More Of The Same

February 13, 2013

Opinion

The President's message last night was, as expected, simply more of the same: More spending and more taxes.

It was expected because the presumptive opinion in America (as defined by politicians, economists and the media) is that the government will find a way to deal with our problems -whatever they are- and that we do not need to worry.

This view, made popular during FDR's reign and reinforced and expanded since by both political parties, believe that the government can and should inject itself into the economy because the economy needs to be managed. That market forces cannot do the job.

The president said we need to do more. I interpret that to mean we need to take more money from the people who earned it, the producers, because the 50-60+% percent being taken now isn't enough or even fair. And besides, the government knows how to spend this money better than the people who earned it.

You may think differently but right now we live, work and invest in this Keynesian world; therefore, going forward we can expect the following:

1. Governments (all levels) will continue to spend excessively and borrow or print more money because there is no incentive to stop (see ZIRP below.) When the States get into trouble, they believe the Federal Government will bail them out.

2. The Federal Reserve will continue their Zero Interest Rate Program (ZIRP) for as long as they can to help banks (it's their job); and to keep interest rates low to "help" people buy/refinance their homes. And maybe one other thing, the Federal Government can't afford to have rates rise because every 1% rise in interest rates will cost the government over $150 billion per year in additional interest.

3. Currently, the Federal Government is running close to $100 billion per month in deficit spending and the Federal Reserve is printing and pumping in another $105 billion per month. The results so far are not too good however. Preliminary Fourth Quarter GDP decreased at an annual rate of -0.1%. But, it's only been four years.

4. Normally, increasing money supply causes inflation. However, even with the trillions of dollars injected into the economy, we do not see inflation as measured by the Consumer Price Index (CPI.) One reason is of course the way CPI is calculated. The other is that the money being injected by the Fed is going directly into the banks. The banks are not lending the money because they can make more money by buying assets (stocks, bonds, currencies, foreign investments, etc.)  

4. Therefore, we have a kind of stealth inflation because real inflation is not visible in the usual places. However, inflation is visible in asset prices (stocks, bonds, metals, etc.) because that is where the banks are "investing" their free or almost free money from the Fed.

5. This kind of malinvestments will eventually cause "cost-push inflation" (increased costs of materials including energy and labor will force prices up and thereby reduce supply.) Reduced supply then causes prices to increase.

6. Today, the government cannot raise rates to combat rising prices (remember Paul Volker) because U.S. debt is too large and interest on the debt would become unaffordable. Nominal rates on the 10-year Treasury of 5% would increase interest payments close to the size of the Defense budget.

So what do we know after the President's speech? The government is going to keep pumping money into the economy raising nominal GDP, asset prices (including the markets) and inflation. We will need to continue investing like a Keynesian whether you believe in this dogma or not, but keep an eye out for the black swan.

Which Housing Story Is More Important?

January 31, 2012

Two versions of the S&P/Case Shiller Composite Housing Index for November were published yesterday.

Story one. The CBS/CNBC version carried the following main points:

1. Headline: "Home prices gain for 10^th month in row"" 
2. Conclusion: "a string of gains point to a housing market that is on the mend" 
3. Reason for conclusion: " the S&P/Case Shiller Composite Index of 20 metropolitan areas gained 0.6% in November on a seasonally adjusted basis, in line with economists' forecasts."

Story two. Article from Market Watch (WSJ) frames the story differently and at takes a closer look:

1. Headline: " November home prices tick down" 
2. Conclusion: Housing is clearly recovering."
3. Reason for conclusion: ..."the S&P/Case-Shiller 20-city composite index posted a non-seasonally adjusted 0.1% decrease in November following a 0.2% decrease in October. (However,) "After seasonal adjustments, the 20-city house-price index rose 0.6% in November ...and prices were 5.5% higher year-over-year."

Note NBC uses seasonally adjusted data only while Market Watch uses both. S&P/Case-Shiller recommends using non-seasonally adjusted data and year-over-year data for the trend.

For the casual reader, this difference may not seen that important. However, for the aggressive reader who is always looking for possible trend changes, this could be important and needs to be watched. For example:

            1. Since prices do not rise forever, maybe after 12 months, this (two month negative) could be the beginning of a correction?  

           

            2. Will prices continue to rise throughout 2013? They will have to if housing is going to contribute to GDP growth the way most economists believe it will. 

Always question data.

The U.S Jobless Claims Drop To 5-Year Low. Really?

Friday January 25, 20012

The media reported yesterday that weekly unemployment claims dropped by 5,000 to a 5-Year low. This is a great example of why media stories are so misleading. Here are the main points made by the Associated Press (AP) story:

1. U.S. jobless claims drop to a 5-year low of 330,000 which is a hopeful sign for the job market.

2. (This) is evidence that employers are cutting fewer jobs and may step up hiring.

3. The 330,000 to 390,000 weekly average of claims and the average increase of 150,000 new jobs per month is enough to slowly push down the unemployment rate which fell 0.7% to 7.8% last year.

As you know, this (150,000 new jobs per month) is not the reason for the drop in the employment rate.This amount just keeps up with the number of people entering the labor force. In fact, people dropping out of the labor force is the primary reason the unemployment rate dropped.

This is not an isolated example of "misinterpreted media facts" or simply one story as many news outlets use the AP releases as the basis for their stories.

Here is the problem. It's not the complete story. They did not mention that three states (California, Virginia, and Hawaii) did not report due to weather issus and a holiday. So, the government made an "educated guess" as to what the number of claims would be from those states. Then they ran all the data through their seasonally adjusted model to arrive at the 330,000 claims.

As many of you know, an important step in my critical thinking process is to always ask yourself what data is missing from the story. You also know they don't have the time or space to include every piece of information. You already knew there was a holiday last week and you knew -if you follow the weekly reports- that this is the lowest number in years. That makes this report unusual and therefore questionable. You have to put the data in context before you can evaluate the argument (a hopeful sign, may step up hiring and the reason the unemployment rate declined) before you can really evaluate this new informaiton.

By the way, this information is available on the government's website. Maybe the writer just didn't have enough time to do the story correctly.

The Debt Ceiling Has Been Reached Again

December 27, 2012

Treasury Secretary Geithner announced today that we would reach the debt ceiling on December 31. 2012.  However, he has some options -like postponing payments to pension plans- that will keep us from defaulting until as late as April.
 
President Obama would like the debt ceiling raised as part of the "Fiscal Cliff" agreement. Rather than come to congress every time the debt ceiling is reached, Mr. Obama would like Congress to give the President authority to raise the debt-ceiling limit whenever it was needed. The Republicans proposed this once in the past as well. I do not think this can pass the House at this time.
 
Incidentally, the debt ceiling came out of the debate to establish the Federal Reserve in 1913.  Congress was worried that the government would spend and the Federal Reserve would print too much money debasing the dollar and destroying purchasing power. So In order to get the votes needed to establish the Federal Reserve, Congress passed a bill limiting the amount of Sovereign debt that could be issued to $2 billion dollars.  We are now talking $18 trillion as a stopgap measure. 
 
In any event, the debt ceiling will probably be part of the Fiscal Cliff negotiations.  If you remember the last time we debated the debt ceiling, it took a 10% market correction before the politicians got serious.  Also, we might see S&P start talking about another credit rating downgrade if it seems that the political parties cannot get something done. It may be different this time, but keep your positions hedged if possible.   

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.