Alan Moore Commentary 12-1-2010

Alan Moore Commentary 12-1-2010                    alanm@slavic.net

     The elections have given us gridlock and you couldn’t pass gas in Congress now. Despite the platitudes, Boehner hates Obama and Obama hates Boehner, meaning the deficits are on automatic and the wars will drone on even though Iran is secretly winning both of them behind our backs using bribes: the military is powerless to stop it, to even see it in the “hoods”.  From now on, the President is a lame duck and has no real power; neither do the Republicans or the Democrats. The only game left in Washington is Quantitative Easing and this is how that should go:  If we see the Fed actually stepping up with a bigger QE-2 ($1 trillion or more over six months), the stock markets will surge more and bonds will tank after the initial Fed purchases are made. Actually, the Fed announced a $600B purchase plan, which caused short-term interest rates to fall a bit and long-term rates to go up, because the Fed declined to buy any long-term bonds. No matter what term they grab, the full scope of the plan means the Federal Reserve Bank will buy 50% of the bonds the Treasury issues next year to pay for the deficit (foreigners are supposed to kick in for 30%, leaving only 20% for the general public to buy).  It doesn’t get any more Ponzi than that, especially when you consider the Treasury will pay the Fed interest on the bonds by creating more bonds, which, in turn, the Fed will buy with more book entries. Like magic, the Fed could do a $4 trillion QE and Bernanke wouldn’t even blush, as he promoted the policy like he does all of them, with the line: It will provide “balanced and sustainable growth”----some people call it the “BS” line for short.

    Going forward, at least we shouldn’t be getting any new laws and regulations out of Congress for awhile, and I thought that called for a celebration; so I took my wife to a fancy restaurant for diner, but the maitre d’ wouldn’t let me in without a tie. We discussed the issue intently at the door with no resolution. After some time, I went back to the car and got my jumper cables and arranged them tie-like around my neck, and went back. The maitre d’ and I had more words, but he finally said: “Ok, go-on in, but don’t start anything.” Right then, I had to love the guy, remembering what my father always said: “a stranger is a friend waiting to happen.” My father was a people-person and I am trying to be more like him……… Too bad Boehner and Obama aren’t strangers.

       Just six months ago the EU did a stress test on the banks in Europe and all of Irelands big banks passed, now we learn they are busted and need a bailout----our stress tests were just a whitewash like the ones done by the EU----- Next Portugal will go down in February and then Spain in the spring-----.  Inflation may die in Europe’s austerity budgets, but I am plagued with the thought that food prices in America have already surged to a new record and oil is up to $85 a barrel, not to mention that health care costs are up 12% this year. The only thing keeping the CPI at bay is rent-equivalents, which for some unknown reason represent 30% of the CPI index calculation. Between rents and the exclusion of food and energy prices from the core inflation statistic(PCE deflator), it appears consumers are getting a free ride to buy big, with interest rates so low. If they take the bait and spend, we are headed for a disaster a few years from now. One of the misconceptions the Republican Party gleaned from the Reagan tax cuts in the early 1980s was that they were responsible for the economic boom from 1984 to 1990; the tax cuts were not primarily responsible and there is no bipartisan economic study that says they were. The problem is not high taxes, it is spending and the resulting debt load.     

      Therefore, along with all of Asia and Europe, I feel worried about the $600B QE, as it appears the Fed is walking the line between inflating the economy and inflating inflation, and I really don’t think they know where the line is. Trying to be objective, I can see there is a strong case for some QE as long as inflation stays dormant------ No QE and we will stay in a liquidity trap, because people don’t want to borrow and spend; as they already have too much debt and home prices are still falling. The one shining light is the decrease in the productivity rate to 2% last month, from 7% three years ago. Private employment always picks up when productivity falls to the point businesses must hire new people and we are at that tipping point. On the other hand, profit margins increase when productivity rises, because fewer workers are needed to produce the same amount of products. You can fire people and, statistically, it will show up as an increase in productivity; albeit, that phenomenon is not occurring anymore and any good news on employment will mean profit margins will shrink, which would be bad news for earnings going forward. Don’t get me wrong, I don’t think the 151,000 new jobs reported in October was good news because the government threw in 200,000 fictitious jobs as a seasonal-adjustment factor in order to produce that result (Barron’s, 11-8). They split the adjustment allocating 100k to September and 100k to October, meaning there were only 51,000 new jobs created in October, which was less than the 71,000 economists expected. No one seemed to notice the adjustment at the time or characterize it as fraud, but government reporting is an on-going crime scene if you ask me.

      Because of a lack of evidence, quantitative easing hasn’t been convicted of an economic crime yet, although the innuendoes are all bad. The economists that claim the Fed is just printing money are wrong: practically zero of the excess bank reserves have leached into the economy ----- 2% GDP-growth and a 1.4% inflation rate are prima facie proof of that. However, the case isn’t closed: potentially the reserves could monetize, but, so far, they haven’t. With the Fed’s obvious intent to commit inflation, individual stock picking is a risky endeavor because the macro environment will determine the return verdict. The Chinese slump, the Korean dispute and the resurrection of the European debt crisis are closing in on us like black swans in a swamp. The macro impact can be seen in the correlation ratios of the different asset classes, they all swing together these days, bound together by artificial, low interest rates. For example, the recovery, spurred by QE liquidity, has been good for bonds, stocks and commodities at the same time, but not for Main Street or the jobless. That is not the modus operandi of asset prices, which means there is no way to diversify properly in a portfolio…………..which could be construed as a crime against investors if the market robs them again in broad trading, like it did in March of 2009. In the mean time, my prosecution of QE rests, on cash.      

    The global system risk is inflation; if it suddenly appears, the power of all central banks will be curtailed as interest rates rise around the world---19 members of the G20 are already targeting price levels versus their economies. Obama and Bernanke stand alone against the world: if they are wrong, we are screwed; our gridlocked Congress could never agree on fiscal stimulus and the fate of the economy would be left entirely to the markets. The last time the Fed employed the easy-money policy for such an extended period was in the late 1970s; starting in 1977, under President Ford, and culminating in the reign of Carter. Fed Chairman Arthur Burns expanded the money supply by 13% for three successive years, thereby driving up inflation to 10% by 1981 (back then consumers were borrowing the excess reserves-----but currently M3 money growth is only 3%). Burns did that to spur the economy out of GDP stagnation caused by the 1975 recession (by the way, Burns invented the term “core inflation” in 1977 to combat criticism caused by a rising CPI index). He was given the mandate to primarily target the employment rate with the Humphrey-Hawkins Act passed in 1978, and secondarily to target inflation. That mandate still exists today; although, millions of people have been out of work for so long, they have forgotten what work they are out of. The Republican administration launched the recession in 2007 and the Democrats grew it into the “Great Recession”.  President Truman was an old-time Democrat and he said, “The buck stops here.” Obama is a modern Democrat, and he says: leave more bucks here and I’ll take care of everything. There is nothing wrong with a Democrat if you compare him to a Republican……..a buck is a buck, no matter who spends it where; and neither one of them have a clue how to buck-up a budget. That is up-beat as I can be on the elections last month; the voters didn’t elect anything new, they passed the buck. The only political figure today with the administration skill to run the government is Indiana Governor Mitch Daniels, who was the former director of the Office of Management and Budget under George Bush. He could decipher the congressional bills and balance the budget, but he can’t sling words well enough to be elected President. Don’t take that as an affiliation with any political party, I’m not affiliated; I dislike both of them equally.

    Before the Christmas break, and before the mantel of power in the House passes to the Republican majority, is the only period in which the Bush tax cuts can be extended before they expire on January 1^st; ----and then everyone’s taxes will go up next month if an agreement is not forthcoming. With no resolution, incomes will drop automatically due to increased payroll tax deductions:  it may take two months to work out a tax compromise, which will probably result in an increase for the rich (whatever that means) and a roll-back for everyone else. However, it will come too late to save GDP in the first quarter and spending will be flat to down. That effect will be impossible to overcome with quantitative easing. Not extending the tax cuts will also be a big deal to the stock market, because the capital gains tax on dividends will rise, meaning stocks that pay them will become less attractive; millions of people rely on dividends to live and their incomes will fall, even though they aren’t branded as rich.

   Another GDP kicker will be the two million people that will see their unemployment benefits expire in the next two months, if they aren’t extended by Congress (their 99 weeks are up). Do you really think the Republicans and Democrats can agree on an extension, say to 2 ½ years? Even if they do extend it, a worker who is on the dole that long probably forgot all his skills.  Right or wrong, if an extension isn’t granted, spending will decline automatically. So here is the total rub, a Congress that can’t agree on tax cuts and can’t agree on unemployment benefits will mean that the economy will slow in the first quarter of 2011, just because people will have less income----- That conclusion is elementary and unassailable----- Therefore, my defense for being in cash rests………. on Congress.  

    Perhaps the greatest flaw with the elected and with the leadership at the top is the lack of practical experience: I doubt whether anyone in Obama’s cabinet has ever changed a tire on a car or run a company; their education is extensive, but their ignorance is encyclopedic. Larry Summers, Geithner and the Federal Reserve Board are consummate academics following a textbook script disconnected from common sense. For that reason, I think it is best to bet against the government’s stimulus policy because it ignores rational consumer behavior, realistic funding and the international backlash to QE-2. Cash is that bet against Obama, Boehner and the whole rat pack in Washington: Congressional committees are just a device to turn coffee into laws that don’t make sense. Should QE-2 work somehow, and I don’t make any money because I’m not invested, then my life will stay the same, which is fine the way it is in its frugal way. My wife, who never shops in a store smaller than a football stadium, dryly pointed out that my cash theory filled a much needed gap in my investment plan: she also expressed that view more succinctly by saying, “you’re missing the boat dummy” (A person like me could be dumb and not know it, but not if he is married.).  I could only respond: “I know you are probably right dear, but please give it a rest, we worked hard for the money”…………………After all, my theory may be crazy, but is it crazy enough to work?

     Now I will tell you about the antithesis of Quantitative Easing, as being utilized in China and Singapore. Even though those countries have surpluses and huge reserves, they recently issued sovereign bonds to sop up the liquidity consumers have there. By selling bonds to the public, China can absorb some of the cash floating around, thereby reducing spending and inflation. Economists call this policy “sterilization of the monetary base”, and many PHD dissertations have been done on the subject, but none have really added any information to the sentence above. Academics aside, the Chinese are realists and they can afford a little sterilization with a 9.6% GDP rate---we sure can’t. Nevertheless, if the money keeps flowing into China due to trade surpluses, but gets tied up for several years in time deposits, bonds and capital controls, then it can’t flow into real estate speculation and other things. In other words, the money will become “sterile”. To accomplish this objective, the government must issue bonds that pay a higher rate of interest than the banks and the inflation rate, even though it does not need the proceeds to operate. If monetary officials start to see an economic slowdown, they can always redeem the bonds early and thereby throw money into the system. Our Federal Reserve Bank is trying to do just that by redeeming bad mortgage loans at the banks and giving them money in return; money that disappeared in losses and doesn’t exist anymore: albeit, they want it to exist again through consumer and small business loans, but that isn’t happening. The immediate problem we have is not QE, because it has not been effective. Fiscal policy is the problem due to excess spending that is creating deficits that must be substantially bailed out by China. Forty percent of the bail money is coming from foreigners and what happens in China, won’t stay in China, it will come here. I sure hope they don’t have a big slowdown; sterilization is one thing, but jacking up interest rates there would jack them here, and QE-2 would turn into Titanic-2. Not to get you worried, but China, Australia, India and South Korea raised interest rates again last month. Asia tightens monetary policy as we loosen it, tic for tac. To boot, these were Obama’s “loose-money” words last month in a speech: “The Fed’s mandate, my mandate, is to grow our economy.” The German finance minister countered: “Americans accuse the Chinese of currency manipulation and then artificially lower the dollar with quantitative easing.” At the G20 conference, Obama gave his pitch to rally the world behind our monetary policy, but he was interpreted by the other nineteen members to mean: If I ask for your opinion, I will give it to you. How humble is that?  Obviously, the Town Hall thing doesn’t work in a country haul.

   The Chinese tried to “sterilize” population growth in the 1980s by making it against the law to have two children; one was promoted as ideal. However, the government didn’t take into account Chinese culture which values male children above females. Many couples dumped their first child in the river or aborted if it was a girl, wanting to have a boy on a second try; and it happened that the male population swelled bigger than normal. This gave government birth control a bad name, but too late to prevent the big social problem in China today, which is a lack of brides, as well as an aging population that used to be supported by a robust proportion of young people. China doesn’t have a social security system---the children are expected to support their parents in old age. Likewise, Japan also had the same problem and lost its growth economy fifteen years ago----- It is still lost because old people don’t work as hard or as cheaply as youngsters, therefore productivity goes down. In America, our population spread is ok, but the unions make our economy old, because their members don’t produce as cost effectively as regular workers, so we have much the same problem as Japan in drag------ our jobs are dragged to China and India by higher profits there. If you still can fantasize about the productivity of unions, just follow the success of GM’s VOLT when it’s rolled out next year from the unionized, DHAM plant in Michigan. The $41k price alone will gut your budget for horse power---------and  Nissan is coming out soon with their all-electric car(LEAF) priced at $32k. GM will produce 10,000 VOLTs next year, while Nissan will make 50,000 of the new LEAF. GM is afraid of a massive recall, so they are limiting their exposure to that risk, but they are sure milking the electric hype. Supporting the “New GM” is a $7,500, Obama tax-credit for suckers that buy a VOLT, as a subsidy for green technology that appears brown if you look closely. GM recently announced the VOLT wasn’t all electric: it uses gas also, meaning it is really a hybrid………. Go figure why the VOLT gets the credit and the Prius doesn’t.

   There is another bailout coming, even after the public offering at $33 a share: GM retains a  $45-billion dollar tax deduction for losses it had before the ownership change in 2009, whereby the government took over 61% of the stock in exchange for $50 billion in cash. Under the tax code, such a change in ownership would normally kill any loss carry forward tax benefit. However, the bailout bill from Congress included an exception to the code, and GM won’t pay corporate tax on the next $45 billion in profits. In other words the taxpayers bailed them out once and will be doing it again. Net-net, it still costs taxpayers every time a bolt is screwed on a wheel in Detroit, even if we get our money back from the sale of the stock, which we won’t unless the next stock offering is sold at $53 a share. Of course Wall Street promoted the IPO hard and it was oversubscribed by institutions because appearances rule the market. Generally, the Wall Street deals are led by promoters that are narcissists by nature and prone to grandiosity; that is part of their charm: they leap from one scheme to the next, indifferent to losses and unable to focus on the slow and boring work of building a solid business over many years. They sell with slick presentations and well-rehearsed enthusiasm, talking-up a persuasive business plan using sound bites such as: scalable, burn rate, positioned-for-growth, and the value-proposition-------- I prefer hearing the story from a veteran manager who has spent his career actually running the company. There have been 3 CEOs at GM in 3 years; so there is no history of leadership there. What I think investors are looking for today is access to industry specific knowledge and facts, versus salesmanship and hype. From Wall Street to Congress to the Federal Reserve Bank, we continue to be plagued with hyperbole, sound-bites and incompetence. My advice is, don’t be a lemming.

    Another buzz word often used by investment promoters is diversification; and, I will point out that downside protection comes from being price conscious and diversification is really a euphemism for ignorance. For example, if you don’t know much about a stock that you buy, then at least don’t buy much of it; in fact, most investors should just own index funds and quit trying to pick individual stocks. However, if after careful study, you think you know what a company is worth, say Exxon at $60 per share and you buy a little, and then it drops to $56, I would buy a lot of it. Currently, at $69, Exxon is not a buy, but it is a small piece of every index fund, which is the best way to buy into the market high, if you must follow the crowd and the urge for a higher return. At $56, and with very little debt on their balance sheet, I wouldn’t shrink from allocating 15% of my portfolio to that stock, because I don’t want to be diversified particularly, I just want to buy low, in whatever asset class offering that opportunity. That’s my investment strategy in a nutshell, which is a mockery of “Modern Portfolio Theory”; actually, the market has made a mockery of that theory over the last couple of years. In short, either get a bargain price or skip diversification and stay in cash, because there is no such thing as diversification in an asset correlated market, like we have today. If you are 100% invested, you are concentrated in risk, unless you bought low and have dividends to sustain you through the volatility. Exxon, for one, has that potential. Watch it, anything below $60 is a buy in my theory: one day it might even get there.  

         As a side note, on Wall Street, Main Street, or any street, Bernard Baruch was the best investor that ever was in my book; in his memoirs, Baruch listed some rules on investing in a chapter entitled “My Investment Philosophy.”  These rules could be useful to you in the future.

    1.  Don’t speculate unless you can make it a full-time job.

    2.  Before you buy a security, find out everything you can about the company, its management       

         and competitors, its earnings and possibilities for growth.
        

    3.  Don’t try to buy at the bottom and sell at the top.  This can’t be done--except by liars.

    4.  Learn how to take your losses quickly and cleanly.  Don’t expect to be right all the time.

         If you have made a mistake, cut your losses as quickly as possible

    5.  Don’t buy too many different securities.  Better have only a few investments which can be

         watched.

    6.  Make a periodic reappraisal of all your investments to see whether changing developments    

         have altered their prospects.

    7.  Always keep a good part of your capital in a cash reserve. Never invest all your funds.

     8.  Don’t try to be a jack of all investments.  Stick to the field you know best       

Amen,

Alan