Brokers Believe Worst Is Over and Recommend Buying of Real BargainsWall Street in looking over the wreckage of the week, has come generally to the opinion that high grade investment issues can be bought now, without fear of a drastic decline. There is some difference of opinion as to whether not the correction must go further, but everyone realizes that the worst is over, and that there are bargains for those who are willing to buy conservatively and live through the immediate irregularity.-- New York Herald Tribune, October 27, 1929
29 December 2007
The Great Crash of 1929 Redux
27 December 2007
Between Scylla and Charybdis: The Odyssey of Ben Bernanke
The Fed is doing a balancing act, and it has been doing so for some time, making its way from bubble to bubble through the uncharted waters of fiat-onomics, the monetary mythology.
On one hand is the US financial system breaking down with the economy in a deep recession. On the other hand is the US dollar and bond in freefall with inflation flying higher than Icarus with a tail wind.
Using a classical Greek metaphor, the Fed is navigating between the Scylla (Σκύλλα)of Recession and the Charybdis (Χάρυβδις) of Currency Debasement.
Greek mythology portrayed Charybdis as lying on one side of a narrow channel of water, which some think was the Strait of Messina. On the other side of the strait was Scylla. The two sides of the strait are within an arrow's range of each other, so close that sailors attempting to avoid Charybdis will pass too close to Scylla and vice versa.
The phrase between Scylla and Charybdis has come to mean being in a state where one is between two dangers and moving away from one will cause you to be in danger of the other. Between Scylla and Charybdis is the origin of the phrase between the rock and the whirlpool (the rock upon which Scylla dwelt and the whirlpool of Charybdis) and may be the genesis of the phrase "between a rock and a hard place".
Scylla is a horribly grotesque sea monster, with six long necks equipped with grisly heads, each of which contained three rows of sharp teeth. Her body consisted of twelve canine legs and a fish's tail.
Charybdis takes form as a monstrous mouth. She swallows huge amounts of water three times a day and then belches them back out again creating whirlpools. Charybdis was originally a naiad, sea-nymph who flooded land to enlarge her father's underwater kingdom, until Zeus turned her into a monster. He was angry that she was taking so much of his land and made it so that she would be incredibly thirsty three times a day and suck in the water.
In the Odyssey, the Argonauts were able to avoid both dangers because they were guided by Thetis, one of the Nereids.
Can Ben Bernanke find Thetis? Can he navigate through uncharted waters on the course that Greenspan has put us upon?
Charybdis Rears Its Ugly Head
Rate cuts will hammer dollar: Chinese official
Flight of capital seeking higher returns in Asia could depress dollar on further rate cuts, China says
December 27 2007: 7:28 AM ESTBEIJING (AP) -- Further cuts in U.S. interest rates would have a "harmful effect" on the dollar and the international finance system, a Chinese finance official wrote in a commentary Thursday in an official newspaper.The dollar's fall against many currencies has prompted investors to sell dollar-denominated assets, Hu Xiaolian, director of the State Administration of Foreign Exchange, wrote in the Financial News, a newspaper published by the central bank. "If the (U.S.) federal funds rate continues to fall, this will certainly have a harmful effect on the U.S. dollar exchange rate and the international currency system," Hu wrote. Financial markets closely watch official Chinese comments on the dollar because Beijing keeps a large portion of its $1.4 trillion in reserves in U.S. Treasury securities and any change in China's investment strategy could affect exchange rates. Despite his warning, Hu wrote, "the U.S. dollar's dominant position in international currency markets is unlikely to change in the near term. "The U.S. Federal Reserve has lowered its federal funds rate, the interest that banks charge each other for overnight loans, to 4.25 percent, a full percentage point lower than it was in September, to ease a credit crunch in the U.S. financial system. Chinese officials have said that cutting the rate could encourage investors to move money to Asia or elsewhere in search of better returns, which could depress the dollar.
23 December 2007
Recessions and the SP 500
So it bothers us quite a bit that the stock market, that great discounter of the future and unerringly efficient prognosticator of economic things yet unseen, is presumed to be rallying back to new all time highs, even if only on a nominal level, not accounting for inflation. We show the SP deflated by gold in this chart, and as you can see, the rebound in US stocks is a bit of a mirage. If the bad times are when the tide goes out and shows who's naked, then inflation is the hurricane storm surge that pushes the waters back in, to provide cover for those au naturel.
By the way, the perception of inflation, or inflation expectations, is not incidental, but rather is absolutely key to the kind of financial engineering that neo-Keynesian economists that infest the Fed and Treasury wish to embrace as the ripe fruits of a fiat monetary system. Don't think for one minute that what is happening with M3, CPI revisions, etc. are a mere coincidence. Its all about control of the many by the few, after all.
If in fact we are on the verge of a recession, the SP500 will likely be in the process of making a top. We might see another push higher by the broad stock indices in response to the unprecedented monetary stimulus being applied by the banks. But even with this latest phase in the financial engineering experienment currently in progress, within the next two months we should see a confirming signal from the equity markets that the economy is turning lower in real terms AND has started contracting, even if the current set of official economic measures say otherwise.
We underestimated the Fed and their banker buddies in the great reflation of 2003-2004, finally catching on to the game after some painful soul searching and genuine confusion. The July 2004 working paper from Small and Close of the Fed, which basically tried to set some boundaries in how far the Fed could go in monetizing things non-traditional was a good clue, well before the infamous speech about the Fed's printing press that gave Helicopter Ben his sobriquet.
So we will strive to not be fooled again, and keep an open mind that the fighting of the housing bubble and massive credit fraud by the banks could have a short term second order effect of inflating the stock markets, along with most other commodities, especially gold and oil. One thing we are certain is that the next twelve months may be among the most interesting we have seen, and can only wonder what we all might be saying about things at this time next year.
21 December 2007
Investment Performance for 2007
We Trust In God, Everyone Else Shows the Data
We like to check the data. The reason should be obvious, but if not, its because often people deal with the complexities of life by using assumptions, which are a kind of shorthand way of breaking reality down into manageable chunks. Everyone does it. You have to. But every once in a while its useful to check those assumptions you make, and that other people are making, to see if they are still valid, especially if they involve things that are important. Does your wife still love you? Is there a bus coming down the road you are crossing? Do you really still look as hot as you did last year? Are you financially solvent? Those sorts of things.
2007 Returns of Some Major Stock Indices
Let's compare the 2007 year-to-date performance of some of the major stock indices. As always, if you click on the chart you will see a larger, much easier to read version.
Its a little suprising that the Russell 2000 is still not quite positive for the year, not including dividends or subtracting fees and commissions. There was quite a bit more divergence in the gains of the major stock indices. An index after all is just a grouping of things for measurement purposes. The Russell is the broadest, most inclusive of the indexes we normally watch.
It looks like tech was the champ of the broad stock sectors this year, if for no other reason that they are NOT financial and NOT housing. The Wall Street storyboard is that tech is invulnerable to the vagaries of housing and financial bubbles, and actually benefits from the weakened US dollar because the we are the champions, the kings of tech, and are selling it to the rest of the world, although very little of it is actually made here anymore, and what we do invent is copied and pirated shamelessly. Its a revenue concept thing perhaps, moreso than real hard cash, like page views and web searches and collateralized debt obligations.
Let's Get Physical
Let's take a look at a different type of investment. How about something that is supposed to be impervious to inflation, a barbarous relic, the bane of central banksters and financial voodoo? Since the generally transitory, subjective, and vaporous nature of financially engineered products is in the headlines it might not be a bad idea to throw in something with a long track record as a hardened test of monetary value into the mix.
Holy goldaroney, Batman! That is one surprisingly fine performance for gold this year. Even we did not think that it has been this good. The assumption has been, at least lately, that gold's day will come soon, especially when the Central Banks get finished monkeying with it. Well, its been a much better return this year than most would think offhand. We're in that group, and we watch it! See how easy it is to fall prey to your own assumptions, especially when you think you have been watching something for a long time.
The Usual Investment Suspects
Let's widen the data net a little more, and see how different things compare. We apologize for the lack of variation in colors on this chart, but we had to tinker with the charting tool a little to get so many items on a single snapshot.
Well, there you have it. Some real information about how various investments performed during 2007. We new the US dollar was doing badly. We did not know that gold had done so well, and had outperformed most of the other major alternative so handily (don't forget about those dividends guys. Gold does not pay any, just like a high performing tech stock).
Let's have one more look at a sector that we have admittedly been cool towards for the latter half of this year, because of the general reluctance we have had toward equities.
Data Mining
Well, as someone who has not owned miners for the latter part of the year, we're just a little disappointed that we overlooked such a hot performing sector. Its been a wild ride, and keep in mind that with high returns comes higher beta (variability of return aka risk, and lately that includes return of capital). Remember this is the HUI gold bugs index, and if you have been playing the junior miners heavily you might have ground your teeth to a fine white powder trying to ride those bucking beta broncos.
Our personal preference is to find a few well financed miners that have a shot at paying dividends for a long time if the dollar really tanks and stocks gets smacked down. Bennie and Hank and crew are working overtime to make sure this happens, make no mistake about it. They are just trying to push the date of reckoning into the future. We admit to a bias that says the dollar will inflate significantly further, and then at some point deflate. Its just that we think the deflation will be when they knock a couple zeros off buckaroo. It might not happen that way. We'll stay flexible.
When people put forward ideas that might be important to you, ask for the data. People are often afraid to ask, because they don't want to look foolish. Some people like to put forward their ideas with great ceremony and pomp, and browbeat and belittle anyone who disagrees with them. They often speak with great confidence bordering on arrogance. We'll let you in on a little secret. What we have learned over the years is that if someone can't explain their ideas to you, it just might be that they do not understand the idea themselves. Don't get us wrong. There are some very fundamental beginner questions that people must and should as. Its just that they aren't necessarily best directed to the advanced class. But that doesn't mean you shouldn't ask. Just try to ask the right person in the right places in the right way.
Questions can be annoying. But we find that often they provide the kind of impedance that causes us to revisit them and test our assumptions, to try to explain things over again to ourselves. If you put in an honest effort, it makes our assumptions and ideas stronger, more reliable. Some people might even publish their ideas so that they can be tested in an environment of peer review. Just putting ideas down on paper forces one to really thing them through. You might even decide to put them into charts and a blog, to force your own performance to a higher standard. Interesting concept.
13 December 2007
A Snapshot of the US Economy
"We publish an analysis of the government statistics: where they are right, where they are wrong, and the implications if they are wrong, which is generally the case. In fact, what has happened over the years is that changes in methodologies have been implemented in reporting the key statistics, with the effect that economic statistics seem stronger than real growth, and inflation numbers tend to be weaker than reality, enough so that GDP (Growth Domestic Product) is overstated by three percent; the unemployment rate is really up around 12 percent as most people would look at it, and the inflation rate is now topping 11 percent."
Remember Okun's Misery Index?
Inflation Rate + Unemployment Rate = the Misery Index
If we use John Williams' numbers for Inflation Rate and Unemployment the current Misery Index is now at 23, which is worse than anything seen in the Carter stagflationary recession. What Jimmy obviously needed was a staff of more creative accountants and statisticians.
If an economy falls in a forest of deception, and no one sees it happening, do the victims make a sound when they hit the wall?
08 December 2007
Recession: Straight Up, With a Twist
Definition of a recession
The textbook definition of a recession is two consecutive quarters of negative growth in real GDP. This definition has been problematic in this decade however, because of the tinkering that our government has done with the measures of inflation. As you know, real GDP is GDP deflated by the inflation rate. The official deflator used for GDP is called the GDP chain deflator.
The National Bureau of Economic Research (NBER) recognized this and determined that there was a recession in the US in 2001 from March through November, even though the quarter to quarter real GDP annualized growth rates for the four quarters of 2001 were -0.5%, 1.2%, -1.4% and 1.6%. As you can see, we did not have two consecutive quarters of real GDP declines. How does the NBER explain this?
"Most of the recessions identified by our procedures do consist of two or more quarters of declining real GDP, but not all of them. According to current data for 2001 [as of October 2003], the present recession falls into the general pattern, with three consecutive quarters of decline. Our procedure differs from the two-quarter rule in a number of ways. First, we consider the depth as well as the duration of the decline in economic activity. Recall that our definition includes the phrase, 'a significant decline in economic activity.' Second, we use a broader array of indicators than just real GDP [including personal income, employment, industrial production and manufacturing/trade sales]. One reason for this is that the GDP data are subject to considerable revision. Third, we use monthly indicators to arrive at a monthly chronology."
The point of this diversion is to define what a recession is, although it cannot be so neatly compartmentalized to such a simple formula, especially in these times of government revision of economic data.
A quick look at the chart at John Williams' excellent site, Shadow Government Statistics will give you the idea of how the notion of Consumer Price Inflation has been distorted by the Clinton and Bush administrations. Inflation has a direct effect on real GDP, and therefore on the formal definition of recessions. Of course, it has a real impact on lots of other things including consumer and voter sentiment, and Social Security and other cost of living increases, which is a strong incentive for the government to down play inflation.
Advance Indicators of Recession
We tend to favor the US Treasury yield curve as a significantly reliable indicator of approaching recessions. Here is a description of the classic definition from Paul Kasriel of Northern Trust:
"...each of the past six recessions (shaded areas) was preceded by an inversion in the spread between the Treasury 10-year yield and the fed funds rate. But there were two other instances of inversion - 1966:Q2 through 1967:1 and 1998:Q3 through 1998:Q4 - immediately after which no recession occurred. It would appear, then, that an inverted yield curve is more of a necessary condition for a recession to occur, but not a sufficient condition. That is, if the spread goes from +25 basis points and to -25 basis points, a recession is not automatically triggered. Rather, whether an inversion results in a recession would seem to depend on the magnitude of the inversion and, to a lesser extent, the duration of it. Recession-signaling aside, the yield curve remains a reliable leading indicatorof economic activity. Although the spread going from +25 basis points to -25 basis points might not result in a recession, it does indicate that monetary policy has become more restrictive." That's the current theory, but has it? Has the growth of US money supply been restrictive?
Has Monetary Policy Been Restrictive?
The most alarming thing to us is that despite the inverted yield curve and the Fed funds tightening we just witnessed over the last few years, from historic lows to the 5+% level, monetary policy has not only NOT been restrictive, it has been what many would define as loose. When one looks at real interest rates we had been in a prolonged period of negative interest rates, and only recently had been back in the positive area. It appears that we might be slipping back down into the negative again as the Fed tries to forestall the impending recession and the collapse of the stock - housing bubbles.
It appears to us that even while the Fed feigned monetary conservatism with the right hand, with the left hand they were doing all that was in their power to encourage the reckless growth of credit and the lowering of regulatory oversight and market discipline. To use an analogy, they were preaching energy conservation while running every light on in the house, the backyard, the neighbors house, and slipping pennies into the fuse box to keep it all going. Well, here we are.
What we are seeing is true moral hazard, the unintended consequence of the financial engineering being practiced by the wizard's apprentices at the Fed helping to nuture market distortions, asset bubbles, and imbalances that have become too big to correct naturally without systemic risk. Even though one can mask one's actions with words, and use information selectively and slyly to dampen the alarms and misdirect the public awareness, the chickens will come home to roost, and in this case they are more like the nemesis of retribution for our many economic trespasses. Let us hope that it is not as bad this time as the last time the Fed tried short circuit market discipline and engineer the economy centrally. We believe that the next twenty years or so will provide a rich opportunity for study, and probably the rise another new theory, a new school of economics, that tries to account for exactly what happened and why.
We are old enough to remember that stagflation, now seemingly so familiar, was once considered an improbability, a black swan. In the 1970's stagflation was triggered by an exogenous supply shock in the disruption in the market pricing of crude oil, impacting a slowing economy in monetary inflation from the post-Nixon era and the abandonment of the vestiges of the gold standard. The tonic that time was the tough monetary love of Paul Volcker.
What will they call it when a slowing economy with monetary inflatin is hit with a currency shock, as the dollar is displaced as the reserve currency of the world? We're not sure what they will call what we are about to experience, except on the bigger scale of thing, it will be just another episode in the hubris of arrogant men who consider themselves to be above principle, above the rules.
06 December 2007
The Non-Farm Payrolls November Boogie Woogie
(By the way you can click on the charts if you wish to read them, or just for fun if you don't care about details as you are on a managerial or government career path.)
01 December 2007
Professor Marvel Never Guesses. He Knows!
We obviously don't know, but suspect this revelation was connected with a subprime contagion affecting the derivatives markets. If derivatives are Weapons of Mass Destruction, then the Credit Default Swaps market is the H Bomb. Credit Default Swaps, if they start unwinding, can develop a chain reaction that will take out a fair chunk of the real economy, in addition to two or three big name corporations.
Subprime had the Fed a little concerned; CDS has them staring into the abyss and shitting their pants. Aren't you glad we have men so familiar with the mistakes the Fed made in 1929 to 1932 with regard to Fed Policy? We wish they had at least audited the courses covering the Fed's mistakes form 1921 to 1929. Sure, they are the experts; we're just concerned that they may be preparing to fight the last war.