The Great Disconnect

December 24, 2012

Several recent events indicate that financial companies may be, once again, coming into favor. But remember, caution and hedging are required in our noise driven, centrally planned world.     

1. A week ago, the Federal Reserve increased the amount of money they are creating from $40 billion a month to $85 billion a month. That's $1trillion more dollars going into the banking system over the next year. This will enable the banks to get rid of a lot of toxic assets and allow them to reclassify assets which will increase their excessive reserves (they have over $1.4 trillion now) and reduce reserve requirements (think bank profits).
2. At the same time, the Central Banks have a coordinated, multi-national Central Bank lending/currency program to help shore up sovereign debt.
3. Last week, Greek sovereign debt was upgraded and their credit rating moved up to stable (they did get part of the $16 billion they need to pay bankers). Result: Greek bond spreads narrowed and Europe equities rallied.
4. A few days ago, Meredith Whitney (a key bank analyst) put a buy on BAC and Citi. She stated that after the next stress tests, BAC should be able to buy back stock, raise its dividend and add billions in capital. One of her reasons is that they have worked off a lot of bad assets.
5. Also, the market thinks a deal will be made on the Fiscal Cliff in that taxes will be raised and spending cuts will be done with smoke and mirrors so there will not be any real cuts (i.e. $350 billion saved in reduced interest costs over the next 10 years, $180 billion saved from Chained CPI numbers for Social Security increases, etc.). Therefore, no immediate cuts and more spending (Sandy relief, a $3.5 trillion budget, $1 trillion in new money by the Fed, etc.) implying that we will not have a recession (negative GDP) in 2013.  

 Net: Thanks to Ben's money, the economy and the markets are on different trajectories. Or to put it another way, the status quo will be maintained at any cost until we meet the black swan.   

Five Thorny Issues In The Next Five Weeks

November 20, 2012

There are several very difficult, very divisive issues that need to be resolve over the next five weeks or four of them will be automatically implemented on January 1, 2013. We know we are going to get higher taxes in 2013 and we may get some spending cuts (but I wouldn't hold my breath for much more than extensions).

Resolved, postponed, or kicked down the road, they should impact (including volatility) the economy and the markets. Following is a summary of these issues so you can begin to prepare for them.

1. The Fiscal Cliff

This is the automatic spending cuts and tax increases that go into effect on January 1, 2013.

The spending cuts amount to 3% of discretionary spending and 3% of defense spending. Per current legislation, the cuts are automatic and politicians cannot pick and choose which items to cut and which items to leave in place. However, as you could guess, they can vote to change anything; and they will because each side is not interested in cutting spending, they are only interested in saving or protecting the spending that is important to them.

Tax increases are also supposed to be automatic. If they are:

Personal income tax rates will rise to 39.5% for the top rate

The Alternative Minimum Tax (ATM) becomes a factor at lower levels

The 2% payroll tax holiday goes away

Estate taxes go back to 55% and for much smaller estates

2. ObamaCare Taxes become effective January 1, 2013

           

            Dividend tax rates go from 15% to your personal income tax rate

            Capital gains tax goes from 15% to 20%

            Investment tax (an additional tax) of 3.8% on dividends

            Exemptions reduced on child care credit and the marriage penalty is back

            Expense limits decrease (what expenses and amounts)

            State and local sales tax deductions are reduced

            1040 deductions reduced (medical)

            Flexible Spending Accounts will be limited to $2,500

            New Medicare wage and salary tax (0.9% above 200,000)

            New Medicare Investment tax of 3.8% (wages above $200,000)

Note: if these remain unchanged, you may have to consult your accountant. This information is only intended to illustrate what might happen and may not apply to any one individual.

3. Debt Ceiling Limit (will be reached before end of year)

This is not a new spending authorization; the increase is for spending which has already been committed to. Last time (last August) this "battle" resulted in a market decline of about 10% and a reduction in the U.S. Credit Rating. The credit agencies have said this new increase without a reduction in spending could result in another credit downgrade which could be a risk to interest rates and bond values.

4. FOMC Meeting and the end of "Twist"

The Federal Open Market Committee (the Fed) meets for its regular meeting on December 12. One thing under consideration will be the "Twist" program which was designed to keep long-term interest rates low and thereby help the housing industry will expire on December 31. Will they renew it, expand it or drop it in favor of something else?

5. Transaction Account Guarantee (TAG) expires December 31, 1212

In the debt crisis, the government (FDIC) raised deposit insurance from $100,000 to $250,000 and made it unlimited for non-interest bearing transaction accounts. When this expires, the estimated $1.4 trillion in cash accounts of corporations and other depositors could leave the small/medium-sized financial firms and go to the large, too-bigger-to-fail firms because they have an implied guarantee.

Election Result: We Want To Maintain The Status Quo, But..

November 6, 2012

After spending $6 billion in platitudes and demagoguery -without addressing a single, important issue - the result of the election was simply to maintain the Status Quo: Democratic President and Senate and Republican House. But now, the President and Congress have to deal with the real issues: spending, revenues and debt.

Mandatory spending (mostly Social Security, Medicare, Medicaid) plus the interest on our debt amount to about $2.5 trillion per year. These are policy programs so the payments are not voted on by Congress, they are made automatically every month just like telling your bank to automatically pay these bills from you checking account each month.

This $2.5 trillion yearly total is paid from federal revenues (mostly taxes) which amount to about $2.5 trillion per year (about 18% of GDP.) Great, except there are 10,000 baby boomers being added to this payroll each month plus the costs of inflation.

But, we still have about $1.2 trillion per year of Discretionary Spending (for things like Defense, Education, Homeland Security, etc.) Since we are out of money, we borrow these funds so we really spend about $3.6 trillion per year, borrow $1.2 trillion and add it to the debt each year.

So, mathematically, how do we solve this problem?

In recent polls, 80% of people want the government to cut spending; 80% of people do not want cuts in mandatory spending; and 66% of people do not want tax increases. Go figure. But we must to do something before our credit card is maxed out.

So after blowing $6 billion on hopium and personal attacks, we are back to raising the debt ceiling and blaming the "other side" for all our problems: The Status Quo.

The Real Debate

October 16, 2012
After watching the debate last night, I had a bunch of questions I thought were important but that were never asked. Here are three of them:

1. Why has the economy (GDP) been trending down for the past two years and the stock market moving up?
The answer of course in that the government has been pumping money into the banks (TARP, QE1, QE2, Twist Program and now QE3 with no limit as to the amount of money they will print.) This money goes to the banks and then the banks use this money to invest in the market (stocks, bonds, foreign investments, etc.). This 65% increase in “green paper” or money has driven the stock market up about 71% from the bottom in February 2009. This is illusionary wealth also called a bubble and like all bubbles, it will pop.

And just to make sure this money will go into assets that raise the value of the market (or what government economist’s call the “wealth effect”) which is suppose to make us run out and spend money; the Federal Reserve has instituted a Zero Interest Rate Policy (ZIRP) to make sure no one saves and is forced to go into the market to earn any interest.

2. How can the government continue to keep spending and driving up debt when mandatory spending (Social Security, Medicare, Medicaid, Other Mandatory spending -like VA benefits, welfare, etc. – and the interest on the debt equal the entire revenue?

In 2012, the government spent $2.5 trillion on mandatory items and interest and received $2.5 trillion in revenues (taxes, tariffs etc.).

That leaves Zero money left for all other discretionary spending ($628t) and defense ($680t). This is more than a trillion dollars a year which means we will likely not even have enough revenues to pay for mandatory spending next year unless the economy picks up.

Follow up question:

So to get to a balanced budget, are you going to cut discretionary spending (education, homeland security, perks for your constituents, etc.) or Defense Spending (even though defense industries are scattered in every State to ensure Congressional votes)?

You know the answer. No and No.

3. Economic data has been very weak and deteriorating; yet this past month, two unbelievable things have happened to make me confused:

A. The Federal Reserve Chairman has been saying for some time that the economy has been slowly improving; and that based on the data, the Federal Reserve stands ready to assist (meaning QE3) if the data shows the economy is slowing further. Yet, two weeks after saying this for the umpteenth time, the Fed surprises the market with potentially the biggest injection of money ever! What about the data? I thought we were improving?

B. The data. This month the data, in contradiction to the Fed action, has been unbelievable: unemployment has dropped, retail sales have jumped significantly higher, housing starts have jumped significantly higher, etc.

We know you have “economic models” to predict the numbers, but the data does not fit the description of the economy provided by the Federal Reserve Chairman prior to injecting money into the banks (QE3). Does this mean the economy is getting worse and the models will reflect the real economy in a month or two or have the models just gone wacky?

Well, I know I’m over the time limit and it’s my opponents turn to talk so I’ll stop.

Bernanke Blowing Bubbles Again

September 14, 2012

Yesterday, Fed Chairman Bernanke announced that the Fed would:


1.. Extend the Zero Interest Rate Policy (ZRIP) until mid 2015

2. Continue the $45 billion per month Twist program (to keep long-term interest rates low)

3. Start buying $40 billion per month of Mortgage Backed Securities until employment improves (does that mean in perpetuity?) He will even add more money if the labor market does not improve.

The market has been expecting this for more than a year. The surprise was that the amount to be purchased was open-ended. That is really kicking the can. Chairman Bernanke also revised his GDP growth number down to 1.7-2. from 1.9-2.4. He must be very nervous because he seems to make downward revisions after each meeting.

Where will all this money go? To the banks of course! They will be able to get damaged bonds off their books at a good price and then use the money to beef up their balance sheets by investing the money in stocks and bonds here and abroad. It may not do much for employment but it should be good for the markets, at least for a while. But sooner or later we will have to pay for it with a deeper recession or inflation.

What went up in price on the announcement? For example: Gold, Silver, Equities, and Oil. What went down? For example: Bond prices and the Dollar.

Oh, Paul Krugman, Nobel-Prize winning economist and professor, again, does not think The Fed is spending enough.

Summer Ends and the Volatility Season Begins

August 20, 2012

As the low summer volume is about to end and the aggressive Presidential campaigns start spending their billions in campaign funds begin; we are about to get some serious volatility over the next six months Maybe sudden sharp drops followed by "clarifications" and short-covering, changing and conflicting poll numbers and then more clarifications again and again.


We are facing a number of serious issues between now and the "State of the Union" speech in late January. For example:

1. The overly optimistic, but constantly being revised downward, GDP, revenues, and profit numbers being forecast for the third and fourth quarters,

2. The debate in Europe (or press releases that levitate the markets until the data is fact checked) about how countries with almost no growth and no way to pay the interest on past debt can increase their debt so they can solve their problems (our economy and markets are correlated with Europe),

3. The end of the "Bush" tax cuts on December 31 which if not extended will increase Government revenues but lower revenues and spending by taxpayers and lower GDP,

4. The debt ceiling (again) will have to be increased by October (a guess) or the government will not be able to pay bills its now obligated to pay (and what about the threat of another credit rating downgrade),

5. The Federal Budget (or some temporary agreement to fund the government) needs to be approved by Fiscal year-end September 30. Even though Congress is obligated to do so, we haven't had a budget in four years, just continuing resolutions,

6. The 3% or $4 trillion dollar cuts the budget (Discretionary and Defense) that are suppose to take effect on January 1 that both sides now claim can't be done in this difficult economic environment (is that the same as "Recovery"). Maybe that's why they kicked the ball into 2013 because there is no willingness to cut anything.

7. The 21 new tax increases and many new requirements of ObamaCare that begin in January. Will they be implemented or rescinded by the election?

That's enough to give you the idea that all of these issues, plus the political rhetoric and the daily polls, will make each day a new adventure. Also, since we have moved from an entrepreneurial to a centrally-planned economy over the years, all we can do is react to what the central planners propose and do.

This increase in volatility with no way to predict the market direction on any given day means we have to look at an investment strategy that will protect our capital during this volatile period; and for more aggressive investors, offer ways to capitalize on this volatility. Call your investment advisor and discuss how to get through this upcoming volatile period.

The Market May Be Saying the Fed Will Move Next Week

July 25, 2012

It looks like the Fed may be ready to move next week (meeting is July 31-August 1) on a new Quantitative Easing Program or QE3 (translation: money printing.) Jon Hilsenrath of the Wall Street Journal mentioned that the Fed may or may not move at their next meeting as the economy has continued to weaken. This "leak" helped move the market up (but still closed down) in the last half-hour yesterday. Today, comments by Steven Roach and others indicate that the Fed will move at the August 1 meeting.


I have been predicting that the Fed would inject more money into the system for some time. It is the only thing they know how to do and they can't escape their Keynesian thought model. However, I thought they would have acted sooner because we haven't solved the problems that created this recession and both parties want to get re-elected.

I don't know if the Fed will move next week or not. But, what you expect the market to do on learning of QE3; it is doing. From this mornings low, equities have rallied to over 100 points, the dollar is down (printing debases the dollar) and gold is up big (reduced buying power and fear of inflation.)

Will this help? Depending on size and pace of printing, etc., it could levitate the market for a short period of time (weeks to months.) But in the long term, it will not work and in fact make our problem of de-leveraging worse (more painful)