Alan Moore Commentary 4-1-2011


  Before I get to the big picture, I want to disclose that I allocated 4% of my portfolio to a utility stock called RWE, the second largest utility company in Germany. I bought it at 43 Euros per share ($60 USD) on the Frankfurt exchange on March 15^th, the day the radioactive steam was released at the Japanese reactor; it is paying an 8% dividend at that price. The power plant problem in Japan sent the stock down because RWE also operates two nuclear plants in Germany and they have been shut down for a safety review by Merkel. Only 15% of RWE’s revenues come from the nuclear source, which isn’t enough to warrant such a big hit to the stock. Caveat: this investment is just a hunch, predicated on a bunch of future dividends that may not materialize.

   In another leap of faith of impending inflation, I began shorting Treasury bonds by buying an ETF fund with the symbol TBT. The UK now has inflation of 4.4%, China 5%, Germany 2.3%%, India 8%, Singapore 5.5% and it is coming this way. As a hedge against whatever happens, I still have 93% allocated to cash, but I will buy any risk that I believe is mispriced on the downside. Speaking of the downside, the housing market showed signs of tanking more as existing home sales fell 9.6% in February and prices dropped 5.2% over the past year. At the same time, the inventory of homes for sale went up 3.5% in the past month, meaning that market is still headed down (Financial Times 3-22). Economist Gary Shiller seems to be on target forecasting another 10% drop in 2011, and I continue to bid on foreclosed homes in Florida.    

Now to the big picture:

NEW YORK (MarketWatch 2-28-2011) —“ Treasury bonds ended a bad month on a quiet note Monday, with benchmark 10-year yields rising for a sixth month in February — and prices tying for their longest losing streak since mid-2006; “ And, on March 17th this announcement followed:  “Consumer prices climb 0.5% in February-- Gasoline and vegetable costs mean pain at the pump and in checkout lines.”

Then Bernanke assessed the current situation with this announcement.

WASHINGTON (MarketWatch--2-29-11) — “Federal Reserve Board Chairman Ben Bernanke stuck his neck out on Tuesday and said the increase in inflation from the spike in oil prices will be modest and temporary. “The most likely outcome is that the recent rise in commodity prices will lead to, at most, a temporary and relatively modest increase in U.S. consumer price inflation,” Bernanke said in remarks to the Senate Banking Committee.”

  The problem I see with a “temporary” rise in inflation is that it will cause a sudden decline in bonds and stocks, not to mention the negative effect on home sales because mortgage rates will go up. And, oil is a big problem over $100-a-barrel. The longer it hangs up there, the more damage it will do to the CPI and Producer Price Index. Bernanke is wrong in dismissing commodity inflation as having only a “temporary and modest” impact. The impact may last longer than he does in office; after all, quantitative easing has systematically caused a commodity bubble in the first place. The Arab revolts, sky-high oil and the Japanese collapse are Black Swans falling out of the sky, catching investors briefly off guard because they are oblivious to tail-risk flanking the bell curve; albeit, the stock market rose as these risks were dismissed.

  Allowing more drilling in the United States and developing oil-shale deposits using fracturing may decrease our dependence on foreign supplies, but it won’t make much difference to our economy. The domestic oil companies would charge the world market price no matter where they got hold of the oil, thus costing consumers the same. Changing suppliers will not fix the energy problem.

   The propaganda to “drill baby drill” is entirely financed by the oil companies and pushed by their paid-for, Republican, Congressional Representatives—big oil will benefit from unrestricted drilling much more than consumers. It is ludicrous to think that Saudi Arabia or Bahrain would oil-embargo the United States, when we have 30,000 military personnel stationed there and supply them with planes and weapons. We are their protection against Iran, if not against internal revolt; albeit, if we produced cars that ran on natural gas, we wouldn’t be dependent on anybody’s oil---that is a real solution.  Case on point, America exports half the world’s supply of corn, even though the price per bushel has doubled in the past year, which created food inflation hitting the poor the hardest; Americans don’t get a bargain price because it is grown here. Our oil companies don’t give us a domestic discount either, and OPEC will reduce capacity to compensate for increased production here. “Drill baby drill” is another stupid, short-term, energy initiative rivaling the ethanol boondoggle. On the other hand, Obama’s no-drilling policy is not addressing the short-term problem either. The policy should be “drill with discretion and full liability.” Of course, such ethical decisions can’t be left up to politicians, the EPA or oil companies, but the Federal courts could do the spanking when discretion strayed. Remember the old Rockefeller proverb: “The meek shall inherit the earth, but the oil companies will retain the mineral rights.”  The Supreme Court broke up Standard Oil Company in 1910, not the politicians. Even so, John D. Rockefeller remained the richest man on earth. Like John D, my mother saved the first dime she ever got and spoke about the original Tea Party like it happened on her watch.  Often she would stare at the wheel spinning on the electric meter attached to the side of the house and yell through the window: “Alan!!! turn something off!”  No matter what conservation steps she took, the bill always went up over time, because the electric company kept increasing their rates.

    Pulled by nostalgia, I went to a Tea Party meeting last month in Boca to see what it was all about. I didn’t want to only get the party line from Sarah Palin and Christine O’Donnell, but actually hear it from the grass-root members. After an earful on the evils of taxes and big government, I came to the conclusion that the party should be split in two: the decaffeinated branch (concerned with financial issues) and the caffeinated-Tea Party which would also take on the moral and religious crusade espoused by far-right-wing Republicans. However, even the Tea Party frontrunner, Herman Cain, would not say on TV that he is for cutting current Social Security and Medicare benefits to reduce the deficit, and I know there is no way to balance the budget without doing that. He dances around that issue like every politician; albeit, at least he is black, which dispels the rumor that this faction contains the remnants of the Klu Klux Klan. In reality, the Tea Party is not racially biased, but just another political party fighting against the tide of government creep, as more voters are on the dole than are paying for it. The dole is too pervasive and has gone on too long to correct without a lot of economic pain that must transcend race, unions, political parties and business interests: Ultimately, the markets will dish it out accordingly. Today, there is no politician that says what he thinks and means what he says.  The only head of state in my lifetime that did that was Margaret Thatcher, and he was a she with more balls than Ronald Reagan.

  With her inspiration, I will say fixing Social Security is politically impossible, because it requires drawing a line between who will get it and who will not: no one dares do that for fear of retribution at the polls---mainly from opposition organized by the AARP. If we set the retirement age at 67 and means-test the benefit phasing out SS checks for incomes exceeding $80k per year (over a 120k get no check; thereby affecting 20% of the population)------------then Social Security would be cash flow positive for the next 100 years. The top 20% would make the sacrifice to insure that the bottom 20% eats well and has a roof over their head (according to the 2010 census, 20% of the population is below the poverty line). As I see it, that is the only solution that will work financially and socially; anything less will be a band aid. The question is: is the Tea Party willing to really toe the budget line? We all know where the mainstream Republicans and Democrats stand on the issue------ on the same ground bleeding red ink, supported by all the baby boomers getting ready to retire who say; “Don’t you dare touch my Social Security benefit that I worked so hard for!” My response: why didn’t you save something instead of spending every dime you made? According to Vanguard, the average 60-yr-old has only $65k in savings, when a minimum of $350k is needed just to stay above the poverty line in retirement. Face it, getting old is the pits for the average boomer. Are we going to bail them out? Of course we will---they have too many votes not to be catered to by both political parties.

   I will offer this final factoid: when Social Security was established in 1935, the average life expectancy was age 62 and the retirement benefit started at age 65, meaning not many people lived long enough to collect it. Now the life expectancy is age 80 and climbing, while the retirement age is just 67, barely 2 years greater than in 1935. Do the math and you can see why Social Security has morphed into a financial abyss for taxpayers.    

This was announced on a different subject:

SAN FRANCISCO (MarketWatch,3-8-11) — “Employers’ hiring plans are slightly higher than they were a year ago, and they’re holding steady compared with the first quarter, according to the Manpower Employment Outlook survey on Tuesday. That’s the good news. The bad news? Companies’ hiring plans are improving at a glacial pace, and they’re still far below what’s considered normal for a robust job market. A seasonally adjusted net 8% of firms said they plan to hire in the second quarter, the same percentage that said they planned to hire in the first quarter, and up from 6% a year ago. In a strong job market, that figure would be closer to 20%.”

   Because of the lack of job creation and the falling housing market, I am sticking with my forecast for a sideways economy averaging 2.5% to 3% growth at best in 2011, with a bias toward the downside, given the end of quantitative easing coming in June, the rise in oil prices and the likelihood of an inflationary scare this year; not to mention a slump in Asia. Despite a 7% increase in car loans and student loans, credit card debt fell again in February at a negative 6.4% annual rate (WSJ, 3-8-11, pg. A5), so there is still deflationary pressure offsetting commodity price increases. Consumers are not spending across the board, but their cars are wearing out and more graduates are going to graduate school to better their chances of getting a job. All told, the second half of the year should be worse than the first if gasoline prices stay above $4 a gallon. Despite the negatives, I am bullish on some utility companies and foreclosed real estate, at the same time shying away from bonds and stocks in general; as ambivalent as that sounds, I am not the only one that feels that way.  Icahn is getting cold feet on the market but he is making offers on distressed real estate at the same time.

 (MarketWatch 3-8-11) — “Carl Icahn is returning all outside money from his $7 billion hedge-fund firm because the activist investor doesn’t want to be responsible for losing other people’s money if there’s another financial crisis, according to a letter he sent to clients. “While we are not forecasting renewed market dislocation, this possibility cannot be dismissed,” Icahn wrote in the letter. He adds:  “Given the rapid market run-up over the past 2 years and our ongoing concerns about the economic outlook, and recent political tensions in the Middle East, I do not wish to be responsible to limited partners through another possible market crisis””.

  Stringing these announcements together causes me to remain investment neutral due to the risks outlined above, as I always weight Beta (risk) more than Alpha (return). Cash is my idea of a neutral position and that is where I continue to be, except for owning the one utility stock and shorting treasuries a smidgen. The Japanese disaster has temporarily masked the inflation headwind and the jobless recovery, which spells 1970s-stagflation to me. Those threats cannot be held at bay by quantitative easing much longer and the ultimate irony is, the cure for inflation is a recession, while the cure for the job market is a boom. Nevertheless, the stock market seems to be in a happy place between quantitative easing and a double dip--- Something has to give and it won’t be cash.

   Politically, the Libya affair is a mistake; America can’t win anything by just dropping bombs. Those tomahawk missiles cost $1.2 million apiece and we shot off 110 of them in one day-----the deficit just got bigger. The bombs may be the “mother-of-all” Black Swans to Gadhafi, but he will just order his troops to take off their uniforms and infiltrate the population like al Qaeda does in Afghanistan; and the civil war will go on and on.  If he is killed, the Arab world will still resent our interference and whoever replaces Gadhafi won’t be any better than a Karsai---America can’t win even if it wins. The best course that we have taken lately is staying entirely out of the Egyptian revolt and we only did because it caught us by surprise. The only thing American policy can’t seem to do is mind our own business. Between saving the banks and underwater home owners, saving jobs and the world from oppressive dictators, who is going to save the taxpayer from the deficits? Who can save our economy if the revolt in Yemen spills over next door to Saudi Arabia? Gadhafi could purposely wipe out his oil fields and fight the rebels for a decade and it wouldn’t mean squat to us. But, shut off Saudi oil and the price would go to $200 per barrel in a month, and investors are not pricing in that tail risk. So which king-dictator does America support next?  It comes down to choosing between the “good, bad and ugly” and I don’t care who Obama picks; I am watching the deficit meter run.   

Alan