Saturday, May 31, 2014

Blah news is good news...

Below are yesterday's important economic indicators: the actual reading, the consensus forecast, and my view of what each means in terms of Fed policy going forward.

The month over month (MoM) Personal Consumption Expenditures (PCE) Price Index (this is what the Fed looks at instead of CPI as an inflation gauge): +0.2%. Forecast: +0.2%. Signal: Inflation remains tame. Fed implications: Supports present interest rate policy.

Personal Spending (MoM): -0.1%. Forecast: +0.2%. Signal: Consumers are hanging onto their cash, doesn't bode well for Q2 GDP. Fed Implications: Supports present interest rate policy.

Chicago Purchasing Managers Index (PMI): 65.5. Expectation: 61. Signal: Manufacturing activity in the Chicago region is picking up. A reading above 50 signifies expansion. 65.5 is the second highest reading (67 in October '13) since November 2011. Fed Implications: Could, if the trend is higher going forward, inspire the Fed to, at a minimum, attempt to normalize interest rates.

The University of Michigan Consumer Sentiment Index: 81.9. Forecast 82.5. Signal: The consumer feels relatively positive about the future, but not quite as much as anticipated. Fed Implications: Could, if the trend is higher going forward, inspire the Fed to, at a minimum, attempt to normalize interest rates.

I was originally thinking that I'd highlight the entire week's published indicators, however, in the interest of your time and attention I decided I'd stick with Friday's. Plus, Friday's published data represent precisely what I've been seeing of late, which is a very mixed economic picture. Whether it's what I listed above, or durable goods orders that came in a little better than expected last Tuesday, or the revised GDP number that showed a, albeit expected, .1% contraction in the weather-torn first quarter, suffice it say that---while when I dig deep, I can find glimmers of growth, and potential inflation---there's really nothing remarkable (one way of the other) about the state of the economy, at least from what I can glean from the indicators. And, frankly, that's been very good news for the stock market.

That's right, a blah economy keeps traders very much engaged. Why? Why would blah news be good news? Because, clearly, traders remain fixated on the Fed---which is why I added "Fed implications" above. You see, traders love an easy money Fed. It keeps short-term interest rates low and, presumably, liquidity high. The bullish trader's favorite term since the spring of '09 has been "the Bernanke put (insert "Yellen" today). A put option is a contract a speculator can purchase that guarantees the sales price of a security (for a limited period). To say that the market is benefitting from the "Yellen put", is to assume the Fed will step in with both barrels should some exogenous surprise hit the market. This, by the way, in my view, has not been the primary driver of equity prices these past five years, and by no means will the Fed be able to circumvent the next major correction/bear market. In fact, the longer we go with subpar growth amid easy Fed policy, the more the efficacy of all its machinations gets called into question. I.e., the law of diminishing returns surely, over time, diminishes the Fed's reputation.

Those last sentences, by the way, are not entirely lost on today's trader. I do believe we are finally past the bad news is good news scenario. I submit that if the data were truly bad, traders---seeing that Fed policy isn't "working"---would sell this market. So-so news, on the other hand, means we're moving forward, but at a pace tepid enough to keep the Fed supportive.

As for yours truly, I say the Fed, and, more importantly, the economy, would be well-served if it would call an immediate end to its monthly bond purchases (QE) and begin gradually bumping up short-term interest rates. Make no mistake, the market would welcome such abrupt action like you would a root canal, but the idea of allowing the bond market to find its equilibrium sooner than later, and allowing for the unwinding of whatever asset price distortions have resulted from all this thin-air money creation would be, long-term, the healthiest thing.

However, alas, that's not about to happen. The Fed, when it finally does begin to tighten, will do so in the most gingerly fashion. We can only hope that some monster inflation isn't lurking somewhere under the indicators just waiting to spring up when least expected. For, with all due respect, I don't know that this Fed has the political will to truly tackle what will have been its very own Frankenstein.

That last paragraph said, I'm not seeing anything in the numbers that yet hints of extreme inflation risk. Which partly explains why the bond market has, to my surprise, been so stubbornly strong of late....

Stay tuned...

There will be no job for Junior at Carl's Jr.

According to the President, and lots of other folks (some, ironically, well-known economists), forcing a higher cost for low-skilled labor onto employers will, by some magic, result in more jobs for all---or, at a minimum, help low-skilled individuals while exacting no harm onto the economy. Apparently, for these folks, the price of labor is the one thing that defies the most basic of economic laws.

I've beaten this one to death here on the blog, so, for this morning, I'll turn it over to a far greater authority than me, the President, or the most academically-acclaimed economists: Here---from a CNBC article titled "Fast Food CEO: Minimum wage hikes closing locations"---is Andy Puzder, the CEO of CKE Restaurants (the parent company of Carl's Jr. and Hardee's): 
What's causing what company CEO Andy Puzder describes as "very little growth" in the state?

In part it's because "the minimum wage is so high so it's harder to come up with profitable business models," Puzder said in an interview. The state's minimum wage is set to rise to $9 in July, making it among the nation's highest, and $10 by January 2016.

In cities in other states where the minimum wage has gone up considerably, Puzder said "franchisees are closing locations" after riding out lease expirations.

If the federal minimum hourly pay shoots up to $10.10 from the current $7.25—as many lawmakers and President Barack Obama are advocating—Puzder predicts fewer entry-level jobs will be created. If this happens, CKE would also create fewer positions, he forecast.

When the minimum wage increases, there are two things you can do," he said. "One is you can reduce the amount of labor that you use or you can increase your prices."

Well, shoot, I can't---after watching the video attached to the CNBC article---resist adding another two-cents. Host Melissa Lee challenges the gentleman with the AEI who opposes minimum wage hikes as she, it appears, reviews something in front of her that claims that the data show that raising the minimum wage doesn't hurt employment---that the state of Washington and the city of San Francisco, sporting two of the highest minimum wages in the country, are showing relatively good job growth. Jared Bernstein adds that while the CBO says 500,000 low-skilled folks may lose their jobs, it also states that some 24+ million may indeed benefit from a minimum wage hike.

So, let's say you live on a budget and you love potato chips. One day you visit your grocer to grab your weekly supply and find that the government---in an effort to help, um, potatoes I guess (politicians know what's better for potatoes than do potato producers)---has forced a 40% increase in the price of chips. Now what do you do? Do you simply bite the bullet, figure out what you'll give up (maybe drink more water and less diet soda, cancel a movie channel, or reduce your 401(k) contribution) and continue to indulge your taste buds? Or do you buy fewer chips and try to like celery? If, later that evening, you hear on the news that potato chip sales were on the rise in Washington and San Francisco---while celery sales are booming in your hometown (you then recall seeing the President on CNN a few months ago hugging the boss of the Celery Grower's Union and think hmm)---would it in anyway change your reality? Would it make you feel better?

And what would you think about some scheme where the government rounds up 500,000 people (some who work for, say, Carl's Jr.), eliminates their jobs and distributes what was once their incomes to millions of others---and, in the process, erects a huge barrier to millions of other young and unskilled individuals hoping to enter the workforce in the coming years? Put that way it sounds criminal. But how else would you---with no political ambition---put it?

Thursday, May 29, 2014

We need old leadership!

"We need new leadership!" Has been the desperate cry from the right for the better part of the past 6 years, and, save for perhaps a rallying moment or two following 9/11/2001, was the left's lamentation of the previous eight.

I don't know about you, but I would never have asked, nor expected, Barak Obama to lead me anywhere. The same goes for George W. Bush, his father, his brother, Bill Clinton, his wife, Jimmy Carter or any politician past, present, dead or alive.

Some of my hard core conservative friends attribute way too much leadership capacity to President Obama. One told me the other day that everything is unfolding in America precisely the way Obama designed from the day he was sworn in. Another recently explained to me how a Marxist society would be created, and then described, step by step, how the President is leading us down that path. At the risk of losing a couple of subscribers, I say hogwash! All I see is a young man, in way over a head that houses a monster-sized ego (which, by the way, is a prerequisite to public office), who responds as best he can to political winds. Whose personal history engenders in him a strong left bent. And big left-bending egos thrive on big government.

As for his immediate predecessor: I must say, for me, the only thing worse than a "progressive" promoting bigger government, is a "conservative" doing the same. At least the "progressive" tells you straight up that he aims to grow the government's reach (although he fails to add the resulting shrink your liberty part). When a "conservative" tells you he's all about shrinking government and expanding liberty, then tells you that he has "abandoned free-market principles to save the free-market system", well, if you could only see how hard I'm pounding my keyboard at this moment!!

Yes, we do need leadership, there's no question. But not leadership in a sense that we allow someone else to dictate our dos and don'ts. Not the sort of leadership that would abandon logic and attempt to avert the necessary, and creative, destruction that occurs naturally in a free-market. We need not, in essence, subject ourselves to the paternalistic directives of politicians steeped in ideology, and possessed by personal political ambitions.

What we need is the style of leadership that founded this great nation. No, I'm not referring to the qualities of the framers of the constitution. I'm talking about our ancestors who, as individuals, led themselves to these shores. Men and women following their own compasses to a land where they would be left entirely to their own devices. With no expectation that some great all-knowing leader would be there to welcome, shelter, protect and direct them. Our ancestors, knowing the price of failure, courageously lead themselves and, consequently, this nation, to prosperity. And we utterly fail them when we look outside ourselves to some person, or some institution, to shelter, protect and direct us.

Don Boudreaux calls last week's opinion piece by George Will "a masterpiece". I second that! Will presents how his ideal Presidential candidate would announce his candidacy (alas, pure fantasy of course).

Here's a snippet:
“To another inane question, ‘How will you create jobs?,’ my answer will be: ‘I won’t.’ Other than by doing whatever the chief executive can to reduce the regulatory state’s impediments to industriousness. I will administer no major economic regulations — those with $100 million economic impacts — that Congress has not voted on. Legislators should be explicitly complicit in burdens they mandate.

Here's another:
“In a radio address to the nation, President Franklin Roosevelt urged Americans to tell him their troubles. Please do not tell me yours. Tell them to your spouse, friends, clergy — not to a politician who is far away, who doesn’t know you and whose job description does not include Empathizer in Chief. ‘I feel your pain,’ Bill Clinton vowed. I won’t insult your intelligence by similarly pretending to feel yours.

“A congenial society is one in which most people most of the time, and all politicians almost all of the time, say, when asked about almost everything: ‘This is none of my business.’ If as president I am asked what I think about the death of a rock star, or the imbecilic opinions of rich blowhards who own professional sports teams, I will say: ‘Americans should have no interest in my thoughts about such things, if I had any.’ I will try not to come to the attention of any television camera more than once a week, and only that often if I am convinced that I can speak without violating what will be my administration’s motto: ‘Don’t speak unless you can improve the silence.’

Wednesday, May 28, 2014

The "All Else" Part 5, The Fed

In The "All Else" Part 2, with a little on the Fed, I covered the very basics of how interest rates can impact stock prices (just redid the whiteboard presentation---made it much clearer and shorter---take another look). Today's essay is all about the Fed, and why it's such a big deal for the stock market.

When you hear "the Fed" in the news these days, chances are you're hearing about the Federal Open Market Committee (FOMC), as opposed to the Federal Reserve System itself. So our topic for today is the FOMC.

But first, here's a little bit about the Federal Reserve:

Founded in 1913 for the purpose of implementing monetary policy. It's headed by the Board of Governors of the Federal Reserve. The Board of Governors consists of seven appointees who each serve 14 year terms. The Board is led by a chairperson, presently Janet Yellen. There are a total of 12 Federal Reserve Banks located in major cities---they are the operating arms of the central bank. They earn their keep by providing services to banks, earning interest on government securities, earning interest on loans to banks, and any income from holding foreign currencies. Profits go to the U.S. Treasury.


Janet Yellen, is also the present chairperson of the FOMC, which is the policymaking branch of the Federal Reserve. The FOMC's voting members consist of the seven Fed governors, the president of the Federal Reserve Bank of New York and the presidents of the other four Reserve Banks who serve on a one-year rotating basis. The remaining Fed presidents serve, but don't vote on interest rate policy.

Suffice it to say that Ms. Yellen and her fellow board members have their work cut out for them. They have been assigned a "dual mandate"---which, in a nutshell, is stable prices and full employment. Now, given that the Fed has no items to sell, or, therefore, price, and it's not in the market for additional labor, they really do have their work cut out for them.

Well, actually, it does have one thing to sell and, therefore, price. And it happens to be a very big thing, the U.S. dollar. They raise and lower the price of the dollar by raising and lowering its quantity. They can produce it at will, then deposit it into banks' reserve accounts, in exchange for fixed income securities, like treasury notes. One result of increasing the supply of reserves in the banking system is a lowering of the cost of borrowing (interest rates). The Fed does this when it needs to boost employment---and/or to ward off deflation---by boosting the economy. I.e., in theory, when money is cheap (when interest rates are low), people will spend it---and stimulate the economy in the process. If, or when, the economy begins humming along at a pace that production can't quite keep up with, inflation ensues. Which of course threatens the Fed from a "stable prices" perspective. To ward off the threat of inflation (higher prices), the Fed will reverse course and begin extracting dollars from the banking system (selling securities back to the banks)---i.e., reducing supply. Reducing the supply of money, all else equal, means raising the cost of borrowing (higher interest rates). I.e., in theory, when money is expensive, people will spend less and the economy will slow---and inflation will wane.

Oh, if it were only that simple---if all the Fed had to do was deposit and withdraw reserves from the banking system to keep prices steady and jobs aplenty, the life of a Fed Governor would be peaches.

Now, there's not nearly enough space here for me to go off on a tangent about how ineffective, and effectively dangerous, all this money manipulation can be---so for now I'll simply pause here and give you a beautiful Friedrich Hayek quote (from his Nobel Prize Lecture):
If man is not to do more harm than good in his efforts to improve the social order, he will have to learn that in this, as in all other fields where essential complexity of an organized kind prevails, he cannot acquire the full knowledge which would make mastery of the events possible. He will therefore have to use what knowledge he can achieve, not to shape the results as the craftsman shapes his handiwork, but rather to cultivate a growth by providing the appropriate environment, in the manner in which the gardener does this for his plants.

Alas, the Fed goes way beyond providing the appropriate environment---it messes with the weather. And that's what creates the messiest of storms, like the recent real estate/credit bubble.

Back to what they do: The FOMC has many tools at its disposal with which to attempt to fulfill its dual mandate. Including, but not limited to:

*As stated above, the buying and selling of fixed income securities in the open market (hence, dubbed "open market operations"), which injects cash into, and extracts cash from, the system---thus raising and lowering interest rates in the process.
*It pays banks interest on the excess reserves it holds for them. It can raise that interest rate (pay them more) when it wants the economy to slow down (interest rates rise), it can lower that rate when it wants to stimulate the economy.
*It sets reserve requirements for the banks. It can lower banks' reserve requirements to free up cash to lend, in an effort to stimulate the economy---it can raise reserve requirements to tighten up the supply of lendable cash, in an effort to cool the economy.
*It can sell holdings out of its massive chest of securities should it decide to cool things down.
*It can raise or lower the rate at which it lends directly to banks (the discount rate).

We could dig deeper into the weeds in terms of all of the Fed's machinations, but in the interest of keeping you awake I'll cut to the chase and explain why I pay attention to the Fed:

The fact that the Fed has the power to create money means that it can do all sorts of strange and wonderful, and not so wonderful, things to the economy. And, therefore, investors, and/or their advisors, must forever formulate their opinions of what the Fed is presently up to, and what it's likely to do in the foreseeable future. Clearly, there is no small number of traders out there who are keenly focused on the Fed. It seems that the merest hint that it might raise short-term rates sooner than, say, the second half of 2015, sends the market---by nature of traders exiting---into a tizzy. Conversely, any indication that it has no interest in taking away the punchbowl anytime soon, seems to get greeted with---by nature of traders buying---a nice rally.

The funny thing about what I just stated is what either of those scenarios actually says about the economy. Should, for example, the Fed declare tomorrow that it's ending its monthly bond buying program (quantitative easing [QE]) now, and raising the Fed Funds rate by a quarter point---while the market would surely tank---it would be making a substantially bullish statement about the economy. It would in essence be saying that the economy is finally taking off and that the Fed is ready to attempt to normalize interest rates. Now you'd think that would be good for stocks, but, in the short-run, I assure you it wouldn't. In the long-run, however, it---"normal" rates---would absolutely be a good thing... And, conversely, should the Fed announce that it's going to cease the tapering of QE (which they've been doing by $10 billion a month since January), and that it expects to keep rates low out to, say, 2017---while the stock market might rally---that would be an ominous statement about the present state of the economy.

In my view, rising interest rates are not only a possibility, they're an inevitability. The Fed's recent success at keeping them at record lows concerns me in terms of when and how violently the bond market will ultimately give way to reality. Most market participants (investors, advisors, fund managers, traders, pundits, etc.) seem very sanguine about the bond market these days. Me, not so much. Regular readers/listeners may recall that on several occasions last year I pulled back from my bond bubble concerns---my reasoning was that, at the time, it seemed like everybody was finally on board with that worry (that the bond bubble would burst [and interest rates would spike] all over the economy). It's been my experience that the widely anticipated disasters tend not to occur---but rather, it's the things no one sees coming that do the real damage. The fact that, these days, "everybody" seems to have dropped the bond bubble story (some pretty smart people are predicting that bonds could even rally [sending interest rates even lower] from here) puts it back on the table for me.

In any event, whether it's a bond market collapse, or a slow, stodgy recovery in interest rates, stocks---some sectors more than others---are interest rate sensitive. Which will indeed influence our sector recommendations in the months and years to come. Which is one reason why we watch the Fed...

Stay tuned...

Sunday, May 25, 2014

The Season of Envy

Is income inequality a problem for you? Does Tiger Woods's $78 million "take" in 2013, Tesla CEO Elon Musk's $78 million, Walmart CEO Doug McMillon's $21 million or McDonald's CEO Don Thompson's $9.5 million somehow mean less for you?

If you believe the headlines, lots of folks have much bigger problems with the pay packages of CEOs whose companies provide cheap fast food, all manner of affordable consumer items, and employment for millions than they do the fortunes of those who gain from product endorsements and the sales of tailpipe-less cars.

Pragmatically-speaking, I can't help but wonder if all that many folks are truly up in arms over the chasm separating their lifestyles and those of millionaire CEOs? Seriously, no small percentage of the would-be victims of today's grand injustice illusion are the folks who purchase their essentials from companies lead by the likes of McMillon and Thompson. Do people really not see the benefits bestowed on society by the world's largest producers and employers? Some apparently, and strangely, don't. Which sparks in me yet another wonder: Would those who bemoan the good fortune of the leaders of the companies they most frequent harbor such resentment were it not for the rhetoric of politicians and pundits? I wonder if the political aspirant who---no one can deny---fans those flames of resentment, isn't the arson who lit them to begin with?

The late Helmut Schoeck, in his enlightening 1966 book Envy: A Theory of Social Behaviour said no. Schoeck taught that envy long pre-dates the rise of the politician and the CEO; that envy is, in fact, innately human---which, therefore, presents a potent platform for even the weakest of candidates.

So then, is this election year headline obsession with "inequality" really about some great capitalism-spawned social injustice, or is it, per Schoeck below, a resort for politicians who---skilled in "the use of the envy-motive"---have little else to run on? In my view, it's the latter:
It would be a miracle if the democratic political process were to renounce the use of the envy-motive. Its usefulness derives, if for no other reason, from the fact that all that is needed, in principle, is to promise the envious the destruction or the confiscation of assets enjoyed by the others; beyond that there is no need to promise anything more constructive. The negativism of envy permits even the weakest of candidates to sound reasonably plausible, since anybody, once in office, can confiscate or destroy. To enlarge a country's capital assets, to create employment etc. requires a more precise programme. Candidates will naturally try to make some positive proposals, but it is often all too apparent that envy looms large in their calculations. The more precarious the state of a nation's economy at election time, the stronger the temptations for politicians to make 'redistribution' their main plank, even when they know how little margin is left for redistributive measures, and, worse still, how likely they are to retard economic growth.

Saturday, May 24, 2014

The "All Else" Part 4, GDP

When you hear that the economy is expected to grow at a 3+% rate in 2014, the expecters are talking about the Gross Domestic Product (GDP): the value of all final goods and services produced within a country. The result arrived at through the expenditure calculation method is the one most-cited. Its formula is:

Consumer spending + investment + government spending + exports minus imports

My goal with this series is to help you understand the data I follow. Which is why, as difficult as it is, I will resist the enormous temptation to complain about how politicians lever GDP to promote all manner of ill-conceived policies. Yes, I know, and I apologize, I have succumbed to similar temptations a time or two in this series already.

GDP is THE economic barometer for investors. Among many things, the economy's growth rate speaks to the prospects for corporate earnings and monetary policy going forward.

When investors discount the economists' consensus forecast of year over year growth of 3%, and it comes in at 0.1%---as Q1 2014's first reading did---there better be some splaining or the stock market's likely to tank. Well, the market didn't tank, which means the number was indeed splained-away---by that ever-convenient scapegoat, weather. Which, in fact, was probably legit this time around.

Notice I said "first reading", that's the advance estimate. Next comes the revised preliminary estimate, then followed a month later by the final number. As more data comes in it's becoming apparent that those revisions will send Q1 GDP into negative territory. Again, it'll be all about the weather.

The thing about GDP is that it's released quarterly, and all that goes into it is released more frequently. Meaning that, while the number itself is indeed important, I spend more time on its component parts to get a feel for the present state, and trend, of the economy.

We live in interesting times: While a faster growing economy would be a beautiful thing for profit growth, job growth, etc.---and, thus, you'd think it'd be welcomed by investors---it would also put pressure on the Fed to begin raising interest rates to ward off the attendant threat of fast-rising inflation. Which presents a headwind for the stock market; in that higher interest rates mean higher nominal yields on fixed-income investments (competition for stocks) and higher borrowing costs for companies and consumers (slowing profit growth and the economy in general).

So then, the challenge for blokes like me---who try to make the best sector allocation recommendations to investors---is trying to figure out the unfigureoutable: How much growth can the economy withstand without sparking a dangerous level of inflation? Or, is the economy growing, or slowing (depending on what I see) at a rate sufficient to justify my present sector targets? So much goes into such an analysis, not the least of which is tracking productivity (a producers output per unit of input (labor and capital). Capacity utilization (how much a facility's total capacity is being utilized), which I've written about before is another important stat to track.

Another way of putting it is: is the economy operating anywhere near its full potential? And how can we possibly know that? Well, we possibly can't! That said, the Congressional Budget Office (CBO) tries. It estimates what it believes to be the economy's full potential. The extent to which the economy isn't reaching that point is called the output gap. And, yes, it is another of the many things I track. The chart below shows the CBO's most recent findings. Notice the gap between the lower solid line and the light blue dotted line: Supposedly, the economy has that far to go to reach its 2014 full potential (and I believe that is, on balance---given present concerns over interest rates---bringing momentary peace to stock, and bond, traders):


Stay tuned...

Wednesday, May 21, 2014

Protectionist, you either are, or you ain't... (video)

In his yesterday's National Review Online column "What STEM Shortage?", the Center for Immigration Studies' Steven Camarota shares his concerns over allowing foreigners with science, technology, engineering and math (STEM) experience into the U.S. labor market.

According to Camarota, he, and others, have extensively studied the claim made by "American business and the political elite" that the supply of STEM workers in the U.S. is not sufficient to meet the demand. Their findings tell us that it's all a bunch of hooey.

Here's a slice:
In looking at the latest government data available, my co-author and I found the following: In 2012, there were more than twice as many people with STEM degrees (immigrants and native-born) as there were STEM jobs — 5.3 million STEM jobs vs. 12.1 million people with STEM degrees. Only one-third of natives who have a STEM degree and have a job work in a STEM occupation. There are 1.5 million native-born Americans with engineering degrees not working as engineers, as well as half a million with technology degrees, 400,000 with math degrees, and 2.6 million with science degrees working outside their field. In addition, there are 1.2 million natives with STEM degrees who are not working.

Here's another:
Wage trends are one of the best measures of labor demand. If STEM workers were in short supply, wages would be increasing rapidly. But wage data from multiple sources show little growth over the last 12 years. We found that real hourly wages (adjusted for inflation) grew on average just 0.7 percent a year from 2000 to 2012 for STEM workers, and annual wages grew even less — 0.4 percent a year. Wage growth is very modest for almost every category of STEM worker as well.

So if there is a superabundance of native and immigrant STEM workers and little wage growth, and STEM immigration already exceeds the absorption capacity of the STEM labor market, why are there calls to allow in even more? The answer, put simply, is greed and politics.

One more:
Another reason that the “we need more STEM workers” argument is taken as gospel is that it is endorsed by many of America’s most prominent billionaire entrepreneurs, such as Bill Gates and Mark Zuckerberg. Their vested interest in holding wages down and improving their bargaining power vis-à-vis their workers goes unmentioned by the media that tend to just transcribe their press releases on the subject.

Okay, for starters, I'm going to---for the sake of this essay---assume that team Camarota and the other organizations he names in his article have their numbers right. I have absolutely no desire to spend even a second in refutation. The reason I'll not waste a second challenging their claim is because I honestly couldn't care less. What I do care deeply about, however, is freedom. 

Regular readers know that I aggressively oppose protectionism. And while you may agree with Camarota when it comes to importing labor, I want you to understand that keeping willing workers outside our border is every bit as pernicious as would be the keeping out of Samsungs and Toyotas.

He asserts that allowing in STEM-degreed foreign workers results in lower wages for equally-educated Americans (that is, lower labor costs for U.S. employers). I must therefore assume that, understanding the law of supply and demand as he does, Camarota would agree that the importing of foreign-made electronics and automobiles results in lower prices for American consumers. Given his grasp of basic economics---and his damning of cronyism---surely he would rail at the thought of "American business and the political elite" colluding to limit the American consumer's access to affordable goods.

Yet he entirely loses sight of---or chooses to ignore---the fact that a reduction in labor costs resulting from immigration can make American enterprises more productive and more globally competitive. Which of course results in lower-priced, higher-quality, and a greater variety of, goods and services for the American, and the non-American (I assume Mr. Camarota has no problem with American companies competing internationally), consumer.

As I suggested earlier, you might sympathize with Camarota and company, yet you might see yourself as a free-market/free-trade advocate. The thing is, protectionism is multidimensional, and protectionist tendencies can be most subtle. Let the above test your resolve (assuming you're indeed free-market minded): If you can recognize, and denounce, the brand of protectionism Camarota and his colleagues promote, you can continue to call yourself a free-market advocate. If not, you can't.

You see, in my view, being a little bit protectionist is like saying you're a little bit pregnant, it doesn't fly---you either are, or you ain't...  

Here's Bryan Caplan on "anti-foreign bias" (HT Don Boudreaux):

Tuesday, May 20, 2014

The "All Else" Part 3, Cap-Ex Spending

When a business spends money on, or invests in, capital---as in plants, and the equipment and machinery used in production---it does so out of the need to maintain, or, better yet, to grow its capacity. And, economically-speaking, it is the best of all forms of spending.

I have maintained for some time now that the key ingredient missing in this long, yet lackadaisical, recovery has been business investment, or cap-ex spending. So why---contrary to the dominant (among policymakers and their advisers) economic theory (Keynesianism) of our time---is capital investment more important to the health of the economy than consumer spending? James Mill, as quoted in Steven Kates's excellent book Say's Law and the Keynesian Revolution, stated it beautifully:
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.

Not to suggest that consumption isn't important. Of course it is! I mean, we produce so that we may consume. Our problem lies in the literally backward ideology that puts consumption ahead of production. Paul Krugman's favorite line (or one of his favorites) is "my spending is your income and your spending is my income"---as if all we need to do is ramp up spending and everyone's income will be taken care of just fine. Seriously, that's what the man preaches! While, in reality, my production generates my income, which allows for my spending on your production (and my saving/investing which provides capital for businesses), which generates your income, which allows for your spending (and " "), and so on.

Okay, enough with the econ lecture.

Suffice it to say that cap-ex is a very very big deal. Businesses expanding leads to growth in production, employment and, yes, consumption. And that's why, as an investment consultant, I track it. And it's been atypically low these past few years.

Companies have cash, we know that from the reports, and from the recent pickup in share buybacks, hiked dividends, mergers and acquisitions---all bullish phenomena for stock prices. However, not what we're looking for in terms of healthy, sustainable, economic growth.

The good news is I'm seeing some signs of a cap-ex pickup. For example, last week's NFIB Small Business Optimism Index suggests an upward trend in capital outlays from the backbone of the U.S. economy---small businesses. I expect, ultimately, the same from large companies as well---although the Business Roundtable's 2014 CEO Economic Outlook (Q1), while showing a slight pickup in capital spending expectations, was nothing to get too excited about: 48% surveyed said they expect to increase cap-ex going forward (vs. 39% to start 2013). So why, 5 years into this recovery, are cash-rich companies unwilling to aggressively expand their operations? According to the survey:
56 percent of CEOs said they would invest and hire more if Congress and the Administration were to cooperate on business tax and immigration reform and move forward on free trade agreements with European Union and Pacific nations.

More than 70 percent said that expanded U.S. trade opportunities would have a positive effect on their businesses, with 42 percent saying they would hire additional employees if global trade expanded.

Nearly 9 in 10 CEOs (89 percent) said regulation has had either a moderately significant or very significant material impact on their investment and hiring activities.

And what have I been telling about free trade all these years? Sorry, couldn't help it...

The (ultimate) bottom line: If companies are to compete in this ever-globalizing marketplace, they'll have to step outside their comfort zones and put new capital to work. It's just a matter of time...

Stay tuned...

Click here for part 1, here for part 2 of this series.

Market Commentary (audio)

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Monday, May 19, 2014

Undeserved credence... (video)

You ever notice how pessimists seem to garner all the attention? They always come across so darn smart! And they can chew up and spit back in your face virtually any optimistic counter you would dare offer up against one of their doomy diatribes. And, you know, come to think of it, when I sound a pessimistic note (you know, when I write about politics) I do tend to receive a higher volume of responsive emails.

Isn't it fascinating how, in the face of all that is in our faces, we give such credence to those crapehangers? Here's Bryan Caplan on the subject (HT Don Boudreaux):

Sunday, May 18, 2014

A win for the Swiss!

Thankfully for the young and unskilled Swiss (their job prospects and the health of their economy [so, for that matter, all the Swiss]), better than three-fourths of their fellow countrymen and women understand that rudimentary economic law I wrote about earlier today. Yes, they voted down that proposal (HT, again, Darren Thomas) to introduce what would have been Switzerland's first, and the world's highest, minimum wage.

In his blog post What Do the Likes of Paul Krugman, Robert Reich, and Barack Obama Know That the Swiss Miss? (Answer: Nothing) Don Boudreaux sums it up perfectly. Here's his closing paragraph:
Low-skilled workers have a difficult enough time of it as it is. Their best hope for finding and keeping gainful employment is their willingness to work for less pay than more-skilled workers demand. Minimum-wage legislation strips from low-skilled workers this option, one of their premier bargaining chips. Ponder this reality if you’re ever tempted to think of minimum-wage supporters as being enlightened and humane. They might be one or the other, but they are certainly not both.

Indecent Proposal

Saturday, May 17, 2014

Envy, a most powerful political weapon...

One day, a couple of years ago, I found myself in the unenviable position of waiting to see if I would have to spend an undetermined number of days sitting, shoulder to shoulder, with eleven of my peers. Our charge would be to determine the fate of a gentleman who'd been accused of breaking into another's home and stealing its contents. At the end of the day I was told to return bright and early the next morning, I had made it to the final round.

I left the courthouse feeling quite good about my prospects, my prospects for being dismissed---bright and early---by the public defender that is. I just knew that there was no way---after my responses to several pointed questions from the accused's counsel---that I would be allowed to move even a single chair closer to the jury box.

And, sure enough, I was dismissed that morning---but not first thing. Yes, the defense attorney went first, and, as is the custom, he dismissed a number of potential jurors who he felt could only hurt his client's case. Not only was I not his very first rejectee, he---to my astonishment, and dismay---never called me out. He just grinned at me every time our eyes would meet. I was utterly panic stricken!

A short time later as I, dazed and confusedly, entered the elevator to the exit floor of the courthouse, a fellow fallen comrade says to me (as I recall) "I knew you were going to get dismissed this morning". I said, "yeah, me too, but by the defense attorney, not the prosecutor". "Nope" he said "the public defender loved you. He totally wanted you in the jury box. The prosecutor, on the other hand, had to get rid of you." "Say what?" I replied. He explained "My Dad's a retired judge and I know the game. You see, you asked too many good questions." "Yeah, but what about when he asked me who I'd instinctively side with, and I said 'the cop'?" "That's exactly what he wanted you to say. He was trying to draw off the prosecutor, in hopes that he'd pick you for the jury." "You've totally lost me" I exclaimed. He chuckled and said "in the eyes of the public defender you were probably his client's greatest hope. You'd be the instigator, you'd be the one who'd push the hardest, the one most likely to discover reasonable doubt and influence the jury."

While the logic fascinated me, in reality I'm pretty sure the public defender, the prosecutor and my elevator mate had it all wrong. I knew that crook was guilty from the moment I laid eyes on him, and there was nothing that was going to change my mind! Haha, just kidding....

So what's my point? It's that the two sides in my court experience had their own objectives and they would exploit every opportunity, honest or otherwise, to gain what they were after. And that instigators---disturbers---often get their way. The public defender was angling for the opportunity to harness a disturber to victory.

Now, think in terms of the politician, his henchmen, and his apologists. They're all after the same thing---his/their success. Today's hot topic, inequality, presents them with a huge opportunity. They understand that those who wish to level life's outcomes---well, actually, and frankly, it's more about those who would take from the wealthy for the sake of the taking alone (I mean, truly, they have to know that taking capital from its deployers and transferring it through the government's filter will in no conceivable way result in greater wealth for anyone)---are the screamers, the instigators, the influencers, and, all too often, the doctorers of data. They don't necessarily covet what the wealthy possess, they simply, and passionately, want the wealthy to possess less, even if it ultimately means less for them---which it virtually has to.

They are the enviers the late Helmut Schoeck referred to in his book Envy, A Theory of Social Behaviour (and they can win you an election):
No system of ethics, no religion, no popular wisdom recorded in proverbs, no moral fables and no rules of behaviour among primitive peoples have ever made a virtue of envy. Quite the opposite, in fact; by means of the most diverse arguments, human societies---or the men who have to live in a society---have persistently sought as far as possible to suppress envy. Why? Because in any group the envious man is inevitably a disturber of the peace, a potential saboteur, an instigator of mutiny and, fundamentally, he cannot be placated by others. Since there can be no absolutely egalitarian society, since people cannot be made truly equal if a community is to be at all viable, the envious man is, by definition, the negation of the basis of any society. Incurably envious people may, for a certain time, inspire and lead chiliastic, revolutionary movements, but they can never establish a stable society except by compromising their 'ideals' of equality.

While, as Shoeck suggested, with its passionate, instigating, disturbing and implacable proponents, the flawed inequality narrative may indeed be a political winner (today's candidate is counting on it), it is, without question, and "by definition, the negation of the basis of any society"...

Friday, May 16, 2014

The "All Else" Part 2, The Fed Funds Rate (white board lesson)

In Part 1 of my "All Else" series I featured the bond market and interest rates. Today we'll look at interest rates from a different angle, how the Fed controls short-term rates and how it can impact the stock market.

Alan Greenspan, Ben Bernanke and Janet Yellen, are the household names of three Fed Chairs, past and present, who---along with their colleagues---highly influence the market that determines what interest rate you'll pay on your next home mortgage, auto loan or, God forbid, your revolving credit card (I want to put "God forbid" in front of auto loan as well, but, well, just pay the sucker off).

The Fed (as in the members of the Federal Open Market Committee) controls the rate that banks pay to borrow money from one another---it's called the Fed Funds Rate. By controlling that rate, the Fed influences the rates that banks charge borrowers. When the Fed Funds target remains, as it does today, in a range of 0% to .25%, banks can make money charging you 4.2% on a 30-year home mortgage. Oh, and---in this environment---they don't pay you much (virtually nothing in fact) on your deposit accounts.

There's much more to be said about the Fed, which I'll be covering in Part 5 of this series. For today, we'll simply look at the very basics of the impact interest rates have on the stock market. In fact, I'll do it super simply on the white board:

Thursday, May 15, 2014

The "all else" (Part 1)

As you may know, my work requires that I pay attention to the opinions of those who---I have to assume based on the audience they attract---know what they're talking about when it comes to the financial markets and the world economy. Having done what I do for a very long time, it has become abundantly clear that even the presumed "best" in the business can be every bit as much the victims, or the beneficiaries, of their ideologies as the rest of us.

My advice to you, dear reader, when it comes to the opinions of "the rest of us"---that would be your family, friends, office mates and neighbors---is to dismiss the opinions of those with the strongest opinions. Pardon my seeming condescension, but the fist-pounders tend to be the faithful parrots of the personalities who, for example, appear on the only cable TV news network they're willing to watch.

As for the opinions of the "experts" who attract wide audiences, my advice is to dismiss the opinions of those who sound like they know precisely what they're talking about. For they are generally the ones with the strongest one-dimensional convictions. And when we're talking about the global markets, and economy, we're talking about ever-evolving structures with moving parts too numerous to even begin to aggregate, let alone anticipate.

That'll be my segue to today's message:

Yesterday, I performed my semi-monthly valuation analysis of sectors, styles, market caps, non-US developed and emerging markets. As I've been reporting, I don't characterize the overall market as cheap, like I did in early 2013. However, I don't see it---historically-speaking---as expensive either. Broken out by sectors, styles, regions and size, I do find areas that look relatively expensive, a couple that look relatively cheap, and many in the middle. The 18,000-point (as in Dow points) question is, what are corporate earnings going to do going forward? Should they rise from here, all else equal, stocks should continue their climb. Should they decline, all else equal, so should stock prices. The problem is the "all else"---it never stays equal.

So, what would be the "all else"? Well, it's a lot of things---and it's different things to different people. For me (in no particular order) it's the bond market, interest rates, cap-ex spending (business expansion), GDP, the Fed, the Eurozone, the ECB, the UK, the Bank of England, China, the Bank of China, Japan, the Bank of Japan, the emerging markets, retail sales, housing, demographic trends, producer prices, consumer prices, small business sentiment, investor sentiment, commodities prices, short interest (how many are betting big on a drop), margin debt (how many are betting big on a rally), stock sector valuations and 200 day moving averages---and that's the short list. And it's way too much to cover in one blog post.

So here's my plan for the next few weeks: Starting today with bonds, I'm going to offer up a brief---succinct as possible---synopsis, one a day (or so), on each of the above. My aim is to help you put what you're hearing from your favorite news source into what I view is a healthy perspective, and---more importantly---to help you understand how the "all else" (or some of the "all else") can impact your portfolio. As I go along, you'll understand why I prefaced this exercise the way I did. Here goes:

BONDS (AND INTEREST RATES): The Basics: The thing to keep in mind about bonds is that the price an investor pays and the interest rate received move inversely to one another. Using treasury bonds as an example: When the federal government runs a budget deficit and, therefore, must borrow (issue treasury bonds) to pay its bills, investor appetite determines how much the government will have to pay in interest. If the interest rate environment is such that high quality debt is paying, say, 4% annually for a 10 year term, the U.S. Treasury will to be forced to offer a comparable yield on 10 year treasury bonds to attract investors. Rising interest rates---with regard to high quality bonds---generally occur during periods of rising optimism over the prospects for economic growth, or a prevailing fear of higher inflation.

As you may know, the 10 year treasury trades today at a remarkably low 2.54%. So, what does that say about the prospects for the economy? Well, based on what you just read, nothing good. And, indeed, that may be what today's very low yield is telling us about the future. Although, it could also be telling us something else. Below I'll list a few possibilities and their reasonings...

Yields offered by other sovereign issuers are comparable---to lower---than the safer U.S Treasury bond: For example, Germany's 10yr currently yields around 1.3%, France's 1.8%, and Spain's 2.8%. According to CNBC's Rick Santelli, the world's central banks' gobbling up of so much government debt has lessened the global supply relative to demand---making such debt more expensive and, therefore, lower yielding...

Geopolitical angst: Today that means fear over Russia's foray into the Ukraine. Should that conflict lead to serious trade disruptions (think Russia not supplying energy to Germany, etc.), there'll be economic headwinds the world economy doesn't need at the moment. Nervous investors might indeed buy treasuries as a safe port till the storm blows over.

Currency manipulation: There's always that game countries play (while denying it the whole time) to goose their exports (and, in some cases, to inflate away their debt). Converting their own currency to dollars (buying treasuries) lowers its relative value against the dollar and makes their goods more attractive to U.S. consumers.

Pension fund rebalancing: This one's been featured a lot in the press lately and, frankly, I'm not entirely buying it. It goes like this: Pension funds made huge gains last year and came a long way in terms of fixing their highly advertised underfunding issues. Having done so well last year in stocks, they're locking in those profits by selling and moving huge amounts into the safe haven of the ten-year treasury bond.

It's not that I'm not buying the rebalancing story (we've been consistently selling back to equity targets throughout this bull market), it's the buying the treasury bond part. I just can't see investment consultants recommending that their pension clients buy a security at a valuation that offers far greater downside than it does upside risk. We're certainly not rebalancing our pension clients into ten-year treasuries these days.

Huge short interest: Warning! This one's a bit wonky: Every economist in a recent CNBC survey anticipated that interest rates will rise in 2014. Bond traders galore believed the same thing coming into the year. And it made perfect sense: if the economy gains some traction this year, which is (or was) widely expected, surely bond yields will rise---perhaps in a big way. So, if everybody heading into this year was thinking interest rates would rise, how is it that, as of today, they've fallen to last October lows. Wouldn't all those bears sell bonds in anticipation, thus making the rise in interest rates a self-fulfilling prophecy? Well, yeah, but remember, the Fed, foreigners, yield-seekers and fradeycats have all been buying. Plus, the federal budget deficit is about a trillion less than it was a couple of years ago, which means the government doesn't need to issue nearly as many treasury bonds in order to pay its bills---which means less supply. In essence, there have been plenty of buyers to buy up what the bears have been selling---and some.

Now, to compound matters, there's that "short interest": When you're savvy (and gutsy), and you're certain the price of a security is fixin to fall, you "short" it (borrow it [through your broker] then sell it, expecting to buy it back later at a lower price and replace it---pocketing the difference), or you short the exchange traded funds (ETFs) that invest in it, or you short its futures contracts, or you buy put options on the ETFs that invest in it (I'll stop there). When we're talking bonds, you're expecting to hit a grand slam with such strategies when interest rates spike and bond prices tank. Oh, but if you're wrong, and the price moves higher instead, you get creamed. If the price moves way higher, you get way creamed. So, when the price moves against your position, and, in the case of bonds, you fear a 1.50% handle on the ten year treasury, you---in the case of shorting---cover your shorts (buy back those bonds at a higher price than you sold them for) and lose the difference. And of course all that short covering (buying) serves to exacerbate the upward momentum in bond prices and the downward momentum in interest rates.


While listening to a Bloomberg radio interview replay last evening---the topic being the bond market---I began to wonder if we're not about to come full circle. The guest was explaining pretty much what I've been hearing from a hoard of "experts" over the past few days; "that everybody's been wrong about bonds". "That the year's half over and, contrary to what everybody thought would occur, interest rates have been going nowhere but down---and that's where they're staying for the balance of this year."

Now, if you believe, as I do, that when an opinion starts to become crowded---when a strong consensus builds---opportunities emerge on those roads less traveled (where the crowd ain't), you expect that the bond market may soon be sending those "experts"---who are predicting low interest rates as far as their eyes can see---straight to their optometrists. In other words: should this downward move in yields make converts out of all those bears---if they finally capitulate and join the bulls---that (once the piling-in rally subsides) is when I suspect we'll see interest rates finally begin to spike and bond prices to fall---which is when you and I will, at last, find opportunities to add bonds to our portfolios.

As for those fist-pounding "experts"---the one's on TV and the one in the cubicle next to yours---if they believe today's low interest rates are 100% about the sluggish economy, they very likely possess a strong political conviction (doesn't mean they're wrong btw). As for me, I believe it's a combination of the above. I mean, surely, some are buying out of fear over the economy, some because treasury yields are higher than German bund yields, some because they're anxious about the Ukraine, some because they're trying to cheapen their home currency, some (few, let's hope) because they're rebalancing their pension portfolios, and some because they're bailing out of their short positions.

As for bonds and the stock market, the question is, how will stocks hold up when bond prices finally begin to come down? Good question!

I'll be back...

Market Commentary (audio)

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Wednesday, May 14, 2014

Market Commentary (audio)

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Sunday, May 11, 2014

The unforeseeable is bright indeed... (video)

Progress is change, by definition. Progress, therefore, is painful for some. Those in pain can find it difficult, at best, to appreciate the big picture. As Bryan Caplan points out in the superb four minute presentation below (HT Don Boudreaux), the really big picture is unforeseeable. Although one thing's for sure, the really big picture is bright indeed, as long as individuals remain free to seek out ways of improving their lives---and to fully capitalize on what they discover:

Immigration and your future...

If morality, personal liberty, the founding of your nation or any of the other points I touch on and link to here  haven't convinced you that allowing citizens of other nations to come en masse to America and stay, work, raise their families and expand our, and their, cultural horizons is in virtually everyone's best interest, perhaps the future of your social retirement benefits and your---and your offspring's---future tax liabilities will.  Here's Ronald Demos Lee in his essay titled "Population": 
Population aging matters for many reasons, but first and foremost because of the costs of retirement (pensions and health care). In the developed countries, these costs are borne principally by the central government and funded through taxes on the working-age population. The old-age-dependency ratio—that is, the population aged 65 and over divided by the population aged 15 to 64—is a key indicator of population aging. Other things being equal, the tax rate for pensions will be proportional to this ratio. In the developed world, this ratio has risen from .12 in 1950 to .21 today, and is projected to increase to .44 by 2050. If, in the developed countries, the elderly in 2050 are to receive the level of benefits given to the current elderly, then the level of payroll taxes needed to fund government pensions will more than double by 2050. Due to higher fertility and immigration, the U.S. population is projected to remain younger than those of other OECD countries, and the pension problem will be less severe. Health costs, however, pose an even more difficult problem because of Medicare, the socialized health-care system for the elderly in the United States. As the population ages and spending per elderly person rises, government spending on health care will likely soar.

Workers paying for the current retirees do so with the understanding that they, in turn, will collect from the next generation of workers. Population aging generates intense political pressure to modify this implicit contract with the government by such devices as delaying the age of retirement or reducing the size of the benefit. The fear of population aging is a strong political force in many developed countries, leading to policies intended to induce people to have larger families. Such policies include banning abortion and contraception (Romania), offering prizes and financial incentives for births (France), and instituting generous paid-leave policies for women who stay home to care for their babies (Sweden). Although the increased costs of the elderly are to some degree offset by declining government and private costs of raising children as the ratio of children to the working-age population declines, population aging increases the total deadweight loss, a loss that always comes about from taxation because most of the child costs are private, while the costs of the elderly are mainly paid by taxpayers.

Friday, May 9, 2014

Hedge funds and little guys...

Picture a 51 year-old man sitting at his desk, fidgeting, his face contorting as if he's experiencing physical pain before he clicks the link to a New York Times Op-Ed written by a well-known Nobel laureate economist. That was me a few minutes ago. The economist was none other than Paul Krugman. Now, you'd think that an economics junkie like me would approach a few minutes of taking in the commentary of a Nobel economist with sheer excitement. Oh, but Mr. Krugman is not your everyday Nobel economist.

In fact, economics (or thoughtful, or legitimate, or sensible economics) generally has very little to do with his frequent ramblings in the Times. Generally, it's about how evil are the rich and the republicans. As for rich republicans, well, if there were only a word more evil than evil. There remains not a remnant of the objectivity he displayed as a younger budding economist. Today it's all about promoting whatever the "progressive" platform deems promote-worthy.

So why the facial contortions? Well, it's that so often when I read Krugman I just can't help but grab my keyboard and flail away. Even when, as is the case this evening, I'd rather be reading a good book. Today's column, alas, leaves me once again unable to resist.

Lately that "progressive" platform is all (or largely) about "income inequality". On this day, for "progressive" Paul Krugman, it's about high paid hedge fund managers.

Here's a snippet:
Once upon a time, you might have been able to argue with a straight face that all this wheeling and dealing was productive, that the financial elite was actually providing services to society commensurate with its rewards. But, at this point, the evidence suggests that hedge funds are a bad deal for everyone except their managers; they don’t deliver high enough returns to justify those huge fees, and they’re a major source of economic instability.

More broadly, we’re still living in the shadow of a crisis brought on by a runaway financial industry. Total catastrophe was avoided by bailing out banks at taxpayer expense, but we’re still nowhere close to making up for job losses in the millions and economic losses in the trillions. Given that history, do you really want to claim that America’s top earners — who are mainly either financial managers or executives at big corporations — are economic heroes?

Finally, a close look at the rich list supports the thesis made famous by Thomas Piketty in his book “Capital in the Twenty-First Century” — namely, that we’re on our way toward a society dominated by wealth, much of it inherited, rather than work.

At first sight, this may not be obvious. The members of the rich list are, after all, self-made men. But, by and large, they did their self-making a long time ago. As Bloomberg View’s Matt Levine points out, these days a lot of top money managers’ income comes not from investing other people’s money but from returns on their own accumulated wealth — that is, the reason they make so much is the fact that they’re already very rich.

(Piketty's book, which is all the rage among "progressives" these days, is second in my pile after the one I'm finishing. So I'll be back later with my opinion...)

Before I continue, I want to say that I reject the popular notion that "total catastrophe" was avoided by not allowing the market to deal with the banks. Not that there was no role for the Fed to play during the crisis, but the fact that the taxpayer was fleeced to pay the price of the utter carelessness, the lack of due diligence, and the greed of the biggest players (and, especially, their investors) in the financial industry---under the unwarranted assumption that the world as we knew it was about to end---is, well, I can't seem to come up with words sufficient to describe the egregiousness. 

While there are several angles from which to approach this one, in the interest of my time and yours, I'll jump on the one that came to mind first.

Being one whose income comes from fees paid by investors, I have many times thought Geez! Those hedge fund fees are outrageous! And when you consider their (on average) underperformance the past few years, well, geez!

But the thing is, rich folks---not little guys---invest in hedge funds, and it's entirely their business that they subject their portfolios to those huge fees. So it's not about the little guy when we talk about hedge fund expenses. It is about the little guy, however, when we talk about the companies hedge funds invest in. Companies that employ little guys. Companies whose stocks are owned by the funds little guys own in their 401(k) accounts. And if the hedge funds are any good at all, they'll buy good companies, and short bad ones. Which---short pain notwithstanding---is a good thing for the little guy. That is, more good companies mean more good jobs, and more good stocks, for the little guy.

And, interestingly, as Krugman points out, that $21 billion made by those top hedge fund managers came mostly by way of the returns they earned by investing in their own funds. Which, ironically, didn't come close to the returns the average investor investing in a plain old S&P 500 index fund earned last year. That's right, the average hedge fund returned barely a fourth of what the S&P 500 returned in 2013. My, the fun Krugman would be having had the hedge fund billionaires made $80 billion last year.

And, lastly, Krugman says it's all about taxes. Meaning, we should be taxing those rich rats. Okay, so let's tax that top 25's income at 100%. Just think about all the good a politician could do with that $21 billion. After all, it amounts to a whole two days worth of government spending. Well, at least we'd then protect the little guys from those hedge funds that invest in the companies they work for and invest in in their 401(k) accounts. Companies like the ones listed below. The ones that, as of 12/31/2013, happened to have occupied the top ten positions in Appaloosa Management LP, the hedge fund managed by David Tepper, the highest paid manager in the business the past two years running:

1. The SPDR S&P 500 (SPY): An exchange traded fund that invests in the stocks of the 500 employers that make up the S&P 500 Index.
2. Powershares QQQ: An exchange traded fund that invests in the stocks of employers listed on the NASDAQ stock exchange.
3. Citigroup
4. Goodyear Tire and Rubber
5. Google
6. HCA
7. United Continental Holdings
8. General Motors
9. Huntsman Corp.
10. American Airlines


Thursday, May 8, 2014

Never underestimate the power of commerce...

Yes, I understand, Putin's claim that Russian troops are stepping back from the Ukrainian border could be a ruse. Or it could be that, as the following snippet from a March 16 Quartz article suggests, he's a bit more concerned about the economic consequences of his actions than many suspect:
Earlier this month, Putin summoned senior economic officials, including central bank governor Elvira Nabiullina, to express his displeasure with the country’s faltering economic growth outlook. Jittery investors are pulling money out of the country, with more than $50 billion in capital flight projected for the first quarter this year, not far from the $63 billion that leaked out of Russia during the whole of last year.

Russia’s central bank is sitting on some $440 billion in foreign exchange reserves, so the country isn’t in danger of an imminent cash crunch. Still, the bank has spent $23 billion in currency markets in the past two weeks alone. Previously, these funds were deployed to stem declines in the ruble’s value, but well-timed interventions can also extend rallies, as was perhaps the thinking yesterday and today.

Here's an excerpt from my March 3rd commentary on the topic: 
One, the U.S. market’s experience with political, geo or otherwise, events of late—think debt ceiling standoffs, budget battles, “fiscal cliffs” and Syria—has been that politicians will forever politic their way (kick the can) to a market-soothing resolution. It’ll be interesting to see if indeed Putin is as careless when it comes to the economic consequences (at home) of his actions as some pundits claim. They’d have to be right if this is indeed to escalate to a level that would cause the market some serious consternation. For, when it comes to energy, for one example, Russia is no longer (potentially) the only game in town, and Putin knows it. And, suffice it to say, if the presently plummeting ruble is any indication, Russia’s economy will have hell to pay if Putin can’t, sooner than later, find a face-saving way out of this mess he’s gotten himself into. Of course he had to know this going in, which is reason to be concerned.

And here's my March 10 commentary in its entirety: 

Bloomberg‘s editors are calling for China to speak out “now against Putin’s aggression.” Which I suspect wouldn’t hurt. However, I’m still thinking that Putin has traded (as in international trade) himself into a corner on this one. As I suggested the other day, the pundits who believe they know Putin have to be spot on (that he cares not about the Russian economy) if he’s to go the distance in Ukraine.

Here’s Bloomberg’s accounting of who’s beholden to whom:
If Putin continues to advance in Ukraine, forcing a military confrontation or breakup of the country, he may well push China to take a stronger stand. The truth is that in material terms, China gains less than Russia does from their relationship. The latter accounts for a little more than 2 percent of China’s external trade. While volumes are growing, in 2011 China got only about 6 percent of its imported oil from Russia.

And here Bloomberg’s editors tell of how Russia is playing in other sandboxes as well:
And though China is Russia’s largest trading partner, Putin has also been hedging his bets. He has sought to expand rail links, pipelines and energy exports not just to China but also to both Koreas and to China’s archrival Japan. Russia is aiming to sell sophisticated weaponry to India, and has deepened economic and military relations with Vietnam.

So will Russia, for all its courting, garner international support for a continued advance in Ukraine? Well, think of it this way: if there’s one thing China, South Korea, Japan and India have in common, it’s that they’re all beholden to the economies of the U.S. and the European Union, and vice versa.

Not that it can’t happen, but clearly, the more Russia looks to expand its economic interests, the less stomach it’ll have for war…


Of course I don't know how this all ends, but I'm quite certain that the more the world's superpowers trade with one another the less likely they are to go to war with one another...

Wednesday, May 7, 2014

So how can the Fed hold back the economy and goose stock prices at the same time?

Allan Meltzer, in today's Wall Street Journal, like so many others, credits the Fed for this remarkable bull run in stocks:
Ironically, despite often repeated demands for increased redistribution to favor middle- and lower-income groups, the policies pursued by the Obama administration and supported by the Federal Reserve have accomplished the opposite. When the president campaigns in the midterm election, he will talk about the relative gains by the 1%. Voters should recognize that goosing the stock market through very low interest rates, not to mention the subsidies and handouts to cronies, have contributed to that result.

Earlier in his column he writes:
The Fed's unprecedented quantitative easing since 2008 failed to lead to a robust recovery. The unemployment rate has gradually declined, but the main reason is that workers have withdrawn from the labor force. The stock market boomed, bringing support from traders, but the rise in asset prices of equities didn't stimulate growth by inducing investment in new capital. Investment continues to be sluggish.

Now, I'm all in with Meltzer in terms of the ill-conceived policies of today's powers that be. But, frankly, I struggle with the tired line about the stock market gains being all about Fed "goosing".

Think about it: As Meltzer rightly states, "the Fed's unprecedented quantitative easing since 2008 failed to lead to a robust recovery." Far from it in fact. Yet, the stock market "boomed". The notion that the stock market would in fact "boom", or, I should say, continue to "boom" (as it can certainly "boom" in anticipation of a robust recovery), amid a most tepid economic recovery, frankly, makes no sense. The it's-all-about-the-Fed crowd never seem to mention record corporate earnings when they talk about record quantitative easing. I don't suppose, therefore, that they're crediting---at least not entirely---quantitative easing for record corporate profits.

So when Electronic Arts reports blowout earnings (yesterday) and the stock price jumps 14% in the after market, does the it's-all-about-the-Fed crowd stand up and say "see, QE is goosing stock prices"? I certainly hope not. Or when Amazon's stock plunges 10% (last Friday) on disappointing numbers, or Ford's is down 3%+ (last Friday) for its uninspiring performance, well, what about them apples? I mean if it's all about the Fed, earnings disappointments should be brushed off amid Yellen's promise to keep rates low way into the foreseeable future. Oh, and speaking of apples, Apple blew away top and bottom line estimates and its stock price rewarded shareholders handsomely as a result. Was that all about the Fed?

Regular readers know that I largely share Meltzer's view that the Fed, in its efforts to be the be all and end all for the economy, is playing a very dangerous game. And I'm warming up to the idea that while "accommodation" is the Fed's description of present policy, tighter regulations, along with the interest it now pays banks on their excess reserves, is anything but accommodative. Meaning, Fed actions may after all be, in fact, holding the economy back. But if that's the case, you'd almost have to conclude that the Fed is holding back the stock market as well (could the market be even higher were it not for the Fed?). Which is opposite the case being made by many of the folks, like Meltzer, who believe the Fed is holding back the economy. Hmm...

Lastly, just to get in front of an email or two from anyone who would point to my seeming naiveté, I'll, in bullet point fashion, answer the question I ask in the title:

How can the Fed goose stock prices?

  • By killing the stock market's competition by keeping interest rates extremely low.

  • By boosting corporate profits by lowering borrowing costs.

  • Conventional wisdom says P/Es should be higher when interest rates are lower. Therefore, keeping interest rates very low permits very high stock prices.

  • Investors who believe that the Fed will ultimately succeed in boosting the economy will bid stocks higher in anticipation---during this period of "accommodation".

I'm sure if I think harder I could add another one or two, but it's getting late.

Aside from the second point---which by itself is insufficient---none of the above explain how the Fed might be boosting corporate earnings (well, I guess you could argue the fourth point, should they succeed, as well). And, at the end of the day, when the price of your average share of stock trades at a multiple above earnings that is consistent with the long-term average, the it's-all-about-the-Fed argument---in that it can't explain record earnings---loses its steam. Otherwise stocks, in the aggregate, would be trading at multiples that would have folks exiting the market like it's 1999.  

Now, all that said, it would not surprise me in the least to see the stock market contract when the Fed finally embarks on its quest to rein in what it's done over the past few years. Which simply means that while the Fed, in my view, does not deserve the credit for this bull market, it could very well earn some of the blame for ultimately ending it...

Tuesday, May 6, 2014

Santelli on climate change

Rick Santelli:
"We know that our corporate tax policy and rules need to be addressed. How many companies do we see doing M and A just to get offshore? We can't even fix that! And you're telling me that those same leaders are going to tackle mother nature?"

Here's 2 minutes of Santelli on climate change...

Market Commentary (audio)

Click the play button below for today's commentary...

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Monday, May 5, 2014

Market Commentary (audio)

Click the play button below for today's commentary:

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Sunday, May 4, 2014

Beware your biases when it comes to investing...

“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.” Nassim Taleb

If you are our client, the next time you're in to review your portfolio I'll be presenting your analysis on a beautiful 51 inch flat screen monitor fastened to my office wall. You'll recognize the brand as one of better than average quality---you may or may not think about the fact that the brand hails from South Korea. The most beautiful thing about that beautiful flat screen is that I got it for just a few hundred bucks.

That's what came to mind Friday as I listened to an "expert" on CNBC harp on about the fact that while the Fed says inflation remains very low, his family's grocery bill is off the charts.

Believe it or not, the fact remains that, while you and I indeed spend more on groceries than we do flatscreen TVs (and food prices are up), we've yet to see the kind of broad-based inflation that conventional wisdom says should have resulted from those trillions of new dollars printed entered onto bank balance sheets over the past few years.

Just last week a neighbor confessed to me that he invested "a ton of money" in commodities three years ago and got creamed. Everything he learned in his college econ courses, so he said, told him that, given what the Fed's been up to, inflation should have skyrocketed. I have a client who has a very intelligent friend who dabbles in the markets. Three years ago he followed his friend's advice, and---with his personal online trading account---loaded up on all sorts of commodity funds (largely energy and metals) and ETFs. Save for his modest exposure to ag commodities (think grocery bill) last year (up 50%, after declining in '11 and '12), it didn't turn out so well. I have another client who, around that same time, sent me a very thoughtful email explaining why he, a highly intelligent and educated gentleman, and the experts he follows, expect the dollar to ultimately descend into oblivion under the weight of excessive printing as well as the massive ownership of treasuries by foreigners who are poised to dump them.

But here's the thing, as I told my neighbor the other day, and counseled those two clients back then, I actually agree that present Fed policy runs the risk of creating a high rate of inflation at some point in the future---at some point in the future (although I disagree that foreigners are poised to shoot themselves in their economic hearts). But not, as I suggested in Little Chasing Going On, until some of those dollars start moving through the economy. And not, as I suggested in A Little Foray Into Cycles Past, until we see a tightening of the present slack in the economy.

In his book Investing From the Top Down, Anthony Crescenzi says you should "curb your selective reasoning": 
There is now scientific evidence indicating that the part of the brain associated with reasoning is inactive when people are given information that conflicts with their own thoughts about a particular subject. In place of reason people seek out information and opinions that confirm their own views.

Your everyday "conservative" loathes government over-spending (except on the stuff he agrees with [say, military], or benefits from) and excessive money printing. Two very loathable things, I might add. So much so that he trumpets every price increase he can lay his eyes on as proof that the government is destroying the foundation of the once-mighty U.S. dollar. So when someone tells your everyday conservative that there's presently little or no inflation, he responds with "no inflation my a**, have you been to the grocery store lately?" I would say "yes, and I've also been to Best Buy."

Crescenzi continues:
This is destructive behavior in any walk of life including the investment world. For you, it is a good thing that you recognize this because it means that while you are doing the math and making rational judgements, others are looking the wrong way, creating opportunities for you to exploit. Look for situations where selective reasoning is blinding the markets from reality, and nail it.

My point? When it comes to our portfolios, narrow convictions can be very dangerous things. And while I complain ad nauseam about politics here on the blog, we have to be very careful not to allow our emotionally-charged political biases to overcome our ability to reason. 

Oh, and guess what we'll be discussing when we review your portfolio on that beautifully inexpensive monitor in my office? Increasing, albeit modestly, your exposure to materials, energy, etc. The sectors that tend to outperform when inflation is on the rise. Like I said, I actually agree...

“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.” Nassim Taleb