclear program is peaceful”. In yesteryear, the US stated that we will not allow a nuclear Iran. Sadly, the US has made a huge turn. We wrote on this was coming when Hillary Clinton mentioned that the key to stability was a defense shield in the region. This implied to us that the US stance was one that was OK with Iran developing nuclear capabilities while at the same time developing a defense strategy. At the time, we were suprised that the US was taking such a reactive stance, and disappointed that we weren’t pursuing an aggressive, multi-faceted approach to ensure that Iran did not reach nuclear status. So by now, I can’t say I’m surprised that what Obama wants is just to send in monitors after Iran goes nuclear.
Most of the current administration are alumni of the Clinton team. They are using the same blueprint they used for North Korea. Monitor, let some things slide, and hope the problem is not as serious as analysts predict. Of course, North Korea now has nuclear weapons, the monitors are long gone, and our ability to stand up to North Korean aggression, human rights violations, etc. are forever diminished.
What does this mean? For starters, it means Israel might be forced to act alone. The ramifications of that are unknowable. Certainly the world will cry out and criticize. However, most of Iran’s neighbors hope Iran doesn’t go nuclear for fear of changing the balance of power. Second, most of the west nations hope they don’t need to deal with a nuclear Iran and the prospect of nuclear terrorist organizations it supports. So all in all, everyone will probably be happy but act mad. I hope, that’s the worst of it.
http://www.cnn.com/2009/POLITICS/09/27/us.iran/index.html
This is from The Tax Foundation blog:
Famed Liberal Economist Casts Doubt on Obama’s Health Care Financing
by William Ahern
Eminent economist and liberal icon Henry Aaron of the Brookings Institution has written in the New England Journal of Medicine that financing universal health care as Pres. Obama and the House have defined it is nigh impossible in this economy.
The current tax proposals to partially fund the health care expansion are two, President Obama’s and Speaker Pelosi’s (HR 3200). They both rely on raising the top two income tax rates from 33 and 35 percent to 36 and 39.6 percent to get some revenue, but then they differ.
President Obama wants to cap the value of itemized deductions at 28 percent. People who pay taxes at the 33 or 35 percent rates (soon to be 36 and 39.6 percent) wouldn’t get the usual deductions on their federal income tax returns when they list their home mortgage interest, their state-local tax deduction, their charitable gifts, etc.
The House bill leaves those deductions intact; in fact, the value of those deductions would increase for high-income people when their tax rates go up. Instead of curtailing deductions, the House would impose surtaxes on top of the higher tax rates, ranging from 1 to 5.4 percent.
Even these ideas don’t fund the public health plans that Democratic lawmakers want, and Aaron dismisses the idea that Senate Democrats can easily push aside Republican ideas and adopt a “go it alone” strategy. He cites one especially daunting obstacle:
The most formidable is the “Byrd rule,” which authorizes any senator to raise a point of order against “extraneous” provisions, which include those that boost deficits during the period of the budget resolution – 5 years for most elements of the 2009 resolution – or in any year thereafter. Any provision that does not affect revenues or mandatory spending is also extraneous. To overcome such points of order requires 60 votes, the same number needed to end a filibuster.
Aaron wistfully mentions the virtue of a value-added tax but quickly acknowledges that it’s a political non-starter:
Even at modest rates, an earmarked VAT could easily pay for health care reform. But no president, including Barack Obama, has embraced this revenue source, and few members of Congress have shown interest in using it.
Finally, he advises Democrats to dial back their wish list because, “The full reform agenda may be beyond immediate political reach.”
Really as a follow-up to the piece by Blodget, but looked at from a different perspective, Hussman, a favorite of mine, even if I sometimes disagree, point to the low volume levels even as the market is rising. This tends to point to fewer and fewer stocks driving the vast majority of returns – not a healthy sign.
http://hussmanfunds.com/rsi/PhoenixVolume.htm
So Blodget came out stating that stocks are now overvalued by 15%-20%, http://www.businessinsider.com/henry-blodget-deja-vu-stocks-already-15-20-overvalued-2009-9. He brings to bear P/E ratios and the limited room for P/E expansion, the main source of capital gains for stocks. While I like to take the other side of most pundits, I happen to agree with Blodgets main conclusion: Long-term returns for the stock market will be challenging from this level. However, that does not mean that there aren’t good stocks out there trading at significantly discounted P/E’s with valuations that suggest significant outperformance going forward. Those are the ones we look for.
In a recent report from the Federal Reserve Board of San Francisco, Bharat Trehan, examines whether there are simplified signals that the Fed should use in the future. For the full report click here. Trehan looks at some recent work done on asset prices, debt levels, financial assets, etc. to determine whether clear signals can be utilized. The article makes a few (huge) assumptions: first, that the Fed should be on the lookout for bubbles and regulate it. The idea now going around DC is that the cost of heading off a crisis is cheaper than cleaning up afterwards, which was the dogma until last year. The second assumption is that there actually are clear signals available. The third assumption is that if there are clear signals the Fed would be able to figure them out. The fourth assumption is that if there are these signals, and the Fed figures them out, that they would know what to do with them and when.
Judging by the governments inability to see clear signals (Madoff, anyone) and their inability to act on those signals, do we really want them pre-empting “bubbles” based on mechanical signals? Hmmm, I doubt it.
Reasons to remain a bear
Buffett taught us that Mr Market is so irrational that only a fool would try to predict his short- and mid-term movements. So I stick to his teachings and continue to pick what I believe are undervalued companies and remain almost fully invested, as I do find interesting opportunities these days. However, given the horrible economic data that keeps pouring in – it’s hard for me to hold back my bearish sentiment. It almost hurts to read headlines these days. How can the press unanimously celebrate 2-3% growth in industrial order intake vs last month if year-on-year numbers are still down 10-20% or more (and we are now comparing to weaker, post-boom numbers)?
Anyways, these links provide fodder for the bears:
US: never before in post-Depression era has consumer credit fallen so dramatically (despite all the government stimulus):
To say that these figures are ugly would be an understatement. In fact, there is simply no way you can spin this – while this contraction in credit has to happen it has horrifying implications if our Washington policymakers don’t get on the stick and deal with the underlying issues here and now instead of pretending that everything is ok or worse, try to “borrow our way to prosperity.”
The important point is that we have never been here before in the post-Depression era. Any and all claims that “The Consumer has reached a bottom”, or “The Recession is over” (based on July data) or any such is pure nonsense. There is not only no sign of a bottom there is no change in the second derivative – that is, the rate of change continues to be essentially straight down!
http://market-ticker.denninger.net/archives/1418-The-Governments-Effort-Has-Failed.html
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Japan’s Debt Mountain
If there is a reason to expect about a prolonged economic winter in Japan, the most likely cause would appear to be an unsustainable level of sovereign debt. Thanks to nearly two decades of “stimulus,” Japan is burdened with debt like few other countries. Debt-to-GDP in Japan is now almost 220%. Netted against the large US dollar cash holdings Japan acquired in efforts to manage the dollar-yen exchange rate in the last decade, Japan’s net debt-to-GDP ratio is “only” 103%. But the ratio will surely grow higher. Japan’s budget deficit which had oscillated between 3% and 7% of GDP over the past five years, is running at nearly 10% in 2009.
It is hardly noteworthy in 2009 that the world’s second largest economy doesn’t meet the criteria to have qualified for European Union membership under the Maastrict treaty. Few of the other major economies do either, these days, least of all the United States. But to the simple-minded such as myself, it does seem odd that a nation with even a couple of credit metrics which rate on par with Weimar Germany and Argentina circa 2001 can hold down a “AA” credit rating. Stranger still are 10 year Japanese Government Bond (JGB) yields of slightly less than 1.3%.
http://www.gurufocus.com/news.php?id=68813
Why do they need to tap the treasury seeing that all the banks are all flush. No?
WASHINGTON — Federal Deposit Insurance Corp. Chairman Sheila Bair said her agency is considering borrowing from the U.S. Treasury to replenish its deposit insurance fund.
“We are carefully considering all options” including borrowing from the Treasury, Ms. Bair said Friday after a speech in Washington.
http://online.wsj.com/article/SB125328162000123101.html#mod=WSJ_hps_LEFTWhatsNews
As bear after bear gets squeezed, the real question is who will be able to wtihstand the most pain? As an example, quite a few people I know have been short UNG. Ouch. Are they right? Should the ETF be trading at a premium to the underlying? Probably not; but anyone who is levered is feeling a lot of pain. Can’t trade volatility with leverage. Once the shorts are out, this rally should see some pullback, because it’s been too good too quickly.
Bernanke comes out with a major call: The Recession is Over. I think that will turn out to be the overstatement of the year, maybe even decade (and there have been a lot of overstatements this decade). I’ve been looking for the real undervalued stocks. For the beaten up stuff that no one wants. I’m having a hard time finding them. Probably not a good sign.
In the recent Journal of Financial Planning, Edward F. McQuarrie highlights how your broker or financial advisor is probably steering you wrong in terms of fees. The traditional thought process is that you should pay less for bonds and more for equity investments (because of the higher expected return, higher risk, or whatever).
Executive Summary
- Mutual fund expense ratios and loads, along with adviser fees and wrap account charges, are among the many ways in which investors pay for investment management.
- Unfortunately, to assess trade-offs between alternative fee arrangements expressed in fractions of a percentage point requires a facility with exponential series (that is, time value of money calculations) that too many investors lack.
- To bring to the surface the kind of misunderstandings to which investors all too often succumb, this article reviews such questions as:
– Are low expense ratios generally more important in the case of stock funds or bond funds?
– If paying a load earns a reduction in expense ratio, should the load be paid on one’s stock funds or bond funds?
– If one financial planner charges an annual wrap fee, and another a one-time setup charge, what’s the best way to compare total costs?
- The proper procedure is not to focus on the magnitude of the expense ratio in relation to the forecast returns, but to calculate dollar results for the two exponential series.
- All basis points are not created equal when they figure in exponential series. This is the dark side of what is sometimes referred to as the magic of compound interest. The higher the rate of return, the more costly a single basis point of additional expense becomes.
- Wrap fees can be far more expensive than they first appear.
http://www.fpajournal.org/CurrentIssue/TableofContents/HowMuchIsThatBasisPointWorth/
I’ve been told that the March lows won’t be breached. I’ve heard that they will be breached and then we’ll bounce back up. I’ve heard V-shaped. I’ve heard W-Shaped. I’ve heard moon cycles mentioned. In the end, bear markets do not end in capitulation…they end in axhaustion, frustration, and disinterest. In his must read book Anatomy of a Bear Russell Napier shows us how the Japanese experience is much more in line with what we should expect for the next few years. False hopes and dire warnings will leave us with higher volatility, and ultimately less return going forward. In between, we’ll experience dramatic recoveries (ala right now) and scary pitfalls (ala coming soon to a theater near you). Don’t be fooled in either direction.
Well, if that’s the case, what should you do right now? Ironically, everything that was wrong for the past 20 years should now be right. Asset allocation and rebalancing was the wrong strategy in a raging bull market (you should have concentrated, focused on equities, invested in ETF’s to keep up). Now, as people are moving away from asset allocation, disciplined rebalancing, and stock picking, is exactly the time when these strategies should outperform.
So many things have been in the news recently, that I’ve had a tough time finding the common thread. Here are a few things I’m watching:
- Trade wars with China: First steel, now tires, who knows what’s next. Bloomberg stated that maybe this is a tactic to opening up free trade (http://www.bloomberg.com/apps/news?pid=20601087&sid=amYovMsrNEg0), but I have another theory. But I’ll hold off.
- Resource nationalism: We hear it in the press in various forms. It ranges from countries thwarting cross border M&A, to Brasil’s politicians making idle threats. Nouriel Roubini wrote about it in Forbes, which means it’s probably premature, but on the right track: http://www.forbes.com/2009/09/09/opec-brazil-oil-china-rare-metals-alberta-opinions-columnists-nouriel-roubini.html
- Iran, UAE, and the rest of the Middle East going nuclear. It’s not a question of “if” but rather “when”. What’s does that mean for oil security, regional security, etc.?
- Inverse correlation between dollar and stocks. It makes sense in a mildly inflating environment, maybe (a big maybe) in a somewhat higher infationary environment, but high inflation is not good for any financial assets, even ones that can raise prices and inflate earnings alongside the CPI. Simultaneously, bonds are holding up. So what are stocks and bonds telling us – they have faith that the US will control it’s re-inflation scenario. I’m not as convinced.
How’re all these related? Well, the US government needs to drive infation up. Monetary policy hasn’t worked. Fiscal policy is quickly going down the drain with waste as virtually none of the money is spent appropriately. (I was going to write a response last week to Paul Krugman’s self-righteous piece in the NY Times http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?_r=1. My main response would be that while he’s a good writer, Keynes is rolling over in his grave at the misapplication of his theories. Keynes would never support government profligate spending. He would support government investments instead. Building infrastructure, investing by government to replace lost consumer spending, is different than government spending on projects that have little to no future benefits. Anyway, we won’t go there here.)
So what other tools are left to the Obama administration? Well, how about sparking a trade war? How about talking up hoarding of resources? I wouldn’t be surprised if in the next few weeks a commodity like sugar or rare earth material becomes “strategically” important to US interests and the administration starts stockpiling it. Yes, it will tick up inflation, and at the same time increase inefficiency. Is that really how we’re going to inflate our way out of this mess? Is that what Keynes meant? I don’t think so.
Please consider these excerpts from Janet Yellen’s recent speech.
Key Quotes
- As painful as this recession has been, I believe that we succeeded in avoiding the second Great Depression that seemed to be a real possibility.
- I regret to say that I expect the recovery to be tepid.
- Even if the economy grows as I expect, things won’t feel very good for some time to come. In particular, the unemployment rate will remain elevated for a few more years, meaning hardship for millions of workers.
- My own forecast envisions a far less robust recovery, one that would look more like the letter U than V. A large body of evidence supports this guarded outlook.
- Unfortunately, more credit losses are in store even as the economy improves and overall financial conditions ease.
- Certainly, households remain stressed. In the face of high and rising unemployment, delinquencies and foreclosures are showing no sign of turning around. Even recent-vintage loans are experiencing rising delinquency rates.
- The chances are slim for a robust rebound in consumer spending, which represents around 70 percent of economic activity. Consumers are getting a boost from the fiscal stimulus package. But this program is temporary.
- It may well be that we are witnessing the start of a new era for consumers following the traumatic financial blows they have endured. While certainly sensible from the standpoint of individual households, this retreat from debt-fueled consumption could reduce the growth rate of consumer spending for years.
- My business contacts indicate that they will be very reluctant to hire again until they see clear evidence of a sustained recovery, and that suggests we could see another so-called jobless recovery in which employment growth lags the improvement in overall output.
General, Politics | Yaron Sadan | 
September 29, 2009 11:06 pm | 
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