Market Commentary (audio)

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"A little too cozy"

Bloomberg radio's Kathleen Hays's interview yesterday with former Republican Senator Judd Gregg caught my attention. Being that I aim to exploit every opportunity to expose incidences of cronyism to my readers, I find Mr. Gregg---who went straight from the U.S. Senate to Goldman Sachs---to be a particularly interesting character.

Now, two years after leaving office, he's made yet another career change; he's now the CEO of the Securities Industry and Financial Markets Association (SIFMA), Wall Street's largest lobbying group. Oh my!!

After the warm-up---where Mr. Gregg spoke inspirationally about how a "strong (insert crony here) capital market system" is essential to the long-term success of everyday folk---followed by a 10 minute love fest that Ms. Hays instigated by lauding his transparency (of all things), a listener tweeted in, asking Mr. Gregg to comment on the fact that Citigroup wrote 70 lines of an 85-line bill titled the Swaps Regulatory Improvement Act. Ms. Hays added; "isn't this just a little too cozy?". He attempted to redirect by talking about his experience (just before he left office to go to work for Goldman Sachs btw) as one of two senators in charge of "negotiating" derivatives regulations in the wake of the financial crisis. Ms. Hays interrupted him mid-stream with "but what about the latest one---the Swaps Regulatory Improvement Act---and how this one's coming down?" He then struggled through an explanation of how existing swaps regulations were poorly written and that, while he doesn't know who wrote this bill, "if it's better than what we're dealing with, and does a better job of making the markets safer, but also liquid, then that's what you want."

So, regulations that would better deal with the systemic risk posed by gargantuan banks, could---in your wildest dreams---be better written by gargantuan banks?? I tell ya, gargantuan banks must be (oh they indeed are) paying and promising an awful lot to get otherwise intelligent people (present and future lobbyists) to insult our intelligence in such a manner...

Market Commentary (audio)

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You believe in capitalism...

As I type the Dow is up over 200 points on the morning. The headlines suggest that supportive comments from world central bank officials (money-printers R us), a spike in existing home prices and a surge in consumer confidence has inspired willingness in buyers and stinginess in sellers. Makes sense (given how short-term traders think) to me.

Now, while you'll love your monthly statement if this keeps up, the price of stocks---that you happen to hold---agreed on by the final buyers and sellers of the day on May 31 is too fleeting a phenomenon to be getting all giddy about.

Thus, the whims of short-term traders will never be the focus for you---the savvy long-term investor. The market for stocks itself is not deserving of your affection. The marketplace---where goods and services are produced and sold---however, is. As I continue to preach, you own

Apple because you and/or oodles of people you know own an iPhone.
Google because you google.
Disney because you like movies, etc.
McDonald's because you see the traffic at their drive-thru windows.
Starbucks because you (and/or) love their coffee.
Lowe's because you own a house.
Exxon Mobil because you drive.
Boeing because you fly.
Monsanto because you eat.
Many, if not all, of the remaining 286 companies featured in the IShares S&P 500 Growth Index ETF because you believe they will continue to produce goods that others who produce goods---or who contribute to the production of goods (or services)---will want to buy.

In other words, you own companies because you believe in capitalism...

Never, ever, ever chase track records...

The factor most often leveraged by those who market their investment management services---be it a hedge fund, mutual fund, separate account manager, or your corner stock broker---is past performance. Which is interesting, since the CYA that follows every performance ad says past performance is not indicative of future results. Of course, despite the disclaimer---which is there per regulatory requirement---past performance does indeed say a lot about the skills of a given manager, right? Well, it depends.

For starters; if we're considering sector funds, past performance, generally, will be more a factor of the performance of the sector (tech, financials, energy, etc.) than of manager-skill. That's why, anymore, we're resorting to low cost sector index exchange traded funds in client portfolios. In which case, whether or not a given sector has outperformed a broad market index over the past 3 years---considering cyclicality---is of zero importance. In fact, while rebalancing---considering cyclicality---we often rotate client portfolios to sectors that have been relative under-performers of late.

As for actively managed funds, sure, past performance takes on more significance. Since all things market are cyclical, you should always buy the fund with the worst recent track record---odds are you'll be catching it right when the cycle turns to favor its manager's strategy. Ridiculous? Well, yeah, but no more so than buying a fund solely because it sports the best recent track record.

Let's do our own little experiment: I'll go to Morningstar's database right now and pull up all U.S.-based mutual funds, and, starting at the top, I'll record the calendar year performance ranking among peers for the first 5 funds that show track records back to 2008. And we'll see how we'd have done chasing yearly track records. Be right back...

Okay, I'm back. The first thing I realized when I went to Morningstar was that looking at just the first 5 funds would have forced me to pick solely on the Aberdeen fund family. So I grabbed the first Aberdeen fund with a track record going back to 2008, then jumped to the next fund family and took its first with a 2008-forward record, and so on. Here are the results:

Aberdeen Asia Bond Institutional:
2008: Underperformed 89% of its peer group. (REALLY BAD)
2009: Outperformed 91% of its peer group. (GREAT)
2010: Outperformed 92% of its peer group. (GREAT)
2011: Underperformed 79% of its peer group. (BAD)
2012: Outperformed 83% of its peer group. (GREAT)

Acadian Emerging Markets Institutional:
2008: Underperformed 84% of its peer group. (BAD)
2009: Outperformed 71% of its peer group. (VERY GOOD)
2010: Outperformed 80% of its peer group. (GREAT)
2011: Underperformed 52% of its peer group. (MEDIOCRE)
2012: Outperformed 88% of its peer group. (GREAT)

Access Capital Community Investment I
2008: Underperformed 70% of its peer group. (BAD)
2009: Outperformed 84% of its peer group. (GREAT)
2010: Underperformed 75% of its peer group. (BAD)
2011: Underperformed 84% of its peer group. (BAD)
2012: Outperformed 78% of its peer group. (GREAT)

Adams Harkness Small Cap Growth
2008: Underperformed 73% of its peer group. (BAD)
2009: Underperformed 91% of its peer group. (REALLY BAD)
2010: Outperformed 89% of its peer group. (GREAT)
2011: Underperformed 74% of its peer group. (BAD)
2012: Underperformed 54% of its peer group. (MEDIOCRE)

Adaptive Allocation C
2008: Outperformed 99+% of its peer group. (FANTASTIC!)
2009: Underperformed 95% of its peer group. (REALLY REALLY BAD!)
2010: Outperformed 97% of its peer group. (FANTASTIC!)
2011: Underperformed 96% of its peer group. (REALLY REALLY BAD!)
2012: Underperformed 99+% of its peer group. (REALLY REALLY REALLY BAD!!)

Now of course that's only five, but it is, honestly, the very first five. Run the first 50 or the first 5,000 and I suspect, by and large, you'll see the same patterns. Which gives you absolutely zero faith in the notion that track records are the most important consideration when allocating your portfolio.

In the end, it's future---as opposed to past---performance we're after. And while, as advisors, we are forever striving to add value at the margin through intelligent sector selection, what makes successful long-term investors successful is that they maintain an asset allocation that matches their time horizon, appetite for risk, income needs, etc. And that they never, ever, ever chase track records...

For more on the subject read No Magic Pill...

Affordable, it ain't...

If The Affordable Care Act (ACA), aka Obamacare, was aptly---in its intent---titled, it appears doomed to fail its objective.

Here's what Washington Post's Robert Samuelson discovered in his interviews with Professional Employer Organizations:

First, some companies now providing insurance are being hit with huge premium increases. Before Obamacare, said one PEO adviser, his clients typically received annual increases of 6 percent to 12 percent. “This year we’re seeing 30 percent rate hikes,” he said. The surge is blamed, rightly or wrongly, on the ACA’s requirement for more comprehensive coverage and on its formula for calculating premiums (aka “community rating”). Costlier insurance could cause some employers to drop it and others not to offer it. But modest increases in overall health spending could relieve pressure on premiums.

Second, most companies haven’t made final decisions. Those who have go both ways. Another adviser described a 250-worker car dealership with good wages but no health insurance; it will provide coverage and cut wages to help pay costs. Another example involved a 60-worker manufacturing firm with wages of $12 to $15 an hour. It offered bare-bones policies with steep deductibles. Confronting higher premiums for expanded coverage, the owner will drop insurance. He found the ACA “too complex,” said this adviser. Wages will be increased somewhat. With subsidies, workers might do better in the exchanges.

Third, many firms are revising their business models to minimize insurance costs. One favorite idea: Hold workers below the 30-hour weekly threshold requiring insurance. Many part-time employees who work more (say, 35 hours a week) will lose hours. One adviser discussed a movie-theater chain that will keep most staff below the threshold. Many restaurants and hotels may do likewise. Similarly, companies are striving to stay below the 50-employee ceiling that triggers the insurance mandate. Another adviser mentioned a client, an engineering firm with 48 workers, that had deliberately restrained expansion.

All of this clouds Obamacare’s promise of universal coverage. The Supreme Court’s decision that states don’t have to join the Medicaid expansion will reduce the number who get coverage. What matters for small and medium-size firms is the gap between providing coverage and paying the tax penalties. The wider it gets, the more likely it is that firms won’t provide insurance. Some will also be deterred by the “hassle factor” of complying. The less private coverage, the more federal subsidies for exchanges will rise — and the greater the chances that individual workers will forsake insurance and pay the tax penalty.

ACA is a vivid example of what should seem so obvious, but what too many politicians and virtually all "progressives" fail to understand: That government's intrusion into the marketplace to coerce outcomes it deems desirable---by imposing higher costs onto producers---inevitably hurts the very group it intends (or pretends) to help.

Careful what you ask for...

Much of the financial media buzz this week is about all that cash Apple legally shelters outside the U.S. If you happen to share John McCain's and Carl Levin's outrage, I'd like you to reconsider in light of the following points:

1. Cash "stashed" overseas was not earned in the U.S. then sent overseas. It was earned and, if at all (under agreements with taxing authorities), taxed overseas.

2. Apple is a global company, serving the global marketplace. When it manufactures a product in a foreign market, sells to consumers in that market, pockets its earnings and pays taxes in that market, what reasoning would justify a U.S. levy on those earnings?

3. If Apple pays a 2% tax in Ireland and decides to use some of its Irish earnings to establish a presence in Canada, the Canadian government will be so thrilled/smart that it wouldn't dream of hitting Apple with a 13% tax (Canada's 15% corporate tax rate minus the 2% paid in Ireland) on the way in.

4. If, on the other hand, Apple decides to invest some of its Irish earnings in the U.S., the U.S. government will be so insane as to hit Apple with a 33% tax (America's 35% corporate tax rate minus 2%) on the way in.

5. Now if Samsung (a South Korean company) pays a 2% tax in Ireland and decides to use some of its Irish earnings to establish a presence in the U.S. market, the U.S. government (like smart Canada) would be so thrilled/smart that it wouldn't dream of hitting Samsung with a 33% tax on the way in.

6. If Apple pays more taxes, are you likely to pay more or less for your next iPad? Would its employees see higher or lower advances in pay and benefits going forward? Will it hire more or fewer people going forward? Will it pay higher or lower dividends to stockholders going forward? Will its stock price grow faster or slower, if at all, going forward?

7. If Apple pays more taxes, is the federal government likely to, therefore, reduce your taxes---or otherwise enrich your life---going forward? Are politicians likely to become more or less responsible with all that additional revenue flowing in?

8. Under whose command do you think Apple's revenue would ultimately bring the greatest value to the consumer: Apple, competing with the likes of Samsung for the consumer's business? Or politicians, competing with each other for the consumer's vote?

9. Ultimately, who pays corporate taxes? Isn't it, per #6 above, customers, employees and shareholders? Clearly, if companies pay higher tax rates, and the government's win-fall doesn't flow to your tax return---which it won't---you, Pyrrhus, will be picking up the tab...

What we're talking about here is worldwide (e.g., U.S.) versus territorial (e.g., Canada) tax policy. Worldwide means, for example, a U.S. company pays U.S. tax on income wherever in the world it's earned (although the U.S. system allows for "deferral" --- meaning foreign income isn't taxed until it's brought to the U.S.). Territorial means, for example, a Canadian company pays no Canadian tax on income it earns in foreign countries (even when it's brought to Canada). Defenders of the worldwide system claim that a territorial system in the U.S. would actually---to an even greater extent---inspire U.S. multi-national companies to book their profits overseas. But, as under the present system, when we allow companies to defer tax until those earnings cross over into the U.S., aren't we inspiring them to keep profits---in perpetuity---overseas? I think the worldwide system's proponents need to realize that 96% of the world's customers live outside the U.S. I.e., opportunity so abounds outside our borders that there's little need to ever bring those earnings home. Of course that's why they'd have us do away with deferral altogether.

And why should we pray they fail at doing away with deferral altogether? Read again points 6-9.

Goods buy goods...

One day last week, on CNBC's Kudlow and Company, Larry gave his expert guest the last word: she justified her optimism for stocks by the fact that consumer spending appears to be trending higher and that "consumer spending is 72% of the economy". Larry closed the evening's show by telling her she had it "almost right". That (words to the effect) what this economy needs is more saving, and business investment, as opposed to more consumer spending. I don't always agree with Mr. Kudlow, but in this instance I believe he was spot on. Although I had no idea where she had it "almost right". She was at least 72% wrong. Of course her assertion that "consumer spending is 72% of the economy" comes straight from the GDP equation, and is an oft-quoted justifier for policies aimed at boosting demand. Once upon a time, I fell prey to the same misconception.

Here, in my (evolved) view, is a more sensible description of what grows the economy: From page 26 of Steven Kates's Say's Law and the Keynesian Revolution:

If one takes the annual produce of a country, writes Mill, and divides it into two parts, that which is consumed is gone. On the other hand, that portion which is used in the production process returns in the following year, with a profit. The more of the produce of a country that is devoted to productive uses, the faster that country grows.

And (from page 40) on the cause of recessions:

The basis of the law of markets is that goods buy goods, but only if the right goods are produced. If the wrong goods are produced, then they cannot be converted into the universal equivalent (i.e. money). If a proportion of goods cannot be sold, then their owners cannot buy. If one set of producers cannot buy, then a second cannot sell. The result is a general downturn in the economy and warehouses filled with unsold goods. But the cause of recession is not demand deficiency or over-production but the production of the wrong assortment of goods and services. The adjustment process thus required is the redeployment of capital from areas where there is too little demand into areas where there will be demand for the goods produced. There is no reason that the process of readjustment will be rapid, but there is no reason to believe that the downturn will be permanent.

So, under whose command should we expect the greatest likelihood of producing the right assortment of goods and services; a self-serving producer of goods and services, or a self-serving politician? Certainly the market, all on its own, can, for a time, produce the wrong assortment of goods and services. However, left to its owns devices---and to natural consequences---the market will adjust accordingly and purge its excesses. The politician, on the other hand, has a professional interest in circumventing the suffering of his supporters, and is adept at neutralizing the natural consequences for the producers of the wrong goods by spreading the loss among the entire population. And, alas, he in effect neutralizes the redeployment of capital from areas where there is too little demand into areas where there will be demand for the goods produced. Hence, a very slow recovery...

When one thinks about the last recession, housing comes to mind. Government-(explicitly)-backed mortgages (Ginnie mae), government-sponsored enterprises (Freddie and Fannie) and a variety of tax incentives are the brainchildren of politicians incentivizing the production of a particular good. Plus, the Fed had flooded the financial sector with liquidity enough to fund the manufacture of trillions of dollars worth of derivative securities designed to leverage---many times over---the housing market. In the end we had the definition of resources diverted to the production of the wrong good, and, thus, the greatest recession since The Great Depression...

Investing wisdom and discipline...

"The best thing for me would be that ten percent correction" my buddy/client Ron declared to me yesterday morning. As you might imagine, that's not the typical sentiment among everyday investors. My friend clearly gets it. He understands that a healthy market, like a healthy long-distance runner, has to take that break every now and again. Or think pit stop if you prefer an auto racing metaphor.

I believe the last ten percent correction occurred the year Mario Andretti won the Indy 500. That's right, I was calling my clients on a rotary dial phone. Well, of course that's not the case (I was only 7 years old) --- and it certainly doesn't express the sentiment of the general population. There's no question many investors, particularly moms and pops, are still smarting from the 2008 bear market. And we've seen a handful of noticeable corrections since then. Just not lately.

What my unusually wise and disciplined friend is hoping for is the opportunity to rebalance---buy stocks---in a down market. You see, virtually without exception, we have been selling stocks after every client review meeting for the past several quarters. That's simply because the market's up, and if your target is 60% equities, your portfolio is over-weight stocks. Which means we sell back to your target. When (yes "when") my friend gets his wish---when your stock exposure drops to (for example) 50%---we're buying back to your target. Ron (as should you) understands that, long-term, his portfolio will be better if it takes that periodic pause, allowing him to reinforce his foundation --- replenish his portfolio's electrolytes if you will.

Bottom line: while, at the margin, sector selection matters, maintaining a diversified portfolio, and the wisdom/discipline to periodically move against the crowd are the secrets to long-term investment success.

No direction needed...

In the sci-fi thriller The Terminator, machines become so advanced that they think for themselves, develop a survival instinct, and set out to destroy everything that threatens their existence.

The Obama Administration is on the proverbial hot seat over the IRS's targeting of conservative organizations. The Republicans are having a field-day. All the buzz is about how the political tide is about to turn in their favor.

We may never know if there's a direct link between the current (there is precedent from both sides of the aisle) Administration and the IRS's shenanigans. I---being too far removed---won't speculate. But here's the thing; direct, in this instance, White House connection or not, know that an ever-growing government---the institution itself---has a life of its own. Those who depend on the largess of large government can become like rogue algorithms from some master system --- needing no direction from above to sense and deal with danger.

Threaten to simplify the tax code, reform entitlements, cut all manner of wasteful government programs --- in essence, threaten livelihoods dependent on big government --- and a naked ex-bodybuilder from the future may visit all manner of hell onto your neighborhood. Or, worse yet, you may be visited by the IRS.

Today's TV Segment - Leaving Liberty?

Where do we go from here?

In the fall of 2010, hedge fund manager David Tepper predicted that stocks would gain measurably based on the economy improving and/or the Fed maintaining an ultra-easy monetary policy. Well, he certainly got the stocks gaining part right. Yesterday, he found himself on an early morning CNBC program making a numeric case for the rally to continue well into the foreseeable future. Hence, yesterday's market action was dubbed "The Tepper Rally". He figures that with the budget deficit coming down measurably, as Freddie and Fannie pay back the treasury, as tax revenues increase (I'd add that smidgen from the "devastating" sequester), etc., over the next six months, that the Fed's monthly bond-buying will result in $400 billion worth of newly "printed" money that won't be needed to fund the budget for the balance of this fiscal year. He says it has to go somewhere; spending, savings or stocks. I guess he's betting it won't snuggle up with the other few trillion in banks' excess reserve accounts.

Now I love a rally just as much as the next guy --- smiling clients make my job a joy. But whenever I hear anyone---smart as he may seem---profess to have factored in the myriad factors and conclude with a prediction as to the short-term (six months is short-term btw) direction of stocks, I cringe. Particularly when the specific factors that he factored are anything but myriad. You see, as I preach ad nauseam, market winds can change on a dime. And the time to get nervous is when nobody's nervous. Now if Tepper indeed, once again, gets it right in terms of price action he'll enjoy the spot light, and heavy net inflows to his hedge fund. But at the end of the day, all he is doing---his quantifying notwithstanding---is making a guess. All the factors in play that would inspire stocks to future highs cannot be known, even in retrospect, by any human being.

All that said, allow me to stick my neck out and make my own guess (two guesses actually):

The stock market will trade measurably higher well into the latter half of this year because buyers, each for his/her own reasons, will come to market with cash, and the holders of stocks will become the most stubborn of sellers. Or, the stock market will trade lower well into the latter half of this year because the holders of stocks, each for his/her own reasons, will bring their shares to market and those with cash will become the most stubborn of buyers. The potentialities behind what will inspire either scenario are too numerous to even begin to assemble, let alone predict.

So what do you do? Now that part's simple: You own stocks because you own stuff, and you want to invest in the companies that are making money selling you that stuff. Knowing full well that the market will give you ample opportunities to rebalance back to your target to stocks. That is, periodically buying when prices are declining and selling when they're rising --- all in the context of your time horizon and tolerance for volatility...

Ah, capitalism...

"Would you like a paper receipt or an email?" asked the Dick's Sporting Goods Store clerk as my wife and I made our purchase yesterday afternoon. We chose email. The experience called to mind the New York Times article I read a couple hours earlier titled Heat Trapping Gas Passes Milestone, Raises Fears. And why so? Well, one less piece of paper means one more piece of a tree out there sucking all that carbon dioxide out of the atmosphere.

Ah, capitalism; that system that inspires profit-seekers to produce their wares as efficiently as possible. And how about all that Internet commerce: Businesses, large and small, the world wide are harnessing the web to reach customers while breaking a whole lot less ground, spreading a whole lot less mortar between bricks, and burning a whole lot less fossil fuel. I know, you armchair environmentalists are thinking yeah, but all that stuff has to be shipped. Which means trucks, trucks, dirty dirty trucks everywhere! Well, as it turns out, capitalists are discovering yet another way to squeeze profit out of a buck; by shipping on cheap-(and clean)-running natural gas vehicles (per this other NY Times article).

It seems to me that environmentalists ought to be lobbying government to step aside and unleash (as opposed to step in and leash) that spontaneous, nature-saving phenomenon we call free-market capitalism.

Things make sense till they don't, part 2 - OR - 2013 Krugman

Here's a followup to my earlier post:

I just read Paul Krugman's piece today on, of all things, the bond bubble. Or, I should say, the lack of one. He, like Moody's analysts (yet unlike Warren Buffet and yours truly) discounts (in true academic---and inexperienced---fashion) what investment blokes like me believe to be commonsense.

The thing is; markets fluctuate. And when they reach extremes they tend to, ultimately, do so (fluctuate) in grand fashion. Yes, I know, Japan. Krugman loves to point out how Japan has remained mired (not his term) in a crazy-low interest rate environment for decades. And if you think the U.S. will be doomed to decades of stagnation as well, Krugman may be right. However, our stock market is (or may be) forecasting something altogether different. And, I suspect, given all the moving parts, there may be a dynamic or two unique to Japan. Of course if Krugman were the least bit objective he'd be exploring, and reporting on, those dynamics. In fact, he does indeed understand that long-term interest rates can be influenced by factors other than the Fed's control over short-term interest rates. As he explained back in 2003, when he wasn't so enamored with the then administration:

Last week I switched to a fixed-rate mortgage. It means higher monthly payments, but I'm terrified about what will happen to interest rates once financial markets wake up to the implications of skyrocketing budget deficits...my prediction is that politicians will eventually be tempted to resolve the crisis the way irresponsible governments usually do: by printing money, both to pay current bills and to inflate away debt.

Wow! What an utter contradiction to virtually everything he's written about budget deficits and money printing over the past 4+ years!

Now back to Krugman 2013: As for the Fed; if my math is correct, the Fed is currently buying up the equivalent of roughly half the treasuries that need to be issued in order to fund our present budget deficit. That leaves the other half to either yield, safety or dollar-support-seeking (Chinese, Japanese, maybe) investors. In theory, the investors buying the other half can stay around till the cows come home. The Fed, on the other hand, can't (although Krugman may disagree). The bond market will begin selling off (to what degree no one knows) when investors decide their objectives will be better met elsewhere. Oh, and by the way, the ten year treasury closed today at a yield of 1.9%. That's a 17% spike above this year's low (which it hit about a week and a half ago). And that's without the Fed changing a thing. Hmm...

And lastly, here he is, in his 2013 brilliance, explaining what makes a long-term interest rate:

Well, the interest rate on long-term bonds depends mainly on the expected path of short-term interest rates, which are controlled by the Federal Reserve. You don’t want to buy a 10-year bond at less than 2 percent, the current going rate, if you believe that the Fed will be raising short-term rates to 4 percent or 5 percent in the not-too-distant future.

Allow me to take a stab at it:

The interest rate on long-term bonds depends entirely on investor appetite for long-term bonds. You don't want to buy a 10 year bond at less than 2 percent if you believe there are better uses for your money elsewhere, regardless of what the Fed does with short-term rates. An uptick in the economy can inspire (or scare, as they anticipate rotation) investors to other asset classes---forcing up bond yields---in a hurry. A too(?)-weak dollar, as 2003 Krugman feared, can do the same.

Things make sense till they don't...

For too long now I've been sounding the bond bubble warning signal. However, of late, while I'm still avoiding bonds, I've begun to back off that stance just a bit. Not because the burst to be felt round the world has yet to happen, but because so many people are now sounding that same signal. You see it's typically not the things you expect to upset the apple cart that upset the apple cart. I recall---after the bursting of the residential real estate balloon---many a pundit was calling for a collapse in commercial that would make the residential experience seem little more than bubble gum on your cheek. Not that the commercial market didn't experience its own pain, but it didn't, after all, turn the Great Recession into the next Great Depression. And what about the European debt crisis? Everybody and his au pair was (many still are) predicting an '08 style (or worse) global equity market meltdown as nations, beginning with Greece, would domino out of the union. Could still happen, but ????

A CNBC article this morning (and a few other recent commentaries/analyses), however, has me back to thinking that the serious global threat of the mother of all bond bubbles bursting is still very much on the table: Three analysts from Moody's cite recent issuance levels and spreads between investment grade, junk and treasuries to be at historically sound levels. They therefore see no strong evidence that a "damaging correction" is on its way. I find their position dangerously sanguine for two reasons: One, citing their credit spread assessments, in an historical context, at a time of historically low interest rates (uncharted waters) as a reason to sleep easy, is historically dangerous. As evidenced by my number two: The great historian Ben Bernanke made the following similar call on the mortgage market back in March of 2007 (OOPS!):

The ongoing tightening of lending standards, although an appropriate market response, will reduce somewhat the effective demand for housing, and foreclosed properties will add to the inventories of unsold homes. At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems likely to be contained. In particular, mortgages to prime borrowers and fixed-rate mortgages to all classes of borrowers continue to perform well, with low rates of delinquency.

Yep, things make sense till they stop making sense.

Stay tuned...

Still no conviction in the stock market...

So how is it that the Dow can top 15,000 while the place---the bond market---that captured the money of the folks who brought it to its knees (back in 2008) remains more flush than ever? If you had told me, say a year ago, that stocks would be at these levels, I would have told you that bonds would be getting trounced. I mean it makes perfect sense, right?

If back in October 2007 stocks were priced at X (all-time high), and bonds were priced at Y, and by March 2009 stocks were priced at Y (multi-year low), and bonds at X, for stocks to once again be priced at X, bonds---to provide the liquidity to push stocks back to X---would have had to sell off back to Y (or, at a minimum, somewhat lower than X), right? Well, as I stated above, no...

There are two factors at play that circumvent this seeming commonsense: One being the Fed, which, with its quantitative easing ("printing" money and buying bonds), has effectively put a lid on bond yields (or a floor under bond prices) to this point. The other being a general lack of conviction: This, as many a pundit has declared of late, has been the most hated rally in history. Meaning there's been no storming of the market's gates. Stocks have eclipsed old highs with no battering ram-wielding buyers pounding liquidity into equities (and out of bonds).

The latter essentially means volume (the number of shares actually changing hands) has been somewhat light. Which means the holders of stocks have been, for whatever reasons---perhaps exceptional corporate earnings, lots of sideline cash earning nothing, record low bond yields and a slightly better-trending economy---reluctant to unload their shares at yesterday's lower prices. But if those reasons are indeed legitimate, why aren't buyers coming in in droves? Well, perhaps it's uncertainty over tax and regulatory policies going forward, or post traumatic stress resulting from the 2008 bear market, or the fact that, while better-trending, this recovery has been the slowest on record, or any number of other reasons I can't think of at the moment.

The good news (maybe) if you're bullish on stocks is that with such little participation from the retail investor (think, for example, 401k accounts), a skeptical tone from many an institutional investor (the ones who missed the rally that is), and a bulging bond market, there's more than ample liquidity to make Warren Buffet (on CNBC yesterday) look like he knows what he's talking about.

As for me, I'm not that interested in where the market goes in the short-run (which keeps me sane since it makes no sense to take great interest in something that, at times, makes no sense). I guess if I had a short-term want, I'd want stock prices to as accurately reflect the real world of earnings as possible. And based on present price-to-earnings ratios, and other valuation metrics, stocks---my indifference (and the political environment) notwithstanding---make short-term sense to me. As for my long-term (what counts) want, I want to own stocks: because I believe I'll be typing future essays with better technology, that (politics notwithstanding) I'll be finding abundant global opportunities---and for all those other reasons I mentioned in Why You Eat Bugs and Own Stocks...

Planning like there's no tomorrow...

This piece by Don Boudreaux puts central election-cycle planning into perspective as well as anything I've read thus far. Here's a snippet:

Who cares about tomorrow? Who cares about the counterfactual that is prevented from coming into existence? It will always be a mere counterfactual. We have no time for economic policies that allow market forces to play out over time – to play out in all of their rockiness, with their failure-to-keep-everyone-optimally satisfied-at-every-moment. We have no time to worry ourselves about the microeconomic structure of production, the pattern of relative prices. Changes for the better in those things take time. Better that we simply treat with greater government spending the symptom – a symptom, sometimes, of real problems and, at other times, merely of beneficial on-going economic changes – than to be patient and let market processes work their way out over time.

If you only have time today, this week, this month, or this year to read one blog post, read this one!

Ideology is like Superglue...

Just listened to four highly-credentialed economists (two to a side) debate the ultimate effects, social and economic, of the minimum wage. Each side made reference to studies that they claimed conclusively proved their case. One side argued so well the (what I believe to be) commonsense points I've expressed and linked to numerously over the years. Only to be shamed by the other for suggesting---commonsense (or empirical evidence) notwithstanding---that raising the cost of labor would somehow compromise the market for labor. Understanding that this was a publicized debate---the sides picked based on their advertised positions on the issue---and that, under no circumstance, would the discussion remotely sway a panelist from his or her conviction, I nonetheless found myself thinking wow, ideology is like Superglue. The resistance, through years of mining bias-confirming data, can become so great that to pry loose would mean to relinquish to the other side some psychic material that composes who we believe ourselves to be.

So I began to pen an essay on the subject then remembered that we already went there last fall. Give this one another read...

The Thing About Coffee - Or - Firm in His Addition - Or - Empirical Evidence is in the Eye of the Beholder

“The question we should ask”, says Paul Krugman in Friday’s NY Times, “is what policies would offer the best prospects for healing the damage?” The administration “would have tried to accelerate recovery by sustaining public spending and putting money in the hands of people likely to use it. Republicans, on the other hand, insist that the path to prosperity involves sharp cuts in government spending. And Republicans are dead wrong.” He goes on to cite the just-released IMF World Economic Outlook, a report that, he says, combines “short-term prediction with insightful economic analysis”. A “grim and disturbing document, telling us that the world economy is doing significantly worse than expected, with rising risks of global recession. But the report isn’t just downbeat; it contains a careful analysis of the reasons things are going so badly. And what this analysis concludes is that a disproportionate share of the bad news is coming from countries pursuing the kind of austerity policies Republicans want to impose on America”. He then confesses; “O.K., it doesn’t say that in so many words. What the report actually says is: “Activity over the past few years has disappointed more in economies with more aggressive fiscal consolidation plans.”"

Fascinating that a man of Krugman’s intellect, and tenure as a political commentator, would suggest that today’s Republican politician—campaign pledges notwithstanding—is somehow less predisposed to spending than his predecessors. I see little, at this juncture, to support that assertion (look no further than their voting records).

The thing about coffee—for the infrequent user—is that the occasional cup will deliver that generally desirable kick. But when one finds oneself partaking on a daily basis, for an extended period of time, it, oddly, can deliver the opposite effect—sluggishness. Should the heavy user find himself in need of a boost (an approaching deadline perhaps)—if caffeine is to remain his stimulant of choice—he’ll have to step it up; go high-octane and maybe throw in a Red Bull or two. Knowing full-well he’ll be suffering the ultimate consequence—a major crash—once the deadline is met. But if he is to keep from destroying his health, crash he must.

From what I understand about alcohol (boring me doesn’t drink), the casual user gets by just fine on the occasional beer, glass of wine, etc. He enjoys the short-term effect, and his life is all about facing the everyday challenges that come with the typical modern human experience. The functioning alcoholic, on the other hand, feels miserable when that cup of coffee on his desk isn’t spiked with whatever it is he spikes that cup of coffee with. “Functioning alcoholic” is a term used for addicts who can hold down a job while simultaneously holding down their liquor. The term, however, is not to be confused with a “functioning liver”—and therein lies the problem. On the surface things may appear just great, while, inside, the abuser eventually drowns his organs and, alas, shortens his modern human experience.

Today’s politician (central planner) is, at best, the chronic caffeine addict. At worst, he’s the functioning alcoholic. He is forever haunted by his constituents’ query; “are we better off today than we were four years ago?” The notion of coming down off of years of over-spending, and suffering the healthy, market-clearing (and economy-saving) pain of recession—on his watch—doesn’t warrant the remotest consideration. And, sadly, as any user can attest, the greater the [stimulant-induced] sluggishness, the greater will be the cry for continued (and heightened) stimulus—particularly when the inevitable “crisis” (or garden-variety recession) occurs. And just like the in-denial addict who believes he can drink his way to success, the planner—whose mantra, a la J.M. Keynes, would be “in the long run we’re all dead”—assures us he’s got everything under control.

I find it utterly baffling how, in the face of the developed world’s record sluggishness and runaway deficits, Krugman remains firm in his conviction. Or is it that he’s firm stuck in his addiction? That would make sense—for addictions make blunderers out of otherwise bright individuals.

Now to be fair, he’s hardly the only hard-core addict Keynesian among us. They are aplenty, and they do indeed have their arguments, as market-advocates (like yours truly) have theirs. Each side offers up its empirical evidence—which the opposition refutes. The ardent Keynesian proffers a compelling—to the layman—exposé of how free-market-fanaticism put us in this pickle. His opponents, he accuses, are addicted to an out-dated ideology—and he has all the “empirical” evidence to prove it.

Thus, with both sides stuck as they are, when we step outside the spin—when we look at the world objectively—we conclude that ideology is indeed (I here confess) addicting, that the Keynesian vs Laissez-faire argument is eternal, and that empirical evidence is forever in the eye of the beholder.

May the following wisdom of Nassim Taleb inspire you to keep your wits about you. As for me, alas, I’m too far gone…

“Our ideas are sticky. And we tend to stick to our theories. Good idea then to delay ones theories, for once they’re made they’re very difficult to let go of.”

“Once your mind is inhabited with a certain view of the world, you’ll tend to only consider instances proving you to be right. Paradoxically, the more information you have, the more justified you’ll feel in your views.”

Jobs and austerity, subsidies, trade and deregulation...

In yesterday's New York Times Jared Bernstein shares his concerns, and offers advice, with regard to our present employment woes. To fully appreciate the following you'll need to read his article first. It'll take you just a couple of minutes.

Okay, now that you get where he's coming from, here again are his suggestions, followed by (what I believe to be) better sense:

What would it take to reverse these trends? For one thing, in the near term, do no harm. Austerity, including sequestration, is the economic version of medieval leeching. The Federal Reserve continues to apply high doses of monetary stimulus, and that’s supporting low interest rates, which in turn are linked to the improving housing market. But it can’t do it alone, and Congress is counteracting such tailwinds with fiscal headwinds.

Austerity, including sequestration, is the economic version of getting yourself in shape after suffering an obesity-caused myocardial infarction. Although the kind of "austerity" we've imposed here in the U.S. is the economic version of reducing an obese caloric intake of 6000/day by a mere 150 calories (literally).

We also need a significant, permanent program to absorb excess labor (an explicit part of the Humphrey-Hawkins law). We should consider restarting and rescaling a subsidized jobs program from the 2009 Recovery Act that, though relatively small, made jobs possible for hundreds of thousands of workers.

Subsidized, by definition, is the process of extracting resources from one group and distributing to another. With the politician being the extractor and distributor. To presume that such an exercise would yield some net economic gain is to presume that the politician can better allocate income than can those who worked their tails off to earn it.

And we have to reassess our manufacturing policy, including reducing the trade deficit. That means both reshaping our dollar policy — going after competitors who suppress their currencies’ value to get an edge on net exports — and public investments in areas where clean energy intersects with production.

Man I wish we had a trade deficit. How awesome would it be for us if China, for example, would give us stuff without taking anything in return? Jobs wouldn't be an issue, we'd have everything we need without having to produce a thing.

The fact of the matter is that the "trade deficit" is an outright myth --- seriously, it's an utter impossibility. Think about it; who would trade something for nothing? The reality is that the Chinese, for example, make stuff super-cheap for us, not because they love us, but because they love stuff that we produce (assets included) that they need U.S. dollars to buy/invest in. E.g., we buy some cell phone covers from them, they buy some pistachios from us. If they're willing to sell us more dollars worth of cell phone covers than they need to buy pistachios, it's absolutely because they want to invest in businesses, treasury bonds, real estate, etc.

Going after competitors who allegedly suppress their currencies' value to give us a break in cost, would be the economic equivalent of shooting ourselves in the proverbial foot, big time! Oh, and the U.S. "going after" currency suppressors is the economic equivalent of the pot calling the kettle black.

As for public investments (subsidies) in clean energy, let's just say our record-to-date speaks for itself.

Finally, financial deregulation has become the enemy of full employment: it funnels capital to unproductive parts of the economy, and plays a key role in the “shampoo cycle” of bubble, bust, repeat. Less volatile capital markets mean fewer shocks to the job market.

Jared misses a critical step in the "shampoo cycle" of bubble, bust, repeat. The problem is not deregulation as much as it is the cycle of bubble, bust, bailout, repeat. Knowing you can't lose allows for the most egregious mismanagement.

Sadly, Jared's proposals, if adopted, would not only not help, they'd in all likelihood exacerbate the issue...

Austerity is not a strategy...

In his New York Times article The Ignoramus Strategy Paul Krugman states "what's really going on in the economy" as follows. Each followed by my take: 

1. The economy isn’t like an individual family that earns a certain amount and spends some other amount, with no relationship between the two. My spending is your income and your spending is my income. If we both slash spending, both of our incomes fall.

The economy is a tad bit more than your spending and my spending. Oh, and by the way, you and me have been spending aplenty while the recovery proceeds at a snail's pace. The economy is, in fact, like an individual family that earns a certain amount---by producing something---then spends that income. If the family doesn't spend it all---that is, if it acts responsibly---and invests the difference, it provides capital for the production of new and improved goods and services, creating jobs in the process.

2. We are now in a situation in which many people have cut spending, either because they chose to or because their creditors forced them to, while relatively few people are willing to spend more. The result is depressed incomes and a depressed economy, with millions of willing workers unable to find jobs.

Nope; consumer spending has held up just fine. Business investment, on the other hand, hasn't of late. 

3. Things aren’t always this way, but when they are, the government is not in competition with the private sector. Government purchases don’t use resources that would otherwise be producing private goods, they put unemployed resources to work. Government borrowing doesn’t crowd out private borrowing, it puts idle funds to work. As a result, now is a time when the government should be spending more, not less. If we ignore this insight and cut government spending instead, the economy will shrink and unemployment will rise. In fact, even private spending will shrink, because of falling incomes.

Government purchases must be paid for. And if government is to borrow, lenders must be willingly to supply it with, yes, their idle funds --- in return for a presently very low interest payment. Investors haven't always been so willing to lend money for such a measly return --- in fact they've never been so willing (rates are at record lows). Of course, one investor, the Fed, has never before committed to purchasing so much government-issued debt. Oh, and those funds from the Fed weren't previously idle, they're brand spanking new. As for government borrowing, well, the private sector will ultimately have to curtail productive activities in order to pay back the debt incurred to finance current "investments".

Now Krugman's response to that last sentence---after calling me an idiot (or an ignoramus)---would be that the private sector will be paying itself back ("we owe it to ourselves"), and that somehow makes it a-okay. I think, in fact, the number---that we've bought of our nation's debt---is somewhere around 66%. So simple math alone suggests that Krugman's own argument should be sliced by about a third. That is, we (our kids/grand kids that is) will be paying two-thirds to "ourselves" and the remaining third to other individuals/entities with whom we share this planet --- who just happen to live on the other side of lines drawn on maps. But, frankly, that's not the least bit the issue --- the domicile of the lender is of little consequence. The basic issue should be intuitive: if I borrow from my brother and spend (God forbid like a government), I'll be paying him back (with funds I borrow from someone else, if I'm like a government). It's in the family, but I'm still out the money. (Please read this open letter to Paul Krugman for a more in depth view of why his argument---which, by the way isn't his, it's a centuries-old fallacy---is the definition of nonsensical)  And if I spend (or "invest" if you prefer) like a government, the odds that I'll be doing more than wasting scarce resources that would have been better utilized by the profit-seeking private sector ("crowding out"  by definition), are very slim indeed. I.e., I will not have produced, or preserved, enough with the borrowed money to pay my brother back. You see there's a reason I (like the government) keep having to hit up the family.

4. This view of our problems has made correct predictions over the past four years, while alternative views have gotten it all wrong. Budget deficits haven’t led to soaring interest rates (and the Fed’s “money-printing” hasn’t led to inflation); austerity policies have greatly deepened economic slumps almost everywhere they have been tried.

Correct; the past four years of budget deficits haven't led to soaring interest rates (not yet anyway), not while the Fed stands "prints" in support. And the Fed's "money-printing" hasn't led to inflation, not while the "printed money" sits idle in banks' excess reserve accounts left on deposit (earning .25%) at the Fed. Austerity policies, by definition, inflict the kind of pain a debt-ridden country (just like a debt-ridden individual family) must ultimately endure while it gets its act together. Austerity is not a growth strategy, it's not something you try, it's a necessity anytime expenditures exceed revenues and there's no credible moment on the horizon when previous investments will yield enough to offset the deficit.

5. Yes, the government must pay its bills in the long run. But spending cuts and/or tax increases should wait until the economy is no longer depressed, and the private sector is willing to spend enough to produce full employment.

Oh sure, spending cuts can wait until future politicians are in a position to cut the federal budget --- that is, to disappoint their supporters. Never happens!! As for tax increases, I concede, it would be a very bad idea to suck more from the private sector to fund yet more government spending, weak economy or not.

Here's his last paragraph (earlier in the article he referred to Ken Langone as an ignorant simpleton):

Is this impossibly complicated? I don’t think so. Now, I suppose that someone like Langone will just respond that it’s all gibberish he can’t understand. But unless he really is stupid, which as I said I doubt, that’s only because he doesn’t want to understand.

Are my followups to his 5 points impossibly complicated? Or do they possibly offer a more sensible, yet more in depth, view of the world? Now, I suppose that someone like Krugman will just respond with name-calling and more of the same one-side-of-the-coin analyses. But unless he really is stupid, which I doubt, that's only because he is, pardon my stooping to name-calling, the absolute worst of partisan hacks.

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