Alan Moore Commentary 3-1-2011     alanmmoorecommentary.blogspot.com

   The price is what you pay, but value is what you get, which is always a matter of the collective mood. The mood has certainly improved in last four months, but none of the experts (except Roubini and Whitney) thought homes where overvalued in 2006, or Tech stocks in 1998, but they were. Currently, stocks and bonds are closing in on historical highs, while the economy is muddling along. Car sales, retailers, manufacturing, fuel and shipping rates, and consumer confidence are pointing to a stronger economy, but that is mostly due to government stimulus, QE and abnormally low interest rates. Countering the optimism, the housing market is still sinking and employment has not turned the corner enough to increase incomes; in fact half the jobs created have been temps (Financial Times 2-3-11). However, the 90% of Americans employed are doing well, except a quarter of them are underwater in their homes. Despite that little wrinkle, the economy can continue to plow through a bad housing market and the permanent loss of jobs outsourced to Asia, but it can’t plow through higher interest rates at this stage. The Fed believes this and continues to keep rates low, trying to give every asset class an advantage over cash and money market funds. Here is the rub: the Fed now owns more US Treasury bonds than China (thanks to QE-2), not to mention $1.7 trillion of mortgages purchased in 2009. Fannie Mae and Freddie Mac own mortgages worth $6 trillion and are sitting on potential write offs of a trillion dollars if they dump their foreclosures on the market. Ninety five percent of new mortgages are purchased by Fannie Mae and the originating banks would never hold on to them with only 3% down---only the government is that stupid.

       In the short-run, the Fed will buy enough bonds to keep interest rates low until inflation appears and the markets jack up interest rates----in the long run, the bond market will control the Federal Reserve Bank, not politics.  Whether inflation can be contained or not is up to three factors: the supply of money, labor costs and commodity prices. Two of the three (M3 & wages) are not growing enough to push inflation up, but commodities have gone through the roof, principally oil and corn. Obviously, the  people owning the commodities are doing the best as prices of most of them have risen 50% recently----------and there is no way to shield the world from commodity cost-push inflation over the next year. The question is how much inflation will occur with just one of the three factors pushing it up? I think 1 out of 3 translates into a 4 to 5% rate, even with the bogus way the government calculates it. In that scenario, there can be only one reaction by a central bank, raise rates to protect the currency. I don’t know when it will happen, but I know what the consequences will be: the perceived value of assets today will be re-priced using a higher discount rate. Even Caterpillar, the most solid company in America, will not sell for 20 times earnings if their bonds yield 8%. That is where triple-A corporate rates will go if we see three months of annualized 5% inflation, which could easily happen now that the recession is over and oil has spiked. No doubt, I am sitting in cash watching the boat go by; albeit, it has some leaks and with a 55% gain in my portfolio in 2009, I don’t feel compelled to continue taking the risk that the economic recovery will stall into higher inflation---- because government policy is hell-bent on creating more of it. Only a recession caused by $200-dollar oil can tackle inflation in 2011. What if riots start in Saudi Arabia though?

    In the South Sea stock bubble in London in the 18^th century, Isaac Newton (the guy who invented Calculus) invested early and sold early, and he was happy with his gain; but then he got jealous of his friends who stayed in and kept making profits, so he bought the stock again with all his money, just before the big bust and he lost it all. He feared missing the boat just as investors do today, but where is the value they are missing? I see the price gains, but I fear the multiples and I am not prone to jealousy. Staying in cash, I don’t expect to be paid for not taking risk, and I made nothing in the last 12 months with interest rates near zero. However going back in time, I am sure Newton wished he had stuck to math because he knew how to value numbers, but the collective mood confused him. At this point in the cycle, I am not confused, just scared because most everyone else is not. The situation comes down to Newton’s First Law of Motion: “Every object in a state of uniform motion tends to remain in that state of motion unless an external force is applied to it.” The stock market works the same way and the only question is what will be the next force that hits it? Libya? Saudi Arabia? Spain? The CPI Index? State budgets in crisis? There are too many potential black swans for me to invest.

Here are some February sentiment statistics about investment managers coming from a pole by Merrill Lynch—my sentiments are in italics:

-28% of investment managers are in commodities, up from 16% in January

                            Commodities are peaking; it is too late to invest

-70% of the managers believe interest rates will rise more in 2011

              They are right, sell bonds

-67% are overweight global equities, an all time high

              Equity prices are too high as a result of the thundering herd

-5% are overweight emerging markets, down from 43% in January

           A deflating bubble caused by high inflation and rising interest rates

  The flow of money into stocks and commodities continues, but what about the poor slobs still in muni bonds and emerging market funds? Another factoid that is interesting: of the homes sold in Miami last month, half the buyers paid all cash and half the sales were foreclosures or short sales; meaning prices have gone so low that investors (the smart money) are stepping in. Miami is hitting a bottom, but the rest of the country has a ways to go, down. Orlando is also getting close to a bottom, prices have fallen 60% and I made a bid on a house there last month, as an investment. I lost out to a family looking for a place to live, which is an emotional purchase, not a rational one based on price and return. Rationally, I think real estate foreclosures offer a better opportunity than the stock market at this juncture and the sooner all the “qualified” irrational buyers get their dream  house, the sooner the remaining inventory will take another price drop into the lap of savvy investors.  In the Wall Street Journal 2-22-2011, page A3, it was revealed the National Association of Realtors had overstated the number of home sales by 20% over the last 3 years, in an effort to promote the housing market. If you see a big revision by the NAR in the next month or so, you will know why: it was caught data cheating.     

   The January government employment report announced on February 4^th   indicated that only 34,000 jobs were created, even as the unemployment rate fell to 9%; you may wonder how can that happen? The labor pool is the denominator in the fraction and the unemployed are the numerator; the household poll resulted in 300,000 unemployed people saying they were not looking for a job anymore, because their 99 weeks of unemployment benefits ended, and they were summarily dropped; however, the denominator number is 10 times bigger than the numerator and 300k subtracted from the 131M labor pool affects it very little compared to 300k subtracted from the 12M unemployed. If the 300k were counted, as they should be, the unemployment rate would have stayed at 9.4%. However, the more important statistic, in determining the direction of GDP, was the number of non-farm jobs created, and that is still pointing to a sideways economy, which isn’t a bad thing. Unnoticed was the increase in hourly pay which may cause a jump in the inflation index, which would be bad for interest rates. Everything I see on the horizon will be bad for interest rates, not to mention the revolutions happening in the OPEC countries. How many times will we hear that the economy has turned the corner?  How many corners can there be before it turns into a circle?     

   Here is another Moore’s law: All sovereign statistics end in a circle of deceit. GDP for the 4^th QTR was just revised down to 2.8% instead of the 3.2% growth reported in January. Here is a global example of misinformation put out by OPEC: The permitted daily output quotas of OPEC member-nations are based on declared national reserves. So the more a country claims they have, the more they get to export. Kuwait for example double their amount of declared reserves overnight several years ago, within six months Venezuela followed, and by the end of that same year almost every OPEC country followed suit. Despite pumping millions of barrels a day, the declared reserves have almost never gone down (how can that be?). I even heard a journalist interviewing a former CIA energy analysts about these claims, and the analyst asked several of these countries "how can you be pumping 5, 10, 15, 20 million barrels a day, yet your reserves don't change?" , and they're reply was "that is just how it works".  In other words, oil reserves everywhere--- except in America--- are not what they are pumped up to be. When Chevron reported that they only have 11 years worth of oil left at their current pumping rate, and Exxon reported 15, you might wonder, where is the energy cliff we going to fall off of in the future? I will predict that the parachute will be natural gas; not ethanol, wind turbines or solar panels. Exxon has already moved the company toward natural gas by buying XTO last year for $41B, the largest producer in the United States. The private sector will move in the right direction at the right time because it can see where the cliff is, whereas the politicians cannot see past their campaign contributions. Natural gas prices are low because of the big jump in production caused by the energy companies moving into that sector all at once, while demand has not grown as fast.  In any case, we can solve the energy problem by removing the legal damage caps and letting the oil companies have their way, but make them 100% liable for their pollution. Then we will get the best of both worlds: energy efficiency balanced by responsible behavior. The courts can regulate oil companies much better than the Energy Department, which is funded $20B a year. What does the Energy Department really do? Within the next 10 years, oil will hit $200 a barrel and there is nothing politically we can do about it. Mandating ethanol usage just raised the price of food and did nothing to reduce oil imports.

      Here is example of bad politics collapsing into reality: The Fitch rating agency just downgraded public pensions across the country by assuming an evaluation rate of return of 7% instead of the fictitious 8% currently used in computing funding for state and local budgets. Twenty five percent of Miami’s budget is already consumed with funding pensions for fire and police and city workers; albeit, Miami is unofficially bankrupt and the 7% rate doesn’t help. I find it hard to believe pensions will even earn 7% over the next ten years when the last decade only yielded an averaged 5% return, prior to stock rally the last quarter. Why are taxpayers putting up with these huge pension benefits in the first place? Ditto for the unfunded Social Security program which was supposed to be a safety net to keep the poor and disabled from starving when it was originally setup by FDR in the 1930s: it was never designed to be a retirement program and it cannot continue that way. The top 5% of incomes need to give up their SS retirement benefits entirely and write-off their paycheck contributions as charity. That is the only salvation for social security in the long run. If we don’t maintain an economic safety net for the poor, we will end up with riots and revolution just like in Egypt---but we should fund the safety-net without raising taxes: that is the only bipartisan idea that makes sense.

      At least Governor Walker of Wisconsin is trying to limit spending by asking public employee to contribute 6% toward their pensions and 13% toward their health insurance; albeit, threatening collective bargaining rights makes unions downright violent. Nevertheless, who do they actually bargain with? Elected officials getting campaign contributions from unions make the decisions to give public workers benefit increases-----Isn’t that a conflict of interest and a scam? What if wage and benefit increases for teachers, fire and police were put on the ballot, letting the taxpayers that fund the benefits approve or deny them--------- that would be the day we have real “collective bargaining”, and that is how it works in the private sector. Making the public unions accountable to public taxpayers is not an attempt to break their backs and destroy them. We need unions to check the innate greed driving capitalism; history shows very little wealth trickles down from the rich on a voluntary basis.  

    Like I wrote last month, the threat of a government shutdown is here, which is nothing more than politics because the money to send out Social Security checks and pay for essential services is there. Instead, Congress haggles over creating another 1,000 page budget bill targeting $61B in spending cuts, which is a drop in the bucket and won’t make any difference anyway. If we just had a law that no bill could be more than 10 pages, and every Senator/Congressman had to pass a written test on what was in it in order to vote, we could stop all this foolishness----- A closely monitored test because you know they would all try to cheat.    

PS-----This was announced today, Monday 2-28, after I had already posted the commentary: see what I mean about the NAR.

"Pending home sales fall for second straight month by Greg Robb

WASHINGTON (MarketWatch) -Pending home sales fell in January, the second straight monthly decline, a real estate trade group reported Monday. The pending home sales index fell 2.8% in January, close to market expectations, the National Association of Realtors said. However, sales in December were much weaker than first thought. Sales in December were revised sharply lower to a fall of 3.2% versus the prior estimate of a 2% increase. The index is 1.5% below January 2010 but 20.6% above the trough hit last June after the homebuyer tax credit expired. Pending homes sales fell in the Northeast, the Midwest, and West but rose in the South. The index is based on sales contracts on existing homes. The NAR also reports on sales of existing homes once the sales close, usually six to eight weeks later."