Fed, FDIC among agencies warning lenders about interest-only and option adjustable-rate mortgages.
December 20, 2005: 2:39 PM EST
WASHINGTON (Reuters) - U.S. bank regulators issued proposed guidance Tuesday telling mortgage lenders they should take caution with innovative new mortgage products that may strain the finances of borrowers and banks as interest rates rise.
"While innovations in mortgage lending can benefit some consumers, the agencies are concerned that these practices can present unique risks that institutions must appropriately manage," bank regulators said in a statement accompanying the proposal.
The guidance targets interest-only and payment option adjustable rate mortgages and the practice of pairing exotic loans with second mortgages and reduced documentation for borrowing.
The proposal was issued by the Office of the Comptroller of the Currency, the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and the National Credit Union Administration.
Regulators proposed that banks assess a borrower's ability to repay a loan with the higher rates and balances that kick in after an introductory "teaser" period.
They also called on banks to be sure they have adequate capital and loan loss reserves on hand as buffers against potential losses because such loans are untested in a "stressed environment."
The agencies further said banks should make certain borrowers have sufficient information to understand loan terms and risks.
Financial institutions have two months to comment on the proposals.
Interest-only mortgages, in which the borrower pays only the interest due, and option adjustable-rate mortgages, which allow borrowers to pay less than the interest due, have joined adjustable rate mortgages as ways borrowers can reduce monthly payments when they buy a house.
Some lenders are waiving detailed documentation to speed the borrowing process. Lenders are also approving second loans simultaneously to keep the primary mortgage under the rate cap for loans that can most easily be sold into secondary markets, thus ensuring a lower interest rate.
Tuesday, December 20, 2005
Monday, December 19, 2005
The Billionaire Pessimists Club
We've heard many times from Warren Buffet about the difficult road ahead for the U.S. economy - the dollar, the perils of living in Squanderville, and the ascendant Sharecropper Society are his most notable objections to the rosy picture painted by Wall Street economists and government officials.
Even Mr. Buffet's much younger, slightly richer, sometimes side-kick, and occasional bridge buddy Bill Gates has been rather down on the dollar lately due to rapidly accumulating debt and the plethora of promises made by the U.S. government.
George Soros and Jim Rogers of Quantum Fund fame are bearish on Bush economic policies and bullish on commodities, respectively. Both of these views bode ill for the American way of life as it has been known for the last half century. That is, the American way of life for most of the citizenry - for the upper few percent of the populace, rising energy and raw material costs are more than offset by a reduced tax burden.
Sir John Templeton has been predicting a U.S. real estate disaster for some time now, and Bill Gross at Pimco has likened the current state of affairs to Rome burning, and much worse.
What do all these gentlemen have in common?
They are all billionaires, they all speak freely, and they all have very serious concerns about the course that the nation's economy has charted.
Is anyone listening to them?
Very few - clearly, not enough. Maybe if there were more billionaires out there talking about issues like this, they could really make a difference. But who? Don't look for the Walton clan of Wal-Mart fame to start talking, or Larry Ellison of Oracle, or Michael Dell of Dell. They don't want to ruin the good thing they all have going.
And certainly don't look for Oprah Winfrey or Donald Trump - they are likely weak on macroeconomics in general and global imbalances in particular.
Just when it looked like the outspoken "Billionaire Pessimists Club" was beginning to lose their momentum, along comes Richard Rainwater.
Richard who?
Good question. Appearing in the current issue of Fortune Magazine, meet Richard Rainwater, billionaire pessimist, dour survivalist, peak oil alarmist, and new hero to this humble blog:
Richard Rainwater doesn't want to sound like a kook. But he's about as worried as a happily married guy with more than $2 billion and a home in Pebble Beach can get. Americans are "in the kind of trouble people shouldn't find themselves in," he says. He's just wary about being the one to sound the alarm.
Rainwater is something of a behind-the-scenes type—at least as far as alpha-male billionaires go. He counts President Bush as a personal friend but dislikes politics, and frankly, when he gets worked up, he says some pretty far-out things that could easily be taken out of context. Such as: An economic tsunami is about to hit the global economy as the world runs out of oil. Or a coalition of communist and Islamic states may decide to stop selling their precious crude to Americans any day now. Or food shortages may soon hit the U.S. Or he read on a blog last night that there's this one gargantuan chunk of ice sitting on a precipice in Antarctica that, if it falls off, will raise sea levels worldwide by two feet—and it's getting closer to the edge.... And then he'll interrupt himself: "Look, I'm not predicting anything," he'll say. "That's when you get a little kooky-sounding."
Rainwater is no crackpot. But you don't get to be a multibillionaire investor—one who's more than doubled his net worth in a decade—through incremental gains on little stock trades. You have to push way past conventional thinking, test the boundaries of chaos, see events in a bigger context. You have to look at all the scenarios, from "A to friggin' Z," as he says, and not be afraid to focus on Z. Only when you've vacuumed up as much information as possible and you know the world is at a major inflection point do you put a hell of a lot of money behind your conviction.
Such insights have allowed Rainwater to turn moments of cataclysm into gigantic paydays before. In the mid-1990s he saw panic selling in Houston real estate and bought some 15 million square feet; now the properties are selling for three times his purchase price. In the late '90s, when oil seemed plentiful and its price had fallen to the low teens, he bet hundreds of millions—by investing in oil stocks and futures—that it would rise. A billion dollars later, that move is still paying off. "Most people invest and then sit around worrying what the next blowup will be," he says. "I do the opposite. I wait for the blowup, then invest."
The next blowup, however, looms so large that it scares and confuses him. For the past few months he's been holed up in hard-core research mode—reading books, academic studies, and, yes, blogs. Every morning he rises before dawn at one of his houses in Texas or South Carolina or California (he actually owns a piece of Pebble Beach Resorts) and spends four or five hours reading sites like LifeAftertheOilCrash.net or DieOff.org, obsessively following links and sifting through data. How worried is he? He has some $500 million of his $2.5 billion fortune in cash, more than ever before. "I'm long oil and I'm liquid," he says. "I've put myself in a position that if the end of the world came tomorrow I'd kind of be prepared." He's also ready to move fast if he spots an opening.
His instincts tell him that another enormous moneymaking opportunity is about to present itself, what he calls a "slow pitch down the middle." But, at 61, wealthier and happier than ever before, Rainwater finds himself reacting differently this time. He's focused more on staying rich than on getting richer. But there's something else too: a sort of billionaire-style civic duty he feels to get a conversation started. Why couldn't energy prices skyrocket, with grave repercussions, not just economic but political? As industry analysts debate whether the world's oil production is destined to decline, the prospect makes him itchy.
"This is a nonrecurring event," he says. "The 100-year flood in Houston real estate was one, the ability to buy oil and gas really cheap was another, and now there's the opportunity to do something based on a shortage of natural resources. Can you make money? Well, yeah. One way is to just stay long domestic oil. But there may be something more important than making money. This is the first scenario I've seen where I question the survivability of mankind. I don't want the world to wake up one day and say, 'How come some doofus billionaire in Texas made all this money by being aware of this, and why didn't someone tell us?'"
Global imbalances, the U.S. dollar, unsound fiscal policies, raging commodities markets, a real estate crash, and Rome burning all seem to be manageable, but an economic tsunami as the world runs out of oil?
That sounds like something that we should keep an eye on.
Even Mr. Buffet's much younger, slightly richer, sometimes side-kick, and occasional bridge buddy Bill Gates has been rather down on the dollar lately due to rapidly accumulating debt and the plethora of promises made by the U.S. government.
George Soros and Jim Rogers of Quantum Fund fame are bearish on Bush economic policies and bullish on commodities, respectively. Both of these views bode ill for the American way of life as it has been known for the last half century. That is, the American way of life for most of the citizenry - for the upper few percent of the populace, rising energy and raw material costs are more than offset by a reduced tax burden.
Sir John Templeton has been predicting a U.S. real estate disaster for some time now, and Bill Gross at Pimco has likened the current state of affairs to Rome burning, and much worse.
What do all these gentlemen have in common?
They are all billionaires, they all speak freely, and they all have very serious concerns about the course that the nation's economy has charted.
Is anyone listening to them?
Very few - clearly, not enough. Maybe if there were more billionaires out there talking about issues like this, they could really make a difference. But who? Don't look for the Walton clan of Wal-Mart fame to start talking, or Larry Ellison of Oracle, or Michael Dell of Dell. They don't want to ruin the good thing they all have going.
And certainly don't look for Oprah Winfrey or Donald Trump - they are likely weak on macroeconomics in general and global imbalances in particular.
Just when it looked like the outspoken "Billionaire Pessimists Club" was beginning to lose their momentum, along comes Richard Rainwater.
Richard who?
Good question. Appearing in the current issue of Fortune Magazine, meet Richard Rainwater, billionaire pessimist, dour survivalist, peak oil alarmist, and new hero to this humble blog:
Richard Rainwater doesn't want to sound like a kook. But he's about as worried as a happily married guy with more than $2 billion and a home in Pebble Beach can get. Americans are "in the kind of trouble people shouldn't find themselves in," he says. He's just wary about being the one to sound the alarm.
Rainwater is something of a behind-the-scenes type—at least as far as alpha-male billionaires go. He counts President Bush as a personal friend but dislikes politics, and frankly, when he gets worked up, he says some pretty far-out things that could easily be taken out of context. Such as: An economic tsunami is about to hit the global economy as the world runs out of oil. Or a coalition of communist and Islamic states may decide to stop selling their precious crude to Americans any day now. Or food shortages may soon hit the U.S. Or he read on a blog last night that there's this one gargantuan chunk of ice sitting on a precipice in Antarctica that, if it falls off, will raise sea levels worldwide by two feet—and it's getting closer to the edge.... And then he'll interrupt himself: "Look, I'm not predicting anything," he'll say. "That's when you get a little kooky-sounding."
Rainwater is no crackpot. But you don't get to be a multibillionaire investor—one who's more than doubled his net worth in a decade—through incremental gains on little stock trades. You have to push way past conventional thinking, test the boundaries of chaos, see events in a bigger context. You have to look at all the scenarios, from "A to friggin' Z," as he says, and not be afraid to focus on Z. Only when you've vacuumed up as much information as possible and you know the world is at a major inflection point do you put a hell of a lot of money behind your conviction.
Such insights have allowed Rainwater to turn moments of cataclysm into gigantic paydays before. In the mid-1990s he saw panic selling in Houston real estate and bought some 15 million square feet; now the properties are selling for three times his purchase price. In the late '90s, when oil seemed plentiful and its price had fallen to the low teens, he bet hundreds of millions—by investing in oil stocks and futures—that it would rise. A billion dollars later, that move is still paying off. "Most people invest and then sit around worrying what the next blowup will be," he says. "I do the opposite. I wait for the blowup, then invest."
The next blowup, however, looms so large that it scares and confuses him. For the past few months he's been holed up in hard-core research mode—reading books, academic studies, and, yes, blogs. Every morning he rises before dawn at one of his houses in Texas or South Carolina or California (he actually owns a piece of Pebble Beach Resorts) and spends four or five hours reading sites like LifeAftertheOilCrash.net or DieOff.org, obsessively following links and sifting through data. How worried is he? He has some $500 million of his $2.5 billion fortune in cash, more than ever before. "I'm long oil and I'm liquid," he says. "I've put myself in a position that if the end of the world came tomorrow I'd kind of be prepared." He's also ready to move fast if he spots an opening.
His instincts tell him that another enormous moneymaking opportunity is about to present itself, what he calls a "slow pitch down the middle." But, at 61, wealthier and happier than ever before, Rainwater finds himself reacting differently this time. He's focused more on staying rich than on getting richer. But there's something else too: a sort of billionaire-style civic duty he feels to get a conversation started. Why couldn't energy prices skyrocket, with grave repercussions, not just economic but political? As industry analysts debate whether the world's oil production is destined to decline, the prospect makes him itchy.
"This is a nonrecurring event," he says. "The 100-year flood in Houston real estate was one, the ability to buy oil and gas really cheap was another, and now there's the opportunity to do something based on a shortage of natural resources. Can you make money? Well, yeah. One way is to just stay long domestic oil. But there may be something more important than making money. This is the first scenario I've seen where I question the survivability of mankind. I don't want the world to wake up one day and say, 'How come some doofus billionaire in Texas made all this money by being aware of this, and why didn't someone tell us?'"
Global imbalances, the U.S. dollar, unsound fiscal policies, raging commodities markets, a real estate crash, and Rome burning all seem to be manageable, but an economic tsunami as the world runs out of oil?
That sounds like something that we should keep an eye on.
Sunday, December 18, 2005
Nope -- we're too gloomy
It's chic to be down on the market. But positive omens abound -- not the least of which is pessimism
December 17, 2005: 8:57 AM EST
By Andy Serwer, FORTUNE editor-at-large
NEW YORK (FORTUNE) - During the darkest days of October -- when the S&P 500 dropped below 1200 and became mired there -- life got a little scary for bulls like Tobias Levkovich.
"There were some anxious moments," acknowledges Citigroup's chief U.S. equity strategist, who had predicted that the markets would rise nicely in 2005, "but you ask yourself, 'Has anything really changed?' And if the answer is no, you stay the course." With the S&P 500 now returning a tidy 6 percent for the year as of presstime, it appears that staying the course was the right move.
Of course, to some nattering nabobs, the good news is actually the bad news. The higher stocks go, the handwringers argue, the further they must fall. Well, I'm not buying it. And Levkovich makes a pretty compelling case that it's best to keep the tiller steady again in 2006. For the record, he is calling for the S&P 500 to hit at least 1400 by the end of next year -- that would be an 11 percent gain from here.
Let the doom-and-gloom crowd cluck. I would simply point out that the economy is sailing right along. The latest GDP readings show us expanding at 4.3 percent. Job growth has rebounded despite the miserable hurricane season, and the unemployment rate hovers at a mere 5 percent. Interest rates and inflation remain relatively low. Meanwhile, corporate earnings are coming in according to plan.
Yes, there's terrorism, global warming and bird flu to worry about. But what's a market without fear to balance greed? Plus, there are plenty of potential catalysts for a rally in 2006. The Fed is expected to stop raising interest rates after the first quarter. And Levkovich also argues that energy prices could be lower in 2006 than in 2005.
But is the market overvalued, as Yale's Robert Shiller argues? Levkovich doesn't think so, Professor. "Stocks are, at worst, fairly valued," he says. "And probably they are attractively valued."
Let Levkovich -- who enjoys working some fairly esoteric models -- count the ways. Yes, the S&P 500 is trading about 17 times trailing earnings, which is above the historical norm. But when Levkovich adds the 4.5 percent yield of the ten-year Treasury bond to his 3.5 percent estimate of the risk premium (the return investors expect from stocks over Treasuries) and compares that 8 percent level with historical charts of the market's P/E, he concludes that the S&P 500 is 25 percent undervalued.
Stocks have been similarly undervalued by this measure 87 times, according to his charts. "And every time the market has gained over the next six months and 12 months
Levkovich is undeterred by the angst of the naysayers. In fact, he's encouraged by it. Consider his Citigroup Panic/Euphoria index, a contrarian indicator if there ever was one. It is a deep, dark, black box of eight measures of investor confidence including everything from Nasdaq daily volume as a percentage of NYSE volume and margin debt, to the put/call ratio and gasoline prices.
In early 2000, his contrarian index was go-go green euphoric, reaching peak levels. Right now it's signaling the brightest-red panic (it hit an eight-year low in October). To Levkovich this means there's a 95 percent chance the market will be higher a year from now.
Sure, investors were irrationally exuberant during the bubble years. And that's exactly why the shrewd market players today should be feeling confident. Look at it this way, says Levkovich: "Six years ago we could do no wrong, and everything was possible in the world. Today everything seems exceedingly challenging. We were wrong six years ago. And I think we could very well be wrong today."
On Wall Street, it most often pays not to follow the leader.
December 17, 2005: 8:57 AM EST
By Andy Serwer, FORTUNE editor-at-large
NEW YORK (FORTUNE) - During the darkest days of October -- when the S&P 500 dropped below 1200 and became mired there -- life got a little scary for bulls like Tobias Levkovich.
"There were some anxious moments," acknowledges Citigroup's chief U.S. equity strategist, who had predicted that the markets would rise nicely in 2005, "but you ask yourself, 'Has anything really changed?' And if the answer is no, you stay the course." With the S&P 500 now returning a tidy 6 percent for the year as of presstime, it appears that staying the course was the right move.
Of course, to some nattering nabobs, the good news is actually the bad news. The higher stocks go, the handwringers argue, the further they must fall. Well, I'm not buying it. And Levkovich makes a pretty compelling case that it's best to keep the tiller steady again in 2006. For the record, he is calling for the S&P 500 to hit at least 1400 by the end of next year -- that would be an 11 percent gain from here.
Let the doom-and-gloom crowd cluck. I would simply point out that the economy is sailing right along. The latest GDP readings show us expanding at 4.3 percent. Job growth has rebounded despite the miserable hurricane season, and the unemployment rate hovers at a mere 5 percent. Interest rates and inflation remain relatively low. Meanwhile, corporate earnings are coming in according to plan.
Yes, there's terrorism, global warming and bird flu to worry about. But what's a market without fear to balance greed? Plus, there are plenty of potential catalysts for a rally in 2006. The Fed is expected to stop raising interest rates after the first quarter. And Levkovich also argues that energy prices could be lower in 2006 than in 2005.
But is the market overvalued, as Yale's Robert Shiller argues? Levkovich doesn't think so, Professor. "Stocks are, at worst, fairly valued," he says. "And probably they are attractively valued."
Let Levkovich -- who enjoys working some fairly esoteric models -- count the ways. Yes, the S&P 500 is trading about 17 times trailing earnings, which is above the historical norm. But when Levkovich adds the 4.5 percent yield of the ten-year Treasury bond to his 3.5 percent estimate of the risk premium (the return investors expect from stocks over Treasuries) and compares that 8 percent level with historical charts of the market's P/E, he concludes that the S&P 500 is 25 percent undervalued.
Stocks have been similarly undervalued by this measure 87 times, according to his charts. "And every time the market has gained over the next six months and 12 months
Levkovich is undeterred by the angst of the naysayers. In fact, he's encouraged by it. Consider his Citigroup Panic/Euphoria index, a contrarian indicator if there ever was one. It is a deep, dark, black box of eight measures of investor confidence including everything from Nasdaq daily volume as a percentage of NYSE volume and margin debt, to the put/call ratio and gasoline prices.
In early 2000, his contrarian index was go-go green euphoric, reaching peak levels. Right now it's signaling the brightest-red panic (it hit an eight-year low in October). To Levkovich this means there's a 95 percent chance the market will be higher a year from now.
Sure, investors were irrationally exuberant during the bubble years. And that's exactly why the shrewd market players today should be feeling confident. Look at it this way, says Levkovich: "Six years ago we could do no wrong, and everything was possible in the world. Today everything seems exceedingly challenging. We were wrong six years ago. And I think we could very well be wrong today."
On Wall Street, it most often pays not to follow the leader.
We're still too exuberant
The man who wrote the book on irrational investing says we haven't learned our lesson. I believe him
December 17, 2005: 9:00 AM EST
By Geoffrey Colvin, FORTUNE senior editor-at-large
NEW YORK (FORTUNE) - One of the most important lessons you can ever learn about markets is also one of the easiest to forget: Just because prices are more reasonable than they were doesn't mean they're reasonable. I'm sorry to report that it's absolutely the lesson to keep in mind now that the Dow has hit 42-year highs and crept back up near 11,000.
The preeminent teacher of that lesson is Robert Shiller, a Yale professor with a strong record of thinking independently and being right. His book "Irrational Exuberance," arguing that stock prices were insanely high, appeared almost precisely at their peak in March 2000. Now he has updated the book to reflect 2005 valuations and concludes that, believe it or not, the market is still irrationally exuberant.
How does he come to this conclusion? After all, stocks are generally lower than back in the bubble days, and we've had four years of economic growth to rehabilitate corporate profits. His answer is simple. As he told me the other day, all the competing theories boil down to one easy-to-understand calculation: "The trailing P/E ratio for the S&P composite is still around 25, vs. a long-term average of 15."
That's a huge difference, much greater than what you read about in the newspapers. The commonly cited figures -- a current market multiple of 17, vs. a historical average of 15.2 -- are based on the previous 12 months' earnings. But, as Shiller points out, that's foolish: "Twelve months is kind of short, only a fraction of one business cycle."
So he uses a ten-year earnings average, an approach advocated by Graham and Dodd in Security Analysis, the value investor's bible. And while prices are clearly above the long-term trend any way you cut it, by that measure they are still mountainously beyond normal.
For some people -- I don't want to mention any names, but cast a glance at "Nope -- We're Too Gloomy" -- that conclusion is impossible to accept. So they contort the numbers and cook up theories about why today's prices aren't really as high as they appear. The most significant theory, which surveys show is believed by vast armies of investors, is that stocks aren't as risky as we used to think they were, so they're actually worth more than investors have historically been willing to pay. In other words, we were simply wrong for the past several decades but at last have seen the light, and in that light today's overall market valuations make sense.
Shiller would hoot at that one if hooting were his style. Instead he just mentions that this is "the Dow 36,000 theory." That 1999 book by investing columnist James Glassman and former Fed economist Kevin Hassett, you'll recall, argued that prices would rocket as the populace realized that in the long run, stocks always beat other investments, so they're really safer than conventionally thought.
We must all thank Shiller for reminding us of this prediction from the book: "... a sensible target date for Dow 36,000 is early 2005, but it could be reached much earlier." Or not.
It's easy to make fun of Dow 36,000, but it's more important to recognize that the theory behind it is still at work, and it still doesn't add up. As Shiller points out with voluminous support, it just isn't true that stocks always outperform other investments over long-term periods, and, he says, "there is certainly no reason to think they must in the future." If that's true, then stocks would appear to be just as risky as ever. We are not in a "new era." Math still works the same way. And today's valuations are too high.
No one wants to hear that. It's almost irresistible to believe that after all we investors have endured -- the hellish bear market, the recession, the scandals -- we've emerged from the crucible sadder but wiser, finally willing to face the truth about stock values. But it isn't so. The amazing reality is that we haven't learned our lesson even yet.
December 17, 2005: 9:00 AM EST
By Geoffrey Colvin, FORTUNE senior editor-at-large
NEW YORK (FORTUNE) - One of the most important lessons you can ever learn about markets is also one of the easiest to forget: Just because prices are more reasonable than they were doesn't mean they're reasonable. I'm sorry to report that it's absolutely the lesson to keep in mind now that the Dow has hit 42-year highs and crept back up near 11,000.
The preeminent teacher of that lesson is Robert Shiller, a Yale professor with a strong record of thinking independently and being right. His book "Irrational Exuberance," arguing that stock prices were insanely high, appeared almost precisely at their peak in March 2000. Now he has updated the book to reflect 2005 valuations and concludes that, believe it or not, the market is still irrationally exuberant.
How does he come to this conclusion? After all, stocks are generally lower than back in the bubble days, and we've had four years of economic growth to rehabilitate corporate profits. His answer is simple. As he told me the other day, all the competing theories boil down to one easy-to-understand calculation: "The trailing P/E ratio for the S&P composite is still around 25, vs. a long-term average of 15."
That's a huge difference, much greater than what you read about in the newspapers. The commonly cited figures -- a current market multiple of 17, vs. a historical average of 15.2 -- are based on the previous 12 months' earnings. But, as Shiller points out, that's foolish: "Twelve months is kind of short, only a fraction of one business cycle."
So he uses a ten-year earnings average, an approach advocated by Graham and Dodd in Security Analysis, the value investor's bible. And while prices are clearly above the long-term trend any way you cut it, by that measure they are still mountainously beyond normal.
For some people -- I don't want to mention any names, but cast a glance at "Nope -- We're Too Gloomy" -- that conclusion is impossible to accept. So they contort the numbers and cook up theories about why today's prices aren't really as high as they appear. The most significant theory, which surveys show is believed by vast armies of investors, is that stocks aren't as risky as we used to think they were, so they're actually worth more than investors have historically been willing to pay. In other words, we were simply wrong for the past several decades but at last have seen the light, and in that light today's overall market valuations make sense.
Shiller would hoot at that one if hooting were his style. Instead he just mentions that this is "the Dow 36,000 theory." That 1999 book by investing columnist James Glassman and former Fed economist Kevin Hassett, you'll recall, argued that prices would rocket as the populace realized that in the long run, stocks always beat other investments, so they're really safer than conventionally thought.
We must all thank Shiller for reminding us of this prediction from the book: "... a sensible target date for Dow 36,000 is early 2005, but it could be reached much earlier." Or not.
It's easy to make fun of Dow 36,000, but it's more important to recognize that the theory behind it is still at work, and it still doesn't add up. As Shiller points out with voluminous support, it just isn't true that stocks always outperform other investments over long-term periods, and, he says, "there is certainly no reason to think they must in the future." If that's true, then stocks would appear to be just as risky as ever. We are not in a "new era." Math still works the same way. And today's valuations are too high.
No one wants to hear that. It's almost irresistible to believe that after all we investors have endured -- the hellish bear market, the recession, the scandals -- we've emerged from the crucible sadder but wiser, finally willing to face the truth about stock values. But it isn't so. The amazing reality is that we haven't learned our lesson even yet.
Friday, December 02, 2005
Greenspan: U.S. Deficit May Hurt Globally
By MARTIN CRUTSINGER
AP Economics Writer
Dec 02 1:22 PM US/Eastern
Federal Reserve Chairman Alan Greenspan expressed concerns Friday that America's failure to deal with its exploding budget defict and worldwide efforts to erect trade barriers could disrupt the global economy. Speaking at an economic conference in London, Greenspan said so far the United States has had no problem financing its current account trade deficit, which last year hit a record $668 billion, because of the flexibility of the American economy.
But he said such flexibility would be threatened by rising protectionism, which would increase barriers to the flow of goods and investments across the U.S. border. He also worried about the harm that could be done if the United States and other nations do not get their budget deficits under control.
"If ... the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalization, the adjustment process could be quite painful for the world economy," Greenspan said in his prepared remarks, which were released in Washington.
The London speech represented the second warning Greenspan delivered Friday on the threats posed by rising budget deficits. In an earlier speech, he had said that there could be severe consequences for the U.S. economy if policy-makers do not attack a federal budget deficit that is projected to soar with baby boomer retirements.
In that taped speech to a conference in Philadelphia, Greenspan said that Congress would likely have to make "significant adjustments" in reducing benefits for future retirees. He said it appears the country has promised more than it can afford to deliver in Social Security and especially Medicare payments, given that health care costs have been exploding.
Greenspan, who will step down as Fed chairman after 18 1/2 years on Jan. 31, used both of the Friday speeches to return to themes he has been emphasizing over the past two years.
He said that the looming retirement of 78 million baby boomers will put severe strains on the country's finances and without changes could disrupt the economy by driving up interest rates from the increased government borrowing.
And he said that the nation's huge trade deficits can be financed as long as the country does not jeopardize the flexibility of the U.S. economy in such ways as increasing protectionist barriers.
"If the currently disturbing drift toward protectionism is contained and markets remain sufficiently flexible," Greenspan said, then a rise in Americans' savings rates and other adjustments needed to reduce the U.S. trade deficit should proceed without problems.
Greenspan was in London to attend his final meeting of finance ministers and central bank president of the world's seven largest economies.
In addition to their normal discussions of the global economy, the Group of Seven finance officials were going to honor Greenspan with a retirement party, including a dinner Friday night, during the meetings.
In the Philadelphia speech, which had been taped earlier, Greenspan urged Congress to act quickly so that the baby boomers will have time to adjust to potential benefit cuts.
Greenspan did not outline what benefit cuts should be considered but in the past he has endorsed proposals such as raising the age at which retirees can draw full Social Security benefits.
"The likelihood of growing deficits in the unified budget is of especially great concern because the deficits would drain a correspondingly growing volume of real resources from private capital formation and cast an ever-larger shadow over the growth of living standards," Greenspan said.
"In the end," he warned, "the consequences for the U.S. economy of doing nothing could be severe."
In a brief mention of current economic conditions, Greenspan said that the economy had delivered a "solid performance" so far in 2005. "And despite the disruptions of hurricanes Katrina, Rita and Wilma, economic activity appears to be expanding at a reasonably good pace as we head into 2006," he said.
However, he said the positive short-term outlook for the economy was occurring against a backdrop of concern about the government's long- term fiscal health.
"Our budget deficit will substantially worsen in the coming years unless major deficit-reduction actions are taken," Greenspan said, echoing comments he made most recently in an appearance Nov. 3 before Congress' Joint Economic Committee.
He again called for Congress to reinstate budget rules that expired in 2002 that required any future increases in benefit payments or cuts in taxes to be paid for by cutting government spending in other areas _ or by increasing taxes.
AP Economics Writer
Dec 02 1:22 PM US/Eastern
Federal Reserve Chairman Alan Greenspan expressed concerns Friday that America's failure to deal with its exploding budget defict and worldwide efforts to erect trade barriers could disrupt the global economy. Speaking at an economic conference in London, Greenspan said so far the United States has had no problem financing its current account trade deficit, which last year hit a record $668 billion, because of the flexibility of the American economy.
But he said such flexibility would be threatened by rising protectionism, which would increase barriers to the flow of goods and investments across the U.S. border. He also worried about the harm that could be done if the United States and other nations do not get their budget deficits under control.
"If ... the pernicious drift toward fiscal instability in the United States and elsewhere is not arrested and is compounded by a protectionist reversal of globalization, the adjustment process could be quite painful for the world economy," Greenspan said in his prepared remarks, which were released in Washington.
The London speech represented the second warning Greenspan delivered Friday on the threats posed by rising budget deficits. In an earlier speech, he had said that there could be severe consequences for the U.S. economy if policy-makers do not attack a federal budget deficit that is projected to soar with baby boomer retirements.
In that taped speech to a conference in Philadelphia, Greenspan said that Congress would likely have to make "significant adjustments" in reducing benefits for future retirees. He said it appears the country has promised more than it can afford to deliver in Social Security and especially Medicare payments, given that health care costs have been exploding.
Greenspan, who will step down as Fed chairman after 18 1/2 years on Jan. 31, used both of the Friday speeches to return to themes he has been emphasizing over the past two years.
He said that the looming retirement of 78 million baby boomers will put severe strains on the country's finances and without changes could disrupt the economy by driving up interest rates from the increased government borrowing.
And he said that the nation's huge trade deficits can be financed as long as the country does not jeopardize the flexibility of the U.S. economy in such ways as increasing protectionist barriers.
"If the currently disturbing drift toward protectionism is contained and markets remain sufficiently flexible," Greenspan said, then a rise in Americans' savings rates and other adjustments needed to reduce the U.S. trade deficit should proceed without problems.
Greenspan was in London to attend his final meeting of finance ministers and central bank president of the world's seven largest economies.
In addition to their normal discussions of the global economy, the Group of Seven finance officials were going to honor Greenspan with a retirement party, including a dinner Friday night, during the meetings.
In the Philadelphia speech, which had been taped earlier, Greenspan urged Congress to act quickly so that the baby boomers will have time to adjust to potential benefit cuts.
Greenspan did not outline what benefit cuts should be considered but in the past he has endorsed proposals such as raising the age at which retirees can draw full Social Security benefits.
"The likelihood of growing deficits in the unified budget is of especially great concern because the deficits would drain a correspondingly growing volume of real resources from private capital formation and cast an ever-larger shadow over the growth of living standards," Greenspan said.
"In the end," he warned, "the consequences for the U.S. economy of doing nothing could be severe."
In a brief mention of current economic conditions, Greenspan said that the economy had delivered a "solid performance" so far in 2005. "And despite the disruptions of hurricanes Katrina, Rita and Wilma, economic activity appears to be expanding at a reasonably good pace as we head into 2006," he said.
However, he said the positive short-term outlook for the economy was occurring against a backdrop of concern about the government's long- term fiscal health.
"Our budget deficit will substantially worsen in the coming years unless major deficit-reduction actions are taken," Greenspan said, echoing comments he made most recently in an appearance Nov. 3 before Congress' Joint Economic Committee.
He again called for Congress to reinstate budget rules that expired in 2002 that required any future increases in benefit payments or cuts in taxes to be paid for by cutting government spending in other areas _ or by increasing taxes.
Tuesday, November 29, 2005
How the government manufactures low inflation
Some government data suggest computer and car prices, among many other things, are falling. But when was the last time you paid less for a car? Here’s why you should be concerned.
By Bill Fleckenstein
Please join me this week in a trip to the government department responsible for fun with numbers. Those D.C. statisticians may churn out their work with a straight face, but that doesn't mean we have to fall for it. Among the skeptics are Steve Milunovich of Merrill Lynch, Jim Grant of Grant's Interest Rate Observer, and, of course, yours truly.
In a recent report, Milunovich noted that the Bureau of Economic Analysis (BEA), whose job it is to compute the Gross Domestic Product each quarter, has "stopped reporting the real computer hardware shipment figure used to calculate real GDP growth, though it is still used in GDP calculations." The BEA, which is part of the Commerce Department, made this readjustment because it is "concerned the rapid price declines for computers made the figures misleading."
Let's stop and review the bidding for a second. Remember: GDP is the measure of goods and services produced in this country. The government decided that certain of its data series involved in calculating GDP were misleading. So, what did it do? Simply stop breaking them out. Makes sense to me; how about you?
This would be a humorous window into the lunacy of government calculations, were it not so important to many statistics. Regular readers of my daily column know that the magic of "hedonics" and all its attendant distortions is something that I have railed about for a long time.
Hedonics: 'miracle' tonic for an ailing economy
For those of you who don't know, hedonics is the way the government transforms price declines into quality improvements. To wit, you buy a PC with twice as much power, so the government concludes that you really paid only half as much money for it. Hedonics is also the government's way of taking quality improvements and converting them into price declines when calculating the CPI. Sure, that brand-new Chevy you just bought cost 40% more than it used to, but it's a 40%-better car for a variety of reasons. So, the government says, the price didn't really go up. (I have oversimplified these examples, but you get the point.)
The idea behind the first case at least makes some sense, though the government carries it too far by acting as though improvements can be precisely measured. The problem with the second case is that those quality improvements are not voluntary. Since you have to pay the new price, it's sheer silliness to say that the price really didn't go up.
There are other ramifications as well. It turns out that the computer-spending component has materially warped GDP calculations in many of the last eight quarters. To put the numbers into perspective, from the second quarter of 2000 through the fourth quarter of 2003, the government estimated that real tech spending rose from $446 billion to $557 billion, when nominal spending only increased to $488 billion. That extra $72 billion represents the value the government imagines the improvement in computer quality is worth.
Now $72 billion doesn't sound like a huge amount in a $10 trillion economy, but at the margin, it makes a difference. And in fact, the contribution of this tech component to real GDP comprised about 12% of growth in the third quarter of 2003 and more than 30% of growth in the first quarter of 2003, i.e., a big chunk of the growth. Since real growth is a factor in the calculation of productivity and productivity growth, these statistics are also distorted.
Slippery CPI, iffy TIPs
Our government has admitted its Alice in Wonderland hedonic-adjustment exercise has produced numbers so distorted that it doesn't want to show them to you. Yet it continues to use the "analysis" and some of the data in calculations of real GDP, productivity growth and CPI calculations. This is one of the reasons I've never been a big fan of Treasury Inflation-Protected Securities, or TIPS. I have stated a million times that the government's calculated cost of inflation, in the form of the CPI, is a joke. So, I refuse to buy a security that's indexed to the CPI, unless the price of the security reflects my skepticism. TIPS may be better than straight bonds, but they're not as good as most people think. As you can see from these two examples, the government aims to cheat you in the calculation, and besides, TIPS don't protect you from a decline in the value of the dollar.
Grant on BEA balderdash
Further reason to be suspicious of all government data comes from the current issue of Grant's Interest Rate Observer, in which the ever-alert Jim Grant broke the story that "the Bureau of Economic Analysis is weighing a study to explore the merits of adjusting the prices of medical services for quality changes."
In other words, the BEA is considering the use of hedonics to lower the impact of rising medical costs on the CPI by subtracting the imagined value of quality improvements in medical care from the price we’re really paying. The government recognizes it has a problem with exploding health costs and is studying the use of that same quick fix which has "worked" when unwelcome rising prices have been an issue in other areas, i.e., to define the problem away. I would imagine that when the folks at AARP and organized labor find this out, they'll be up in arms. Maybe their clout can stop this nonsense before it gets even worse.
Take heed, enjoins Sir John
On a final note, I would like to share with readers a rather interesting comment that John Templeton, founder of the Templeton Funds, made to Paul Kangas during a PBS interview last Monday.
Templeton's quote will be instantly recognizable to folks who have read the longstanding header on my Web site, which echoes one of my most fervently held views: "In a social democracy with a fiat currency, all roads lead to inflation." (Readers of the Contrarian Chronicles may also refer back to my Nov. 17 column, "All roads now lead to inflation."
And now for Sir John's wisdom: "All currencies, not only the American dollar, but all currencies, always go down, mainly because of democracy. The voters will vote for a person who is going to spend too much, and so you have to expect all currencies to go down." In future columns, I'll have more to say about the dollar, the variables affecting it and why this should be of concern to you.
(Editor’s note: the Bureau of Economic Analysis published an article in 2000 about the use of hedonics in valuing the impact of computers on the economy. You can access it here.)
By Bill Fleckenstein
Please join me this week in a trip to the government department responsible for fun with numbers. Those D.C. statisticians may churn out their work with a straight face, but that doesn't mean we have to fall for it. Among the skeptics are Steve Milunovich of Merrill Lynch, Jim Grant of Grant's Interest Rate Observer, and, of course, yours truly.
In a recent report, Milunovich noted that the Bureau of Economic Analysis (BEA), whose job it is to compute the Gross Domestic Product each quarter, has "stopped reporting the real computer hardware shipment figure used to calculate real GDP growth, though it is still used in GDP calculations." The BEA, which is part of the Commerce Department, made this readjustment because it is "concerned the rapid price declines for computers made the figures misleading."
Let's stop and review the bidding for a second. Remember: GDP is the measure of goods and services produced in this country. The government decided that certain of its data series involved in calculating GDP were misleading. So, what did it do? Simply stop breaking them out. Makes sense to me; how about you?
This would be a humorous window into the lunacy of government calculations, were it not so important to many statistics. Regular readers of my daily column know that the magic of "hedonics" and all its attendant distortions is something that I have railed about for a long time.
Hedonics: 'miracle' tonic for an ailing economy
For those of you who don't know, hedonics is the way the government transforms price declines into quality improvements. To wit, you buy a PC with twice as much power, so the government concludes that you really paid only half as much money for it. Hedonics is also the government's way of taking quality improvements and converting them into price declines when calculating the CPI. Sure, that brand-new Chevy you just bought cost 40% more than it used to, but it's a 40%-better car for a variety of reasons. So, the government says, the price didn't really go up. (I have oversimplified these examples, but you get the point.)
The idea behind the first case at least makes some sense, though the government carries it too far by acting as though improvements can be precisely measured. The problem with the second case is that those quality improvements are not voluntary. Since you have to pay the new price, it's sheer silliness to say that the price really didn't go up.
There are other ramifications as well. It turns out that the computer-spending component has materially warped GDP calculations in many of the last eight quarters. To put the numbers into perspective, from the second quarter of 2000 through the fourth quarter of 2003, the government estimated that real tech spending rose from $446 billion to $557 billion, when nominal spending only increased to $488 billion. That extra $72 billion represents the value the government imagines the improvement in computer quality is worth.
Now $72 billion doesn't sound like a huge amount in a $10 trillion economy, but at the margin, it makes a difference. And in fact, the contribution of this tech component to real GDP comprised about 12% of growth in the third quarter of 2003 and more than 30% of growth in the first quarter of 2003, i.e., a big chunk of the growth. Since real growth is a factor in the calculation of productivity and productivity growth, these statistics are also distorted.
Slippery CPI, iffy TIPs
Our government has admitted its Alice in Wonderland hedonic-adjustment exercise has produced numbers so distorted that it doesn't want to show them to you. Yet it continues to use the "analysis" and some of the data in calculations of real GDP, productivity growth and CPI calculations. This is one of the reasons I've never been a big fan of Treasury Inflation-Protected Securities, or TIPS. I have stated a million times that the government's calculated cost of inflation, in the form of the CPI, is a joke. So, I refuse to buy a security that's indexed to the CPI, unless the price of the security reflects my skepticism. TIPS may be better than straight bonds, but they're not as good as most people think. As you can see from these two examples, the government aims to cheat you in the calculation, and besides, TIPS don't protect you from a decline in the value of the dollar.
Grant on BEA balderdash
Further reason to be suspicious of all government data comes from the current issue of Grant's Interest Rate Observer, in which the ever-alert Jim Grant broke the story that "the Bureau of Economic Analysis is weighing a study to explore the merits of adjusting the prices of medical services for quality changes."
In other words, the BEA is considering the use of hedonics to lower the impact of rising medical costs on the CPI by subtracting the imagined value of quality improvements in medical care from the price we’re really paying. The government recognizes it has a problem with exploding health costs and is studying the use of that same quick fix which has "worked" when unwelcome rising prices have been an issue in other areas, i.e., to define the problem away. I would imagine that when the folks at AARP and organized labor find this out, they'll be up in arms. Maybe their clout can stop this nonsense before it gets even worse.
Take heed, enjoins Sir John
On a final note, I would like to share with readers a rather interesting comment that John Templeton, founder of the Templeton Funds, made to Paul Kangas during a PBS interview last Monday.
Templeton's quote will be instantly recognizable to folks who have read the longstanding header on my Web site, which echoes one of my most fervently held views: "In a social democracy with a fiat currency, all roads lead to inflation." (Readers of the Contrarian Chronicles may also refer back to my Nov. 17 column, "All roads now lead to inflation."
And now for Sir John's wisdom: "All currencies, not only the American dollar, but all currencies, always go down, mainly because of democracy. The voters will vote for a person who is going to spend too much, and so you have to expect all currencies to go down." In future columns, I'll have more to say about the dollar, the variables affecting it and why this should be of concern to you.
(Editor’s note: the Bureau of Economic Analysis published an article in 2000 about the use of hedonics in valuing the impact of computers on the economy. You can access it here.)
Dare to Be Wrong
In 1996 three independent-minded investors came to the same conclusion: The U.S. stock market had come loose from its moorings, with many stocks trading nowhere near a price justified by their fundamentals. And so each in his same way jumped off the train, and paid mightily for it in the short term. Turns out they were right.
By Bill Mann (TMF Otter)
March 31, 2004
I often come up against a real disconnect in the way that most people perceive the market versus the way they perceive their perception of the market actually is.
Didn't understand the above? Yeah, me either. Work with me.
I've been reading about some of the folks who were bearish during the big boom of the 1990s, in particular Jeff Vinik, who took over after Peter Lynch left Fidelity Magellan; Jean-Marie Eveillard, who runs the First Eagle Global Fund (SGENX); and Bill Fleckenstein, who started a short fund in 1996, "a little early," as he put it in a speech recently.
Here's what I noticed about these guys: They each have deep intellectual fortitude. They had opinions about the market -- about the total disconnect between price and value that developed during the time involved. And they all just stepped off the train, right into the path of an oncoming bus. Before the bubble finally popped, Vinik had lost his job and Eveillard lost more than half of his clients.
Bill Fleckenstein's periodic columns during the time period had the distinction of being pleasures to read, uniformly smart, and nearly uniformly wrong, as the market continued to climb. In early 1999, Fleckenstein made this point, referring to a conversation between Bob Olstein of Olstein Financial and Joe Kernen of CNBC, noting that Kernen had dressed down Olstein for pointing out the accounting trickery going on at Lucent (NYSE: LU). Kernen told Olstein that "We all know that. Nobody cares. The price is where it is." Fleckenstein then made a statement that resonates with me: "Therefore, anyone who has been negative is simply wrong because the market has gone up."
Here's something that superior investors understand: Just because a risk has yet to manifest itself doesn't mean that it doesn't exist. It's certainly true in life, so why would it be any different in investing? Some examples:
1) You and some friends spend the afternoon drinking, riding a motorbike, and operating a chainsaw. No one gets hurt. Was this a riskless activity?
2) A man wanders into a random bar in Philadelphia yelling, "The Eagles suck!" He is dressed head to toe in Dallas Cowboys gear. The bar patrons laugh and buy him a drink. Does this mean that he didn't put himself in harm's way in the first place?
3) You run through a dynamite plant with a lit torch. Nothing explodes. Does this mean that you aren't an idiot?
4) You bet a friend $100 that Tiger Woods will completely miss the ball the next time he steps into the tee box. Tiger Woods hasn't whiffed since he was 6. Against all odds, he whiffs. Good bet?
Obviously, in each case the answer is no. So how can it possibly be any different in investing? A risk taken without consideration of the consequences is a bad move, regardless of whether the worst of those consequences comes to pass.
Look at it this way: In April of 2001, someone was able to sell his shares in Enron for more than $70 per share, even though the company had been diddling its numbers for several years. Most people who have commented on Enron have said the same thing: "We couldn't figure out what they were doing." It is extremely doubtful that someone who held Enron at the time suddenly looked at its footnotes, noticed there were some funny related-party transactions, and said, "I'm out of here." No, anyone who sold at $70 was probably more lucky than smart. He snuggled a wolverine, and the next morning it made 'em breakfast.
Exiled from Magellan
Even though we would like to think that the people who are managing large sums of money have a greater sense of what is going to happen in the market, or even with individual stocks in the short term, they absolutely, positively do not. All you can deal with, then, are the risks involved, and determining whether you have a chance for being fairly compensated for them.
This is not easy. Particularly when the stock market starts to run like mad, you risk being, or at least seeming, wrong. While it's easy to look at the scoreboard and kick yourself for a stock that keeps going up, remember that for every Microsoft (Nasdaq: MSFT) there are dozens of Kmarts (Nasdaq: KMRT), Tycos (NYSE: TYC), and WorldComs -- companies that succumb, temporarily or permanently, to risks that have been building up for years.
It can take some fortitude, particularly when your performance affects others. In early 1996, Jeff Vinik determined that he didn't particularly trust technology companies, so he began selling. Fidelity Magellan, a $50 billion-plus fund at the time, went from being two-fifths technology shares in late 1995 to almost none by mid-1996.
We know what happened. Technology continued to skyrocket. Magellan couldn't keep up with its dowdier profile, and by May 1996 Vinik had departed the firm, leaving in his wake thousands of investors furious that he had missed continued gains. Never mind that Vinik had provided market-beating returns during his tenure. He made a decision, and -- in the short term, at least -- he was wrong.
The pain of being right, but early
Similarly, Eveillard had noted in 1996 that trying to determine what investors will do next, as opposed to what companies are worth, is a game he would not play. His point was simple. The U.S. stock market was in a bubble, and rather than trying to guess, using client money, where it would end, he would simply wait and invest elsewhere in the interim. He had to wait more than four years, and half of his clients left for funds that had bigger and better returns.
Think about that for a minute. Eveillard's asset base is shrinking because clients are leaving in disgust. He has to endure day after day of stories about profitless wonders like Internet Capital Group (Nasdaq: ICGE) skyrocketing to $40 billion market caps, and other companies like Inktomi rising $90 per share in a single day.
For four years all of the evidence pointed to Eveillard being nothing but wrong, but he knew where the risks lay and how much he would be willing to pay in spite of them. And he waited for that price!
Eventually, when other funds were melting down, the First Eagle Funds began to strike, to use the cash that Essentials of Fund Management 101 taught was foolish for funds to hold. In spite of this handicap, each $10,000 invested into his First Eagle Global fund in 1996 would become $16,300 by April of 2000. And by the end of 2003, it would have risen to $26,985. That latter part came as some of the funds that chased the bubble dropped by 70%, 80%, even 90%. Having seen what happened to Jeff Vinik when he sold too soon, most elected not to make the same mistake. And they didn't.
It seems that every investor who doesn't consider himself a momentum junkie now wants to grab hold of the appellation "contrarian." Being contrary has its benefits -- you're by definition going where most investors are not. But the true contrarian has to have two elements in his favor. He has to be willing to seem wrong for long periods of time, and he must actually be correct. It doesn't do you any good to be "contrary" about a Bethlehem Steel, which provided shareholders with little more than 50 years of misery before finally falling to bankruptcy. But if you have conviction and discipline, it needn't matter that the folks who do little more than trade four-letter codes are doing great for a time. It only lasts for a precious few of them.
By Bill Mann (TMF Otter)
March 31, 2004
I often come up against a real disconnect in the way that most people perceive the market versus the way they perceive their perception of the market actually is.
Didn't understand the above? Yeah, me either. Work with me.
I've been reading about some of the folks who were bearish during the big boom of the 1990s, in particular Jeff Vinik, who took over after Peter Lynch left Fidelity Magellan; Jean-Marie Eveillard, who runs the First Eagle Global Fund (SGENX); and Bill Fleckenstein, who started a short fund in 1996, "a little early," as he put it in a speech recently.
Here's what I noticed about these guys: They each have deep intellectual fortitude. They had opinions about the market -- about the total disconnect between price and value that developed during the time involved. And they all just stepped off the train, right into the path of an oncoming bus. Before the bubble finally popped, Vinik had lost his job and Eveillard lost more than half of his clients.
Bill Fleckenstein's periodic columns during the time period had the distinction of being pleasures to read, uniformly smart, and nearly uniformly wrong, as the market continued to climb. In early 1999, Fleckenstein made this point, referring to a conversation between Bob Olstein of Olstein Financial and Joe Kernen of CNBC, noting that Kernen had dressed down Olstein for pointing out the accounting trickery going on at Lucent (NYSE: LU). Kernen told Olstein that "We all know that. Nobody cares. The price is where it is." Fleckenstein then made a statement that resonates with me: "Therefore, anyone who has been negative is simply wrong because the market has gone up."
Here's something that superior investors understand: Just because a risk has yet to manifest itself doesn't mean that it doesn't exist. It's certainly true in life, so why would it be any different in investing? Some examples:
1) You and some friends spend the afternoon drinking, riding a motorbike, and operating a chainsaw. No one gets hurt. Was this a riskless activity?
2) A man wanders into a random bar in Philadelphia yelling, "The Eagles suck!" He is dressed head to toe in Dallas Cowboys gear. The bar patrons laugh and buy him a drink. Does this mean that he didn't put himself in harm's way in the first place?
3) You run through a dynamite plant with a lit torch. Nothing explodes. Does this mean that you aren't an idiot?
4) You bet a friend $100 that Tiger Woods will completely miss the ball the next time he steps into the tee box. Tiger Woods hasn't whiffed since he was 6. Against all odds, he whiffs. Good bet?
Obviously, in each case the answer is no. So how can it possibly be any different in investing? A risk taken without consideration of the consequences is a bad move, regardless of whether the worst of those consequences comes to pass.
Look at it this way: In April of 2001, someone was able to sell his shares in Enron for more than $70 per share, even though the company had been diddling its numbers for several years. Most people who have commented on Enron have said the same thing: "We couldn't figure out what they were doing." It is extremely doubtful that someone who held Enron at the time suddenly looked at its footnotes, noticed there were some funny related-party transactions, and said, "I'm out of here." No, anyone who sold at $70 was probably more lucky than smart. He snuggled a wolverine, and the next morning it made 'em breakfast.
Exiled from Magellan
Even though we would like to think that the people who are managing large sums of money have a greater sense of what is going to happen in the market, or even with individual stocks in the short term, they absolutely, positively do not. All you can deal with, then, are the risks involved, and determining whether you have a chance for being fairly compensated for them.
This is not easy. Particularly when the stock market starts to run like mad, you risk being, or at least seeming, wrong. While it's easy to look at the scoreboard and kick yourself for a stock that keeps going up, remember that for every Microsoft (Nasdaq: MSFT) there are dozens of Kmarts (Nasdaq: KMRT), Tycos (NYSE: TYC), and WorldComs -- companies that succumb, temporarily or permanently, to risks that have been building up for years.
It can take some fortitude, particularly when your performance affects others. In early 1996, Jeff Vinik determined that he didn't particularly trust technology companies, so he began selling. Fidelity Magellan, a $50 billion-plus fund at the time, went from being two-fifths technology shares in late 1995 to almost none by mid-1996.
We know what happened. Technology continued to skyrocket. Magellan couldn't keep up with its dowdier profile, and by May 1996 Vinik had departed the firm, leaving in his wake thousands of investors furious that he had missed continued gains. Never mind that Vinik had provided market-beating returns during his tenure. He made a decision, and -- in the short term, at least -- he was wrong.
The pain of being right, but early
Similarly, Eveillard had noted in 1996 that trying to determine what investors will do next, as opposed to what companies are worth, is a game he would not play. His point was simple. The U.S. stock market was in a bubble, and rather than trying to guess, using client money, where it would end, he would simply wait and invest elsewhere in the interim. He had to wait more than four years, and half of his clients left for funds that had bigger and better returns.
Think about that for a minute. Eveillard's asset base is shrinking because clients are leaving in disgust. He has to endure day after day of stories about profitless wonders like Internet Capital Group (Nasdaq: ICGE) skyrocketing to $40 billion market caps, and other companies like Inktomi rising $90 per share in a single day.
For four years all of the evidence pointed to Eveillard being nothing but wrong, but he knew where the risks lay and how much he would be willing to pay in spite of them. And he waited for that price!
Eventually, when other funds were melting down, the First Eagle Funds began to strike, to use the cash that Essentials of Fund Management 101 taught was foolish for funds to hold. In spite of this handicap, each $10,000 invested into his First Eagle Global fund in 1996 would become $16,300 by April of 2000. And by the end of 2003, it would have risen to $26,985. That latter part came as some of the funds that chased the bubble dropped by 70%, 80%, even 90%. Having seen what happened to Jeff Vinik when he sold too soon, most elected not to make the same mistake. And they didn't.
It seems that every investor who doesn't consider himself a momentum junkie now wants to grab hold of the appellation "contrarian." Being contrary has its benefits -- you're by definition going where most investors are not. But the true contrarian has to have two elements in his favor. He has to be willing to seem wrong for long periods of time, and he must actually be correct. It doesn't do you any good to be "contrary" about a Bethlehem Steel, which provided shareholders with little more than 50 years of misery before finally falling to bankruptcy. But if you have conviction and discipline, it needn't matter that the folks who do little more than trade four-letter codes are doing great for a time. It only lasts for a precious few of them.
Friday, November 25, 2005
Boring May Be Beautiful When Money's on the Line
Nov. 25 (Bloomberg - Chet Currier) -- A yawner of a year in the financial markets? Don't complain too much.
Excitement may be the enemy when you're trying to manage money -- and boredom can be an investor's good friend.
The sexier a stock or other financial proposition appears, the more likely it is overpriced. If you're looking for a bargain, search out things that offer nothing to tickle your fancy until you look below the surface.
These old contrarian ideas can be more relevant than ever in the modern world of ceaseless sensory stimulation. To judge by all the behavioral evidence, the average human attention span is at a record low.
``We are attracted to companies that are complicated, dull or unglamorous,'' says Chris Davis, manager of the $31.2 billion Davis New York Venture Fund, which has averaged an 11.7 percent annual return over the past 10 years through October against a 9.3 percent-a-year gain for the Standard & Poor's 500 Index.
``Insurance and gravel may not be spicy, but companies like Geico (now part of Berkshire Hathaway) and Martin Marietta Materials have sure produced exciting returns,'' Davis says in his latest shareholder letter. ``There are not too many brilliant 25-year-olds who graduate from the best universities determined to study the ins and outs of insurance or gravel. This relative lack of analytical scrutiny may help us gain some advantage in studying these businesses.''
Just Stand There
The principle applies in many different ways. The impulse to action, instead of plodding patience, may cause as much trouble for investors as any other human failing.
``Most investors, particularly supposedly professional ones, overtrade their portfolios,'' writes Tim Price, senior investment strategist at London money manager Ansbacher & Co. Ltd. ``One of the pressures to overtrade is psychological: The grass is always greener in another stock. Another pressure to overtrade is the financial services industry itself.''
In this environment, sitting tight often takes more courage and conviction than rushing hither and yon in a frenzy of buying and selling. Something about human nature makes a hired manager especially subject to being fired when he isn't doing much of anything just now.
The problem is only complicated by the learned desire of 21st century homo sapiens to be endlessly entertained. In a recent study on the subject of asset allocation, New York money manager AllianceBernstein cites a continuing need to ``unwind the short-term, performance-chasing investment culture of the 1990s.''
High Stakes
Asset allocation, or the choice of how to spread one's money among categories such as stocks and bonds, holds the key to investment success, Alliance says. But in a recent survey, more than half of all advisers say their typical client would be more likely to explain the rules of Texas Hold 'Em poker than the principles of asset allocation.
Well, that's really not so strange. Texas Hold 'Em inherently makes much better drama. As hungry as cable TV may be for new material, Celebrity Asset Allocation shows remain rare.
Some evidence exists that asset-allocation consciousness is on the rise already. Witness the popularity of ``allocation'' mutual funds, which in their various hybrid stock-and-bond forms attracted $70 billion in net inflows from investors through the first nine months of 2005, according to consultants Financial Research Corp. in Boston. That's a whopping share -- one half -- of all the net new money that funds have attracted this year.
Professional Help
Likewise, witness the long and steady shift of investors to owning stocks and stock funds through brokers, financial planners and other go-betweens rather than buying direct from fund management firms.
More than three-quarters of all U.S. investors who own shares outside retirement plans use a professional adviser, according to a survey just published by the Investment Company Institute and the Securities Industry Association.
That puts a great deal of the onus on these intermediaries for increasing awareness from here on out. Many an employer- sponsored 401(k) retirement plan, for instance, ought to do a much better job of laying out the choices. If the story is told right, boredom shouldn't be a problem.
Excitement may be the enemy when you're trying to manage money -- and boredom can be an investor's good friend.
The sexier a stock or other financial proposition appears, the more likely it is overpriced. If you're looking for a bargain, search out things that offer nothing to tickle your fancy until you look below the surface.
These old contrarian ideas can be more relevant than ever in the modern world of ceaseless sensory stimulation. To judge by all the behavioral evidence, the average human attention span is at a record low.
``We are attracted to companies that are complicated, dull or unglamorous,'' says Chris Davis, manager of the $31.2 billion Davis New York Venture Fund, which has averaged an 11.7 percent annual return over the past 10 years through October against a 9.3 percent-a-year gain for the Standard & Poor's 500 Index.
``Insurance and gravel may not be spicy, but companies like Geico (now part of Berkshire Hathaway) and Martin Marietta Materials have sure produced exciting returns,'' Davis says in his latest shareholder letter. ``There are not too many brilliant 25-year-olds who graduate from the best universities determined to study the ins and outs of insurance or gravel. This relative lack of analytical scrutiny may help us gain some advantage in studying these businesses.''
Just Stand There
The principle applies in many different ways. The impulse to action, instead of plodding patience, may cause as much trouble for investors as any other human failing.
``Most investors, particularly supposedly professional ones, overtrade their portfolios,'' writes Tim Price, senior investment strategist at London money manager Ansbacher & Co. Ltd. ``One of the pressures to overtrade is psychological: The grass is always greener in another stock. Another pressure to overtrade is the financial services industry itself.''
In this environment, sitting tight often takes more courage and conviction than rushing hither and yon in a frenzy of buying and selling. Something about human nature makes a hired manager especially subject to being fired when he isn't doing much of anything just now.
The problem is only complicated by the learned desire of 21st century homo sapiens to be endlessly entertained. In a recent study on the subject of asset allocation, New York money manager AllianceBernstein cites a continuing need to ``unwind the short-term, performance-chasing investment culture of the 1990s.''
High Stakes
Asset allocation, or the choice of how to spread one's money among categories such as stocks and bonds, holds the key to investment success, Alliance says. But in a recent survey, more than half of all advisers say their typical client would be more likely to explain the rules of Texas Hold 'Em poker than the principles of asset allocation.
Well, that's really not so strange. Texas Hold 'Em inherently makes much better drama. As hungry as cable TV may be for new material, Celebrity Asset Allocation shows remain rare.
Some evidence exists that asset-allocation consciousness is on the rise already. Witness the popularity of ``allocation'' mutual funds, which in their various hybrid stock-and-bond forms attracted $70 billion in net inflows from investors through the first nine months of 2005, according to consultants Financial Research Corp. in Boston. That's a whopping share -- one half -- of all the net new money that funds have attracted this year.
Professional Help
Likewise, witness the long and steady shift of investors to owning stocks and stock funds through brokers, financial planners and other go-betweens rather than buying direct from fund management firms.
More than three-quarters of all U.S. investors who own shares outside retirement plans use a professional adviser, according to a survey just published by the Investment Company Institute and the Securities Industry Association.
That puts a great deal of the onus on these intermediaries for increasing awareness from here on out. Many an employer- sponsored 401(k) retirement plan, for instance, ought to do a much better job of laying out the choices. If the story is told right, boredom shouldn't be a problem.
Sunday, November 20, 2005
A year-end rally for no good reason
The much-anticipated year-end rally may happen, but it's merely the calm before the storm. As the housing bubble dissolves and the economy slows, watch out in 2006.
By Bill Fleckenstein
As 2005 winds to a close, I have been wrestling with a question: Whether or not the market can hold together for the rest of this year -- leaving the serious business of "the next time down" an issue for 2006. In the face of that unknown, I must look to seasonal market psychology for clues.
Bulls have been feeling pretty bulletproof due to the combination of the "calendar" and what I refer to as the "no-news period." Let me explain the latter -- and how it works into the equation of what the rest of this quarter and calendar year might look like.
Lifecycle of the corporate-spin cycle
Most companies in America are on calendar quarters. In the case of the third quarter, by the time October was finished, we had heard from pretty much all of them. We won't really hear anything further until early December, when we get the mid-quarter updates. Next, we get whatever preannouncements are going to occur. Then in January, we hear from the companies about the fourth quarter.
So in essence, the news period starts roughly with the last month of the quarter and runs through the first month or so of the new quarter. Said differently, the no-news period is the month in the middle of the quarter. (Obviously, this is not precise. Sometimes, due to the way the quarters have aligned vs. expectations, the no-news period can be longer. Also, it isn't strictly a no-news period. It's just a diminished-news period.)
Vaporing thrives in a vacuum
Why does that matter? Because even though most people who operate on Wall Street are adults, they seem to want to believe in childhood fantasies -- witness them describing the economy as a Goldilocks economy and planning for the Santa Claus rally and assorted other dreams.
When I got into the business in the late 1970s, this sort of brazen naiveté would have wiped you out in short order. By my reckoning, individual stocks figured out (or discounted) the news long before they seem to do so today. I attribute this to the fact that people have made so much money basically ignoring all forms of bad news since roughly the mid-1990s that they have invented new rules. (Yes, we did have a nasty 18-month period after the bubble burst. But, as one can see by the craze that's shifted into housing, that sell-off seems mostly forgotten.)
In any case, combine the no-news period (which November essentially is) with folks' belief in the Santa Claus rally, and you have the dynamic for a big rally -- if there is the money to do so (meaning that folks haven't already made the bet) and if what news there is cooperates.
The writing on the drywall
Last Tuesday was an example of the news not cooperating, as Toll Brothers (TOL, news, msgs) was forced to take guidance down for next year. The company's stock declined about 14%, with every other homebuilder hit for 5%, plus or minus. (It is worth noting that since last summer, insiders -- continuing to wax poetic about their business prospects -- sold more than 3 million Toll shares, at an average price of approximately $51.)
Anyone who's read the Contrarian Chronicles for any length of time knows that this is just another data point signaling the demise of the housing ATM and, as a consequence, the consumer and the economy running out of gas. What we don't know is:
• At what rate the process will unfold.
• When it will be recognized and acted on in the stock market.
A potential sign of that recognition: last Tuesday's 3% decline in the shares of Best Buy (BBY, news, msgs), a prominent beneficiary of consumers' spending spree, financed by you-know-what.
I may be making way too much of the dots being connected. But dots will have to be connected about what the demise of the housing ATM will mean before it can collectively mean anything. So, along the lines of what I said earlier, one of the things I'm looking for are signs, outside of the housing stocks themselves, that folks are figuring out what the demise of the housing ATM means.
End-of-year rally or trap?
Back to my original question about the market's path into year-end: I still find it hard to believe that all the people who've made the calendar/no-news bet are going to get paid this year -- though the weight of their sentiment may suffice to keep serious downside action at bay until next year. If so, we might just see a giant flop-and-chop for the rest of the year (with the averages finishing plus or minus a couple percent).
Of course, even if something like that scenario did play out, it doesn't mean there wouldn't be a handful of stocks that might go up a bunch and a handful that might go down a bunch. Again, this is only a near-term scenario, as I continue to be completely convinced that the next move of any consequence will be lower. However, when you're speculating on the short side, as I do, getting the timing right is crucial.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC on MSN Money.
By Bill Fleckenstein
As 2005 winds to a close, I have been wrestling with a question: Whether or not the market can hold together for the rest of this year -- leaving the serious business of "the next time down" an issue for 2006. In the face of that unknown, I must look to seasonal market psychology for clues.
Bulls have been feeling pretty bulletproof due to the combination of the "calendar" and what I refer to as the "no-news period." Let me explain the latter -- and how it works into the equation of what the rest of this quarter and calendar year might look like.
Lifecycle of the corporate-spin cycle
Most companies in America are on calendar quarters. In the case of the third quarter, by the time October was finished, we had heard from pretty much all of them. We won't really hear anything further until early December, when we get the mid-quarter updates. Next, we get whatever preannouncements are going to occur. Then in January, we hear from the companies about the fourth quarter.
So in essence, the news period starts roughly with the last month of the quarter and runs through the first month or so of the new quarter. Said differently, the no-news period is the month in the middle of the quarter. (Obviously, this is not precise. Sometimes, due to the way the quarters have aligned vs. expectations, the no-news period can be longer. Also, it isn't strictly a no-news period. It's just a diminished-news period.)
Vaporing thrives in a vacuum
Why does that matter? Because even though most people who operate on Wall Street are adults, they seem to want to believe in childhood fantasies -- witness them describing the economy as a Goldilocks economy and planning for the Santa Claus rally and assorted other dreams.
When I got into the business in the late 1970s, this sort of brazen naiveté would have wiped you out in short order. By my reckoning, individual stocks figured out (or discounted) the news long before they seem to do so today. I attribute this to the fact that people have made so much money basically ignoring all forms of bad news since roughly the mid-1990s that they have invented new rules. (Yes, we did have a nasty 18-month period after the bubble burst. But, as one can see by the craze that's shifted into housing, that sell-off seems mostly forgotten.)
In any case, combine the no-news period (which November essentially is) with folks' belief in the Santa Claus rally, and you have the dynamic for a big rally -- if there is the money to do so (meaning that folks haven't already made the bet) and if what news there is cooperates.
The writing on the drywall
Last Tuesday was an example of the news not cooperating, as Toll Brothers (TOL, news, msgs) was forced to take guidance down for next year. The company's stock declined about 14%, with every other homebuilder hit for 5%, plus or minus. (It is worth noting that since last summer, insiders -- continuing to wax poetic about their business prospects -- sold more than 3 million Toll shares, at an average price of approximately $51.)
Anyone who's read the Contrarian Chronicles for any length of time knows that this is just another data point signaling the demise of the housing ATM and, as a consequence, the consumer and the economy running out of gas. What we don't know is:
• At what rate the process will unfold.
• When it will be recognized and acted on in the stock market.
A potential sign of that recognition: last Tuesday's 3% decline in the shares of Best Buy (BBY, news, msgs), a prominent beneficiary of consumers' spending spree, financed by you-know-what.
I may be making way too much of the dots being connected. But dots will have to be connected about what the demise of the housing ATM will mean before it can collectively mean anything. So, along the lines of what I said earlier, one of the things I'm looking for are signs, outside of the housing stocks themselves, that folks are figuring out what the demise of the housing ATM means.
End-of-year rally or trap?
Back to my original question about the market's path into year-end: I still find it hard to believe that all the people who've made the calendar/no-news bet are going to get paid this year -- though the weight of their sentiment may suffice to keep serious downside action at bay until next year. If so, we might just see a giant flop-and-chop for the rest of the year (with the averages finishing plus or minus a couple percent).
Of course, even if something like that scenario did play out, it doesn't mean there wouldn't be a handful of stocks that might go up a bunch and a handful that might go down a bunch. Again, this is only a near-term scenario, as I continue to be completely convinced that the next move of any consequence will be lower. However, when you're speculating on the short side, as I do, getting the timing right is crucial.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily Market Rap column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC on MSN Money.
Thursday, November 10, 2005
Lessons from the days of 13% inflation
As inflation returns to life, let’s recall some hard truths: Now is cheaper than later. Fixed interest is better than variable. And don’t bail on stocks and bonds.
By Liz Pulliam Weston
If you have ever lived in an era of real inflation, you understand why economists are so paranoid about even the slightest hint of accelerating prices.But more than half the U.S. population is under 40, which means they either weren't born yet or were still minors the last time the country experienced double-digit inflation rates.
Here's just a sample of what life was like then:
Prices increased 40% in just three years, from 1979 to 1981. Every trip to the grocery store, it seemed, resulted in a bigger bill.
The prime rate, currently 6.75%, peaked at 21.5% in December 1980. Borrowing became prohibitively expensive as the Fed tried to break inflation's back.
Fixed-rate mortgages, currently hovering around 6%, averaged 17.5% in 1982. That means the payment on a $200,000 mortgage back then was $2,933 --compared to less than $1,200 at today's rates.
What real inflation looks like
Source: Ibbotson Associates
Don't eschew bonds. Even though bonds tend to suffer when rates rise, they're still important to most people's portfolios. They can provide an important cushion against stock market volatility. And when they fall in value, they tend to fall far less than stocks.
Finally, remember that nothing is certain. This inflation scare could be just that: a scare.
"As long as the Fed continues to control the money supply, as indicated by short-term interest rates, inflation will not necessarily be the result," Benton said. "The system may self-adjust and (Federal Reserve chief Alan) Greenspan may be able to induce a final 'soft landing.' "Those who have lived through inflation in the past certainly hope so.
By Liz Pulliam Weston
If you have ever lived in an era of real inflation, you understand why economists are so paranoid about even the slightest hint of accelerating prices.But more than half the U.S. population is under 40, which means they either weren't born yet or were still minors the last time the country experienced double-digit inflation rates.
Here's just a sample of what life was like then:
Prices increased 40% in just three years, from 1979 to 1981. Every trip to the grocery store, it seemed, resulted in a bigger bill.
The prime rate, currently 6.75%, peaked at 21.5% in December 1980. Borrowing became prohibitively expensive as the Fed tried to break inflation's back.
Fixed-rate mortgages, currently hovering around 6%, averaged 17.5% in 1982. That means the payment on a $200,000 mortgage back then was $2,933 --compared to less than $1,200 at today's rates.
What real inflation looks like
| What real inflation looks like | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Source: Bureau of Labor Statistics By contrast, today's inflation rates still seem relatively tame: consumer prices are up 4.7% for the past 12 months, while wholesale prices are up 6.9%. But the trends economists see are ominous. In September alone, for example, consumer prices rose 1.2%, the biggest jump in 25 years. Wholesale prices rose at the fastest rate in 15 years. Who hurts, who prospersSince so many of us have never dealt with serious inflation, and the rest of us are out of practice, it's time to review the basics: who wins, who loses and how best to cope.When inflation starts eroding the purchasing power of the dollar, the folks most at risk include:
Your inflation game planSo here are the lessons to be learned when dealing with inflation: Don't rush to pay off your fixed-rate debt. Even at modest inflation rates, the payments on fixed-rate mortgages, auto loans and other debt get cheaper every year. If prices continue to accelerate, the mortgage payment that seems so monumental today will quickly start to feel like a bargain. Push harder for that raise. Rising wages can accelerate the inflationary cycle: as workers demand more pay to cope with rising prices, employers boost prices even more to cope with the higher costs. But that doesn't mean you should take the fall. If you're going to cope with higher gas, heating and food costs, you're going to want more income. Get ready to substitute. Prices for different goods and services rise at different rates, which means savvy shoppers have opportunities to substitute a relatively cheaper item for a more expensive one. Eggs, for example, rose nearly 50% after Hurricane Katrina devastated many of the nation's poultry producers; price-conscious consumers will be eating more oatmeal for breakfast. All the ways frugal folks have traditionally found to save money become even more helpful as prices soar. Buy now, but don't charge it. Today's consumers are used to being rewarded for waiting. Delay buying that computer, for example, and you'll get a better, more powerful one for less next year. In an inflationary environment, though, rising prices reward those who buy now rather than later." As a young man, I tried to buy things quickly before they went up in price -- a convenient excuse," mused Bob Rockwell, a financial planner with CCB Financial Services in Sandy, Ore. Obviously, you'll want to keep living within your means, and you don't want to finance these purchases with variable-rate debt, like credit cards. But if it's a matter of buying now or buying later, the scales start to tip in favor of buying now. Get real. Investments in so-called "real assets" -- real estate, natural resources and commodities -- can help you hedge against inflation. Mutual funds that specialize in natural-resource investments, for instance, rose 22% in the third quarter, compared to 4.7% for funds overall."If you invest in assets that are part of inflation," Rockwell said, "then they should inflate in value and offset much of the damage." Stay invested in stocks. The slightest hint of accelerating inflation often sends the stock market into a tizzy, which has given some investors the mistaken notion that equities are a bad place to be in an inflationary environment.In reality, stocks did pretty well during the country's last bout with significant inflation, posting double-digit returns in six out of the 10 years during the inflationary decade starting in 1974. Over the long haul, most investors need the inflation-beating returns stocks provide if they want to reach their retirement and other goals.
|
Don't eschew bonds. Even though bonds tend to suffer when rates rise, they're still important to most people's portfolios. They can provide an important cushion against stock market volatility. And when they fall in value, they tend to fall far less than stocks.
Finally, remember that nothing is certain. This inflation scare could be just that: a scare.
"As long as the Fed continues to control the money supply, as indicated by short-term interest rates, inflation will not necessarily be the result," Benton said. "The system may self-adjust and (Federal Reserve chief Alan) Greenspan may be able to induce a final 'soft landing.' "Those who have lived through inflation in the past certainly hope so.
Saturday, November 05, 2005
How Long Can Consumers Keep Economy Going?
The million dollar question which will determine the fate of the current bull market is "How Long Can Consumers Keep the Economy Going?". Corporations have not stepped up in any significant way to offset any potential decrease in Consumer spending. This question will have wide-sweeping implications for the overall economy. As a follow-up to my reference to the article on Plutonomy, I found an interesting article from the Associated Press that discusses the current disconnect betweent the wealthiest 9% earning over $100,000 and the remaining 91% that do not and the implications of inflation to both groups. The themes in this article highlight the potential risks to the overall economy for both the upper and middle class:
How Long Can Consumers Keep Economy Going?
NEW YORK (AP) - Wall Street is worried about you.
Yes, you. The one they call "The Consumer." From the trophy-arrayed corner office of the richest CEO to the windowless cubicle of the most junior analyst, your immediate future is a pressing concern. What will you get for Christmas? How much will it cost to heat your house this winter? Will you get a raise next year?
This isn't personal. What they really care about is the 70 percent of gross domestic product that depends on consumer spending. Put another way, the 70 percent of the total economy that depends on you.
Retailers, car makers, consumer technology companies, wireless carriers, home builders: They all count on you.
You've been keeping the economy churning during the last five years, spending enough to make up for sluggish corporate spending. When you got tax cuts, you quickly spent them. Rising housing prices let you take out second and third mortgages, using your house as an ATM.
But now you're just not spending the way you were.
You aren't buying as many cars as you used to -- October auto sales were the weakest for any month since mid-1998. Your interest in home buying has hit its lowest level since 1991.
Your debt has increased. Outstanding balances on credit cards have risen to more than $800 billion, or $7,200 per U.S. household. The United States debt-to-income ratio rose as much in the past five years as it did in the previous 15 years, according to Merrill Lynch.
Your outlook is gloomy. "Our Consumer index continued to fall off a cliff in the past week," Merrill said in an Oct. 21 note. The last week in October, the ABC/Washington Post "consumer comfort index" dropped to roughly the same level reached after the hurricanes struck the Gulf Coast.
While October sales at many chain stores remained strong, you're eating at restaurants less. Sales at "food services and drinking places" increased only 0.2 percent in September, according to a Goldman Sachs report. That's the fifth straight month of an increase at or below that meager pace.
"Usually, restaurant spending turns down before or during economic slowdowns," the report said.
The fact is, you could use a little more money. While economists look at "core" inflation, which strips out volatile energy and food prices, you need only look at your bills to see that life has become more expensive.
Jumps in gasoline and heating prices make getting anywhere and staying warm at home more challenging. Increases in interest rates and higher minimum credit card payments have chipped away at your checking account. If you've been renting and want to buy a home, good luck: Affordability for first-time home buyers is the worst it has been in 16 years.
Then, there's your pay.
"Here we are, officially celebrating the fourth anniversary of this economic expansion, and the wage income share of the national income pie is south of 46 percent," fumed a research note by Merrill Lynch North American economist David A. Rosenberg. "At no point in the past 50 years has this ratio been so low so far into a business cycle." Historically, the ratio has been 3.5 percentage points higher.
The ratio is important because it looks at wages -- your paycheck -- instead of other sources of income, like the stellar Wall Street bonuses we saw last year and are almost certain to see again this year. Wage gains haven't kept pace with inflation, but total income continues to look good, thanks to those hefty bonuses.
Americans now find themselves in one of two groups: The 9 percent who make $100,000 or more and the 91 percent who don't, said Diane C. Swonk, senior managing director and chief economist at Mesirow Financial, a financial services firm based in Chicago.
"The bifurcation of the economy makes the economy look better on paper than it does to the majority of consumers," she said.
She blames the lousy summer movie season on higher gasoline prices, which inspired families to stay home and rent a DVD instead of spending $50 for gas and movie tickets. Wal-Mart Stores Inc. and Target Corp. did well during back-to-school shopping season, she said, "because middle income households started to move down the food chain."
For the top 9 percent, the good times continue to roll. According to Swonk, World Series tickets sold for $15,000 a pair. The Four Seasons Hotels Inc. says its $500 and higher rooms are doing better than ever, topping the Internet boom years. Sales of Coach Inc. handbags, which average about $435, increased 9 percent last summer and have stayed there.
After the Internet bust, "we kept this wealthy population," Swonk said. "The problem is, we continue to restructure everyone else. We want a flexible economy, but the trade off is pain."
That's why Wall Street is worried about you. No bond broker (unless you have one in your family) cares whether your car breaks down or you spend winter shivering in a sleeping bag, hoping the pipes don't freeze. But if you, the 91 percent of the population called The Consumer, hit a point where a trip to Target is out of the question, even the Coach-handbag carrying Four Seasons Hotel-staying 9 percent may feel the pain.
How Long Can Consumers Keep Economy Going?
NEW YORK (AP) - Wall Street is worried about you.
Yes, you. The one they call "The Consumer." From the trophy-arrayed corner office of the richest CEO to the windowless cubicle of the most junior analyst, your immediate future is a pressing concern. What will you get for Christmas? How much will it cost to heat your house this winter? Will you get a raise next year?
This isn't personal. What they really care about is the 70 percent of gross domestic product that depends on consumer spending. Put another way, the 70 percent of the total economy that depends on you.
Retailers, car makers, consumer technology companies, wireless carriers, home builders: They all count on you.
You've been keeping the economy churning during the last five years, spending enough to make up for sluggish corporate spending. When you got tax cuts, you quickly spent them. Rising housing prices let you take out second and third mortgages, using your house as an ATM.
But now you're just not spending the way you were.
You aren't buying as many cars as you used to -- October auto sales were the weakest for any month since mid-1998. Your interest in home buying has hit its lowest level since 1991.
Your debt has increased. Outstanding balances on credit cards have risen to more than $800 billion, or $7,200 per U.S. household. The United States debt-to-income ratio rose as much in the past five years as it did in the previous 15 years, according to Merrill Lynch.
Your outlook is gloomy. "Our Consumer index continued to fall off a cliff in the past week," Merrill said in an Oct. 21 note. The last week in October, the ABC/Washington Post "consumer comfort index" dropped to roughly the same level reached after the hurricanes struck the Gulf Coast.
While October sales at many chain stores remained strong, you're eating at restaurants less. Sales at "food services and drinking places" increased only 0.2 percent in September, according to a Goldman Sachs report. That's the fifth straight month of an increase at or below that meager pace.
"Usually, restaurant spending turns down before or during economic slowdowns," the report said.
The fact is, you could use a little more money. While economists look at "core" inflation, which strips out volatile energy and food prices, you need only look at your bills to see that life has become more expensive.
Jumps in gasoline and heating prices make getting anywhere and staying warm at home more challenging. Increases in interest rates and higher minimum credit card payments have chipped away at your checking account. If you've been renting and want to buy a home, good luck: Affordability for first-time home buyers is the worst it has been in 16 years.
Then, there's your pay.
"Here we are, officially celebrating the fourth anniversary of this economic expansion, and the wage income share of the national income pie is south of 46 percent," fumed a research note by Merrill Lynch North American economist David A. Rosenberg. "At no point in the past 50 years has this ratio been so low so far into a business cycle." Historically, the ratio has been 3.5 percentage points higher.
The ratio is important because it looks at wages -- your paycheck -- instead of other sources of income, like the stellar Wall Street bonuses we saw last year and are almost certain to see again this year. Wage gains haven't kept pace with inflation, but total income continues to look good, thanks to those hefty bonuses.
Americans now find themselves in one of two groups: The 9 percent who make $100,000 or more and the 91 percent who don't, said Diane C. Swonk, senior managing director and chief economist at Mesirow Financial, a financial services firm based in Chicago.
"The bifurcation of the economy makes the economy look better on paper than it does to the majority of consumers," she said.
She blames the lousy summer movie season on higher gasoline prices, which inspired families to stay home and rent a DVD instead of spending $50 for gas and movie tickets. Wal-Mart Stores Inc. and Target Corp. did well during back-to-school shopping season, she said, "because middle income households started to move down the food chain."
For the top 9 percent, the good times continue to roll. According to Swonk, World Series tickets sold for $15,000 a pair. The Four Seasons Hotels Inc. says its $500 and higher rooms are doing better than ever, topping the Internet boom years. Sales of Coach Inc. handbags, which average about $435, increased 9 percent last summer and have stayed there.
After the Internet bust, "we kept this wealthy population," Swonk said. "The problem is, we continue to restructure everyone else. We want a flexible economy, but the trade off is pain."
That's why Wall Street is worried about you. No bond broker (unless you have one in your family) cares whether your car breaks down or you spend winter shivering in a sleeping bag, hoping the pipes don't freeze. But if you, the 91 percent of the population called The Consumer, hit a point where a trip to Target is out of the question, even the Coach-handbag carrying Four Seasons Hotel-staying 9 percent may feel the pain.
Zero? Less than zero?
What will earnings growth look like in 2006?
Zero? Less than zero?
An analyst at a prominent bank is forecasting no corporate profit growth next year. Could it happen?November 4, 2005: 12:54 PM EST By Alexandra Twin, CNN/Money staff writer
NEW YORK (CNN/Money) - 'Twas the week before Halloween when a big Wall Street firm did send, a note most scary to investors that said ...
Next year, no earnings growth.
What? Zero earnings growth?
Granted, a boatload of bulls and bears alike are concerned about the outlook for stocks, and the economy, in 2006, particularly in the first half. And "slowing earnings growth" has become something of a mantra for many on Wall Street.
But none? Zero? Zip? It would be the first time in four years Wall Street's had to weather that.
In his Oct. 25 note titled "10 reasons to be bearish," J.P. Morgan Chase's global stock analyst Abhijit Chakrabortti highlighted why he thinks that a mix of higher inflation and interest rates, better returns on cash and no earnings growth mean the stock market could be in for a rough ride next year.
Not everyone agrees.
"I don't expect zero earnings growth next year, but I do expect slower growth," said Barry Hyman, equity strategist at Ehrenkrantz King Nussbaum.
Hyman cited a possible slowdown in the economy coupled with higher inflation and interest rates, not to mention tougher comparisons from the previous year. Earnings were bound to slow down after more than three years of surprisingly strong growth.
Profit growth was essentially flat as recently as 2002, when earnings for the S&P 500 grew a scant 0.1 percent from 2001, according to earnings tracker Thomson Financial. (see chart)
But for that to happen in 2006 "you'd need some kind of doomsday scenario," said David Dropsey, a Thomson Financial research analyst. "You'd need an environment where you have rampant inflation, increased unemployment and surging interest rates. I just can't see zero earnings growth next year."
Zero? Less than Zero?
Other market analysts contacted for this story agree that no earnings growth next year doesn't seem likely. Calls to Chakrabortti's office were not returned.
Right now, S&P 500 earnings are expected to grow 12.6 percent in 2006 from 2005, when earnings growth is expected to come in at around 14.5 percent, according to economists surveyed by Thomson Financial.
Of course what comes out in fourth-quarter earnings reports and forecasts could change the outlook for next year considerably.
And to be sure, not everyone out there is as rosy as the consensus. While Thomson Financial's average forecast is nearly 13 percent, many analysts say profit increases could easily come in below 10 percent for 2006.
"We won't see 15 percent growth like we're seeing in the third quarter (of 2005), but I think certainly low- to mid-single digits," said Jon Burnham, portfolio manager at Burnham Securities.
Burnham thinks that's partly because the economy is going to keep posting respectable growth, citing government spending that will kick in from the rebuilding efforts after the 2005 hurricanes.
That's a sentiment that Federal Reserve Chairman Alan Greenspan and other central bankers seem to share.
But some market watchers question whether the economy, and the stock market, will hold up as well next year.
"I see the whole business cycle slowing down," said Ken Tower, chief market strategist at CyberTrader, adding he expects a bear market in 2006, something he says tends to happen every four years or so. The current bull market has stretched for nearly three years.
Better quality earnings?
Energy, consumer and tech are among the early sectors primed for strong earnings growth next year, according to Thomson Financial.
Energy earnings are expected to grow another 13 percent in 2006 on top of the 50 percent growth forecast for 2005. Consumer Discretionary is expected to grow 20 percent versus 1 percent in 2005. Technology is expected to grow 17 percent next year after growing 16 percent in 2005.
Corporations could be better set to handle a possible economic slowdown next year than would first seem to be the case, said Donn Veckery, co-founder of independent research firm Gradient Analytics.
"Typically, market analysts are too optimistic about earnings, but I think in terms of 2006, there's an excess of pessimism," Veckery said.
He noted that while there are definite exceptions, the quality of earnings overall has been improving in the third quarter of 2005 and that looks to stretch into the fourth quarter, and 2006 as well.
The Power of Wal-Mart
Wal-Mart economy keeps lid on US inflation: study
The "rock-bottom" pricing strategy used by retail giant Wal-Mart has filtered into the US economy and kept a lid on inflation, according to a study commissioned by the company and released.
The study by the economic research firm Global Insight concluded that the discounting along with other measures led to cumulative savings for consumers of 263 billion dollars between 1985 and 2004, or 895 dollars per person.
The researchers concluded that Wal-Mart had a positive impact on US employment, generating 210,000 jobs by 2004, or 0.15 percent more that would have existed without Wal-Mart.
The report also found that Wal-Mart's low pay for employees led to a 2.2 percent drop in overall wages across the economy but maintained that this was offset by falling consumer prices.
"Consumers earned less in nominal dollars, but their income bought them more in the economy with Wal-Mart because of real disposable income gains," the study concluded.
The study drew criticism from Wal-Mart's chief detractors, who argue that the company benefits from a variety of public subsidies while depressing wages.
Tracy Sefl, spokeswoman for Wal-Mart Watch, a leading critic of the company, said her group's research, based on data from congressional reports, concludes that Wal-Mart benefits from at least 1.5 billion dollars in public subsidies each year.
Additionally, Sefl noted other reports showing retail workers lost 4.7 billion dollars as a result of depressed wages and that nearly half of the children of Wal-Mart employees qualify for the government's Medicaid health program for the needy.
"Wal-Mart is only telling part of the story, which is not the same as telling the whole story," Sefl said.
Global Insight concluded that over the 1985-2004 period, Wal-Mart led to to 9.1 percent decline in food prices, a 4.2 percent decline in prices of other goods and a 3.1 percent decline in overall consumer prices.
The research firm found Wal-Mart led to a 0.75 percent improvement in the overall efficiency of the economy, based on capital intensity and lower import prices.
The "rock-bottom" pricing strategy used by retail giant Wal-Mart has filtered into the US economy and kept a lid on inflation, according to a study commissioned by the company and released.
The study by the economic research firm Global Insight concluded that the discounting along with other measures led to cumulative savings for consumers of 263 billion dollars between 1985 and 2004, or 895 dollars per person.
The researchers concluded that Wal-Mart had a positive impact on US employment, generating 210,000 jobs by 2004, or 0.15 percent more that would have existed without Wal-Mart.
The report also found that Wal-Mart's low pay for employees led to a 2.2 percent drop in overall wages across the economy but maintained that this was offset by falling consumer prices.
"Consumers earned less in nominal dollars, but their income bought them more in the economy with Wal-Mart because of real disposable income gains," the study concluded.
The study drew criticism from Wal-Mart's chief detractors, who argue that the company benefits from a variety of public subsidies while depressing wages.
Tracy Sefl, spokeswoman for Wal-Mart Watch, a leading critic of the company, said her group's research, based on data from congressional reports, concludes that Wal-Mart benefits from at least 1.5 billion dollars in public subsidies each year.
Additionally, Sefl noted other reports showing retail workers lost 4.7 billion dollars as a result of depressed wages and that nearly half of the children of Wal-Mart employees qualify for the government's Medicaid health program for the needy.
"Wal-Mart is only telling part of the story, which is not the same as telling the whole story," Sefl said.
Global Insight concluded that over the 1985-2004 period, Wal-Mart led to to 9.1 percent decline in food prices, a 4.2 percent decline in prices of other goods and a 3.1 percent decline in overall consumer prices.
The research firm found Wal-Mart led to a 0.75 percent improvement in the overall efficiency of the economy, based on capital intensity and lower import prices.
Wednesday, November 02, 2005
Plutonomy
I found an interesting article that attempts to explain the resiliency of the U.S. economy, despite the recent wave of economic challenges that the nation has faced. The concept of a Plutonomy is nothing new but the emphasis of it as an explanation for continued economic expansion is a bit of a stretch, in my opinion. To suggest that the continued consumption of the wealthy is all that matters in the economy and that this upper class is immune to market shocks is an oversimplification of the current economic environment. It is an interesting article, nonetheless:
U.S. resilient despite wealth gap
Friday, October 21, 2005; Posted: 7:27 a.m. EDT (11:27 GMT)
WASHINGTON (Reuters) -- It will be no consolation to poorer U.S. households struggling to make ends meet, but rising U.S. income disparity may explain how the world's biggest economy continues to expand rapidly amid repeated shocks.
For those puzzled at how the United States continues to grow well above historical averages despite blistering fuel price rises, rising debt and interest rates and ballooning national deficits, many economists say one answer lies in the American "plutonomy".
In a "plutonomy", according to Citigroup global strategist Ajay Kapur, economic growth is powered by and largely consumed by the wealthy few. Canada and Britain fall into that category too, he says, the euro zone and Japan much less so.
Spurred by capitalist-friendly governments, technology-driven productivity gains, high immigration and strict property rights and patents, Kapur argues the U.S. plutonomy has mushroomed since the early 1980s.
With huge chunks of national income and wealth increasingly concentrated in a tiny percentage of households at the top, national spending, profits and economic growth are disproportionately dependent on the fortunes of that same group.
And the more there is growth in the economy, profits and the price of assets, such as houses and equity, the relatively richer and more significant this group is in assessing nationwide growth.
In other words, calculating how higher energy costs will affect the economy by simply looking at the impact on 'average' American households can be hugely misleading.
"It is easy to drown in a lake with an 'average' depth of four feet - if one steps into the deeper extremes," Kapur wrote in report released this week.
"There is no average consumer in a 'plutonomy'," he said, adding: "Consensus analysis focusing on the average consumer are flawed from the start."
To be sure, hurricanes Katrina and Rita devastated the lives of millions of poor Americans. Many more now see household budgets squeezed to the limit by the ensuing surge in gasoline and home heating costs.
But the bald facts of rising inequality in America's wealth distribution means the trials of low- and even middle-income families will have only a small impact on gauges of gross domestic product, aggregate spending growth and corporate profits.
Kapur's report highlights consumer finance surveys showing the top one percent of U.S. households -- about 1 million households -- accounted for about 20 percent of overall U.S. income as recently as 2000.
That is only a slightly smaller share than the bottom 60 percent of some 60 million households put together.
And the top one percent also accounts for a third of household net worth, the difference between household assets -- such as equity or houses -- and debts. That is greater than the total held in the bottom 90 percent.
Economists say the decline in equity values since 2000 may have reduced the skew in this 2001 Survey of Consumer Finances, a triennial survey sponsored by the Federal Reserve. Data from the 2004 survey has yet to be released.
The rise in house prices since then will have distributed asset wealth a little wider than the concentration of equity.
But more recent household surveys ram home the point.
The 2003 Consumer Expenditure Survey shows pre-tax average income of the top quintile income group, at $127,146 per annum, just a thousand dollars short of the combined average income of all of the bottom 80 percent.
And it showed the average expenditure of the top 20 percent of households exceeded the total of the lowest 60 percent.
Dean Maki, Head of U.S. Economic Research at Barclays Capital, said spending by this top quintile seems very unlikely to drop substantially in response to higher energy prices.
Maki, co-author of a 2001 Fed study demonstrating the fall in the U.S. savings rate of rich Americans in response to the 1990s equity boom, said the top quintile are now seeing strong income growth, plentiful jobs and housing and equity gains.
"Energy prices represent a substantially smaller share of spending in these households than for poorer Americans," said Maki. "With fundamentals so positive for this group, we believe spending growth by the wealthy should continue to provide some insurance to the overall consumption outlook."
David Kelly, senior economic adviser at Putnam Investments in Boston, reckons debt among poorer households also play a significant part in keeping U.S. consumers seemingly spending beyond their means.
But Maki at Barclays pointed out that a large part of the nationwide debt too is held by the top income quintile and for that group, assets far outweigh debt holdings.
"That's one reason we don't see much of a relationship between aggregate debt burden and consumer spending," he said.
For all the implications of this idea -- and Kapur reckons it goes along way to explaining the wider issues of global economic imbalances -- many feel the reality of the situation should be obvious too all.
"Whatever about the political system, the U.S. economy is not a democracy -- it doesn't count by heads, it counts by dollars," said Putnam's Kelly.
U.S. resilient despite wealth gap
Friday, October 21, 2005; Posted: 7:27 a.m. EDT (11:27 GMT)
WASHINGTON (Reuters) -- It will be no consolation to poorer U.S. households struggling to make ends meet, but rising U.S. income disparity may explain how the world's biggest economy continues to expand rapidly amid repeated shocks.
For those puzzled at how the United States continues to grow well above historical averages despite blistering fuel price rises, rising debt and interest rates and ballooning national deficits, many economists say one answer lies in the American "plutonomy".
In a "plutonomy", according to Citigroup global strategist Ajay Kapur, economic growth is powered by and largely consumed by the wealthy few. Canada and Britain fall into that category too, he says, the euro zone and Japan much less so.
Spurred by capitalist-friendly governments, technology-driven productivity gains, high immigration and strict property rights and patents, Kapur argues the U.S. plutonomy has mushroomed since the early 1980s.
With huge chunks of national income and wealth increasingly concentrated in a tiny percentage of households at the top, national spending, profits and economic growth are disproportionately dependent on the fortunes of that same group.
And the more there is growth in the economy, profits and the price of assets, such as houses and equity, the relatively richer and more significant this group is in assessing nationwide growth.
In other words, calculating how higher energy costs will affect the economy by simply looking at the impact on 'average' American households can be hugely misleading.
"It is easy to drown in a lake with an 'average' depth of four feet - if one steps into the deeper extremes," Kapur wrote in report released this week.
"There is no average consumer in a 'plutonomy'," he said, adding: "Consensus analysis focusing on the average consumer are flawed from the start."
To be sure, hurricanes Katrina and Rita devastated the lives of millions of poor Americans. Many more now see household budgets squeezed to the limit by the ensuing surge in gasoline and home heating costs.
But the bald facts of rising inequality in America's wealth distribution means the trials of low- and even middle-income families will have only a small impact on gauges of gross domestic product, aggregate spending growth and corporate profits.
Kapur's report highlights consumer finance surveys showing the top one percent of U.S. households -- about 1 million households -- accounted for about 20 percent of overall U.S. income as recently as 2000.
That is only a slightly smaller share than the bottom 60 percent of some 60 million households put together.
And the top one percent also accounts for a third of household net worth, the difference between household assets -- such as equity or houses -- and debts. That is greater than the total held in the bottom 90 percent.
Economists say the decline in equity values since 2000 may have reduced the skew in this 2001 Survey of Consumer Finances, a triennial survey sponsored by the Federal Reserve. Data from the 2004 survey has yet to be released.
The rise in house prices since then will have distributed asset wealth a little wider than the concentration of equity.
But more recent household surveys ram home the point.
The 2003 Consumer Expenditure Survey shows pre-tax average income of the top quintile income group, at $127,146 per annum, just a thousand dollars short of the combined average income of all of the bottom 80 percent.
And it showed the average expenditure of the top 20 percent of households exceeded the total of the lowest 60 percent.
Dean Maki, Head of U.S. Economic Research at Barclays Capital, said spending by this top quintile seems very unlikely to drop substantially in response to higher energy prices.
Maki, co-author of a 2001 Fed study demonstrating the fall in the U.S. savings rate of rich Americans in response to the 1990s equity boom, said the top quintile are now seeing strong income growth, plentiful jobs and housing and equity gains.
"Energy prices represent a substantially smaller share of spending in these households than for poorer Americans," said Maki. "With fundamentals so positive for this group, we believe spending growth by the wealthy should continue to provide some insurance to the overall consumption outlook."
David Kelly, senior economic adviser at Putnam Investments in Boston, reckons debt among poorer households also play a significant part in keeping U.S. consumers seemingly spending beyond their means.
But Maki at Barclays pointed out that a large part of the nationwide debt too is held by the top income quintile and for that group, assets far outweigh debt holdings.
"That's one reason we don't see much of a relationship between aggregate debt burden and consumer spending," he said.
For all the implications of this idea -- and Kapur reckons it goes along way to explaining the wider issues of global economic imbalances -- many feel the reality of the situation should be obvious too all.
"Whatever about the political system, the U.S. economy is not a democracy -- it doesn't count by heads, it counts by dollars," said Putnam's Kelly.
Monday, October 31, 2005
Consumer Crunch
The driving force behind the economy, the consumer, may finally be approaching the "tapped out" stage. There is only so much debt that the average consumer can accumulate on low interest rate expectations and assumptions that housing prices will continue to increase at remarkable rates.
Kathleen Hays of CNN Money has written a good article analyzing the decline in consumer spending and the threats that this continued trend poses for the economy:
The threat behind consumer spending
The economy could take a huge hit, and soon, if the underlying spending trend doesn't strengthen.
October 31, 2005: 3:46 PM EST
NEW YORK (CNN/Money) - Hurricanes can bury a lot of things, but don't let them bury a very important nugget in Monday's personal income and spending report: the consumer fell off a spending cliff in August and September!
On the surface, the spending numbers look fine.
Personal spending rose 0.5 percent last month, but when the effect of soaring oil and gas prices is removed to get a "real" view of spending instead of a "nominal" reading, then the number looks pretty anemic: real spending fell 0.4 percent in September after falling by 1 percent in August.
And, given that consumer spending is about two-thirds of the economy, and given the way the government's economic math works, the economy's growth rate could actually turn negative in the fourth quarter if the consumer doesn't perk up quickly.
"Coming on the heels of a 1 percent drop in August, the two-month decline was the biggest in nearly 19 years and leaves the spending level at quarter-end well below the Q3 average," economist Dave Resler at Nomura Securities wrote in a report Monday.
"For spending to match the third-quarter level -- thereby avoiding a decline -- real spending must grow at a 3.6 percent annual rate (about 0.3 percent each month). With car sales reportedly quite weak in October, this could prove to be a rather tall order."
Now, it's true that falling auto sales had a lot to do with this. Spending on durable goods (remember? Big-ticket items built to last three years or more?) fell by 2.4 percent in September after plunging 8.9 percent in August, according to the Bureau of Economic Analysis, the economics arm of the Commerce Department.
Problem is that the early read from a lot of auto dealers this month has been another month of crummy sales. So there could more of this kind of weakness in the pipeline.
What about spending on other stuff you say? Certainly people buy a lot more than cars. Yes they do and unfortunately, when you adjust again for inflation, mainly boosted by energy prices right now, you see that it's not just autos that consumers are shying away from.
Purchases of "non-durable" goods -- less durable items like clothing, books, DVDs, etc. -- fell by 1 percent in September after rising a mere 0.1 percent in August.
Only spending on services was growing, and that's the category that includes visits to the doctor's office, lawyers' fees, financial services, etc.: up 0.3 percent in September on top of an increase of 0.2 percent the month before.
Nomura's Resler says if the consumer fails to shift back into a higher spending gear, the Fed will take note, if not tomorrow, then surely in December at its final meeting of the year.
"Unless spending (primarily ex-autos) stages a rather convincing recovery in the next few weeks, the prospect of the first quarterly decline in consumer spending in 15 years could factor into the December 13 FOMC decision," Resler wrote, referring to the Federal Open Market Committee, the Fed's policy-making arm.
According to some economists, it all depends on the job market.
"Consumer spending is unlikely to slow by enough to materially harm the overall economy, if, as expected, the unemployment rate resumes its downward trend in 2006," is the view of Jon Lonski of Moody's Investor's Service.
A possible assist for the consumer could be shaping up in the steady drop in gas prices at the pump as the impact of the hurricanes pass and as crude oil prices fall back near $60 a barrel.
The problem is, in the view of Dave Gilmore of FXA up in Connecticut, that the Fed is raising interest rates, bond yields are rising finally as a result, and if energy prices keep falling and give the consumer some relief -- and the economy a bounce -- that could encourage even more rate hikes.
"Yes, the U.S. consumer is quite vulnerable to rising market rates...the home ATM machine gets gummed up if rising mortgage rates lead to a correction in the U.S. housing market," he said.
Remember, the Fed has been raising short-term rates since June of 2004 but the long-term, bond-market rates that determine mortgage rates have stayed relatively low -- until the Fed's last rate hike in September.
"If bond yields keep rising which I think they will, then not even stocks are safe from a welcome decline in energy prices," observes Gilmore. "In this case lower energy prices could prove to be a Trojan horse unleashing a problematic rise in market rates."
Kathleen Hays of CNN Money has written a good article analyzing the decline in consumer spending and the threats that this continued trend poses for the economy:
The threat behind consumer spending
The economy could take a huge hit, and soon, if the underlying spending trend doesn't strengthen.
October 31, 2005: 3:46 PM EST
NEW YORK (CNN/Money) - Hurricanes can bury a lot of things, but don't let them bury a very important nugget in Monday's personal income and spending report: the consumer fell off a spending cliff in August and September!
On the surface, the spending numbers look fine.
Personal spending rose 0.5 percent last month, but when the effect of soaring oil and gas prices is removed to get a "real" view of spending instead of a "nominal" reading, then the number looks pretty anemic: real spending fell 0.4 percent in September after falling by 1 percent in August.
And, given that consumer spending is about two-thirds of the economy, and given the way the government's economic math works, the economy's growth rate could actually turn negative in the fourth quarter if the consumer doesn't perk up quickly.
"Coming on the heels of a 1 percent drop in August, the two-month decline was the biggest in nearly 19 years and leaves the spending level at quarter-end well below the Q3 average," economist Dave Resler at Nomura Securities wrote in a report Monday.
"For spending to match the third-quarter level -- thereby avoiding a decline -- real spending must grow at a 3.6 percent annual rate (about 0.3 percent each month). With car sales reportedly quite weak in October, this could prove to be a rather tall order."
Now, it's true that falling auto sales had a lot to do with this. Spending on durable goods (remember? Big-ticket items built to last three years or more?) fell by 2.4 percent in September after plunging 8.9 percent in August, according to the Bureau of Economic Analysis, the economics arm of the Commerce Department.
Problem is that the early read from a lot of auto dealers this month has been another month of crummy sales. So there could more of this kind of weakness in the pipeline.
What about spending on other stuff you say? Certainly people buy a lot more than cars. Yes they do and unfortunately, when you adjust again for inflation, mainly boosted by energy prices right now, you see that it's not just autos that consumers are shying away from.
Purchases of "non-durable" goods -- less durable items like clothing, books, DVDs, etc. -- fell by 1 percent in September after rising a mere 0.1 percent in August.
Only spending on services was growing, and that's the category that includes visits to the doctor's office, lawyers' fees, financial services, etc.: up 0.3 percent in September on top of an increase of 0.2 percent the month before.
Nomura's Resler says if the consumer fails to shift back into a higher spending gear, the Fed will take note, if not tomorrow, then surely in December at its final meeting of the year.
"Unless spending (primarily ex-autos) stages a rather convincing recovery in the next few weeks, the prospect of the first quarterly decline in consumer spending in 15 years could factor into the December 13 FOMC decision," Resler wrote, referring to the Federal Open Market Committee, the Fed's policy-making arm.
According to some economists, it all depends on the job market.
"Consumer spending is unlikely to slow by enough to materially harm the overall economy, if, as expected, the unemployment rate resumes its downward trend in 2006," is the view of Jon Lonski of Moody's Investor's Service.
A possible assist for the consumer could be shaping up in the steady drop in gas prices at the pump as the impact of the hurricanes pass and as crude oil prices fall back near $60 a barrel.
The problem is, in the view of Dave Gilmore of FXA up in Connecticut, that the Fed is raising interest rates, bond yields are rising finally as a result, and if energy prices keep falling and give the consumer some relief -- and the economy a bounce -- that could encourage even more rate hikes.
"Yes, the U.S. consumer is quite vulnerable to rising market rates...the home ATM machine gets gummed up if rising mortgage rates lead to a correction in the U.S. housing market," he said.
Remember, the Fed has been raising short-term rates since June of 2004 but the long-term, bond-market rates that determine mortgage rates have stayed relatively low -- until the Fed's last rate hike in September.
"If bond yields keep rising which I think they will, then not even stocks are safe from a welcome decline in energy prices," observes Gilmore. "In this case lower energy prices could prove to be a Trojan horse unleashing a problematic rise in market rates."
Bernanke Realities
With the recent appointment of Ben Bernanke as Greenspan's successor, the markets have largely applauded the appointment. How important was this appointment? It was only important in the sense that it quelled any fears that investors may have had after the questionable nomination of Harriet Miers for the Supreme Court.
Allan Sloan of Newsweek wrote a terrific article that discusses Bernanke's challenges ahead amidst the global realities of a less effective Federal Reserve:
Opinion: Reality Check on the Fed
The nation's central bank hates inflation, except the kind that's puffed up its reputation as an all-powerful agency.
By Allan Sloan
Newsweek
Nov. 7, 2005 issue - We all like to believe that there's an all-knowing, all-powerful force looking after us. No, I'm not talking about organized religion and God. I'm talking about the widespread belief that an all-powerful Federal Reserve Board controls interest rates and inflation, and is looking out for each and every one of us.
Since President Bush nominated Ben Bernanke to become the next Alan Greenspan, we've heard endlessly about the Fed's powers over the financial markets and the economy, and about how hard it will be for Cousin Ben to fill Uncle Alan's shoes. But despite the outsize attention that any utterance from the head Fed typically gets, the economic world isn't controlled by one person, or even one institution.
Bernanke will be a powerful guy, of course, and well worth watching and listening to. But you've got to remember two things about the Fed. First, it's not looking after your personal interests—it's looking after the financial system, which isn't the same thing. A for-instance: in the early 1990s, when many major banks were effectively insolvent, the Fed bailed them out by lowering short rates, handing them huge profits at the expense of people who depended on CD income for food money.
Second, the Fed is far from all powerful. In fact, it's considerably less powerful than it was when Greenspan took the helm in 1987. Since then, the United States has become dependent on the rest of the world—especially the central banks of Japan and China and other Asian countries—to finance our budget and trade deficits. If Asia grows less eager to hold dollars, U.S. interest rates will rise, regardless of the Fed's wishes.
On the U.S. domestic front, our largely deregulated financial system is far harder for the Fed to influence than the old regulated system was. When interest rates paid to depositors were regulated, the Fed could raise short rates, lure money out of banks into Treasury bills and slow down bank lending. Now, with no interest-rate ceilings and such nonbank lenders as hedge funds abounding, the Fed's influence has waned.
The one important interest rate that the Fed controls—the federal funds rate—drives short-term interest rates. But the fed funds rate doesn't drive long-term rates, which are set by financial markets and are more important to businesses and home buyers than short rates are. In fact, during Bernanke's stint as a Fed governor, he tried to talk down long-term rates by threatening to have the Fed print money to buy up long-term bonds. Had that happened, the markets would have bested the Fed the way they bested the Bank of England in 1992 when it spent billions trying to defend the British pound. He raised a hue and cry about the prospect of deflation, but it never appeared.
The fact that Bernanke isn't perfect shouldn't be cause for alarm. Neither is Greenspan, as he'd be the first to admit if you bought him a couple of beers and promised him anonymity. He's been very good. But the stock bubble grew and burst on his watch, and we've now got a housing bubble that will inevitably burst. Last year, Greenspan talked about how foolish home buyers had been to get fixed-rate mortgages rather than variable-rate ones—but given the sharp rise in short rates, anyone who switched to a floating-rate loan is wailing the blues today.
What I like best about Greenspan is that he plays things by ear and won't say what he's really up to. That magnifies the Fed's influence by keeping big market players off balance. The players care only about making money, but the financial system needs balance, which the Fed provides. With the Fed less powerful than it once was, guile is good.
We won't know how effective a Fed chairman Cousin Ben is until after his first crisis. But one thing we know already: a divinity, he's not.
© 2005 Newsweek, Inc
Allan Sloan of Newsweek wrote a terrific article that discusses Bernanke's challenges ahead amidst the global realities of a less effective Federal Reserve:
Opinion: Reality Check on the Fed
The nation's central bank hates inflation, except the kind that's puffed up its reputation as an all-powerful agency.
By Allan Sloan
Newsweek
Nov. 7, 2005 issue - We all like to believe that there's an all-knowing, all-powerful force looking after us. No, I'm not talking about organized religion and God. I'm talking about the widespread belief that an all-powerful Federal Reserve Board controls interest rates and inflation, and is looking out for each and every one of us.
Since President Bush nominated Ben Bernanke to become the next Alan Greenspan, we've heard endlessly about the Fed's powers over the financial markets and the economy, and about how hard it will be for Cousin Ben to fill Uncle Alan's shoes. But despite the outsize attention that any utterance from the head Fed typically gets, the economic world isn't controlled by one person, or even one institution.
Bernanke will be a powerful guy, of course, and well worth watching and listening to. But you've got to remember two things about the Fed. First, it's not looking after your personal interests—it's looking after the financial system, which isn't the same thing. A for-instance: in the early 1990s, when many major banks were effectively insolvent, the Fed bailed them out by lowering short rates, handing them huge profits at the expense of people who depended on CD income for food money.
Second, the Fed is far from all powerful. In fact, it's considerably less powerful than it was when Greenspan took the helm in 1987. Since then, the United States has become dependent on the rest of the world—especially the central banks of Japan and China and other Asian countries—to finance our budget and trade deficits. If Asia grows less eager to hold dollars, U.S. interest rates will rise, regardless of the Fed's wishes.
On the U.S. domestic front, our largely deregulated financial system is far harder for the Fed to influence than the old regulated system was. When interest rates paid to depositors were regulated, the Fed could raise short rates, lure money out of banks into Treasury bills and slow down bank lending. Now, with no interest-rate ceilings and such nonbank lenders as hedge funds abounding, the Fed's influence has waned.
The one important interest rate that the Fed controls—the federal funds rate—drives short-term interest rates. But the fed funds rate doesn't drive long-term rates, which are set by financial markets and are more important to businesses and home buyers than short rates are. In fact, during Bernanke's stint as a Fed governor, he tried to talk down long-term rates by threatening to have the Fed print money to buy up long-term bonds. Had that happened, the markets would have bested the Fed the way they bested the Bank of England in 1992 when it spent billions trying to defend the British pound. He raised a hue and cry about the prospect of deflation, but it never appeared.
The fact that Bernanke isn't perfect shouldn't be cause for alarm. Neither is Greenspan, as he'd be the first to admit if you bought him a couple of beers and promised him anonymity. He's been very good. But the stock bubble grew and burst on his watch, and we've now got a housing bubble that will inevitably burst. Last year, Greenspan talked about how foolish home buyers had been to get fixed-rate mortgages rather than variable-rate ones—but given the sharp rise in short rates, anyone who switched to a floating-rate loan is wailing the blues today.
What I like best about Greenspan is that he plays things by ear and won't say what he's really up to. That magnifies the Fed's influence by keeping big market players off balance. The players care only about making money, but the financial system needs balance, which the Fed provides. With the Fed less powerful than it once was, guile is good.
We won't know how effective a Fed chairman Cousin Ben is until after his first crisis. But one thing we know already: a divinity, he's not.
© 2005 Newsweek, Inc
Thursday, October 27, 2005
The Cheque is in the Mail
Many clients have been receiving cheques from various mutual fund companies over the last month. As expected, I have received a flood of phone calls from clients asking about the money received.
The cheques were sent as part of a settlement between various Mutual Fund Companies and the Ontario Securities Commission for "Market Timing" issues that were discovered from an OSC investigation. The OSC defines Market Timing as follows:
Market timing involves short-term trading of mutual fund securities to take advantage of short term discrepancies between the "stale" values of securities within a mutual fund's portfolio and the current market value of those securities. Stale values can occur in mutual fund portfolios comprised, in whole or in part, of non-North American foreign equities. Stale values of those securities may result in stale values of the units of a mutual fund as a result of the way in which the net asset value of most mutual funds is calculated for the purpose of determining the price at which an investor may buy or sell a unit of the fund.
A market timer will attempt to take advantage of the difference between the "stale" value and an expected price movement of a fund the following day by trading in anticipation of those price movements.
The Harm Caused by Frequent Trading? When certain investors engage in frequent trading market timing in foreign funds, and when those investors are not required to pay a proportionate fee to the fund, the economic interest of long-term unitholders of these foreign funds is adversely affected. Significant harm may be incurred by a fund in which frequent trading market timing occurs. Any such harm would be borne by all investors in the fund. In addition to dilution, market timing in a fund also may result in certain inefficiencies in that fund. Those inefficiencies, which will vary depending upon the particular fund, may involve increased transaction costs and disruption of a fund's portfolio management strategy (including the maintenance of cash or cash equivalents and/or monetization of investments to meet redemption requirements) and may impair a fund's long-term performance.
If you would like to know more about the Market Timing investigation, please visit the following link:
http://www.osc.gov.on.ca/HotTopics/FundSettle/fs_backgrounder.jsp
If you have any further questions, please call me.
The cheques were sent as part of a settlement between various Mutual Fund Companies and the Ontario Securities Commission for "Market Timing" issues that were discovered from an OSC investigation. The OSC defines Market Timing as follows:
Market timing involves short-term trading of mutual fund securities to take advantage of short term discrepancies between the "stale" values of securities within a mutual fund's portfolio and the current market value of those securities. Stale values can occur in mutual fund portfolios comprised, in whole or in part, of non-North American foreign equities. Stale values of those securities may result in stale values of the units of a mutual fund as a result of the way in which the net asset value of most mutual funds is calculated for the purpose of determining the price at which an investor may buy or sell a unit of the fund.
A market timer will attempt to take advantage of the difference between the "stale" value and an expected price movement of a fund the following day by trading in anticipation of those price movements.
The Harm Caused by Frequent Trading? When certain investors engage in frequent trading market timing in foreign funds, and when those investors are not required to pay a proportionate fee to the fund, the economic interest of long-term unitholders of these foreign funds is adversely affected. Significant harm may be incurred by a fund in which frequent trading market timing occurs. Any such harm would be borne by all investors in the fund. In addition to dilution, market timing in a fund also may result in certain inefficiencies in that fund. Those inefficiencies, which will vary depending upon the particular fund, may involve increased transaction costs and disruption of a fund's portfolio management strategy (including the maintenance of cash or cash equivalents and/or monetization of investments to meet redemption requirements) and may impair a fund's long-term performance.
If you would like to know more about the Market Timing investigation, please visit the following link:
http://www.osc.gov.on.ca/HotTopics/FundSettle/fs_backgrounder.jsp
If you have any further questions, please call me.
Clone Funds - R.I.P. Now What?
Over the past few months, clone funds have been steadily "wound down" due to the elimination of the RSP foreign content rules. Investors, that wished to maximize their foreign content within their RRSP, used clone funds, to bypass the foreign content rule. The cost of the forward contracts, associated with clone funds, made them slightly more expensive than the underlying funds. However, with the elimination of the foreign content constraints, investors can have 100% of their money outside of Canada at no additional cost.
The traditional perspective has always been that Canada represents approximately 3% of world Gross Domestic Product (GDP) and therefore you shouldn't have more than 3% of your investments in Canada, as there are better opportunities elsewhere in the world. Over the last few years, however, this would not have been the case. As the Canadian dollar has appreciated, it has done severe damage to rates of return in U.S. investments, as the returns were converted from U.S. to Canadian Dollars. Also, as China's economic expansion has exploded, the demand for Canadian resources has elevated the Canadian economy and created impressive rates of return for Canadian stocks in the energy, financial, and materials sectors.
The temptation for investors is to eliminate their "global focus" and flock back to Canadian investments to eliminate potential currency risks and to enjoy the benefits of the global expansion through the natural appreciation of Canadian resource and materials companies.
I would suggest that many of the companies in these sectors have already reached or at least approached "fair value" and the future potential gains that may be enjoyed pale in comparison to other global stocks that have lagged in performance in recent years.
The timing of the elimination of the Foreign Content Rule makes for some very interesting investment allocation decisions going forward. Logically, investors understand the need for global diversification but they may find it hard to ignore the recent surge in the Canadian stock market.
Stay tuned...
The traditional perspective has always been that Canada represents approximately 3% of world Gross Domestic Product (GDP) and therefore you shouldn't have more than 3% of your investments in Canada, as there are better opportunities elsewhere in the world. Over the last few years, however, this would not have been the case. As the Canadian dollar has appreciated, it has done severe damage to rates of return in U.S. investments, as the returns were converted from U.S. to Canadian Dollars. Also, as China's economic expansion has exploded, the demand for Canadian resources has elevated the Canadian economy and created impressive rates of return for Canadian stocks in the energy, financial, and materials sectors.
The temptation for investors is to eliminate their "global focus" and flock back to Canadian investments to eliminate potential currency risks and to enjoy the benefits of the global expansion through the natural appreciation of Canadian resource and materials companies.
I would suggest that many of the companies in these sectors have already reached or at least approached "fair value" and the future potential gains that may be enjoyed pale in comparison to other global stocks that have lagged in performance in recent years.
The timing of the elimination of the Foreign Content Rule makes for some very interesting investment allocation decisions going forward. Logically, investors understand the need for global diversification but they may find it hard to ignore the recent surge in the Canadian stock market.
Stay tuned...
Wednesday, October 26, 2005
Welcome to my Blog!
After spending over a month researching, creating, and tweaking my most recent newsletter, I realized why I write so few newsletters....they take too long to publish and often the timeliness of the information is less effective and relevant than I would like.
Every day, seven days a week, I have the same routine. I spend approximately 1 hour during the morning and 1 hour every evening, researching timely and relevant economic and political articles from various sources around the world. I also attend many conferences to hear views directly from Economists, Mutual Fund Managers, and other financial experts. I do this for the purpose of disseminating information that may ultimately affect my client's investment portfolios. While every client is different and each portfolio is created in a custom manner to reflect their individual goals, timelines, risk tolerances, the macroeconomic and political factors that affect them are the same.
By creating this blog, I hope to share more information that can be useful in "real time" so that my clients can understand what my current thoughts are regarding various financial issues and therefore they can make better decisions in working with me.
I encourage you to visit this site often and to share your comments.
Thank you.
Every day, seven days a week, I have the same routine. I spend approximately 1 hour during the morning and 1 hour every evening, researching timely and relevant economic and political articles from various sources around the world. I also attend many conferences to hear views directly from Economists, Mutual Fund Managers, and other financial experts. I do this for the purpose of disseminating information that may ultimately affect my client's investment portfolios. While every client is different and each portfolio is created in a custom manner to reflect their individual goals, timelines, risk tolerances, the macroeconomic and political factors that affect them are the same.
By creating this blog, I hope to share more information that can be useful in "real time" so that my clients can understand what my current thoughts are regarding various financial issues and therefore they can make better decisions in working with me.
I encourage you to visit this site often and to share your comments.
Thank you.
Subscribe to:
Posts (Atom)