They saved Europe! Greek bondholders will be forced to take a 50% writedown. They’ve got a bailout fund (i.e. taxpayer money) to make sure banks stay capitalized.
The market likes this. It’s partying today. But it’ll only be a matter of time before our manic depressive friend starts worrying about Portugal or Italy. Or something a little more deeply unnerving like LIBOR-OIS making a new post-crisis high.
Credit markets aren’t showing the same enthusiasm about these exciting headlines:
But for the most part, stocks have showed great strength after the technical breakout last week. This is a positive sign. It doesn’t mean you should jump into the market head first, but it’s something worth listening to.
The short-term trend is definitively up. Technical analysis can help you view the market without bias. That’s why I mentioned the breakout last week, to allow for the possibility of something like today, where stocks rally ferociously. When you get those breakouts, they aren’t always a guarantee that the market will keep moving in that direction. We had a big downside head-fake earlier in the month. But these breakouts are a time when you need to stop and take a hard look at how you’re positioned. Ask yourself if your fundamental thesis is still relevant.
When it comes to investing, I usually look further out on the time horizon. This is where things get a little more gray.
In a throwaway line from a couple of weeks ago, I wrote the following:
If you’re looking for sneaky economic monsters out there, an unexpectedly bad couple of earnings seasons could pose a threat.
So far, we’re off to an interesting start on that front. Netflix got taken out to slaughter early in the week, which is saying something, because NFLX was already down about 60% from its highs. Amazon, today’s most important retail bellwether, posted terrible earnings on Tuesday night and collapsed like a stone. Sprint also missed their revenue target. Time Warner lost a boatload of subscribers and posted a huge miss. On balance, most companies have been OK, but that’s technically a change from not too long ago when it seemed like every single stock on the street beat earnings. Keep watching the data here.
Europe headlines have driven the market lately and if those stay positive, they’re likely to offset any disappointing economic headlines. At least for a while. If you think the current EuroEuphoria will last forever, you probably haven’t been following this market for very long.
Consumer Confidence
The other big news this week was the Conference Board’s latest consumer confidence survey. It came in at 39.8 for October. The estimate was 46 and it’s down from 46.4 last month. Huuuge miss. To provide some context, it’s the lowest reading since March of 2009. How confident were you feeling in March of 2009? Stay tuned for how the University of Michigan consumer sentiment index comes in next Monday.
Consumer confidence is a really bad indicator to trade or invest on. I don’t know a single person that does it. It’s just one of those metrics that provides a little background color and context. I bring it up today to highlight one of the more interesting economic dichotomies I’ve ever seen.
Consumer sentiment and confidence are at historic lows right now.
Consumers are as negative as they’ve ever been, but when you look at the actual economic data, people aren’t really behaving in a way that’s consistent with that kind of sentiment. For the most part, they’re still spending. Retail sales in September actually rose 1% and are up almost 8% from a year prior. No joke.
Visa reported very strong results on credit card spending, another sign that people haven’t crawled into a cave.
The latest durable goods number was pretty good. The best in six months.
The recent weekly jobless claims numbers have all come in OK, hovering right around 400,000. That’s not bad!
GDP should be positive for both the third and fourth quarters.
Look, I’m as cautious as anybody right now because I don’t like the short-term risks associated with whatever comes next out of Europe, and I don’t like the shaky economic footing the U.S. appears to be standing on in 2012. All the leading economic indicators have turned down. Even still, none of these factors and none of the current data support such historically awful sentiment.
What gives? Why the inconsistency?
Why folks are down
You don’t need me to tell you that everyone is nervous right now. This is, as they say, “known.” But let me tell you why that is and why people aren’t behaving in a manner consistent with this epic lack of confidence.
I think it has less to do with our actual economy and more to do with a complete absence of faith in our leaders to guide us out of this quagmire.
I think the plunge in consumer confidence, which began back in the summer, is mostly attributable to the sheer dysfunction we see every day in Washington D.C. We have no confidence whatsoever in any policymaker’s ability to put together any kind of plan. Not Obama. Not the Republicans in Congress. Not Harry Reid and the Senate. Not Mitt Romney. Not Bernanke or Geithner, either.
All that we see is fighting, bickering, name-calling, posturing, political gamesmanship, and rabble-rousing. We don’t see anything concrete. We don’t see any productive activity. We’re like the frightened child watching our parents fight over the dinner table.
Maybe our economy really needs a plan or maybe it just needs to be left alone. I honestly can’t say. All I know is that the American people need to see a more focused and productive dialog. Nobody’s going to feel any better about the path our country’s on until some of these guys step up and start acting like adults.
I’ve got a little daughter now. I feel that one of my important jobs as a father is to make her feel like everything will be OK. My job is to make sure that she knows that if gets a little scary outside, Daddy has things under control. Stick with him and you’ll be OK. He always has a plan, and the plan will see everybody through.
This is the job of a leader.
Good leaders inspire confidence in their followers and good leaders make people want to follow them.
Right now in San Francisco 49erland we’re all really excited about our new hire, Jim Harbaugh. He’s a leader. We fans believe he has a plan to turn our decades of frustration around. His players will follow him to the ends of the earth, especially now that he’s got the team off to a 5-1 start. Maybe they’ll make the playoffs and maybe they won’t. In truth, that doesn’t matter. What matters is that having a good leader lets everybody know that it’s safe to root for the team again.
It doesn’t matter which side of the political aisle you hang out on. Every single one of you guys will agree that we have a major crisis of leadership in this country. It’s a gargantuan, yawning void. And it’s one of the reasons why we’re all so nervous right now.
What to do about it
In an abstract sense, it’s a very easy fix. All we have to do is realign the incentives of our elected officials with those of the people who elect them. I can hear some of you saying, “Well, duh, that’s the way it already works in a democratic system.” But that isn’t the way it’s working right now.
For some fixes, allow me to direct you to Barry Ritholtz’s recent article in the Washington Post. Occupy Wall Street Needs to Occupy Congress and Lobbyists.
Nothing I could write will be better than that. So just go read it. I’m pretty sure that his three proposals would be a nice start towards getting people more confident in our leaders:
- No more bailouts & bring back honest capitalism.
- End the “too big to fail” banks.
- Get Wall Street money out of the legislative process.
Wouldn’t you agree?
How to guard against Europe
We’ve spent a lot of time in the last few months talking about Europe. There’s nothing really of significant incremental value to add to the discussion today. But I will share this insight from world famous hedge fund manager Jeff Gundlach. At a recent investor presentation, he said:
“I don’t know what’s going to happen in Europe but there is one thing I am certain about – eventually, someone is going to take a big loss. As investors, the most important thing we can do is to make sure that we aren’t the parties taking that loss.”
He said his funds have zero exposure to:
- European stocks
- European bonds
- European currencies
- Assets denominated in euro currencies
- U.S. bank stocks
For what it’s worth, I think this is a good path if Europe makes you nervous. It’s tied exactly to The Big Conclusion of my book, The Trade of the Decade. I’ll spoil the punchline for those of you who haven’t read it. I’ll quote it directly:
Avoid the sovereign debt, banking systems, and currencies of over-leveraged economies and buy real assets and the equity of unloved, under-priced companies, especially if they’re involved in making stuff that people need and have a global footprint.
That’s how you can protect yourself from Europe. Avoid it.
Sure, most stocks and assets will get dragged down with Europe as collateral damage. But it’ll be the difference between a tennis ball and an egg. As Gundlach said, someone will eventually take a big loss because of Europe. They’ll go splat like an egg on the sidewalk and they won’t bounce back from that loss. But other assets, ones that aren’t directly linked to EU sovereign debt and their banking system, will act like the tennis ball — they’ll fall, but they’ll bounce back.
If it makes you nervous, why play with fire? Just avoid it. Then you can tune out the headlines and start recovering from your Eurofatigue.
Cultural Mile-Markers
I saw two really good movies last weekend, each relevant to finance and our economy. Back when we started this newsletter, one of the things I wrote about was a reminder to never get too lost in the numerical details and headlines. Stay on top of cultural changes as well. This is important stuff and it’ll let you know where we’re at in the grand scheme of things.
The first was Margin Call. It was awesome. For guys like me who love finance, it’s borderline pornography.
The drama is tense; the pacing is fast and suspenseful; and the script is dead-on accurate. In fact, I’m not sure I’ve seen another movie about the financial industry that captures the culture with such accuracy. Everything about it reeked of authenticity, from the analyst slaving away at his Bloomberg terminal into the wee hours of the night to the junior trader obsessed with how much money each of those above him are making to the floor head who has a rational, sensible explanation for how he spent every last dollar of his $2.5 million paycheck.
The thing I really liked about it was that it wasn’t a heavy-handed indictment of Wall Street. It’s just a taut drama that shows you the way that things are. You’re free to make your own judgments about the culture.
Once yet get beyond the shock of what this world is like, the movie asks a really scary question. This extra layer of depth is what makes it a truly good movie instead of just finance porn. Margin Call asks whether you would do the same thing if you found yourself in their position. What if you discovered a ticking time bomb on your company’s balance sheet? Forget about how that time bomb got there. That’s no longer relevant. In the past. The question is how far would you go to shield yourself from the damage? I like movies that ask difficult, ethically challenging questions.
Margin Call is relevant and instructive for a couple of reasons. First, the fact that this movie even got made should indicate that more people are interested in what’s happening on Wall Street than at any point in our lifetimes. Nobody would have gone to see a movie like this back in 2003. Nobody would have made this movie in 2003.
Before the financial crisis there were exactly three really good movies about the financial industry. Wall Street, Boiler Room, and Rogue Trader. That’s three good movies in twenty years, only two of which anybody actually went to see. And before Oliver Stone’s Wall Street, I can’t think of anything else that really stood out. Since 2007, we’ve had Floored, Wall Street 2, Inside Job, Too Big to Fail, and now Margin Call. All of these were excellent. Even The Company Men was pretty good.
The cultural spotlight is shining on Wall Street right now in a way that it never has. What’s happening here is important. For thousands of years human beings have used art as a vehicle for illustrating what’s right and wrong with our society. This art is a mirror for how we’re all feeling.
Listen to it.
The other movie I watched was Moneyball. I know it’s not technically about finance or the economy, but it’s an even better and more culturally relevant movie. I can’t recommend it highly enough.
For starters, it’s just a really well made movie. I was as shocked as the rest of you guys when I heard that they were turning Michael Lewis’ book into a film. But man, did they knock it out of the park.
For what it’s worth, I think this is the most important cultural mile marker to appear out of Hollywood in years. It’s a straight-up glorification of the idea that we should challenge deeply held conventions and ask ourselves if there might be a better way of doing things, however radical and scary questioning those old conventions may seem. It reminded me of one of my favorite quotes:
The difficulty lies, not in the new ideas, but in escaping from the old ones, which ramify, for those brought up as most of us have been, into every corner of our minds.
—John Maynard Keynes
Remember that Keynes was at his most influential during an eerily similar era, a moment when Americans were starting to realize that their country had made some pretty big mistakes in the past and that maybe it wasn’t such a good idea to keep doing things in the same way. Moneyball is just a two hour dramatization of that above quote from Keynes.
Which is interesting, because Keynes wrote that in 1935.
The road back
Every post-crisis society deals with this. This is when people start listening to new ideas, but more importantly, start wondering if the way they’ve always done things might not be the best way to keep doing them. In a clumsy, somewhat misdirected sense, I think this is what the Occupy Wall Street movement is all about.
I we’re ready to start having this conversation here in the U.S. Or we’re at least getting close. Enough of us are ready to have this conversation that it makes sense to start having it.
And you know the explicit conversation I’m referencing. It’s the conversation about blowing up the political status quo. It’s the one about completely re-writing the tax code, the one about touching the “third rails” of politics, the one about how we should really be allocating our resources in the future and where we should be investing our money today.
People are going to see Moneyball. It has now spent 5 weeks in the top 10 and has grossed over $60 million. This really intrigues me. Why has this movie been so popular? Maybe it’s because of Brad Pitt, who I can guarantee will be up for a best actor nomination next spring. But The Tree of Life starred Brad Pitt and nobody except film geeks like me went to go see that one. Historically, serious movies about baseball haven’t ever made a lot of money, even if they’re really good like Eight Men Out. Baseball on its own isn’t a good enough reason to get people into the theater.
Why has this talky indie drama about an obscure figure from a small market baseball team caught on?
I think people are going to see Moneyball because they’re responding to the message and they’re telling their friends to go. On the surface, it’s a story about how a couple of guys completely changed the game of baseball. But in a broader, more abstract sense, it’s about an idea whose time has come. It’s about destroying deeply held conventions and installing a system that’s better.
Culturally, we’re ready to listen to this kind of message. Finally.
I think this is a good sign. Before you get real policy change in a democracy, you need a voter base who’s ready for it. We’re getting there. We’re less afraid about letting go of the past and embracing something new than we were a few years ago. At some point we’ll actually start laying a new foundation for our culture and economy, and that’ll be great for our collective future.
But these transitions are always bumpy and volatile. Transition environments have always been very difficult on investors. Once the foundation is poured and a new policy vision is adopted, the period that comes after has usually been pretty profitable. The early 1950s and early 1980s were a great time to invest. Those were moments in history where the U.S. finally decided to zig in a very different direction and adopt a new Grand Vision. That will happen at some point later in this decade.
You might think it’s silly to suggest that investors pay attention to popular culture. But it’s not. Investors frequently get lost in the tiny details and lose sight of the bigger picture. The worlds of art and popular culture can offer very valuable and useful perspective.
- The short term technicals of the market are bullish. Whatever your fundamental bias, keep the technicals in mind when it comes to short term trading.
- There is a huge disconnect between consumer sentiment and the actual economic data. My theory is that sentiment is being suppressed by the extreme dysfunction in Washington D.C.
- If Europe makes you nervous, just avoid it. Seriously. Greek debt totals around $350 billion. At least 50% of that isn’t going to get paid back and that’ll mean losses for somebody over there. If you’re worried about that, just avoid Europe (banks, currency, stocks, etc.)
- Go see Margin Call and Moneyball if you get a chance. They’re both excellent films and important cultural mile markers.
One of the challenges about running a public newsletter and putting yourself up in front of a few thousand strangers every week and telling them what’s what is that you’re always stepping on somebody‘s toes. This is the reality that every single person with any kind of experience in the public space has had to deal with.
It bothers some. Others don’t mind. Everybody manages the best they can, or else shrinks back into the safety of their private network. Ultimately, we all filter to wherever we’re most comfortable. This is as it should be.
As someone in the public space, I owe you each an explanation of where I come from every week. And you all, as consumers of external opinion, have a responsibility to understand the backgrounds and biases of the sources you seek.
Here are three things to know about me.
They have nothing to do with the markets and they are more important than anything else in this newsletter. They have everything to do with everything we’ll ever talk about on here.
I’m just a guy.
One of the things I inherited from my parents was a sense of humor.
I was a baby once. I went to school. As a kid I read comic books and science fiction. I still do. I have an 18 month old daughter. I fire up the grill in the summer as often as I can. Nothing makes me happier than having my friends over and enjoying a nice beer. I love finance. I love to write about investing and strategy. I’ll talk to you until next Tuesday about it. I’ll also talk to you about German-style board games until next Tuesday. Or the San Francisco 49ers.
I mention this because sometimes you see these guys come on CNBC and we forget they are human. They wear Italian suits. They have $100 haircuts. They always speak in tidy, elegant talking points. Their shoes are never scuffed. And they come across as these all-knowing, all-seeing oracles of financial authority. We feel compelled to follow them anywhere, however mindless that may be. Are these guys human? Do they grill steaks and share beers with their pals on Saturday afternoon? Do they make mistakes? Are all of their ideas winners? Why is our faith so absolute in what they have to say?
It’s the haircut, isn’t it?
Look, I don’t consider myself an expert on anything. I think of myself as a student, and when I’m on my death bed, I will still consider myself a student. Especially a student of finance and economics. The only thing that’s different about me is that I’ve been doing this for a little while now and I know what all the jargon means and how to spot the phonies. There are a lot of other investment professionals that read this newsletter and some of these guys have twice as much experience as I do. I think they read it because we’re both in it together, lifelong students, trying to figure it all out.
I learn something new every day. And every day I’m reminded of just how much I don’t know. It’s a scary feeling. But this is the good fight that we all must fight. It’s the fight for wisdom.
I’m not sure there’s anything more important to our entire species.
What I say is not always what I do.
Professionally, nothing is more important to me than making money for our clients. We have a fiduciary duty to our investors, to grow their capital in a prudent manner. It’s not an easy job. There’s a lot of turnover in this business but our firm has been at it for 27 years. My goal is to be doing this 27 years from now.
One of the things that I feel differentiates our firm from a lot of other firms out there is the way we show our commitment to it. The overwhelming majority of my personal assets are invested in the products that our firm manages. Same with each of my partners. It’s always been that way. It’ll always be that way because I believe in what we do. Not every investment our firm makes is a winner. But I have conviction in our approach, and I believe it’ll make me more money per unit of risk in the future than anything else on the menu of investment options.
In fact, this is a key part of our history. What we’ve always done is design investment products for ourselves to invest in. We build them. We tell other people about them. If other people like it, they’re welcome to invest alongside us. If we make money, they make money. If they lose money, that means we’ve lost it too.
This is very different from an investment supermarket. I think the most important statistic in finance is that roughly half of all equity mutual funds report zero manager ownership. And the median investment of the fund manager in his own fund is less than $100,000. Those guys launch a fund because they think the market demands it and that it will make their firm some money. Some of these guys are really good salesmen and they can sell the heck out of even the most mediocre product.
I don’t judge them for that approach. Those firms and individuals make a lot of money. It pays to be a good salesman in this business. Bully for those guys. It’s just not our approach.
The pardox, however, is that I can’t ever talk about what our firm does. Not on this newsletter. I can’t talk about the strategies and I can’t talk about the performance. Sorry, folks. Write your congressmen and tell them that some of the rules on hedge fund regulation are silly. I’d love to show you our track record and talk about the trades we’re eyeballing, but I am legally prohibited from doing so. You have to be what the regulators define as a “high net worth individual.”
In this environment where — all of a sudden — tremendous scrutiny is being given to the differences between rich and poor, this is another item on the fringe. The rich have access to better investments than everybody else does. The top 1% can invest in things that have a whole lot more flexibility about how to deal with tricky economic environments.
Let me be clear: not all of these investments are good. Some are better than others and a lot of them are garbage. (Just like with mutual funds. Or beer, or movies, or whatever.) We certainly do not encourage amateurs to swim around in these waters without professional guidance. But the point is that some of these investments are awesome and there is a whole lot more diversity than you’ll find in the traditional investment space.
The average investor at home is denied access to all of this. And in the meantime, I have to think about other interesting things to share with you all.
I am bound by the rules of honest disclosure.
Most of what I own is invested in the funds our firm manages. But sometimes I make smaller investments elsewhere. If I ever talk about these things, I am legally required to let you know that I also own them. As an example, I’ve written before about one of the TIPS ETFs (specifically, TIP). In the past, when writing about that, I’ve had to tell you that I owned it.
Also, I don’t own everything that I talk about. I might talk about dividend stocks and I might think they’re a good investment. It doesn’t mean I’m actually buying dividend stocks, but it also doesn’t mean that I’m just writing that willy nilly. I believe the things I write.
Besides, you shouldn’t be listening to me for investment advice anyway! That’s what you pay your financial advisor for. He’s the guy who is supposed to be helping you draw up strategies that make the most sense for you and your unique situation.
Not everything I write will be a good idea. And I won’t act on everything I write about. But every last bit of it is honest.
Don’t laugh. Honesty is a rare currency in this world, particularly in finance.
A lot of people ask me if I have any suggestions for funds to invest in or financial advisors to contact. There are a lot of bad ones out there but there are some good ones too. When you’re shopping around for these guys, the single most important thing to look for is honesty. Honesty is one of the most important pillars in any relationship. Financial relationships, especially. Make sure that your bank, fund, or asset manager always gives it to you straight. And if you feel like they aren’t, well, you might be having those feelings for a reason.
Have you seen the tagline for the incredibly-awesome looking new movie Margin Call?
(Check out the trailer – you guys all know where I’ll be this weekend!)
“There are three ways to make a living in this business. Be first. Be smarter. Or cheat.”
Be on the lookout for smooth-talking hucksters wherever you go in life. They weren’t first. They aren’t smarter. And they’re out to cheat you.
What I write won’t always be what you want to hear. It won’t always be correct. But it’ll always be honest.
If you want stuff that does always sound like what you want to hear or that is “always correct,” you can call the guys on the desk at Lehman Brothers that fictional firm in the movie.
I know that none of this will surprise our longtime readers. You guys all know that I don’t have any better an idea about what’ll happen in the future than anybody else. You all know how I’m invested. But there are a ton of new readers on here and readers who just stop by occasionally. So it’s worthwhile to make this stuff explicit every so often.
Again, I can’t over-emphasize how important it is that you understand the foundation beneath all of the opinions that you consume.
Apparently, they fixed Europe
I was out of the office for a week and a half, and when I returned last weekend the news headlines really surprised me. Apparently while I was gone, the world worked out all its problems! The EU leaders said they would figure out a plan in the next 7 days. It may or may not involve a $2 trillion bailout fund. And a magic wand.
Good to see that they’re not dawdling anymore. They’ve bickered about how to fix the problem for the last two years, but now that they sound really committed to it, I’m sure they’ll be able to get this all solved by Monday.
Sarcasm and snark aside, there are a couple of serious issues here.
The first is avoiding a banking crisis. A banking crisis is where people run to the ATMs and pull out as much cash as they can. It’s where This Bank is afraid to loan That Bank money overnight because This Bank thinks That Bank won’t be solvent in the morning. Crises like these are really, really bad. They’re bad for Wall Street and they’re also bad for Main Street. This is why I’ve said repeatedly in the past that the best way to avoid problems like this is to limit — legally limit through regulation – the risks that banks can take and how big they can grow.
Banks perform a quasi-public service. I don’t care about “maximizing shareholder profitability” for publicly traded companies that perform quasi-public, systemically-necessary services. Neither should you. This was one of the lessons we learned from the early days of the Great Depression — don’t let banks engage in highly risky activity! So Congress passed the Glass-Steagall Act in 1933. This established the FDIC and put up a big wall between retail banking and investment banking. Problem solved. No more catastrophic U.S. banking crises until — cue the drumroll — shortly after we repealed the Glass Steagall Act. But I guess it was time for an entirely new generation to learn this lesson on their own.
In any case, I am getting slightly more optimistic that Europe can get through this without a full-blown banking crisis. That’s not to say that it’ll be a walk in the park for them. And that’s not to say that everybody makes it out without any blood on their hands. I just think there’s at least a chance that Europe can avoid a messy, 2008-style scenario. I know I’ve said a lot of mean things about our political leaders in the past, but the truth is that these guys really aren’t that stupid. At least I hope not? The memory of 2008 is still pretty visceral.
The second issue, which the media headlines seem much less concerned about, yet I am much more concerned about, is what this does to future economic growth. We might be able to raise capital requirements on the banks, put together a $2 trillion fund to finance some bailouts, and coerce the ECB to keep throwing money at the problem until people stop freaking out about it. We can do all those things. Buuut… who pays for it?
I think there’s this perception out there that bailouts mean that losses disappear. They do nothing of the sort. All bailouts do is transfer losses from one party to another. Who ultimately eats these losses?
My guess is that it’ll play out in a similar fashion to the U.S.. Some banks will get their bailouts and in a couple of years they’ll pay back the EFSF (the Euro-TARP). But some banks won’t be able to pay that back. The Euro-TARP will have to eat that loss. Who pays for the Euro-TARP? The countries in the EU, and therefore, the taxpayers of the EU.
Mostly: Germany.
This is why German taxpayers are so pissed off at Greek bureaucrats. They’re paying for somebody else’s mistake. We know how that feels here in this country, too. It really irks us.
There’s another lesson here and it’s the difference between the U.S. financial crisis of 2008 and the current EU financial crisis. It’s that it’s really difficult to run a monetary union when you don’t have a corresponding fiscal or political union. Radically different cultures don’t make it any easier. Remember two years ago when we were joking around about how the Euro isn’t really a currency, but an experiment. I wasn’t technically joking. You folks on the other side of the Atlantic are running one of the biggest economic experiments in human history.
I’m pulling for you. I really am. I’d like to see you guys get this monster back under control, ideally in a more elegant fashion than we did here in the U.S.. Everybody should care about this. The Eurozone as a whole represents the largest economic unit in the world.
Anyway, it doesn’t have to be catastrophe for the EU. But there’s going to be pain, and regardless of how that pain is allocated, it’ll mean less economic growth in the region than the rest of us were hoping for.
Technical Talk
I’m really glad we had that big discussion on technical analysis a couple weeks ago because it’s looking highly relevant for this current market setup.
The first super-important event was that decisive violation of support. The market didn’t spend much time below there; it rallied very quickly in the next few days on some positive news flow out of Europe. Sometimes that happens. That’s why you have to be vigilant if you ever put trades on as a result of signals like these and be willing to pull the plug if it moves against you.
What’s important is that the support has been broken. It could set up a search for new support or a new low, and it’ll make any future re-tests a little bit more dicey.
HOWEVER.
The market also could be cracking through resistance right now. That’s good news, folks. At least for the short-term. We’ll see how far it gets above here, but if moves decisively and holds, it could then set up a run to re-test the old highs, as crazy as that sounds.
Ultimately, it comes down to one’s view of the future economy. If you think that growth will stay OK and Europe will be able to dance its way through the minefield, stocks could keep going up. If you think that growth will slow or contract, and that the Europe problem metastasizes, then stocks will find a new low. The chart technicals right now are allowing for either possibility.
This is why I like to use fundamental analysis alongside technical analysis.
No, Mr. Bond, I expect you to die (of boring yields)
If you’re looking for a good reason to be bullish on stocks, allow me to submit what I believe is the most compelling one. Ladies and gentlemen, the Bond Market.
Kinda makes you long for the days of 3.5% yields, doesn’ it? How said is that? Longing for a 3.5% yield on Treasuries… yeesh.
The bottom line is that 2% is not an attractive rate of return.
Investors have to go elsewhere if they want to make any money and they’re sorta forced to go into the stock market. Rates are low because of Fed monetary policy, and if you asked Ben Bernanke if he was hoping to get people to buy stocks because yields were too low, he’d say, “well, yeah. QE, dontchaknow?”
I’m not sure if effectively forcing investors and savers to take risk in the stock market is a responsible national strategy. But Ben Bernanke thinks it’s OK, and he’s a whole lot smarter than I am, with more degrees and much more expensive suits.
Way back at the beginning of the year I drew up an interesting little yield strategy. Basically, it involved over-weighting Treasuries when the 10year is in mid 3% range. Then when yields drop down towards 2%, it involved shifting out of Treasuries and into high quality dividend stocks.
It’s hard to earn a decent yield in the market right now, but so far, that’s one of the best strategies I can come up with for the investor at home who’s stuck in the traditional investment space. The strategy isn’t sexy, and it takes a little bit of work, but I think it’s a good way to earn an acceptable yield without taking crazy risk. At some point, there will be better options available. But this has been working so far and I can see it working for a little while longer.
Ultimately, however, you’ve gotta find something that feels right to you. This is the other thing we talk about all the time on here. There are very few things that I can tell you about this industry with absolute confidence and certainty. But one of them is that if you aren’t investing in a way that suits who you are and your personality, you’re setting yourself up for inevitable disaster.
I heard a great interview with Bill Isaac the other day. Mr. Isaac was the chair of the FDIC back in the 70′s and 80′s and he’s one of the reasons the banking system didn’t fall apart during the S&L debacle.
The host asked him about what was wrong with the economy and the investment landscape, and he said that guys like him were the problem. He talked about how a couple years ago he pulled all his money out of the stock market. He’d been a believer in the stock market his entire career! He’d been invested in it for 40 years. Now he’s all the way out. He also had a vacation home. He sold that too. He got rid of pretty much every asset that carried risk.
Sure, he’s highly liquid. But he’s not invested anywhere.
This pretty much describes my situation too. But with much smaller dollar amounts. I’ve been invested in the markets since high school. I traded stocks in college. I’ve spent my whole career in finance. But in the financial crisis (during the early phase in late 2007) I went to cash with my non-hedge fund investments in our own firm’s products.
I’ve been in cash ever since, occasionally dabbling in really exciting things like TIPS or short-term Treasuries. I sold all my GLD a few months ago and now the only gold exposure I have left is a small stack of coins. I don’t have a vacation house but if I did I surely would have sold that too. Mrs. Draconian wanted to know what to buy with her IRA and I suggested short-term, ultra high quality corporate bonds. That’s only like two steps more risky than cash.
There are a lot of people like me and Bill Isaac in this country. We are part of what’s wrong with the economy. Nobody is investing. Nobody wants to because nobody knows what’s going to happen. There’s so much uncertainty: economic uncertainty, tax code uncertainty, uncertainty with respect to healthcare and financial regulation, political uncertainty, inflation uncertainty, and uncertainty about all of these shifty macro winds.
Individuals are paralyzed with a complete lack of confidence.
A lot of people ask me in conversation what can be done to fix the jam we’re in.
They want to know if the Fed is going to lower interest rates or if we need a new round of stimulus. Some ask if there will be a tax cut. Basically, they want to know which one of the band aids is going to be the one that sticks.
The answer is none of them.
Real Medicine
Unfortunately, the cure for what ails us is a very long term thing. We have to repair investor and consumer confidence. This is not easy to do.
To answer this, take a moment and think about what would make you feel better about our economy. Seriously. Take a minute and do it.
What would make you want to get out there and spend and invest again?
OK, let’s do it together.
Will a temporary tax rebate check in the mail make you feel better? No. It won’t. You’ll feel good for a couple of days as you rush out and buy an iPad or a vacation to Cancun. But you won’t feel any better about our economy. Not long-term.
What about this temporary reduction in the payroll tax? Don’t get me wrong, this is a really cool idea. It puts more money in your pocket every paycheck! Employees are cheaper for businesses to maintain. But the key word here is temporary. What happens when it goes away? It’s just a slightly longer-term variant of getting a rebate check in the mail. And in the back of your mind you’re wondering where this free money came from. Your rational brain wonders: who paid for that?
What about raising taxes on the rich? Yeah! Awesome idea! So let’s say we tax the rich more. How does this make you now suddenly more confident in the future prospects of our economy? What if a tax hike targeted at you is next?
What if the Fed lowered interest rates more? That wouldn’t make you feel better either. Rates are already crazy low and there are a billion other reasons why you don’t want to buy a house right now.
How about another round of QE? LOL!
What if the Debt Fairy appeared, waved her magic wand, and made all the problems in Europe disappear? Forgot how this would actually be accomplished. It’s magic! The EU is stable again! Now all these banks can stop worrying about their stinky Greek paper. But do you, Joe Shlabotnik on Main Street USA, feel more confident in our American economy? No. An EU banking crisis isn’t what’s keeping you from investing. Not really.
Does it make you feel better when Obama or Bernanke get up there and give a speech to “calm the markets?” Please.
Does it make you feel better when the solution for the inevitable bankruptcy of Social Security or the parabolic increase in cost of Medicare is to just ignore it? To “protect” the benefits that have been promised and figure out how to deliver on those promises later? Does reassuring rhetoric fill you with confidence?
Yet this is what we’re doing
You can see now what’s going on. We’re fixing things that may need fixing. But nobody seems to have any interest in fixing what’s really wrong with our economy. Nobody wants to tackle the big problems.
The strategy right now seems to be to load up on steroids and just hang out until the economy starts naturally growing again and generating its own momentum. I understand this. It makes sense. It’s the easiest strategy to employ and it’s the only one that’s really possible within the current political environment.
All this stimulus may be holding our economy together. Whether you’re a critic or supporter, we can all agree that these stimulus measures are doing something even if we want to squabble about exactly how much. We’re not exactly flushing all these trillions down the toilet. But I think we can also agree that these trillions that we’re spending aren’t fully addressing the long-term lack of confidence that’s plaguing the economy. I’d contend that it may even be making things worse.
What’s making it worse isn’t so much the direction that we’re targeting, it’s the short-term nature of it.
It begs the question, ”So what happens when the stimulus goes away…?”
And this, my friends, is why we’re all nervous.
We know we can’t keep transferring wealth from the future to hold it together in the present. We’re not stupid. Deep down, I think we all know the answer to that question. We know what happens if we pull the plug and let Greece go. We know what happens when we roll back these short-term tax breaks. We know what happens when the Fed takes its boot of the neck of the yield curve.
Bad things, man. Baaad things.
To put it into cruder terms: what happens when you take the heroin away from the junkie?
Intervention
The thing is, though, the junkie eventually gets better. That period of sobering up is godawful and withdrawal is ugly. But eventually the junkie comes out clean.
The U.S. economy is the junkie. We’re waist deep in our addiction and we’re stuck. We know what happens when the drugs go away and we’re terrified of it. It’s keeping us from doing the things we need to do, the long term things.
Several years ago I started writing about how U.S. policy and American psychology was dominated by a single crucial dynamic. As a nation and a culture we have all elected to exchange short-term, acute pain for prolonged suffering. Pretty much every economic debate in the world right now can be traced back to this concept. It’s what Japan did in the early 90′s and it’s what they’re still doing today.
This is one of those situations where I wish I was an old-timer. It’s one of those occasions where I’d kinda like to trade my youth for wisdom and experience. (Isn’t that what life is, though? A long, slow exchange of youth for wisdom?) I wish I had the body of experience to know if this cultural psychology is something new or something endemic in our species. Is this just the way that humans are? Or was there a time when we were willing to make hard decisions because they’d pay off somehow down the road? Any grandparents out there that can speak to this?
In any case: I think the reason that none of us are investing is because we don’t see America investing in herself.
Read that again.
That just blew your mind, huh? It’s OK. It blew mine too.
Painful stuff that will make us better
I hate it when people rant about the way things are and offer zero solutions of their own. So I’m going to offer a few ideas that I think are good ones. These are ideas that will repair consumer and investor confidence. They are not easy to implement and they will undoubtedly hurt some people along the way. Such is life. They also won’t make it all better overnight.
1. Reform the tax code. This is the biggee. Everybody hates this thing. We have to rebuild it from scratch and we have to do it in a way that generates more revenue and is also politically feasible, which basically amounts to “broaden the base and lower the rates.” We talked about taxes a few months ago. Right now, effective tax rates are historically low across the board. If you shut your ears to the political rhetoric, you don’t have to get too far into the actual math to see that none of this adds up.
Let people know what to expect. Let them know how much they’ll be taking home. Today and twenty years from now. Let’s make it simple so we don’t have to worry about it. And let’s get the incentives aligned so that people have a motivation to invest and invest for the long run.
2. Financial regulation. Is there a person among us who really believes that Dodd-Frank made the financial industry safe again? Seriously. Chris Dodd and Barney Frank, feel free to chime in if you guys honestly believe deep down inside that this regulation will shield us from future crises. Do you guys and your comrades in Congress think this bill would have even protected us from the last crisis? I don’t know a single financial professional who thinks it would have.
One of the big reasons we’ve all got our money under a mattress right now is that we’re freaked out we’ll get another banking crisis. We’re worried about a repeat of 2008 whether the foundation is in place for a repeat or not.
So let’s restore faith in the banking system. First of all let’s make these banks smaller so that if one goes -poof!- the world won’t collapse. Let’s carve out risky stuff like proprietary trading
Let’s utilify the banking sector. I don’t care if this hurts their profit margins. Congress: ignore your Wall Street lobby friends. For over 60 years after the passage of the Glass-Steagall Act, nobody seemed to have a problem with banking being a rather low-margin line of work. Banks provide a systemically important, quasi-public service. That kind of service should come from a firm who’s not levered to the hilt and manufacturing profitable-but-dangerous stuff like Collateralized Debt Obligations. In truth, I have no problem with that kind of activity. It just needs to be conducted in a silo where the American taxpayer won’t get pummeled with shrapnel if it explodes.
Oh yeah, and while we’re at it, let’s bring back the uptick rule. This was another mechanism that kept markets rather well-behaved and orderly for about seven decades. Sure, it could be coincidence that as soon as we took it away, mean volatility spiked through the roof, high-frequency trading exploded from a nonexistant to multi-billion dollar industry, and 500 point daily declines became eerily common. But I doubt it. What was so bad about the uptick rule, anyway? Who was it hurting?
3. A balanced budget. In the last couple years, people on Main Street saw what happened first hand when you keep spending more than you make. The American Public is stupid, but they’re not that stupid. They know that a government can’t continue to borrow and spend and borrow and spend without some kind of price being paid down the road.
It’s that “price” that has everybody nervous right now. If you bring the budget into balance and show people that government expenditures are matching revenues, you show people that there’s light at the end of the tunnel. You say, “OK, I know the current debt burden is high but I also know that it’s not getting any bigger. We’ve got this thing under control and over time the economy slowly grows it’s way out.” Rock ‘n roll. Now you get out there and invest. Because you know there are good deals to be had right now.
4. Infrastructure spending. Look, I accept that the reality of the world we live in is one where the government has to spend money. Republicans and Democrats ought to be able to agree on this. And behind closed doors, they all do.
So if we’re going to spend money, let’s do the kind of spending where after it’s done we have something real to show for it. Let’s build a bridge. Let’s lay some rail. Let’s make our airports modern and safe. Let’s kick off a massive, government-funded project for research into alternate energy. It’ll be like the Space Race, only the winner will be the country who develops solar panels that produce energy less expensively than coal or oil. Then let’s sell that technology to anybody that wants it. I know that the major oil companies would hate that. But voters shouldn’t. Again, Congress: ignore your lobbyist friends!
While we’re at it, let’s figure out how to get cars — or how about just our heavy trucks — running on a network of natural gas. The U.S. has more natural gas than it knows what to do with right now. Let’s be energy pragmatists.
5. Let’s get some certainty about Social Security and Medicare. I’d argue that my entire generation has already accepted the reality of this. None of us really believe that we’re going to receive benefits that are equal to or better than any of the generations before us. We know this. So let’s just make it official. Let’s raise the retirement age for people that are still a couple decades away from retiring. Let’s put some sensible limits on this madness. We don’t need to screw the people already receiving benefits or will be very shortly. Let them have their benefits. What we really need to do is be honest with everybody else.
This addresses the long-term part of the problem and it’s the long-term that’s killing our confidence. We all know Social Security is OK right now but we also all know that someday it won’t be. Let’s fix that and make that uncertainty go away. Then we can stop piling cash under our mattresses and get back to spending and investing money.
Look, Social Security is a really important program. In my happy Libertarian utopia, it obviously doesn’t exist. But in the real world, Americans can’t be trusted to save for their retirement. I know that some of us can. But our culture isn’t one that can be overhauled in a way that won’t cause complete economic chaos. Part of the reason why we have a really robust economy is because we have a social safety net. This is what differentiates us from China. China doesn’t have this. The average Chinese worker saves something like 40% of his paycheck. Imagine what would happen to the Chinese economy if he went out and spent that. Setting up some sort of a social safety net is one of their major economic challenges of the coming decade.
These are all important goals, but I think think there are two issues that stand head and shoulders above the rest. When I asked, “What would make you feel better about the economy?” two items probably filtered to the top.
6. Create jobs. Job insecurity is the big one. The problem runs deeper than the headline rate and this is why I like to look at broader measures of unemployment. I also want to track things like discouraged part time workers and people who have dropped out of the labor force altogether.
This is the tricky one to fix. It’s hard to create a job. What creates jobs are businesses. And businesses aren’t hiring. It has nothing to do with credit or interest rates. The number one reason that businesses aren’t hiring is weak demand from their customers. The number two reason is regulatory and tax uncertainty. This is not rhetoric, this is data and fact. If you want to create jobs in the private sector you have to manufacture an environment where businesses feel confident to get after it.
There are a couple things you can do to jump-start hiring and incentivize job creation. But the key is that you have to do things that are long-term in nature. You can’t give a firm a one year tax break for hiring somebody or repatriation tax holiday. Because what happens in year two? You have to manufacture an environment where businesses have a permanent incentive to hire. Restoring confidence is a big part of that. Our firm would happily hire another an employee. But only if we knew that consumers would demand our product. Your business is probably the same.
7. Let’s fix housing. This is how you really create jobs. Home construction is a massive part of the economy. It employes a ton of people. A large portion of the unemployment rate are people who lost their construction jobs and never got them back. Right now, we aren’t building any new homes. New home construction is at an all time low. The unemployment rate isn’t going to come down and the economy isn’t going to find its footing until the housing industry bottoms out and gets better. Let’s get these foreclosures and short sales moving and get some of this inventory off the market. Show people that homes can sell and not get stuck in legal limbo and people will feel more confident about buying.
The other housing issue sapping the confidence of our economy is negative equity. I’ve said before that I wouldn’t be surprised to see “debt forgiveness” become a buzzword towards the 2012 election. In fact, mere weeks after suggesting that, these Occupy Wall Street folks started banging the drum about debt slavery and other vague, abstract complaints. The point is valid, though. We’ve got to get some sensible solutions in place to address this negativy equity monster.
Maybe that’s some kind of loss sharing or maybe it’s something like John Hussman’s “Property Appreciation Rights” where individuals restructure their loans and lower the principal in exchange for giving the bank what is basically an option on future property appreciation or a low-interest claim directly via the Treasury.
And this fringe suggestion of granting citizenship to foreigners who buy houses isn’t as crazy as it sounds. Why are we so afraid of this? With the right screening, this could entice foreign talent to stay in our country and it would also make a huge dent in the housing oversupply. That gets us building more houses again and creating jobs. It also makes all the Realtors happy. Good for them. They’ve had a pretty awful couple of years.
I know we can’t fix things overnight, but we can get started laying a foundation for the future. It’ll take time and it’ll mean some short term pain. But it’ll get investors committed for the long haul again and help consumers feel like the U.S. is back on track for greatness.
Or we could stick to this strategy of short-term pain mitigation while we wait in terror for the other shoe to drop.
Believe it or not, we still do have a choice.
Would you be surprised if I told you we’re headed into recession?
Well, Lakshman Achuthan of the Economic Cycle Research Institute made some waves last week saying that a recession is imminent. Not 50/50. Not even highly likely. Imminent.
Click here if you want to read the full text of their statement. Make sure you’ve had your morning coffee. If you happen to be reading this in the afternoon, go fix one of your favorite adult beverages.
Make it a stiff one.
I started following the ECRI a while back. Their research is really interesting. And so far, I’ve been very impressed with the signals. They were calling for a slowdown earlier than everybody else when it was starting to get messy in 2007. And they were also among the first to call for a recovery in 2009.
So far they haven’t had any false alarms, either. They don’t manage money so maybe that lack of bias helps keep their research objective and unafraid to go against the crowd. They’ll botch some calls eventually — and they could botch this one — but in the meantime, I’ll prefer to listen to research organizations that seem agnostic about making calls in either direction. The economy does move in a cyclical fashion, after all.
Expect the consensus view to change
The crowd on Wall Street right up until a week or two ago was saying “growth, but slow growth.” Almost to a man. Unlike last year where I was hearing a wide range of economic forecasts, this year pretty much everybody is singing the same song. To my knowledge, this recession call from the ECRI is the first major one to come from someone who isn’t a perma-bear. I’d expect the consensus view to slowly follow the ECRI and other bearish forecasts down.
I think that the most interesting bit from this ECRI forecast is that they said there is nothing the government can do about it. On the surface, that seems pretty bold. But keep in mind that something changed as Greenspan started building the modern Fed. There was this idea that we could iron out the business cycle, softening or eliminating recessions while maintaining growth. Before the financial crisis, we only had two recessions in twenty years, and both were pretty mild.
As I’ve written repeatedly elsewhere and in other contexts, the previous few decades were the outlier. The Long Boom was not the norm. For pretty much all of recorded history, recessions were a much more frequent event. Between the Civil War and WWII, the average duration of a growth cycle was something like 2.5 years. We’re already 3 years into this current expansion.
One of the things I keep telling investors is that they need to prepare their portfolios for a world in which recessions are much more common than they got used to during the long boom. It’s not the end of the world, it’s just a return to normalcy.
Here’s how it could play out:
Another recession would have a significant impact on the economy. For starters, you could count on the unemployment rate rising. I wouldn’t expect it to rise too dramatically, given the fact that corporations are already running very lean and so many people have dropped out of the labor force. By and large, firms didn’t get back out there and aggressively staff up during the recovery. So we’ll see how much further they can shrink their labor forces.
What concerns me most are the next couple quarters of earnings. Recessions wreak havoc on earnings — they usually drop 25-40% during a recession. In every economic recession, the first thing that businesses do is cut their expenses any way they can. That’s what you do when demand for your business slows down, right? Companies try and make their operations more efficient so that their bottom line doesn’t suffer in proportion to their top line. The goal is to defend net earnings as revenues drop or slow down.
The problem is that firms already made these efficiency cuts back in 2008 and 2009. I’m not sure of a good way to measure operational efficiency — maybe I’ll dust off some of these old books on fundamental analysis. But my guess is that there isn’t a whole lot of fat left to cut. Companies right now are particularly vulnerable to demand shocks.
I think they know this, too, and I think it’s why everybody out there has been amassing as big a cash pile as they can. Remember what we discussed last month? We listened to the markets. We all got a heads up. Corporate America is worried that another demand shock is coming. They know that the only way to ride it out will be to stockpile enough nuts for the winter.
The EU mess is still the Big Bogeyman right now. That’ll continue to drive the headlines. But if you’re looking for sneaky economic monsters out there, an unexpectedly bad couple of earnings seasons could pose a threat. The Street is notoriously slow to adjust their earnings forecasts when the economy slows down. Their forecasts lag the whole way down.
If you want to see just how wrong analysts can get it, check out this chart:
Earnings estimates are almost always too high, except during those brief expansionary windows where companies game their earnings to “beat the street”. Forecasting earnings is a difficult task, so I don’t want to be too critical on these analysts. In fact, it’s the rest of us that should probably take a moment and recognize that these forecasts come from mere humans. Like everything else that comes from mere humans, it’s imperfect.
I’ve been reading headlines about how the market is cheap right now. It is somewhat cheap. Earnings have been fine this year (because of all that operational efficiency). The consensus operating earnings forecast for the S&P is around $111/share for 2011. Today’s prices imply a forward PE of around 10. That’s low enough for a value hound like me to start sniffing, but not low enough to get really aggressive about.
The problem is that if you think that forecast of $111 is overly optimistic. S&P earnings will clock in somewhere around $95 for 2011, so there’s a fair amount of growth built into that 2012 forecast.
The problem is that if there’s a recession, and earnings shrink 25%, you’re looking at something in the neighborhood of $75/share.
If earnings get tagged by 40%, you’re looking at operating earnings somewhere in the $50′s, which is where we were in 2009, 2003, and 1999. To justify today’s current market prices, you’d have to hang a 15-20 multiple on the S&P. That’s way expensive.
Anyway, if the ECRI is correct in their call, I have a reeeally hard time envisioning scenarios where the S&P stays above 1,000.
That’s another 15% drop from here. If you can sustain that kind of loss, bully for you. Keep searching for some long term value and growth in stocks. But if another 15% (on top of the 15% you’ve lost since July) sounds a little too painful, then think about taking some risk off the table.
The good news is that all of the structural economic problems out there are baked into the cake. They’re a known quantity and nobody is expecting those to get much better any time soon. I think there’s a good chance that if a recession does materialize, it will be more of your “garden variety” cyclical contraction.
That’s the good news.
Why it won’t be as bad as it was last time
The collapse of the housing industry was one of the reasons why it was so ugly last time. That was a massive, structural change. Today there are about 5.5 million workers in the construction industry, down from around 8 million workers, to say nothing of those that were self-employed or working jobs related to the construction industry. That collapse already happened and we’re not going to have another 3 million people lose their jobs overnight.
The housing industry is dead right now. No joke. New home construction is at all time lows. For all intents and purposes we have stopped building houses in the U.S. The industry isn’t going to get much deader.
Seriously. Look at this:
My morbidity aside, this is a hidden positive for the economy. To get a real economic disaster you have to get a banking crisis and a collapse in housing. That’s where the leverage lives on Wall Street and Main Street, respectively. Leverage is the common denominator of basically every economic blowup in history.
Now that banks don’t have to mark their assets to market anymore, I’m not concerned about a banking crisis. Not really. I wouldn’t touch the industry with a 10-foot pole but I also don’t think it’ll go supernova the way it did in 2008.
And as I said, I don’t think housing construction is going to get much worse. The fact that it has totally flat-lined is a hidden positive. The worst is behind us. And once the current oversupply clears out — which it will eventually because of demographic reasons — then we will have to go back to building something like 1.2 million new homes per year. I heard somewhere a while back that each new home creates like 3 jobs. You can do the math.
We may indeed get a recession. But I think you’re barking up the wrong tree if you’re buckling down for the U.S. to totally fall apart again.
It won’t.
(Europe is a different story.)
Volatility is here to stay
That doesn’t mean the stock market won’t stop being so volatile.
It’s going to stay volatile and I’ll tell you why.
The problem is that there are a boatload of assets out there that aren’t really worth what the people holding them say their worth. Everybody knows this. It’s the worst-kept secret in finance.
You guys all remember playing musical chairs when you were kids, right? Everybody walks around a circle where there is one fewer chair than kid. When the music stops, and everyone races to sit down, we know that one poor bugger will be left without a chair.
If you think about it, it’s a pretty stressful game. At a birthday party full of sugar-addled kids, that’s a lot of fun. But investors respond to this sort of thing in a different fashion. It’s different when there is real money involved.
We are playing a game right now where…
…we know that the music will stop
…and when the music does stop we know that someone will be left without a chair
…and nobody wants to be invested in the company without a chair.
The scary thing is that we don’t really know who will be left standing. We really don’t. We can make guesses — maybe it’ll be the slow, fat kid, or maybe it’ll be the space cadet who doesn’t really understand the game that’s being played or what really is at stake — but they’re just guesses. Investors choose instead to bet on nobody.
There are losses out there. Big ones. Nobody seems to want to take them. There’s this dark, delusional hope that, geez, maybe we’ll make it through and nobody will get burned. Maybe Greece will make good on its debts. That’s the policy line. But it’s bunk and investors know it and the action in the market is a reflection of this.
As long as we’re playing this twisted version of musical chairs, the market will stay volatile. When we’ve dealt with the hard choices, brought all the skeletons out from the closet into the light, and laid the foundation honest economic growth, the markets will embark on something that is legitimate.
Until then, skepticism and wariness will rule.
Two final bits of good news
Here are a few final tidbits to remind that the whole economy, while depressing, isn’t sailing off the cliff.
The unquestionable best bit is the resilient ISM Purchasing Managers Index.
Everybody was expecting the September reading to drop, and it rose, from 50.6 to 51.6. Remember that values below 50 indicate contraction and values above 50 indicate expansion.
Don’t get me wrong, readings in the low 50s are bad. But if this thing is stabilizing, it could mean that the economy will hang in there. We may still get a recession, but it might be a very mild one. The headlines may get pretty dark, but don’t get lost in them unless you see the data confirm the story.
Always watch the data. There’s still hope.
The last bit of good news is crude oil. Nymex Crude is trading in the $70′s now, people!
Everybody freaks out about the economic impact of rising gas prices. But nobody seems to get very excited about the positive impact of falling energy prices. I don’t know why that is.
Unleaded gas futures have fallen from almost $3.50 a gallon to $2.75. That’s still higher than the $2 that prices averaged in 2009 and 2010, but it’s a big step in the right direction. So far, I haven’t really heard a lot of economists discuss how this is moderately stimulative. But it is. Gas prices have a lot to do with how confident consumers feel, too.
If energy prices stay low and we start to see some good news in housing like rising prices, more construction, and more employment, people will start to feel good again. Especially if that’s combined with some transparency in the financial sector and some clarity about things like taxes and social security.
We’ll feel OK about spending money.
We’ll grow.
The guy on the street
Look, I know that all this discussion about recessions and obscure economic indicators may seem technical and pointless. Most of you out there probably feel like we never left the last recession. You’re watching your company (or the State) make more cuts. Your benefits are getting worse. You’re not getting the annual merit raises that you once did. Your brother in law who worked in construction is still struggling to find work. Your son who just graduated has moved back in because he can’t find a job.
I sympathize with you all. You missed out on the economic recovery. It happened and unless you owned stock or were a NYSE listed corporation, you didn’t feel it.
Bill Gross really got to to the heart of this in his latest missive. All of the policy prescriptions the U.S. has adopted since the crisis have favored capital not labor. The hope was that if we could get interest rates down and stabilize markets, we’d create some jobs. We did that, and it’s been a pretty awesome ride for corporate profits. But we didn’t make many jobs. The economy still sucks.
We could keep trying these policies. Or we could try something a little more radical. I just saw a terrific interview with Michael Lewis on Bloomberg. He said that the U.S. still hasn’t hit rock bottom yet. We know this because the pain hasn’t become so great that we’re finally willing to throw our arms up in the air and embrace real change.
Maybe this is what we’ll see next year as we head towards the election.
A guy can hope, can’t he?
I want to make sure I get the message right here:
- Markets will stay volatile until investors can get a handle on how big the losses will be and who will be taking them. Or until investors fall back into a numb, complacent sleep.
- Growth will contract or stay slow enough to pose serious challenges.
- It’s not the end of the world, and someday, when the losses have been taken, the leverage has come down, and we start building houses again, the U.S. will embark on a major growth cycle. I’ve tentatively penciled that in for about 2017 +/- 2 years depending on how quickly Washington D.C. pulls its head out of its ass.
