Thursday, February 28, 2013

Thursday, February 28, 2013 - How Now, Dow Jones

I will be speaking at the 2013 Wealth Protection Conference in Tempe, AZ, April 5 & 6. For information please click here. This is an excellent conference. Hope to see you there.

How Now, Dow Jones
by Sinclair Noe

DOW – 20 = 14,054
SPX - 1 = 1514
NAS – 2 = 3160
10 YR YLD - .02 = 1.89%
OIL - .91 = 91.85
GOLD – 16.80 = 1580.50
SILV - .47 = 28.61

Kate can now marry Herbert; or is it Charley? I don't remember; the idea was part of a play from the late 60's, called “How Now, Dow Jones” and the idea was that the girl had been engaged for about 4 years to a stock broker, and the guy was putting off marriage on the pretext of having to wait until the Dow Industrial hit a record high, which back then meant a move above 1,000. The Dow closed above 1,000 in November 1972, and then it floundered through the 70's and didn't close above 1,000 again until 1982. So, we didn't hit the record high today. No milk and cookies. I don't remember what happened to Kate. Records are made to be broken but its not easy. Even when the Federal Reserve is juicing the market, it isn't easy.

Records are may to be broken. It doesn't happen when you expect. The Nasdaq is still some 38% below its all-time high of 5,132.50, which was hit on March 10, 2000. In inflation-adjusted terms, this market average is more than 53% off its March 2000 high. The Dow Industrials closed at a nominal high of 14,164.53 on October 9, 2007. However, if you adjust the price for inflation, using the CPI, we'd have to hit 15,639 to really hit a record; so, we still have about 10% to go. Adjusting the price with the GDP deflator, which considers economy-wide inflation instead of consumer level inflation, then the high is 15,359. On an inflation adjusted basis, the Dow is still below the 1966, 1972, and 1982 highs.

Of course, that doesn't prove anything. I'm not telling you to buy or sell. I'm not a Wall Street flack. The bears have good points. The bulls have good points. The markets are up 15% since Thanksgiving. This past week has been much more volatile. We are at some pretty significant resistance levels. My view is to keep it simple. Unless you are a day trader or a very active trader, I've been telling you for a long time to consider the “Best Six Months, Worst Six Months” method. You sell in May and stay away. You get back in in November.

This has worked quite nicely for a long time. The Spring of 2009 was an exception; that was the beginning of a strong uptrend that you would have missed; it wouldn't have cost you a realized loss, just a missed opportunity. The past couple of years we've seen strong moves from the start of the year through mid-February, a slight pullback in March and then another bounce higher in April before undergoing larger pullbacks over the summer. So, this simple approach has been a real winner. You're welcome.

I'm just saying, don't get caught up in the hype. Keep it simple.

Speaking of hype. Buckle your seat belt, make sure all snack trays are in the full upright and locked positions. Brace for impact. The sequester hits tomorrow, probably. You won't feel it right away; it won't be a sudden impact, more like a plane losing power and going into a downward glide. Some folks will tell you it's not a big deal. The argument is that it's just a 2.3% cut. That doesn't sound so bad, but timing is …. everything.

The timing and the method of cutting is important. If I go on a diet and lose 2.3% of my body weight, you would hardly notice. If you cut off my hand I would also lose about the same amount of weight immediately, but it would not be good. The budget mess is far more complicated than the simplistic idea of cutting 2.3%. For one thing, these new spending cuts would come on top of $1.7 trillion of spending reductions already set to take effect over a decade. For another, the spending reductions mandated by the sequester legislation are confined to a group of programs representing less than half of the budget.

Even within this select group, all programs are not alike. Medicare is slated to be trimmed by only 2 percent, while a 7.9 percent reduction will be imposed on the military. Cuts in military spending are blamed for a fourth quarter slowdown. By the way, fourth quarter GDP was revised today from a negative 0.1% to a positive o.1%. Toss in the payroll tax increase that started at the first of the year, then add in higher gasoline prices, and then look at the automatic cuts triggered by the sequester, and there is a strong chance we are still a long way from anything resembling robust growth.

Nondefense discretionary spending, everything from education aid to research grants, will be reduced by 5.3 percent. Under the budget legislation, in agencies and programs that are not exempt, the cuts must occur indiscriminately, across the board. So, yes, there will be some wasteful and silly programs that are cut; but there will also be some wasteful and silly programs that are not cut. There will be some programs, maybe the cancer research that could have saved your life 10 years from now, that will also be cut. Tough luck.

Finally, the legislation requires that the cuts take effect immediately, rather than being phased in over a number of years, as would be appropriate in such a weak economy. House Republicans have floated the idea of giving Mr. Obama more discretion over how to enact the cuts. A party that says it can't trust Obama enough to negotiate with him would trust him so much as to grant him exceptional power. The contradiction is so glaring that Republicans are split on the idea, and it's foolish anyway. As a senior administration official suggested, it's like being told that two of your fingers will be cut off but you could choose which fingers. How is it a "concession" to ask Obama to organize the cuts he says would be a disaster? He isn't falling for that one; because with discretion comes blame. Meanwhile, the Republicans refuse tax increases. So, for now we are looking at cuts on top of two years of cuts. If sequestration remains in place, we will have taken $3.5 trillion out of the projected budget deficits of the coming decade. 

Most of the burden of deficit reduction will fall on only a portion of the government, nondefense discretionary spending, which includes those key investment areas like education and infrastructure; these areas constitute only 14 percent of the federal budget but is they'll bear 44 percent of the cuts. All told, the three rounds of cuts will reduce expenditures on these items by 16 percent; a lot more than the phony 2.3 percent number.

Similarly, the Defense Department, which also represents 14 percent of the budget, will bear 38 percent of the cuts. Meanwhile, entitlements; Medicare, Medicaid and Social Security will face only a 4 percent reduction, even though they total nearly half of all federal spending. Do we need structural reforms to our health care system? Yes. Do we need structural reforms to the tax code? Yes.

Nondefense discretionary programs sounds like some bureaucratic mumbo-jumbo, but it includes things like infrastructure, in other words, an investment in our productivity, our competitive advantage and our future. In the early 1950s, government devoted about 1.2 percent of gross domestic product to infrastructure; by 2010, that amount had fallen to just 0.2 percent. Meanwhile, federal spending on research and development dropped from a high of nearly 2 percent in 1964 to 0.9 percent in 2009.

It may be fun to say you want spending cuts across-the-board but you probably also think it is fun to drive safely on a bridge and have cargo safely transported via rail. Infrastructure investments are not short-term. It takes time to build a highway, or a railroad, or an airport, or a research lab, or a university; and they are expected to last over time. The politicians in Washington can't seem to think beyond the next six months.

Despite the fact that working out budgets is mostly what we hire members of Congress to do, they seem to have a terrible time doing it on time, and instead routinely rely upon the continuing resolutions, which is political lingo for kicking the can down the road, to keep funding levels static for some ludicrously short-term period like six months.
The failure to work out sensible budgets makes it impossible for government agencies to make long-term plans, and instead leaves them scrambling to spend money in the short term. It's an incredibly stupid way of doing business. I understand that politics is ugly but this doesn't even qualify as real politicking; that would involve negotiating and compromising and maybe a little pork barrel wheeling and dealing to bring some bacon back to the home district without crossing the line into antipatriotic acts of self-destruction; like a national default, for instance. This is just crazy ugly.
Both parties understood that the debt situation had to be addressed. But neither side could think of a way to work with the other party to get that done in a way that didn't outrage its base. So what we ended up with a plan of mutually assured destruction. Each side has strapped dynamite to their chest and tomorrow they will light the fuse and try to manipulate the media to blame the other side for the fallout.
But when the sequestration hits, and like I said, it won't be a sudden impact; but when it hits, you will feel it. 

Wednesday, February 27, 2013

Wednesday, February 27, 2013 - It's Ben's World

I will be speaking at the 2013 Wealth Protection Conference in Tempe, AZ, April 5 & 6. For information please click here. This is an excellent conference. Hope to see you there.

It's Ben's World
by Sinclair Noe

DOW + 175 = 14,075
SPX + 19 = 1515
NAS + 32 = 3162
10 YR YLD +.02 = 1.90%
OIL + .22 = 92.85
GOLD – 18.40 = 1597.30
SILV - .45 = 29.08

Yesterday, Federal Reserve Chairman Ben Bernanke deliver his semi-annual testimony before the Senate; today he talked to the House of Representatives, repeating testimony in which he defended the Fed's policy of buying bonds to keep interest rates low in order to promote growth and bring down the unemployment rate. Woohoo! Ben is going to continue with QE to infinity and beyond. Wall Street loves free money. The markets moved higher. That pretty much covers it.

The stock market tumbled a few days ago. Bernanke promised more free money and the market moved higher yesterday. And then today, Bernanke reiterated that the free money spigot is wide open, and the market moved higher again. That pretty much covers it.

So, maybe we can play some music. Start happy hour a little early today if that's your thing. I'm just saying that you need to keep it all in perspective. If you have friends, call them up and thank them for being friends. If you don't have friends, go make some. If you are doing something productive, keep doing it. If your not doing something productive, then enjoy the sunset. Go placidly amidst the noise and confusion.

So, Bernanke was on the Hill. The lawmakers questioning Bernanke today were by and large, stupid; they talked a lot and didn't allow much time for answers. So, here's a rundown of what Bernanke actually said, because after all, you can forget the fundamentals, forget the technicals; the Fed is running the game. It's Ben's world, and we're just trying to make a living in it.
"First, we can simply allow securities on our balance sheet to run off and not replace them as we currently are doing. Secondly, we have a number of tools that can be used to drain reserves from the system such as reverse repos. Thirdly, we can raise interest rates even without reducing our balance sheet, by raising the interest rate we pay on excess reserves, which will in turn translate into higher interest rates in money markets. And fourth and finally ... eventually we can sell the securities back into the market in a slow, predictable way."
"Each of the elements is something that we have tested, that we have seen other countries use, so we think we understand it pretty well."

"In the longer term, what matters is our productive capacity and there, human talent and skills is really the most important thing. In this country we had a period where we brought women into the labor force and that brought a whole new set of skills and talents into our economy.

"We have seen recovery that is not as fast as we would like but it is nevertheless meaningful and is stronger than many other industrial countries."

"It's the cost of these policies and one that we take very seriously. We look at these possible mis-pricings and we ask ourselves are they in fact mis-pricings, how large are they, and if they are mis-pricings, what is the vulnerability."
"I ask you what the alternative is - interest rates are low for a good reason."

"We haven't done a new review of the exit strategy yet. I think we will have to do that sometime soon. Even if we don't sell any securities, it doesn't mean that our balance sheet is going to be large for many years, it just would be maybe an extra year, that's all it would take to get down to a more normal size."
So, here we learn the Fed might just hold onto the Treasuries and mortgage backed securities. Just hold them to maturity.

"I don't think the economy is overheating. There still seems to be quite a bit of unused resources, people that could be working, capital that could be used and is not being used. We believe the monetary policies that we've conducted have helped get stronger recovery and more jobs than we otherwise would have had."

"...state and local governments seem now to have stabilized their budgets, and as a result we don't expect to see those ongoing layoffs to the extent we have in the past."

"It's hard to predict but a reasonable guess for 6 percent (unemployment) would be around 2016, about three more years."
Just in case you were wondering when QE might end.

"We are not asking for any additional tools at this juncture. We continue to work on the orderly liquidation authority with the FDIC and at some point it would be good idea for Congress to review that process and see if you are comfortable with the approach that the FDIC in particular has suggested for dealing with a failing firm."
"So we have generally been supportive actually of banks doing more reserving so they would have some more reserves available against losses not yet seen."
In other words, the banks balance sheets are not in good shape; they need to be shored up. This was pretty scary, but remember – no more bailouts.
"The best way to get sustainable high returns to savers is to get the economy back to running on all cylinders. It's somewhat paradoxical, but in some ways the best way to get interest rates up is to not raise them too quickly, because by keeping rates low, now, we can help the economies get stronger, we can create more jobs, we can create more momentum in the economy, that's the way to get a sustainable higher set of interest rates. Until we can get greater forward momentum, we are not going to get sustainable higher returns."
So, why is everyone concerned about breaking the speed limit when we can't get this jalopy out of first gear?
"If we see no progress for an extended period, which I don't expect because we've already seen some progress, then I think we want to discuss the efficacy side of the equation."
"This is very much focused on the average American citizen. Our estimates are that we've helped create many private sector jobs, government jobs to support the economy quite significantly."
And then Bernanke bowed, threw a kiss to the audience and bowed again.

"The Treasury and the MBS market functioning is something that we do … every hour because we are heavily engaged in those markets obviously. To this point we don't see any significant problems with those markets. But if we do see any problems obviously we will react to that."
I guess that's Bernanke's way of saying the Fed has completely taken over the bond markets.

"The evidence thus far is that the housing market has hit the bottom and is recovering. ... So we're still far from where we'd like to be but the evidence is that the housing market is strengthening."
This would be reassuring, except I remember it's the same thing Bernanke was saying about the housing market in 2007.

"What I am advising is a more gradual approach. I'm not saying we should ignore the deficit, I am not saying we shouldn't deal with long-term fiscal issues, but I think that from the perspective of our recovery, a more gradual approach would be constructive. ...
"The more gradual this is, as long as there is offsetting changes in the further horizon, the less the immediate impact will be on jobs and growth in this recovery in 2013. ... I think there is some cost to the economy of these repeated, I won't say 'crises,' but these repeated episodes where Congress is unable to come to some agreement and therefore some automatic thing kicks in, I think that's on the whole not a good thing for confidence."

"I cited in my testimony just the numbers from the Congressional Budget Office which suggest that fiscal measures will reduce growth this year by 1.5 percentage points which is very significant. … "My suggestion for your consideration is to align the timing of your fiscal consolidation better with the problem, that is to do somewhat less in the very near term when it will have the greatest impact on growth and jobs and where the Federal Reserve doesn't have any scope to offset it and instead to focus on the longer term where the real problems I think still remain.
"I am very much in favor of getting our fiscal house in order but I think it's a long run issue and I would be supportive of a less front-loaded set of measures."
Bernanke should get some kind of an award for constraint when talking to the politicians about sequestration and fiscal policy. And I'm not one to hand out kudos to Bernanke; he does that himself. The simple fact is that we don't have a real emergency, we have a manufactured crisis. The deficit is already falling at the fastest rate since the end of World War II. The deficit is down 50% as a percentage of GDP in the past four year. It's not growing, it's shrinking. Austerity – budget cuts – hurt the economy; they cut economic growth. Europe is engaged in a grand experiment with austerity, and we can see the results. The differences between the US and the Euro-zone are not that great. They cut their budgets, their economies decline, less tax revenue comes in the door, and their deficits as a percent of GDP actually go up making the problem worse. And the next thing you know, Italy elects a clown. I'm just saying.

The sequester is coming; it will hit Friday. The world will not end. The sky will not fall. Do not distress yourself with imaginings. And most important. Strive to be happy.

Tuesday, February 26, 2013

Tuesday, February 26, 2013 - Send in the Clowns

I will be speaking at the Wealth Protection Conference 2013, April 5 & 6 in Tempe. It's a great conference. Click here to find out more and make a reservation.

Send in the Clowns
by Sinclair Noe

DOW + 115 = 13900
SPX + 9 = 1496
NAS + 13 = 3129
10 YR YLD -.02 = 1,88%
OIL - .42 = 92.69
GOLD + 21.10 = 1615.70
SILV + .44 = 29.53

Twice a year the Fed Chairman visits Capitol Hill. He talks to senators and the next day he talks to the House of Representatives. Today, Bernanke told lawmakers that he had done a good job and he tried to take his bows. Bernanke said Fed policymakers are cognizant of potential risks from their extraordinary support for the economy, including the possibility that it might fuel unwanted inflation or stoke asset bubbles. But, he said the risks did not seem material at the moment, adding the central bank has all the tools it needs to retreat from its monetary support in a timely fashion.

Bernanke said: "To this point, we do not see the potential costs of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery and more rapid job creation."

When asked pointedly by Republican Senator Bob Corker about whether the Fed's easy monetary policy was contributing to competitive currency devaluations globally and laying the groundwork for inflation, Bernanke was unequivocal. He said: "My inflation record is the best of any Federal Reserve chairman in the post-war period. We are not engaged in a currency war."

 Elizabeth Warren, a Democrat, pressed Bernanke on what she said is an implicit subsidy that large banks receive in the form of lower borrowing costs from being perceived as too big to fail. Warren asked:"We've now understood this problem for nearly five years, so when are we gonna get rid of 'too big to fail?'"

Warren also asked whether big banks should repay taxpayers for the billions of dollars they save in borrowing costs because of the credit market's belief that they won't be allowed to fail, repeatedly citing a recent Bloomberg View study estimating that the biggest banks essentially get a government subsidy of $83 billion a year, nearly matching their annual profits.

Bernanke countered that Dodd-Frank financial reform rules had given regulators more power to wind down failing financial institutions, making the issue less of a concern. Bernanke said: "The subsidy is coming because of market expectations that the government would bail out these firms if they fail. Those expectations are incorrect. "

Bernanke warned the near-term spending cuts known as the sequester, which are set to take hold later this week, would threaten an already challenged economic expansion: "The Congress and the administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration, with policies that reduce the federal deficit more gradually in the near term but more substantially in the longer run."

Bernanke also addressed the labor market:"High unemployment has substantial costs, including not only the hardship faced by the unemployed and their families, but also the harm done to the vitality and productive potential of our economy as a whole."
Here is a link to video of Warren questioning Bernanke.
The main takeaway from the testimony is Bernanke downplayed the risks from the Fed’s economic stimulus campaign, describing it as necessary and effective and making clear it is likely to continue for some time. And then he told the lawmakers they need to do their part, saying: “Although monetary policy is working to promote a more robust recovery, it cannot carry the entire burden of ensuring a speedier return to economic health.”

Speaking of which: The economy is going to hell in a hand basket! The sky is falling, or airplanes will fall from the sky! The sequester is coming, the sequester is coming!

Yeah well. While President Obama warns of the dire economic impact from across-the-board budget cuts, the nation may face more serious fiscal debates in the months ahead on a potential government shutdown and renegotiation of the debt ceiling.

With just three days before the $85 billion in reductions for this year are scheduled to start, Obama and Republicans led by House Speaker John Boehner yesterday traded blame again for the impasse. The president and his Cabinet officers drew a landscape of lost jobs, long lines at airports, delays at ports and cutbacks at national parks.

There’s been no public sign of negotiations between Obama and congressional Republicans. As the administration continued laying out details of how programs used by many Americans would be curtailed, Republican governors joined their congressional delegations in accusing Obama of overplaying his hand. And it will probably take about a month before most people really start to notice the cuts. Obama said they were no less a threat to the world’s largest economy, which stalled in the fourth quarter. “The uncertainty is already having an effect,” Obama said. “Companies are preparing layoff notices. Families are preparing to cut back on expenses. The longer these cuts are in place, the bigger the impact will become.”

And for now, the markets are freaked out, traders and analysts still think there will be a compromise within the next 30 days or so.

Looming even larger than the March 1 start of the automatic spending cuts is a potential government shutdown if Democrats and Republicans can’t agree on a stopgap funding measure by March 27, the date that current government funding expires. Without a deal in Congress that Obama would sign, government spending would halt.

In the battle over the sequester, Boehner has maintained his pledge not to entertain any new tax revenues. President Barack Obama and Democrats have called for a resolution that consists of both spending cuts and increased revenue, such as closing corporate tax loopholes and implementing the Buffet rule to raise taxes on billionaires.

During a news conference, Boehner showed no signs of hedging. "The president says we have to have another tax increase in order to avoid the sequester,” he said. "Well, Mr. President, you got your tax increase. It’s time to cut spending here in Washington."

So, don't expect a sequester deal. Sen. Ron Johnson (R-Wis.) said House Speaker John Boehner (R-Ohio) would lose his speakership if he agrees to new tax revenues to avert the across-the-board spending cuts that are set to kick in on March 1.

Much of the motivation for deficit reduction, a goal shared by policy makers across the political spectrum, is the belief that deficits consume the nation’s seed corn. That is, deficits represent negative saving. Because saving is presumed to be the key determinant of long-term real economic growth, deficits deplete the supply of saving and thus reduce growth. There are many problems with this analysis. One is that it assumes that all government spending is consumption. In fact, much of it consists of investment. the federal government will invest $550 billion this year in physical capital (buildings, equipment), research and development and human capital (education). This includes grants to state and local governments for these purposes.

It is perfectly reasonable to finance long-lived capital projects with borrowing. Because the benefits will accrue over many years, it would be silly to treat things like highways as if they were consumed within a single year for budget purposes.

Unfortunately, the federal budget is silly in this respect. It treats investment spending the same way every other budgetary item is treated – as if it were consumption with no long-lasting benefits for the nation.

An unfortunate consequence of this budgetary convention is that reducing federal investment is viewed as beneficial if it reduces the deficit. Moreover, it is often easier to cut investment spending than consumption, just as homeowners suffering from an income loss may find that deferring maintenance or planned improvements is the easiest way to conserve cash.

Many economists say they believe that the best thing the federal government can do to raise the long-term economic growth rate is increase infrastructure spending. It would have the double benefit of mobilizing idle resources, especially unemployed workers, while low interest rates permit capital projects to be financed very cheaply. One main barrier to achieving this double benefit is the confusion between investment spending and consumption spending, which is distorted by the way the budget is presented and the way we calculate saving.

Meanwhile, Italy's politics have almost literally become a clown show. The front-runner, who had teamed with the former European Central bank technocrat, did not do well in yesterday's election. Go figure. Beppe Grillo, the clown comedian did well, his movement was the top vote getter, even though he didn't win, and even though or perhaps because he is not a politician, he is not particularly wise, he does not have a permanent tan, he does not own the entire telecommunications industry in Italy, he is no a shameless unrehabilitated whoremonger, and he is not a Goldman Sachs puppet, (which may be a bit redundant). The Italians failed to do the responsible thing and vote for austerity. Go figure.

Italy is doing what Greece was (quite understandably) too small, too afraid and too vulnerable to do which is to say, collectively, “up yours” to austerity, technocracy and cronyism. And yes, they probably won't get away with it. Italian party chiefs began jockeying to forge a coalition of rivals and head off a second vote as a political vacuum of at least a month loomed.

The Five Star protest movement of comedian Beppe Grillo looked likely to emerge as the biggest single party in the lower house. The scourge of bankers and corrupt elites, Mr Grillo has campaigned for a return to the lira and a restructuring of Italy’s $2 trillion public debt.

The conservative bloc of ex-premier Silvio Berlusconi looked poised to win the senate, coming back from the political grave with vows to rip up the EU’s austerity plans and push through tax cuts to pull Italy out of deep slump. The majority of Italians have clearly voted against the Brussels consensus. That is a damning indictment. But if they can't come up with a coalition, look for another technocrat to be installed to run things until they figure it out. 

Monday, February 25, 2013

Monday, February 25, 2013 - Playing With Fire

I will be speaking at the 2013 Wealth Protection Conference April 5 & 6. Click here for more information or call 800-494-4149

Playing With Fire
by Sinclair Noe

DOW – 216 = 13,784
SPX – 27 = 1487
NAS – 45 = 3116
10 YR YLD - .07 = 1.90%
OIL - .86 = 92.27
GOLD + 12.30 = 1594.80
SILV + .26 = 29.12

Let's make sure you're prepared for the week.

Late Friday, Moody's cut Britain's sovereign credit rating by one notch to Aa1 from Triple-A, with a stable outlook. Moody's cited the prospect of a further slow-down in the British economy, which would in turn undermine the government's deficit reduction plans. The official word from the Bank of England is that the downgrade will not affect deficit reduction targets, but there are calls for stimulus spending, specifically infrastructure spending, where a one pound investment results in 3 pounds of economic growth. Alternatively, the risk is that too great a focus on deficit reduction could further squeeze the economy and domestic corporate revenues.

This was a vote of no confidence in Britain's austerity policies which have only served to worsen the economic outlook. The pound sterling dropped to $1.51 earlier in the morning, a two-and-a-half year low. UK sovereign debt actually strengthened in late trading. The Triple-A rating may be lost but it has not resulted in a surge in UK borrowing costs, at least not yet. It's difficult to figure exactly how a lower credit rating effects a soverign nation which prints its own currency. The Brits, though, are playing with fire.

The revival of sovereign debt fears have largely been buried under several rounds of QE around the world. As for precious metals, the impact may be mixed: A stronger dollar is bearish, while the revival of sovereign debt risk is bullish for precious metals. And with the EU crisis back in the headlines, we have a brief repreive in the US Treasury bond tumble, with rates dropping for the first time in a long time. On the other end of the continent, the Italians are likewise, playing with fire.

One of the reasons for sterling pound's recovery is the twists and turns in the Italian election. The European economic crisis and the austerity policies that came in its wake have had a destructive effect on democracy in almost every member state. Politicians, some out of conviction and some simply in pursuit of advantage, have identified a constituency of anger and discontent ripe for exploitation.

The Italians are voting for a new Prime Minister and the candidates include an old Prime Minister. Silvio Berlusconi is trying to tap into the populist anger by promising to repeal a tax on primary homes introduced last year. We'll wait to see, but Berlusconi might have drummed up enough support to stop the front running coalition of Bersani and Monti and create a deadlock in Parliament. Again, we'll wait and see but any surprises here could re-ignite sovereign debt issues in Europe; so,don't be surprised if we see Italian bonds shoot into the stratosphere again.

Meanwhile, Fed Chairman Ben Bernanke goes to Washington to deliver his two-day testimony before Congress. Wall Street traders will be looking for clarifications of the Fed minutes. Most notably, whether the Fed will seek an exit from QE before the economy reaches the target numbers of 6.5% unemployment or 2.5% inflation. The rate-sensitive sectors, most notably housing and autos, are kicking into a higher gear.

Lawmakers criticized Bernanke during past outings; they questioned the effectiveness of his strategy and fretted about inflation, all the while trying to deflect criticisms of fiscal policy, or the lack thereof. The most recent Fed minutes seem to point to Bernanke talking about an improving economy. "Most participants" at the central bank's Jan. 29-30 meeting said the asset purchases have helped "stimulate economic activity, and many pointed, in particular, to the support that low longer-term interest rates had provided to housing or consumer-durable purchases.”

Of course the Federal Reserves Quantitative Easing Stimulus Plan doesn't have a broad reach through the economy, and limits were on display with a fourth quarter cut in defense spending, leading to a 0.1 percent contraction in GDP. Government outlays dropped 6.6 percent from October through December, subtracting 1.3 percentage points from growth. The Fed has an extra job to do because it has to offset some of this austerity.
The central bank might not be able to offset further reductions, as well as the impact of taxes that rose in January. The automatic budget cuts known as sequestration would reduce 2013 gross domestic product growth by 0.6 percentage point and pare about 700,000 jobs by the end of 2014. And the sequester hits on Friday, unless Congress can work out a deal before then; don't hold your breath.
The Murdoch Street Journal reports Congress has already given up on Friday's deadline and is now looking forward to the next deadline, which is March 27th, when Congress will need to pass a new federal budget or a continuing resolution or face the prospect of shutting down the government. Congressional leadership, if that's not too much of an oxymoron, has already started discussing a bill to fund government operations through September. The lack of action on the sequester is strange, to say the least. One line of thinking is that it won't be resolved until we see long lines at airports, or kids kicked out of Head Start, late arriving tax refunds, or some other ugly optic. The other line of thinking is that the bigger cuts will come to defense programs, so some of the economic impact will fall on overseas activities, which would blunt the domestic impact.
The effects of the sequester should not be underestimated, especially because it would hit at the same time as the Japanese and British and Euro-zone are looking at the negative effects of austerity programs and fiscal contraction. In the stock market, the S&P 500 has now gone 505 days without a 10% correction; that's only happened 6 times in the last 50 years. We're ripe for a bit of a pullback.
Still, it doesn't necessarily spell doom and gloom. The interest rate sensitive housing and auto sectors have improved; this could not occur without the zero interest rate policy of the Fed, and also because household finances are looking more solid than they have in years. Of course, one reason for the improving household financial situation is that many people defaulted on debt, which is the fastest course for most people to increase net worth. The point is that it works, and we're finally on the cusp of what almost looks like a normal recovery.
This hint of normalcy suggests the slow improvements in the labor market over the past few years can now provide a bigger boost to consumer spending, which will in turn create more jobs; the virtuous cycle. This is not to say the sequester doesn't matter; it does. It will slow growth, but the growth may now have enough momentum to where it won't be stopped in its tracks.
Even after the austerity shock recedes, nobody is expecting a boom. Credit is still hard to come by, especially for the millions of Americans who defaulted on their debts during the depression. Europe's debt crisis and higher gasoline prices also pose constant threats to recovery. Of course, we've heard the refrain before: recovery is just around the next corner, just a couple of quarters away. And that is where the recovery has remained; just out of reach; an ongoing promise of tomorrow; just out of reach.

Today also marked the first day of the BP trial, the federal civil trial against the operators of the doomed Deepwater Horizon oil rig. The trial is a high-dollar showdown pitting oil giant BP's cash wealth against the legacy of one of America's richest, yet most troubled wildlife habitats.
The April 20, 2010 spill that began with an explosion that killed 11 rig workers and ended three months later with over 200 million gallons of light crude spilled into the Gulf still resonates physically and psychologically in the five coastal states affected, even as BP has gone to massive lengths to clean up the mess while paying billions in damages to residents and communities along the sullied coastline. The trial which started today is about answering the still-critical question: Did BP exhibit "gross negligence" in its operation of the rig, causing the largest offshore oil spill in US history? If so, the company could be on the hook for up to $17 billion in damages, after having already paid out $24 billion.

The trial judge (there is no jury) will have to decide what percentage of responsibility each of the three major players - BP, the speculator; Transocean, the rig owner; and Halliburton, a key drilling consultant - will have to bear if found responsible. While BP has claimed responsibility, the ultimate legal liability is not cut-and-dried as the judge has made clear that the two other companies also may bear blame for what became a domino effect of missed signs and overlooked problems that finally led to the explosion. And that is really a big part of the case. Was the accident ultimately avoidable or did the companies carelessly and negligently cut corners as they hunted for profit. Gross negligence is a very high bar that BP believes cannot be met in this case. They will contend this was a tragic accident, resulting from multiple causes and involving multiple parties, but not gross negligence.

The trial could drag out for 3 months, or BP could seek a settlement. One reason for the states’ difficulty in shaping an offer has been their disagreement over how the money would be paid. Some states, like Florida, prefer to see the company pay more in economic damages because those would give the states greater flexibility in spending the payouts. Payments for pollution-related penalties typically must be used for environmental purposes.

There's a lot of talk about currency wars these days, but very little understanding about what that means for specific countries, economic growth, inflation, and your pocketbook. Let's fix that.
First of all, there has been no declaration of any currency war. And won't be. Currency wars lead to global crisis. Currency adjustments, however, are happening all the time. Here's an over-simplified explanation about how currency adjustments affect you.
If Japan exports cars to America and America exports grain to Japan, each has to pay the other. American grain exporters want to get paid in dollars, so they can spend those dollars in the US. The Japanese want to get paid in yen so they can pay their workers in yen, pay their taxes in yen, and spend their money in Japan.
American car importers can "buy" yen with their dollars to pay the Japanese for their cars, or the Japanese can accept dollars as payment and then use those dollars to buy yen themselves. Of course it works the other way around if you're a grain farmer selling to Japan.
But the value of yen to dollars, or dollars to yen, isn't constant. There is no set exchange rate. Exchange rates are set in open currency trading markets where currencies are bought and sold to the tune of several trillions of dollars a day, every day. One day a dollar might buy 100 yen and the next day it might buy only 98 yen, or it could buy 102 yen. Lots of factors determine exchange rates, but the biggest, by far, is interest rates.
Currency adjustments are all about the value of your "home" currency relative to other countries' currencies. Our home currency in America is the dollar, in Japan it's the yen, and so on.
Countries that export a lot of goods want their currency to be "cheap" relative to other countries, especially those countries who are buying the home countries' exported goods. If the value of American dollars to Japanese yen is strong, meaning a dollar can buy a lot of yen, when you buy a Japanese car, for example, it will take fewer dollars to pay for it.
Because Japan exports a lot of cars it wants its currency to be "cheaper" than other currencies so it doesn't take as many dollars, or euros, or pounds to buy a Japanese car, or any product exported from Japan.
Here's the problem. America is a huge exporter of goods and services, too. So is Germany, and of course so is China. All governments want to support their exporting industries. It's about manufacturing and jobs, and revenue and profits, and economic growth and standards of living. The easiest way to facilitate an export-driven economy is to keep the home currency "cheap" relative to other currencies.

If exporting countries, especially those that don't have big domestic demand bases, meaning less-developed and "emerging-markets" economies, are all trying to export their way to growth and they all want to have their currencies be "cheap" on a relative basis, that can't happen. Everyone's currency can't be cheap at the same time.
So, adjustments are made. Governments who want to stimulate growth through exports take measures to lower the value of their currencies. Japan's new Prime Minister, Shinzo Abe, in an unusual exception to the pacifist approach to currency skirmishes, recently fired a shot heard round the world. To lower the value of the yen, Abe is demanding domestic monetary easing, aggressive stimulus, and more dangerously, has openly been talking down the yen.
Sound familiar? That's because the US has been involved in its own stimulus program, which includes more American exports. Also, the Federal Reserve has kept interest rates low, as in very low. One of the ways the Fed has done this is by "printing" money. The Fed has the ability, beyond the reach of Congress or the President, to buy what it wants, which is most often US Treasury government bonds. It pays for what it buys by simply issuing "credits" as payment.
Those credits are turned into money as they are spent by the government whose bonds the Fed buys, or by banks who sell the Fed their underwater mortgage-backed securities. Thus, the banks supposedly have money to lend.
Because the Fed has kept interest rates so low in America, investors are parking their money in other countries where interest rates are higher. In order to put your money into a bank in another country that offers higher interest rates than banks offer in the US you have to first buy that country's currency. And that bids up that country's currency relative to the dollars that you are selling.
In addition to the dollar being weakened, by investors selling dollars to buy and invest in other countries currencies, the amount of money being printed by the Fed means that at some point in the future all that money in the system will cause prices to rise, and causing the dollar to fall further. And if the dollar is falling relative to the Japanese yen or the euro, other countries who want to grow their exports are going to eventually do what they have to in order to lower the value of their own currencies.
That's how we get into currency wars.
You'll know when it's starting to spread. Interest rates will start to rise; watch the yield on the U.S. 10-year treasury. There are no real safe havens in a currency war. Commodity prices will rise; you'll see it in your grocery bills. Eliminate your debt and accumulate cash, and when prices crash, be ready to buy.

Friday, February 22, 2013

Friday, February 22, 2013 - Taxes, Sequester, Inequality, Name That Stadium

Note: I will be speaking at the 2013 Wealth Protection Conference on April 5th and 6th. For information, click here

Taxes, Sequester, Inequality, Name That Stadium
by Sinclair Noe

DOW + 119 = 14,000
SPX + 13 = 1515
NAS + 30 = 3161
10 YR YLD - .01 = 1.97%
OIL + .52 = 93.36
GOLD + 4.50 = 1582.50
SILV + .08 = 28.86

The European Commission has released its forecast for this year for Euro-zone economic growth, or lack thereof. The economy is expected to shrink in back to back year for the first time, driving unemployment higher, and spending will likely be lower for governments, consumers, and companies. Gross domestic product in the 17-nation region will fall 0.3% this year, compared with a November prediction of 0.1% growth. Unemployment will climb to 12.2%, up from the previous estimate of 11.8%.  The commission’s weak outlook reflects government austerity measures and efforts by companies and consumers to reduce debt. Seven Euro-zone economies are expected to contract in 2013, including: Italy, Spain, Portugal, Greece, Cyprus, Slovenia, and the Netherlands. Germany is expected to show modest growth of 0.5%, revised down from earlier estimates.

One of the things the Europeans are considering is a tax on financial trading; it will likely go into effect as soon as next year. The traders claim a tax would hurt economic growth and raise the cost of capital for companies, and they claim it would drive trading to other countries, leaving the country that adopted it with less revenue and fewer jobs. But those arguments have not proved persuasive in Europe, which thinks it has found a way to keep institutions from avoiding the tax.

The tax would be tiny for investors who buy and hold, but could prove to be significant for traders who place millions of orders a day. Under the proposal,  a trade of shares worth 10,000 euros would face a tax of one-tenth of 1 percent, or 10 euros. A trade of a derivative would face a tax of one-hundredth of 1 percent. But that tax would be applied to the notional value, which can be very large relative to the cost of the derivative. So a credit-default swap on 1 million euros of debt would have a tax of 100 euros, or about 0.4 percent of the annual premium on such a swap.

The tax would be far smaller than the fixed commissions that American investors once took for granted, and even less than the costs implicit in the fact that until decimalization arrived in 2001, that most stocks could move only in increments of one-eighth of a dollar, or 12.5 cents.

So, the tax isn't likely to destroy markets, however it will probably slow down high frequency traders and some hedge fund trading. In those circumstances, traders typically trade with highly leveraged funds on very narrow margins; it's a great strategy when it works; it's a huge disaster when it doesn't work.

But, what's to prevent investors from just trading in other jurisdictions? The tax would be owed no matter where the trade took place, as long as a European security or European institution was involved. The law has been written so broadly that if a French bank bought shares in an American company on the New York Stock Exchange, the tax would be owed. The Europeans call it a Triple A approach: all markets, all actors and all products.

To get out of the tax, a financial institution would have to do more than simply move its headquarters out of the 11 countries that now plan to impose the tax. It would also have to forgo serving clients in any of those countries and trading in securities or derivatives from any of the countries. Officials are confident that no major institution will be willing to forsake such large markets as France, Germany, Italy and Spain.

The scope of the tax is very broad. The proposal has exceptions for currency trading and the physical trading of commodities, but not for derivatives like currency or commodity futures contracts. When a company sold newly issued securities to investors, that transaction would not be taxed, but subsequent market trades would be. Over-the-counter trades would be subject to tax just as would transactions on a stock exchange, as long as a financial institution was involved. You could sell your shares in Daimler to a friend without paying tax, but not if you got a broker involved.

Europe thinks it can bring in 31 billion euros, about $41 billion at current exchange rates, from the tax. The United States presumably could collect more if it adopted a similar tax. A secondary benefit of the tax is something the Euro-Commission describes as “creating appropriate disincentives for transactions that do not enhance the efficiency of financial markets”; in other words, it will be tougher on gamblers and reckless speculation. Will it work? We'll find out.

Italians will cast ballots on Sunday and Monday for a new government. The likely winner is the center-left candidate, Pier Luigi Bersani, but there is a very good chance he won't get enough votes to actually form a government. Bersani may be forced into a coalition governmment involving Mario Monti, the technocrat who served as temporary PM following Berlusconi's resignation. The other candidates include former Prime Minister Silvio Berlusconi, (who just won't go away) representing the right, and a comedian named Beppe Grillo, representing left field.

I mention the Italian elections, not because I have great insight into Italian politics, nor do I think it represents a make or break moment for the European Union, although it certainly has the potential to reignite the euor-zone crisis and affect the world economy. Rather I bring it to your attention in the hope that, by way of comparison, the Washington political situation isn't a complete mess....


It's a mess, and that mess will be on full display next week as we head to the finish line for sequestration. The quick recap is  that there was a budget stalemate in the summer of 2011. A “super committee” of Democrats and Republicans were unable to agree to a large-scale deficit reduction package and as a result both parties signed off on the Budget Control Act, which slashed domestic and military spending by $1 trillion over the next decade. The deal between the two parties was designed to force them to come to the negotiating table again to avoid these draconian measures but both sides have been shockingly partisan and uncompromising. It appears unlikely there will be consensus by next Friday.

If the sequester takes effect as planned, employee furloughs in the Defense Department as well as air traffic controllers, meat inspectors and other government workers could begin in April. It is not a doomsday scenario but it is going to be tough because there are other factors at play.  If the sequester takes effect as planned, employee furloughs in the Defense Department as well as air traffic controllers, meat inspectors and other government workers could begin in April.  The Payroll Tax Holiday ended with the fiscal cliff deal; and that means 2% less from paychecks. Toss in a one month 47 cent per gallon jump in gas prices. Don't forget that stock prices have bumped their hats on resistance. And the Federal Reserve's printing press is already running full  speed. You don't have to turn bearish, but this is not the time for complacency.

One of the most frightening things this past week was the FOMC minutes, wherein at least a few Federal Reserve policymakers actually started believing their own PR, and started to subscribe to the notion that the markets reflect fundamentals, and they actually believe that the strength of the markets reflects an improving economy. And an improving economy doesn't need the Federal Reserve's printing press running at full speed, so some of them want to shut down the printing press, which is the lifeblood of the markets.

During the debate over the sequester, Democrats and the Obama administration have repeatedly called for closing loopholes in the tax code that disproportionally benefit the wealthy in lieu of drastic cuts to each and every sector of government. Republicans have continued to back spending cuts, and have indicated that they are generally opposed to tax increases, except maybe, very specific tax increases, but nothing big.  The backdrop for this debate is income inequality. There is a way to measure income inequality; it's the Gini ratio, which measures the gap between the rich and the poor. The US ranks 41st out of 136 countries for inequality and we have the 4th highest inequality levels of 34 so-called developed nations. Income inequality is a problem. The question is, why?

Republicans have argued big government, taxation and regulations are restricting small business owners from moving up to a higher income bracket. They have proposed cutting the size of government to enable small business owners to flourish. 

Democrats have argued that the income disparity comes from low wages and privileges granted to the wealthy in the form of low capital gains taxes on investment incomes and on other tax loopholes.  They have proposed increasing the minimum wage and raising the capital gains rate.

Thomas Hungerford of the non-partisan Congressional Research Service has published a report that says income inequality is largely derived from changes in the way the government taxes income from capital gains and dividends.

This study found that the wealthy benefited from low tax rates on investment income, which in turn caused their wealth to grow faster. Wages, interest, and taxes have contributed to a lowering of income inequality. Business income and retirement income have contributed to an increase in income inequality. Capital gains and dividends have contributed more to the rise of income inequality than everything else put together.

Essentially, taxing capital gains as ordinary income would make the playing field more fair, and reduce over time income inequality. Such a tax would serve as a deficit reduction measure that could replace portions of the sequester. Of course the next question is whether a higher capital gains tax would hurt the economy and growth prospects. There is very little evidence to suggest higher capital gains rates have any effect on economic growth. There simply is no empirical evidence that investment levels increase when capital gains rates are reduced, nor is there indication that investment levels decrease when capital gains are increased.

And I want to mention a story that actually appeared earlier in the week.  I don't know why I waited; maybe I was incredulous; maybe I was concerned it was one of those Chuck Hagel speaking gigs with Friends of Hamas – type stories. But this one is real. It involves the naming rights to the football stadium for Florida Atlantic University, which I had never heard of. For $6 million, the stadium will henceforth be known as the GEO Group Stadium. GEO Group is a private prison corporation.  The FAU team mascot is an owl, and already, the students have nicknamed the stadium “owlcatraz”.

 The United States penitentiary-industrial complex imprisons one-third to one-half of all incarcerated individuals in the world. Additionally, it has been reported that one of every three US individuals have some sort of interaction with the criminal justice system before they are 25. While there are some six million behind bars – often for penalties of 25 years or more – these figures do not include people on parole and others who are out of the formal system but still suffer the consequences of being behind bars.

I understand naming rights; it's a form of advertising. The KFC Yum! Center hopes to sell more Pepsi's and chicken. The University of Phoenix Stadium which is actually located in Glendale, hopes to draw attention to the online University which doesn't have an actual football team.  And don't forget Enron Field. 

GEO Group reported revenues in excess of $1.6 billion in 2011, income generated mostly from state and federal prisons and detention centers for illegal immigrants. The company owns or runs more than 100 properties that operate more than 73,000 beds. And they are not just a private prison corporation, they a a bad private prison. Specifically there have been accusations and GEO has lost lawsuits regarding unnecessary deaths of people in their custody, pervasive levels of staff sexual misconduct, cruelty and abuse of children held in custody, and really disgusting and filthy conditions that would make Carnival Cruise lines blush, and more.

So, why would GEO need to advertise its brand? Is this supposed to make us want to embrace for profit incarceration? The single purpose of a private prison corporation is to deliver the highest possible revenue stream at the lowest possible cost. Justice is not part of that equation. Rehabilitation and deterrence are not part of the profit equation.

I will now try to save you three hours on Sunday evening. It is not necessary to sit through the tediously boring Oscar show to find the winners. Nate Silver, the statistician who runs FiveThirtyEight, and who accurately predicted the November elections; like 100% accuracy; Silver has come out with the statistical probabilities of who will win Oscars. I should warn you that he is better at predicting elections than Oscar winners, but he has a 75% accuracy rate on the Oscars. The methodology involves looking at the other awards programs, such as the Screen Actors Guild, the Golden Globe, and then weighting to awards that have frequently corresponded with the Oscar winners in the past, and which are voted on by people who will also vote for the Oscars.

Best Actor to Daniel Day-Lewis for Lincoln. Best Actress for Jennifer Lawrence in Silver Linings Playboook. Tommy Lee Jones for Best Supporting Actor in Lincoln. Best Supporting Actress goes to Anne Hathaway for Les Miserables. The Best Director goes to Spielberg for Lincoln. The Best Picture goes to Argo.