You probably know that famous quote comes from a great philosopher of our time, Yogi Berra. While a humorous comment, there is certainly an element of truth in it as I take my annual look at what happened in 2011 and what I think might happen in 2012.
\r\nI have heard that some people have started calling me Edmond’s Dr. Doom. I try not to be negative, but sometimes you just have to call it like it is. I’m not a “perma-bear” though. At times in the past I have been accused of being too optimistic. Go figure. The truth is that I don’t really care if the markets go up or down as long as I’m on the right side of it to protect my clients.
\r\nThe global economy, as I see it, is in a period between two crises with a respite from the chaos. Unfortunately, we didn’t fix anything and have mostly sown the seeds for what will eventually be another crisis. Things seem stable now but there is a lot of unfinished business. The calm on the surface belies the turmoil underneath.
\r\nIt has been said that those who ignore history are doomed to repeat it. Unfortunately, I am sorry to tell you that we are about to endure 2011 all over again with extreme volatility and uncertainty.
\r\nThe biggest challenge now, from a forecaster’s perspective, is sorting out all the news and trying to determine what is important and what is just noise. This is especially true when looking at the economy (locally, nationally and globally) and the stock and bond markets. While these are all certainly related and mutually determinant, they don’t always move together or logically. In fact, they seldom do.
\r\nHere is what I said in January 2011 and what actually happened:
\r\n1. “The stock market works its way higher in a volatile fashion to a top sometime in the fall, possibly to 12,800 on the Dow, before rolling over late in the year.” Mostly correct. The Dow hit 12,876 in May and fell to 10,404 in October, and then finished slightly up for the year at 12,217. The S&P performed similarly, in a range from up 9 percent to down 11 percent, but finished unchanged for the year at 1,257.
\r\n2. “Gold, oil and commodities in general continue higher with gold hitting $1,500 an ounce and oil $100 a barrel.” Oil hit $114 in May and then down to $75 in October, and then finished the year at $99. Gold hit $1,925 an ounce in September, up from a low of $1,321 in January, and then finished the year at $1,567.
\r\n3. “Interest rates on long term Treasury bonds spike in late 2011 creating a great buying opportunity in bonds again.” Oops! I blew that one. I had not counted on the Federal Reserve’s insanity of QE2 and Operation Twist. 10 year Treasury yields went down to 1.77 percent from a start of 3.36 percent in a giant flight to quality from the European debt crisis.
\r\n4. “Predictions of 4 percent GDP growth by some analysts are likely way too optimistic. Look for GDP at 2.0-2.5 percent at best. Unemployment will remain above 9 percent.” GDP figures thru 3rd quarter were 1.8 percent. 4th quarter figures, not released yet, will likely move the number back into the 2.5 percent range. Unemployment remained over 9 percent for most of the year and was revised downward in late December to 8.5 percent. However, most, if not all, of that was due to people dropping out of the workforce and not counting anymore; not because they found a job. The real number is closer to 12 percent.
\r\n5. “Home prices on a national average fall another 10 percent.” The Case-Shiller housing index thru October showed a 3.4 percent average price drop nationally. Many of the major housing markets where the biggest bubble occurred fell between 6 and 8 percent.
\r\n6. “U.S. Municipal bankruptcies become headline news. More cities that are technically bankrupt are contemplating the idea of making it official.” Partially true, but not as big a story as I thought. A few declared bankruptcy, but many are still hanging on and praying for a recovery to bail them out.
\r\n7. “The sovereign debt crisis in Europe will put the Eurozone under more pressure. Their problems have not gone away and several countries will be forced into massive austerity programs or the European Central Bank will be forced to print money and devalue their currency.” Bull’s eye! This became the dominant story of 2011.
\r\n8. “China’s economy is overheating and they are raising interest rates as rapidly as possible to stop runaway inflation. This will eventually pop their real estate bubble, slow their economy and put pressure on commodity prices.” Partially true. This story is still evolving.
\r\n2012 will be one of transition; politically in the US with the presidential election; financially in Europe with the potential breakup of the monetary union; and economically in China as the debate finally gets settled over soft-landing versus hard-landing risks. It also looks to be a year when tactical asset allocation will need to be emphasized at least as much as longer-term strategic considerations.
\r\nOne thing seems reasonably certain; the global economy is going to endure a significant deleveraging cycle as we move through 2012 – one that will affect most if not all parts of the developed world. It will be accomplished by some combination of default and write-downs, debt repayment and rising savings rates. All this promises to be very deflationary and we will have to invest with that prospect in mind.
\r\nNow is when demographic trends I have talked about for so long really start to bite and overwhelm the health care requirements and pension funds obligations for the 78 million baby boomers. The median age of the US baby boomer (and mostly everywhere else in the developed world) is 56 and the oldest are now in their mid-60s. For those who were betting on elevated portfolio returns to deliver adequate retirements savings, time has run out. They will have to save the old fashioned way at some point.
\r\nWe are reaching the end of the Debt Supercycle, a term coined by Hamilton Bolton of the “Bank Credit Analyst” and further discussed by John Mauldin in his book “Endgame.” Essentially, the Debt Supercycle is the decades-long growth of debt from small and manageable levels, to a point where bond markets rebel and the debt has to be restructured or reduced. A program of austerity must be undertaken in order to bring the debt back to acceptable levels. If we are not already there, we are getting very close.
\r\nA term that you are going to hear a lot this year is “Risk On/Risk Off.” Risk on means putting risk back into your portfolio for potential bigger gains. Risk off means investors trying to reduce risk in fear of possible portfolio losses. Last year, and probably this year also, institutional investors jumped back and forth between the two and that is one reason we saw so much volatility.
\r\nOne thing I should point out is that while all of this predicting is fun to do, it is important not to take it too seriously. Even more important, as much as I might believe my predictions or anyone’s predictions, I would NEVER make a major bet on one or a few areas. Neither should you. It is in uncertain times like these where diversification among asset classes and risk management is even more important than ever. We are just trying to figure out what we ought to believe in order to end the coming year in the best possible situation. That is, which belief is least likely to be fatal and which is most likely to pay off?
\r\nYou should also know that the local economy is often much different than the national or global economy and may have different outcomes. So what happens next? Here are my thoughts for 2012:
\r\n1. The European debt crisis continues in and out of the headlines as Europe goes into a recession. Nothing is resolved but they do manage to kick the can down the road a little longer. The Eurozone does not break up but inches closer to fiscal union, only because the breakup would be even more painful. One reason for creation of the European Union was to keep from going to war with each other every 50 years or so. Now they just kill each other economically.
\r\n2. The U.S. economy does not go into recession in 2012 but continues to limp along at a weak 1 to 2 percent GDP growth rate. Global GDP will be the same. 1st quarter GDP will look good as it carries over from 4th quarter 2011, but will slow significantly after the 2nd quarter. QE3 from the Fed is unlikely, and will be too late if they try.
\r\n3. U.S. corporate earnings grow, but fail to beat estimates for the first time in more than three years. S&P 500 earnings per share are forecast at $105 but shrinking P/E multiples will result in a lower stock market by year end.
\r\n4. The S&P 500 moves up to about 1,370 but probably peaks by April - an increase of 9 percent. Conservative investors may want to be out before that or hedge their portfolios. Aggressive investors may want to short stocks then. Several risk off events in the 2nd and 3rd quarters will result in a major sell off for 4 to 7 months, taking the S&P 500 down 23 percent from the high to 1,050. As we near election time we will see a relief rally take the market back up, but still finish down about 8 percent for the year at 1,160 on the S&P 500. Few on Wall Street would agree with this assessment. We’ll see.
\r\n5. Interest rates on the 10 year US Treasury bond decline to historical lows of 1.5 percent on the next risk off event and then head slightly higher by year end.
\r\n6. The US dollar continues up and the euro down, with the Euro going as low as $1.19 exchange rate. Gold rises at first to $1750 and then falls into summer. The longer term target for gold is $2300 but is too speculative here except for long term investors. Wait to buy gold at $1250.
\r\n7. Oil and commodity prices peak sometime this year and start to decline by late in the year, if not sooner, as the global economy slows and demand falls. This, of course, would not be true for oil if further conflict breaks out in the Middle East. Oil is at $100 now and could see a spike to $120 at some point. However, the next risk off trade or a slowing global economy could take it down to $75 by year end.
\r\n8. Unemployment remains stuck at the 8 to 9 percent level, then goes up again in late 2012 or 2013. GDP growth of 1 to 2 percent is not enough to make any meaningful dent in the unemployment rate.
\r\n9. The US government runs another $1.3 trillion deficit. Current government debt is now over $15 trillion, up over $1 trillion just in the last year. This is unsustainable and something that is unsustainable will eventually stop. At some point we will stop the insanity voluntarily, or the bond market will force us to stop.
\r\n10. The Presidential Election is too close to call. Who wins and what decisions are made by policy makers now and next year will matter significantly for the long term, making the future better or worse depending on the economic choices made. However, it won’t matter at all for the short term as far as the economy is concerned. A recession and stock market decline is already “baked in the cake” for 2013 and there is not much either party can do about it at this point. The good news is that the worst of all this is probably behind us by the end of 2014 and we start growing again.
\r\nWhen times become extremely uncertain (as they are now), investors want to reach for more certainty. Since capital gains or losses represent uncertainly, then what can we focus on that is certain? The answer in part is cash flow. Interest income and/or dividends from an array of investments options can help reinstate that certainty that so many of us desire for our portfolios.
\r\nThis will be part of our over-riding theme for 2012. Our purpose, as always, is to serve our valued clients in a responsible fiduciary manner. Our hallmark, our over-riding theme, will always be that “we want to win by not losing.” A focus on principle protection helps provide principle preservation, which will serve our clients for not just this year, but for the many years to come.
\r\nSo there you have it. Am I right? We’ll see when we review it again next year and see how I did this time. Perhaps we should borrow another quote from Yogi. “When you come to a fork in the road, take it.”
You probably know that famous quote comes from a great philosopher of our time, Yogi Berra. While a humorous comment, there is certainly an element....
“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” John Maynard Keynes, 1936. We might say the same about being slaves to the International Monetary Fund (IMF). Christine Lagarde, the current IMF Chief, recently said something to the effect that “Rescue of the Euro must involve all nations.” Uh Oh. When the head of the IMF makes a statement as broad as this, it is time to worry.
\r\nThe IMF is a relic of a previous era, born out of the Bretton Woods agreement in 1944. Interestingly, the US made the first contribution to the fund using the money that President Franklin D. Roosevelt stole from those that held gold in 1933. Roosevelt declared it illegal to hold gold in May 1933; then once all physical gold was confiscated, he promptly re-priced gold higher and the US dollar lower. This meant that the gold FDR had taken from individuals was suddenly worth more, creating something of a nice little government slush fund. Part of this fund ended up as the initial US contribution to the IMF, and part of it was used by President Clinton to rescue Mexico in the 1990s.
\r\nBut I digress. The US is one of 187 countries in the IMF, but is responsible for 17.7 percent of the funding for the organization. The next biggest contributors are Japan and Germany, both at just over 6 percent. So when the leader of the IMF makes a statement about “all nations” being responsible for the rescue of the euro, you can bet that she will use her position and her organization to make that happen. The fact that US taxpayers foot about 1/6th of the bill is worrisome to say the least. It’s not like we’ve got a lot of spare change sitting around to help out with.
\r\nThen there is the stark reality that the euro crisis is nowhere near a resolution. People in positions of power are well aware that a group of countries carrying way too much debt can’t possibly solve a crisis of confidence with more debt. What a surprise. Isn’t this a little like trying to drink yourself sober?
\r\nThis leaves investors sitting on a powder keg and facing a tough decision. The choices are fairly grim – either be willing to move at a moment’s notice or simply withdraw from the game completely, taking a fixed income approach and letting the markets do what they will. It isn’t pretty, and it isn’t fun, but it is where we find ourselves at the start of 2012.
\r\nSpeaking of 2012, there is no escaping the fact that we are in a presidential election year and the political knives are already coming out. In addition to all the economic uncertainty that we are facing, we also have the uncertainty of what effect a presidential election year has on the stock market. Of course, we have all heard that the stock market is almost always positive in presidential election years. Right? At least that assurance is one of those supposed truism we have heard for many decades, and repeated as fact each year in numerous interviews and financial columns.
\r\nIt makes sense doesn’t it? After all, the four-year presidential cycle (which I have discussed in past columns) has an unusually consistent pattern of the market experiencing most of its serious corrections in the first two years of a presidential term and most often making a substantial recovery in the last two years.
\r\nThe pattern was interrupted when the financial crisis hit in 2007 and 2008, the last two years of the Bush Administration, and we experienced a serious bear market. But the circumstances were unusual, and the few times over the last hundred years that the cycle did not hold true to form did not affect the long-term percentage of the cycle. It also makes sense that election years would be positive as each Administration pulls out all the stops to make sure the economy and stock market are positive when re-election time arrives.
\r\nThis is all nice election-year theory. The problem is that it’s just not true. In looking at a study of all 23 election years since 1920, just 15 were positive, or 67.6 percent. However, ignoring whether or not they were elections years, over those 91 years, 62 years were positive anyway, or 68 percent. It seems a fair conclusion that the market was up in 68 percent of years overall and 67 percent in election years. Whether it was an election year or not seemed to have had no effect on the market’s performance. Whatever happened was likely to have happened anyway.
\r\nOf the 23 election years, the market was up 63.3 percent of the years when a Democrat was in the White House, and 66.7 percent when it was a Republican. One could also conclude that it makes no difference which party is in the White House at election time; at least with respect to the direction of the stock market.
\r\nWill a presidential election drive the stock market up in 2012? Maybe, maybe not. For those of you looking for an “election year indicator” to guide you, I’m afraid you’ll need something a little more conclusive. Perhaps even economic fundamentals. What a novel idea that is. But what do I know? Be sure to look for my next column on January 21st where I discuss my forecast hits and misses from 2011 and my new predictions for 2012.
“Practical men, who believe themselves to be quite....
You probably know that famous quote comes from a great philosopher of our time, Yogi Berra. While a humorous comment, there is certainly an element of truth in it as I take my annual look at what happened in 2011 and what I think might happen in 2012.
I have heard that some people have started calling me Edmond’s Dr. Doom. I try not to be negative, but sometimes you just have to call it like it is. I’m not a “perma-bear” though. At times in the past I have been accused of being too optimistic. Go figure. The truth is that I don’t really care if the markets go up or down as long as I’m on the right side of it to protect my clients.
The global economy, as I see it, is in a period between two crises with a respite from the chaos. Unfortunately, we didn’t fix anything and have mostly sown the seeds for what will eventually be another crisis. Things seem stable now but there is a lot of unfinished business. The calm on the surface belies the turmoil underneath.
It has been said that those who ignore history are doomed to repeat it. Unfortunately, I am sorry to tell you that we are about to endure 2011 all over again with extreme volatility and uncertainty.
The biggest challenge now, from a forecaster’s perspective, is sorting out all the news and trying to determine what is important and what is just noise. This is especially true when looking at the economy (locally, nationally and globally) and the stock and bond markets. While these are all certainly related and mutually determinant, they don’t always move together or logically. In fact, they seldom do.
Here is what I said in January 2011 and what actually happened:
1. “The stock market works its way higher in a volatile fashion to a top sometime in the fall, possibly to 12,800 on the Dow, before rolling over late in the year.” Mostly correct. The Dow hit 12,876 in May and fell to 10,404 in October, and then finished slightly up for the year at 12,217. The S&P performed similarly, in a range from up 9 percent to down 11 percent, but finished unchanged for the year at 1,257.
2. “Gold, oil and commodities in general continue higher with gold hitting $1,500 an ounce and oil $100 a barrel.” Oil hit $114 in May and then down to $75 in October, and then finished the year at $99. Gold hit $1,925 an ounce in September, up from a low of $1,321 in January, and then finished the year at $1,567.
3. “Interest rates on long term Treasury bonds spike in late 2011 creating a great buying opportunity in bonds again.” Oops! I blew that one. I had not counted on the Federal Reserve’s insanity of QE2 and Operation Twist. 10 year Treasury yields went down to 1.77 percent from a start of 3.36 percent in a giant flight to quality from the European debt crisis.
4. “Predictions of 4 percent GDP growth by some analysts are likely way too optimistic. Look for GDP at 2.0-2.5 percent at best. Unemployment will remain above 9 percent.” GDP figures thru 3rd quarter were 1.8 percent. 4th quarter figures, not released yet, will likely move the number back into the 2.5 percent range. Unemployment remained over 9 percent for most of the year and was revised downward in late December to 8.5 percent. However, most, if not all, of that was due to people dropping out of the workforce and not counting anymore; not because they found a job. The real number is closer to 12 percent.
5. “Home prices on a national average fall another 10 percent.” The Case-Shiller housing index thru October showed a 3.4 percent average price drop nationally. Many of the major housing markets where the biggest bubble occurred fell between 6 and 8 percent.
6. “U.S. Municipal bankruptcies become headline news. More cities that are technically bankrupt are contemplating the idea of making it official.” Partially true, but not as big a story as I thought. A few declared bankruptcy, but many are still hanging on and praying for a recovery to bail them out.
7. “The sovereign debt crisis in Europe will put the Eurozone under more pressure. Their problems have not gone away and several countries will be forced into massive austerity programs or the European Central Bank will be forced to print money and devalue their currency.” Bull’s eye! This became the dominant story of 2011.
8. “China’s economy is overheating and they are raising interest rates as rapidly as possible to stop runaway inflation. This will eventually pop their real estate bubble, slow their economy and put pressure on commodity prices.” Partially true. This story is still evolving.
2012 will be one of transition; politically in the US with the presidential election; financially in Europe with the potential breakup of the monetary union; and economically in China as the debate finally gets settled over soft-landing versus hard-landing risks. It also looks to be a year when tactical asset allocation will need to be emphasized at least as much as longer-term strategic considerations.
One thing seems reasonably certain; the global economy is going to endure a significant deleveraging cycle as we move through 2012 – one that will affect most if not all parts of the developed world. It will be accomplished by some combination of default and write-downs, debt repayment and rising savings rates. All this promises to be very deflationary and we will have to invest with that prospect in mind.
Now is when demographic trends I have talked about for so long really start to bite and overwhelm the health care requirements and pension funds obligations for the 78 million baby boomers. The median age of the US baby boomer (and mostly everywhere else in the developed world) is 56 and the oldest are now in their mid-60s. For those who were betting on elevated portfolio returns to deliver adequate retirements savings, time has run out. They will have to save the old fashioned way at some point.
We are reaching the end of the Debt Supercycle, a term coined by Hamilton Bolton of the “Bank Credit Analyst” and further discussed by John Mauldin in his book “Endgame.” Essentially, the Debt Supercycle is the decades-long growth of debt from small and manageable levels, to a point where bond markets rebel and the debt has to be restructured or reduced. A program of austerity must be undertaken in order to bring the debt back to acceptable levels. If we are not already there, we are getting very close.
A term that you are going to hear a lot this year is “Risk On/Risk Off.” Risk on means putting risk back into your portfolio for potential bigger gains. Risk off means investors trying to reduce risk in fear of possible portfolio losses. Last year, and probably this year also, institutional investors jumped back and forth between the two and that is one reason we saw so much volatility.
One thing I should point out is that while all of this predicting is fun to do, it is important not to take it too seriously. Even more important, as much as I might believe my predictions or anyone’s predictions, I would NEVER make a major bet on one or a few areas. Neither should you. It is in uncertain times like these where diversification among asset classes and risk management is even more important than ever. We are just trying to figure out what we ought to believe in order to end the coming year in the best possible situation. That is, which belief is least likely to be fatal and which is most likely to pay off?
You should also know that the local economy is often much different than the national or global economy and may have different outcomes. So what happens next? Here are my thoughts for 2012:
1. The European debt crisis continues in and out of the headlines as Europe goes into a recession. Nothing is resolved but they do manage to kick the can down the road a little longer. The Eurozone does not break up but inches closer to fiscal union, only because the breakup would be even more painful. One reason for creation of the European Union was to keep from going to war with each other every 50 years or so. Now they just kill each other economically.
2. The U.S. economy does not go into recession in 2012 but continues to limp along at a weak 1 to 2 percent GDP growth rate. Global GDP will be the same. 1st quarter GDP will look good as it carries over from 4th quarter 2011, but will slow significantly after the 2nd quarter. QE3 from the Fed is unlikely, and will be too late if they try.
3. U.S. corporate earnings grow, but fail to beat estimates for the first time in more than three years. S&P 500 earnings per share are forecast at $105 but shrinking P/E multiples will result in a lower stock market by year end.
4. The S&P 500 moves up to about 1,370 but probably peaks by April - an increase of 9 percent. Conservative investors may want to be out before that or hedge their portfolios. Aggressive investors may want to short stocks then. Several risk off events in the 2nd and 3rd quarters will result in a major sell off for 4 to 7 months, taking the S&P 500 down 23 percent from the high to 1,050. As we near election time we will see a relief rally take the market back up, but still finish down about 8 percent for the year at 1,160 on the S&P 500. Few on Wall Street would agree with this assessment. We’ll see.
5. Interest rates on the 10 year US Treasury bond decline to historical lows of 1.5 percent on the next risk off event and then head slightly higher by year end.
6. The US dollar continues up and the euro down, with the Euro going as low as $1.19 exchange rate. Gold rises at first to $1750 and then falls into summer. The longer term target for gold is $2300 but is too speculative here except for long term investors. Wait to buy gold at $1250.
7. Oil and commodity prices peak sometime this year and start to decline by late in the year, if not sooner, as the global economy slows and demand falls. This, of course, would not be true for oil if further conflict breaks out in the Middle East. Oil is at $100 now and could see a spike to $120 at some point. However, the next risk off trade or a slowing global economy could take it down to $75 by year end.
8. Unemployment remains stuck at the 8 to 9 percent level, then goes up again in late 2012 or 2013. GDP growth of 1 to 2 percent is not enough to make any meaningful dent in the unemployment rate.
9. The US government runs another $1.3 trillion deficit. Current government debt is now over $15 trillion, up over $1 trillion just in the last year. This is unsustainable and something that is unsustainable will eventually stop. At some point we will stop the insanity voluntarily, or the bond market will force us to stop.
10. The Presidential Election is too close to call. Who wins and what decisions are made by policy makers now and next year will matter significantly for the long term, making the future better or worse depending on the economic choices made. However, it won’t matter at all for the short term as far as the economy is concerned. A recession and stock market decline is already “baked in the cake” for 2013 and there is not much either party can do about it at this point. The good news is that the worst of all this is probably behind us by the end of 2014 and we start growing again.
When times become extremely uncertain (as they are now), investors want to reach for more certainty. Since capital gains or losses represent uncertainly, then what can we focus on that is certain? The answer in part is cash flow. Interest income and/or dividends from an array of investments options can help reinstate that certainty that so many of us desire for our portfolios.
This will be part of our over-riding theme for 2012. Our purpose, as always, is to serve our valued clients in a responsible fiduciary manner. Our hallmark, our over-riding theme, will always be that “we want to win by not losing.” A focus on principle protection helps provide principle preservation, which will serve our clients for not just this year, but for the many years to come.
So there you have it. Am I right? We’ll see when we review it again next year and see how I did this time. Perhaps we should borrow another quote from Yogi. “When you come to a fork in the road, take it.”
You probably know that famous quote comes from a great philosopher of our time, Yogi Berra. While a humorous comment, there is certainly an element....
“Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economist.” John Maynard Keynes, 1936. We might say the same about being slaves to the International Monetary Fund (IMF). Christine Lagarde, the current IMF Chief, recently said something to the effect that “Rescue of the Euro must involve all nations.” Uh Oh. When the head of the IMF makes a statement as broad as this, it is time to worry.
The IMF is a relic of a previous era, born out of the Bretton Woods agreement in 1944. Interestingly, the US made the first contribution to the fund using the money that President Franklin D. Roosevelt stole from those that held gold in 1933. Roosevelt declared it illegal to hold gold in May 1933; then once all physical gold was confiscated, he promptly re-priced gold higher and the US dollar lower. This meant that the gold FDR had taken from individuals was suddenly worth more, creating something of a nice little government slush fund. Part of this fund ended up as the initial US contribution to the IMF, and part of it was used by President Clinton to rescue Mexico in the 1990s.
But I digress. The US is one of 187 countries in the IMF, but is responsible for 17.7 percent of the funding for the organization. The next biggest contributors are Japan and Germany, both at just over 6 percent. So when the leader of the IMF makes a statement about “all nations” being responsible for the rescue of the euro, you can bet that she will use her position and her organization to make that happen. The fact that US taxpayers foot about 1/6th of the bill is worrisome to say the least. It’s not like we’ve got a lot of spare change sitting around to help out with.
Then there is the stark reality that the euro crisis is nowhere near a resolution. People in positions of power are well aware that a group of countries carrying way too much debt can’t possibly solve a crisis of confidence with more debt. What a surprise. Isn’t this a little like trying to drink yourself sober?
This leaves investors sitting on a powder keg and facing a tough decision. The choices are fairly grim – either be willing to move at a moment’s notice or simply withdraw from the game completely, taking a fixed income approach and letting the markets do what they will. It isn’t pretty, and it isn’t fun, but it is where we find ourselves at the start of 2012.
Speaking of 2012, there is no escaping the fact that we are in a presidential election year and the political knives are already coming out. In addition to all the economic uncertainty that we are facing, we also have the uncertainty of what effect a presidential election year has on the stock market. Of course, we have all heard that the stock market is almost always positive in presidential election years. Right? At least that assurance is one of those supposed truism we have heard for many decades, and repeated as fact each year in numerous interviews and financial columns.
It makes sense doesn’t it? After all, the four-year presidential cycle (which I have discussed in past columns) has an unusually consistent pattern of the market experiencing most of its serious corrections in the first two years of a presidential term and most often making a substantial recovery in the last two years.
The pattern was interrupted when the financial crisis hit in 2007 and 2008, the last two years of the Bush Administration, and we experienced a serious bear market. But the circumstances were unusual, and the few times over the last hundred years that the cycle did not hold true to form did not affect the long-term percentage of the cycle. It also makes sense that election years would be positive as each Administration pulls out all the stops to make sure the economy and stock market are positive when re-election time arrives.
This is all nice election-year theory. The problem is that it’s just not true. In looking at a study of all 23 election years since 1920, just 15 were positive, or 67.6 percent. However, ignoring whether or not they were elections years, over those 91 years, 62 years were positive anyway, or 68 percent. It seems a fair conclusion that the market was up in 68 percent of years overall and 67 percent in election years. Whether it was an election year or not seemed to have had no effect on the market’s performance. Whatever happened was likely to have happened anyway.
Of the 23 election years, the market was up 63.3 percent of the years when a Democrat was in the White House, and 66.7 percent when it was a Republican. One could also conclude that it makes no difference which party is in the White House at election time; at least with respect to the direction of the stock market.
Will a presidential election drive the stock market up in 2012? Maybe, maybe not. For those of you looking for an “election year indicator” to guide you, I’m afraid you’ll need something a little more conclusive. Perhaps even economic fundamentals. What a novel idea that is. But what do I know? Be sure to look for my next column on January 21st where I discuss my forecast hits and misses from 2011 and my new predictions for 2012.
“Practical men, who believe themselves to be quite....
‘Tis the season again. Well, almost anyway. No, not that season. The season of the stock market when you need to come back. Last April I wrote a newsletter about an old Wall Street saying that says “Sell in May and go away.” (Go to www.nickmassey.com to see it.) Then you’re supposed to come back and buy again in November. Does it really work? Not always, but more yes than no.
The market has a proven tendency to make most of its gains between November and May, and it experiences most of its losses in the remaining months. Obviously, a positive market move does not begin and end on the same day each year. That’s just the general time frame. Some people dismiss the idea as an interesting theory that doesn’t always work. But it’s not a theory; it’s a proven fact. In spite of the few years when it has not worked, investing over the long-term based on the market’s seasonality significantly outperforms the market, and with much less risk.
In that column I suggested that while it doesn’t always work, 2011 was setting up to be a classic example of being one of those years that it would work. Now, a little over five months later, we know that it worked very well this year. After the S&P 500 hit a high for the year of up approximately 9 percent in April, we are now down about 11 percent for the year and down 20 percent from the highs. People are quite worried. If only we had known for sure, most people would love to have a do-over and sell everything back in May. Unfortunately, life and markets don’t work that way. Congratulations to those who had the courage to sell or hedge their portfolios.
The big question now is what will happen in October (statistically the worst month for the market) and then in November, when the theory says you should buy again? Of course, I don’t know for sure. Nobody does. But I’m inclined to think that we’re setting up for it to work again, at least for awhile.
The year has been going pretty much as expected. If it continues that way, it means more bad news for awhile, but eventually good news. The first part of the sell theory continues to play out. We are now in a significant market correction and probably a bear market (down 20 percent or more). All twelve of the world’s biggest economies are in a bear market, with declines of up to 35 percent, and no signs their declines are over. The U.S. market just hit the 20 percent down mark. Will we be the only one to buck the trend? I doubt it.
There is some good news though. I think this correction is going to be followed by a substantial rally off the lows to produce a positive year. Not a new high, but a small number with a plus sign in front of it.
Why? While the economic slowdown in the U.S., and the European debt crisis, continue to worsen, and the downside target on this correction is still quite a bit lower, some of the serious negatives have begun to reverse. Investor sentiment, which just 6 months ago was at an extreme of confidence and bullishness, is moving toward the level of despair and bearishness seen at important lows. It’s not quite at extremes yet, but one more big sell-off will put it there. When sentiment hits extremes, either positive or negative, there is often a reversal not long afterwards.
The Economic Cycle Research Institute recently notified its clients that a recession is now unavoidable, saying, “The vicious cycle is underway where lower sales lead to lower production, which leads to lower employment, which leads to lower income, which leads back to still lower sales, and the cycle feeds on itself.” While I agree with them to some extent, I don’t think recession is in the cards for 2011. For now, corporate earnings are still pretty good. 2012 is another story though.
Even though the U.S economy is limping along at stall speed, there are signs of improvement in some areas, and we are seeing consumer spending picking back up in some sectors. This is likely a temporary phenomenon, but it might be enough to see a slight improvement in GDP for the 4th quarter. Unless there is a complete meltdown in Europe, which is not likely yet, this might be enough to cause the year end rally that seasonality would predict. If Europe blows up this year, all bets are off. We shall see.
While no one can be certain, if I had to guess I think the market will break to lower levels sometime in October, possibly as low as 10,000 on the Dow and 1,040 on the S&P 500, and find the low for the year there. That could be the buying opportunity for the year end rally. If it doesn’t break, the buying opportunity will be at current levels.
What should you do now? If you are still invested in the market and haven’t been scared out yet, unless you are a very nimble trader and willing to get out and back in again quickly, it’s too late to do anything now. Ride it out and re-evaluate at the end of the year or early 2012. If I’m right, you’ll be glad. If I’m wrong, most of the damage has been done already and it won’t matter.
Seasonality could be even more important this year than in other years. So, will this strategy work again this November? I think maybe yes. What should you do? Here’s a better idea; if you’re not already a client, call me and I’ll help you. Thanks for reading.
‘Tis the season again. Well, almost anyway. No, not that season. The season of the stock market when you need to come back. Last April I ....
Several years ago I was riding the subway in Chicago when two young men wearing red berets got on. They call themselves the Guardian Angels and they ride public transportation in major cities to protect regular people from the gangs. At first I felt safe knowing they were on the train looking out for me. But then I wondered what they needed to protect me from. What did they know that I didn’t know? Suddenly, I didn’t feel so safe anymore.
We might be seeing something similar in the global banking system when central banks from England, the U.S., Japan and Switzerland recently promised to provide truck loads of dollars to any bank finding itself temporarily short of greenbacks. This is not a loan, per se; just an agreement to provide dollars in exchange for the currency of the bank in need.
Like my Guardian Angels above, I guess this is a nice thing to do. But then, you have to wonder why this is suddenly necessary? What do they know that we don’t know? Central Banks don’t do that sort of thing unless something is up; and something is most certainly up. Money market funds are getting nervous and have been pulling their funds out of short-term debt in European banks, thus creating a shortage of dollars necessary for global trade. Hmmmm. Makes you wonder doesn’t it?
In the eurozone, an unfolding Greek tragedy is careening towards its final brutal act. In our inter-connected global economy, that spells trouble everywhere with the odds shortening by the day on a return to recession. Of course, they all say there is nothing to worry about. Bernanke said that in 2008 also. But as said in a funny quote from a British television comedy, “The first rule of politics is to never believe anything until it is officially denied.”
All the recent talk about debt issues in Europe have focused on Greece, Portugal, Italy, Ireland and Spain. But less talked about, and equally problematic, are the same problems faced by Eastern European countries. A decade of excess lending, wage and price growth, and large current account deficits has created major imbalances. To make things worse, most of the borrowing by the Baltics, Romania, Bulgaria and Hungary was in foreign currencies.
My wife and I spent four days in Budapest, Hungary this summer. It is a beautiful country with wonderful people who could not have been nicer to us. But sometimes I can’t help myself and the closet economist in me comes out and I had to do some research on the effects of debt issues facing the Hungarian people. I’m afraid that they too are in for a rough time.
You may have heard of a financial term called the “carry trade.” Recently this usually referred to the Japanese carry trade. In essence, investors exploited Japan’s very low interest rates by borrowing in yen and using the funds to buy assets in another country, such as the U.K. or the U.S., to earn a much higher rate of interest. (Remember those days?)
Much less discussed though, was the Eastern European carry trade. After the fall of communism in 1989 among many Eastern Bloc countries, rapid growth among these countries was also accompanied by high inflation rates and high interest rates. Hungary’s interest rates reached 12.5 percent in 2004 to try to combat a rising inflation rate that eventually peaked out at well over 7 percent.
That was great for savers but made borrowing in Hungary very expensive. In neighboring Austria, the banks there had started to offer loans and mortgages denominated in Swiss Francs at rates as low as 0.5 percent. Since this was a huge difference from lending rates in Hungary, this became very popular.
Suddenly, people who were unable to afford a mortgage in Hungarian forints (the Hungarian currency) were able to get a seemingly great deal in Swiss francs or Euros. Property prices exploded and so did the economy. It was not long before almost 2/3 of the debt in Hungary was denominated in a foreign currency.
As we have all learned, there is no such thing as a free lunch. Sure, you can borrow much cheaper in a foreign currency and save a lot of money. But what happens if the currency exchange rate goes against you - something the average borrower never considered?
Imagine as a Hungarian you borrowed money in Swiss Francs to buy a house in Hungary. If you earned your income in Hungarian forints, you needed to exchange your money into Swiss Francs to make payments. If the Hungarian forint weakened significantly against the Swiss Franc, you would have to exchange more forints to pay back what you owed in Swiss Francs. Exchange rates can move fast and far, and they did. The debt almost doubled overnight as the forint weakened in late 2008. It’s even worse now as the Swiss Franc has been one of the world’s strongest and most expensive currencies.
Hungary has had austerity measures in place from as early as 2006 as the government fought to reduce a swelling budget deficit to be ready to comply with European Union requirements. But now we are seeing “reform fatigue”, which is fairly common in response to tough economic medicine. This is a little like going on a diet. It starts out with good intentions, but the sacrifice gets old very fast. Austerity sounds great until about a year or two into it and taxpayers start to grow weary of the struggle and governments find it harder and harder to maintain taxpayer resolve.
That is the problem Greece faces and many other European countries will soon face. Sovereign risks remain very real. We should not be so complacent as to think austerity programs agreed to in countries like Greece and Ireland will be the end of the matter. If we watch Hungary, we will have a good idea how things will play out in many other parts of the world.
It’s a little off the radar for now, but Hungary and other Eastern European countries will be important to watch as this debt crisis plays out. The country will remain a potential economic hand grenade in the European region. It wouldn’t take much to kick off a wave of defaults in Hungary, which would mean grave problems for European banks, on top of all the other problems they have. And as we have learned throughout this crisis, when banks have a problem, we all have a problem.
How will this all play out? Who knows? As Yogi Berra once said, “When you come to a fork in the road, take it.” Investors are now at that proverbial fork in the road and the economic noise is advising that they take it. The question never answered is which way to go. I think we are seeing the beginning stages of the Euro cracking and the dollar soaring. You could say that rumors of the dollar’s death are greatly exaggerated. For you dollar bears and gold bugs out there, I think you are about to get whipsawed. Maybe we should call in the Guardian Angels. Thanks for reading.
Several years ago I was riding the subway in Chicago when two young men wearing red berets got on. They call themselves the Guardian Angels and th....
In the 1978 “Superman” movie, Lois Lane falls out the window of a tall building, on her way to certain death. Superman swoops in at the last moment to save the day. Superman proudly says, “Don’t worry Lois, I’ve got you.” Of course, Lois replies with that great line, “You’ve got me? Who’s got you?”
Perhaps that is a question we should be asking as we continually look to the government and Federal Reserve for financial rescue. Unfortunately, there is only so much they can do and at some point we have to ask who or what will rescue them? Rather than dealing with the problem of too much debt and too little growth, we expect to be rescued from ourselves and postpone the inevitable as we hope for a miracle. Here’s a news flash - the tooth fairy is not coming and neither is the miracle. We have to deal with the debt issue and it won’t be pretty.
One of the most pronounced trends in the global economy over the last 40 years has been the growth in the use of credit. In the 1960s, if I wanted to buy something I could spend money I had in my pocket or I could write a check against money I had in the bank. The one thing I could not do was spend money I didn’t have. (What a quaint custom that was!) As a result, I had no way to buy things I could not afford.
Around 1967, Bank of America came out with the first modern day credit card, the “BankAmericard”; and First National City Bank countered with “The Everything Card.” The challenge in those days was to convince retailers to accept the card. Before this, the credit cards in circulation consisted mostly of travel and entertainment cards – American Express, Diners Club and Carte Blanche – and they had to be paid off each month. They were generally limited to people in the upper income brackets. It was only in the last forty years that BankAmericard turned into Visa and The Everything Card into MasterCard. With these cards consumers were able to maintain an outstanding balance. It then became easy for people to buy things they couldn’t afford. And so they did.
At the risk of sounding like some old geezer, in those days it was important to “establish credit” somehow, but there was quite the “catch 22” to do it. You needed to have good credit to get a credit card, but you first needed to get someone to give you a loan that you could pay on to prove your credit worthiness. Something easier said than done. I recall how in the late 60s I applied for a credit card from every major gasoline company and was repeatedly turned down until Texaco showed mercy on me and gave me a credit card. I used it for all my gas and paid it off religiously so I could prove that I was a worthy credit risk. I would imagine that many of you my age have similar stories. Now, of course, they send credit card offers to you in the mail completely unsolicited.
I also recall that owing money was considered undesirable and debts were generally expected to be paid off. When people bought homes, they put down 30% and took out thirty-year mortgages to finance the rest. They made level payments that included a substantial principal component that grew over time. They eventually paid off their debt and invited their friends over for mortgage-burning parties, owning the home free and clear in time for retirement.
Attitudes have since changed and consumer credit has exploded. Anyone with five dollars and a pulse could get a credit card and creative mortgages allowed anyone to own a home whether they could afford it or not. Of course, that is partly what led to the recent financial crisis and that is the debt many people are trying to pay off now.
But it is not just consumer debt. There has been massive growth in corporate debt and sovereign (government) debt as well. Even the commercial paper market, where companies could access loans measured in days, exploded on the assumption that the paper could always be rolled over. That is until it couldn’t and the market froze.
Most debt, outside of mortgage and consumer debt, is seldom amortized, i.e. payments covering interest and some of the principal so the debt is eventually paid off. Instead, bonds, whether corporate or government, and commercial paper are loans for fixed time periods where interest is paid along the way, but the principal is returned at maturity. And then, more often than not, the note or bond is rolled over into a new one. This has the effect of keeping huge amounts of debt in circulation that is seldom paid off. It becomes a form of rolling permanent capital to some corporations and governments and all they have to do is be able to pay the interest.
This is all fine and good until a bondholder says, “No thanks. I don’t want to roll it over. I’ll just take my money please.” If enough people do that and the corporation or government or bank doesn’t have enough money to pay the principal back, we have a serious problem. That’s where we are today with sovereign debt issues. If you were at all concerned about your bond investment being paid off at maturity, would you opt to roll it over again or would you take the money and run if you could?
Now look at it another way. In much the same way as consumers, credit has been available to governments deemed creditworthy without limit and without concern for the fact that many countries were constantly spending more than they were taking in, their deficits were growing relative to GDP, and their national debts were expanding relative to GDP. In other words, repayment of principal is not even in the cards. They are just hoping to be able to pay the interest and get the debt to roll over. This is where the U.S. is right now.
Ultimately, the security of capital providers comes not from the borrower, but from the continued willingness of other capital providers to roll debts in the future. It was their occasional refusal in 2007-08 that caused the worst moments of the financial crisis. This is a house of cards that falls apart rapidly if the debt cannot be rolled over.
With no one asking how debt could be repaid, nations were allowed for decades to increase their deficits and debt relative to their GDP. And then suddenly people started asking serious questions about how the debt might get repaid. Unfortunately, many are finding that they can’t.
That’s what happened in Greece and suddenly nobody wants to loan to them anymore. And then people took a look around at other European countries and saw more of the same. The European Central Bank is desperately trying to keep the whole thing from coming unraveled. Today, although the situation is nowhere near as dire, they’re also looking at the U.S. and some of its states. The U.S. has run deficits almost every year since World War II, with prominent surpluses only in 1998-2001.
Here is the undeniable truth: Quoting from “This Time is Different” by Reinhart and Rogoff, “We have learned that excessive debt accumulation, whether by the government, banks, corporations, or consumers, poses greater systemic risks than we realize during a boom period. Infusions of cash can make a government look like it is providing greater growth to its economy than it really is. Private sector borrowing binges can inflate housing and stock prices far beyond their long-run sustainable levels, and make banks seem more stable and profitable than they really are. Such large-scale debt buildups pose risks because they make an economy vulnerable to crises of confidence, particularly when debt is short term and needs to be constantly refinanced. Debt-fueled booms all too often provide false affirmation of a government’s policies, a financial institution’s ability to make outsized profits, or a country’s standard of living. Most of these booms end badly.”
We all wish things were different today. But wishing that something is so doesn’t make it so. This problem will eventually require massive debt restructuring, much like a gigantic chapter 11 bankruptcy process. No one wants to hear that because it would mean losses for banks, bondholders and stock holders. The truth is that they already have the losses. They just have not admitted it yet.
In the broadest sense, monetary and fiscal policies have failed because government financial transactions are not the key to prosperity. Instead, the economic well-being of a country is determined by the creativity, inventiveness and hard work of its households and individuals. So once again I ask the question, “Who will rescue the rescuers?” Ultimately, it will be all of us and it won’t be easy. Where is Superman when you need him?
In the 1978 “Superman” movie, Lois Lane falls out the window of a tall building, on her way to certain death. Superman swoops in at th....
There is an old saying in the investment world that says, “Don’t fight the Fed.” What it means is you need to be sure that your investment positions are not at odds with what the Federal Reserve is trying to do with monetary policy. After all, they’ve got the biggest check book and they’ve got the money printing press too.
Well, it appears you shouldn’t fight Bill Gross and Mohamed El-Erian either. I have always had great respect for the opinions of these two gentlemen from Pacific Investment Management Company (PIMCO). They have consistently proven themselves in difficult economic times, and are pragmatic and unemotional about their assessment of the investment world today.
They coined the term "The New Normal" in assessing the economic outlook for many years to come. Get used to it. At the same time, they have sometimes been criticized and ridiculed for the views they hold, with some analysts calling the new normal "idiotic", "fatalistic", and other colorful terms. Gross and El-Erian now get the last laugh because they were right.
A recent story from Bloomberg News headlined: "Bill Gross was Right After All." Former White House economic advisor Larry Summers, and former chairman of the U.S. Council of Economic Advisors Christina Romer were quite critical of the term. Well-known money manager Ken Fisher called the concept “idiotic.”
Idiotic? Really Ken? Not according to Bloomberg. They have been vindicated by Fed Chairman Ben Bernanke who recently said the economic recovery is “considerably slower” than anticipated following the biggest stock market loss since December 2008. Even Blackrock co-founder Lawrence Fink, who said last January that he didn’t believe in the “new normal,” is now forecasting growth of 1 to 2 percent for much of the next decade.
When Summers and Romer were recently asked about their position now, they were “unavailable for comment.” Are you surprised? Me neither.
As the Federal Reserve propped up the markets with two consecutive rounds of "Quantitative Easing", known affectionately as QE1 and QE2, to try and revive the markets (notice I didn't say economy) and the stock markets took off on a Federal drug induced high, the criticism of PIMCO’s views strengthened. In April Romer said that the jobless rate “is not the new normal.” Fink said he never shared PIMCO’s view on the post-crisis economy. He said in January that “We were always talking about a U.S. economy growing at three-plus percent.”
Of course now we have the GDP growth numbers for the first two quarters of this year - 1.3 percent annual pace in the second quarter, which was considerably less than forecast by most economists. The economy almost stalled in the prior quarter, growing at a 0.4 percent pace, the weakest three-month period since the "recovery" began in mid-2009.
Ben Bernanke recently said he expects a "somewhat slower pace of recovery over the coming quarters," adding that "downside risks to the economic outlook have increased." Additionally, he said there has been "deterioration in overall labor-market conditions in recent months" and household spending has "flattened out." He also intimated that the Fed had more tools in its toolbox and they would use them "as needed" to help get the economy going in the right direction. Sounds familiar doesn’t it? Looks to me like the boys at PIMCO were right and what I have been telling you for quite some time has been right also. I hope you have been listening.
One final thought - the following comes from investment analyst Gary Kaltbaum. It’s just too good to pass up. “Imagine Warren Buffett getting a call from a company who asked Warren to invest $2 billion in that company. This company then went on to tell Warren that the $2 billion had already been spent and that they could not account for how well that $2 billion was spent. Therefore, that $2 billion would be of no help to the future of the company. This company went on to tell Warren that there was massive fraud and waste in the company and that the people that ran the company get payoffs in order to make decisions to help those doing the paying off. They also told Warren that their company was running massive deficits. In fact, total deficits ran 8 times the amount of revenue and that the company was doing nothing in order to stop those deficits. On top of that, those deficits continue to grow leaps and bounds with no end in sight. May I also add that most of the people running the company had never run any companies prior to running this company? Bottom line – there is no way in this lifetime that Warren would invest a dime in this company. So Warren, please stop telling others that they need to.”
Of course, you can guess what this imaginary company is. Pretty scary isn’t it? So why is everyone so bullish? Beats me. I guess we’re all just optimists. Can I borrow those rose-colored glasses?
There is an old saying in the investment world that says, “Don’t fight the Fed.” What it means is you need to be sure that your ....
Well they finally did it – raised the debt ceiling. Now everything is cool again and we can all go back to enjoying life and watching the economic recovery unfold. Well, maybe not. While everyone was focused on the political circus in Washington and our self-inflicted shot in the foot, it seems that the stock market went back to focusing on things that matter - like a slowing U.S. and global economy and sovereign debt issues that just won’t go away.
When it was announced that a “deal” on debt reduction and the debt ceiling had been reached, the stock market exploded about 150 points to the upside. Unfortunately, the euphoria lasted about an hour before people realized that the underlying economy continued to deteriorate, and the stock market has been mostly in free-fall since. To use a technical economic term – this so-called economic recovery pretty much sucks. This may not be as useful as Ben Bernanke’s comment last year that “things are unusually uncertain.”
While the world was fixated on the debt ceiling debate, first and second quarter GDP figures were released on July 29th and they were not pretty. First quarter GDP had previously been reported at a disappointing 1.9 percent when most economists were looking for something over 3 percent. Remarkably, the market just yawned and nobody seemed to care. Economists started to revise second quarter GDP estimates down to 2.7 percent.
Second quarter GDP actually came in at a shocking 1.3 percent. At this stage of an economic recovery we should be growing at close to 4 percent. But even worse than that, the first quarter GDP figure was revised down from 1.9 percent to a snail pace .4 percent. On top of that, fourth quarter 2011 GDP figures were revised down from 3.1 percent to only 2.35 percent.
This is shocking and quite worrisome. All the money in stimulus and quantitative easing that has been thrown at the economy and that’s it? Almost two years after the recession “officially” ended, the economy has still not recovered back to pre-recession levels. Clearly, QE1 and QE2 have been dismal failures. Maybe government leaders will finally bury Keynesian economic theory.
But at least things are good now because Congress has reached an agreement on how to reduce our deficit, right? Not likely. As I understand it, the compromise calls for $2.4 trillion in spending cuts over the next ten years. We need at least $4 trillion over 10 years to come anywhere near to keeping the debt level from increasing, and some would argue that is just a start. It doesn’t stop the growth of government debt or reduce it. It just slows down the rate of growth and will certainly not fix the problem.
Many of the cuts being discussed are not cuts from current amounts being spent, but cuts in projected spending increases. As Congressman Ron Paul pointed out, “this is akin to a family "saving" $100,000 in expenses by deciding not to buy a Lamborghini, and instead getting a fully loaded Mercedes, when really their budget dictates that they need to stick with their perfectly serviceable Honda.”
While there is no question that we need to reduce spending, nobody wants to talk about the effect doing so will have on the economy for at least the next decade. As my friend and hedge fund manager John Thomas points out, a $2.4 trillion reduction in government spending over 10 years is 16.6 percent of GDP, or an average of 1.6 percent a year. Unless that is somehow offset by an equivalent amount of growth in the private sector, which is not likely, we will guarantee minimal economic growth for at least that period and worse if anything goes wrong.
The Federal Reserve has a current forecast of 3 percent GDP growth. That is highly unlikely. But even if that somehow happens, taking 1.6 percent away from the economy means a paltry 1.4 percent GDP growth rate. A rate that low will do absolutely nothing to reduce overall unemployment. As the old saying goes, “be careful what you wish for because you just might get it.” I’m not suggesting that cutting government spending is wrong. I’m just suggesting that we need to understand the consequences and not lose the faith along the way.
On top of all this, European sovereign debt problems have not gone away and seem to be getting worse. (See my June 25th Edmond Sun column on Greece.) As I write this, the European Central Bank (ECB) has just announced that they need to buy more debt from countries such as Greece, Portugal, Spain and Italy. European bonds promptly took a nosedive.
The ECB is basically stuck. Their banks hold so much of weaker country sovereign debt that they can’t afford to let them fail without serious damage to their own capital and solvency. It’s a little like loaning money to your deadbeat brother-in-law. You know you’re not going to get the money back but you do it to keep peace in the family. But that only goes so far. Unfortunately, in this case there are several other relatives asking for the same thing. The question is how long can it go on?
Keep in mind that an agreement to raise the U.S. debt ceiling and reduce government spending, or kicking the European debt crisis further down the road will not have any effect on the current global economic slowdown. It only provides temporary relief. Once the relief runs out, as it is now, the reality will set in that the global economy continues to slow and government spending cuts involved in any agreement will be yet another negative for the slowing economy to deal with.
What does all this mean for the stock market? While the economy and the stock market are certainly related, they don’t always move together. We may well be experiencing a long overdue correction that may run its course soon, leaving us with a possibility of a year end rally. We’ll see. Economist Dave Rosenberg says that the possibility of the economy going back into recession is clearly back on the table. Whether it will or not remains to be seen. One thing is for sure right now – we don’t have much room for something more to go wrong. Thanks for reading.
Well they finally did it – raised the debt ceiling. Now everything is cool again and we can all go back to enjoying life and watching t....
“If you start me up; if you start me up I'll never stop. If you start me up; if you start me up I'll never stop. I've been running hot. You got me ticking, gonna blow my top. If you start me up; if you start me up I'll never stop. Never stop, never stop, never stop. You make a grown man cry. Spread out the oil, the gasoline. I walk smooth, ride in a mean, mean machine. Start it up.”
That 1981 bit of prose and wisdom came from one of the great philosophers of our time – Mick Jagger of the Rolling Stones. Maybe these words would be better used by our current economist rock star, Federal Reserve Chairman Ben Bernanke, as he pleads with the economy. I’m having a little trouble with the mental image, but rocker Ben has been trying everything he can think of to get the economy going again. What the heck. QE1 and QE2 didn’t work. Why not get the country rocking? Start me up Ben.
Speaking of rock stars, hedge fund managers, the rock stars of the investment world, are not having a good year either. These are supposed to be the smartest guys and gals around. According to HSBC’s private bank, of the 300 hedge funds they track, only nine are up double digits, and most of those are narrowly mandated technology funds. Almost every fund lost money in June. And oh how the mighty have fallen, with the biggest funds producing the soggiest performance.
Bruce Kovner is off by 3.88 percent this year, Paul Tudor Jones is down by 2.25 percent, Louis Bacon took a 2.84 percent hickey, and Fortress Capital has dipped 2.44 percent. Emerging markets have done worse, with Brevan Howard taking a 4.64 percent hit. Paulsen & Company, considered by some to be the superstar legend, pursued a bullish strategy in the banks and lost an eye popping 20 percent. Ouch!
So why such a tough year for all these smart people? For a start, you can blame the almost complete absence of any clear trends this year. The S&P 500 was up 7 percent in the first half of the year, with the entire move occurring only during the last three days. Until then, we spent all our time inside a narrow 120 point, 9 percent trading range. Same thing for Treasury bonds, which are up only 3 points on the year with a yield so small you need a magnifying glass to find it. Uh, wasn’t quantitative easing supposed make everything better? How is that working out Ben?
How about the Euro? You would think the never ending European sovereign debt crisis would present great shorting opportunities? Nope. The European currency is up 7 percent this year. Unless something fundamentally changes, it can’t defy gravity forever. But so far Sir Isaac Newton would be amazed.
What about commodities? Did copper, the only metal with a PhD in economics, open its wallet for “hedgies” this year? Not a chance. Copper is actually down 1 percent. Maybe it should go back to night school for another course in macroeconomics?
Perhaps precious metals were the hot ticket. Negative again. Despite all of the fear, angst, and forecasts of doom seen this year, gold has managed a modest 4 percent gain; while silver, after a lot of sound and fury, delivered a middling 8 percent increase. Platinum and palladium are dead unchanged on the year, thanks to the deflationary impact of the Japanese earthquake on the global auto industry.
Far be it from me to brag, but perhaps you’ll allow me a moment of totally shameless self-promotion. Much of what has happened this year so far is what I wrote in my annual predictions column on January 29th. And so far it looks like I’m beating many of the hotshot hedge fund gurus. How cool is that?
I think the rest of the year will be pretty crazy also. Worry, worry, worry. Is rock star Ben going cold turkey and swearing off the hard stuff – quantitative easing? Or will it be back at the first sign of trouble? Who knows? After all, there is an election year coming and old habits die hard. Perhaps this really is the year when cash is king for investors. Sounds to me like the best thing to do may be to just go to the beach. Or just call me.
“If you start me up; if you start me up I\'ll never stop. If you start me up; if you start me up I\'ll never stop. I\'ve been run....
You have no doubt heard the concerns over Greece and whether they might default on their government debt. Their bonds have been downgraded to junk status by S&P and the interest rate on short term Greek bonds is over 20%. When a country has to pay over 20% to borrow money, you know there is extreme worry that the money will not be paid back. Until this happened, I used to joke that the only people who got more than 20 percent on a loan was the mafia.
The question for many people is whether Greece will default on its debt. In my opinion, it’s not a matter of “if” Greece will default but “when.” I see no way out of this for them and they will eventually have to default or restructure their debt obligations. Perhaps they will have a nice pleasant word for it and call it something else, but the end result is the same.
Many people think this is just a problem for Greece or the Eurozone and really doesn’t matter to the rest of us. But is that really the case? What might be the effect on the global economy if Greece were to actually default on the debt? Savers all over the world and U.S. retirees would likely be impacted in some way. We could get a domino effect if things really get out of control.
Greek banks are heavily exposed to their own sovereign debt and a default would require many of them to seek new capital to make up for the losses. This would likely trigger a run on the banks by Greek depositors. If you were a Greek citizen with money in the bank, what would you do? You can be quite sure that anyone with any kind money in Greece is trying to get it out of there. It is very likely that the Greek government would be forced to declare a "bank holiday" to prevent a run. Eventually, the most exposed Greek banks would have to be nationalized.
Europe's banks are big holders of Greek debt. They are holding approximately $53 billion with France, Germany and the U.K. the most exposed. If bondholders were required to take a 40 percent 'haircut', i.e. reduction in what they will get paid - a figure thrown out by many analysts - this would translate to losses of about $22 billion in U.S dollars. This would cause many of these banks to be undercapitalized, which is why they desperately want to keep propping up Greece in the hopes that this problem will somehow go away. It won’t.
Remember the term “Credit Default Swaps?” Most people had never heard of them before the AIG blow-up. A Credit Default Swap, or CDS, is basically a financial institution selling an insurance policy on a bond that would pay the holder the value of the bond if the issuer defaults. They are traded in private transactions and no one really knows for sure how many are out there, who the counter-parties are, and what kind of collateral exists to be sure the issuer can actually pay off if there is a default.
According to economist Kash Monsori, in looking at a detailed report from the Bank of International Settlements, U.S. banks have sold about $120 billion of credit default swaps to European banks. A default would trigger a "credit event" payout on these insurance contracts. Remember AIG? They were issuing CDS’s on mortgage backed securities and were on the hook for far more than they could pay when it all blew up. Let’s think about that for a minute. When, not if, Greece defaults, U.S. banks are going to have to dip into capital to pay those commitments. Capital that should be available for loans to businesses but will have to be paid to European banks instead.
If doubts about the stability of financial institutions with direct and indirect exposure to Greece spread, it could lead to another global credit crunch. Banks may hesitate to extend credit to each other out of fear about exposures. Many would require counter-parties to hand over additional collateral, forcing assets sales. In a repeat of the aftermath of the bankruptcy of Lehman Brothers, global credit markets could seize up.
It’s not just Greece though. Ireland and Portugal are facing years of slow economic growth as their governments attempt to bring down debt levels and stabilize their banking systems. A default by Greece - especially if brought about by a popular uprising - could encourage these countries to default. If Greece can force creditors to take a haircut, why should Ireland and Portugal pay in full?
The turmoil across Europe may shake the government in Germany. The German people strongly oppose bailouts of what they view as less responsible countries. Any moves by the German government to alleviate the crisis caused by Greece could be met with a political revolt in the already shaky government of Angela Merkel.
U.S. consumer confidence is already at record lows. A global credit crisis would likely convince U.S. consumers to reduce spending and increase savings. This could drag the already slowing American economy nearer to a recession.
I could go on and on, but you get the point. Will any of what I described actually happen? Who knows? It is certainly possible and something to be aware of. Any way you look at it, this is not just a little problem in Greece. It affects all of us and you need to understand the implications of it for your investments. If your financial advisor is not telling you how he or she is going to deal with this, you need another advisor. Perhaps even me.
You have no doubt heard the concerns over Greece and whether they might default on their government debt. Their bonds have been downgraded to....
A recent Associated Press headline read, “Late Credit Card Payments Hit 15-Year Low.” Late credit card payments are at their lowest levels since the late 1990s - the last time our economy was in a full-blown boom! The rate of payments 90 days or more delinquent dropped to 0.74 percent in the first quarter. This is a reduction of almost half from the highs seen in the first quarter of 2009, during the peak of the meltdown and credit crisis.
Given that unemployment remains near multi-decade highs and that million of Americans are in debt trouble or underwater on their mortgages, you would wonder, “How is this possible?” Is the crisis over? Not exactly.
When something sounds too good to be true, it generally is. As is always the case with economic data, you have to read between the lines. Yes, credit card delinquency is at its lowest levels since 1996. But a major reason, according to Moody’s, is that the banks have written off $74.5 billion in bad credit card debts over the past few years. It’s not that delinquent borrowers got religion and started making payments. No, the banks simply gave up and wrote off the debt as a loss. Debt that gets written off is no longer “delinquent.” It just disappears, along with a corresponding amount of shareholder equity.
Continued consumer deleveraging has also played a large part. Americans, and particularly the Baby Boomers who see retirement looming in front of them, underwent a major psychological shift over the last few years. With their home equity and stock market investments decimated by the crisis, they have reacted prudently by cutting back on their spending, paying down their debts, and building up their savings. As a result, the average credit card balance has dropped from $5,165 to $4,679 over the past year - a drop of 9 percent.
Consumers aren’t the only ones with a newfound sense of responsibility. The banks have significantly raised credit standards. Most mortgage lenders require substantial down payments now, and credit card lenders have become far more cautious about who gets a card and how large a credit line they get.
So, while a reduction in credit card delinquency should be viewed as a positive, it’s important to understand the underlying parts and what they mean for the economy. Writing off bad loans reduces banks’ capital and their ability to extend new credit. Every dollar that a consumer decides to save is a dollar that does not get spent growing the economy.
On a lighter note, I have exciting news! You know that your fearless forecaster scours endless sources of information, leaving no stone unturned in an effort to bring you all the economic insight you can use. There is no end to which I am willing to go to understand the future direction of the global economy.
In doing so, I discovered what might be the ultimate economic indicator for inflation. When I learned that the price of a bikini wax in Brazil was going through the roof, I had to sit up and take notice. Recently, the price of this popular beauty treatment has soared by 16.6 percent to 35 Reals, which is about $22. I have to confess to not having any first hand knowledge about this sort of thing, but I guess that is expensive. I considered a quick trip to Brazil to personally investigate on your behalf, but decided to just take their word for it.
I know. You’re thinking that I have finally lost it. But this is no joke. One of the ways most countries, including the U.S., attempt to measure inflation is to constantly monitor the prices of a basket of various consumer services to see if those prices are going up or down. Well, it seems that the Brazilian government includes the removal of body hair in the most strategic of places in their basket of consumer services to help determine the country’s inflation rate, which is now estimated at 6.5%. Apparently this has nothing to do with the opposite-gender. It is one of the few measures they track which can’t be manipulated by economists or government officials. No splitting hairs here. You either get the treatment, or you don’t.
The big picture here is that inflation is getting worse, not only in Brazil, but also in other emerging markets like China, India and Vietnam. This is why the yield on one year Brazilian bonds is at sky high double digit rates as the government tries to slow inflation. It is also why the People’s Bank of China’s efforts to control inflation through higher interest rates and higher bank reserve requirements are likely to get worse before they get better.
So who says economics is boring? This is economics you can use. An economic indicator in the hand is worth two in the bush. Perhaps if I take a trip to Brazil I can find an indicator for other inflated assets. Maybe that would be stealth inflation. Oh, the mind wanders.
A recent Associated Press headline read, “Late Credit Card Payments Hit 15-Year Low.” Late credit card payments are at their lowe....
“I’ve always depended on the kindness of strangers.” So said Vivian Leigh in her role as Blanch in the Tennessee Williams play “A Streetcar Named Desire.” We might say the same thing in the U.S. as we have depended on foreign countries to buy our debt and finance our excessive spending. Now the problem is coming to a head as we wrestle with how to deal with it. One of the discussions front and center now is the debate over the debt ceiling and whether to raise it or not. For those who like political dog fights, this is like the Super Bowl.
Recently, Treasury Secretary Tim Geithner notified Congress that the public debt limit will become binding soon and Treasury will no longer be able to borrow additional funds. Nevertheless, Congress is taking its time on raising the debt limit with some lawmakers still saying they will not vote for an increase under any circumstances.
There is no question that we need to reduce government spending, balance the budget and reduce government debt. If you have been reading my columns you know I have been ranting about this for years. However, the debt ceiling is a separate subject and should not be confused with how we balance the budget and reduce government debt going forward. The debt ceiling involves money already spent or obligations made. Like them or not, existing debts and obligations need to be paid.
If you had $100,000 worth of obligations this year and your income was only $80,000 you are going to need to find $20,000 somewhere. You will either need to find additional income to make up the shortfall, or borrow the money, or default on some of the obligations. If your personal debt ceiling is $100,000 and you can’t borrow anymore, and you can’t bring in additional income, you will default.
Is this the solution we are suggesting for the U.S government? I certainly hope not because the consequences are unthinkable. We would lose our AAA credit rating. Many countries and entities would no longer be allowed to buy our debt. Interest rates would skyrocket and the cost of renewing current debt would go up. All other interest rates would move up also and immediately put a halt to our current weak economic recovery. Recession is too mild a word for what will happen.
The federal budget deficit and debt didn’t just suddenly happen. It has built up for many years. There is no shortage of people to blame, but that is not what is important here. I have no problem with political maneuvering to reduce spending and reduce government debt. But the debt ceiling is just a number and it’s important not to get bogged down in this and lose site of the goal. Playing chicken with the economy and the debt ceiling is political grandstanding and quite reckless.
It’s reckless because failure to raise the debt limit not only threatens a default that could potentially destabilize the entire world financial system, but could potentially deprive federal workers of their salaries, deny payments to businesses for goods and services sold to the federal government, renege on Social Security benefits to retirees, and shortchange savers who depend on interest income.
It is difficult to comprehend the vastness and variety of payments the Treasury must make everyday. Here are just a few samples. On May 2nd it paid out $6.4 billion in interest on the debt, $4.5 billion to retired federal workers, $3.7 billion to military retirees, $2.6 billion to house the indigent, and $1.6 billion in federal salaries, among other things. On May 3rd, the Treasury paid $21.8 billion to Social Security recipients, $1.6 billion to Medicare providers, and $1.6 billion to vendors that sold supplies to the Department of Defense.
On most days, the Treasury does not take in enough in taxes to cover its payments. On May 2nd it took in almost $26 billion, but on May 3rd it took in less than $4 billion. Through May 3rd the Treasury had received a little less than $1.3 trillion in taxes for fiscal year 2011, but had made payments of almost $7 trillion. The reason the payment number is so large is because it includes funds that were paid to Treasury’s lenders, whose bonds matured and needed to be paid off. Redemptions to owners of Treasury bonds eat up a vast amount of its cash on a day to day basis.
Because the federal government runs a budget deficit, the Treasury must borrow a little more on most days. On May 2nd, there was a net increase in Treasury borrowing of $33 billion, on May 3rd the increase was $11 billion. This is how much the national debt increased on those days. As of May 3, the total amount of debt outstanding was $14,280,140,000 and the debt limit is $14,294,000,000.
Some have argued that as long as it has sufficient monthly cash flow from taxes to pay monthly interest on the debt, then the Treasury can just stop making other payments. That could include payments to doctors and hospitals that provide Medicare services, stop paying salaries to federal workers, stop paying vendors that provide food and ammunition for our troops in the field, and stop paying Social Security benefits. Are you kidding? Does anyone really want to go down that path?
The real issue with the debt limit isn’t whether the government should run a budget deficit or if the deficit is too large. That is a big problem that needs to be fixed. But the debt ceiling is about cash flow and making sure that the Treasury has enough on a daily basis to pay its bills and neither inconvenience nor break faith with those who sold goods and services to the government, loaned it money, or depend on federal programs for life and health. The word “irresponsible” is inadequate to describe those in Congress who use doubletalk to justify refusing to raise the debt limit. They are playing with fire and are going to get us all burned.
“I’ve always depended on the kindness of strangers.” So said Vivian Leigh in her role as Blanch in the Tennessee Williams p....
Some things just never change. A few years ago the major financial firms created a devastating financial crisis and meltdown that harmed the country and global economy. This wasn’t the first time of course. Think about the S&L crisis in the early 90’s and many others before. Once again investigations were held but no one was punished, and once again regulations were promised that would prevent it from ever happening again. And once again those regulations were so watered down that nothing much has changed.
A couple of years ago I said that this would happen. The stock market has recovered and has investors excited and no longer focused on or caring about how the system operates. Life is good again. Even the watered-down regulations that did survive are being pushed aside so the major financial firms can carry on as before. And no one cares or protests.
For example, new regulations require that trading in contracts involving currency derivatives must be made on exchanges where regulators and others can see them, rather than in secret as was previously happening. Many feel this was a significant part of the problem in the recent financial system meltdown.
Treasury Secretary Geithner recently announced he had decided to exempt major banks and financial firms from the ruling and allow them to continue trading certain contracts “over the counter” (i.e. not on an open exchange) and out of sight as before. According to the Treasury Department, the contracts that Geithner carved out from the rules account for $30 trillion of the global market for such derivatives.
Why would they want to do that in private and not on an exchange? The fact that they can create all kinds of exotic products, put up far less collateral, charge much higher commissions and be subject to less regulation wouldn’t have anything to do with it, would it? I am aghast. Who would have thought that the greedy SOB’s would put their own self interests ahead of doing what’s right!
New financial regulations were also supposed to prevent abuse of investors in IPO’s (initial public offerings). Basically, investment banks have used their influence over IPO’s to allocate IPO shares to the executives of their investment banking clients and others they wanted to do favors for, with only tiny portions available to the investing public. The investing public could then go after the shares in the open market after the offering, which often doubled and tripled the price in a matter of hours or days, allowing the favored few to sell their shares into the frenzy and thus make huge profits.
A few weeks ago, a section of the regulations requiring that investment bankers have no involvement or influence, directly or indirectly, in how the shares of IPO’s are allocated was removed from the new regulations by the SEC. What a surprise! Coincidently, this is happening just as Wall Street firms are preparing an unusually high number of IPO’s of internet companies related to the hot new areas of social-networking, online gaming, and music downloading. Looks like we’re back to business as usual and the inmates still run the asylum. And they wonder why the public doesn’t trust them anymore.
On another note, have you noticed the ongoing evolution of investments in agricultural products, metals, and foreign currencies? They enable an investor to invest in a variety of asset classes that the general public could not easily do before. The question is should the average person be investing there at all?
There are now ways to invest all types of agricultural commodities, as well as ways to invest in German, Italian and Japanese sovereign-bond futures. Many of these are even leveraged two or three times, which significantly increases the potential return or loss. Retail investors can now place their bets on volatile farm prices and the credit worthiness of assorted countries, and leverage themselves to the hilt in the process. It looks like a train wreck waiting to happen to me.
To each their own I guess. For the life of me, I cannot understand why a retail investor would want to dabble in these types of investments. You’re making a high-risk bet on the direction of a commodity, or currency or sovereign bond, on which you have no special insight or information. And you’re entering a market full of well-informed insiders who often do have special insights or information. This is not investing. It’s gambling.
As a retail investor, do you feel you have better information on, say, the corn market than the pit traders in Chicago, or than professional international currency traders? This is like one of us going one on one with a NBA player. It’s not even a contest.
I know a guy who makes his living as a professional Texas Hold ‘Em poker player. He says the world of poker is a Darwinian fight for survival in which “sharks” (the
professionals) feast on the “fish” (the amateurs).
I can think of no better analogy for this area of the investment world. The entry of legions of new inexperienced fish into commodities, currencies, and bond futures will keep the sharks in New York and Chicago well fed for years. My recommendation? Play a game you can win. Invest in companies and sectors you understand that are attractively priced and backed by durable macro trends. Over time, you’ll come out on top.
Some things just never change. A few years ago the major financial firms created a devastating financial crisis and meltdown that harmed the ....
‘Tis the season. No, not that season. The season of the stock market when you need to go away. Well, almost anyway. There’s an old saying about a trading pattern on Wall Street that says “Sell in May and go away.” Then you’re supposed to come back and buy again in November. Does it really work? Yes and no.
There is certainly something to it though. The market has a proven tendency to make most of its gains between November and May, and experiences most of its losses in the remaining months. Some people dismiss the idea as an interesting theory that doesn’t always work. But it’s not a theory; it’s a proven fact. In spite of the few years when it has not worked, investing over the long-term based on the market’s seasonality significantly outperforms the market, and with much less risk.
Don’t take my word for it. Academic studies provide clear evidence. For instance, a study published in the 2002 American Economic Review concludes, “We found that this inherited wisdom of Sell in May to be true in 36 of 37 developed and emerging markets.” It went on to say that, “A trading strategy based on this anomaly would be highly profitable in many countries. The annual risk-adjusted outperformance ranges between 1.5% and 8.9% annually depending on the country being considered. The effect is robust over time, economically significant, unlikely to be caused by data-mining, and not related to taking excess risk.” Another study in 2008 at the New Zealand Institute of Advanced Study, which focused solely on the U.S. stock market, concluded that “All U.S. stock market sectors, and 48 and out of 49 U.S. industry sectors, performed better during the winter months than summer months in our sampling from 1926-2006.”
Of course, it doesn’t work every year, but let’s put that into context. To begin with, no strategy, particularly a buy and hold strategy, works every year. And that is also true of seasonality. For instance, it underperformed in 2003 and 2009. In those years the market made gains in the winter months, and then, fueled by massive government stimulus programs, continued still higher during the summer months when a seasonal investor would have been in cash or invested in something other than stocks.
But the seasonal investor did not lose money by being out of the market in the unfavorable season in those years. He or she merely missed further gains. But when an investor is in the market in unfavorable seasons in which the market experiences the serious declines that most often take place in unfavorable seasons, that investor actually loses money. Those losses can be substantial, with investors giving back much, if not all of the gains made in the previous favorable season. For instance, from May 1st to its low during the summer months, the S&P 500 lost 22% of its value in 2001, 24% in 2002, 38% in 2008, and even 16% in the early summer correction in the positive year last year. Those are the experiences that created the “lost decade” that buy and hold investors experienced but which seasonal investors avoided.
Seasonality could be even more important this year than in other years. There are negative factors working against the economy and market to a degree not seen in a number of years. They include rising inflation; global central banks raising interest rates to ward off inflation, which is also likely to slow their economic growth; signs of the U.S. economy slowing again (sharp declines in home sales, durable goods orders, and consumer confidence); the coming end of the Federal Reserve’s QE2 stimulus efforts in June; and the austerity measures Congress will be forcing on the country in efforts to bring the record budget deficit under control.
Then there is the high level of investor bullishness usually seen near market tops. For instance, the Investors Intelligence Sentiment survey shows bullishness has jumped up to 57%, while bearishness has fallen to just 15.7%. That spread of 41.6% is considered to be in a danger zone. The last time it reached 40% was in October, 2007 as the market topped out coming into the 2007-2009 bear market.
The traditional seasonality maxim, ‘Sell in May and Go Away’, calls for buying November 1 and selling on May 1 of the following year. Those dates were the basis for the academic studies mentioned earlier. But obviously a positive market move does not begin and end on the same day each year. That’s just the general time frame. Depending on what is going on, the sell date could be as early as mid-April or as late as mid-June.
So, will this strategy work in 2011? Beats me. But given the negative items I listed above, and a market that has experienced a substantial rally since March 2009, it certainly is something to be aware of.
One closing topic I want to share with you. It’s totally unrelated to the subject of this article but I just can’t resist. I have written before how gold may well be in a bubble. Here is one more indicator. It appears now that the Islamic Republic of Iran, that bastion of cutting edge modern finance and economic theory, has recently converted a significant amount of its currency reserves into gold in order to avoid holding the dollars of the Great Satan. According to WikiLeaks, the gold buying was an attempt to avoid currency seizure by hostile powers. You can’t make this stuff up folks.
‘Tis the season. No, not that season. The season of the stock market when you need to go away. Well, almost anyway. T....
Depending on your point of view, you may or may not be too happy with Fed Chairman Ben Bernanke and all the money printing going on at the Federal Reserve. If you think he’s unpopular, consider the case of John Law, the Scottish adventurer who, as France’s first central banker in the early 1700s, became the most powerful man in international finance—and the wealthiest man in the world—before having to flee penniless into exile and obscurity.
Law presided over one of the greatest financial spectacles in history: the Mississippi Land Scheme, which was aided and abetted by the creation of the first modern central bank in Europe, the French Banque Generale (later re-named the Banque Royale). Law was an interesting character; a gentleman gambler with a taste for wealth, wine, women and power. His financial career began in the gaming halls of Europe after escaping a death sentence in England for killing a man in 1694, allegedly over the affections of a woman.
John Law was born in 1671 to an Edinburgh goldsmith. Goldsmiths were the foundation of the early European banking system, performing basic deposit and lending functions. They would take deposits of gold and issue paper certificates which could be redeemed at any time for the gold they represented. Learning the basic tricks of the trade from his father—and having a gift for calculating odds that made him dangerous in Europe’s casinos—Law was exceptionally well positioned for a career in finance.
Law spent nine years on the run in Continental Europe after escaping England and amassed a small fortune before returning to Scotland (English warrants were not honored in Scotland at the time). The Scotland that Law returned to was in the midst of a financial crisis after a disastrous colonial venture in Panama that wiped out the savings of much of the country’s citizenry. Law’s proposal to get the Scottish economy moving again—which was defeated by the Scottish parliament—was the issuance of paper money backed by the land owned by the government.
Monetary conditions in the wake of the crisis were extraordinarily tight. Given that there was a shortage of physical gold (as most of it was lost in the Panama debacle), banks and private citizens alike were hoarding what little cash they did have. The money supply was diminished and the velocity of money was in free fall. (Sound familiar? It should. A collapse in the velocity of money is a common occurrence in nearly all post-bubble crises, and the American housing and debt crisis of 2008 was no exception.)
Law believed that paper money was preferable to gold or silver coinage for several reasons. Paper money is highly portable, making it more convenient than gold or silver as a medium of exchange and facilitator of economic activity. Law was correct in this observation and noted—as Adam Smith would write more than 70 years later in “The Wealth of Nations —that a country’s wealth should be measured by its output, not by its holdings of precious metals. Unfortunately, paper money can also be printed at will, as we are learning all too well lately.
Though rejected in Scotland, Law’s ideas soon found a home on the other side of the English Channel. Upon his death, Louis XIV had left France virtually bankrupt. As it turned out, building Versailles and spending decades at war cost money—a lot of money. 3 billion livres, to be exact, while annual tax revenues were only 145 million livres. To keep this in perspective, the U.S. debt-to-income ratio is about 4 times, while the ratio that Louis XIV bequeathed to his son was an almost unfathomable 21 times!
The interest payments on the debt took up 120 million of the 145 livres in revenues—leaving a mere 25 million to finance the rest of the French government’s expenses. Given that annual expenses were 142 million livres, the French crown depended on further access to credit to keep afloat. Suffice it to say that France was a bad credit risk.
Then along came John Law. Because Louis XV was only a young boy when his father died, his uncle Philip II, the Duc d’Orleans, became the Regent of France. Philip was in a bind and was willing to try anything to avoid default and collapse. And John Law appeared to have the answer—the creation of new money by a powerful government-chartered bank that would be used to pay off the existing debts. Law would issue stock in the new bank and would use the proceeds of the IPO to buy back government debt. He would also take deposits in coin but issue loans and withdrawals in paper. How is that for quantitative easing? What a sweet deal - if you’re the bank.
The rest of the story is quite complicated and too long for this column, but a full telling of the story can be found in Niall Ferguson’s “The Ascent of Money.” The short story is basically that the French government declared all taxes must be paid with notes issued by Law’s bank, thus making them legal tender. Law didn’t want to drive up the price government bonds he was purchasing, so he solved the problem by offering bank shares exclusively in exchange for the government bonds. Unbeknownst to the buyers, this retired much of the existing government debt, which they couldn’t pay anyway, for something of far worse credit quality.
Law built trust in his new paper money by making it redeemable for the full value in gold coin and went so far as to say that any banker unable to meet redemptions on demand “deserved death.” His rhetoric worked. The French bought into the scheme completely. Of course, there was this little problem of not having anywhere near the amount of gold necessary to back up the paper, but Law figured nobody would ever call his bluff. Never let the facts get in the way of a good story.
In a truly unusual sign of the times, Law’s paper currency actually traded at a 15% premium to comparable gold coins one year into the scheme. As Law anticipated, the jolt in both the money supply and the velocity of money jump-started the French economy.
France might have prospered had Law stopped there, gradually paying off its debts through a mixture of economic growth and mild inflation, but he got cocky. To pay off the country’s remaining debts in one grand swoop, Law launched the next phase of his scheme.
Law convinced Philip II to back a trading company with monopoly trading rights over the Mississippi River and France’s land claim in Louisiana. Shares in the new company would be offered to the public, and investors would only be allowed to buy them with the remaining billets d’etat on the market [i.e. the existing French Crown junk bonds]. So began the famed Mississippi Scheme.
Law’s new venture, which would come to be known as the Compagnie des Indes, was granted all the possessions of its competitors—the Senegal Company, the China Company, and the French East India company—giving it exclusive French trading rights for the Mississippi River, Louisiana, China, East India, and South America. Law’s enterprise also received the sole right to mint royal coins for nine years; it was allowed to act as the royal tax collector for the same amount of time; and it was granted a monopoly on all tobacco trade under French rule.
Immediately after the initial public offering, applications for shares in the Compagnie des Indes started coming in from all levels of society. So many, in fact, that it took the staff at the bank weeks to sort through all the applications. Traders, merchants, dukes, counts, and marquises crowded into the little rue Quincampoix and waited for hours to find out if their subscriptions had been granted. When the final list of subscribers was announced, Law and his awaiting public learned that the shares had been oversubscribed by a factor of six. The immediate result? Shares in the Compagnie des Indes skyrocketed in value.
The Compagnie des Indes—popularly called the Mississippi Company—was France’s answer to the Dutch East India Company, but with one critical difference: the Dutch company actually had profitable trading routes. (Who knew that you needed a profitable business model??) The French trading company had the mosquito-infested bog we today call Louisiana and little else.
The investors that piled in were buying shares in a company without any real business model. How exactly Law intended to make money in Louisiana—a land of tepid swamps, not mountains of gold—was never fully explained. Though we can shake our heads at the Frenchmen in retrospect, it is easy to understand their enthusiasm. They were trading in rather junky junk bonds for an exciting opportunity in the New World—an investment that, while ridiculous in retrospect, was no more absurd than buying inflated tech stocks in 1999 or Miami condos in 2005. The “animal spirits” that characterize all financial bubbles was fueled by an exceptionally loose monetary policy, with predictable results.
Impressed with the success of the original paper banknotes, Phillip II decided to expand Law’s operation. He renamed the Banque Generale the Banque Royale, made it an official organ of the Crown, and proceeded to expand the money supply by 16 times its previous amount—by literally printing money—and later increasing it by even more. Suddenly, Ben Bernanke’s much maligned “QE2” would seem tame by comparison!
Much of the new money went directly into shares of the Mississippi Company. In a matter of months, the share price rose from 500 livres to 10,000 livres, creating a new class of “millionaires.” A cycle developed whereby demand for the Mississippi shares would create demand for new paper currency with which to buy them. And Philip and Law were only too happy to oblige.
Law’s central bank allowed investors to borrow money at low interest rates using their Mississippi shares as collateral. (Sound familiar again?) This would be like the Federal Reserve lending you money directly to buy shares of a new, unproven technology start-up company and using your existing shares of the company as collateral, creating something of a self-contained Ponzi scheme.
In the later stages of the scheme, the Banque and Mississippi Company were effectively merged and there was no discernable difference between bank notes, Mississippi shares, and the old government debt. The system evolved from a paper system backed by a gold standard to a paper system backed by Mississippi shares which were in turn “backed” by land in Louisiana. (How the currency would be redeemed for land was, again, never really explained.)
The entire scheme began to unravel when Law attempted to deflate the bubble, which had already led to hyperinflation throughout the French economy and which had spread to neighboring England as well. The surge in liquidity created by Law’s scheme spilled across the English Channel and helped to inflate the South Sea Bubble, which had its own excesses nearly as legendary as those of France. Perhaps the most notorious was the successful IPO for “a company for carrying out an undertaking of great advantage, but nobody to know what it is.” It’s hard to imagine anyone actually buying shares in something this ridiculous, but then, is it really any more absurd than lending money for a technology company with no assets and no earnings, or a no-doc “liar loan” on a generic Miami Beach condo?
The French bubble was roughly twice the size of the British, measured by the share price appreciation of the Mississippi Company relative to the South Sea Company. Law’s company rose by a factor of 20, whereas the South Sea Company rose by “only” a factor of ten. For this, we can credit John Law’s willingness to liberally offer central bank credit for the purchase of shares!
When French investors attempted to redeem their banknotes for gold, it quickly became obvious that there was not enough gold to back the banknotes in circulation. The bank stopped payment on it notes, the economy collapsed and Law was forced to flee the country in disgrace. Shares in the Mississippi Company fell all the way back to their issue price, destroying both the newly rich and the established order alike.
The only thing more painful than hyperinflation is the inevitable deflation that follows. When the credit markets seized up, the supply and velocity of money plummeted as desperate Frenchmen scurried to dump their worthless banknotes and shares. France and her middle and upper classes were ruined, and the Monarchy was discredited—setting the stage for the bloody French Revolution a generation later. The French developed a strong distaste for banking and capital markets that arguably lingers to this day. The debacle set back the development of modern capitalism in France by decades.
As for the investors, they endured a bear market that would make modern investors shudder. What followed was 70 years of secular bear market conditions. Stocks did not meaningfully rise again until the 1790s. So much for “stocks for the long run” or “buy and hold” investing!
What lessons can we learn from this? One point on which nearly all market historians would agree is that the bigger the bubble, the bigger the bust that follows. Bubbles almost always return to the level at which they started. This was the case in the Mississippi Scheme—the share price rose from 500 livres to over 10,000 livres before collapsing back to 500—and it will likely be the case in the American real estate markets most affected by the bubble of the mid-2000s.
Perhaps the most important lesson would be that credit-fueled bubbles always end badly. This was certainly the case with the spectacular collapse of the U.S. housing bubble—which led to the destruction of the banking system—and to the collapse of the Japanese “miracle economy” at the beginning of the 1990s, to give two recent examples.
It is popular these days to lay all blame at the feet of the Fed for keeping interest rates artificially low. In the U.S. housing bubble, this is not really accurate or fair. The Fed played its part, of course, but so did irresponsible bankers, mortgage brokers, real estate agents, speculators and even the home buyers themselves.
The Fed’s actions in the aftermath of the bust are what have generated the most controversy. The Fed has always engaged in “open market operations,” buying and selling U.S. government securities in an attempt to regulate the money supply. But this has evolved from a purely monetary objective to becoming a de facto funding mechanism for the U.S. government. The government is effectively printing money at the Fed in order to lend it to itself when the Fed uses that money to buy bonds that it will likely never sell. Though not quite as egregious as the Mississippi Scheme, whereby money was printed to buy inflated shares, there are obvious parallels.
The question on everyone’s minds is “what happens when the Fed eventually has to reverse course?” When the Fed takes the punchbowl away, bond yields should rise and most risky assets—like stocks—should fall. But when? And by how much? The volatile stock correction that started in late spring 2010 coincided with a lull in the Fed’s easing. Given that stocks have had an unusually good run in recent months, we might expect a similar decline once the effects of QE2 wear off, or perhaps something much worse.
Regardless, we should learn from the lessons of history. Quantitative easing is dangerous and does not “fix” a bad economy. It does, however, generally lead to destabilizing asset bubbles. The quantitative easing following the “dot com” bust helped to create the conditions that made the housing and mortgage bubble possible. And today, we have incipient bubbles in gold and food prices forming. Again, using history as a guide, the most likely outcome is a prolonged period of deflationary conditions and slow growth.
Depending on your point of view, you may or may not be too happy with Fed Chairman Ben Bernanke and all the money printing going on at the Federal ....
Oscar Wilde once said, “Experience is the name everyone gives to their mistakes.” If that is true, many people have gained a lot of investing experience over the last 10 to 20 years. In a previous column I discussed the significance of secular (i.e. long term) bull and bear markets. Contrary to what you might think, secular bear markets don’t really trend down as much as they move sideways for long periods of time, with lots of mini bull and bear markets bouncing around in between.
Let’s look at a stock such as Wal-Mart and see what takes place in a sideways market. (This is just an example and not a recommendation to buy or sell Wal-Mart.) Over the past 10 years, the stock has basically gone nowhere. However, during that time Wal-Mart’s earnings almost tripled from $1.25 to $3.42 per share, growing at an impressive rate of 11.8% a year. This doesn’t look like a stagnant, failing company. In fact, it’s quite an impressive performance for a company whose sales are approaching half a trillion dollars. Its stock chart would lead you to believe otherwise.
The reason for this unexciting stock performance was valuation – the P/E (price/earnings) ratio – which declined from 45 to 13.7, or about a 12.4% decline a year. The stock price has not gone anywhere because much of the benefits from earnings growth were canceled out by a declining P/E ratio. Even though revenues more than doubled and earnings almost tripled, all of the return for shareholders of this terrific company came from dividends, which did not amount to much. This is exactly what we see in the broader stock market.
Let’s zero in on the last secular bear market the U.S. saw from 1966 to 1982. Overall stock market earnings grew about 6.6% a year, while P/E ratios declined 4.2%. Thus stock prices only went up about 2.2% a year. Of course there were lots of brief up and down cycles during that period, called cyclical bull and bear markets. That time period had five cyclical bull and five cyclical bear markets. Two forces worked against each other. The benefits of earnings growth are wiped out by P/E ratio contraction.
Secular bull and bear markets tend to last about 15 to 18 years on average. As I have written before, I think we are currently in a secular bear market that began in 2000 and probably has another six to eight years to go. We saw a similar trend in P/E ratios in the 1966 to 1982 period. Since 2000, P/E ratios declined from 30 to 19, a decline of 4.6% a year, while earnings grew 2.4%. This explains why in 2010 the stock market was pretty much where it was in 2000, despite 10 years of earnings growth.
Historically, though earnings growth fluctuates in the short term, it generally mirrors the growth of the economy, averaging about 5% a year. If P/E ratios never changed and always remained at an average of 15, we would not have bull or bear markets at all. Stock prices would simply go up or down with whatever earnings were. That is what would happen in a utopian world where people are completely rational and unemotional. Of course, there is no utopian world and people are not rational.
The change of P/E ratios from one extreme to the other through market and economic cycles is largely responsible for sideways and bull markets. P/E ratios moving from low to high levels cause bull markets and P/E ratios moving from high to low cause the roller coaster ride of sideways markets.
Secular bear markets occurred when you had two conditions in place; a high starting P/E ratio and prolonged economic distress. Together they are a lethal combination. High P/E ratios reflect high investor expectations for the economy. Economic problems such as runaway inflation, recessions or severe deflation, declining or stagnating earnings, a credit crisis or a combination of these things destroy those high expectations. Instead of an above average economy, investors find themselves in an economy that is below average. Suddenly, a bear market has started. That is where we are today.
What about a cheerier subject - the bull market? We saw a great example of a secular bull market from 1982–2000. Earnings grew about 6.5% a year and P/E ratios rose from very low levels of around 10 to the unprecedented level of 30, adding another 7.7% to earnings growth. Add up the positive numbers and you get incredible compounded stock returns of 14.7% a year. Add dividends on top and you had even more incredible returns of 18.2% over almost two decades. No wonder everyone thought they were stock market geniuses in the late 1990s. Not anymore.
Mean reversion is a statistical term for things going back to what could be considered normal. Mean reversion is the Rodney Dangerfield of investing: it gets no respect. Mean reversion is as important to investing as the law of gravity is to physics. As long as humans come equipped with emotions like fear and greed, market cycles will persist and the pendulum will continue to swing from one extreme to the other. Prices never stop at the mean. They always overshoot on the way up and on the way down. When P/E ratios hit the extremes is when the next bull or bear cycle starts.
So what does this mean for investors today? It means that if we are in fact in a long term bear market for the next several years, we are not likely to see major advances in stock prices even with improving earnings. I am often asked how stock prices can go down or stay flat even when company earnings are improving. It is because of P/E ratio contraction and it is very important for investors to consider whether we are in a bull or bear market when considering their investment decisions. Short term, I think we’re in a brief bull market cycle. But we may be just whistling past the graveyard. Longer term, I think we’re still in a secular bear market with several more years to go. You’ll have to decide what you think.
Oscar Wilde once said, “Experience is the name everyone gives to their mistakes.” If that is true, many people have gained a lot of inv....
Risk is a funny thing. Everybody loves it when it works out, but it can be quite painful when it doesn’t. I learned a lot about risk from a cat named Vern. Vern was a cat I had years ago; or I should say that Vern had me. He wasn’t anything special; just an ordinary gray barn cat. But he was special to me and made me smile and laugh a lot. I loved that old cat.
Vern was a house cat meant to live his life protected indoors. The problem was that Vern didn’t seem to know that and never missed an opportunity to be out hunting for whatever it was that he liked to hunt. Unfortunately, in the real world the hunter can sometimes become the hunted.
As long as Vern hunted during the day, the risks were fairly small. He almost always managed to come home about dinner time carrying his trophy from the hunt, much to the dismay of my horrified daughters. But night time was a different matter. The big hunters came out at night and the risks got a lot higher and the odds changed against him. As hard as I tried to prevent it, Vern often managed to find the right moment to bolt out the door and he was off for the night. He always came home; although more than a few times he looked like he got the worst end of a fight. At least he made it home.
I never understood why he would never abandon the thrill of the hunt in exchange for the comfort of watching TV and eating snacks with me in the easy chair, but that’s just the way he was. The good news is that Vern was lucky and lived a long and happy life.
This is not a story about Vern though. This is a story about risk. More specifically, it’s about asymmetrical risk; when the risk in one direction is far greater than the other. This is the risk/reward equation people talk about but rarely consider. An example of asymmetrical risk is catching a plane. If you arrive too early, you waste some time sitting in the airport. This is unfortunate, but it’s tolerable. If you arrive too late, you miss the plane altogether. This can be expensive and very inconvenient.
Asymmetrical risk has nothing to do with the odds of a given risk, but everything to do with the consequences of a given risk. In Vern’s case, the odds that a coyote would kill him were relatively low and the odds were hugely in his favor. For example, let’s say the odds were 50-to-1 in his favor. But the consequences of that risk were incredibly asymmetrical. In our hypothetical 50-to-1 risk, Vern returns home alive 50 times out of 51. But one time in 50, the coyotes kill him. By the numbers, that's a good risk. In reality, that's a horrible risk. No investor would take a bet like that...at least not knowingly.
As investors, we can’t afford to turn a blind eye to risks, especially not to asymmetrical risks. We can’t afford to take risks that are likely to work, but are likely to wipe us out if they don't work. Understanding your potential reward is worthwhile. Understanding your potential risk is everything.
We hear a lot about risk versus reward. If someone were to ask, “How did you do last year?” (with your investments), an appropriate answer might be “Compared to what?” You see, if you were to measure your performance against the S&P 500, which was up 12.88% in 2010, you might not have done as well if you had been quite conservative with your investments. What if you were conservative and only made 5%? Is that bad? Well, if you compare it to the overall stock market, yes. However, if you compare it to the risk-free rate of return, that was pretty good if you didn’t take a lot of risk doing it.
The “risk-free rate of return” is a term analysts use to identify what you could have earned without taking any risk. Typically that is something like short term T-bills or CDs. In a time not too long ago, you could have earned 3% in T-bills or perhaps 4% in a one year CD, all guaranteed and no risk.
If you could make 4% on a risk-free investment (and were happy with that), but instead you invested in a diversified portfolio of stocks and bonds and earned 5% - well, that’s not too impressive. In fact, it’s pretty awful given the extra risk you had to take to make 1% more.
Today, however, the risk-free rate of return in T-bills, money market funds and CDs is almost zero. Given that scenario, if you managed to earn 5% in your portfolio and you took a minimal amount of risk doing it, then you might consider that fairly significant excess performance. Oh sure, making 12% in the market is far better; but you have to consider the extra risk it would have required you to take to achieve that. In retrospect, if you had done that in 2010, it would have worked out and you would have been quite happy. But what if it didn’t? In January 2010 you didn’t know for sure that was going to happen. In fact, there were many times during the year that it didn’t look like that was going to happen at all.
The point is no matter how much we try to ignore it, risk versus reward is a factor we constantly have to measure. Big returns are nice, but how would you feel if the opposite happened? Many people experienced that first hand in 2008 and found out the thrill of victory may not be enough to offset the agony of defeat when it comes to investing. Unless you’re truly an aggressive investor who can stomach occasional big losses, don’t measure your investment performance against the stock market. Measure it against the risk-free rate of return and stop driving yourself crazy. In the words of Bobby McFerrin’s song, “Don’t worry, be happy.” My pal Vern beat the odds. You may not be so lucky.
Risk is a funny thing. Everybody loves it when it works out, but it can be quite painful when it doesn’t. I learned a lot about risk from a c....
“Is that all there is, is that all there is? If that's all there is my friends, then let's keep dancing. Let's break out the booze and have a ball.” Perhaps those words from Peggy Lee’s 1969 hit song “Is that all there is?” are an appropriate opening for my annual predictions column. The investment mood has changed along with a general feeling that the worst is behind us, things are getting better, and maybe things were not so bad after all.
Or perhaps not. I hate to rain on everybody’s parade, but maybe that’s not all there is. The global economy, as I see it, is in a period between two crises. In 2007-2008 we had the global credit crisis, the private sector banking crisis and the bursting of the real estate bubble. Now we are in a period of clean up with a respite from the chaos.
Unfortunately, we didn’t fix anything and have mostly sown the seeds for what will eventually be another crisis. Things seem stable now but there is a lot of unfinished business. Sadly, we swept it under the rug and transferred the problem from the private sector to the public sector, i.e. you and me. We bailed out different institutions and people who had positioned themselves incorrectly. We created “too big to fail” instead of “you have an opportunity to succeed or fail.”
As Yogi Berra famously said, “Predictions are tough, especially when it concerns the future.” In 2009 I was right on 100% of my predictions for the markets and the economy, and in 2008 nearly so. And for 2010? Well, not so hot. Maybe I should follow cowboy logic: “If your horse dies, I suggest you dismount.” I don’t think the horse is dead yet, so your fearless forecaster continues on. Having said that, I could use a little extra ketchup on that crow I’m eating.
Here is what I said in January 2010 and what actually happened:
1. “The Dow climbs to 11,300 but heads lower in the second half of 2010, falling back to the 8,500 level by year end.” I got the first half right but missed on the 8,500 part. I had not counted on the Fed throwing another $600 billion into the market in the form of quantitative easing, commonly called QE2. I still think I’m right on the second part, but it looks like I’m about a year or so early.
2. “The housing market improves slightly in the first half of the year and then falls again by late 2010 as a tsunami of Alt-A and Option ARM mortgages reset this year, leading to another surge in foreclosures and home prices falling another 10%.” Mostly correct.
3. “The national unemployment rate remains stubbornly high and exceeds 11% by late 2010.” Missed on this one. Unemployment dropped to 9.4% but is still exceptionally high and most experts, including the Fed, think it will remain high for several years.
4. “The U.S. federal budget for 2010 runs another $1.5 trillion deficit. U.S. Government debt hits 94% of GDP.” Right on this one! Our number one problem is too much spending and too much debt, so we’re fixing it with more spending and more debt. Huh?
5. “Oil prices inch higher in 2010 and hit $100 a barrel, further depressing the U.S. economy.” Almost, but not quite. Oil hit $91 but the resulting increase in gasoline prices has already taken $67 billion out of household income. Higher energy prices are great if you’re a producer, painful if you’re a user.
6. “U.S. economic recovery continues with positive GDP growth in 1st and 2nd quarter, mostly due to inventory rebuilding. The recovery stalls and we see the early signs of a double dip recession by the end of 2010.” Half right. Double dip is probably off the table until 2012 because of continued government spending and stimulus.
7. “The Fed raises interest rates earlier than expected. The 10 year Treasury bond yield hits 4.7% by late 2010.” The Fed has not raised interest rates but the bond market did it for them to some extent with 10 year rates going from 2.3% to 3.5% in the last quarter.
8. “The U.S dollar explodes higher in 2010. Although we have lots of problems, the world realizes that we’re not as bad as they thought and everyone else is not that great.” Correct.
9. “Gold will likely fall below $900, although it could go to $1300 first.” Gold corrected to $1,050 but never saw $900. It got to a high of $1,432.
10. “Over 500 U.S. banks fail in 2010, up from 150 in 2009. Several major European banks fail due to defaults in former Eastern block countries and the weak links in the Eurozone, the so-called PIIGS (Portugal, Ireland, Italy, Greece and Spain), triggering the next leg down in Europe.” Correct on Europe but wrong on U.S. banks. 157 banks failed in the US in 2010, up from 150. There are still over 800 U.S. banks on the FDIC’s watch list of troubled banks.
So what happens next? Here are my thoughts for 2011:
1. After a brief correction early in the year, the stock market works its way higher in a volatile fashion to a top sometime in the fall, possibly to 12,800 on the Dow, before rolling over late in the year or early 2012.
2. Gold, oil and commodities in general continue higher with gold eventually hitting $1,500 an ounce and oil $100 a barrel.
3. Interest rates on long term Treasury bonds spike in late 2011 creating a great buying opportunity in bonds again.
4. GDP figures continue to show improvement in the 1st and 2nd quarters before turning down again in the second half of the year. Predictions of 4% GDP growth by some analysts are likely way too optimistic. Inventory rebuilding, which was over half of the GDP growth in 2010, is largely over. Fiscal stimulus from the U.S. Government runs out and state and local governments have to make major cut-backs to balance their budgets. Look for GDP at 2.0-2.5% at best. Unemployment will remain above 9%.
5. Home prices on a national average fall another 10%. If home prices stay flat or continue to fall, the level of defaults will accelerate and the banks finally will have to admit to and deal with massive levels of bad loans. Another round of mortgage resets is on the horizon in mid-2011.
6. U.S. Municipal bankruptcies become headline news. More cities that are technically bankrupt are contemplating the idea of making it official. This will finally force a major shift in dealing with public unions and the funding of public pensions. The first major city to go bankrupt will cause a huge stir in the municipal bond market.
7. The sovereign debt crisis in Europe will put the Eurozone under more pressure. Their problems have not gone away and several countries will be forced into massive austerity programs or the European Central Bank will be forced to print money and devalue their currency.
8. China’s economy is overheating and they are raising interest rates as rapidly as possible to stop runaway inflation. This will eventually pop their real estate bubble, slow their economy and put pressure on commodity prices.
So there you have it. No guts no glory, right? We’ll review it again next year and see how I did this time.
“Is that all there is, is that all there is? If that\'s all there is my friends, then let\'s keep dancing. Let\'s break out the booze and hav....
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