Stagflationary Recession

Stagflationary Recession Deepening: Retailers Lining Up In The Crosshairs

By Frank Barbera, CMT | 27 May 2008

Amid the endless gasoline headlines crossing the news this past weekend came the headline from Germany that billionaire investment guru Warren Buffett sees the USA already in recession. According to Buffett, "the US is already in a recession, which will be deeper and longer than many think".

BERLIN (AP)— Warren Buffett, whose business and investment acumen has made him one of the world's wealthiest men, said in an interview published Sunday he believes the U.S. economy is already in a recession. Asked by Germany's Der Spiegel weekly whether he thinks the U.S. could still avoid a recession, he said that as far as the average person is concerned, it's already here. "I believe that we are already in a recession," Buffett was quoted by Spiegel as saying. "Perhaps not in the sense as defined by economists… But people are already feeling the effects of a recession… It will be deeper and longer than many think," he added.

Of course, the good folks at the BLS have managed to make sure that the ‘official data’ have been massaged enough to the upside in this election year so that, despite two consecutive quarters of negative real GDP growth, have been postponing the ‘official’ recession signal so far. In today’s update, we review some of the economic data released today from a bigger picture point of view to illustrate just how ‘spot on’ Mr. Buffett's comments in fact are. The primary focus of the last 12 months has been, and remains, the sinking housing market, where this month's action produced a technical bounce.

Earlier today, the Commerce Department reported that New Homes sales rose by 3.3% in April to a seasonally adjusted annual rate of 526,000 units. At the same time, the government also revised March activity lower to show an even bigger drop of 11 percent to an annual rate of 509,000, which was the weakest pace for sales since April 1991, a 17 year low. Viewed through the lens of a smoothed Rate of Change, we see that New Home Sales are still very close to the lowest levels of the last 40 years, sinking to the depths of the 1980 Carter ‘Stagflationary Recession.’ Appropriate, since today’s unreported inflation rate is running close to 12%.


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Above: Annual Rate of Change on New Home Sales in Deep Recession territory

In addition to the data on Housing Sales, today’s report also reported that inventories of unsold new homes edged down slightly to 10.6 months' supply at the April sales pace, compared with 11.1 months in March. According to CBS Marketwatch and AP, the April level was still about double the inventory level that was normal during the five-year housing boom. In our work, we follow the Ratio of Houses For Sale versus Houses Sold, which remains well above the 8 month upper benchmark that in the past has defined US recessions.


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Above: the Ratio of Houses FOR SALE versus Houses Sold— still in deep recession territory

With inventories still at near record levels of supply, it was also no big surprise that Housing prices remained under heavy downside pressure. According to CBS Marketwatch, the pace of home price declines accelerated in March with home prices in 20 major U.S. cities now down 14.40% over the past 12 months, a record breaking decline. According to the 20 City Case-Shiller Home Price Index, prices fell 2.2% from February to March marking the 16th consecutive monthly decline. Within the 10 largest US cities, prices fell by 2.4% in March, and by 15.3% over the last 12 months.

The combination of falling home prices and rising food and energy prices, stagflation (no growth and rising prices) continued to put a major damper on Consumer Confidence with the Conference Board Index plunging to 57.20 in May, down from 62.80 in April. At this point, there is simply no longer any argument remaining about whether or not the US is in recession, as the Conference Board Index has only declined below the lower +70 benchmark during recessions and is now closing in on some of the worst readings seen in prior recessions.


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Above: Consumer Confidence Survey fell to a 16 year low in May, now well below the +70.00 recession benchmark with a reading of 5.720 in May, down from 62.80 in April.

In fact, if one looks closely at the components which comprise the Conference Board Composite Index, the outlook going forward is bleak. To begin with, we note that the Forward Expectations Index which looks out six months from today, plunged this month to a reading of 50.00 to a value of 45.70. For proper context, that is an ALL TIME LOW since record keeping was started in the 1970’s. Talk about huge, this makes a strong case that the current economy is nowhere close to an important bottom as the Expectations component tends to usually lead bottoms by a year or more. What’s more, the overall Consumer Confidence Composite has actually been benefiting to this point by the Present Situation Component, which has been trending down in consistent fashion, but not falling out of bed.


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Above: Conference Board Index of Forward Expectations (6 months out)

If we look at the Present Situation Component in May the indicator fell to a reading of 74.4, down from 81.90 in April. Historically, this gauge is very likely to dip under the +50 mark, and could even— given today’s circumstances— be expected to fall into the +40 to +30 range. From where it stands at the current time near +75, we are still a long way from the zone where an important bottom could be seen. In our view, this implies that the current recession is simply just beginning to pick up downside momentum, and that the current bout of economic weakness will remain right through 2009.


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Above: Conference Board— Present Situation, still a long, long way from a low


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Above: Ratio of Leading to Lagging Indicators— 12 Month Rate of Change

Paralleling the steep declines in all of these gauges in the last 12 months are a number of other gauges, including the Ratio of Leading to Lagging Economic Indicators, which for the balance of the last two years has been drifting its way steadily lower toward the full recession levels of— 5%.

Again, in very deep recessions this gauge has fallen to readings well below— 10 to— 12%, and thus, for anyone concluding that a bottom has been seen, we would argue that historically what is showing up right now in terms of falling Home Sales, Home prices, and diminished Forward Expectations makes a compelling case that the Ratio of Leading to Lagging Indicators has potentially a long way to go on the downside. To bring things full circle and close the loop, in the chart below we plot the annual rate of change on Home Sales (thin line) and overlay it against the Ratio of Leading to Lagging Indicators (thick line).

What we find is that over a long stretch of time, the directional change of Home Sales has led the Ratio of Leading to Lagging gauges by about 5 to 6 months. That means that from where things stand right now, we could be staring down the barrel of new record lows in the Leading to Lagging Gauge Ratio which would imply a very deep recession, possibly even a depression getting underway. The same time of implication is seen with an overlay of the Conference Board Confidence data versus the Leading to Lagging Indicators. The clear implication from the way some of these ultra leading indicators are pointing is that the downside risk in the US, and likely the global economy, is still very substantial and that at present, we are a long way from the bottom of this downside contractionary cycle.


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Above: Housing sales at Annual Rate of Change lead even the Leading Indicators (Thick line is Leading to Lagging Ratio at Annual Rate of Change)


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Above: Ratio of Leading to Lagging Indicators versus Conference Board Composite


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Above: top clip: S&P rate of change, middle clip: Payrolls rate of change, and bottom: Home Prices— rate of change.

Finally, we view the current decelerating economy through the lens of the stock market as a leading indicator for broader economic conditions. In the chart above, we plot a two year rate of change for the S&P in the top clip. Immediately below the S&P we show the 12 months rate of change on Non-Farm Payrolls, and below that, the 12 months Rate of Change for Real (Inflation Adjusted Home Prices). In both cases, we have lagged Employment and Home Prices by 12 months as the stock market has historically turned down in advance of economic weakness. In all three cases, the rate of change data is now negative with Housing leading the way on the downside over the last few months as the Credit Crisis has had a powerful negative impact on Housing Affordability.

In our view, given what is happening in Housing, it is a very logical outcome to suggest that the Employment Rate of Change will revisit prior lows and that the stock market rate of change may also have another big excursion below zero dead ahead. Again, the implications are powerful that this down cycle still could have a long way to go as neither the stock market rate of change or the Non-Farm Payroll Rate of Change has seen the kind of figures which typically mark major lows; we suspect before this is over, those readings will be seen.


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Above: the S&P 500 (top clip) and lower clip Relative Strength Ratio of Recession Retailers versus Discretionary Retailers

As far as the stock market is concerned, we believe that an extended recession from here will place more downside pressure on both cyclical stocks, and on retailers. In the chart above, we plot the relative strength ratio of defensive retailers, what I call ‘recession retailers’ versus ‘discretionary retailers.’ On the defensive side, we have names like Wal-Mart, Costco, Ross Stores, Big Lots, TJX Corp, and CVS all in rising configuration, while on the downside names like Radio Shack, Pacific Sunwear, Guess, Starbucks, Whole Foods, Urban Outfitters, and Nordstrom all look overbought and vulnerable.

In the chart above, we plot the R/S Ratio of the recession retailers versus discretionary retailers, which is just now breaking out of a multi-week consolidation phase. The vertical dashed line on the chart shows that this ratio bottomed the same week that Sub-Prime Mortgages became headline news in February 2007. Clearly, the defensive tone remains intact within the stock market, a trend which should continue to favor the most basic industries with a special emphasis on commodities, sectors such as Energy and Precious Metals.

We end with the most discretionary of all items, New Cars, where last week Ford Motor guided lower, reversing its prior upbeat forecasts. We continue to maintain that neither GM nor Ford are likely to survive this downturn (in present form) as both companies have severe financial problems unlikely to withstand the Category 4 or 5 storm just now making landfall. On Friday, GM (which owns Rescap/Green Light Financial), Ambac, MBIA, Lehman Brothers, Indymac Bank and Bank America all closed near historic lows, and all are on the high alert watch list for potentially major pieces of bad news.

From CBS Marketwatch— May 22nd Ford cuts truck production, scales back profit view SAN FRANCISCO (MarketWatch)— Automaker's coming to grip? Ford Motor Co.'s grand plans for profits in 2009 came to an end Thursday, sending the automaker's shares down more than 8% as plunging demand for trucks and SUVs have combined with rising fuel and steel costs to weigh on the bottom line. Ford Motor Company also cut its outlook for full-year car and truck sales to a range of 15 million to 15.4 million units, down from 15.3 million to 15.6 million previously. And in an effort to align production with the sliding demand, the company now plans to build fewer vehicles. "Unless there is a fairly rapid turnaround in U.S. business conditions, which we are not anticipating, it now looks like it will take longer than expected to achieve our North American Automotive profitability goal," Ford CEO Alan Mulally said.

That’s all for now,



Battlestations! S&P In Topping Mode.

By Frank Barbera, CMT | 20 May 2008

In reviewing the action in various markets over the last few days, it appears as though another juncture is rapidly approaching. Call it the start of "The Great Credit Bubble Phase II." In Phase I, Sub-prime and Alt-A mortgage paper collapsed, Bear Stearns slid beneath the waves, and Gold soared above $1,000 per ounce. The Stock Market tumbled nearly 20% (18.48%) and the Dollar plunged to record lows. For the last few weeks, markets have enjoyed a pleasant hiatus with stock indices recovering and the Dollar strengthening. That is until the last few days, as Gold has revived, stocks have reversed lower as has the US Dollar. While we still believe there is a good chance that equities may not actually break down to new multi-month lows until the fall, there is nevertheless a high risk that prices are at present very close to a major interim peak.

Back on April 22nd in our piece entitled "Oreo Cookies and the Stock Market," we opined:

"Thus, this 1380 to 1400 range becomes a very important zone. If the stock market as measured by the S&P 500 can press above this resistance in the weeks ahead, there is a good chance that prices will continue to extend the bear market rally over the next few weeks into the summer months. Under this outcome, prices could be moving up toward the 1440 level, which represent a .618 Fibonacci retracement of the prior decline."

Since then, the indices have surpassed 1,400 and have managed to stagger their way higher with the S&P hitting a peak of 1440.24 just yesterday. In that same article, we placed a lot of emphasis on one of our favorite indicators, the Medium Term ARMS Index. At the time, the ARMS Index had NOT seen an overbought reading of any material sort, and as a result we concluded that the stock market advance probably had further to run. We stated:

"So where are we right now? With a close of 1.065 last night, the Medium Term ARMS is just slightly above neutral having come down off the deeply oversold values seen a number of weeks back. Of note, we have NOT seen a 0.80 value, a true overbought value on this gauge since last June, and that is becoming somewhat overdue. Even accounting for the fact that Bear Market rallies might not peak as low as bull market values, what I call a bearish upward "scale shift," one would normally expect at least a reading below 0.90 BEFORE an intermediate term B-Wave had run its course. So far, that type of low value has not been seen, and thus, in our view, the important ARMS Index is suggesting that the stock market may try to move still higher."

In that same update, we also included a chart of the ARMS Index which is shown below.


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Above: "THEN"— a snapshot of the ARMS Index from April 22nd, "Oreo Cookies and the Stock Market"

Importantly, as stock prices have moved sequentially higher, the ARMS Index has "done its thing" and moved sequentially lower. Remember, this indicator is plotted on an inverse scale, where high ARMS Index values reflect great fear, while low Index values reflect a swing toward optimism. Over the last few days, the Medium Term ARMS Index has plunged to values of 0.864 on Monday the 19th, 0.8730 on Friday the 16th, 0.874 on Thursday the 15th and a recent low last Wednesday at 0.846. We have now not only recorded a value below 0.90, but we have very closely approached the 0.85 to 0.80 window which is usually a very big warning.


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Above: "NOW"— the ARMS Index updated to present, with very low values signaling high risk of a market peak.

So what kind of warning could be at hand? In our view, it seems as though there is a good chance that a medium term peak for the S&P could be cemented into place over the course of the next 10 days within the range of 1405 to 1440. At the moment, today’s sharp S&P decline has not convincingly violated the rising uptrend of the last few weeks, and to that end, a retest of the highs for the S&P is probably still ahead over the next few days. That said, in the larger scheme of things, we have been leaning toward the idea that a large (a,b,c,d,e) triangle B-Wave is unfolding in the stock market, with the recent advance of the last few weeks comprising Wave C, an upward trending portion of the pattern. We outlined this in general terms back on April 22nd in the "Oreo Cookies and the Stock Market" discussion. In our view, much of that same process remains in place, even though the "C-Wave" has pushed a bit higher toward the 1440 zone. In Elliott parlance, this is known as an irregular "C-Wave" and this is fairly common within triangles.


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The bottom line for the stock market as we see it, from a late May high, the S&P could be vulnerable to a trip all the way back down toward the area of the March lows, in the low 1300’s. This type of decline may not be a full on resumption of the bear market, as there could still be a final "E-Wave" advance later this year which would ultimately complete the larger five wave triangle pattern and Wave [B]. Thus, thinking "trading range" is probably a wise approach, and to that end, prices right now may be in the act of defining the ‘high’ end of the range.


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Above: the 20 day Average of Advances less Declines, and Below: the McClellan Oscillator


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Other short-term oriented technical gauges also reflect the market swing back toward overbought territory. In the case of the 20 day Advance-Decline Oscillator, with a close of +93.52 last night, we are now back up to the area where each of the last three peak readings, +91.52 on 2/27/08, +82.88 on 12/26/07 and +108.00 on 10.05.07, were highly problematic for the stock market. Likewise, the McClellan Oscillator has also moved back to overbought territory with a close of +297.63 last night. Importantly, the oscillator has essentially continued to trace out a series of sequentially lower highs throughout the rally, indicating that internally this advance is not robust and most likely of the bear market stripe.


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Above: Operating Company Only Put To Call Ratio

In addition to the recent set of overbought values on key daily oscillators, we also note that sentiment has swung widely in the last few weeks moving from high levels of fear to a now cautious optimism. 'The Worst is Behind Us’ mind set now rules the roost, with the Dollar Weighted Put-Call Ratio for Operating Companies swinging down toward its lower band. Again, this does not mean the market cannot move back up and retest the highs, or even record a token new high in the days just ahead. What it does mean is that traders operating on the long side of the market should be advised that perhaps the lion's share of the rally is now over, and that from a risk-reward point of view, downside risk seems high in the weeks just ahead.

So where are the risks if things get rough? In our view, when we survey the financial world, we still see a dismal road ahead with a lot more problems in front of us rather than behind us. In fact, instead of the "worst being already over," we lean heavily toward the idea that the "worst is still ahead." The price action in stocks like Fannie Mae, Lehman Brothers, and Citicorp is enough to cause us bad indigestion following lunch, if you know what I mean. None of these holds any hint that the worst is over, not fundamentally, and certainly not from the positively wretched price action seen on the charts. In each case, huge degrees of financial leverage are in play, and in each case the ‘light at the end of the tunnel’ is most likely a 100-car freight train on a head on collision rolling down the tracks at 100mph. 'Run, don’t walk for the exits' would be our best advice.


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Above: Fannie Mae— an odds on favorite for leading the parade of Phase Two major problems, way too much balance sheet leverage at work… ultra bearish chart configuration.


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Above: very likely still nowhere close to being "out of the woods," no bargain to be had here. Company survivability potentially still in serious doubt.


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Above: Long term view of Lehman Brothers (LEH) looks ripe for a renewed major decline; many big questions as to whether LEH will have the financial muscle needed to survive this down cycle…potentially another great example of too much leverage in reverse.

Finally, another indication of a trend reversal now rapidly approaching is the Goldman Sachs to Gold Ratio which measures relative confidence. If confidence is high in the financial system, money flows into Goldman Sachs (GS), the bluest of the blue chips, and shuns Gold, and the ratio falls. Alternatively, if confidence is frayed and frightened by the financial system, money flees Goldman and heads for Gold. We note that the ratio has recently undergone a hefty correction as the stock market rallied, but now in recent days, we see the ratio breaking out top side above its declining trend. Gold is regaining the upper footing, and as a barometer of faltering confidence, the rising ratio warns that a more challenging period may be just ahead. For those willing to listen, this breakout is the sounding of an alarm, a call to general quarters, and a warning to review portfolios on the spot. From here forward, odds are high that rallies should be viewed as opportunities to sell and that portfolios should be reverting back to a fully defensive posture.


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Above: the Goldman Sachs to Gold Ratio with 9 day RSI. Upside breakout signals "Battle-Stations" to all who will listen.

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America's Hottest Investor:
Never Mind The Rocky Market. After A String Of Supersmart Calls, Mutual Fund Manager Ken Heebner Is Putting Up The Best Numbers Of His Sterling Career.

By Jon Birger, Senior Writer | 29 May 2008

(Fortune Magazine)— The best mutual fund manager around— a.k.a. Ken Heebner of Capital Growth Management— looks restless. He is sitting in a conference room at Goldman Sachs's Boston office, listening to a young analyst pontificate about all the trends he thinks will sweep the markets in coming years. Oil demand outpacing supply. The rapid growth of agriculture. The increased sway of sovereign wealth funds. And on and on.

Heebner couldn't care less. His flagship fund, CGM Focus (CGMFX), has already made a killing on energy and agriculture, and Heebner has no patience for the pet theories of this or any other analyst (or economist or strategist). "I want information, not opinions," Heebner will later tell me. Then, just as the meeting is looking like a washout, Goldman analyst Marc Fox lets something slip that starts Heebner's brain whirling. Fox mentions that sovereign wealth funds are diversifying out of bonds and bank bailouts and into broad portfolios of common stocks. Coming from Goldman, the world's top trading house, this is valuable information. Heebner is one of the few fund managers who routinely engages in short-selling, and the prospect of a couple of trillion dollars flooding the equity markets should be enough to give any short-seller pause.

Immediately Heebner is peppering Fox with questions about where all this sovereign dough is going, wondering, for instance, whether Goldman is now recommending "short-busting" strategies to its worldwide clientele. (Short-busting involves trying to drive up the prices of stocks that a lot of investors have sold short.) "All I can say," Fox replies, looking a tad overwhelmed, "is you're multiple steps ahead of me."

Fox shouldn't feel too bad: Heebner is multiple steps ahead of everyone these days. At an age when most of his contemporaries have either retired or given up the daily grind of running publicly traded funds, the 67-year-old Heebner is putting up the best numbers of an already exemplary 30-year career. He's Barry Bonds without the steroids. "He's a rock star— he's Bono," quips his Irish-born (and U2-loving) analyst Catherine Columb. Given that U2 hasn't put out a good album since Joshua Tree— sorry, Catherine— Bono should feel flattered. (Of course, it's doubtful that Heebner, who by his own admission spends most of his waking hours thinking about the markets, could pick either Bonds or Bono out of a lineup.)

Just how good has Heebner been? We may well be witnessing the most dazzling run of stock picking in mutual fund history. Since May 1998, Focus has an average annualized return of 24%, the best ten-year record of any U.S. mutual fund, compared with only 4% for Standard & Poor's 500. Focus, which has $7.4 billion in assets, is already up 15% in 2008 (as of May 19), but it is 2007 that will be remembered as Heebner's pièce de résistance. Fueled by big bets on energy, fertilizer, and metals, Focus soared 80% last year, vs. 5% for the S&P 500. "I told Ken it was like he was walking between the raindrops," says CGM president Bob Kemp, who oversees sales and marketing at the firm, of the year Heebner had in 2007. "It amazes even us." Last year marked the fourth time since 2000 that the fund returned 45% or better. And it's not as if Heebner has needed the big years to make up for a lot of losses: Launched in late 1997, Focus has had only one money-losing calendar year (2002).

Peter Lynch's 14-year tenure at Fidelity Magellan has long been the gold standard for mutual fund excellence. During Lynch's best ten years— August 1977 to August 1987— Magellan recorded an average annual return of 36%, according to fund tracker Morningstar. It's a remarkable achievement, but even Lynch acknowledges that he was backed by a strong tailwind. The S&P 500 returned 19% a year over the same period. In other words, Lynch beat the market by 17 percentage points a year during his heyday. Ken Heebner has beaten the market by 20 points a year during his.

And Focus isn't the only Heebner-managed fund that's excelling. CGM Realty (a sector fund), CGM Mutual (a balanced fund that owns stocks and bonds), and CGM Capital Development (closed to new investors since 1969 and soon to be merged into Focus) have been standouts too. Realty boasts a 22% annualized return for the past ten years, sixth-best in the mutual fund universe, according to Morningstar. It's also the only fund in its category that's been bucking the real estate slump. Realty's one-year total return: 34%, vs. 6% for its nearest rival.

A True Contrarian

Even more remarkable than the raw numbers is how Heebner has earned them. Heebner is a true contrarian, who says he's most confident as an investor "when everyone else thinks I'm nuts." He works long hours trying to identify emerging trends in the economy. When he finds a promising one, he'll go all in, making huge bets on the stocks poised to benefit. Asked how long it takes him to identify those stocks, Heebner answers, "About ten minutes. I've been at this a long time." It's an investing style that will never be taught in business schools and is definitely not something any amateur should try at home. But Heebner, blessed with uncanny instincts, has managed to see around just about every corner in a market that has befuddled just about everyone else.

Never a fan of technology stocks (or of technology itself— CGM just got its first voicemail system), Heebner shorted tech and telecom stocks with gusto from January 2000 to September 2001, profiting mightily from the bursting of the bubble. In December 2000, he began buying homebuilders like D.R. Horton and Lennar, convinced that falling interest rates would be good for housing. The stocks went on a tear, and by 2004, Heebner's stake in the sector accounted for 19% of assets in Focus and 79% in Realty. But toward the end of 2004 he grew uncomfortable with the spread of what he termed "funny-money mortgages," and by January 2005— mere months before the industry started to collapse— Heebner had sold off every homebuilder share he owned.

Heebner used his homebuilder profits to load up on oil and coal stocks, positions he'd started to establish in 2004. He even bought coal stocks for the Realty fund— a move that style purists might criticize but for which Heebner makes no apologies. "I did it because it was the best thing for shareholders," he says, noting that Realty's prospectus explicitly defines "companies involved in the real estate industry" to include mining companies, which obviously own a lot of real estate.

In August 2005, Heebner doubled down on commodities by taking big stakes in copper miners Southern Copper and Phelps Dodge. The price of copper— and of copper stocks— doubled in a little over a year. In November 2006 he built large positions in fertilizer companies Mosaic and Potash Corp. of Saskatchewan. This time the stocks quadrupled. In October 2005 he shorted mortgage lender Countrywide. Heebner was early on that one, but he stuck with the short for two years, and his conviction was rewarded in 2007 when Countrywide collapsed from $40 to $8. By then, Heebner had short positions in three more drain-circling mortgage lenders: BankUnited, IndyMac, and FirstFed Financial.

Not every one of his moves worked out so well, of course. But Kemp, Heebner's longtime mentor and colleague dating back to their days at Loomis Sayles in the 1970s, says that one of Heebner's many strengths is knowing when to cut his losses. "A lot of fund managers fall in love with an idea and ride it all the way down," Kemp says. "Ken's quick to admit when he's wrong." Heebner actually began 2007 with a quarter of Focus's money invested in five Wall Street banks: Bear Stearns (BSC, Fortune 500), Citigroup (C, Fortune 500), Goldman Sachs (GS, Fortune 500), Lehman Brothers (LEH, Fortune 500), and Merrill Lynch (MER, Fortune 500). The holdings could have proved disastrous, but by June— before the credit crisis really snowballed— he was out. "How do you explain genius?" muses Douglas Pratt, a former Invesco fund manager who was an analyst at Loomis. "Ken just sees things others don't."

A League Of His Own

Spend some time with Heebner, and it becomes clear why. His brain is wired differently. His ideas come faster, his focus is more intense, and his ability to sift through massive quantities of information and zero in on what matters is downright spooky. Pity the Salieris of the investing world who have to compete with this guy.

There's no simple formula that captures his investing principles, and explaining his approach is something even Heebner struggles with— which may be why CGM manages only $13 billion (including private accounts), a relatively modest amount given Heebner's track record. Basically, he's the last of the gunslingers— a go-anywhere manager who can be investing in left-for-dead U.S. value stocks one day and red-hot Brazilian growth stocks the next. But he's not just playing hunches. He knows from years of experience, for example, that when steel scrap prices soar— as they have of late— steel stocks usually follow. And Heebner is a workaholic who's up at 5:30 a.m. reading stock reports and checking business news and who never leaves the office at night without a stack of articles and research that make up his bedtime reading.

CGM is pretty much a one-man show. Heebner's entire investment team consists of two traders— Elise Schaefer and Sue Small— and Columb, the U2 fan. Being an analyst for Heebner is a bit like being a beauty consultant for Halle Berry, so Columb knows better than to try to suggest stocks. She operates more like a sleuth. Heebner will ask her to dig up the latest information on, say, scrap steel prices in China or deep-sea oil rig leases, and within an hour or two her findings are on his desk.

These days Heebner is keeping close tabs on the latest economic data out of China, because China is the key to his enormous bet on commodities. As of March, 64% of Focus's assets were invested in commodities-related stocks. His biggest stakes are in steel (ArcelorMittal, Nucor, and United States Steel) and in oil (Apache, Devon Energy, Petrobras, and Schlumberger). Petrobras, the Brazilian oil company that has announced two giant offshore oil discoveries, is his favorite. "Petrobras could become the biggest stock in the world," he says.

Heebner thinks steel prices could double and oil could blow past $200 a barrel. (He also thinks inflation will hit double digits within the next five years: "I don't know why anyone would buy a bond.") Yet he is constantly on the lookout for any sign that the economic slowdown in the U.S. may be infecting emerging economies abroad. That would deep-six his whole investment thesis, which hinges on China and other emerging nations using more energy and building more infrastructure. "I'm not waiting for Morgan Stanley to tell me there's something wrong in China," Heebner says. "By then it's too late."

One oil expert Heebner has consulted is Matthew Simmons, a Houston-based investment banker who's become the oracle of "peak oil" since his book Twilight in the Desert was published in 2005. Twilight argues that Saudi Arabia is running out of oil faster than we think, and Heebner's own research leads him to the same conclusion.

Simmons says he first met with Heebner around the time Twilight was going to press. Heebner spread out on CGM's conference room table a map of Ghawar, the world's largest oilfield. "I thought, 'Jesus, most of the people in the money-management business don't have any idea what any of the Saudi Arabian oil fields are called, much less where they are or what their production history is. But Kenny Heebner has a blown-up, detailed map of Ghawar that's better than anything I've ever seen,'" recalls Simmons. "Then he says, 'Let me tell you what I'm hearing.' Turns out he'd been digging up retirees from the oil business and finding people who were willing to talk. About an hour and a half later, I walked out and said, 'That guy is amazing.'" (CGM has become one of Simmons & Co.'s biggest clients.)

Mixing Business With Pleasure

Heebner enjoys his job enormously, which is the key to his longevity. "It's not a business for him, it's a pleasure," says his brother Jeffrey, 70, who ran a home-security business before retiring. Jeff says his brother is truly married to his work, which is why he was happily surprised when Ken got married at age 60. (Ken's wife, Renie, a microcap fund manager at another Boston firm, declined to be interviewed.) In fact, the line between pleasure and obsession sometimes gets a little blurry. Heebner doesn't take vacations, he insists he'll never retire, he knows less about pop culture than my 8-year-old twins (which, come to think of it, may be a good thing), and other than sailing and politics, he has few interests outside the investing world.

Even his morning commute— a half-mile walk from his home on Beacon Hill to Boston's financial district— is spent in deep thought about his stocks and the markets. Arthur Bauernfeind, chairman of Westfield Capital and a friend of Heebner's from their days together at Loomis, recalls once bumping into a snow-covered Heebner on the Loomis elevator on the way to work. When Bauernfeind started making small talk about the wintry weather, an oblivious Heebner looked up and asked, "Is it snowing?"

Heebner's intensity and one-track mind used to come with a volcanic temper, but Janine Hermsdorf, Heebner's head trader until her retirement in December, says he's mellowed with age. That said, the one time you still want to steer clear of him is the Friday before any three-day weekend. "It's like clockwork," says Hermsdorf, who otherwise sings Heebner's praises as a boss and friend. "He'll get agitated because he's not going to be trading for three days."

For better or for worse, the hyperactive trading has always been one of Heebner's calling cards. The turnover rate in CGM Focus, which typically holds 20 to 30 stocks at a time, was a whopping 384% last year, which in theory means he traded enough to buy and sell the entire portfolio nearly four times. Indeed, CGM's trading costs are sufficiently high that Hermsdorf was called on the carpet by one institutional client who, despite CGM's superior returns, was livid about its inflated VWAP, or volume-weighted average price, which is a measure of trading efficiency. "I thought the guy was going to eat me, he was so mad," she says.

Jeff Heebner says that his brother has always been a little obsessed with making a buck— even though spending it has never been his thing. Jeff recalls Ken showing up at Thanksgiving one year in a car so beat up that it was leaking gasoline. And Jeff has repeatedly begged his brother to replace the 45-foot sloop Nunaga— purchased used in 1987— with a new sailboat. "I keep telling him to get something bigger," Jeff says. "I worry he's going to drown in that thing someday."

It's the same story with his office. Located on the 45th floor of a tony Boston high-rise, it boasts a million-dollar view of Boston Harbor. On a clear day you can even see Cape Cod. But the interior looks as though he's barely unpacked. Award plaques sit unhung on the floor. There's a photograph near his desk of Acadia National Park in Maine that's been so bleached out by the sun it's unrecognizable. And while Heebner does have a stylish Kieninger clock on his wall, it doesn't work. "I haven't gotten around to getting it fixed," he says.

Heebner grew up in Philadelphia, the son of George Heebner, a building contractor, and Ruth Heebner, a homemaker. His paternal grandfather was a farmer in Pennsylvania Dutch country, where the town of Heebnerville bears the family name. Heebner inherited his work ethic as well as his love of sailing from his dad. George, Ken, Jeff, and youngest brother Donald would go on weekend excursions on their 42-foot boat, but Ken was the only Heebner boy who truly loved being out on the open water. A reluctant sailor himself, Jeff recalls a particularly harrowing voyage across Chesapeake Bay when they got caught in a storm. "I'm looking for the life preserver," he says. "And I look back at Ken, and he's kneeling on the seat with the steering wheel in his hand, smiling ear to ear. My knees are shaking, and he's having the time of his life."

Heebner was also the family bookworm, and his grades were good enough to take him to Amherst College and then on to Harvard Business School. He is one of a handful of business celebrities from the HBS class of 1965— former IBM CEO Louis Gerstner, consultant Ram Charan, and New England Patriots owner Bob Kraft are some others— but Heebner apparently made little impression on his classmates. "Ken was a very quiet guy," recalls fellow HBS '65 alum John Herrell, former chief administrator of the Mayo Clinic. "He didn't stand out." Adds another Harvard classmate, executive search consultant Tony Price: "There's nothing I recall about Ken that suggested the kind of success he's had as an investor. He was relatively quiet in a group of individuals who were pretty dynamic."

"They didn't know him well enough," counters John Henry (a retired Philadelphia businessman, not the Boston Red Sox owner of the same name), who knew Heebner at both Amherst and Harvard. "Ken did march to his own drumbeat, but he was absolutely brilliant. I never, ever doubted that he was going to be a great investor." Henry, himself a long-time shareholder in Heebner's funds, says what first impressed him about Heebner was a little gambit he had going in finance class. Classmates would bring him silver dollars, which Heebner would exchange for dollar bills. Says Henry: "Ken was hoarding silver dollars on the idea that silver was going to keep appreciating, which would eventually force the Treasury to stop issuing new silver coins." And that's exactly what happened. "It was funny as hell— he'd be sitting there with piles of silver dollars on his desk— but Ken had it nailed," Henry says. "He saw something the rest of us didn't. That's Ken— that's always been Ken."

Asked about the silver dollars, Heebner smiles and reveals that it was more than a lark for him. At one point he'd accumulated 13,000 silver dollars and had even taken out a bank loan to help finance his little venture. "The Treasury had these uncirculated silver dollars in bags in vaults. You could walk in with a thousand dollars, and they'd give you a bag of 1,000 silver dollars." It's still the best deal he's ever seen, he says: "You couldn't lose, but you could make a lot." Heebner figures he eventually netted around $15,000, but he was less successful when he tried to parlay his experience into a term paper about why silver prices were going up: "I didn't get a very good grade."

After getting his MBA, Heebner wanted to go to work on Wall Street as an investment banker. Nobody would hire him. "I think my energy level back then was so high that I just made people uneasy," he says. Heebner eventually took a position at the economic forecasting firm A&H Kroeger, where he spent four years and honed his ability to identify trends from reams of data.

Controversial Opinions

Eager to get into the investing world, Heebner thought he'd gotten his big break when Scudder Stevens & Clark hired him as a conglomerate analyst in 1969 and then promoted him to assistant portfolio manager for the Scudder Development fund four years later. Ned Swanberg, who was the fund's lead manager back then, says what he remembers most about Heebner is an idea he never acted on. Heebner returned from a trip to the New Jersey shore with what seemed like a bizarre suggestion: He wanted Scudder to invest in Atlantic City real estate. Atlantic City had fallen on hard times by the early 1970s, but there was talk of bringing in casinos. "I should have listened to him," Swanberg says. "We'd have made a fortune." (Gambling was approved in 1976, setting off a boom.)

Heebner was eventually fired from Scudder, but it had nothing to do with investing. During a three-martini lunch with some colleagues, Heebner made some comments critical of Scudder's CEO, and one of his lunchmates blabbed. "I wasn't a martini drinker," Heebner says. "That was the problem." Scudder's loss proved to be Loomis Sayles's gain. Kemp had just been made chief investment officer at Boston-based Loomis, and one of his first assignments was fixing Loomis's two struggling mutual funds. "Someone told me there was a fellow with some talent at Scudder, but he was loud and talked back," Kemp recalls. "I said, 'I don't care if he talks back, just as long as he has the right answers.'"

Heebner usually did. He took over the Loomis Sayles Capital Development fund (now CGM Capital Development) in 1976 and eventually turned it into Boston's second-hottest mutual fund, after Lynch's Magellan. The investment community in Boston is fairly collegial, and Heebner and Lynch soon became friends. "Peter would talk about Heebner constantly," says Brian Posner, a former Fidelity fund manager who early in his career was one of Lynch's analysts. "Here was a guy with a much more modest organization who kept just punching out the numbers."

In Heebner's early days at Loomis, he was forced to make all his stock picks from a list of 300 names approved by the firm's research department. Heebner was so frustrated by this restriction that he'd occasionally give Lynch stock ideas he wasn't permitted to use himself. Lynch confirms this, adding that in those days he, Heebner, and several other top Boston money managers used to talk stocks at a monthly dinner. Lynch says he even tried to recruit Heebner to Fidelity, an opportunity Heebner says he passed up because he would have been managing separate accounts instead of a mutual fund. "Ken is an incredible fundamental analyst," says Lynch. "He's very thematic, and he stays with things for a very long time, but once he's convinced that something is deteriorating, that's it."

Lynch says he never really thought of himself as competing with Heebner, but evidently that feeling was not mutual. "The day Peter retired, I thought Ken was going to cry," Hermsdorf says. "Ken thought he was catching up to Peter." In 1990, Heebner and Kemp broke from Loomis to form CGM. Or more precisely, they persuaded Loomis's parent company, New England Life, to spin them off. (Natixis, the French bank that acquired New England Life's money management operations, still owns a 50% stake in CGM.) Heebner wanted to leave Loomis largely because other money managers there were piggybacking on his ideas. "I had a good investment record, so obviously if they saw me buying something, they would want to look at it too," he says.

He continued to put up excellent returns until the mid-1990s, when tech stocks started to dominate the market. For Heebner, that was a problem, because he usually shied away from technology. The barriers to entry were too low, and forecasting winners and losers too hard. Focus eked out single-digit gains in both '98 and '99, whereas many rival funds were soaring 40% or 50%. Though Heebner never doubted his decision to steer clear of technology, others (ahem, ahem) weren't so sure. In October 1999, Fortune made Heebner the poster child for fallen fund stars in a story headlined "Where Have All the Geniuses Gone?"

With shareholders pulling money out of his funds, Heebner eventually gave in and bought a handful of tech stocks. But he was always a nervous holder, tending to buy and sell at the wrong times. "I knew it was a train wreck," he says. "The problem I had is that when you go from 50 times earnings to 100 times to 150 times, how do you know when the idiots are going to stop bidding these things up? That's the thing about bubbles— how do you know when they're going to end?"

Of course, skeptics are asking the same question today about commodities. Heebner doesn't see the parallel. He believes that the consensus view on Wall Street is still that the U.S. will drag the rest of the world into a global recession. He thinks that by betting big on oil and steel, he's actually being contrarian. We'll see if he's right. But by the time you read this, it may not even matter. Perhaps one of the Chinese steel prices Heebner tracks will have ticked in the wrong direction. Perhaps one of his Petrobras sources will have told him that the offshore discoveries are so big that they might oversaturate the market. Perhaps by the time you read this Heebner will have done the same about-face on commodities that he did on homebuilders 3 1/2 years ago.

Heebner's friend Bob Molloy, a retired broker from Merrill Lynch, likes to tell the story of the time Heebner took him and some Merrill colleagues sailing after work. "We'd just got out of Boston Harbor and we're about to put up the sails when Ken announces, 'We've got to turn back.' I said, 'What do you mean, we have to turn back? It's a beautiful day.' Ken said, 'Look out there. There's a big bank of fog rolling in.' Well, all I saw was the horizon, but by the time we got back to the slip, you couldn't even see from the cockpit up to the front of the boat— that's how thick the fog was." Like we said, Heebner just sees things before anyone else.

ߧ

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

S&P/Case Shille Price Index

S&P/Case Shiller Home Price Index Reveals Largest Drop In 20-Year History

By RTT Staff Writer | 27 May 2008

(RTTNews)— Home prices plunged at a record pace in the first quarter, data released on Tuesday showed. The S&P/Case-Shiller national home-price index— a closely-watched gauge of housing prices— revealed a 14.4 percent decline from last year. This was the largest drop in the two-decades since the index began recording home prices in 1988. The quarterly index covers the nine U.S. Census divisions. A separate index examining 20-cities around the United States also revealed a decline of 14.4 percent in the first quarter. That index is only 7 years old, making this decline the steepest since its inception in 2001. A smaller, older 10-city index plummeted 15.3 percent— the most in its 20-year history.

David Blitzer, Chairman of the Index committee at Standard & Poor's, commenting on what he called the "steep downturn in residential real estate," adding that "there are very few silver linings that one can see in the data." "Most of the nation appears to remain on a downward path, with 19 of the 20 metro areas reporting annual declines, and six of those now at negative rates exceeding -20%," Blitzer said. The weakest market remains Las Vegas, with an annual decline of 25.9 percent. It is followed closely by Miami and Phoenix, with declines of 24.6 and 23.0 percent, respectively.

On an annual basis, Charlotte is the only market in the 20-city index to see an increase in home prices from last year, gaining 0.8 percent. Fifteen of the 20 metro areas surveyed are reporting record lows, Blitzer said. Eleven of those 20 are in double digit decline. A small dose of good news came from Charlotte and Dallas, which saw monthly price appreciation for the first time in seven months. Charlotte was up 0.2 percent in March over February, and Dallas was up 1.1 percent.

On a month to month basis, nationwide home prices dropped 2.2 percent from February to March, the index showed. The news is the latest in a series of reports that hint at continued problems for the housing market, which is said to be in its worst slump since the Great Depression. Last week, a report from the Office of Federal Housing Enterprise Oversight revealed that U.S. home prices plunged at a record pace in the first quarter. U.S. home prices saw their sharpest decline in the 17 years since the government began tracking home data. OFHEO's seasonally-adjusted purchase-only house price index fell 3.1 percent from last year, and declined 1.7 percent from the fourth quarter— the largest quarterly drop on record. Between the third and fourth quarters of 2007, home prices fell 1.4 percent.

"These substantial home price declines bring positive and negative news," said OFHEO's Managing Director James Lockhart said in a statement. "For homeowners and financial market observers, these declines spell further erosion in home equity levels and potentially more trouble for mortgage markets," he explained. "To prospective home buyers who have been shut out of homeownership because of affordability constraints, these declines may be welcome news, as are continued low mortgage rates." The lingering supply overhang is forcing prices down, the OFHEO's Chief Economist Patrick Lawler said.

"The large overhang of real estate inventory awaiting sale continues to force price declines in many areas, but particularly in places that had seen very sharp appreciation in previous periods," he said in a statement. Last week, Federal Reserve Vice Chairman Donald Kohn warned of further problems for the housing market. "The demand for housing continued to decline early this year, and sales could fall even further in coming months, given the tightness in mortgage lending," he said. The housing market could see further decline, Kohn said, although he noted that eventually low prices will likely lead to increased demand [[really definite and committal, isn't he?: normxxx]]

"All prominent measures of house prices are now showing declines," he noted. "Although lower prices would eventually help bolster housing demand, the expectations of further declines in prices may currently be exacerbating the difficulties in housing markets." Specifically, Kohn cited the lingering overhang in supply which has weighed heavily on the housing market, dragging down home prices across the country. "The supply of existing homes on the market also remains quite high and is likely to be augmented in coming months by rising foreclosures," he added. "As a result, further cuts in construction appear to be in train."

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Crash!?!

Crash! (Version 2.0)

By Dr. Housing Bubble, | 27 May 2008

I am a big fan of Frederick Lewis Allen who has written extensively on the historical, social, and economic circumstances of the early half of the last century. For those of you who want to see where we are heading, we need to have a wider scope than just the last few decades. It seems that people don't much care about history yet are quite willing to accept a repeat. This is a chapter titled Crash! that gives an amazing account of the days and time surrounding the crash of 1929:

Only Yesterday: An Informal History of the 1920's (Perennial Classics) (Paperback)
by Frederick L. Allen

[1929] Early in September the stock market broke. It quickly recovered however; indeed, on September 19th the averages as compiled by the New York Times reached an even higher level than that of September 3rd. Once more it slipped, farther and faster, until by October 4th the prices of a good many stocks had coasted to what seemed first-class bargain levels. Steel, for example, after having touched 261 3/4 a few weeks earlier, had dropped as low as 204; American Can, at the closing on October 4th, was nearly twenty Points below its high for the year; General Electric was over fifty points below -its high; Radio had gone down from 114 3/4 to 82 1/2.

A bad break, to be sure, but there had been other bad breaks, and the speculators who escaped unscathed proceeded to take advantage of the lessons they had learned in June and December of 1928 and March and May of 1929: when there was a break it was a good time to buy. In the face of all this tremendous liquidation, brokers’ loans as compiled by the Federal Reserve Bank of New York mounted to a new high record on October 2nd, reaching $6,804,000,000— a sure sign that margin buyers were not deserting the market but coming into it in numbers at least undiminished. (Part of the increase in the loan figure was probably due to the piling up of unsold securities in dealers, hands, as the spawning of investment trusts and the issue of new common stock by every manner of business concern continued unabated.)

History, it seemed, was about to repeat itself, and those who picked up Anaconda at 109 3/4 or American Telephone at 281 would count themselves wise investors. And sure enough, prices once more began to climb. They had already turned upward before that Sunday in early October when Ramsay MacDonald sat on a log with Herbert Hoover at the Rapidan camp and talked over the prospects for naval limitation and peace.

Something was wrong, however. The decline began once more. The wiseacres of Wall Street, looking about for causes, fixed upon the collapse of the Hatry financial group in England (which had led to much forced telling among foreign investors and speculators), and upon the bold refusal of the Massachusetts Department of Public Utilities to allow the Edison Company of Boston to split up its stock. They pointed, too, to the fact that the steel industry was undoubtedly slipping, and to the accumulation of "undigested" securities. But there was little real alarm until the week of October 21st. The consensus of opinion, in the meantime, was merely that the equinoctial storm of September had not quite blown over. The market was readjusting itself into a "more secure technical position."

[It is clear from anyone that has studied the Great Depression, that not one event collapsed the market. It was like a tipping point that finally catapulted the market downward. Interestingly enough, a major financial group had indeed collapsed in England and also, a public utility company was not allowed to split its stock {doesn’t it seem familiar that these two parallel with Bear Stearns being bailed out and also, the proposed splitting up of the monolines?}. Either way, the market in early 1929 had already had a few incidents where the market declined only to be propped back up by massive speculation. The speculation was so spectacular, indeed, that even at the last minute, investors were still pushing stocks up. And of course, it almost seemed unfathomable that the market could or would collapse. Even the prophets of Wall Street couldn’t envision such a scenario.]

In view of what was about to happen, it is enlightening to recall how things looked at this juncture to the financial prophets, those gentlemen whose wizardly reputations were based upon their supposed ability to examine a set of graphs brought to them by a statistician and discover, from the relation of curve to curve and index to index, whether things were going to get better or worse. Their opinions differed, of course; there never has been a moment when the best financial opinion was unanimous.

In examining these opinions, and the outgivings of eminent bankers, it must furthermore be acknowledged that a bullish statement cannot always be taken at its face value: few men like to assume the responsibility of spreading alarm by making dire predictions, nor is a banker with unsold securities on his hands likely to say anything which will make it more difficult to dispose of them, unquiet as his private mind may be. Finally, one must admit that prophecy is at best the most hazardous of occupations. Nevertheless, the general state of financial opinion in October, 1929, makes an instructive contrast with that in February and March, 1928, when, as we have seen, the skies had not appeared any too bright.

Some forecasters, to be sure, were so unconventional as to counsel caution. Roger W. Babson, an investment adviser who had not always been highly regarded in the inner circles of Wall Street, especially since he had for a long time been warning his clients of future trouble, predicted early in September a decline of sixty or eighty points in the averages. On October 7th the Standard Trade and Securities Service of the Standard Statistics Company advised its clients to pursue an "ultraconservative policy," and ventured this prediction: "We remain of the opinion that, over the next few months, the trend of common-stock prices will be toward lower levels."

Poor’s Weekly Business and Investment Letter spoke its mind on the "great common-stock delusion" and predicted "further liquidation in stocks." Among the big bankers, Paul M. Warburg had shown months before this that he was alive to the dangers of the situation. These commentators— along with others such as the editor of the Commercial and Financial Chronicle and the financial editor of the New York Times— would appear to deserve the 1929 gold medals for foresight."

[It is often cited that no one really foresaw the crash of 1929— there were a handful of people that were echoing a warning cry— but how many people listened? Even though their predictions were rather more modest than outright bearish, yet they were still not given the time of day. But of course you now have your perpetual housing bulls.]

Professor Irving Fisher, however, was more optimistic. In the newspapers of October 17th he was reported as telling the Purchasing Agents Association that stock prices had reached "what looks like a permanently high plateau." He expected to see the stock market, within a few months, "a good deal higher than it is today." On the very eve of the panic of October 24th he was further quoted as expecting a recovery in prices. Only two days before the panic, the Boston News Bureau quoted R. W. McNeel, director of McNeel’s Financial Service, as suspecting "that some pretty intelligent people are now buying stocks… Unless we are to have a panic— which no one seriously believes— stocks have hit bottom," said Mr. McNeel.

As for Charles E. Mitchell, chairman of the great National City Bank of New York, he continuously and enthusiastically, radiated sunshine. Early in October Mr. Mitchell was positive that, despite the stock-market break, "The industrial situation of the United States is absolutely sound and our credit situation is in no way critical… The interest given by the public to brokers’ loans is always exaggerated," he added. "Altogether too much attention is paid to it."

A few days later Mr. Mitchell spoke again: "Although in some cases speculation has gone too far in the United States, the markets generally are now in a healthy condition. The last six weeks have done an immense amount of good by shaking down prices… The market values have a sound basis in the general prosperity of our country." Finally, on October 22nd, two days before the panic, he arrived in the United States from a short trip to Europe with these reassuring words: "I know of nothing fundamentally wrong with the stock market or with the underlying business and credit structure… The public is suffering from ‘brokers’ loanitis."

[In these types of situations, be careful whom you listen to. The CEO of Bear Stearns as early as 2 days before his company was bailed out by the Federal Reserve was quoted in the news as follows: 'New Chief Executive Alan Schwartz appeared on CNBC Wednesday to allay fears that the firm faces a liquidity crisis, a perception heightened by the Federal Reserve’s decision on Tuesday to loan up to $200 billion in Treasury bonds to primary dealers, a move that would allow Bear to swap some of its mortgage-backed securities for more secure debt.' "Our balance sheet has not weakened at all," said Schwartz, noting that Bear’s $17 billion cash position was the same as it had been in November. On Monday, the company posted a similar message on its web site: "The company stated that there is absolutely no truth to the rumors of liquidity problems that circulated today in the market." So much for not having a weak balance sheet. In 2 days Bear Stearns lost 40 percent of its market value. In these times, even those perceived as experts have a motivation to keep the pretense up that all is well. Clearly as CEO, one entitled to expect that you would have a better sense of your company’s situation. I still think we have yet to see the break point where the market trends fully lower. During 1929 that moment came in late October.]

The next day was Thursday, October 24th.

On that momentous day stocks opened moderately steady in price, but in enormous volume. Kennecott appeared on the tape in a block of 20,000 shares, General Motors in another, of the same amount. Almost at once the ticker tape began to lag behind the trading on the floor. The pressure of selling orders was disconcertingly heavy. Prices were going down… Presently they were going down with some rapidity… Before the first hour of trading was over, it was already apparent that they were going down with an altogether unprecedented and amazing violence. In brokers’ offices all over the Country, tape-watchers looked at one another in astonishment and perplexity. Where on earth was this torrent of selling orders coming from?

The exact answer to this question will probably never be known. But it seems probable that the principal cause of the break in prices during that first hour on October 24th was not fear. Nor was it short selling. It was forced selling. It was the dumping on the market of hundreds of thousands of shares of stock held in the name of miserable traders [[today's hedge funds and SIVs?: normxxx]] whose margins were exhausted or about to be exhausted. The gigantic edifice of prices was honeycombed with speculative credit and was now breaking under its own weight.

Fear, however, did not long delay its coming. As the price structure crumbled there was a sudden stampede to get out from under. By eleven o’clock traders on the floor of the Stock Exchange were in a wild scramble to "sell at the market." Long before the lagging ticker could tell what was happening, word had gone out by telephone and telegraph that the bottom was dropping out of things, and the selling orders redoubled in volume. The leading stocks were going down two, three, and even five points between sales. Down, down, down…. Where were the bargain-hunters who were supposed to come to the rescue at times like this?

Where were those investment trusts, which were expected to provide a cushion for the market by making new purchases at low prices? Where were the big operators who had declared that they were still bullish? Where were the powerful bankers who were supposed to be able at any moment to support prices? There seemed no support whatever. Down, down, down. The roar of voices which rose from the floor of the Exchange had become a roar of panic.

United States Steel had opened at 205 1/2. It crashed through 200 and presently was at 193 1/2. General Electric, which only a few weeks before had been selling above 400, had opened this morning at 315— now it had slid to 283. Things were even worse with Radio: opening at 68 3/4, it had gone dismally down through the sixties and the fifties and forties to the abysmal price of 44 1/2. And as for Montgomery Ward, vehicle of the hopes of thousands who saw the chain store as the harbinger of the new economic era, it had dropped headlong from 83 to 50. In the space of two short hours, dozens of stocks lost ground which had required many months of the bull market to gain.

Even this sudden decline in values might not have been utterly terrifying if people could have known precisely what was happening at any moment. It is the unknown which causes real panic.

[Amazingly, it seems like the fire that lit the fuse was forced selling in October 1929. The current catalyst of this market is the forced liquidation of many companies and 'margin calls' are now starting to creep back into the lexicon of the market. Without credit, the system cannot function— just as a Ponzi Scheme cannot go on without increasingly greater numbers of new players [[just like the housing market: normxxx]]. Once the buyers (credit) dries up, the gig is up. It wouldn’t be a problem if companies were adequately capitalized but everone is leveraged to the hilt and really have no viability without access to credit. That [greed] is their mistake. Just like the many unable to save during the good times for the inevitable future downturn. Those that claim we will not have a recession need their heads examined. Even after the "crash" the market had a few short rallies until it finally capitulated.]

The New York Times averages for fifty leading stocks had been cut almost in half, falling from a high of 311.90 in September to a low of 164.43 on November 13th; and the Times averages for twenty-five leading industrials had fared still worse, diving from 469.49 to 220.95.

The Big Bull Market was dead. Billions of dollars’ worth of profits-and paper profits-had disappeared. The grocer, the window-cleaner, and the seamstress had lost their capital. In every town there were families who had suddenly dropped from showy affluence into penury. Investors who had dreamed of retiring to live on their fortunes now found themselves back once more at the very beginning of the long road to riches. Day by day the newspapers printed the grim reports of 'celebrity' suicides.

Coolidge-Hoover Prosperity was not yet dead, but it was rapidly dying. Under the impact of the shock of panic, a multitude of ills which hitherto had passed unnoticed or had been offset by stock-market optimism began to beset the body economic, as poisons seep through the human system when a vital organ has ceased to function normally. Although the liquidation of nearly three billion dollars of brokers’ loans contracted credit, the Reserve Banks lowered the rediscount rate, and the way in which the larger banks and corporations of the country survived the emergency without a single failure of significant proportions offered real encouragement.

[ Normxxx Here:  That was in 1929. The major bank failures were to begin the next year, 1930, with the failure of the N.Y. Bank of the United States, and finally peak by the end of 1932, by which time, every significant state had declared a "bank holiday" of one kind or another— except Nevada, which only had two banks of significance.  ]

Nevertheless the social and economic poisons were there, soon to become readily evident; overproduction of capital equipment; overambitious expansion of business concerns; overproduction of commodities under the stimulus of installment buying and buying with stock-market profits; the maintenance of an artificial price level for many commodities, the depressed condition of European trade. No matter how many soothsayers of high finance proclaimed that all was well, no matter how earnestly the President set to work to repair the damage with soft words and White House conferences, a major depression was inevitably under way.

Nor was that all. Prosperity is more than an economic condition: it is also a state of mind. The Big Bull Market had been more than the climax of a business cycle; it had been the climax of a cycle in American mass thinking and mass emotion. There was hardly a man or woman in the country whose views and attitude toward life had not been enlivened by the booming '20s in some degree and was not now affected by the sudden and brutal shattering of those grandiose visions. With the Big Bull Market gone and prosperity rapidly following, Americans were very soon to find themselves living in an altogether unexpected world which called for new adjustments, new ideas, new habits of thought, and a new set of values. The psychological climate was changing; the ever-shifting currents of American life were turning into new channels.

The Post-WW I war Decade had come to its close. An era had ended."

[It is only a matter of time before our current era of easy credit and new el Dorado ends. The question remains only of when it will happen.]

ߧ

Normxxx    
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The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

They're Wrong About Oil

They're Wrong About Oil, By George
Rip Up Your Textbooks, The Doubling Of Oil Prices Has Little To Do With China's Appetite

By Anatole Kaletsky, TimesOnline | 25 May 2008

Just as the credit crunch seemed to be passing, at least in the US, another and much more ominous financial crisis has broken out. The escalation of oil prices, which this week reached a previously unthinkable $130 a barrel (with predictions of $150 and $200 soon to come), threatens to do far more damage to the world economy than the credit crunch. Instead of just causing a brief recession, the oil and commodity boom threatens a prolonged period of global "stagflation", the lethal combination of high inflation and economic stagnation last seen in the world economy in the 1970s and early 1980s. This would be a disaster far more momentous than the repossession of a few million homes or collapse of a couple of banks.

Commodity inflation is far more lethal than a credit crunch for two reasons. It prevents central banks in advanced economies from cutting interest rates to keep their economies growing. Even worse, it encourages the governments of developing countries to turn their backs on global markets, resorting instead to price controls, trade restrictions and currency manipulations to protect their citizens from the rising costs of energy and food. For both these reasons, the boom in oil and commodity prices, if it lasts much longer, could reverse the globalisation process that has delivered 20 years of almost uninterrupted growth to America and Europe and rescued billions of people from extreme poverty in China, India, Brazil and many other countries.

That is the bad news. The good news is that the world is not as impotent as is often suggested in the face of this danger, since soaring commodity prices are not the ineluctable outcome of some fateful conjuncture of global economic forces, but rather the product of a typical financial boom-bust cycle, which could be deflated— especially with some help from sensible political action— as quickly as it built up.

The present commodity and oil boom shows all the classic symptoms of a financial bubble, such as Japan in the 1980s, technology stocks in the 1990s and, most recently, housing and mortgages in the US. But surely, you will say, this commodity boom is different? Surely it is driven by profound and lasting changes in global supply and demand: China's insatiable appetite for food and energy, geopolitical conflicts in the Middle East, the peaking of global oil reserves, droughts caused by global warming and so on. All these fundamental points are perfectly valid, but they tell us nothing about whether the oil price will soon jump to $200, stay at $130 or fall back to $60 next month.

To see that these "fundamentals" are all irrelevant, we have merely to ask which of them has changed in the past nine months. The answer is none. The oil markets didn't suddenly discover China's oil demand nine months ago so this cannot explain the doubling of prices since last August. In fact, China's "insatiable" demand growth has decelerated. In 2004 it was consuming an extra 0.9 million barrels a day; in 2007 it was consuming just an extra 0.3 mbd. In the same period global demand growth has slowed from 3.6 mbd to 0.7 mbd. As a result, the increase in global demand growth is now well below last year's increase of 0.8 mbd in non-Opec production, according to Mike Rothman, of ISI, a leading New York consulting group.

Why, then, are commodity prices still rising? The first point to note is that many no longer are. Rice, wheat and pork are 20 to 30 per cent cheaper than they were two months ago, when financial pundits identified Asian and African food riots as the first symptoms of a commodity "super-cycle" that would drive prices much higher. And the price of industrial commodities such as lead, zinc and nickel, supposedly in short supply a year ago, has now dropped by 40 to 60 per cent. In fact, most major commodity indices would already be in a downtrend were it not for the dominance of oil.

But oil is the commodity that really matters and surely the latest jump in prices proves that demand really does exceed supply? Not at all. In the late stages of financial bubbles, it is quite normal for prices to become completely detached from economic fundamentals. House prices in Florida and Spain kept rising even after property developers built far more homes than they could possibly sell. The same thing happened in credit markets: mortgage securities kept rising even while banks created "special purpose vehicles" to acquire vast "inventories" of bonds for which there were no genuine buyers— and dozens of similar examples can be cited from the bubbles in internet stocks and Japan. Similarly, the International Gold Council reported this week that gold demand for commercial uses and investment fell 17 per cent in January, just as the gold price surged through $1,000 for the first time.

Now consider the situation today in oil markets: the Gulf, according to Mr Rothman, is crammed with supertankers chartered by oil-producing governments to hold the inventories of oil they are pumping but cannot sell. That physical oil is in excess supply at today's prices does not mean that producers are somehow cheating by storing their oil in tankers or keeping it in the ground. All it suggests is that there are few buyers for physical oil cargoes at today's prices, but there are plenty of buyers for pieces of paper linked to the price of oil next month and next year. This situation is exactly analogous to the bubble in credit markets a year ago, where nobody wanted to buy sub-prime mortgage bonds, but there was plenty of demand for "financial derivatives" that allowed investors to bet on the future value of these bonds.

In short, the standard economic assumption that supply and demand drive prices is only a starting point for understanding financial markets. In boom-bust cycles, the textbook theory is not just slightly inaccurate but totally wrong. This is the main argument made by George Soros in his fascinating book on the credit crunch, The New Paradigm for Financial Markets, launched at an LSE lecture last night. In this book Mr Soros explains how financial bubbles always start with some genuine economic transformation— the invention of the internet, the deregulation of credit or the rise of China as a commodity consumer.

He could have added the Netherlands' emergence as a financial centre (and world naval power) triggering Tulipmania, or Britain's emergence as a dominant global naval power before the South Sea Bubble of 1720. The trouble is that these initial perceptions of a new paradigm tell us nothing about how far financial prices will adjust in response— will Chinese demand drive oil prices to $50 or $100 or $1,000? Instead they can create a self-fulfilling momentum of rising prices and an inbuilt bias in the way that investors interpret the world. The resulting misconceptions drive market prices to a "far from equilibrium position" that bears almost no relation to the balance of underlying supply and demand.

The people who tell you that commodity prices today are driven by "economic fundamentals" are the same ones who said that house prices in Britain were rising because of land shortages. The amazing thing is that just months after losing hundreds of billions in the housing and mortgage bubbles, investors and governments around the world have reverted to the discredited fallacy that financial markets always reflect economic reality, instead of the boom-bust cycles and misconceptions that George Soros's book vividly describes.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Inflation: An Old Enemy Back Again

The World Economy: Inflation's Back
Double-Digit Price Rises Are About To Afflict Two-Thirds Of The World's Population

From The Economist Print Edition | 22 May 2008

Ronald Reagan once described inflation as being "as violent as a mugger, as frightening as an armed robber and as deadly as a hit-man". Until recently, central bankers thought that this thug had been locked up for life. Thanks to sound monetary policies, inflation worldwide had stayed low in recent years. But the mugger is back on the prowl. Even though America is close to recession and growth in other developed economies has slowed, inflation is rising. Jean-Claude Trichet, president of the European Central Bank, this week gave warning about the mistakes of the 1970s, when inflation was let loose at huge cost to growth.

His words were aimed at rich-country central banks, but policymakers in emerging economies are the ones who should most take heed. In countries such as China, India, Indonesia and Saudi Arabia even the often dodgy official statistics show prices have risen by 8-10% over the past year; in Russia the rate is over 14%; in Argentina the true figure is 23% and in Venezuela it is 29%. If you measure the numbers correctly, two-thirds of the world's population will probably suffer double-digit rates of inflation this summer (see article).

A 1970s reunion you really don't want to attend

Taken as a whole (and using official figures), the average world inflation rate has risen to 5.5%, its highest since 1999. The main cause has been the surge in the prices of food and oil, which briefly soared above $135 a barrel this week. But Mr Trichet's concern is that higher headline rates could push up inflation expectations, leading to bigger pay demands, and so trigger a wage-price spiral, as in the 1970s. Central bankers' mistake then was to hold monetary policy too loose, so that higher oil prices quickly fed into other prices. So it is worrying that global monetary policy is now at its loosest since the 1970s: the average world real interest rate is negative.

By slashing interest rates as inflation has climbed, has the Fed sowed the seeds of a new inflationary era? That case looks hard to prove in the rich world. Inflation rates of 3.9% in America and 3.3% in the euro area are far higher than central banks want, and inflation expectations are rising. If growth in the euro area remains robust, the ECB should certainly worry more about inflation. Yet so far there is little sign that higher food and oil prices are pushing up other prices in the rich economies.

Wages have remained relatively subdued and core rates of inflation (excluding food and energy) are little higher than a year ago. Moreover, growth is expected to be below trend in America and Europe over the next year or so and unemployment is likely to climb, which will help to curb wage rises. America's consumer-confidence index has fallen to a 28-year low, which suggests that consumer spending will fall. This, in turn, will spur firms to cut costs and limit pay rises.

The picture is very different in emerging countries. Prices are rising much faster partly because food accounts for a bigger chunk of their consumer-price indices. But wages (rising at nearly 30% a year in Russia) and core-inflation rates are also accelerating. Many of these economies are operating close to full capacity, where inflation is more likely to take hold.

There are alarming similarities between emerging economies today and the rich world in the 1970s when the Great Inflation lifted off. Many policymakers in emerging markets view the rise in inflation as a short-term supply shock and so see little need to raise interest rates. Instead they are using price controls and subsidies to cap prices. Money supplies are growing almost three times as fast as in the developed world. Many central banks are still not fully independent. And inflationary expectations are not properly anchored, increasing the risk of a wage-price spiral. Emerging markets may as well be inviting the muggers into their own homes.

Watch your back

Rising inflation, like so much of the world economy in recent years, can be explained partly by the increasingly complex links between developed and emerging economies. Emerging economies shared some responsibility for America's housing and credit bubble. As Asian economies and Middle East oil exporters ran large current-account surpluses, they piled up foreign reserves (mostly in American Treasury securities) in order to prevent their currencies from rising. This pushed down bond yields. At the same time, cheap imports from China and elsewhere helped central banks in rich economies hold down inflation while keeping short-term interest rates lower than in the past. Cheap money fuelled America's bubble.

Now that this bubble has burst, the cross-border monetary stimulus has changed direction. As the Fed has cut interest rates, emerging economies that link their currencies to the dollar have been forced to run a looser monetary policy, even though their economies are overheating. Emerging economies with currencies most closely aligned to the dollar, notably in Asia and the Gulf, have seen the biggest price rises. Countries, such as Mexico, that have more flexible exchange rates and are more committed to inflation targets have done better.

Even if the Fed's interest rate suits the American economy, global interest rates are too low. In turn, the unwarranted stimulus to demand in emerging economies is further pushing up commodity prices; so too is speculative buying by investors seeking higher returns than from bond yields, which are still being depressed by the emerging economies' build-up of reserves. This stokes inflationary pressures in America and Europe and makes life difficult for rich-country central banks.

Loose money in America and rigid exchange rates in emerging economies are a perilous mix. The longer emerging economies hold down their exchange rates, the greater the risk of rising global inflation. Admittedly, exchange-rate appreciation is not as simple a remedy for emerging economies as some claim: a rise in interest rates and the expectation of a further appreciation in the exchange rate could, perversely, exacerbate inflation by sucking in more capital; and setting the exchange rate free risks massive overvaluation. But with an economic serial killer on the loose, one way or another monetary policy will have to tighten and exchange rates rise.


Inflation In Emerging Economies: An Old Enemy Rears Its Head
Emerging Economies Risk Repeating The Same Mistakes That The Developed World Made In The Inflationary 1970s

From The Economist Print Edition | 22 May 2008

Even as America's economy teeters on the brink of recession and many European economies are slowing, central bankers in rich countries fear rising inflation. Yet the risks they face are smaller than those in emerging economies, where inflation has risen far more over the past year to its highest for nine years. There are also an alarming number of similarities between developing economies today and developed economies in the early 1970s, when the Great Inflation took off. Are the young upstarts heading for trouble?

China's official rate of consumer-price inflation is at a 12-year high of 8.5%, up from 3% a year ago (see chart 1). Russia's has leapt from 8% to over 14%. Most Gulf oil producers also have double-digit rates. India's wholesale-price inflation rate (the Reserve Bank's preferred measure) is 7.8%, a four-year high. Indonesian inflation, already 9%, is likely to reach 12% next month, when the government is expected to raise the price of subsidised fuel by 25-30%.

Inflation in Latin America remains low relative to its ignominious past. Even so, Brazil's rate has risen to 5% from less than 3% early last year. Chile's has leapt from 2.5% to 8.3%. Most alarming are Venezuela, where the rate is 29.3%, and Argentina. Officially, Argentina's inflation rate is 8.9%, but few economists believe the numbers. Morgan Stanley estimates that the true figure is 23%, up from 14.3% last year.

Indeed, official figures understate inflationary pressures in many emerging economies. Widespread government subsidies and price controls are one reason, and price indices are often skewed by a lack of data or government cheating. China's true inflation rate may be higher because the consumer-price index does not properly cover private services. Delays in data collection in India can mean big revisions to inflation: the final number for early March was almost two percentage points higher than the original. The latest wholesale-price inflation rate might therefore be pushed up to 9-10%. If measured correctly, five of the ten biggest emerging economies could have inflation rates of 10% or more by mid-summer. Two-thirds of the world's population may then be struggling with double-digit inflation.

The recent jump has been caused mainly by surging oil and food prices. For example, in China food prices have risen by 22% in the past year, whereas non-food prices have gone up by only 1.8%. Governments have responded with more price controls and export bans. India's government has suspended futures trading in several commodities, which it blames (wrongly) for high prices. In the short run such measures may help to cap inflation and avoid social unrest, but in the long run they do more harm than good. Preventing prices from rising reduces the incentive for farmers to increase supply and for consumers to curb demand, prolonging the very imbalance that has stoked prices.

Some central banks, including those in Brazil, Indonesia and Russia, have nudged up interest rates this year. But they have not kept pace with inflation, so real rates have fallen and are now negative in most countries, with a few exceptions such as Brazil, Mexico and South Korea. China's real lending rate is minus 1%. Russia's main policy rate of 6.5% is almost eight percentage points below its inflation rate.

Many policymakers in emerging economies argue that serious monetary tightening is not warranted: higher inflation, they say, is due solely to spikes in food and energy prices, caused by temporary supply shocks and speculation. Higher interest rates cannot call forth more pigs or grain. They expect inflation to ease later this year as higher prices prompt an increase in supply (food prices have started to edge down over the past month) and as sharp rises in commodity prices drop out of year-on-year comparisons.

Yes, food inflation is likely to slow later this year; but that does not mean rising headline inflation can be ignored. The synchronised jump in global food prices suggests that there is more to the story than disruptions to supply. Prices are also rising partly because loose monetary conditions in emerging economies have boosted domestic demand [[and encouraged cost free hoarding (using interest-free money) for those who have the space to do so: normxxx]]. These economies have accounted for over 90% of the increase in global consumption of oil and metals since 2002 and for 80% of the rise in demand for grain. This partly reflects long-term structural forces, but it is also the product of a money-fuelled cyclical boom. Peter Morgan, of HSBC, says that the initial shock to food prices may have come from the supply side, but the strength of income and money growth helps to validate higher prices. Were monetary conditions tighter, rises in food prices might be offset by declines elsewhere, keeping inflation under control.

Another reason why central banks cannot ignore agflation is that it can quickly spill over into other prices. Food accounts for 30-40% of the consumer-price index in most emerging economies, compared with only 15% in the G7 economies (see chart 2). So food prices weigh more heavily on inflation expectations and hence wage demands than in the rich world. Tighter monetary policy would help anchor expectations and stop higher commodity prices spreading into the wider economy.

Analysis by Goldman Sachs, for 1990-2007, confirms that in emerging markets, higher food prices did seem to push up other prices. In most developed economies the link from food to non-food inflation was statistically insignificant. Besides the larger share of food, this has two causes: central banks' credibility is weaker in most emerging economies, so that inflation expectations are less firmly anchored; and real wages tend to be less flexible. Both increase the risk of a price-wage spiral.

Philip Poole, also of HSBC, says that many emerging economies have run out of spare capacity because investment has not kept pace with economic growth. Hence firms are more likely to pass on cost increases. In both Brazil and India capacity utilisation is at record rates. Brazil's unemployment rate is at its lowest for almost 20 years. China, though, may still have some slack, thanks to strong investment.

The second-round effects of rising food prices are already visible in most economies. Andrew Cates, of UBS, calculates that in both Asia and Latin America the core rate of inflation (ie, excluding food and energy) has risen by one percentage point in the past year, to 3.4% and 6.2% respectively; in eastern Europe it has risen by three points, to 7.4%, largely because Russia is overheating. (In contrast, average core inflation in rich economies has barely budged.) Inflationary expectations are rising and workers clamouring for pay increases. In a survey of inflation expectations in Argentina, the average reply for the next 12 months was 36%. Russian wages are rising at an annual rate of almost 30%.

Turning Off The Tap

Some countries look more prone to rising inflation than others. From an analysis of wages, inflation expectations, demand and capacity pressures, and monetary growth, Mr Cates infers that Argentina, Brazil, India, Russia and the Middle East oil exporters face the biggest risks in the months ahead. Pressures seem less great in China, Mexico, South Korea and Turkey.

Clearly, monetary policy needs to be tightened. Instead, it has in effect been loosened: real interest rates are generally lower than they were a year ago. Short-term interest rates are also unusually low relative to nominal GDP growth (a crude gauge of where rates should be), which implies that monetary policy is very loose (see chart 3). The broad money supply has grown by an average of 20% over the past year in emerging economies, almost three times the pace in the developed world (see chart 4). Russia's money supply has swelled by fully 42%.

Add all this up, and emerging economies bear strong similarities to rich countries in the 1970s, when the Great Inflation took off. A synchronised boom in the world economy has caused commodity prices to surge. Governments have responded with subsidies and wage and price controls. Official statistics understate price pressures. Economies are running at full pelt. Money-supply growth is soaring. Inflation expectations are not anchored and labour markets are fairly rigid, increasing the risk of a spiral in wages and prices.

According to conventional wisdom, the monetary-policy mistakes that caused the Great Inflation are much less likely today because central banks are independent of politicians. But unlike the Federal Reserve and the European Central Bank (ECB), many central banks in emerging economies (notably China, India and Russia) are not fully independent. In another echo of the 1970s, they often face intense political pressure to hold rates low to boost growth and jobs.

Emerging economies are also in danger of repeating the blunder of central bankers in the rich world in the 1970s: they focus on core inflation as a reason for holding interest rates below the headline inflation rate. But negative real interest rates then further boost demand, while rising inflation expectations trigger bigger pay claims. Unless central banks tighten their grip soon, inflationary expectations could surge.

Central banks' monetary independence is also severely constrained by governments' desire to hold down currencies at a time when international capital is highly mobile— a problem the developed world did not face three decades ago. When central banks intervene in the foreign-exchange market to prevent a currency appreciating, they have to print money to buy dollars, which boosts domestic liquidity. The Fed's recent interest-rate cuts have made it even harder for emerging economies to tighten policy. If they raise rates they attract bigger capital inflows, and the extra intervention required to hold down their currency fuels inflation further, defeating the rate rise.

The central banks of both China and India have raised banks' reserve requirements several times this year to try to mop up excess liquidity, but they have left interest rates unchanged. The recent slide in the rupee leaves the Reserve Bank of India with more room to raise rates, but it has been slow to act. Hong Kong and the Gulf states, which still peg their currencies tightly to the dollar, have even been forced to cut interest rates, although their buoyant economies need tighter policy.

You might suppose that a downturn in America would tend to slow the emerging economies, but they have continued to sprint. Although emerging economies may have decoupled from America, their monetary policies have not. As a result, a slowing United States could perversely prove inflationary for them. The more the Fed cuts, the stronger the growth in liquidity and domestic demand in the developing world. In turn, this means higher commodity prices, which further squeeze American incomes and spending, prompting the Fed to push interest rates even lower. One way to regain control of interest rates is to impose tougher temporary restrictions on capital inflows. For example, in March Brazil introduced a 1.5% tax on foreign investment in government bonds. However, most studies suggest that capital controls do not work well in the long term.

To many Western economists and policymakers the solution is simple: emerging economies should allow more flexibility in their exchange rates. This would permit them to raise interest rates, and a stronger currency would help to curb import prices. But the links between exchange rates and inflation are complicated. Stephen Jen, of Morgan Stanley, argues that revaluation could encourage investors to expect further appreciation, which would attract yet more inflows of hot money and so exacerbate inflation. This is the problem that China now faces.

The only way to stem speculative inflows is to revalue a currency by so much that investors do not expect a further rise. But how much is that? Take the yuan. Mr Jen reckons it is already near "fair value" against the dollar, judged by such things as relative productivity growth and the terms of trade. On the other hand, to eliminate China's current-account surplus, the yuan might need to rise by a staggering (and politically unacceptable) 100%.

Mohsin Khan, the IMF's director for the Middle East and Central Asia, made a similar argument last week for the Gulf states. They should not revalue or modify their exchange-rate regimes now, he said, although inflation is high and rising. Any move too small to alter investors' expectations could draw in more short-term capital and add to inflationary pressures.

With capital so mobile and America's monetary policy so loose, emerging economies have no easy fix for inflation. Interest rates clearly need to be raised by a lot, but a tidal wave of capital could either boost domestic liquidity or cause currencies to become overvalued. Brazil has allowed its currency to rise by more than 100% against the dollar over the past five years. This has helped to bring inflation down (though it is now rising again), but the real is now widely thought to be overvalued, pushing the current account back into deficit.

The Only Way Is Up
One solution is to tighten fiscal policy, which would reduce excess demand. Rapid growth in public spending is partly to blame for the excessive growth in Brazil's domestic demand. But fiscal tightening would be hard to justify in China, which already has a budget surplus. A larger surplus would boost domestic saving and hence the country's already large current-account surplus. Either way, emerging economies need to accept that because their productivity growth is faster than the rich world's, their real exchange rates will have to rise over time.

That must mean either a rise in the nominal exchange rate or higher inflation; they cannot escape both. What does higher inflation in emerging economies mean for the rich world? Continued rapid growth in those economies means that the prices of food, energy and raw materials will remain high. In other words this is a permanent relative-price shock, not a temporary one. Yet this does not mean that commodity prices will keep rising at their current pace. Higher prices will encourage increased supply. And even if prices remain at today's levels, the 12-month rate of increase will decline, helping to ease global inflation.

There are also concerns, however, that after many years in which its exports have helped to hold down global prices, China is now exporting inflation in manufactured goods. Figures from America's Bureau of Labour Statistics show that after falling for several years, the prices of imports from China rose by 4.1% in the year to April, the largest 12-month increase since the series started in December 2004.

China's new export?

However, Jonathan Anderson, of UBS, reckons that the sudden spurt in the prices of Chinese goods is misleading. If you look instead at the dollar prices of Chinese re-exports from Hong Kong (a series with a much longer pedigree), mainland export prices have been rising by around 3% a year since 2004. And if export prices have picked up recently this is entirely because of the rise in the yuan against the dollar, not faster inflation in China.

In any case, the impact of China on global inflation depends on differences in price levels between countries, not on the rate of change in its export prices. China has helped to hold down inflation in developed economies because its goods are much cheaper and they are gaining market share, replacing more costly goods. This will remain true for many years. Competition from China also forces local producers to cut their prices and it curbs wage demands in rich countries. As China moves up the value chain it will pull down the prices of a wider range of products. In other words, China will continue to help hold down global prices— although possibly by less than in the past.

The biggest risk from rising inflation lies in emerging economies, not in the developed world. Because food has a much bigger weight in household spending, not only are those economies more prone to a surge in inflation now, but the social and political consequences would also be more severe. This week Jean-Claude Trichet, the ECB's president, warned central banks around the globe not to repeat the mistakes of the 1970s. Back then, emerging economies played a far smaller role in the world than they do now. To maintain their new-found strength, their policymakers need to keep a firm grip on inflation. The longer it is allowed to climb, the greater the danger to future economic growth.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

OIL: Time To Do Something

Time To Do Something About Oil

By Martin Hutchinson | 23 May 2008

The oil price rise of more than $50 per barrel since the Fed started cutting interest rates in September is beginning to get serious. Since the rise of oil import prices alone removes $170 billion from the US economy, more than 1% of Gross Domestic Product, it is both inflationary and highly recession-producing, especially since it has been accompanied by similar rises in other commodity prices. Its full effects have not been seen yet but they’re coming— don’t worry! At some point we are probably going to have to do something about it. The question is: what?

In general, the populist clamor to "do something" about a sharp move in commodity prices makes no sense. The price mechanism acts as a shock absorber for supply and demand hiccups, so that if storms shut down the Gulf oil platforms or rapid growth in China causes its use of automobiles to soar, oil price rises can signal to other consumers to cut back consumption and to producers to enter into new exploration projects. That’s why the fuel subsidies in Third World countries are foolish— they encourage the consumption of a substance that is increasingly scarce and at times like the present impose an appalling burden on local taxpayers or the government’s financing mechanisms (as in India, where government deficits threaten to derail that country’s magnificent economic boom.)

While oil prices were rising from $20 to $80 per barrel in 2002-07, this rationale seemed unquestionable. The rise was gradual, and the price remained well within the parameters that the world economy had survived, albeit with some difficulty, in the early eighties. (Although the peak 1980 price of $40 per barrel was equivalent to about $105 in today’s dollars, that peak was ephemeral; the major economic effect of expensive oil came from the roughly six years of oil prices hovering around $30— $70-80 in today’s dollars— in 1980-85.)

However the $50 rise since September has been sudden, has taken oil prices to a level never before experienced, and shows no sign of abating. Its principal short term cause has been the excessive lowering of interest rates and relaxation of credit conditions in the United States and elsewhere, but there are a number of long term factors which may make it difficult to reverse.

The International Energy Agency is said to be producing a study showing that future oil supplies will be more restricted than had been thought, topping out at about 100 million barrels per day rather than the 115 million that had been thought necessary to accommodate the world’s growth to 2030. The IEA’s new caution is probably inevitable, given the rise in prices and the considerable uncertainty in reserve and production estimates; it’s mostly a matter of IEA geologists seeing the inexorable rise in prices and deciding to use more pessimistic assumptions about future trends. In any case, since current production is only around 85 million barrels per day, the decline in estimated future production is not an immediate problem. However its psychological effect on the market is considerable.

Whatever the views of the IEA, it should be clear that the recent rise in oil prices is not driven by fundamentals. Economists differ about the price elasticity of oil, but the lowest plausible estimates for short term price elasticity are around 10%, with medium term elasticity being much higher. Thus if oil legend T. Boone Pickens is right that oil supplies are currently 85 million barrels per day and oil demand is 87 million, that is a supply shortfall of 2.4%, which at a 10% elasticity should produce a price increase of 24%, not 60%.

The principal influence behind the huge rise in oil prices has been speculation, whether by the international oil companies, by hedge funds deprived of easy pickings in the housing and equities markets, or by the oil suppliers themselves, drunk with the glory of their new-found wealth. Naturally, easy money provided by Ben Bernanke, Jacques Trichet and the rest of the gang since September has empowered the speculators. Indeed, while real interest rates remain below zero oil speculators would appear to be onto a one-way bet, provided they are rich enough to sustain their buying— and the combined resources of the world’s hedge funds, oil companies and dubious energy-rich Third World dictators are very great indeed. Hence if we do nothing, but continue to focus on housing, consumer inflation and the NBA playoffs, oil prices will continue rising. This will have only a modest short term effect, but a highly damaging effect in the medium term, as the recession-producing tendency of high oil prices works its malign magic on the long-suffering world economy.

Further rises are additionally dangerous because they may not quickly be reversed. In a market of entirely rational trading robots, the 1980 oil price spike to $40 might have been just a spike, with prices reverting within weeks to the $15 or so that was then the equilibrium. In the world of fallible speculators and other humans, the psychology of a rise to $40 made the price "sticky" on the downside at around $30, so that it was November 1985 before prices collapsed to $10. Thus if the oil price soars to $200 next week, we are probably condemned to $150 oil until 2013 or so, after which the price will collapse to $25 for several decades, as new supplies and bizarre and expensive government-mandated conservation schemes overwhelm the market.

To avoid this dreadful fate, what should we do? There are a number of possibilities:

We could invade somewhere. Considered as an oil acquisition exercise, Operation Iraqi Freedom has been a smashing success, and only appalling Wilsonian wimpiness in the US government has prevented the United States from taking full advantage of it. Iraq’s known oil reserves have been increased by about 100 billion barrels since the invasion, as competent US oil companies have been free to explore for new oil employing techniques more advanced than the 40-year-old dowsing sticks used by Saddam’s oil operation. At today’s oil price of $130, less a generous $20 for drilling and extraction, those additional reserves have a value of $11 trillion— approximately 10 times the most alarmist estimate of the cost of the war to date.

The problem is that the US did not secure itself a proper royalty on the new oil finds (even 10% would have been worthwhile— $1.1 trillion over the next few decades.) Nor did it ensure, by setting up a privatized oil company and a trust fund for the Iraqi people diverting oil revenues from the Iraqi government, that the new oil finds would be exploited in an efficient manner and the supplies directed properly into the world oil market. Any future invasion of an oil producing country should avoid these two mistakes and thus make itself self-financing.

The obvious place to invade is Venezuela (even if current estimates of Venezuelan and Saudi reserves are wrong and there is in reality more oil in Saudi Arabia that could be unlocked if ExxonMobil and the boys were given free rein, the Saudis are nominally our allies, so an invasion would be considered unsporting by world opinion.) Since the 1.8 trillion barrels of Venezuelan oil deposits consist largely of the Orinoco tar sands, a Venezuelan oil-related invasion would impose an additional requirement: to keep the environmentalists away, in order that reserves could be exploited with maximum efficiency.

For those who feel that invasion-for-oil is altogether too Bismarckian in its implications, there are other alternatives. The most effective would be to use the interest rate weapon, reversing the damage caused by the cuts since September and ideally going a little further, to fight the resulting consumer price inflation. A series of small interest rate rises would not be effective, because it would enable speculators to adjust. (The seventeen 0.25% rate rises in 2004-06, we now know, were completely ineffective in quelling housing speculation as they allowed the speculating frog to bask in the gradually warming interest rate water, rather than being forced by a sudden temperature rise to jump out of the saucepan.)

The most effective interest rate trajectory would probably be an immediate reversal of the post-September cuts, jumping the Federal Funds rate from 2% back to 5.25%. This would still be too low to be effective in fighting consumer price inflation, currently around 4% even on the suspect government figures. However it should shock commodity speculators sufficiently to cause a sharp drop in oil and commodity prices which might, if we were lucky, become self-reinforcing enough to push oil prices down to the $80 level which is probably the lowest we can currently expect. Once the immediate effect of higher interest rates had worn off, further rate rises, probably to around an 8% Federal Funds rate, would be needed to wring out inflation, but those could be undertaken over the next 18-24 months in the normal manner.

It is quite certain that the interest rate weapon, if used with sufficient vigor, would quell oil prices, but it’s not entirely clear whether a single rise to 5.25% would do it. However draconian rate rises beyond 5.25% to quell oil price rises would be deeply unpopular and would cause further catastrophe in the US housing market. Since invasion is presumably off the table, the political classes may thus attempt to impose other remedies for high oil prices, all of which would be either counterproductive, disastrous or both.

These might include some or all of the following:

• Price controls on oil companies. These would have the cathartic effect of eliminating the profits of Western oil companies, but would have little effect on the market, since the majority of oil supplies are today not controlled by Western oil companies.


• Subsidies. The effect on consumers of spiraling oil prices could be reduced by cutting petroleum taxes (as recently proposed by Senators McCain and Clinton) or subsidizing gasoline prices directly. Such subsidies would increase rather than reduce consumption and would divert income from taxpayers (the ultimate providers of the subsidies) to OPEC and other oil producers. Terrible and counterproductive idea.


• Rationing. Britain did this at the time of the Suez crisis in 1956, when overall rationing was still a recent memory. Its initial psychological effect would be considerable and it might well prove politically appealing to a populist, economically illiterate President after January 2009. The principal gainers from such a measure would be the Mafia, who would find a new business in stolen and forged ration coupons.


• Intensified Corporate Average Fuel Economy standards, ethanol mandates and public transportation subsidies. These would be highly politically attractive to the left, and are thus probably quite likely. Their effect would be far too long term to change short-term price movements. Apart from increasing costs in the economy, they would result in tens of thousands of additional fatalities a year, as the feeble mini-cars took to America’s roads.


• Intensified drilling in Alaska and offshore US areas. The right wing alternative to CAFÉ standards; equally ineffective in the short term but much more helpful long-term. Would probably intensify the 2013 price collapse as the new sources came on stream.


• Closing down the commodities exchanges. The speculators have already found the counter to this one; a new crude oil contract is opening for trading in Dubai. To close that down, we would need to revert to the invasion option.

In summary, a sharp rise in US and world interest rates is the best way to solve the problem of spiraling energy and commodity prices, which will probably not solve itself. If that doesn’t work or is "politically impossible" it’s time to prepare the 82nd Airborne for jungle warfare in the Orinoco Basin.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Pushback

Pushback
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By Richard Berner, Morganstanley | 20 May 2008

"It's time for the human race to enter the solar system." -George W. Bush "It isn't pollution that's harming the environment. It's the impurities in our air and water that are doing it." -George W. Bush

Investors and issuers alike are pushing back on our bearish calls for economies and markets. Small wonder: They are relieved that the economic slowdown has so far been mild both here and abroad, and they hope that a rebound in US and global growth is coming. In the US, the hope is that tax rebates will sustain consumers until the lagged impact of an easier monetary policy bolsters credit-sensitive outlays, especially housing. The rebound in global equity markets over the past two months— ranging from 12% in the US to more than 20% in Japan and some emerging markets— has gone beyond typical bear-market rallies. Thus, it’s critical for us honestly and objectively to acknowledge and vet the bullish case.

But I want to emphasize downside risks for two key reasons: First, my level of conviction in a darker outlook than what seems to be in the price remains high. And second, markets seem priced to a just-right, muddle-through outcome— one that will limit the damage to earnings and also keep the Fed from tightening. Indeed, the view now in the price dismisses some essential ingredients for our base case as mere low-probability tail risks. Thus I agree with our strategy team that it’s time to take some money off the table, perhaps until the economic fallout gains pace.

The bull case has some legitimate props; indeed, we’ve cited some of the factors that underpin it as reasons we expect only a mild downturn. In particular, we have long thought that global growth will hold up relatively well in the developing world; it is primarily the industrial economies that are at risk (see "The Year of Recoupling," Global Economic Forum, February 11, 2008). And an aggressive policy response will limit the downside risks in the US case. Thus, in the wake of the events of mid-March, our strategy team correctly expected bear-market rallies, as officials ensured that the financial firestorm would not spread out of control, even if the economic fallout had yet to arrive (see "The Eye of the Storm," Global Economic Forum, April 7, 2008).

Several factors seem to suggest that the bull case has legs. First, despite all the headwinds, economies are holding up better than expected. Economic activity in the US, Europe and Japan appears to have accelerated in the first quarter, to 1% (revised), 3%, and 3.3%, respectively. Likewise, non-financial US companies reported healthy earnings (10% year-on-year), and the gains were broad based: 8 of 10 sectors rose, 6 of them by double digits, and 62% of S&P 500 firms surprised positively.

In the US, moreover, consumers have slowed spending but haven’t retrenched, capital spending dipped only slightly in the winter quarter, and net exports continue to provide strong support for output. That resilience for US net exports is echoed in domestic demand in many developed and emerging market economies in Asia and Latin America. Indeed, as our global economics team has emphasized, inflation in those economies is by far the bigger problem than growth, and policymakers welcome some slowing to help cap inflation.

Looking ahead, tax rebates for US consumers are arriving in bank accounts and mailboxes, promising at least a one-time lift for consumer spending. At this writing, roughly $30 billion has been distributed to about 30 million households since late April, or nearly one-third of the total to be distributed in the current fiscal year. At that pace, the tax rebates will boost disposable income by roughly 14 percentage points annualized in the second quarter, and may well give a lift to spending sooner than we expected. Inflation, moreover, has remained subdued despite the acceleration in food and energy quotes; we estimate that headline inflation measured by the personal consumption price index (PCEPI) ran at an estimated 2.9% annual rate in the first four months of 2008.

Investors hope that slower growth will help further to offset inflationary forces [[incredible that anyone is still quoting 'official' inflation numbers! : normxxx]] In addition, the credit markets are healing[!?!], hinting that tighter financial conditions may not cripple growth. Moreover, the dollar is stabilizing, potentially helping to cool off commodity prices and arrest their assault on discretionary spending power.

In my view, however, the downside risks outweigh those positives. Financial conditions are still tightening and are only beginning to affect credit-sensitive demand. In housing, the prospective further declines in home prices and associated rise in foreclosures means that writedowns at financial institutions have further to go. We estimate that, measured by the OFHEO purchase-only index that home prices may decline by another 7-10%, and broader indexes likely will show even larger declines. As evidenced in the Fed’s April Senior Loan Officer Survey, those factors are making lenders broadly more cautious; banks tightened lending standards across all loan categories, not just in mortgages.

And as Morgan Stanley Bank analyst Betsy Graseck points out, such lender caution will make it more difficult for borrowers to refinance, implying that bigger losses are coming into 2009 (see Sr. Loan Officer Survey: Less Credit Today Means More Losses Tomorrow, May 8, 2008). Likewise, our credit strategy team thinks that banks and broker dealers in the US and Europe are perhaps two-thirds of the way through the writedowns they will need to take, while provisioning at many banks is only beginning (see A Writedown Writeup, May 13, 2008). Although yield spreads have narrowed significantly in investment-grade debt and leveraged loans, small businesses are reporting that credit is harder to get than at any time since the early 1990s.

Moreover, supply-induced increases in energy and food prices are lifting headline inflation and eroding discretionary income. Indeed, the resulting loss in discretionary income from the start of the year nearly offsets coming tax rebates. With crude quotes at $127/bbl and gasoline apparently headed to $4/gallon, we now estimate that the rise in energy quotes between December 2007 and September 2008 will absorb an annualized $85 billion in US consumer discretionary income, or $15 billion more than two weeks ago, while price hikes in food— a much bigger share of consumer budgets— will drain about $50 billion from wherewithal.

By comparison, the tax rebates that started going out to consumers at the end of April will amount to $117 billion by year-end. Despite stronger-than-expected April retailing results, the combination of falling home prices, tighter credit, slipping employment, and rising food and energy quotes leads us to think that cautious consumers are likely to spend less of their rebates than many assume. Indeed, those April results may indicate that some strapped consumers spent the checks even before they arrived. The recent plunge in canvasses of consumer sentiment hardly seems consistent with buoyant fundamentals.

In addition, cautious businesses, who are beginning to see operating rates slip and profit margins erode, are apt to cut back on capital spending. In that regard, the 180 bp decline in manufacturing operating rates since August (taking out motor vehicles and high-tech industries to remove the influence of the strike in automotive parts) is strong evidence for a weakening in a time-honored support for business investment. Moreover, sources of capex funding are drying up. Slower US and global growth is just starting to hit margins, with a contraction in nonfinancial earnings the most likely outcome.

That will undermine corporations’ ability to use cash flow to fund capital spending. Indeed, nonfinancial corporate external financing needs (capex and inventory accumulation less cash flow) had already risen to 4.3% of comparable GDP in the fourth quarter of 2007. With tighter financial conditions curbing their ability to finance outlays, downside risks to companies’ capital spending are rising. The evidence: Revised data now show an 11.1% decline in nondefense capital goods orders excluding aircraft. Finally, US state and local officials are also turning cautious, tightening their belts in several regions.

This debate on the fundamentals probably won’t be resolved soon. So what should investors do? For risky assets, I think the bulls’ strongest case is that equity valuations don’t seem stretched, debt seems reasonably priced, and with cash on the sidelines, appetite for risk in debt and equities is substantial. The bear case now is that there is a fair amount of good economic and earnings news in the price, so any downside surprises now pose risks. I see that as a recipe for taking profits.

In that context, the muddle-through scenario is the biggest risk to our bearish market call, but it is delicately balanced. In particular, there are a couple of catch-22’s out there for the bulls. If growth fades further, and operating rates continue to slide, that might offer some relief from soaring commodity price hikes. But under those circumstances, operating leverage, pricing power, and profit margins may also crumble. Conversely, if the bulls are right and growth does prove more sustainable, there is a risk that the inflation and interest-rate backdrop will prove significantly less benign than investors believe. Higher inflation and/or interest rates will not be kind to multiples in either US or overseas equity markets.

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

2008: Every Bear Is Doing Well

Tice Proves Every Bear Has A 9.5% Return As He Invokes `D' Word

By Edward Robinson, Bloomberg.Com | 26 May 2008

May 21 (Bloomberg)— Money manager David Tice pokes his head into a conference room at his Dallas offices and tells Doug Noland, his top market strategist, the morning investment meeting is starting. "It's a historic day," Tice says as he disappears down the hall. "This is crazy; just wild." It's March 13, one of the worst days yet in the spiraling credit crisis. Shares of Bear Stearns Cos. are cratering en route to the bank's emergency rescue 72 hours later. Buyout giant Carlyle Group's mortgage bond fund has collapsed after defaulting on $16.6 billion of debt. The U.S. dollar is trading at a record low of $1.56 to the euro. New York University economics professor Nouriel Roubini is forecasting a severe recession that may last six quarters.

"Cookie anyone?" says Tice, 53, offering peanut butter Girl Scout sandwich cremes to his four-member investment team. Tice, founder of the Prudent Bear Fund, is in his element as short sellers savor a rare advantage in their tug of war with Wall Street's bulls. Tice, an economic history addict who lines his office bookshelves with volumes on the Great Depression, is the most bearish of bears. He's been preaching for almost a decade that runaway mortgage lending would blow up. Tice blames former Federal Reserve Chairman Alan Greenspan, who led the central bank as it ratcheted down the benchmark U.S. interest rate to 1 percent in June 2003 from 5 percent in March 2001 and held it there for a year. Borrowers rushed in and mortgage debt soared to $1.4 trillion in 2006, double the $708 billion in 2001, according to Fed data.

15-Year Bear Market

Now, Tice says the Standard & Poor's 500 Index may tumble 40 percent during the next 12-24 months as the credit crisis undermines the economy, bankrupts households and companies and whacks profits. The drop would be worse than the 37 percent plunge in the index from 2000 through 2002. Tice predicts U.S. equities will enter a bear market that may exceed the 15-year slump from 1965 to 1980.

Moreover, he says if the Fed and Wall Street don't break their addiction to easy credit, the economy will eventually crash in a depression— a condition marked by sharply reduced purchasing power [[via wage cuts/freezes and high inflation: normxxx]], massive unemployment and massive corporate failures. The U.S. can't continue to inflate bubbles in stocks, real estate and other assets without crippling the financial system, Tice says.

`Drunken Sailors'

"We've become a country of drunken sailors" he says, snapping his fingers as he makes his point. "If you spend, spend, spend, there are going to be consequences to that— you can't borrow your way to prosperity." Even so, the turmoil has been good for Prudent Bear. After five years of trailing the S&P 500 with an annualized 0.9 percent loss compared with the index's 11 percent annual gain, the tables have turned for Tice's mutual fund. Prudent Bear, which has $1.1 billion in assets, has returned 9.5 percent from June 30, 2007, to May 20. That's almost 14 percentage points better than the 4.3 percent decline in the S&P 500.

Tice, a short seller who profits when prices fall by borrowing and selling shares and then repaying at a lower price, bet correctly that Citigroup Inc. and Merrill Lynch & Co. would be hammered by mortgage losses. He shorted companies that consumers were likely to avoid in a declining economy, such as Bed Bath & Beyond Inc. and Harley-Davidson Inc., according to Prudent Bear's annual report released on Sept. 30, 2007. Prudent Bear went long on metals with Capstone Mining Corp. and other ore producers. Shares of the Vancouver-based silver, copper and zinc miner jumped 81 percent during the past year through May 20 thanks to the commodities boom and the falling dollar.

Predicting The Credit Bubble

"Tice has been talking about the credit bubble for years," says David Kathman, a mutual fund analyst at Morningstar Inc., the Chicago— based investment research firm. "He may have looked foolish there for a while, but now the chickens are coming home to roost." Tice and fellow bears had better savor their moment because the bulls are poised to take back the market, says Robert Olstein, a money manager in Purchase, New York, who runs the $1.2 billion Olstein All Cap Value Fund. The S&P 500 has rallied 11 percent since Fed Chairman Ben S. Bernanke's unprecedented moves to stabilize the U.S. financial system began in March.

In addition to backing JPMorgan Chase & Co.'s takeover of Bear Stearns, the Fed for the first time since the Great Depression allowed securities firms to borrow cash at the same rate as commercial banks. By March 20, Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc., among others, tapped $28.8 billion in cheap Fed loans, bolstering confidence that Wall Street would overcome the crisis.

`Butt Kicking'

"Don't bet against the Fed," says Olstein, 66, whose fund is down 6 percent this year. "The worst is over, and the market is looking to turn; and when it takes off, the bears are going to be in for a good butt kicking." Richard Yamarone, chief economist at New York-based equity analysis firm Argus Research Co., says the $152 billion package of tax rebates and incentives that lawmakers passed this year will set off a shopping spree.

Another silver lining: Companies in the S&P 500 have almost doubled the average level of cash and equivalents in their coffers since 2001, to $2.05 billion from $1.08 billion, according to data compiled by Bloomberg. After gross domestic product inched ahead 0.6 percent in the first quarter, Yamarone is forecasting the economy will eke out a 1.7 percent increase by year's end.

`Doom and Gloom'

"Depression? C'mon, that's just the doomsayers trying to be funny," Yamarone says. "We're going to be on the rocks during the first half of the year, but the pendulum is swinging too far toward doom and gloom." As he's been doing for two decades, Tice counters that bulls are ignoring the pain ahead. Losses from the U.S. mortgage crisis may reach $945 billion, the International Monetary Fund said in April. That would be a bill six times more costly than the savings and loan debacle of the late 1980s, according to the U.S. Government Accountability Office.

Banks alone have reported more than $323 billion in losses or writedowns worldwide since early 2007. U.S. consumer confidence fell to its lowest in 28 years in May as record gasoline prices and the loss of more than a quarter million U.S. jobs this year cut into spending. "The economy is still a wreck," Tice says. "We're not out of the woods."

End Of The Golden Age

The credit meltdown runs so deep that the prosperous years on Wall Street that began in 1982 are probably drawing to a close, says Barton Biggs, 75, managing partner at Traxis Partners LLC, a New York— based hedge fund. "We had a spectacular era of financial success that was extended by the subprime mortgage mania to 2007," says Biggs, who was chief global strategist at Morgan Stanley until 2003. "But I think the golden age of Wall Street is over."

Tice couldn't agree more. For him, the day of reckoning is long overdue. Yet profiting from the upheaval is fraught with peril. The No. 1 danger for bears: No matter how sound their analyses or prescient their predictions, they're often steamrolled by bullish momentum, Morningstar's Kathman says. During the mid-1990s, Tice bet the tech boom was unsustainable. No matter.

Prudent Bear was pounded for four straight years, dropping 58 percent from 1996 to the end of '99 as dot-coms exploded in value. Following the 31 percent drop in the S&P 500 in 2001 and '02, Tice predicted equities had entered a long-term bear market. He was wrong again. The S&P 500 climbed to its all-time peak of 1,565.15 on Oct. 9, 2007.

`Bearish Convictions'

Tice says the market's record-breaking rise has only cemented his view that dangers lie ahead. "He's unshakable in his bearish convictions on the credit bubble and how we're all going to pay for it," says James Chanos, founder and president of Kynikos Associates Ltd., a New York-based hedge fund that, like Prudent Bear, shorts stocks. Chanos says he appreciates Tice's arguments; yet, as a pure stock picker, he doesn't apply macroeconomic analysis in his fund.

Tice, who zips around his Dallas neighborhood on a Vespa scooter and grooves to Led Zeppelin, says dire predictions aside, he's not some dour cynic. He's been enamored with the stock market since his teenage years in Independence, Missouri, in the 1970s. His mother introduced him to investments and analysis by tuning in to "Wall Street Week with Louis Rukeyser," a TV program then broadcast regularly on public television stations. Tice started on his path to becoming a "perma-bear," a market skeptic in good times and bad, after Black Monday, Oct. 19, 1987. That day, the Dow Jones Industrial Average tumbled 508 points, or 23 percent: the worst single-day drop in its history.

Dead Houseplant

Tice, who was studying to pass the chartered financial analyst examinations, was already leery of Wall Street and put off by how investment banks skewed equity research to curry underwriting business. "The banks were just touting the damn things and never had any skepticism," Tice says. "So we would be the devil's advocate." He's still playing that role from a third-floor warren of offices in a 10-story building north of downtown Dallas that he shares with eight members of his investment team.

A couple of these analysts are so contrarian, they delight in rooting against the Dallas Cowboys professional football team, heresy in a town that worships the five-time Super Bowl champs. The offices look like the headquarters that time forgot, with prints of English fox hunts lining the walls and dusty stacks of financial reports in wooden bookcases. A dead houseplant sits on a filing cabinet. Paintings depict lighthouses withstanding the crashing sea, presenting an apt metaphor for how Tice and his colleagues see themselves in relation to the markets.

Biggest Challenge

On this March afternoon, Tice is keeping an eye cocked toward a computer screen that flashes prices of stocks, metals, oil and the dollar. He even plunks his laptop on the table of an upscale Italian restaurant in Dallas during lunch to monitor the action. "There it is; gold just hit $1,000," he says as he tucks into a grilled salmon filet. With many of his predictions about the credit crisis coming true, Tice's biggest challenge may be outfoxing the newly minted short sellers who are rushing to cash in on the economic gloom.

In April, short interest on the New York Stock Exchange reached 4.1 percent of total shares outstanding, the highest level since Bloomberg started tracking the data in 1995. The flood of shorts increases the chances for a market phenomenon that strikes dread in investors such as Tice: the short squeeze.

Short Squeeze

That's when a stock that's being sold short experiences a sudden upturn. Bears, fearful that shares are moving against them, rush in to buy the stock— to "cover" in trading parlance. That buying spurs prices ever higher [[and, in a thinly traded stock, no stock may be available for purchase at any price! (Old Wall Street adage: "He who sells what isn't his'n, must buy it back or go to pris'n."): normxxx]]. Tice says he and Noland defend against squeezes by maintaining short positions in 75 different stocks: none of them exceeding 1.25 percent of the portfolio. That way Prudent Bear can quickly unload any shares that start to climb. As of March 31, Tice was shorting organic grocer Whole Foods Market Inc. and credit card provider Capital One Financial Corp. He expects both to suffer if there's a recession as consumers cut back.

Noland and Prudent Bear analyst Ryan Bend feared a short squeeze on CarMax Inc., the national auto retailer based in Richmond, Virginia. In April 2007, Tice bet the worsening economy would wallop CarMax with falling sales and rising auto loan delinquencies. So Prudent Bear started shorting it at $24.78. By Feb. 29, other bears had sniffed out the opportunity and laid siege to the stock: CarMax's short interest climbed to 17 percent of its daily trading volume from 9.8 percent on Dec. 31, according to Bloomberg data.

`Candy Bars'

Worried any scrap of good news might send shares higher and trigger a squeeze, Noland trimmed CarMax to 0.5 percent from 0.85 percent of the fund in the first quarter. "We have to cut back on the candy bars to rein in risk," says Bend, 32, using lingo for a tasty short candidate. On April 18, with short interest at 23 percent, Bend closed the position. Based on the stock's drop from $24.78 in April 2007 to $17.50 in January, Tice's target price, the trade delivered a 29 percent return. Tice and Noland also have to be careful not to fall so in love with their own analysis that they overstay their short positions.

Homebuilders have been so-called candy bars amid the real estate crash. As of September, Prudent Bear was shorting 75,000 shares of Los Angeles-based KB Home, which dropped 58 percent last year. The fund was also short 90,000 shares of Toll Brothers Inc., based in Horsham, Pennsylvania, which fell 38 percent. The two hit bottom in January. KB Home returned 9 percent and Toll Brothers rose 15 percent this year through May 20. Prudent Bear closed its short positions in the companies in the first quarter even though Tice expects little immediate improvement in homebuilders' fortunes.

Pulling Weeds

"You have to pull the weeds," he says, referring to closing out losing positions. Tice forged his bearish views in Texas's investing scene during the 1980s, the era of the TV drama Dallas. He earned a bachelor's degree in accounting from Texas Christian University in Fort Worth in 1976 and a Master of Business Administration from the same school the following year. He spent the next eight years toiling as an internal auditor and acquisition planning executive in the Texas operations of oil giant Atlantic Richfield Co. and Enserch Corp., a Houston-based oil and natural gas firm.

Tice witnessed firsthand the perils of rampant speculation as the oil boom turned to bust. Then came the S&L debacle, when more than 740 lending institutions failed in a wave of corruption. By Black Monday 1987, Tice identified with the skeptics, not the market boosters. And he opted against looking for a job on Wall Street, which he considered a haven for Ivy Leaguers.

Investing Career

"I had a little chip on my shoulder," says Tice, leaning back behind a wooden desk in his office. Eager to start an investing career, Tice read a book by Thornton O'glove called "Quality of Earnings" (Free Press, 1998). O'glove, who co-wrote a newsletter by the same name with money manager Olstein, showed that financial statements could reveal how companies used legerdemain to boost income and downplay expenses.

As a CPA, Tice loved the notion of becoming a financial detective. He also recognized that there was money to be made when stocks tumbled. Tice started his own newsletter called "Behind the Numbers." It dissected financial statements and issued sell recommendations. He tapped $10,000 in savings and worked out of a spare bedroom in the Dallas home he shared with his wife and infant daughter. Soon enough, he started signing clients who saw his research as a way to cross-check Wall Street analysis.

`Cracks in the Financials'

"We didn't always agree with him," says Luther King, a fellow TCU grad and founder of Luther King Capital Management in Fort Worth, a money management firm with $7.7 billion in long-only funds. "But he was an independent voice, and I knew by his nature he was looking for cracks in the financials." In the mid-90s, Tice was charging $10,000 a year for his reports. He counted hedge fund managers George Soros, Michael Steinhardt and Chanos as clients. CEOs often recoiled at his research.

In October 1999, Tice issued a sell on Tyco International Ltd. Chief Executive Officer Dennis Kozlowski expressed outrage after Tice raised concern that the Bermuda-based conglomerate was generating quarterly increases in income partly by disguising routine operating expenses as one-time charges for acquisitions. Analysts at Credit Suisse First Boston Inc., Bear Stearns and JPMorgan reiterated bullish recommendations on Tyco. "Kozlowski was ripping us, and Wall Street was attacking, but we felt strongly that we were right," Tice says. In December 2002, an internal review found Tyco had used "aggressive accounting" to bolster results.

Bloodied And Unbowed

Separately, Kozlowski and Chief Financial Officer Mark Swartz were charged in New York state court with looting $137 million from Tyco. Convicted in June 2005, they're serving 8- to 25-year prison sentences. Tice sold "Behind the Numbers" for an undisclosed sum to his former analysts last year. By the time Tice had made the Tyco call, he'd expanded into managing money himself by opening Prudent Bear in 1995. He chose the name to reflect his investing approach: He shuns using leverage to boost returns and doesn't hesitate to close out positions to rein in risk.

Still, Tice's wager that the technology-led boom was headed for the rocks was four years too early. Crushed by dot-com mania, the fund suffered a 34 percent drop in 1998. Tice refused to become a bull. "I was bloodied, but I couldn't waver," he says. "We were a [reverse] hedge; that was our mandate, and I couldn't just tell clients, 'Well, I'm just going to be bullish for three months."'

Finding Footing

Prudent Bear found its footing in 2000. Betting that Wall Street would suffer from a decline in underwriting securities offerings and weak earnings amid the economic slump, Tice shorted shares of Goldman Sachs, Lehman Brothers and Morgan Stanley in 2002. They each fell more than 20 percent that year, contributing to Tice's best performance ever: a 63 percent return. Tice became intrigued by forces such as credit. As early as 2001, he cautioned that the Fed, by lowering interest rates, was rescuing the economy from one bubble by inflating a new one.

"We do not believe it is advisable to stimulate a burst of unprecedented mortgage credit creation," he wrote in Prudent Bear's annual report in September 2001. Tice also decried Wall Street's use of derivatives to transform toxic subprime mortgages into investment-grade securities. Derivatives are financial contracts whose value is based on, and determined by, another security or benchmark. He says banks pumped the credit bubble by manufacturing collateralized debt obligations and mortgage-backed securities.

Mining Fed Data

Ultimately, many of these instruments couldn't justify their value. Net issuance of asset-backed securities skyrocketed to a seasonally adjusted annualized rate of $906.8 billion in the fourth quarter of 2006, three and a half times the $255.6 billion in 2001, Fed data show. Last year, issuance plunged to $177.4 billion. Noland, whom Tice had met in 1997, was a kindred spirit when it came to the credit bubble. The Indiana University MBA holder had turned bearish working for short seller GW Ringoen & Co. in San Francisco before joining Tice in 1999.

An intense man who utters complex sentences in a husky voice, Noland, 45, revels in mining arcane Fed data. Setting down a document that's 2 inches (5 centimeters) thick called "Flow of Funds Accounts of the United States," Noland says, "The whole story is right here." Noland points to tables showing how total borrowing in the credit markets climbed to a seasonally adjusted annual rate of $4.96 trillion in the third quarter of last year, a 148 percent jump from 2001. The increase occurred even as U.S. home prices fell for the 14th straight month and foreclosures spiked.

Five-Alarm Fire

For Noland, this was a five-alarm fire: Wall Street was cranking out more high-risk debt securities in the face of deteriorating credit quality. "Unlike the tech bubble, which was isolated, the mortgage finance burst is causing huge distortions in the entire economy," Noland says. Tice and Noland anticipated the pummeling Wall Street would take and bet against securities firms. Prudent Bear was short 65,000 shares of Citigroup as of Sept. 30. The bank wrote down $18.1 billion on subprime losses in the fourth quarter.

Tice also sold short 21,000 shares of Merrill Lynch, which lost a record $9.8 billion in the same period. Both stocks dropped more than 40 percent last year. Last May, Tice started shorting about 351,000 shares of Starbucks Corp. at $28.46 in a bet that stretched consumers would balk at $4 coffee drinks. Yesterday, the gourmet coffee maker closed at $16.83, meaning Prudent Bear would have reaped at least a 41 percent return if Tice covered that day.

Resilient Market

Now the challenge dogging Tice and Noland is that the markets may once again prove as resilient as they have in the past. Since March 10, bullish investors have driven the Dow up more than 350 points on three occasions, including a 420.4 point surge on March 18— five days after Tice was proffering cookies amid Bear Stearns's meltdown. "The bears won for a while, but winter will turn to spring, trees will bloom and market psychology will shift," says Neil Hennessy, CEO of Novato, California-based investment firm Hennessy Advisors Inc.

For Tice, who has long been dismissed by bulls as a Cassandra warning of doom that would never come, the credit implosion has at least for now validated his pessimism. "I do feel intellectually vindicated," he says. Vindication may be cold comfort. In April, the S&P 500 rallied 4.8 percent, its biggest monthly rise in more than four years. If the bulls continue their stampede, Tice may find that even after being right about the credit crisis, he may be wrong about how long the bears will reign.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Rethinking The No-Thinking Strategy

Rethinking The No-Thinking Strategy

By Rob Peebles | 24 May 2008

Click.

That’s the sound of a light coming on at the Fed. The one at the end of the hallway. In the supplies closet. There, the Assistant Vice President of Containment rummages for the legal-sized copier paper. His flow chart titled "Stop It and Mop It Disaster Recovery Plan" requires the extra length. "There it was on the bottom shelf," the AVP told the board members eight years later, "The asset bubble of 1999. Sure, we all thought it existed, but until then, none of us had seen it. It was beautiful— encrusted with strange symbols like KOOP and WBVN. It was pumped so tight it seemed it would burst at the slightest touch."

He went on: "Yes, I saw it with my own eyes." But when I returned to the closet to show the others, it was gone. I didn’t see it again until Greenspan rushed into the conference room with it, months and months later. By then, it was shriveled and deflated. The Maestro cradled it in his arms like it was an injured kitten. "We’ve got to do something about this," he wailed. "And we will."

What else could explain the Fed’s about-face on former Fed chairman Greenspan’s policy of not looking for bubbles until they grab you by the assets? Greenspan, of course, claimed it was impossible to spot a bubble while it was inflating. Rather than battle futility, he argued, the Fed should stand at the ready, blinders in place, with mops poised to clean things up after they got messy. Chairman Bernanke affirmed Greenspan’s Avert-The-Eyes Policy in 2002.

But last week, the Financial Times told us that the Federal Reserve is re-thinking its no-thinking approach to asset bubbles. Eight years after the internet blow-up and several months into the housing meltdown, the FT says that some at the Fed "are open" to the idea that asset bubbles, unlike the Yeti, can be readily identified. Exactly what weapons the Fed would wield apparently remains under discussion.

This idea that asset bubbles are somehow encased in military composite materials that defy detection seems especially silly given another FT piece, this one an editorial by Roger Altman. Mr. Altman reminds us of the following items that sprang from the bubble after the bubble:

• Credit Default Swap insurance spiked from $5 trillion in 2005 to $50 trillion two years later— 10 times the value of all insurable bonds.


• Securities companies ratcheted up borrowing to a record 32 times their capital.


• Junk bond spreads were cut in half.


• Record ratio of financial assets to GDP


• Bank regulators ignoring off-balance sheet risk

The above of course was in addition to the Great Mortgage Funding Race and the transformation of millions of otherwise sane Americans into leveraged real estate speculators.

Back in April 2000, PIMCO’s Paul McCulley was addressing Congress on Greenspan’s Close the Barn Door After the Horses Exit policy. He thought it puzzling that even though Greenspan himself equated the absurd valuations of internet stocks with lottery tickets, the Fed chairman actually argued against raising margin requirements. Rather than play the dorm mother who quashes the midnight shenanigans, Greenspan saw himself as the cavalry, arriving just in time to avert disaster. Or maybe Greenspan really believed there was less risk in ignoring a bubble than deciding what to do with it once you caught it.

But surely doing something beats picking up pom poms and high kicking over technology’s productivity miracles, or counseling first time home buyers to buy adjustable rate mortgages with fixed rates near all-time lows. Besides, the risks of doing the wrong thing at the wrong time aren’t just limited to the bubbly phase. Former Fed Super Chair Paul Volcker warned last week that actions taken after an asset bubble bursts have risks of their own. The Great Volcker was particularly concerned that the Fed’s independence can be called into question when, with disaster upon them, the Fed tries novel tactics to save the day. "If we lose confidence in the ability and the willingness of the Federal Reserve to deal with inflationary pressures… we will be in real trouble," Volcker said.

According to the Bloomberg story covering Volcker’s comments to Congress, the old warrior remains concerned about the implications of recent unconventional tactics, including the Bear Stearns rescue package and the Fed’s willingness to accept mortgage bonds from bond dealers. But now that they have seen how messy mopping up can be, the Fed may have decided that limiting the size of the spill is not such a bad idea.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Gloss Is Off Weddings; Cutting Corners

Downturn Takes Gloss Off Weddings;
Tough Economy Causes Couples To Cut Corners

By Madlen Read The Associated Press | 26 May 2008

Rebecca Stamilio (left) photographs her friend, Erin Robertson, as they shop for wedding dresses at Filene's Basement in New York. Many brides are buying gowns at discount retailers.
Photo: Mark Lennihan

NEW YORK— The fairy-tale weddings that many couples have yearned for are starting to come back down to earth— leveled by everyday problems like house payments and rising gas and food bills. The wedding industry has long been considered one of most recession-proof. Most brides, grooms and their parents see the "big day" as a once-in-a-lifetime event not to be skimped on. But unlike Cinderella and Prince Charming, who didn't have to worry about a mortgage on the castle, more couples are finding it hard to swallow the average price tag of items like wedding cakes (about $500), bridal gowns (around $1,300) and flowers (near $2,000).

"Every girl dreams about their wedding day," said Rebecca Stamilio, who braved the February chill and the crowds at Filene's Basement's bridal sale in Manhattan to find a gown. "But at the same time, you're like, oh my gosh— I could pay off this much of my mortgage." Stamilio, a 30-year-old physics instructor at Edgecombe Community College in Tarboro, N.C., found a long, simple, white gown for $249 that was originally $1,600. "I just don't want to be indebt," she said.

Many other couples apparently share that sentiment and are cutting some corners as they put their weddings together. Wedding trend tracker The Wedding Report Inc. estimates that the average cost of a wedding will dip slightly this year to $28,704, compared with $28,732 in 2007. That runs counter to the trend of the past 15 years, when wedding spending has nearly doubled, according to Conde Nast data. Tammy Elliot, president of the Perfect Wedding Guide wedding planning Web site, noted that the market is growing quickly due to the children of baby boomers.

Spending on the actual ceremony and the rehearsal dinner appear to be up this year, according to The Wedding Report data, while outlays for the reception and rings are declining. It's important to note that the data include inflation, so with food, energy and metals prices on the rise, couples are really getting less for their dollar. The wholesale price of gold is up more than 30 percent from a year ago, while platinum is up more than 50 percent, and retailers are having to pass these increases on to consumers.

With costs surging, some new wedding trends are sprouting. Liene Stevens, a consultant at the wedding and event planner Blue Orchid Designs, said she's noticing couples opting for more do-it-yourself wedding items, such as table centerpieces. They also are planning more brunch and afternoon weddings so they can shell out less for food and alcohol, she said. Stamilio is accustomed to being frugal; she is not the only one keeping track of her receipts (she's aiming for under $10,000 in total)— bigger spenders are seeking out ways to save money, too. Erin Robertson and her family are willing to budget as much as $30,000 for her upcoming wedding, but Robertson went bargain shopping with Stamilio at Filene's Basement. She got a $730 ivory silk dress, tax included, that was originally $3,500.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Middle Class Jitters

Middle Class Jitters

By Robert J. Samuelson, WP | 26 May 2008

Thursday, May 22, 2008; Page A25

We middle-class Americans are in a funk. "The overarching economic narrative of the 2008 campaign is the idea that life for the middle class has grown more difficult," writes Paul Taylor of the Pew Research Center, which recently published a massive report on middle-class anxieties. By its survey, more than half of Americans believe they either have not moved ahead in the past five years (25 percent) or have fallen behind (31 percent). Pew pronounces this "the most downbeat short-term assessment of personal progress in nearly half a century."

It's not that Americans have lost their optimism. About two-thirds say they have higher living standards than their parents did at the same age, and by a ratio of two to one they expect their children to live better than they do. But there's an underlying disenchantment that seems to predate today's higher oil prices, falling home values and declining employment.

"When my college-educated, gainfully employed thirty-something friends and I get together, we talk about money," writes Nan Mooney in her new book, "(Not) Keeping Up With Our Parents." "We talk about our inadequate health insurance and whether we can afford it, about how to juggle credit card payments and crushing student loans… This wasn't the life I'd expected."

"Progress" keeps draining our pocketbooks. Pew finds that four-fifths of Americans find it hard to maintain middle-class lifestyles; in 1986, two-thirds did. But today's middle-class anxieties transcend the well-advertised "squeeze" on incomes. The deeper source of disquiet, I think, lies elsewhere. Middle-class families value predictability, order and security, and these reassuring qualities have eroded. People worry about rising living expenses, but what really upsets them is the possibility that their incomes or fringe benefits— pensions, health and disability insurance— might vanish.

Paradoxically, "the lives of individual Americans have grown simultaneously more prosperous and more precarious," writes Peter Gosselin in his new book, "High Wire." Gosselin, a Los Angeles Times reporter, has provided the most thorough account of this phenomenon to date. As he shows, the chances of being hit by a life-altering event (a long spell of unemployment, divorce, a big decline in work hours for one spouse) have actually declined slightly since the inflation-plagued 1970s and early 1980s.

But the consequences of setbacks have grown, he finds. The share of families suffering a 50 percent loss of income with a spell of unemployment rose from 17 percent to almost 26 percent. Fear of these setbacks has also climbed up the social ladder: It's not just factory workers and low-paid service employees but also managers and engineers. Companies downsize. Older workers exit in buyouts. Companies raise health insurance premiums. The reliable "defined benefit" pension (which paid a fixed monthly amount) has given way to the riskier 401(k)— vulnerable to bad investment decisions and sinking stocks. Corporate protections have weakened, as Gosselin notes.

One result is that bad economic news packs greater psychological punch than it once did, because more people identify with the victims. Change isn't just something that happens to them; it could happen to us. People worry even if they hold well-paying jobs.

We are losing our sense of entitlement. Under the implied social contract, people who "played by the rules" (to use a phrase popularized by Bill Clinton) deserved modest middle-class guarantees: a steady job, rising incomes and protection against random misfortune (sickness, disability, job loss, accidents). There was a belief that diligence and responsibility were their own rewards.

It's worth noting that this imagined entitlement never universally existed. From 1975 to 1984, unemployment averaged 7.7 percent (today's: 5 percent) [[actualy, currently about the same as then— maybe a little higher— using 1970s - 1980s calculations! : normxxx]] The now venerated defined-benefit pensions sometimes weren't fully funded (so promised benefits weren't always paid) or were funded at the expense of the next generation. Today's retired and well-pensioned autoworkers have condemned those who followed to lower-paid jobs or no jobs at all.

Almost all Americans consider themselves middle class. In the Pew survey, 53 percent put themselves in the "middle class" [[actually, not bad— that's within ±1 s.d. of the norm for the Bell curve : normxxx]] and 19 percent each in the "upper middle" and "lower middle" classes. But the prevalence of middle-class ambitions and values creates a vexing contradiction: The advances in living standards that Americans expect require a flexible and competitive economy that weakens the security and stability that Americans also expect.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

How 'Thinking' Costs You

How 'Thinking' Costs You:
Behavioral Economics Shows That When It Comes To Investing, People Aren't That Smart

By Michael S. Rosenwald | 25 May 2008

Princeton psychologist Daniel Kahneman won a Nobel Prize for integrating his field of study into economics.
(By Jon Roemer— Associated Press)

Four months ago, judging myself to be the next Warren Buffett, I logged on to my Charles Schwab account and did something that in hindsight was astonishingly stupid, even for my own very long roster of financial screw-ups. I clicked over to the trading page and bought shares of Citigroup. The company, like most of the big Wall Street banks then staring down the subprime meltdown, was limping along. The headlines were bad. The chatter on CNBC was pessimistic. I saw a bargain. I saw a company whose credit card bills and offers show up in millions of mailboxes every day. Just as soon as the banks got their write-offs out of the way, optimism would return to the sector. There would be more buyers of the stock than sellers. I would profit.

Now here I am today: My investment is down 22 percent. And I'm still holding on to the stock. Am I, as my wife and closest friends sometimes insist, the dumbest man walking the Earth? "You are human," said Russell Fuller, chief investment officer of Fuller & Thaler Asset Management in San Mateo, Calif. His firm uses behavioral economic theories of Nobel Prize winners and university economists to profit from the mistakes made by everyday investors and the pros on Wall Street. Humans, no matter how hard we try, act in ways that cause us to make the wrong investment decisions almost all the time.

We are— as I was four months ago when I logged on to my Schwab account— absurdly overconfident about what we think we know. We are— as I am now— reluctant to part with our losers, even though the tax code rewards us for doing so. We sell winners too soon, then we buy stocks that perform worse than the ones we sold. We get anchored on certain opinions about stocks and react too slowly to information that should change those beliefs. We believe things will happen based on how easily we can think of recent examples. (A hurricane just hit. Another one will come soon.)

The world of the behavioral economics, which melds psychology, finance and emotion, seeks to explain and sometimes exploit why we do what we do when it comes to investing. It is a field that has become more accepted lately, particularly since 2002, when Princeton University psychologist Daniel Kahneman was awarded the Nobel Prize in Economics for, as the Swedes put it, "[integrating] insights from psychology into economics, thereby laying the foundation for a new field of research."

[ Normxxx Here:  With his late partner Amos Tversky (an Israeli, who studied for his Ph.D. with me at the University of Michigan in the '60s), who unfortunately died of cancer just before the Nobel was awarded— and Nobels are never awarded posthumously. BTW, they did their research for their first break though paper at Las Vegas!  ]

Kahneman is a director at Fuller & Thaler, a firm whose other namesake is Richard Thaler, a prominent University of Chicago behavioral economist and a frequent collaborator with Kahneman. Two of the funds the firm manages that use behavioral methods have beaten Russell benchmarks from their inception through the first quarter of this year. Not surprisingly, Fuller & Thaler is not the only firm using such techniques. Firms ranging from J.P. Morgan to AllianceBernstein say they seek to capitalize on the faulty investor mind.

For instance, Fuller & Thaler likes to pay close attention to analysts who may be anchored on a stock, not raising their earnings-per-share estimates enough even though positive information has come out about the company. Fuller & Thaler's investment team pounces before the analysts realize they were wrong. As Kahneman said in an interview, "I think that betting on mistakes of people is a pretty safe bet."

Good for them. My interest in talking to the likes of Kahneman, Thaler and other behavioral economists and personal finance advisers— besides confirming that I am not dumb— was to understand these mistakes and what there is to do about them. "I don't think you can fix what's in your head," Thaler said. "What you can do is train yourself to say, 'This is a risky situation, and this is the kind of situation where I get fooled.' "

I asked Kahneman what fools us most frequently. That was simple, he said: overconfidence. "It's the idea that you know better than the market, which is a very strange idea," he said. "Individual investors have no business at all thinking they can do better." Why do we? "It's because we have no way of thinking properly about what we don't know," Kahneman said. "What we do is we give weight to what we know and then we add a margin of uncertainty. You act on what you think will happen." That's what I did by buying Citigroup. But Kahneman added, "In fact, in most situations what you don't know is so overwhelmingly more important than what you do know that you have no business acting on what you know." Oops.

Barbara Warner, a financial planner with Warner Financial in Bethesda, said she sees a lot of overconfidence among two groups of people: relatively new investors to the market (me), particularly recent business school graduates (not me), and retirees (never, with my investment sense). The latter group can be exceptionally frustrating. "Now they have entirely too much time on their hands to devote to CNBC and Money magazine," she said. "People suddenly think they are smarter than they used to be because they have more time to pay attention to it."

That's a disastrous situation, Kahneman said: "The more closely you pay attention, the more you do things. And the more you do things, the worse off you will be." For proof, he pointed to groundbreaking research done by one of his former students, Terrance Odean, now a professor at the University of California at Berkeley. Odean has written that "overconfidence gives investors the courage of their misguided convictions."

He has gathered trading records from discount brokerage houses for hundreds of thousands of investors, and in several published studies, he has shown that when people had a choice of two stocks to sell, more often than not they sold the stock that did better in the future and held on to the one that did worse. And when they bought something new, they tended to buy a stock that did worse than the stock they just sold. As Kahneman once told Odean, "It is expensive for these people to have ideas."

It is particularly curious when investors hold on to losing stocks, as I have done with Citigroup. This is a function of something called loss aversion, a discovery that helped Kahneman win the Nobel Prize. Thaler, Kahneman's close colleague, put it this way: "Loss aversion refers to the fact that we're wired in such a way that losing money hurts more than getting money feels good." So let's say a hundred bucks falls out of my wallet, lost forever. Under loss aversion, this hurts a lot more than it feels good to find $100 that somebody else lost.

When it comes to trading, this helps explain why we would want to hold on to losers. Selling the loser, even though it gives us a tax write-off, causes us to admit we have lost. So we do something that makes us feel better: We sell the winners. This feeds our overconfidence. But as Odean's research has shown, we often sell winners that still have some winning to do. That puts stocks with upward momentum on the market for less than they are really worth long-term, allowing savvier investors to snap them up. "What I believe is that individual investors probably as a group create the dynamics by which they lose money and institutions make money," Odean said. "They create mispricings."

Along with several co-authors , he has published a somewhat depressing study about just how much wealth can be lost by everyday investors just because they trade. Looking at data from every trade made by all investors in Taiwan from 1995 to 1999, Odean discovered that the "aggregate portfolio of individual investors suffers an annual performance penalty of 3.8 percentage points," which includes trading costs. If investors had simply bought the index and not traded at all, they would have done about 3.5 percent better. The amount of money lost was equivalent to 2.2 percent of Taiwan's gross domestic product.

So what should mere humans do about all of this?

Like most things human, it depends on which one you ask. Odean said he saw two options: Be dumb and let others make money off you, or just buy a no-load index mutual fund and stop focusing on beating the market. Kahneman said there was no one-size-fits-all advice, but he liked the idea of having one sure thing and one long shot [[aka, the "barbell" approach; this can also be somewhat achieved by buying a non-cap (i.e., 'equal') weighted fund: normxxx]]. The personal finance planners say investors should stick with them— they get paid to understand this stuff, and to win. Of course, they are human too, which means they could be prone to the same problematic behaviors.

As for me, I'm taking some responsibility for myself, which is probably where everyone should start. Earlier this week, I logged in to my Schwab account. I sold my Citigroup shares, at a loss. I'm going to push the money into an index fund. The move felt bad, no doubt about it. I didn't fix what was in my head, but I did fix what my head had done.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A Run On Central Banks?

A Run On Central Banks?

By Steve Waldman | 25 May 2008

When I see what commodity prices are doing, I don't think "low interest rates" or "skyrocketing demand." I think about a loss of confidence. There is that old saw about gold, that it is the only money that is no one's liability. Wheat is no one's liability, and neither is corn. Oil is no one's liability. It is common to invest in commodities as an "inflation hedge." If the central bank prints too much money, you need wheelbarrows to buy bread. If you have a sack of wheat, you will have your bread whatever the central bank does. But if everyone buys wheat, the price of grains will rise, even if the central bank does nothing at all.

Just as the fear of a bank's insolvency can precipitate a run that drives a bank to ruin, loss of confidence in a central bank can provoke a great inflation. The Federal Reserve, much as I might criticize it, has not gone on a printing spree. It has lowered interest rates, and altered the composition of bank assets by replacing less liquid with more liquid securities. But the most these measures should do is bring us back, monetarily speaking, to the status quo ante, back to a year ago when asset-backed securities were liquid. The Fed's actions are best described as antideflationary, not inflationary.

But confidence is a funny thing. Central bankers are supposed to be dour and dependable. The current crop is not. Rather than "taking away the punchbowl", central bankers have become the life of the party. Japan's central bankers hand out Yen like free acid. China's guy will give you a microwave oven and a DVD player if you draw him a picture (and sign Henry Paulson's name to it). Our man Ben is an Amadeus-cum-McGyver, he's brilliant, unpredictable, he'll improvise a Delaware company from paper clips and vacuum up your derivative book with a toenail clipper. Even the ECB's Trichet, who at first comes off like a sourpuss, turns out to be all right, when you've got some Spanish mortgages to pawn.

Some of us think that something's wrong, and these guys we're drinking with aren't serious enough to fix it. We know that trillions of dollars in presumed housing wealth have disappeared, but we don't know who's ultimately going to bear the loss. Americans know that as a nation, we cannot afford our clothes, furniture, or gas, unless the people who are selling it to us lend us our money back. Economists fret about "imbalance" and "adjustment", but we've yet to see a serious plan, other than let's-keep-this-party-going. So, we lose faith. When we lost faith in Northern Rock, Bear Stearns (BS), Citigroup (C), or Lehman (LEH), the central bankers stepped into the fray, and stood behind them.

So, we ask, who stands behind the central bankers? We take a peek, and all we see is our own money [[do we, indeed; or do we see a pile of Treasury I.O.U. notes to the Federal Government!?!: normxxx]] Which we quickly start exchanging for something else [[more tangible than paper, at least!: normxxx]] Although commodity prices have been increasing for years, you'll notice that the very sharp run-up began last summer, at roughly the same time as the credit crisis. Commodities soared when interest rates were still high, but predicted to fall. Commodities are soaring today, even though US interest rates are now predicted to rise. Commodities have soared in euro terms, despite the ECB's refusal to drop interest rates.

I can't tell you where the inventories are, except to wonder why anyone would put them where they would be counted. Hoarders tend to get nervous, and not advertise their hoards. (But this one is pretty obvious.) Perhaps producers of storable commodities who lose faith in paper quietly hold back production. Interestingly, people who no longer trust the very core of the financial system remain comfortable with collateralized, centrally-cleared futures exchanges. These are well designed to manage credit risk, but they can default, have defaulted, and will default in extremis. I heartily endorse Cassandra's suggestion that they step up their margin requirements, ASAP.

None of this is any good at all. Capital devoted to precautionary storage would be better employed building new enterprises, laying a foundation for tomorrow's prosperity. But claims on future money are only promises, easily broken or devalued. A run on central banks, a flight from financial assets to stored goods, sacrifices the hope of future abundance for certain present scarcity. Governments can shut futures exchanges, confiscate gold, 'ban' "hoarding, profiteering, and price-gouging".

People will hoard anyway if they don't believe in the paper. People are losing faith in financial assets for good reason. Rather than organizing productive economies, the machinery of finance has recently functioned as an anesthetic, masking the pain while resources were mismanaged and stolen. We need a solid financial system, but confidence cannot be imposed or legislated. It will have to be earned. There has to be a plan. Earnest promises to do better soon won't suffice. Nor will yet another drink from the punch bowl.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Investment Outlook: Hmmmmm?

Investment Outlook: Hmmmmm?
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By Bill Gross, PIMCO | 24 May 2008

You can fool some of the people all of the time, and all of the people some of the time, but you cannot fool all of the people all of the time. — Abraham Lincoln

What this country needs is either a good 5¢ cigar or the reincarnation of an Illinois "rail-splitter" willing to tell the American people "what up"— "what really up." We have for so long now been willing to be entertained rather than informed, that we more or less accept majority opinion, perpetually shaped by ratings obsessed media, at face value. After 12 months of an endless primary campaign barrage, for instance, most of us believe that a candidate’s preacher— Democrat or Republican— should be a significant factor in how we vote. We care more about who’s going to be eliminated from this week’s American Idol than the deteriorating quality of our healthcare system. Alternative energy discussion takes a bleacher’s seat to the latest foibles of Lindsay Lohan or Britney Spears and then we wonder why gas is four bucks a gallon. We care as much as we always have— we just care about the wrong things: entertainment, as opposed to informed choices; trivia vs. hardcore ideological debate.

It’s Sunday afternoon at the Coliseum folks, and all good fun, but the hordes are crossing the Alps and headed for modern day Rome— better educated, harder working, and willing to sacrifice today for a better tomorrow. Can it be any wonder that an estimated 1% of America’s wealth migrates into foreign hands every year? We, as a people, are overweight, poorly educated, overindulged, and imbued with such a sense of self importance on a geopolitical scale, that our allies are dropping like flies. "Yes we can?" Well, if so, then the "we" is the critical element, not the leader that will be chosen in November. Let’s get off the couch and shape up— physically, intellectually, and institutionally— and begin to make some informed choices about our future. Lincoln didn’t say it, but might have agreed, that the worst part about being fooled is fooling yourself, and as a nation, we’ve been doing a pretty good job of that for a long time now.

I’ll tell you another area where we’ve been foolin’ ourselves and that’s the belief that inflation is under control. I laid out the case three years ago in an Investment Outlook titled, "Haute Con Job." I wasn’t an inflationary Paul Revere or anything, but I joined others in arguing that our CPI numbers were not reflecting reality at the checkout counter. In the ensuing four years, the debate has been joined by the press and astute authors such as Kevin Phillips whose recent Bad Money is as good a summer read detailing the state of the economy and how we got here as an "informed" American could make.

Let me reacquaint you with the debate about the authenticity of U.S. inflation calculations by presenting two ten-year graphs— one showing the ups and downs of year-over-year price changes for 24 representative foreign countries, and the other, the same time period for the U.S. An observer’s immediate take is that there are glaring differences, first in terms of trend and second in the actual mean or average of the 2 calculations. These representative countries, chosen and graphed by Ed Hyman and ISI, have averaged nearly 7% inflation for the past decade, while the U.S. has measured 2.6%. The most recent 12 months produces that same 7% number for the world but a closer 4% in the U.S.

This, dear reader, looks a mite suspicious. Sure, inflation was legitimately much higher in selected hot spots such as Brazil and Vietnam in the late 90s and the U.S. productivity "miracle" may have helped reduce ours a touch compared to some of the rest, but the U.S. dollar over the same period has declined by 30% against a currency basket of its major competitors which should have had an opposite effect, everything else being equal. I ask you: does it make sense that we have a 3% - 4% lower rate of inflation than the rest of the world? Can economists really explain this with their contorted Phillips curve, output gap, multifactor productivity theorizing in an increasingly globalized "one price fits all" commodity driven global economy? I suspect not. Somebody’s been foolin’, perhaps foolin’ themselves— I don’t know. This isn’t a conspiracy blog and there are too many statisticians and analysts at the Bureau of Labor Statistics (BLS) and Treasury with rapid turnover to even think of it. I’m just concerned that some of the people are being fooled all of the time and that as an investor, an accurate measure of inflation makes a huge difference.

The U.S. seems to differ from the rest of the world in how it computes its inflation rate in three primary ways: 1) 'hedonic quality' adjustments, 2) calculations of housing costs via 'owners’ equivalent rent', and 3) 'geometric weighting'/'product substitution'. The changes in all three areas have favored lower U.S. inflation and have taken place over the past 25 years, the first occurring in 1983 with the BLS decision to modify the cost of housing. It was claimed that a measure based on what an owner might get for renting his house would more accurately reflect the real world— a dubious assumption belied by the experience of the past 10 years during which the average cost of homes has appreciated at 3x the annual pace of the substituted owners’ equivalent rent (OER), and which would have raised the total CPI by approximately 1% annually if the switch had not been made.

In the 1990s the U.S. CPI was subjected to three additional changes that have not been adopted to the same degree (or at all) by other countries, each of which resulted in downward adjustments to our annual inflation rate. Product substitution and geometric weighting both presumed that more expensive goods and services would be used less and substituted with their less costly alternatives: more hamburger/less filet mignon when beef prices were rising, for example. In turn, hedonic quality adjustments accelerated in the late 1990s paving the way for huge price declines in the cost of computers and other durables. As your new model MAC or PC was going up in price by a hundred bucks or so, it was actually going down according to CPI calculations because it was twice as powerful. Hmmmmm? Bet your wallet didn’t really feel as good as the BLS did.

In 2004, I claimed that these revised methodologies were understating CPI by perhaps 1% annually and therefore overstating real GDP growth by close to the same amount. Others have actually tracked the CPI that "would have been" based on the good old fashioned way of calculation. The results are not pretty, but are undisclosed here because I cannot verify them. Still, the differences in my 10-year history of global CPI charts are startling, aren’t they? This in spite of a decade of finance-based, securitized, reflationary policies in the U.S. led by the public and private sector and a [[rapidly: normxxx]] declining dollar. Hmmmmm?

In addition, Fed policy has for years focused on "core" as opposed to "headline" inflation, a concept actually initiated during the Nixon Administration to offset the sudden impact of OPEC and $12 a barrel oil prices! For a few decades the logic of inflation’s mean reversion drew a fairly tight fit between the two measures, but now in a chart shared frequently with PIMCO’s Investment Committee by Mohamed El-Erian, the divergence is beginning to raise questions as to whether "headline" will ever drop below "core" for a sufficiently long period of time to rebalance the two. Global commodity depletion and a tightening of excess labor as argued in El-Erian’s recent Secular Outlook summary suggest otherwise.

The correct measure of inflation matters in a number of areas, not the least of which are social security payments and wage bargaining adjustments. There is no doubt that an artificially low number favors government and corporations as opposed to ordinary citizens. But the number is also critical in any estimation of bond yields, stock prices, and commercial real estate cap rates. If core inflation were really 3% instead of 2%, then nominal bond yields might logically be 1% higher than they are today, because bond investors would require more compensation. And although the Gordon model for the valuation of stocks and real estate would stress "real" as opposed to nominal inflation additive yields, today’s acceptance of an artificially low CPI in the calculation of nominal bond yields in effect means that real yields— including TIPS— are 1% lower than believed. If real yields move higher to compensate, with a constant equity risk premium, then U.S. P/E ratios would move lower. A readjustment of investor mentality in the valuation of all three of these investment categories— bonds, stocks, and real estate— would mean a downward adjustment of price of maybe 5% in bonds and perhaps 10% or more in U.S. stocks and commercial real estate.

A skeptic would wonder whether the U.S. asset-based economy can afford an appropriate repricing or the BLS was ever willing to entertain serious argument on the validity of CPI changes that differed from the rest of the world during the heyday of market-based capitalism beginning in the early 1980s. It perhaps was better to be "entertained" with the notion of artificially low inflation than to be seriously "informed." But just as many in the global economy are refusing to mimic the American-style fixation with superficialities in favor of hard work and legitimate disclosure, investors might suddenly awake to the notion that U.S. inflation should be and in fact is closer to worldwide levels than previously thought. Foreign holders of trillions of dollars of U.S. assets are increasingly becoming price makers not price takers and in this case the price may not be right. Hmmmmm?

What are the investment ramifications? With global headline inflation now at 7% there is a need for new global investment solutions, a role that PIMCO is more than willing (and able) to provide. In this role we would suggest: 1) Treasury bonds are obviously not to be favored because of their negative (unreal) real yields. 2) U.S. TIPS, while affording headline CPI protection, risk the delusion of an artificially low inflation number as well. 3) On the other hand, commodity-based assets as well as foreign equities whose P/Es are better grounded with local CPI and nominal bond yield comparisons should be excellent candidates. 4) These assets should in turn be denominated in currencies that demonstrate authentic real growth and inflation rates, that while high, at least are credible. 5) Developing, BRIC¹-like economies are obvious choices for investment dollars.

Investment success depends on an ability to anticipate the herd, ride with it for a substantial period of time, and then begin to reorient portfolios for a changing world. Today’s world, including its inflation rate, is changing. Being fooled some of the time is no sin, but being fooled all of the time is intolerable. Join me in lobbying for change in U.S. leadership, the attitude of its citizenry, and (to the point of this Outlook) the market’s assumption of low relative U.S. inflation in comparison to our global competitors.

There are bleak days ahead. If you want a measure of just how bleak, consider that Vallejo, California, a city of almost 120,000 people on San Francisco Bay, voted to file for Chapter 9 bankruptcy on May 7, and nobody outside of California paid much attention. Nobody cares.

¹Brazil, Russia, India, and China.

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Time To Buy?

An Alarm Is Blaring: Time To Buy

By Mark Hulbert | 21 May 2008

Market timing— trying to jump into or out of the stock market just before rallies and declines— is notoriously difficult. Most investors would probably be better off sticking with a buy-and-hold strategy. Nevertheless, anyone trying to beat the odds may be interested in a market indicator with an excellent track record— and it has just flashed a buy signal. Of course, it is just one signpost, so proceed with caution. But it may help shift the weight of market evidence toward the bulls.

Called the Recession Buy Indicator, it was devised by Norman Fosback, who was editor of Mutual Funds magazine in the 1990s and the author in the mid-1970s of the popular investment textbook "Stock Market Logic." He currently edits Fosback’s Fund Forecaster, an investment newsletter. The indicator is based on the notion that it is darkest just before the dawn— that when the economic news becomes bad enough, the stock market’s likely subsequent direction is up. Because the stock market is forward-looking, Mr. Fosback said in the most recent issue of his newsletter, it "has little use for yesterday’s, or even today’s, crises."

"The focus," he added, "is always on the future— how will business be six months, or a year or two, from now?" When the economy appears to be on tenuous ground, as it does today, he said, "stock investors looking well out to the future are able to perceive the seeds of the next economic expansion." It is one thing to appreciate this market cycle from a conceptual point of view, but quite another to come up with a market-timing system based on it.

Mr. Fosback’s indicator focuses on the four business barometers that together make up the federal government’s index of coincident economic indicators. These four focus on industrial production, manufacturing and trade sales, nonfarm payrolls and personal income. The Recession Buy Indicator is triggered when— as is the case today— each of these four gauges is below its level of six months earlier. On such occasions, Mr. Fosback considers the economy to be in a recession or very close to it.

He came up with this indicator in 1979, and since then it has set off four buy signals (not counting the current one). On average over the 12 months following those signals, according to his research, the average stock on the New York Stock Exchange had a total return of 37 percent. And in the three years after such a signal, the average gain was 106 percent. These gains are triple the stock market’s long-term average.

(Mr. Fosback has also backtested this indicator to the late 1940s, the earliest period for which data on the coincident economic indicators were available, and it performed just as well from then until the late ’70s as it did in more recent decades.) NOT everyone draws the conclusions that Mr. Fosback does. Ned Davis Research, an institutional research firm based in Venice, Fla., has extensively studied the stock market’s performance during and after United States recessions since World War II.

Like Mr. Fosback, the firm’s analysts found that the stock market typically hit bottom six months after a recession began, and that at such times the stock market was a "table-pounding buy." But, in an interview, Ed Clissold, the firm’s senior global analyst, cautioned that this conclusion was based on an average, and that on some past occasions the stock market’s actual bottom came much later. That is one reason, he said, that his firm doesn’t mechanically issue a buy signal six months after the economy begins to turn downward. Instead, it prefers to await confirmation from a number of its other indicators that a bottom has been formed. In the current market, that confirmation has not yet come, he said, and his firm has a policy of not trying to predict when it will.

The advantages of not automatically jumping into the market six months into a recession were clear the last time the Recession Buy Indicator flashed: in February 2001, a year and a half before the low of the 2000 - 2002 bear market. In his latest newsletter, Mr. Fosback acknowledged that this particular signal was "the poorest performing of the 10 signals" since World War II. Even so, he argued, the average stock was still higher three years later.

He agreed that many people might be wary of plunging into the market when the economic news is so bad. But, he added, his indicator is a classic illustration of the virtues of contrary opinion: "When everything seems gloomiest, it’s time for the smart money to buy."

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Not A Consensus?

When Is A Consensus On Climate Not A Consensus?
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By Janet Raloff, Sciencenews | 23 May 2008

Last year, the Intergovernmental Panel on Climate Change issued a series of consensus documents under the auspices of the United Nations. They claimed that accumulating data are now strong enough to conclude that human activities are warming the planet and that Earth’s slowly building fever threatens to alter life and geography as we know it. For the IPCC’s efforts, it shared last year’s Nobel Peace Prize with Al Gore.

But the idea that the IPCC’s conclusions represented a consensus is nothing short of bunk, according to Arthur Robinson, a protein chemist and co-founder of the Oregon Institute of Science and Medicine in Cave Junction. He matintains that the UN was wrong in suggesting to the public that the IPCC’s findings "settle the issue" of whether fossil-fuel combustion’s emissions can be linked to climate. Indeed, he argued, in the United States alone, a great many scientists don’t subscribe to this view.

At a very sparsely attended press briefing, this morning, Robinson reported that his organization had compiled a list of more than 30,000 scientists who have signed onto a petition saying that "There is no convincing scientific evidence that human release of carbon dioxide, methane, or other greenhouse gases is causing or will, in the foreseeable future, cause catastrophic heating of the Earth’s atmosphere and disruption of the Earth’s climate.

"Moreover," the petition continues, "there is substantial scientific evidence that increases in atmospheric carbon dioxide produce many beneficial effects upon the natural plant and animal environments of the Earth." The petition’s signatories "urge the United States government to reject the global warming agreement that was written in Kyoto, Japan . . . and any other similar proposals. The proposed limits on greenhouse gases would harm the environment, hinder the advance of science and technology, and damage the health and welfare of mankind."

Robinson doesn’t dispute that Earth’s temperature is rising. He only takes issue with the contention that increasing atmospheric concentrations of greenhouse gases— especially CO2— drive temperature. In fact, he argues, it’s the other way around: Temperature drives atmospheric increases of CO2. As temperature rises, the partial pressure of CO2 in water will cause increasing amounts to volatilize from the oceans and enter the atmosphere. He likened this to the way heating a carbonated soft drink causes its CO2 to quickly bubble out.

Plenty of people trained the in the physical sciences have read climate-science papers or digested reviews of those papers and realize that the IPCC consensus statements’ conclusions are silly, at best, and dangerous at worst, Robinson said. If the IPCC’s conclusions are used to justify regulations that limit use of fossil fuels, this will deny many people across the globe of their "human rights" to a safe and affordable fuel to propel their societies’ growth and development, he charged.

When I (one of perhaps eight to 10 reporters in the audience) asked whether there were any climatologists who had signed the petition, Robinson said yes, 40 of them. Another 341 were meteorologists, and 114 were atmospheric scientists, he said. Add in environmental scientists and the total in this composite category jumps to 3,697. Some 900 were trained in computer science, math, or statistics. Roughly 9,900 were trained as engineers or in general science (whatever that means). An additional 5,690 were trained as physicists, 4,800 as chemists, and 2,923 as biochemists. Several thousand more were trained in still other fields. Of the total, roughly one-third said they held PhDs.

But there’s an important caveat. There’s been no vetting of the petition’s signers to confirm that they indeed trained in the field they claimed to have had. What’s more, Robinson’s group made no attempt to find out whether people worked in the field for which they trained. So someone educated as a physical chemist or computer scientist might actually be working today as a stock broker, pianist, or taxi driver.

Before asking scientists to sign the peition, Robinson’s group sent many of the individuals a packet containing the document’s wording together with a 12-page paper that he, his son, and another scientist had written. It claims to have reviewed much of the same climate literature that the IPCC did.

Also in the package sent out to potential petition signers: a letter from the late Frederick Seitz, president emeritus of Rockefeller University and former president of the National Academy of Sciences. His imprimatur was likely a weighty and influential part of the package. Seitz asked recipients to carefully read Robinson’s review paper— published in, of all places— the quarterly Journal of American Physicians and Surgeons.

Why in a journal for doctors? Robinson says it had no copyright objections to his distributing the paper far and wide. Because climate journals would likely have offered up such an objection, he said he wanted to wait until after the petition drive was over before he reformulated the material and submitted it for publication in one of them.

Although I don’t buy Robinson’s facile castigation of the IPCC process and its conclusions, he does have a point. The 'consensus' statements [[of the faithful: normxxx]] that IPCC issued don’t represent the views of all scientists. But then I, for one, never thought they did. Let’s see who else has problems with Robinson’s opus and the nonvalidated qualifications of his petition’s signatories.



  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Climate Clues In Ice

Climate Clues In Ice: Antarctic Core Reveals Lowest Levels Of Atmospheric Carbon Dioxide On Record
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By Sid Perkins, Sciencenews | 23 May 2008

It’s In There
The concentrations of carbon dioxide and methane found in bubbles of ancient air (dark spots) trapped in Antarctic ice provide clues to ancient climate.
AWI Bremerhaven, University of Bern

A kilometers-long ice core from Antarctica has recorded climate information for the past 800,000 years and has revealed a three millennia–long period when carbon dioxide levels in the air were lower than any previously measured. The longest detailed records of atmospheric gases previously reported, from the uppermost sections of a 3.2 kilometer–long ice core drilled in eastern Antarctica, go back 650,000 years, says Thomas Stocker, a climate physicist at the University of Bern in Switzerland.

Isotopic analyses of the ice in the deepest portions of that sample— at depths between 3,060 meters and 3,190 meters— have revealed how temperature in the region varied between 650,000 and 800,000 years ago. But researchers previously hadn’t assayed the gases trapped in bubbles in that portion of the core, Stocker notes. He and his colleagues have now performed those analyses and report their findings in the May 15 Nature.

Once snow piles up more than 80 meters or so deep, the pressure at the bottom of the heap converts the densely packed, somewhat porous snow into impermeable ice, thereby locking bubbles of air in place. As snow continues to accumulate, the mass of ice— whether a mountain glacier or a continent-wide ice sheet— becomes a chronicle of long-term variations in the atmospheric concentrations of various gases, including those such as carbon dioxide and methane that are linked to climate change.

Going Way Back

Researchers drilled a 3.2 kilometer–long,
98 millimeter–diameter ice core from East Antarctica,
one portion shown here, that includes precipitation
that fell during the past 800,000 years.
L. Augustin/LGGE

In many aspects, the new results provide no surprises, Stocker says. Earth still plunged into an ice age every 100,000 years or so, punctuated with warm spells, or interglacials, that lasted about 10,000 years[[ NOTE: It's been about 12,000 years since the end of the last Ice Age!¹: normxxx]] And, as found in previous studies of this core’s shallower ice, the rises and falls of the region’s temperature are closely linked to increases and decreases in levels of carbon dioxide and methane trapped in the ice’s bubbles [[A-a-ah! But which came first, the decrease in carbon dioxide or the ice? And what causes the onset of Ice Ages— or their end!?!: normxxx]]. In other aspects, however, the samples provide some new clues about ancient climate.

Previously, ice core studies have found that natural levels of atmospheric carbon dioxide varied between 180 and 300 parts per million. However, during a 3,000-year period that began about 670,000 years ago, CO₂ levels dropped to a minimum of 172 ppm, a low level unseen in other, more recent samples. Since the Industrial Revolution began, CO₂ concentrations have been on the rise because of the burning of fossil fuels[!?!]; today, levels of that greenhouse gas exceed 380 ppm and are increasing, on average, about 2 ppm each year (SN: 5/10/08, p. 18).

The geologic record, including seafloor sediments, suggests that the long-term average amount of CO₂ in the air has been declining for at least 50 million years.¹ The new findings, however, hint that atmospheric levels of CO₂ in general rose from 800,000 to 400,000 years ago and then began to decline again. Also, the researchers report, interglacial periods between 800,000 and 400,000 years ago weren’t as warm as those that have occurred more recently. These variations, although small, may reveal previously unrecognized cycles in climate that scientists don’t yet understand, Stocker says.

Determining the duration and magnitude of these cycles, if indeed they are real, may require scientists to discover Antarctic locales that harbor ice older than 800,000 years, says Ed Brook, a paleoclimatologist at Oregon State University in Corvallis. The coldest and thickest parts of the ice sheet in East Antarctica, for example, may retain deep ice that fell as precipitation more than 1.5 million years ago, he notes. Samples that old, he adds, could help solve a long-standing mystery posed by the geologic record: Why does a 100,000 year–long climate cycle recorded in recently deposited ocean sediments disappear in rocks laid down as sediments more than 900,000 years ago?

Even if scientists never find ice more than 800,000 years old, the new findings confirm that Earth’s atmosphere today is unusual, Brook says. "Modern levels of greenhouse gases have no natural analogue in the ice record," he notes.

1[ Normxxx Here:  Phew, guess we escaped that next Ice Age for a while!  ]

Wall Of Worry/ Well Of Despair?

Stocks Facing Wall Of Worry, Or Well Of Despair?
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By Minyanville Staff | 20 May 2008

History doesn't always repeat, but it often rhymes. An old market saw says stocks like to climb a wall of worry. But occasionally, they also like to plunge down a well of despair. The trick is figuring out whether we're looking at a wall, or well.

According to Minyanville's Jason Roney of Sharmac Captial Management, what looks like a wall from afar may reveal itself as a well upon closer inspection. The Nasdaq 100 (NDX), (QQQQ), index has now had 10 consecutive weekly higher highs, only the third time that feat has been accomplished in at least 15 years. According to Roney, the prior two were January 2000— that would be a pretty deep well— and December 1998— that would be a pretty steep wall.

So which one do we choose, wall or well? Roney says this observation requires a grain of salt: "December '98 and January '00 were much different market environments and it's a sample size of two periods that were too statistically irrelevant to predict performance." But, he adds, "a number of divergences over the past few days (Research in Motion (RIMM), Google (GOOG) and Apple (AAPL) which accounted for half the Nasdaq 10-week rally in points failed to make new highs with the index on Monday." That, combined with the unusual weekly pattern of 10 higher highs may suggest the analog of what looks like a 1-3 day top is actually a more significant top.

Meanwhile, prompted by Roney's observations, Minyanville's Todd Harrison found the following datapoints worth noting: From March 17 to May 13, almost half of the entire NDX gain (311 points) was a function of three stocks— Apple (AAPL), Research in Motion (RIMM) and Google (GOOG). Those stocks have since made lower highs while the index has not. That’s a negative divergence in momentum leadership names. We’ve seen this movie before. On October 23, 2007 half of the year’s entire gains (400 points) came from the same three stocks— AAPL, RIMM and GOOG.

The NDX proceeded to lose 25% from that point until… yep, March 17th.

Fine, the Nasdaq may indeed be facing a deep well of despair, but what about the S&P 500 (SPX), (SPY)? According to Minyanville contributor Jon Markman, a columnist at MSN money and producer of daily investment commentary in his Strategic Advantage and Trader's Advantage advisory services, there are some reasons to believe it's not just the Nasdaq peering down a well.

Markman notes that back in bear market of 2001, the S&P rallied hard off a low set in the third week of March to a peak in the third week of May (the week before Memorial Day weekend). The S&P 500 hit its 200 Exponential Moving Average on that Friday, May 18th. Interestingly, Markman observes, this year, the market also rallied hard off a low set in the third week of March and touched its 200 Simple Moving Average Monday, May 19. Of course, we know what happened next. Back in 2001, the market then went on to fall 26% through the middle of September. "If that were to happen again," says Markman, "give or take a few percentage points, the S&P would fall to around 1080; not saying that it will happen, but simply raising the possibility."

And how about this for a final cause for pause: "If you think about it," Markman says, "the financials, which are the backbone of the market, are actually in much worse shape now than then." Of course the spike down in Sept 2001 was due to the terrorist attacks. "But," Markman adds, "there's an old Wall Street adage that states, 'Bad things happen in bear markets.'" History doesn't always repeat, but it often rhymes.


  M O R E. . .


Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A Derivative World

Living In A Derivative World

By Paul Tolnai | 22 May 2008

All these housing bailout schemes got your head spinning? All these central bank swap-o-ramas with financial institutions got you perplexed? Are you trying to understand it all?

Well, imagine for a moment that there is a budding craze developing around toilet paper. Yes, plain old-fashioned TP is about to become the next "big thing" in the investment universe. Now some folks might just continue to consume what they need, while others will begin to horde TP like crazy. Soon the backyards of North America may be filling up with rented shipping containers to provide the storage space for that most valuable of all commodities— TP. Still others, the smart set, will make a play on TP future contracts, and options on TP manufacturers.

What will be the consequence of all this activity? Well the price of TP will skyrocket and the hoarder/speculators will become rich. And yes the more levered they are, the more of a modern day Croesus they will have become— everything they touched seemed to have turned into TP. These high TP prices will have created an affordability issue and there will be a growing call for the establishment of a Federal Toilet Paper Administration (the FTPA) to provide more liquidity (eau de toilette?) to the TP marketplace.

However, this may all seem a bit irrational to some of you because nowhere was there a real increase in demand for TP, or curtailment of supply. Some of you may think this all a bubble which will have to, sooner or later, be flushed away. The hoarder/speculators will be stuck with a bunch of TP that isn't worth, well, more than toilet paper [[actually, quite a bit less: he forgot to mention that during the TP "crisis", the capacity to manufacture TP increased by at least 10-fold and, moreover, all of those TP hoarders will be trying to unload TP at about the same time!: normxxx]]. They're in distress. What to do? Should the FTPA be given an expanded mandate to help relieve the distress, or should this job just be offloaded to Fannie Mae? (sorry 'bout that; couldn't resist).

Two potential solutions will present themselves in this coming scenario/crisis. The one "solution" is to tax, one way or another, overtly or stealthily, the non-hoarders in order to rescue the backyard TP stuffed container people— to accommodate "stability". Why? And what good will that do? What happens when a mania on Kleenex tissue develops— and what is going to stop that from developing? There will be potential profits to be made then, and the same arguments for mitigating losses will be served up then as well. On the other hand, the TP hoarders that can't pay their debts could simply have their assets seized and liquidated. What would the outcome be? Well, the price of TP will come down and TP will become plentiful and affordable again. Is that so bad?

Well, that's a bit simplistic because one is forgetting about the devastating effect this would cause the speculators. Can you imagine the Wall Street crowd having to power lunch at Micky D's instead of the '21' (.....oh the humanity!). And what of all the TP hedge funds and the banks who provided the leverage? Are you forgetting that our banking system is a fractional reserve one and it is likely that their losses will exceed their capital?

It seems to me that we are living in a derivative world. If one focuses just on the physical toilet paper, the problem isn't really all that complex. The problem arises due to the increasing financialization of our economy. Everything from physical commodities, to the paper security instruments of the stocks of productive companies, to the intangibles, such as interest rates and credit risks become nothing than more than "play activity" in this derivative world of ours. Of course, that will be countered with the 'efficient markets' counter argument: that all this capital shifting hither and tither, to and fro, arbitraging its way into the crevices of inefficiencies and smoothing them out is actually good for the overall economy.

But all of this strikes me as nothing more than a debate between a pragmatic roll-up-your-sleeves world and the world of the chalkboard, nothing more than a philosophical debate over a priori versus a posteriori knowledge. If all of these efficient markets nostrums are so right on the money, how could the men and women of America in the 1940's, '50's, and 60's, who built up this great land of ours, be so utterly ignorant? And how did such vast ignorance yield such stellar results? And how indeed, could such wonderful theory yield such abysmal results? With apologies to Nassim Nicholas Taleb, perhaps it wasn't a black swan that so recently disturbed our economic pond— I believe it was just a run of the mill American Turkey.

The physical sciences periodically go through paradigm shifts: the materialistic view of Thales supplanting the Olympian, the mechanical view of Descartes and Newton, the relativistic and quantum mechanical views of Einstein and Heisenberg. All of these shook up man's view of his physical world. Perhaps too, economics can revisit its fundamental assumptions as well. I would suggest revisiting the Modigliani-Miller theorem and its capital structure irrelevance principle. Although not cause and effect by any means, not long after its acceptance into the corporate finance world, the U.S. was transmuted into a fiat money economy and it seems one was the fulminate of mercury to the other's dynamite.

So what does the world of corporate finance post Modigliani-Miller, investment houses, hedge funds, credit default swaps, fractional reserve banking, and traditional security derivatives have in common? Simply put, a propensity toward leverage. Even current Black Swan theories attempting to explain what went wrong resemble an apologia. It wasn't the strategy of camping out in Vegas, per se, that is the result of your downfall, rather, "what are the odds, who coulda known" that the dealer would have had such a [bad] run. Asian countries save 15% to 50% of their income; we use to be the world's largest creditor nation. Now we worship debt.

In 1847 in a Vienna hospital, Ignaz Semmelweiss noticed a dramatically high incidence of death among women who were assisted in child birth by physicians who had come directly from autopsies. He recommended some practical reforms, like washing of hands [[and the changing of the surgeons outer 'robe', on which was borne every mark of past bloodied encounter, like a badge of honor: normxxx]]. It was a practical instinct that animated him since this was before the germ theory of disease [[and even 'correlation' was unknown, since statistics was still largely a hobby of a few mathematicians and hardly taken seriously by 'real men of learning': normxxx]]. Despite the devastation all around them, his recommendations were viciously attacked by the establishment. Let us learn from history and return to the practical ways of our forebears.

Many years ago Alexander Pope, wrote:

"Nature and Nature's Laws lay hid in Night God said, Let Newton be! and all was Light."

So until that time comes, when a new paradigm is revealed to us, and we can all bask in the light, returning to the practical ways of our forebears might very well mean, what people across civilizations have been doing for the past few thousand years: trust in gold.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Poor Fundamentals

Poor Fundamentals With Borderline Market Action
Click here for a link to complete article:

By John P. Hussman, Ph.D. | 20 May 2008
All rights reserved and actively enforced.

One of the lessons that kids sometimes learn the hard way is that mid-air is the wrong place to be asking, "What now!?!"

Investors may end up learning that lesson the hard way too. In recent weeks, investors have chased stock prices higher (though on relatively dull volume and narrow, cyclical leadership) like kids riding their bikes up a board they've laid over a pile of bricks to take a sweet jump. Once in the air, the question is "What now?"

The S&P 500 currently trades at 22.9 times trailing net earnings, but these earnings are somewhat depressed and not representative of normal long-term earnings power. What is more important is that the S&P 500 presently trades at over 20 times normalized earnings (sustainable earnings at normal profit margins). More friendly price/earnings multiples on the basis of "forward operating earnings" or even price-to-peak-earnings are had only on the assumption of a remarkable earnings rebound in the second-half, or a permanent return to the record-high profit margins of recent years.

This is a lot like a kid imagining, once airborne on the bike, that a foam pit will suddenly appear to break the impending fall.

As of last week, valuations remained unfavorable for stocks. Meanwhile, however, market action continued to hover near the point where speculation could begin to feed on itself. The behavior of trading volume and leadership remains relatively uninspiring, but some popular moving averages have been crossed (such as the 200-day moving average of the S&P 500), which has fed some amount of technical buying. Stocks are clearly overbought on a short-term basis, and given that, it's likely we'll observe some sideways movement for a bit even if the speculative interest of investors ends up continuing in the weeks ahead. Meanwhile, that same overbought condition, given a still-unfavorable Market Climate overall, leaves us braced for a possibly hard retreat.

In short, the fundamentals continue to appear very poor, but market action is at something of a crossroads. The reality is that as recessions develop (and I continue to believe the U.S. faces a much more significant downturn than we've observed to date), the data can take months to accumulate to a compelling verdict, and in the meantime, speculative pressures can remain alive. If the consolidation to clear the current overbought condition is fairly shallow, it will suggest that speculation might begin to feed on itself for a while. A sharp selloff from current levels, particularly on lopsided negative breadth, would suggest that the second round of negative financial and economic news is somewhat nearer.

On the economic front, we learned last week that April capacity utilization dropped below 80%. As I had noted in my March 10 comment, "Indeed, among indicators that have generally turned negative early into recessions, about the only one that has not is manufacturing capacity utilization, which generally drops below 80% as the economy turns down." So much for small comforts. It is important to recognize that the kinds of indicators that investors are looking to for verification of a recession (spiking unemployment, negative GDP reports, bankruptcies, margin-related cost cutting, etc) are generally seen further into a recession than we probably are.

As Martin Feldstein of the NBER (the group that officially dates U.S. recessions) noted a week ago, January appeared to be the recent peak in economic activity, and "there's no question that the economy is down by just about every measure" since then. That suggests that an economic recession would currently be only a few months old, so the recent low in the stock market would have occurred with the U.S. economy only about a month into that recession. This is very implausible from a historical perspective.

So there appear to be two possibilities at hand. Either the March low marked the final trough of the recent decline, and the economy will avert a recession despite the fact that virtually every measure that has historically signaled recession risk has now turned negative, or further trouble is ahead for both the stock market and the economy. Some near-term speculative potential aside (which we would respond to using a modest amount of call option exposure only, leaving our defensive put options in place), the evidence continues to suggest continued caution.

Market Climate

As noted above, the Market Climate for stocks last week was characterized by unfavorable valuations and borderline market action— overbought, but also near the point where speculation could be fed by technical "trend followers." The character of any consolidation here will affect the staying power of that speculation, so we'll be paying close attention to breadth, leadership, and price/volume features of any pullback we observe in the next week or two. In any event, we will continue to hold a defense against fresh or abrupt losses, but we may establish a 1-2% of exposure in call options if market internals hold or strengthen here.

In bonds, the Market Climate last week was characterized by relatively neutral yield levels and moderately unfavorable yield pressures. CPI inflation is now about even with 10-year Treasury yields, suggesting that we are near the point where commodity price weakness could emerge. The Strategic Total Return Fund continues to carry a very short duration of less than 1 year, primarily in Treasury bills, with about 15% of assets in foreign currencies. Last week's strong rally in precious metals shares gave us an opportunity to clip our exposure in precious metals down to less than 2% of assets. We are about at the point where economic slack may begin to restrain demand for many commodities, and it is typical for commodities to retreat from their peaks with very little in the way of upward corrections.

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Barron's Interview: Confessions Of A Short Seller

Interview: Confessions Of A Short Seller
Interview With Douglas A. Kass, President, Seabreeze Partners Management
Click here for a link to complete article:

By Lawrence C. Strauss | 20 May 2008

Douglas A. Kass occupies a special niche in Wall Street's pantheon of brains and wit. He's a short seller, and an outspoken one, at a time when most investors have abandoned the business of betting against stocks. After all, it's a tough way to make a living, and a short seller— who sells borrowed shares in the hope of buying them back later at a lower price— can get wiped out quickly, especially if there's leverage involved. Which there usually is. Brian Smith Kass, 58, is founder and president of Seabreeze Partners Management in Palm Beach, Fla., a hedge-fund firm overseeing about $200 million in short positions. A veteran investor with a research background, he headed institutional equities at First Albany and later, JW Charles/CSG, in the early to mid-1990s. So far, Kass and his crew have made good on their goal of providing returns that aren't highly correlated to the stock market, while eschewing leverage has helped to reduce the firm's investment risk. As of April 30, flagship Seabreeze Partners Short fund was up 16.5%, excluding fees, versus a 5.6% loss for the S&P 500. Since inception in January 2005, the fund is up 40.7%, versus a 15% gain for the S&P. For more about how Kass shorts— and what— please read on.

Barron's: Why short, Doug? What got you interested in that line of work?

Kass: Short sellers are an endangered species, like the dodo bird. The dedicated short pool totals about $5.4 billion, according to Knowledge@Wharton, a Website. That's roughly one-seventh the size of the Fidelity Magellan Fund. It's also a tiny sliver of the approximately $1.9 trillion of hedge-fund assets. But it provides a huge business opportunity for Seabreeze. My friend Jim Cramer's mantra is that there is always a bull market somewhere. At Seabreeze we consider ourselves the anti-Cramers; we say there is always a bear market somewhere, and it's our job to find it.

[For Kass' Pans, see Table below] In the past two decades of the bull market, on average about 58% of the issues on the New York Stock Exchange have advanced and roughly 42% have declined every year. The 42% provides us with fertile opportunities for secular, cyclical and thematic shorts. Short selling is the least served and most uncrowded hedge-fund strategy out there.

What makes short selling so difficult to do effectively over a long period?

The objectives of a long buyer and a short seller are similar. Both want to produce uncommon returns by taking common risk— typically by developing a variant view. Many believe short selling is a mug's game, but I don't, and thus far our results at Seabreeze have supported our opinion. But it is essential to maintain a disciplined short-selling strategy because, remember, risk and reward are asymmetric in selling stocks short. An investor can make only 100% if correct— that is, if the stock sold short goes to zero. But you can lose an infinite amount if you're wrong as the stock keeps appreciating. And there is a gravitational pull of stocks higher over longer periods of time. So we use a very conservative approach to shorting.

Explain it, please.

First, we're diversified across company and industry lines. No individual security exceeds 2.5% of our partnership's assets and no industry sector exceeds 20% of the assets. We'll have 35 to 40 holdings at any given time. Second, "Wee Willie" Keeler, a .341 lifetime hitter who played in the early part of the 20th century, liked to say he "tried to hit 'em where they ain't." We try to do the same by being creative in our stock-selection process.

In what ways are you creative?

We strenuously avoid stocks whose short interest is high relative to the float, or companies whose shares have large short positions relative to their average daily trading volumes. Many short sellers have made the mistake of shorting valuation and have blown up during short squeezes. Avoiding them allows us to sleep at night and allows time for our negative fundamental catalysts to develop.

We also mitigate risk by avoiding leverage [borrowing to enhance the size of a position]. Historically, short sellers have taken concentrated positions, often in companies with small to medium capitalizations, and then used— and abused— leverage. That's a recipe for disaster, particularly when they select investments with too many shorts. The average market capitalization of our holdings is more than $10 billion. Shorting large-caps is another way to control risk.

One of the latest trends in asset management is 130-30 funds, in which the manager shorts 30% of the portfolio and uses the proceeds to buy more long positions. What do you make of this idea?

These funds are a silly gimmick and their half-life will be short. Nearly every long/short manager thinks he is equally facile on the short side as the long. Shorting requires a different skill set; you have to have the mindset of an investigative reporter and be a skeptic at the core. Also, many 130-30 funds use exchange-traded funds [ETFs] as a proxy to short. That's a cop-out and a poor way to produce excess returns.

What are your current investment themes?

Right now our emphasis is on the consumer sector. We've found an undiscovered sector that has limited short interest, namely the dental industry. We wouldn't look at traditional retailers like Target [ticker: TGT] or Kohl's [KSS], or short the Retail Holdrs [Merrill Lynch Retail HLDRs [RTH], a retailing ETF. ETFs are the opium of the hedge-fund community because they are an excuse for lazy hedge-fund managers not to go belly to belly with companies and their managements. A dependency on ETFs as a shorting tool is simply an excuse for not doing hard-hitting and creative research.

But why are you so bearish on the U.S. consumer?

The consumer is spent up, not pent up, and more levered than during any period in history. That's one of the structural problems facing the economy. At the same time, job growth is declining and real disposable incomes are pressured as inflation literally is eating away at the consumer's buying power. It is frightening that the consumer has entered this economic downturn with the most levered position in history. On top of that, we're facing four consecutive months of job losses. We've seen the depreciation of the two most important assets, home prices and equities. Consumer confidence is at a 26-year low. The availability of credit continues to be a problem that will plague the economy for a while. Inflation, the cruelest tax of all, is rising as energy and food prices, in particular, are soaring. And the first-quarter GDP report contained a number of ominous signs that the consumer is spent up while the housing depression continues apace.

So, which consumer stocks are you shorting?

Colgate-Palmolive [CL], Kellogg [K] and General Mills [GIS], which are trading at 17 to 18 times earnings, but have secular earnings-growth rates of 7% to 10%. These companies historically are seen as recession-resistant, but we doubt it. All three are aggressively lifting their selling prices in response to huge cost increases, but demand is starting to suffer as private-label companies and generics gain market share. Demand elasticity, or sensitivity to changes in prices, in toothpaste, soaps and other consumer products has begun to surface in the current recession, as consumers trade down to private-label products.

You're short Berkshire Hathaway [BRK.A]. Betting against Warren Buffett in the past was a costly move, as evidenced by Berkshire's stellar performance since the 1960s. Why do so now?

No. 1, there will never be another Warren Buffett. I respect and admire him considerably, but in part because of the lucrative compensation set-up in the hedge-fund industry, the investment landscape now is inhabited by a lot more smart and aggressive managers who comb for value— far more than there were 10, 20 or 30 years ago. Berkshire Hathaway's outperformance versus the market has been narrowing in the last decade, and I expect that will continue. Investors are going to dump the shares if Buffett is no longer at the helm, though I'm not signaling that he plans to step down anytime soon.

What else concerns you about Berkshire?

More than anything, I'm short Berkshire because of Buffett's recent investment-style drift. In the past five years, Buffett frequently called derivatives "financial weapons of mass destruction." Yet, very much out of character, he immersed himself in several large and thus far unprofitable derivative transactions, leading to an unrealized $1.6 billion pretax loss in the first quarter. I'm also short Berkshire because the salad days for insurance, which is the cornerstone of Berkshire's business, are over. Also, Berkshire's premium valuation seemingly has been a byproduct of the credit crisis, and the perception of the company as a safe haven. Berkshire's shares might underperform as some of the deflated financial companies regain their footing. And Buffett is substantially exposed not only to financials— he owns large positions in Wells Fargo [WFC], Bank of America [BAC] and American Express [AXP]— but also to a weakening housing market through his ownership of Clayton Homes.

You mentioned one of your short themes is the dental industry. What's behind that?

We're short three companies in that space: Danaher [DHR], Henry Schein [HSIC] and Patterson Cos. [PDCO]. The sector is exposed to a weakening consumer and it's not heavily shorted, something we look for. My father was a dentist, and through him I know a great many dentists and CPAs whose clientele consists of dentists and doctors. We have made extensive channel checks of practitioners around the country. One thing we have learned is that elective cosmetic dental procedures are starting to tail off dramatically.

What was the bullish case on these stocks?

Dental distributors and original-equipment manufacturers are seen by many as defensive investments with minimal exposure to recessionary pressures and health-care reimbursement risk. The reality is that nearly half of the roughly $96 billion in annual dental spending— which is basic dental care and cosmetic dental surgery in the U.S.— is paid out of pocket. What's more, there are substantive signs that a slowdown in dental care has begun, especially in weak housing markets around the country. And there are signs that third-party financing is becoming generally less available. At the same time, there's evidence dental consumables and dental equipment like chairs and X-ray machines are tailing off as dentists have begun to cut back.

Do you have a favorite dental short?

Yes, it's Danaher, which isn't typically thought of as a dental company. It's actually a diversified industrial company, but dental products account for roughly 25% of revenue. What caught my eye in Danaher's latest quarter was that they reported flat core dental equipment and consumable sales. Danaher has a trailing 12-month price/earnings ratio of about 20. In contrast, the P/E ratio of General Electric [GE], another diversified industrial company, is under 15. This is surprising since GE consistently has had more rapid organic growth overall than Danaher, and organic growth is the key sentiment driver and metric that moves the diversified-stock group.

How about one more short idea?

Fastenal [FAST], whose stock has risen from 33 in late January to around 50. They operate about 2,200 stores in nonmetropolitan areas selling an array of services and industrial supplies, including threaded fasteners. What intrigues me about this company, in looking at the second half of the year, is that their sales growth is going to be increasingly difficult to sustain, and a profit miss will likely follow. Earlier this month, Fastenal announced its daily sales in April dropped by half a percentage point on a sequential basis. That compares to an 11-year average gain of 0.5%. Companywide sales in May could be several percentage points lower than the typical seasonal growth.

Thanks very much, Doug.

Kass' Pans...

Company               Ticker  Recent Price 
Berkshire Hathaway     BRK.A   $121,510.  
Colgate-Palmolive         CL         72.30  
Kellogg                    K         51.53  
General Mills            GIS         62.08  
Danaher                  DHR         80.07  
Henry Schein            HSIC         56.21  
Patterson Cos.          PDCO         36.09  
Fastenal                FAST         51.66  
Source: Bloomberg

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

"Throw Deep!?!"

Investment Strategy: "Throw Deep!?!"

By Jeffrey Saut | 19 May 2008

Back in the late 1980s a newspaperman visiting the Oakland Raiders football training camp in California had just returned from the Jack London Historic Monument. He read a sample of London’s prose to the colorful Raiders’ quarterback, Ken "The Snake" Stabler: "I would rather be ashes than dust! I would rather that my spark should burn out in a brilliant blaze than it should be stifled by rot! I would rather be a superb meteor, every atom of me in magnificent glow, than a sleepy and permanent planet. The proper function of a man is to live, not to exist. I shall not waste my days in trying to prolong them. I shall use my time." The newspaperman asked the quarterback, "What does this mean to you?" "Throw deep," said Stabler.

Throwing Deep, the Long Bomb, the Hail Mary, are all phrases usually associated with football. It is the spectacular play with the possibility of a quick score, as opposed to the Woody Hayes three-yards-and-a-cloud-of-dust "grind it out" strategy. Throwing Deep is also an attitude, and emotion, that has recently reappeared on Wall Street. Indeed, a mere seven weeks ago the S&P 500 (SPX/1388.28) retested its January 2007 "low" of 1270, traumatizing participants into inaction as the threat of "financial contagion" echoed down the canyons of Wall Street. We, however, were bullish, opining that said retest would be successful and the ensuing rally would carry the averages above their respective February "highs" into mid-May, where a "trading top" should occur in the 1420-1440 zone (basis the SPX). From there, we suggested, a decline would commence that should be measured by "if" the U.S. economy spills into recession (we still doubt it); and then, by if the recession would be short/shallow, or long/deep.

And, isn’t it amazing how fear has morphed into greed in a mere seven weeks, for now the cry on the "Street of Dreams" is about the new bull market that has emerged! We, on the other hand, have turned cautious. Our caution centers on the belief that our economic problems are NOT all behind us, the Dow Theory "sell signal" of November 21, 2007, the double-top chart configuration of the SPX at 1560-1570, and "The Snake;" except in this case we are not referring to Kenny "The Snake" Stabler, but rather the 20-month moving average (MMA) (aka "The Snake") that has often represented the demarcation line of bull and bear markets. As can be seen in the nearby chart, the 20-MMA tends to mark the difference between the "bull" and the "bear." When the SPX is above its 20-MMA stocks are in an "up" phase. Even when "the snake" is marginally violated to the downside, but then quickly recaptured to the upside, the bull trend remains in force. However, when it is violated decisively to the downside, and stays there, caution is warranted.

Clearly, "the snake" has been decisively penetrated to the downside. Even the past seven-week rally has done nothing more than bring the SPX back toward the "belly" of "the snake." While we are certainly hopeful this will be a false technical breakdown, for the past eight years, whenever the "hair" on our neck has been standing up, like it is now, we have tended to err on the side of caution, consistent with Warren Buffet’s two rules of investing: 1) Don’t lose money; and rule number 2) Don’t forget rule number one!

Yet another observation has us worried, that being the price action in crude oil. We are old enough to remember a similar sequence of events that occurred in the 1990-1991 timeframe. As now, the price of crude oil was surging and smart money was selling crude oil short around its then double-top of $24 per barrel. Fundamentally those short sellers were right; oil was clearly overpriced. But then the Persian Gulf War began and in a mere two months oil spurted from $17/bbl. to more than $41/bbl. Long-time readers of these missives know that we are ALWAYS respectful of price action. And while crude is currently fundamentally overpriced, its price continues to elevate. Whether this means another geopolitical event is in the works is unknowable, but crude oil should not be doing what it is doing and it worries us!

Consistent with these thoughts, we are recommending rebalancing energy positions in portfolios (read: selling partial positions to bring weightings back in-line with the portfolio’s original objectives). While longer-term we remain bullish on energy, crude oil is currently 37% above its 200-day moving average, a level that has historically suggested it is well overbought and due for a correction barring some unforeseen geopolitical event.

That said, we are increasingly bullish on the oilfield services complex, believing that the huge cash flows accruing to the exploration & production oil companies (E&P) will result in increased capex spending. Bolstering that view has been unusually bad weather in the Gulf of Mexico this spring, where high winds and choppy waters have curtailed contract awards. Over the past week ocean winds have "laid down," however, and our sense is contract awards will start to flourish. We think this will make pleasant reading for oilfield services companies like Cal-Dive (DVR/$14.00/Outperform) and Superior Energy (SPN/$52.60/Outperform), both of which broke out to the upside in the charts last week.

As for the recent "financials fascination," like the E&P complex we are currently shy of financials after their spectacular rally, driven by the belief that their problems are all in the rearview mirror. We don’t believe it; hello AIG (AIG/$40.28), whose Friday revelations shocked Wall Street participants. As repeatedly stated, we think that after 28 years of financial deregulation the financials are now being re-regulated, which implies a crimp in their profit margins with an attendant P/E multiple compression. And that, ladies and gentlemen, is why we have avoided the financials.

So what should we do? Well, our trading strategy has been to sell trading positions into strength on any rally above 1420 (basis the SPX). This is especially true now that we have entered our cluster of trading-top "timing points" in the May 7th— May 14th timeframe. If you followed that advice, you have "lost" (read: sold) two-thirds of your trading positions and raised stop-loss points on the remaining one-third. As for the investment account, we remain opportunistic buyers of fundamentally sound, favorably rated, dividend yielding, hopefully non-economically sensitive situations on price weakness as they approach support levels in the charts.

In past missives we have recommended names like 7.7%-yielding Alaska Communications (ALSK/$11.11/Outperform), 6.3%-yielding Embarq (EQ/$43.59/Strong Buy), as well as Schering-Plough’s 8%-yielding convertible-preferred "B" shares (SGP+B/$181.79); SGP is still favorably rated by our correspondent research affiliates, as is 3.8%-yielding GE (GE/$32.27). And this morning we offer for your consideration, even though it is currently rated Market Perform by our fundamental analyst, 11%-yielding LINN Energy (LINE/$22.59) with a stop-loss point of $18.57, which is its recent reaction low. Additionally, the dry bulk shipping complex is worthy of consideration given the recent strengthening shipping surveys, and rising Baltic freight rates, which suggests emerging markets remain strong. Verily, our favorite "country play" over the past few years has been Brazil, whose bourse has broken out to the upside in the charts. Yet for bulk shipping ideas, we defer to our correspondent research affiliates along the lines of DryShips (DRYS/$91.96).

The call for this week: Sometimes you "throw deep," and sometimes you "grind it out." We were cautious entering 2008 fearful of a "selling stampede," but turned bullish at the late January "lows." Again we were cautious at the February "highs," suggesting that a re-test of the January "lows" was in order, but became aggressively bullish at the subsequent downside re-test of those January "lows" in March, believing said re-test would be successful. And that the ensuing rally would carry the major averages above their respective February "highs." Regrettably, once again we are "grinding it out" (read: cautious) now that we have rallied 12%, entered our cluster of topside "timing points," and traveled into our upside target zone of 1420-1440. Indeed, it’s never the snake you see that bites you!

S&P 500 with 20-month Moving Average

Click Here, or on the image, to see a larger, undistorted image.
Source: Reuters.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

2009: The 120-Year Cycle Trough Begins?

Economic Collapse In September?

By Clif Droke, GSR snippet | 19 May 2008

A rumor is swirling around the Internet that an inglorious end to the U.S. economy is imminent. Unlike previous rumors to this effect, this one carries the weight of recent events in the financial realm and has many believing the rumor will come to pass.

Let's examine some of the claims being made: On March 18, 2008, a "closed door" session of Congress was held for only the fourth time in history. According to House Rule XVII, clause 9, it is forbidden for members of the U.S. House of Representatives to reveal the discussions held behind those doors. The penalty for leaking such information includes loss of seniority, fines, reprimand, censure or expulsion. According to news 'leaks' [[on pain of 'loss of seniority, fines, reprimand, censure or expulsion': normxxx]], one purpose of the meetings was to discuss new surveillance techniques to be used by U.S. Homeland Security. Rumors continue to swirl as to what the other topics of discussion took place in that meeting.

According to the Australia.TO newspaper, as reported in the May 2008 Last Trumpet Newsletter (LTM), several congressmen were so incensed about what was discussed behind those doors that they were compelled[!?!] to leak the contents of the meeting. Following is what is rumored to have been discussed: Imminent collapse of the U.S. economy by September 2008; imminent collapse of the U.S. Government finances by February 2009; possibility of civil war within the U.S. resulting from the collapse; detainment of "insurgent U.S. citizens" in anticipation of their moving against the government; the potential for violent action taken by citizens against members of Congress due to the collapses; the merger of the U.S. economy with those of Canada and Mexico as a solution to the collapse; the introduction of a new tri-national currency called the "AMERO" as another economic solution.

Needless to say, that's a lot of information to process. Unfortunately none of it can be verified and it essentially falls under the category of rumor and as such must be treated as suspect. It brings to mind another rumor that had the Internet community abuzz last September regarding the so-called "Bin Laden options trade." You may recall the rumors that circulated across many Internet sites in Sept. 2007. The rumors concerned an unknown trader or traders placing options bets on the S&P 500 and the Dow Jones Eurostoxx50 index that wouldn't pay off unless a 25%+ crash occurred by options expiration that same month. These high-profile "mystery" trades were used by several independent and mainstream media outlets to conjure up images of another 9/11-type terrorist episode.

The end result was that the stock market rallied sharply shortly after the stories appeared and several indices made new all-time highs in October. The terrorist event that was conjured up by the options trade never came to pass.

Now before you dismiss me as a Pollyanna, let me say that there does ring a certain measure of truth to the rumor concerning an economic collapse. There wouldn't be as much fear generated over the headlines, nor would they be as widely circulated as they have been, if there wasn't. The fact that many people even consider these stories as being potentially true is revealing of the mindset of Americans today: they are nervous about the economy, scared over high oil and gas prices and none too happy over the housing price deflation. So we can imagine how easily someone might be swayed by a rumor of this magnitude. More than anything else, the rumors of an imminent financial and economic collapse are symptomatic of a wounded mass psyche.

The next consideration is that even if the substance of the rumor is untrue (to say nothing of the projected timeline), the fact that many are inclined to believe it doesn't reflect well, nor does it bode well, for the government. When rumors like this one begin to spread, and are believed even in part, it is a vote of no confidence for the government and monetary authorities. While such problems can be remedied with short term solutions, the longer term implications are disturbing and are much harder to remedy.

The Fed may well have dodged the bullet this time but in so doing it has created for itself a new set of difficulties down the road. Those challenges can only be viewed properly through the lens of the long-term Kress cycles. Quoting Machiavelli, "It is in the nature of things that you can never escape one setback without running into another." In the here and now, consumers are feeling the weight of high gas and food prices. An article appeared in the May 14 edition of the Washington Post bearing the headline: "Burdened by the weight of inflation, standards of living are challenged." The article reported the results of a Washington Post/ABC News poll which surveyed households across the socio-economic spectrum.

The poll found that nearly 7 in 10 are concerned with their ability to keep up their lifestyles high. Moreover, those expressing concern are not only from the lower and middle classes but also from upper income levels. The results showed a significant spike in just the last five months when a previous poll was taken. The Post reported that anxiety over the economy is at its highest level since 1981. The poll found that 40% of respondents are "somewhat worried" about their standard of living, compared to 34% in December 2007. Of those saying they are "very worried", the number is 28% compared to 17% in December. The combined totals for these worried responses equals 51% in December compared to 68% today.

Among other findings of the poll is that the top five economic worries among consumers are:

1. Inflation
2. Gasoline
3. Healthcare costs
4. Taxes
5. Jobs

The Post also asked respondents to give their reasons why they think oil and gas prices are as high as they are today. The top responses were:

1. Greed/profit motive of the oil companies
2. Iraq war
3. George Bush

With nationwide gas prices hovering precariously close to $4.00/gallon, the poll found that many respondents had already cut back on their driving habits and were more inclined to use public transportation. Of those who haven't cut back on their driving, the poll asked what the gas price would have to be to make them drive less. The average response was $5.65/gallon.


Click Here, or on the image, to see a larger, undistorted image.

How have the authorities responded to the problems that Americans are now facing? The Congresses' response to the economic malaise has been the approval of a "tax relief" bill which provides a few paltry hundreds of dollars for the purpose of 'stimulating' the retail economy. But will this measure succeed in winning a vote of confidence from the people?

Let's turn once again to the wisdom of the one of Machiavelli for the answer. Machiavelli, in his Discourses on Livy, wrote that "no ruler should... wait for dangerous times in order to win over the populace." He stated further that "in the eyes of the populace, it will not be that ruler who grants them their new benefits, but his enemy, and they will have every reason to fear that once the adversity has passed, their ruler will take back what he was forced to give. Consequently, the populace will not feel bound to him in any way."

Since the announcement that $600 checks would be mailed to taxpayers in the form of "relief", we've heard nothing but criticism from the taxpayers. The remarks range from, "Bush is borrowing the money from Red China," to "we'll have to pay it all back in next year's taxes," to "$600 won't cover my expenses for even a month!"

As Machiavelli informs us in his Discourses, a government "must try to foresee what adversity might befall [it]", and that a government "which acts otherwise, and then believes that during perilous times [it] can win back the populace with benefits, is deceiving [itself]. Not only will [it] not win over the populace, but [it] will bring about [its] own ruin."

To this end, an article appearing in the May 14 edition of the Financial Times addressed the evolving monetary policy of the Federal Reserve in dealing with asset "bubbles." The old-line method employed by former Fed Chief Greenspan was to wait for the bubble to burst, then belatedly attack the problem. Of this unwise policy we have only to consult Machiavelli or simply look at the results of Greenspan's many policy blunders since at least the '90s.

In the wake of the latest blunders [[that is, since at least last summer— or, far earlier, for those in the 'know': normxxx]], the Bernanke-led Fed is examining the role the Fed should play in lancing asset price bubbles before they burst. How successful the Fed will be in implementing this new strategy remains to be seen. With time running out on the 120-year cycle clock, the economic winds are not against their back as was the case in the 1990s.

Beginning sometime around the summer of 2009 [[but increasingly likely to be triggered by some financial "accident" between now and then: normxxx]], we'll be entering a period unlike any ever experienced before by a single one of us, regardless of age! The last of the Kress long-term cycles peaks at that time, namely the 10-year cycle. From that point until 2014 there won't be any cycle of long-term consequence (i.e., a year or more) in the ascending phase, a configuration that hasn't been seen the 1890s [[not a good time, needless to say: normxxx]]. The 120-year Master Cycle will be in its final "hard down" phase and governments and monetary 'authorities' will be confronted with many challenges and obstacles, with little history to guide them.

It's very easy, though, to get wrapped up in the fear that anticipating this coming event will bring. Fear is paralyzing and causes us to miss opportunities we might otherwise recognize were we not under its grip. As Jesus said, "Sufficient until the day is the evil thereof." Let's not get caught in the trap of constantly fearing the problems of the years to come when we still have today to concern ourselves with.

Let's turn now to the present stock market outlook. In my April 24 commentary entitled, "At last, good news is on the way!", I pointed out that "beneath the surface of this stock market, things are improving more and more each week. It won't be long now before eventually those individual stock prices start moving higher in response to the market's internal improvement." This statement was a reference to the dramatic improvement in the stock market's internal momentum indicators, which show the 30-day, 90-day and 120-day internal rate of change for the NYSE broad market. These indicators are in turn reflections of the dominant interim cycles.

Since then the stock market has been in recovery mode with the S&P 400 Mid-cap index (MID) showing the most impressive rally of the major indices. Take a look at the progression of the mid-cap stocks since the March price bottom. The Mid-cap index is now at a high for the year and has completely recovered the damage inflicted by the sell-off in December-January. Besides being a good barometer of the corporate outlook, the MID is also a good leading indicator for the S&P 500.


Click Here, or on the image, to see a larger, undistorted image.
chart courtesy of BigCharts

The stock market continues its upward bias in spite of a lack of broad participation from sidelined investors. The rally up until now has been of the "phantom" variety in the sense that few have participated in it. Billions of dollars in cash remains in low-yielding money market and other "safe haven" funds as the crowd demands more proof of recovery before jumping back into the stock market. This speaks to the paralyzing fear that has many investors in its grip. By looking at the cycles, however, we don't have to be controlled by fear. Instead, we can put fear aside and take advantage of the opportunities the market hands to us along the way in this once-in-a-lifetime adventure on the road to the 120-year cycle.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A Bubble That Broke The World

A Bubble That Broke The World:
Lessons From The Great Depression When Credit And Debt Are One.
Click here for a link to complete article:

By Dr. Housing Bubble | 18 May 2008

We are swimming in a world of debt. Somewhere in the past decade debt lost the negative connotation of being a four letter word. In fact, the language of so many things has changed and the ultimate ramifications now have sweet language to soften the utter destructiveness of the underlying instrument. 'Junk' bonds are now looked at as "high yield" bonds. I don’t like junk, but I sure love the sound of "high yield"! The most profound change has been the idea that current connotations of 'credit' has now supplanted the former connotations of 'debt' [[and, in fact, is used iterchangeably with 'money', aka, 'Federal Reserve notes', (which, after all, is only the debt of the Federal Reserve to the government of the US!): normxxx]].

We talk about the worldwide 'credit' crisis, when what we are really talking about is the global 'debt problem'. When you think of 'credit', the connotations are invariably positive. You received 'credit' for completing the assignment. 'Hey Joe, I give you great credit for working so hard on the project.' 'We credit you sir for the excellent job here!' It would be extremely different if 'credit' cards were titled 'debt' cards. Or, what if we called them "instant layaway" cards instead of calling them 'platinum premium member cards'.

The psychology of this housing bubble is absolutely fascinating and disturbing. When you really boil it down, you have to wonder what people were thinking. These were folks who were reluctant to place a $100 bet in Vegas, yet they readily purchased a grotesquely overpriced home, and many are now sitting on $100,000 or more of negative equity. Many would like to think they weren’t 'speculating' (a nicer name for 'gambling')— because it was real estate [[and real estate never goes down in price, right? : normxxx]]— but there was no fundamental reason for home prices to reach the level that they did. The irony of all this is that we still keep hearing that this is a 'credit crisis'.

The fact is that Americans were unable to keep this economy going without massive amounts of debt [['funny money' created by the banks outside of the Federal reserve system by selling those 'credits' in the commercial paper market! : normxxx]]. 'Debt' in all forms that fueled spending and accounted for a large percentage of our GDP. In reality it was a gigantic Ponzi scheme [[on a truly world-wide scale! : normxxx]] and in the end, like all Ponzi schemes, it come crashing down of its own weight when the markets ran out of suckers.

Today in our "lessons from the Great Depression" series, we are going to look at a book written in 1932

A Bubble That Broke The World (Paperback)
by Garet Garrett

It is a fascinating look at the social reasons why bubbles form and ultimately collapse. It is worth a full read but we’ll go through some important passages here and parallel them to our current situation. This lesson is part IX in our continuing series.

A Bubble That Broke The World

"Mass delusions are not rare. They salt the human story. The hallucinatory types are well known; so also is the sudden variation called mania, generally localized, like the tulip mania in Holland many years ago or the common-stock mania of a recent time in Wall Street. But a delusion affecting the mentality of the entire world at one time was hitherto unknown. All our experience with it is original. This is a delusion about credit. And whereas from the nature of credit it is to be expected that a certain line will divide the view between creditor and debtor, the irrational fact in this case is that for more than ten years debtors and creditors together have pursued the same deceptions. In many ways, as will appear, the folly of the lender has exceeded the extravagance of the borrower."

I think it is important to note that in this current bubble it does take two to tango. Many borrowers bought in many cases as speculators even though they thought they were making a prudent decision. It can be said that this is no more logical than buying a luxury car and expecting more than what you paid for it 5 years later. Ultimately when you go to sell the market will dictate the price. But not everyone participated in this mania. Look at these sobering numbers and I’ve tried to word it to change your perspective on what is going on.

According to the U.S. Census Bureau, 31.8 percent of all U.S. owner-occupied homes have no mortgage. 32 percent of the country rents. The vast majority of those remaining with mortgages have been financially responsible. Why should it now be the responsibility of those who managed their finances prudently to bailout the few who speculated— including irresponsible lenders who made loans to people who had no chance of ever paying it back?

Let us continue with the article:

"The general shape of this universal delusion may be indicated by three of its familiar features. First, the idea that the panacea for debt is credit. Debt in the present order of magnitude began with the World War. Without credit, the war could not have continued above four months; with benefit of credit it went more than four years. Victory followed the credit. The price was appalling debt. In Europe the war debt was both internal and external. The American war debt was internal only. This was the one country that borrowed nothing; not only did it borrow nothing, but parallel to its own war exertions it loaned to its European associates more than ten billions of dollars. This the European governments owed to the United States Treasury, besides what they owed to one another and to their own people. Europe’s attack upon her debt, both internal and external, was a resort to credit. She called upon this country for immense sums of private credit-sums which before the war had been unimaginable-saying that unless American credit provided her with the ways and means to begin moving her burden of debt she would be unable to move it at all. Result: The burden of Europe’s private debt to this country now is greater than the burden of her war debt; and the war debt, with arrears of interest, is greater than it was the day the peace was signed. And it is not Europe alone. Debt was the economic terror of the world when the war ended. How to pay it was the colossal problem. Yet you will find hardly a nation, hardly any subdivision of a nation, state, city, town or region that has not multiplied its debt since the war. The aggregate of this increase is prodigious, and a very high proportion of it represents recourse to credit to avoid payment of debt."

How the tables have turned. We are now a largely debtor nation. We owe money to China, Japan, Europe, and many other foreign players [[HUGE amounts; amounts so huge they are probably unrepayable!: normxxx]]. We are no longer a lender but the world’s greatest borrower. We are now a debtor in this game. In fact, each day we have to borrow large sums of money to keep consuming at current levels. Our trade deficits show this unnerving fact clearer than anything else. Simply looking at cargo coming into our large ports in San Pedro and Long Beach, we see that 3 cargo containers come in loaded with produced goods and we send out barely 1 full container; many times when we export items it is raw materials. This imbalance is harming us. And of course, what we learn from Europe from the early part of the 1900s is that war debt drags an economy down into the abyss.

"Second, a social and political doctrine, now widely accepted, beginning with the premise that people are entitled to certain betterments of life. If they cannot immediately afford them, that is, if out of their own resources these betterments cannot be provided, nevertheless people are entitled to them, and credit must provide them. And lest it should sound unreasonable, the conclusion is annexed that if the standard of living be raised by credit, as of course it may be for a while, then people will be better creditors, better customers, better to live with and able at last to pay their debts willingly. Result: Probably one half of all government, national and civic, in the area of western civilization is either bankrupt or in acute distress from having over-borrowed according to this doctrine. It has ruined the credit of countries that had no war debts to begin with, countries that were enormously enriched by the war trade, and countries that were created new out of the war. Now as credit fails and the standards of living tend to fall from the planes on which credit for a while sustained them, there is political dismay. You will hear that government itself is in jeopardy. How shall government avert social chaos, how shall it survive, without benefit of credit? How shall people live as they have learned to live, and as they are entitled to live, without benefit of credit? Shall they be told to go back? They will not go back. They will rise first. Thus rhetoric, indicating the emotional position. It does not say that what people are threatening to rise against is the payment of debt for credit devoured. When they have been living on credit beyond their means the debt overtakes them. If they tax themselves to pay it, that means going back a little. If they repudiate their debt, that is the end of their credit. In this dilemma the ideal solution, so recommended even to the creditor, is more credit, more debt."

Was this written yesterday? Talk about repeating history again. This psychological notion that one is entitled to a better life regardless of savings is not new. In fact, it seems that the mentality then was the same as today: if you can’t afford the artifacts of middle class life with your own saved [!?!] money then it is probably the fault of lack of credit. Forget that it should mean that you probably can’t afford it [[or, indeed, need it! : normxxx]]. And the solution offered at the time? More debt!

I can hear Bernanke saying, "more credit for liquidity" and we are back at square one. Remember that Ben Bernanke is a student of the Great Depression, so none of this is lost on him. Yet somehow he thinks the problem wasn’t too much 'debt' but not enough "credit" quick enough. Well he just saw how impotent the Fed was with their rate cuts. He bought a wee bit of breathing room, but we are still nowhere out of the woods. And, if we keep thinking that the only problem is the need for still more debt, we are going to spiral downward into a debtor’s hell. Many are already at this point.

"Third, the argument that prosperity is a product of credit, whereas from the beginning of economic thought it had been supposed that prosperity was from the increase and exchange of wealth, and credit was its product. This inverted way of thinking was fundamental. It rationalized the delusion as a whole. Its most astonishing imaginary success was in the field of international finance, where it became unorthodox to doubt that by use of credit in 'progressive' magnitudes to inflate international trade the problem of international debt was solved. All debtor nations were going to meet their foreign obligations from a favorable balance of trade. A nation’s favorable balance in foreign trade is from selling more than it buys. Was it possible for nations to sell to one another more than they bought from one another, so that every one should have a favorable trade balance? Certainly. But how? By selling on credit. By lending one another the credit to buy one another’s goods [[still better, as today, lend the debtor the money to buy your goods with! : normxxx]]. All nations would not be able to lend equally, of course. Each should lend according to its means. In that case this country would be the principal lender. And it was. As American credit was loaned to European nations in amounts rising to more than a billion a year [[a billion? a billion? more like hundreds of trillions, today! : normxxx]], all in the general name of expanding our foreign trade. The question was sometimes asked: "Where is the profit in trade for the sake of which you must lend your customers the money to buy your goods?" [[where, indeed: normxxx]] The answer given was: "But unless we lend them the money to buy our goods they cannot buy them at all. Then what should we do with our surplus?" As it appeared that European nations were using enormous sums of American credit to increase the power of their industrial equipment parallel to our own, all with intent to produce a great surplus of competitive goods to be sold in foreign trade, another question was sometimes asked: "Are we not lending American credit to increase Europe’s exportable surplus of things similar to those of which we have ourselves an increasing surplus to sell? Is it not true that with American credit we are assisting our competitors to advance themselves against American goods in the markets of the world?"

Welcome to our new world. Guess where these foreign nations are putting their money? Does the idea of sovereign wealth funds ring a bell? Not only are they placing it back into their own countries building stronger internal economies but they are also buying the best businesses in the United States on the cheap. This is all well and good if you look at it from a strictly economical stand point[!?!] but what about countries like Russia or Venezuela that clearly do not have the same political ideologies as we do here. In fact, in some cases, they are in direct opposition the values of this country that is sending them loads of money. Therein lies the problem. The solution would be simple say, in the case of Venezuela— we just stop buying oil from them. But do you think the American people would go for that and see prices sky rocket [[or, perish the thought, even tighten their belts and reduce consumption: normxxx]]? Of course not. They jumped in elation over a $30 gas tax break for the summer [[actually they didn't; most saw through the ploy!: normxxx]] so you really have got to be kidding when it comes to the masses. If we are unwilling to reshape our economy and see the interconnectedness of the problems that debt brings with it, are we really going to wake up and see that America is up for sale to the world, pennies on the dollar? In fact, this may already be unavoidable— you need only look at the state of the dollar for this to resonate.

"The answer was: "Of course that is so. You must remember that these nations you speak of as competitors are to be regarded also as debtors. They owe us a great deal of money. Unless we lend them the credit to increase their power of surplus production for export they will never be able to repay us their debt." Lingering doubts, if any, concerning the place at which a creditor nation might expect to come out, were resolved by an eminent German mind with its racial gift to subdue by logic all the difficult implications of a grand delusion. That was Doctor Schacht, formerly head of the German Reichsbank. He was speaking in this country. For creditor nations, principally this one, he reserved the business of lending credit through an international bank to the 'backward people' [[aka, "undeveloped" or "third" world nations: normxxx]] of the world for the purpose of moving them to buy American radios and German dyes. By this argument for endless world prosperity as a product of unlimited credit bestowed upon foreign trade, we lent billions of American credits to our debtors, to our competitors, to our customers, with some beginning toward the 'backward people'; we loaned credit to competitors who loaned it to their customers; we loaned credit to Germany who loaned credit to Russia for the purpose of enabling Russia to buy German things, including German chemicals. For several years there was ecstasy in the foreign trade. All the statistical curves representing world prosperity rose like serpents rampant. Result: Much more debt [[indeed, MOUNTAINS of debt: normxxx]]. A world-wide collapse of foreign trade, by far the worst since the beginning of the modern epoch. Utter prostration of the statistical serpents. Credit representing many hundreds of millions of labor days locked up in idle industrial equipment both here and in Europe. It is idle because people cannot afford to buy its product at prices which will enable industry to pay interest on its debt. One country might forget its debt, set its equipment free, and flood the markets of the world with cheap goods, and by this offense kill off a lot of competition. But of course this thought occurs to all of them, and so all, with one impulse, raise very high tariff barriers against one another’s goods, to keep them out. These tariff barriers may be regarded as instinctive reactions. They do probably portend a reorganization of foreign trade wherein the exchange of competitive goods will tend to fall as the exchange of goods unlike and noncompetitive tend to rise. Yet you will be almost persuaded that tariff barriers as such were the ruin of foreign trade, not credit inflation, not the absurdity of attempting by credit to create a total of international exports greater than the sum of international imports, so that every country should have a favorable balance out of which to pay its debts, but only in this stupid way of people all wanting to sell without buying."

Our trade imbalance is a danger to our country’s long-term prosperity and has global implications beyond economics. It is certain that if we continue on this path there will be a worldwide meltdown. Yet, there has been no desire from any political party to reign in the manic spending of the American people. Somehow they thought prosperity lay in a decade of trading paper back and forth to one another, flipping houses, and taking money out of homes to add upgrades was the idea of a healthy economy. What we ended up doing was simply rearranging the deck chairs at home, while the 'backward nations' of the world built up an ever stronger production and intellectual capital, and have since siphoned off enough for a more than competitive advantage in many areas.

Spending more than you earn impacts the world more than you think. It is time to get serious about this and make it a national priority to get our books in order. Former Federal Reserve Chairman Paul Volcker knew this and jacked up the Fed Funds Rate into the double-digits to reign in inflation. People did not like this but in the end it made us more productive in the 80s and 90s. Who will be the next person to reign in spending before this bubble breaks the world back to barter?

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

A Rally To Nowhere

A Rally To Nowhere
Click here for a link to complete article:

By Brady Willett | 10 May 2008

The only thing remarkable about the recent rally in U.S. equities is how unremarkable it has been. To be sure, you would think that with the ‘worst’ being ‘over’ stocks would be able to mount a significant bounce. This hasn’t been the case, at least not yet.

To put the above rally in perspective, during the last bear market the S&P 500 notched 3-notable rallies before finally reaching a bottom. Assuming the October 9, 2007 S&P 500 close of 1565.15 proves a ‘top’ and/or we are in a bear market (which has not been confirmed on a closing basis), today’s 11% jump is exceptionally weak by comparison.

Incidentally, there is the argument— recently explored by Russell the revisionist— that stocks are still in a long-term bull market. However, what quickly busts this theory is common sense: for the 7½ years ending October 9, 2007 the S&P 500 gained a total of 2.5%! Does this price action really represent the continuation of the 1982-2000 bull market? (Russell the realist would no doubt remind us that the 2.5% gain in the S&P 500 from March 24, 2000 to October 9, 2007 translates into a significant decline when priced in most non-USD currencies).

Leaving the realm of bulls and bears, it may be important to note that the current market rally is backed by some potentially potent near-term drivers. First and foremost, the yield on so called ‘sidelined’ capital (primarily parked in money market funds) has reached a point where it doesn’t match inflation. Some market timers think— a la Greenspan’s 2003 trick— that this means the Fed has reduced interest rates low enough to entice some of this money back into equities. Next, volatility is showing signs of trending down, and with the Fed essentially guaranteeing the survival of any party too ‘interconnected’ to fail it is plausible that we have entered a period of calm.

Finally, the shorts, which aggressively covered some of their positions following the Bear Stearns bailout, are still holding a historically high short position. If a major move higher transpires these shorts could be burned, adding some volume to the buy side of the equation.

Is the ‘sidelined’/VIX/short selling story reason enough to buy stocks now? Unfortunately no. Rather, the more pressing story is that as the Fed tries to hit the reset button on the credit bubble the U.S. economy is threatening to go tilt. Quite frankly, even if you assume that the Fed will be entirely successful in its efforts to stimulate lending and bring risk taking back to the financial markets, there is the real risk that dangerous amounts of inflation are sticking in the system (if the period of creative destruction that is ongoing in the housing market and structured finance markets is not enough to quell the inflation monster what are the odds that U.S. stock market and economic rebound in the latter half of 2008 will do the trick?) When you combine these uncertainties with the unattractive market valuations it is clear that pinball wizards need only apply to the speculative bets being made in equities today.

In short, the mayhem that erupted in late 2007/early 2008 has indeed calmed, but many years will likely have to pass before the markets are once again restored to 'normal'. With the Fed, U.S. government, and U.S. consumer forced to adopt emergency measures simply to keep up the norm a little while longer, those that cheer the relief rallies and unsustainable economic bounces may end up doing so at their peril. Beware!

"The increase in consumer debt totaled $15.3 billion at an annual rate in March, much bigger than the $6 billion increase that economists had been expecting. The bigger gain was seen as a sign that the weaker economy was forcing consumers to increase their borrowing to support spending…" AP ~~~ FED

  M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Winter Warning: Chaos Chronicled

Winter Warning: Chaos Chronicled
Click here for a link to complete article:

By Ian Gordon/Alf Field | 28 April 2008

Ed. Ian Gordon, Economic Forecaster & Interpreter of the Kondratieff Cycle: Winter Warning this week is entirely the work of Alf Field who has written a very good piece entitled "Chaos Chronicled" Alf leads you through the history of the world financial crisis. He begins with an explanation of Goldsmiths, the original bankers, followed by the development into the Fractional Reserve Banking system. Alf then discusses the International Monetary System based on the dollar and the inherent weakness in such a system due to the ability of banks around the world to consistently add massively to loans. This is followed by an explanation of the OTC derivatives market and the crisis which has developed in that milieu. "Chaos Chronicled" is a coherent and chronological evolution into the crisis that has now enveloped the world.

[ Normxxx Here:  The following is only the conclusion of this very erudite piece by Alf. See the link above for the remainder.  ]

It does not take a genius to work out that the US Dollar Standard (with the US dollar as the reserve currency) has to go, but it will take a genius to work out what the new system should be. The new system will require sound money that cannot be manufactured at will by Governments, money that performs the 3 basic functions of medium of exchange, unit of measurement and store of value. A new international monetary system needs to be developed. It seems that the eternal money, gold, will have to be returned to the monetary systems, both national and international, to provide the necessary discipline. That is all for the future. Meanwhile there is a mess to clear up and how that occurs will have investment consequences and implications.

There was a crisis in the US banking system during the 1970’s with major loans to South American Governments going sour. South American countries actually defaulted on their sovereign loans, leaving the American banks with large losses. If these losses had been brought to account, the banking system would have wiped out its reserves. Special permission was granted to allow the loans to be carried at book value until the banks raised new capital and/or accumulated sufficient profits to write off their South American loan losses. The banks were allowed time to trade out of their losses.

The current situation is different. In the 1970’s crisis it was possible to identify where the losses would fall and the individual banks could quantify their losses. In 2008 it is impossible to identify the degree of loss within an order of magnitude or determine where or how they will fall. The US banking system has already recognised losses that have wiped out bank reserves to the extent that the banks can only continue operating with aid from the Fed. The losses written off to date are likely to be augmented by substantial additional sub-prime and CDS losses of presently unknown magnitude. Moreover, it is unclear where those losses will finally appear. Every bank is suspect.

The mountain of OTC derivatives is one of the major problems facing the world’s banking and financial systems. Unfortunately there is no easy way of getting rid of these derivatives. George Soros recently suggested that a clearing house system should be established for the OTC derivatives. This is an impractical suggestion as a brief example will quickly illustrate.

Assume that investor A buys $100m of 5 year bonds in XYZ Company. He is unsure of the strength of XYZ Co. so he also buys a 5 year CDS from B to cover any loss in the event of XYZ Co defaulting on its bonds. The investor pays a premium of say $2m per annum. Two years later it is desired to close down this transaction. If A and B were still the only parties to the transaction, they could sit around a table and discuss how to determine the current market value of the CDS. IF they could agree a market value for the CDS and IF both parties were willing to cancel the CDS, it could be cancelled by one party paying to the other the mutually agreed amount.

In reality B will probably have arbitraged its position to a number of other parties and the investor A may have sold his bonds to a number of other investors with the CDS protection attached. It is a practical impossibility to get all parties to this 'simple' transaction together to discuss a possible settlement and cancellation of the deal. This is just a single 'simple' transaction without the complication of additional features such as collars, caps, swaptions, etc. It is also only one of zillions of OTC transactions that are in existence. To expect any clearing house to be able to settle these derivative contracts is just wishful thinking.

Nevertheless, this mountain of OTC derivatives has the capacity to bring down the entire international financial system, including the banking systems of the key players in the event of the bankruptcy of one or more of the larger counter parties. Some way has to be found to reduce or eliminate this OTC derivative overhang which would otherwise eventually prove fatal to the present system [[In past, whenever a default threatened or was realized, this could be largely 'papered over' with further derivatives; this is no longer true.: normxxx]]. History has shown that when debt becomes excessive, the lenders almost always lose.

They lose either because their debtors go bankrupt or they lose because they are repaid in currency which has been debased by wholesale printing, making the currency worth very little in real terms. There is no doubt that the world has reached an extreme level of debt creation. The only question is whether the debt will be settled by bankruptcies or whether the debt will be repaid in largely worthless currency. Fed chief Ben Bernanke has made it quite plain that his plan is NOT to allow debt to be repaid by bankruptcy and deflation. All his actions to date are in line with his proclaimed policy. There is no reason to think that he will change his thinking or modus operandi. Thus we have to believe that USA has embarked on a voyage that will allow debts to be repaid in debased, largely worthless currency.

Jim Sinclair has drawn an analogy comparing the Weimar Republic in 1919 with the present mountain of OTC derivatives. After World War I the Allies imposed excessively large reparation claims on the German Republic. The Germans objected to the magnitude of the claims, but finally agreed when the Allies allowed the Germans to settle the reparation payments in Reichsmarks. The Germans then adopted the attitude that "if they want Reichsmarks, we will give them Reichsmarks". They then proceeded to print new Reichsmarks at an accelerating rate to settle the reparation debts and keep abreast of the ensuing inflation, eventually causing the classic hyperinflation that destroyed the German currency [[and, collaterally, the German economy, all Reichsmark 'savers' and, eventually, also the Weimar Republic: normxxx]].

Jim Sinclair suggests that if one crosses out the words "reparation payments" and replaces them with the words "OTC derivative contracts" one would have a clearer picture of the current circumstances. The suggestion is that the OTC derivative problem can only be settled by creating sufficient additional currency to inflate the current currency to the point where it is largely worthless. That would allow all these derivative contracts and other loans to be settled in debased currency [[where everyone shares in the world bankruptcy— many, by giving up eating. Too bad most didn't share in the preceding boom.: normxxx]]...

  Much, Much, M O R E. . .

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

The Numbers Racket

Numbers Racket: Why The Economy Is Worse Than We Know

By Kevin Phillips, Harper's Magazine | May 2008

This article is from the original. It is not complete. To obtain the complete article, please go to Harper's Magazine.

Bad Money: Reckless Finance, Failed Politics, and the Global Crisis of American Capitalism
by Kevin Phillips


If Washington's harping on weapons of mass destruction was essential to buoy public support for the invasion of Iraq, the use of deceptive statistics has played its own vital role in convincing many Americans that the U.S. economy is stronger, fairer, more productive, more dominant, and richer with opportunity than it actually is.

The corruption has tainted the very measures that most shape public perception of the economy— the monthly Consumer Price Index (CPI), which serves as the chief bellwether of inflation; the quarterly Gross Domestic Product (GDP), which tracks the U.S. economy's overall growth; and the monthly unemployment figure, which for the general public is perhaps the most vivid indicator of economic health or infirmity. Not only do governments, businesses, and individuals use these yardsticks in their decision-making but minor revisions in the data can mean major changes in household circumstances— inflation measurements help determine interest rates, federal interest payments on the national debt, and cost-of-living increases for wages, pensions, and Social Security benefits. And, of course, our statistics have political consequences too. An administration is helped when it can mouth banalities about price levels being "anchored" as food and energy costs begin to soar.

The truth, though it would not exactly set Americans free, would at least open a window to wider economic and political understanding. Readers should ask themselves how much angrier the electorate might be if the media, over the past five years, had been citing 8 percent unemployment (instead of 5 percent), 5 percent inflation (instead of 2 percent), and average annual growth in the 1 percent range (instead of the 3–4 percent range). We might ponder as well who profits from a low-growth U.S. economy hidden under statistical camouflage. Might it be Washington politicos and affluent elites, anxious to mislead voters, coddle the financial markets, and tamp down expensive cost-of-living increases for wages and pensions?

Let me stipulate: the deception arose gradually, at no stage stemming from any concerted or cynical scheme [[well, maybe just a little, here and there: normxxx]]. There was no grand conspiracy, just an accumulation of opportunisms. As we will see, the political blame for the slow, piecemeal distortion is bipartisan— both Democratic and Republican administrations had a hand in the abetting of political dishonesty, reckless debt, and a casino-like financial sector. To see how, we must revisit forty years of economic and statistical dissembling.

Two Views of Consumer Inflation

Click Here, or on the image, to see a larger, undistorted image.
Sources: John Williams, ShadowStats.com
U.S. Bureau of Labor

A Short History Of "Pollyanna Creep"

The story starts after the inauguration of John F. Kennedy in 1961, when high jobless numbers marred the image of Camelot-on-the-Potomac and the new administration appointed a committee to weigh changes. The result, implemented a few years later, was that out-of-work Americans who had stopped looking for jobs— even if this was because none could he found— were labeled "discouraged workers" and excluded from the ranks of the unemployed, where many, if not most, of them had been previously classified.

Lyndon Johnson, for his part, was widely rumored to have personally scrutinized and sometimes tweaked Gross National Product numbers before their release; and by the 1969 fiscal year, Johnson had orchestrated a "unified budget" that combined Social Security with the rest of the federal outlays. This innovation allowed the surplus receipts in the former to mask the emerging deficit in the latter.

Richard Nixon, besides continuing the unified budget [[and other mods: normxxx]], developed his own taste for 'statistical improvement'. He proposed, albeit unsuccessfully— that the Labor Department, which prepared both seasonally adjusted and non-adjusted unemployment numbers, should just publish whichever number was lower. In a more consequential move, he asked his second Federal Reserve chairman, Arthur Burns, to develop what became an ultimately famous division between "core" inflation and "headline" inflation.

Since the Consumer Price Index was calculated by tracking a bundle of prices, so-called "core" inflation would simply exclude, because of "volatility," categories that happened to be particularly troublesome: at that time, food and energy. Core inflation could then be spotlighted when the "headline" number was embarrassing, as it was in 1973 and 1974. (The economic commentator Barry Ritholtz has joked that core inflation is better called "inflation ex-inflation"— i.e., inflation after the inflation has been excluded.)

In 1983, under the Reagan Administration, inflation was further finagled when the Bureau of Labor Statistics decided that housing, too, was overstating the Consumer Price Index; the BLS substituted an entirely different "Owner Equivalent Rent" measurement, based on what a homeowner might get for renting his or her house. This methodology, controversial at the time, but still firmly in place today, simply sidestepped what was happening in the real world of homeowner costs.

Because low inflation encourages low interest rates, which in turn makes it much easier to borrow money, the BLS's decision no doubt encouraged, during the late 1980s, the large and often speculative expansion in private debt— much of which involved real estate, and some of which went spectacularly bad between 1989 and 1992 in the savings-and-loan, real estate, and junk-bond scandals. Also, on the unemployment front, as Austan Goolsbee pointed out in a New York Times op-ed, the Reagan Administration further trimmed the number by reclassifying members of the military as "employed" instead of outside the labor force.

The distortional inclinations of the next president, George H.W. Bush, came into focus in 1990, when Michael Boskin, the chairman of his Council of Economic Advisers, baldly proposed to reorient U.S. economic statistics principally to reduce the measured rate of inflation. His stated grand ambition was to move the calculus from old industrial-era economy weighted methodologies toward the emerging services economy and the expanding retail and financial sectors. Skeptics, however, countered that the underlying goal, driven by worry over federal budget deficits, was to reduce the inflation rate in order to reduce federal payments— from interest on the national debt to cost-of-living outlays for government employees, retirees, and Social Security recipients.

But, it was left to the Clinton Administration to implement these convoluted CPI measurements, which were reiterated in 1996 through a commission headed by Boskin and promoted by Federal Reserve Chairman Alan Greenspan [[the latter being famously myopic when it came to inflation: normxxx]]. The Clintonites also extended the Pollyanna Creep of the nation's employment figures. Although expunged from the ranks of the unemployed, discouraged workers had nevertheless been counted in the larger workforce. But in 1994, the Bureau of Labor Statistics redefined the workforce to include only that small percentage of the discouraged who had been seeking work for less than a year.

The longer-term discouraged— some 4 million U.S. adults— fell out of the main monthly tally. Some now call them the "hidden unemployed." For its last four years, the Clinton Administration also thinned the monthly household economic sampling by one sixth, from 60,000 to 50,000, and a disproportionate number of the dropped households were in the inner cities; the reduced sample (and a new adjustment formula) is believed to have reduced black unemployment estimates and eased worsening poverty figures.

Despite the present Bush Administration's overall penchant for manipulating data (e.g., Iraq, climate change), it has yet to match its immediate predecessor in economic revisions. In 2002, the administration did, however, for two months, fail to publish the Mass Layoff Statistics report, because of its embarrassing nature after the 2001 recession had supposedly ended; it introduced, that same year, an "experimental" new CPI calculation (the C-CPI-U), which shaved another 0.3 percent off the official CPI; and since 2006 it has stopped publishing the M-3 money supply numbers, which captured rising inflationary impetus from bank credit activity. In 2005, Bush proposed, but Congress shunned, a new, narrower historical wage basis for calculating future retiree Social Security benefits.

By late last year, the Gallup Poll reported that public faith in the federal government had sunk below even post-Watergate levels. Whether statistical deceit played any direct role is unclear, but it does seem that citizens have got the right general idea. After forty years of manipulation, more than a few measurements of the U.S. economy have been distorted beyond recognition.

What Does "Unemployment" Mean?

Click Here, or on the image, to see a larger, undistorted image.
source: US Bureau of Labor Statistics
Including workers who are part-time for "economic reasons"
Including other "marginally attached" workers
Including "discouraged" workers
The "official" unemployment rate

America's "Opacity" Crisis

Transparency is the hallmark of democracy, but we now find ourselves with economic statistics every bit as opaque— and as vulnerable to double-dealing— as a subprime CDO. Of the "big three" statistics, let us start with unemployment. Most of the people tired of looking for work, as mentioned above, are no longer counted in the workforce, though they do still show up in one of the auxiliary unemployment numbers. The BLS has six different regular jobless measurements— U-1, U-2, U-3 (the one routinely cited), U-4, U-5, and U-6. In January 2008, the U-4 to U-6 series produced unemployment numbers ranging from 5.2 percent to 9.0 percent, all above the "official" number.

The series nearest to real-world conditions is, not surprisingly, the highest: U-6, which includes part-timers looking for full-time employment as well as other members of the "marginally attached," a new catchall meaning those not looking for a job but who say they want one. Yet this does not even include the Americans who (as Austan Goolsbee puts it) have been "bought off the unemployment rolls" by government programs such as Social Security disability, whose recipients are classified as outside the labor force.

Second is the Gross Domestic Product, which in itself represents something of a fudge: federal economists used the Gross National Product until 1991, when rising U.S. international debt costs made the narrower GDP assessment more palatable. The GDP has been subject to many further fiddles, the most manipulatable of which are the adjustments made for the presumed starting up and ending of businesses (the infamous "birth/death of businesses" equation) and the amounts that the Bureau of Economic Analysis "imputes" to nationwide personal income data (known as phantom income boosters, or 'imputations'; for example, the 'imputed' income from living in one's own home, or the benefit one receives from a free checking account, or the value of employer-paid health-and-life-insurance premiums).

During 2007, believe it or not, imputed income accounted for some 15 percent of GDP. John Williams, the economic statistician, is briskly contemptuous of GDP numbers over the past quarter century. "Upward growth biases built into GDP modeling since the early 1980s have rendered this important series nearly worthless," he wrote in 2004. "[T]he recessions of 1990/1991 and 2001 were much longer and deeper than currently reported [and the] lesser downturns in 1986 and 1995 were missed completely."

Nothing, however, can match the tortured evolution of the third key number, the somewhat misnamed Consumer Price Index. Government economists themselves admit that the revisions during the Clinton years worked to reduce the current inflation figures by more than a percentage point, but the overall distortion has been considerably more severe. Just the 1983 manipulation, which substituted "owner equivalent rent" for home-ownership costs, served to understate or reduce inflation during the recent housing boom by 3 to 4 percentage points.

Moreover, since the 1990s, the CPI has been subjected to three other adjustments, all downward and all dubious: product substitution (if flank steak gets too expensive, people are assumed to shift to hamburger, but nobody is assumed to move up to filet mignon), geometric weighting (goods and services in which costs are rising most rapidly get a lower weighting for a presumed reduction in consumption), and, most bizarrely, hedonic adjustment, an unusual computation by which additional quality is attributed to a product or service.

The hedonic adjustment, in particular, is as hard to estimate as it is to take seriously. (That it was launched during the tenure of the Oval Office's preeminent hedonist, William Jefferson Clinton, only adds to the absurdity.) No small part of the condemnation must lie in the timing. If quality improvements are to be counted, that count should have begun in the 1950s and 1960s, when such products and services as air-conditioning, air travel, and automatic transmissions— and these are just the A's!— improved consumer satisfaction to a comparable or greater degree than have more recent innovations. That the change was made only in the late Nineties shrieks of politics and opportunism, not integrity of measurement [[moreover, NO adjustment is ever made for a DEcrease in quality or service, which is assumed never to occur! : normxxx]]

Most of the time, hedonic adjustment is used to reduce the effective cost of goods, which in turn reduces the stated rate of inflation. Reversing the theory, however, the declining quality of goods or services should adjust effective prices and thereby add to inflation, but that side of the equation generally goes missing. "All in all," Williams points out, "if you were to peel back changes that were made in the CPI going back to the Carter years, you'd see that the CPI would now be 3.5 percent to 4 percent higher"— meaning that, because of lost CPI increases, Social Security checks would be 70 percent greater than they currently are.

Furthermore, when discussing price pressure, government officials invariably bring up "core" inflation, which excludes precisely the two categories— food and energy— now verging on another 1970s-style price surge. This year we have already seen major U.S. food and grocery companies, among them Kellogg and Kraft, report sharp declines in earnings caused by rising grain and dairy prices. Central banks from Europe to Japan worry that the biggest inflation jumps in ten to fifteen years could get in the way of reducing interest rates to cope with weakening economies.

Even the U.S. Labor Department acknowledged that in January, the price of imported goods had increased 13.7 percent compared with a year earlier, the biggest surge since record-keeping began in 1982. From Maine to Australia, from Alaska to the Middle East, a hydra-headed inflation is on the loose, unleashed by the many years of rapid growth in the supply of money from the world's central banks (not least the U.S. Federal Reserve), as well as by massive public and private debt creation.

The U.S. Economy Ex-Distortion

The real numbers, to most economically minded Americans, would be a face full of cold water. Based on the criteria in place a quarter century ago, today's U.S. unemployment rate is somewhere between 9 percent and 12 percent; the inflation rate is as high as 7 or even 10 percent; economic growth since the recession of 2001 has been mediocre, despite a huge surge in the wealth and incomes of the superrich, and we are falling back into recession. If what we have been sold in recent years has been delusional "Pollyanna Creep," what we really need today is a picture of our economy ex-distortion. For what reveals is a nation in deep difficulty, not just domestically, but also globally.

Undermeasurement of inflation, in particular, hangs over our heads like a guillotine. To acknowledge it would send interest rates climbing, and thereby would endanger the viability of the massive buildup of public and private debt (from less than $11 trillion in 1987 to $49 trillion last year) that props up the American economy. Moreover, the rising cost of pensions, benefits, borrowing, and interest payments— all indexed or related to inflation— would join with the cost of financial bailouts to overwhelm the federal budget. As inflation and interest rates have been kept artificially suppressed, the United States has been indentured to its volatile financial sector, with its predilection for leverage and risky buccaneering.

Arguably, the unraveling has already begun. As Robert Hardaway, a professor at the University of Denver, pointed out last September, the subprime lending crisis "can be directly traced back to the [1983] BLS decision to exclude the price of housing from the CPI… With the illusion of low inflation inducing lenders to offer 6 percent loans, not only has speculation run rampant on the expectations of ever-rising home prices, but home buyers by the millions have been tricked into buying homes even though they only qualified for the teaser rates."

Were mainstream interest rates to jump into the 7 to 9 percent range— which could happen if inflation were to spur new concern— both Washington and Wall Street would be walking in quicksand. The make-believe economy of the past two decades, with its asset bubbles, massive borrowing, and rampant data distortion, would be in serious jeopardy. The U.S. dollar, off more than 40 percent against the euro just since 2002, could slip down an even rockier slope.

The credit markets are fearful, and the financial markets are nervous. If the gloom continues, our humbugged nation may truly regret losing sight of history, risk, and common sense.

ߧ

Normxxx    
______________

The contents of any third-party letters/reports above do not necessarily reflect the opinions or viewpoint of normxxx. They are provided for informational/educational purposes only.
The content of any message or post by normxxx anywhere on this site is not to be construed as constituting market or investment advice. Such is intended for educational purposes only. Individuals should always consult with their own advisors for specific investment advice.

Inconvenient Facts

BBC Rewrites Warming Story To Satisfy Activist.
Click here for a link to complete article:

This is one of those twofer stories. That’s where you get two stories for the price of one. Let us start with how the BBC first reported this story. To get the original we had to go to a cached version of it since pressure was put on the BBC to rewrite the story immediately.

Basically the story announced that: "Global temperatures this year will be lower than in 2007 due to the cooling effect of the La Nina current in the Pacific," UN meteorologists have said. "This would mean that global temperatures have not risen since 1998, prompting some to question climate change theory."

Over the next couple of hours the headline on the story changed, twice. And the content was shifted around with new sentences added and others deleted. Why this flurry of rewriting?

The PC Police over at "Campaign against Climate Change" (a ludicrous name if you think about it) got involved and started demanding changes and making threats. It asks readers to "challenge any piece of media that seems like it’s been subject to spin or scepticism." No one must question the faith! More importantly no one must publish anything that sounds like it questions the faith. And any comment that seems to question the divine wisdom of the Church of Anthropogenic Warming must be surrounded by a wall of claims saying it does not deny the divinity of the warming models.

The Campaign against Climate Change got into gear the moment the BBC article appeared— literally within minutes. Jo Abbess of this "activist network" wrote the author demanding he "correct" his piece. She was offended that he mentioned that "a minority of scientists" question warming alarmism and says that there are "very few actual scientists" who do this. That is easily proven false and there is no evidence showing what most scientists believe one way or another.

She was pissed off that the BBC said that global temperatures "will be lower than in 2007." Actually the BBC was quoting the secretary-general of the World Meteorological Society. And Mother Abbess then resorted to falsifying facts to make her case. To prove that 2008 won’t be cooler than 2007 (which was already cooler than the previous decade) she noted that "the ocean systems of temperatures do not change in yearly timescales, and are massive heat sinks that have shown gradual and continual warming. It is only near-surface air temperatures that will be affected by La Nina, plus a bit of the lower atmosphere."

What is the lie there? Simple: the oceans have not shown "gradual and continual warming" as this activist claims. What they have shown is cooling. This article in Geophysical Research Letters shows: "A new estimate of sampling error in the heat content record suggests that both the recent and previous cooling events are significant..." It says that the ocean temperature decrease "represents a significant loss of heat over a 2-year period amounting to one-fifth of the long-term upper-ocean heat gain between 1955 and 2003..."

Under the Argos System some 3,000 robotic sensors were scattered in the world’s oceans to take the temperature accurately. That took place in 2003, and in the years since there has been NO warming at all but a cooling. Mother Abbess was telling a porker when she claimed the ocean’s have had "gradual and continual warming." Well, continual in the sense of ignoring the best data collected over the last five years.

Global temperatures have remained reasonably flat since a decline in 1998 and cooling trends are now being observed despite the fact that carbon dioxide levels have increased in the atmosphere (see graph below).

Indeed, the latest evidence from climatological surveys shows that the earth's upper oceans and the troposphere, the primary indicators of climate change, have not been warming for the last four years.

On the whole, the world is getting colder (see above), which is why "global warming" suddenly became "climate change" when temperature levels since 2003 started to prove the alarmists wrong.

The BBC author first resisted the "activist network" noting that he was quoting the official from the WMO and he wrote: "There are scientists who question whether warming will continue as projected by IPCC." He said there was no reason for a "correction".

Mother Abbess then wrote back saying she was going to get other activists involved in educating this poor science reporter. She also wagged her finger at him: "I think it is highly irresponsible to play into the hands of the sceptics/skeptics who continually promote the idea that ‘global warming finished in 1998’, when that is so patently not true." Actually the skeptics note that warming trends stopped in 1998 which is not the same thing as ended. Ended means it is finished and can’t restart. I don’t know anyone who says that we can’t have further warming trends. All that is is being said is that for ten years now the trend has not supported the warming alarmists.

Mother Abbess preaches, "I think it’s counterproductive to even hint that the Earth is cooling down again, when the sum total of the data tells you the opposite. Glaringly." Please note that for ten years there has been no warming. For the last year and this year it appears that global temperatures will cool. Mother Abbess says that one shouldn’t even "hint" that these facts exist. The public must be deceived.

Now the BBC reporter gets defensive. He says that "sceptics have jumped on the lack of increases since 1998" and this can’t be ignored. So the BBC has to run stories admitting the facts but denying the skeptics any ground otherwise "people feel like debate is being censored".

Mother Abbess responds saying that the headline and lead have to be changed to put the attacks on skeptics near the top of the article lest people get confused and not accept the true, revealed word of God as the warming modellers have written it. That the article is about the earth cooling for the next year is immaterial. It has to attack the skeptics hard right at the beginning in case people don’t read the whole article. At this point she is suggesting a political strategy.

Abbess repeats the false claim that "the oceans have been warming consistently" and says "we’re not seeing temperatures go into reverse, in general, anywhere." I’m not sure how you can have "in general, anywhere". The first implies an average of all places and the second refers to specific locations. But the fact is that, whatever the cause, the evidence is that global temperatures dropped last year and are expected to drop again this year. I wouldn’t use an imprecise phrase like "go into reverse" to describe the climatological process. It is far more complex and can’t be described by automotive references.

Mother Abbess assures the BBC reporter that "this is an issue of emerging truth" which will show "the desperate plight of the planet." She 'implores' him to embrace the faith and "reverse the main BBC Online channel for emerging truth." She tells him it "would be better if you did not quote the sceptics" and that she thought he was educated enough to know "when you have been psychologically manipulated" and that his story implies he is "an unreliable reporter."

Then she turns to the threats. She tells the reporter she intends to send "your comments to others for their contribution" unless he immediately asks her not to do so. And she warns him: "You may appear in an unfavourable light because it could be said that you have had your head turned by the sceptics." Please note that we are supposedly discussing facts of science yet Mother Abbess is talking about one’s "head being turned by the sceptics" much the way a Grand Inquisitor might note that some may deny the divinity of Jesus or even doubt the Trinity.

At this point the BBC reporter caved and wrote back: "Have a look in 10 minutes and tell me you are happier. We have changed headline and more." Mother Abbess then bragged: "The BBC actually changed an article I requested a correction for."

How did the BBC rewrite their story in order placate this "activist" and her demands?

In the original story it mentioned the "cooling effect of the La Nina current". The phrase "cooling effect" was taken out entirely and it was now referred to as merely the "cold La Nina current".

Also moved was the reference to scientists who disagree with warming alarmism. The original said that the "cooling effect" prompted "some to question climate change theory." That reference was moved down several paragraphs. The reason to move it down was given by Mother Abbess. She told the BBC that many readers don’t read past the first couple of paragraphs so anything farther down in the story is often ignored. In response the BBC moved the reference of skeptics down several paragraphs where Abbess had noted it is likely to be ignored.

The original story said "global temperatures have not risen since 1998." That may be true but that is not acceptable. So that sentence was deleted. In it’s place the story then read: "this year’s temperature would still be way above the average— and we would soon exceed the record year of 1998 because of global warming...."

Notice how all the rewrites are in the alarmist direction. The existence of skeptics is deleted entirely. The fact that there has been NO increase in temperatures for ten years has been entirely deleted and instead people are told how "new record high temperature[s]" should be expected "within five years."

I don’t know if the eight years of no warming, followed by two years of cooling, are a trend or a blip. Neither does anyone else [[and nor does anyone know what the next ten years will bring; anything else is pseudo-science! : normxxx]] The only way to tell is wait for more time to pass. But what is obvious is that the claims that we shouldn’t judge what is happening "by one year" are dishonest. They are dishonest because what is under discussion is one year on top of nine other years. It is a decade contrary to warming theory that is under discussion not a one year anomaly. What is clear is that the BBC rewrote a science article to satisfy a political activist, not a scientist.

How many years does it take to be a trend? I personally had not made much of the current state of temperatures until recently. I knew about the current state of affairs for some years now but didn’t comment much on it because I wanted at least ten years of comparison. And I think ten years is worthy of note and indicates potential problems for the warming theory. I don’t say it "proves" anything— just that it is worth consideration and contrary to what we were told to expect. I also note that the cooling oceans for the last half decade also ought not be happening and call into question the theory as it stands. It is not impossible that plausible explanations for these anomalies could be found.

I wonder what Mother Abbess and her activists will do when they discover that a paper published on-line by the British government says "a global temperature decline of 1.5º C is predicted to 2020" due to shifts in the solar cycle. Of course, they could be wrong as well. Only time will tell— but, of course, we are supposed to take "urgent" action "now" "before it’s too late."

Calif Foreclosure "Surge"

California Foreclosure "Surge": Up 327% From '07 Levels
Click here for a link to complete article:

By Peter Viles, LAT | 22 April 2008

The number of California homes lost to foreclosure in the first quarter surged 327% from year-ago levels— reaching an average of more than 500 foreclosures per day— DataQuick said in a report, warning that the widening foreclosure problem could "spread beyond the current categories of dicey mortgages, and into mainstream home loans."

From DataQuick's report on California foreclosures in the first three months of 2008: "Trustees Deeds recorded, or the actual loss of a home to foreclosure, totaled 47,171 during the first quarter. ... Last quarter's total rose 48.9 percent from 31,676 in the previous quarter, and jumped 327.6 percent from 11,032 in first quarter 2007." That translates into 517 foreclosures every day in the first quarter of 2008.

DataQuick president Marshall Prentice: "The main factor behind this foreclosure surge remains the decline in home values. Additionally, a lot of the 'loans-gone-wild' activity happened in late 2005 and 2006 and that's working its way through the system. The big 'if' right now is whether or not the economy is in recession. If it is, the foreclosure problem could spread beyond the current categories of dicey mortgages, and into mainstream home loans." From The L.A. Times' Peter Hong: "Sinking home values and the collapse of flimsy mortgages sent a record number of California homes into the foreclosure process in the first three months of this year, a real estate information service reported today."

Default notices— which mark the beginning of the foreclosure process— increased sharply, but not as rapidly as outright foreclosures. From Bloomberg News: "California mortgage defaults more than doubled in the first quarter to the highest in 15 years as a drop in sales and prices prevented some homeowners from selling their properties to pay debt," DataQuick Information Systems said. More: "Homeowners received 113,676 default notices in the first quarter, up 143 percent from a year ago, La Jolla, California— based DataQuick said today in a statement. The level was the highest since at least 1992, when DataQuick's statistics begin."

Despite well publicized federal efforts to reach out to homeowners in default, the odds that they will ultimately lose their homes appears to be increasing. DataQuick reports that, of the homeowners in default, "an estimated 32 percent emerge from the foreclosure process by bringing their payments current, refinancing, or selling the home and paying off what they owe. A year ago it was about 52 percent."

  M O R E. . .

Normxxx    
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Lies And Other Statistics

Lies And Other Statistics

By John Mauldin | 11 May 2008

"There are three kinds of lies: lies, damn lies, and statistics." — commonly attributed to Benjamin Disraeli

If we are to believe the government statistics, the GDP of the US grew by 0.6% in the first quarter of this year. And unemployment actually fell. And there were only 20,000 job losses. This week we do a quick review of why the statistics can be so misleading. We also look at why I was wrong about the housing number last week, and I highlight what could be a very serious Black Swan lurking in the agricultural bushes. It should make for an interesting letter. It's hard to know where to begin, there are just so many tempting targets; so let's take the statistical aberrations in the order they came out this week.

Who Is Inflating the Numbers?

In my January 2007 annual forecast, I said that we would see a recession or a serious slowdown by the end of 2007 and that it would be mild as these things go, triggered by a bursting of the housing bubble and a slowdown in consumer spending. During the summer and specifically in October I wrote that we were facing a Slow Motion Recession— that the recovery process would be lengthy and take several years before we got back to the 3% growth rate that is more typical of the US economy.

There were lots of people who made fun of my forecasts, and some were quite snide. I really let stuff like that roll off my back. But I have yet to see those writers admit they were wrong (as I will at the end of this letter). And I doubt I will. I take little pleasure in being right on the recession call, as recessions are not fun for those in harm's way, but I call it as I see it. We'll just have to wait and see if some of my other forecasts come to pass. I am sure I will miss a few things. Part of the nature of the business.

Last week I suggested that this week's release of the GDP would be slightly positive, as the BEA would have a much lower number for inflation than our common experience suggests to be the case in the real world. It turns out my cynicism was well justified.

The Bureau of Economic Analysis (BEA) of the Department of Commerce publishes the GDP statistics. They tell us the US economy grew by 0.6% in each of the last two quarters. They come by that number by taking the nominal or "current dollar" measure of the economy and subtracting their figure for inflation, which gives us "real GDP," or after-inflation GDP.

Nominal GDP in the fourth quarter grew by 3%. In the first quarter it was 3.2%. They figure that inflation was 2.4% in the fourth quarter and 2.6% this quarter, giving us the slightly positive growth numbers.

There are several government agencies which track inflation. And in fairness, inflation in an economy as large as that of the US is a very tricky thing to measure. The Consumer Price Index (CPI) is done by another division of the Department of Commerce, the Bureau of Labor Statistics. Let's look at what they calculate inflation to be since last August, in the following table.


Click Here, or on the image, to see a larger, undistorted image.

Note the string of five consecutive months of 4%-plus inflation, and that the average for the 4th quarter was 4%, while for the first quarter of 2008 it was over 4.1%. Never mind whether that is the right number or whether there are problems with how they calculate it— that is a story for another letter. The key here is that if the BEA used the BLS number (remember, both groups are in the same Department of Commerce), it would show the economy shrinking by 1% in the 4th quarter and by almost 1% in the first quarter. That is not what the happy-talk analysts are saying.

But let's use the Fed's favorite measure of inflation, personal consumption expenditures, or PCE. The PCE has been about one-third less than the CPI since about 1992. The difference is in the way they are calculated. The CPI uses a weighted average of expenditures over several years. As I understand it, the PCE tracks changes in relative expenditures from one quarter to the next, assuming that consumers change their habits as prices rise and fall. In simplistic terms, if steak gets expensive, we substitute with hamburger or chicken. One index tracks those changes over years and the other (PCE) does it over quarters. Also, the PCE only tracks personal consumption and not imports or inventories.

If we use the PCE numbers (yet another measure using Commerce Department data), inflation was about 3.3% for both quarters, which would mean negative growth quarters by a few tenths of a percent. That would also mean two quarters of negative growth and a recession.

Further, GDP in the first quarter was helped by inventory build-up to the tune of 0.8%. In times of expansion it is good to see inventories grow, as that means companies are optimistic. But when the economy begins to slow, growing inventories mean that companies anticipated sales that did not materialize. That means that as inventories are allowed to fall in the second quarter, they will show up as a negative factor in second-quarter GDP.

But all these numbers will be changed in a few years, as looking back over several years is the only way we can get somewhat accurate numbers. My bet is that the numbers for GDP will be revised down when the economy is well on its way to recovery. It will show up on page 16 of the Wall Street Journal and no one will care. That is what happened when we found out a few years later that the last recession started in the third quarter of 2000. The initial numbers were positive.

The "official" arbiter of whether or not we are in a recession is the National Bureau of Economic Research. And they do not use the GDP numbers. If they did, then what would be the point of asking them? We could just look at the government statistics. But we don't. Normally, we think of two consecutive quarters of negative GDP as a recession. But NBER has other ways to look at it.

Barry Ritholtz sent this note to me:

"The two consecutive quarters of GDP contraction is not the only metric for identifying recessions. According to the econo-geeks at the National Bureau of Economic Research, a recession is defined as a "significant decline in economic activity spread across the economy, lasting more than a few months." Here's their specific language: " 'Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, 'a significant decline in economic activity.' Second, we use a broader array of indicators than just real GDP. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology.'" "Hence, if we follow what the people who actually determine what is and isn't a recession say about the matter, and not just limit our analysis to GDP, then it's pretty clear we are now experiencing an economic contraction."

Real (inflation-adjusted) retail sales have been flat for the last six months. Incomes are stagnant. Consumer spending is showing every sign of slowing even more. Unemployment is rising (see more below). Consumer sentiment is at 25-year lows. You can count on it that the NBER will show a recession starting the fourth quarter of last year and continuing at the least through the first quarter of this year. This one could last another six months. I still think long and shallow with a very slow recovery.

One last point. The US population grows by about 1% a year. Thus economic growth should increase by at least 1% for the US to stay even on a per capita basis. Thus, at least with regard to GDP per capita, the US is definitely in a recession. And if you use real-world inflation data, we are also in a mild recession [[the latest international GDP reading is 1%; according to the statisticians/economists, anything less than 2% world GDP is recessionary: normxxx]].

Honey, I Blew Up The Employment Numbers

Long-time readers know the problems I have demonstrated with the monthly employment report. It is one of the most revised reports released by any government agency, and for some reason the market seems to react to it l